**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

**FORM 10-Q**

**(Mark One)**

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

**Forthe quarterly period ended June 30, 2007**

**OR**

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

**Forthe transition periodfrom               to**

**CommissionFile Number 0-22871**

**OMTOOL, LTD.**

(Exact Name of Registrantas Specified in Its Charter)
| **Delaware**                                                     | ** ** | **02-0447481**                           |
|------------------------------------------------------------------|------------|------------------------------------------|
| (State or Other  Jurisdiction of  Incorporation or Organization) |       | (I.R.S. Employer  Identification Number) |
|                                                             |       |                                     |
| **6  Riverside Drive, Andover, MA**                              | ** ** | **01810**                                |
| (Address of  Principal Executive Offices)                        |       | (Zip Code)                               |

 

**(978) 327-5700**

(Registrant’s TelephoneNumber Including Area Code)

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes x   No o

Indicate by check mark whether the Registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of accelerated filer and largeaccelerated filer in Rule 12b-2 of the Exchange Act.

| Large accelerated filer   o |   | Accelerated  filer o |   | Non-accelerated  filer x |
|----------------------------------|--------|---------------------------|--------|-------------------------------|

 

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

Yes o   No x

Therewere 4,563,235 shares of the Company’s common stock, par value $0.01,outstanding on July 31, 2007.

 

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**OMTOOL, LTD. AND SUBSIDIARIES**

FORM 10-Q

For the Quarter EndedJune 30, 2007

CONTENTS

**Item Number**
| PART  I: FINANCIAL INFORMATION |   |                                                                                                                |
|--------------------------------|--------|---------------------------------------------------------------------------------------------------------------------|
|                           |   |                                                                                                                |   |   |
| Item 1.                        |   | Consolidated Financial Statements                                                                                   |   |   |
|                           |   | Consolidated  Balance Sheets as of June 30, 2007 (Unaudited) and December 31, 2006                                  |   |   |
|                           |   | Consolidated Statements of Operations for the three  months and six months ended June 30, 2007 and 2006 (Unaudited) |   |   |
|                           |   | Consolidated Statements of Cash Flows for the six  months ended June 30, 2007 and 2006 (Unaudited)                  |   |   |
|                           |   | Notes to Consolidated Financial Statements                                                                          |   |   |
|                           |   |                                                                                                                |   |   |
| Item 2.                        |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                         |   |   |
|                           |   |                                                                                                                |   |   |
| Item 3.                        |   | Quantitative and Qualitative Disclosures About Market  Risk                                                         |   |   |
|                           |   |                                                                                                                |   |   |
| Item 4.                        |   | Controls and Procedures                                                                                             |   |   |
|                           |   |                                                                                                                |   |   |
| PART  II: OTHER INFORMATION    |   |                                                                                                                |
|                           |   |                                                                                                                |   |   |
| Item  1.                       |   | Legal  Proceedings                                                                                                  |   |   |
|                           |   |                                                                                                                |   |   |
| Item 1A.                       |   | Risk Factors                                                                                                        |   |   |
|                           |   |                                                                                                                |   |   |
| Item 4.                        |   | Submission of Matters to a Vote of Security Holders                                                                 |   |   |
|                           |   |                                                                                                                |   |   |
| Item  5.                       |   | Other  Information                                                                                                  |   |   |
|                           |   |                                                                                                                |   |   |
| Item 6.                        |   | Exhibits                                                                                                            |   |   |
|                           |   |                                                                                                                |   |   |
| Signatures                     |   |                                                                                                                |
|                           |   |                                                                                                                |   |   |
| Exhibit Index                  |   |                                                                                                                |
|                           |   |                                                                                                                |   |   |
| Exhibits                       |   |                                                                                                                |

 

2

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**PARTI:  FINANCIAL INFORMATION**

**Item1.  Consolidated Financial Statements**

**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Balance Sheets**
| ** **                                                                                                                                                                                                                            | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                            | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                            | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                                                                       |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                            |       | $                       | 2,605,228  |                        | $          | 5,469,366 |   |
| Accounts receivable,  net of reserves of $29,000 at June 30, 2007 and $14,000 at December 31, 2006,  respectively                                                                                                                     |       | 1,921,563               |       | 2,100,266                   |       |
| Unbilled accounts  receivable                                                                                                                                                                                                         |       | 464,120                 |       | 677,624                     |       |
| Inventory                                                                                                                                                                                                                             |       | 44,956                  |       | 111,389                     |       |
| Prepaid expenses and other  current assets                                                                                                                                                                                            |       | 370,824                 |       | 491,483                     |       |
| Total current assets                                                                                                                                                                                                                  |       | 5,406,691               |       | 8,850,128                   |       |
| Property and equipment,  net                                                                                                                                                                                                          |       | 1,417,945               |       | 1,525,028                   |       |
| Goodwill                                                                                                                                                                                                                              |       | 1,883,096               |       | 1,776,051                   |       |
| Intangible assets, net                                                                                                                                                                                                                |       | 1,530,828               |       | 1,785,000                   |       |
| Unbilled accounts  receivable, long-term                                                                                                                                                                                              |       | 341,176                 |       | 424,469                     |       |
| Other assets                                                                                                                                                                                                                          |       | 55,168                  |       | 66,730                      |       |
| Total assets                                                                                                                                                                                                                          |       | $                       | 10,634,904 |                        | $          | 14,427,406 |   |
|                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                                        | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                                                                                  |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                                                                                      |       | $                       | 1,040,222  |                        | $          | 2,069,727 |   |
| Accrued liabilities                                                                                                                                                                                                                   |       | 1,583,127               |       | 1,521,644                   |       |
| Deferred revenue,  current                                                                                                                                                                                                            |       | 4,427,427               |       | 4,026,773                   |       |
| Capital lease  obligations                                                                                                                                                                                                            |       | 399,338                 |       | 442,438                     |       |
| Amount due to seller                                                                                                                                                                                                                  |       | —                  |       | 562,090                     |       |
| Note payable, current                                                                                                                                                                                                                 |       | 561,234                 |       | 467,695                     |       |
| Total current  liabilities                                                                                                                                                                                                            |       | 8,011,348               |       | 9,090,367                   |       |
| Long term liabilities:                                                                                                                                                                                                                |       |                    |       |                        |       |
| Deferred rent                                                                                                                                                                                                                         |       | 467,220                 |       | 498,348                     |       |
| Deferred revenue,  long-term                                                                                                                                                                                                          |       | 539,614                 |       | 436,086                     |       |
| Note payable, long-term                                                                                                                                                                                                               |       | 982,160                 |       | 1,216,007                   |       |
| Total liabilities                                                                                                                                                                                                                     |       | 10,000,342              |       | 11,240,808                  |       |
|                                                                                                                                                                                                                                  |       |                    |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                                                            |       |                    |       |                        |       |
| Preferred Stock, $0.01  par value —                                                                                                                                                                                              |       |                    |       |                        |       |
| Authorized — 2,000,000  shares; Issued and outstanding — none                                                                                                                                                               |       | —                  |       | —                      |       |
| Common stock, $0.01 par  value —                                                                                                                                                                                                 |       |                    |       |                        |       |
| Authorized — 35,000,000  shares; Issued — 4,743,209 shares at June 30, 2007 and  December 31, 2006; Outstanding — 4,544,902 shares at June 30, 2007  and 4,432,101 shares at December 31, 2006, respectively |       | 47,432                  |       | 47,432                      |       |
| Additional paid-in  capital                                                                                                                                                                                                           |       | 36,678,041              |       | 36,668,927                  |       |
| Accumulated deficit                                                                                                                                                                                                                   |       | (34,374,734             | )          | (31,608,373                 | )          |
| Treasury stock, at  cost, 198,307 shares at June 30, 2007 and 311,108 shares at December 31, 2006                                                                                                                                     |       | (1,641,001              | )          | (1,858,435                  | )          |
| Accumulated other  comprehensive loss                                                                                                                                                                                                 |       | (75,176                 | )          | (62,953                     | )          |
| Total stockholders’  equity                                                                                                                                                                                                      |       | 634,562                 |       | 3,186,598                   |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                       |       | $                       | 10,634,904 |                        | $          | 14,427,406 |   |

 

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

3

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements of Operations**

(Unaudited)
| ** **                                               | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                               | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenue:                                                 |       |                                            |       |                                          |       |   |   |   |   |
| Software license                                         |       | $                                               | 1,281,462  |                                          | $          | 925,896 |   | $ | 2,328,775 |   | $ | 1,957,715 |   |
| Hardware and  media                                      |       | 593,685                                         |       | 406,667                                       |       | 1,055,691 |   | 964,067 |   |
| Service and  other                                       |       | 2,399,955                                       |       | 1,735,993                                     |       | 4,723,750 |   | 3,483,278 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Total revenue                                            |       | 4,275,102                                       |       | 3,068,556                                     |       | 8,108,216 |   | 6,405,060 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Cost of revenue:                                         |       |                                            |       |                                          |       |   |   |   |   |
| Software license                                         |       | 107,270                                         |       | 52,000                                        |       | 208,545 |   | 83,441 |   |
| Hardware and  media                                      |       | 400,008                                         |       | 269,604                                       |       | 694,138 |   | 614,682 |   |
| Service and  other                                       |       | 943,904                                         |       | 881,684                                       |       | 2,012,279 |   | 1,594,783 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Total cost of  revenue                                   |       | 1,451,182                                       |       | 1,203,288                                     |       | 2,914,962 |   | 2,292,906 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Gross profit                                             |       | 2,823,920                                       |       | 1,865,268                                     |       | 5,193,254 |   | 4,112,154 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Operating  expenses:                                     |       |                                            |       |                                          |       |   |   |   |   |
| Sales and  marketing                                     |       | 1,870,215                                       |       | 2,158,993                                     |       | 4,066,944 |   | 4,211,200 |   |
| Research and  development                                |       | 729,681                                         |       | 724,302                                       |       | 1,609,762 |   | 1,431,554 |   |
| General and  administrative                              |       | 854,999                                         |       | 818,486                                       |       | 1,851,944 |   | 1,718,428 |   |
| Restructuring  costs                                     |       | 130,648                                         |       | —                                        |       | 343,450 |   | — |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Total operating  expenses                                |       | 3,585,543                                       |       | 3,701,781                                     |       | 7,872,100 |   | 7,361,182 |   |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Loss from  operations                                    |       | (761,623                                        | )          | (1,836,513                                    | )          | (2,678,846 | ) | (3,249,028 | ) |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Interest and  other income                               |       | 27,544                                          |       | 44,058                                        |       | 48,032 |   | 88,631 |   |
| Interest expense                                         |       | (44,498                                         | )          | (5,042                                        | )          | (95,535 | ) | (5,102 | ) |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Net loss                                                 |       | $                                               | (778,577   | )                                             | $          | (1,797,497 | ) | $ | (2,726,349 | ) | $ | (3,165,499 | ) |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Net loss per  share:                                     |       |                                            |       |                                          |       |   |   |   |   |
| Basic and  diluted                                       |       | $                                               | (0.17      | )                                             | $          | (0.45 | ) | $ | (0.60 | ) | $ | (0.79 | ) |
|                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Weighted average  shares used in per share calculations: |       |                                            |       |                                          |       |   |   |   |   |
| Basic and diluted                                        |       | 4,543,300                                       |       | 4,031,512                                     |       | 4,512,000 |   | 4,026,073 |   |

 

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

4

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements of Cash Flows**

(Unaudited)
| ** **                                                                   | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| Cash Flows from  Operating Activities:                                       |       |                                          |       |   |   |
| Net loss                                                                     |       | $                                             | (2,726,349 | ) | $ | (3,165,499 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                          |       |   |   |
| Depreciation and  amortization                                               |       | 385,768                                       |       | 88,248 |   |
| Accounts  receivable reserves                                                |       | 14,892                                        |       | (641 | ) |
| Stock-based  compensation                                                    |       | 170,530                                       |       | 166,854 |   |
| Changes in  assets and liabilities:                                          |       |                                          |       |   |   |
| Accounts  receivable                                                         |       | 185,350                                       |       | (302,883 | ) |
| Unbilled  accounts receivable                                                |       | 296,797                                       |       | — |   |
| Prepaid expenses  and other current assets                                   |       | 122,398                                       |       | (115,606 | ) |
| Inventory                                                                    |       | 66,433                                        |       | (88,767 | ) |
| Other assets                                                                 |       | 11,562                                        |       | (41,568 | ) |
| Accounts payable                                                             |       | (1,034,061                                    | )          | 356,361 |   |
| Accrued  liabilities                                                         |       | 56,380                                        |       | 11,293 |   |
| Deferred revenue                                                             |       | 495,863                                       |       | 172,817 |   |
| Deferred rent                                                                |       | (31,128                                       | )          | 309,950 |   |
|                                                                         |       |                                          |       |   |   |
| Net cash used in  operating activities                                       |       | (1,985,565                                    | )          | (2,609,441 | ) |
|                                                                         |       |                                          |       |   |   |
| Cash Flows from  Investing Activities:                                       |       |                                          |       |   |   |
| Additional  purchase consideration for prior period acquisition              |       | (107,045                                      | )          | — |   |
| Purchases of  property and equipment                                         |       | (23,835                                       | )          | (920,861 | ) |
|                                                                         |       |                                          |       |   |   |
| Net cash used in  investing activities                                       |       | (130,880                                      | )          | (920,861 | ) |
|                                                                         |       |                                          |       |   |   |
| Cash Flows from  Financing Activities:                                       |       |                                          |       |   |   |
| Net proceeds  from issuance of common stock                                  |       | 14,950                                        |       | 11,937 |   |
| Net proceeds  from issuance of restricted common stock                       |       | 1,287                                         |       | 622 |   |
| Forfeiture of  restricted common stock                                       |       | (230                                          | )          | — |   |
| Purchase of  treasury stock                                                  |       | —                                        |       | (153,267 | ) |
| Payment for amount  due to seller                                            |       | (562,090                                      | )          | — |   |
| Principal  payments for note payable                                         |       | (140,309                                      | )          | — |   |
| Principal  payments for capital lease obligations                            |       | (43,100                                       | )          | (9,826 | ) |
|                                                                         |       |                                          |       |   |   |
| Net cash used in  financing activities                                       |       | (729,492                                      | )          | (150,534 | ) |
|                                                                         |       |                                          |       |   |   |
| Exchange rate  effect on cash and cash equivalents                           |       | (18,201                                       | )          | 35,013 |   |
|                                                                         |       |                                          |       |   |   |
| Net decrease in  cash and cash equivalents                                   |       | (2,864,138                                    | )          | (3,645,823 | ) |
|                                                                         |       |                                          |       |   |   |
|  Cash and  cash equivalents, beginning of period                        |       | 5,469,366                                     |       | 10,471,272 |   |
|                                                                         |       |                                          |       |   |   |
| Cash and cash  equivalents, end of period                                    |       | $                                             | 2,605,228  |   | $ | 6,825,449 |   |
| Supplemental  Disclosure of Cash Flow Information:                           |       |                                          |       |   |   |
| Cash paid during  the period for interest                                    |       | $                                             | 79,664     |   | $ | 5,103 |   |
| Property and equipment  purchased under capital lease                        |       | $                                             | —     |   | $ | 493,790 |   |

 

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

5

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

(Unaudited)

**(1) Basisof Presentation**

Omtool, Ltd. (“Omtool” or the “Company”)provides document and information handling solutions that control documentlifecycles and simplify the integration of paper and electronic documents inenterprise information systems. As a result of the Company’s acquisition ofBlueChip Technologies (“BlueChip”) in December 2006, the Company nowprovides electronic forms automation, document imaging and object archivingsolutions for the healthcare vertical market.

The accompanyingunaudited consolidated financial statements have been prepared by Omtoolpursuant to the rules and regulations of the Securities and Exchange Commission(“SEC”) regarding interim financial reporting. Accordingly, they do notinclude all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements and should be read inconjunction with the consolidated financial statements and notes thereto forthe year ended December 31, 2006 as filed with the SEC as part of the Company’sAnnual Report on Form 10-K on March 26, 2007. The accompanying unauditedconsolidated financial statements reflect all adjustments (consisting of normalrecurring adjustments) that are, in the opinion of management, necessary for afair presentation of results for the interim periods presented. The results ofoperations for the three and six month periods ended June 30, 2007 are notnecessarily indicative of the results to be expected for the full fiscal year.

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

The Companyreports net loss per share in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 128,**“*Earningsper Share*.” Diluted weighted average shares outstanding forthe three and six month periods ended June 30, 2007 and June 30, 2006 exclude432,660 and 357,288, respectively of potential common shares from stock optionsand 51,000 shares for a stock warrant because to include them would have beenanti-dilutive for the periods presented as the Company reported a net lossduring the periods.

**(3) IncomeTaxes**

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

As of January 1, 2007 theCompany adopted the provisions of Financial Accounting Standards Board (“FASB”)Interpretation No. 48, *“Accounting forUncertainty in Income Taxes, an Interpretation of FASB Statement No. 109”*(“FIN 48”). The adoption of FIN 48, did not have a material impact onthe Company’s financial position or results of operations for the three and sixmonths ended June 30, 2007.

During the three and sixmonth periods ended June 30, 2007 and June 30, 2006, the Company did not recordan income tax benefit associated with any pre-tax loss due to the uncertaintyregarding future taxable income.

**(4) ComprehensiveLoss**

The components of theCompany’s comprehensive loss are as follows:
| ** **                                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net loss                                  |       | $                                               | (778,577   | )                                             | $          | (1,797,497 | ) | $ | (2,726,349 | ) | $ | (3,165,499 | ) |
| Foreign currency  translation adjustments |       | (13,886                                         | )          | 3,256                                         |       | (15,549 | ) | 10,441 |   |
| Comprehensive loss                        |       | $                                               | (792,463   | )                                             | $          | (1,794,241 | ) | $ | (2,741,898 | ) | $ | (3,155,058 | ) |

 

6

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** **

**(5) Acquisition**

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

As of December 31, 2006, the $562,090 owed to theSeller of BlueChip was classified in the accompanying consolidated balancesheet as “Amount due to seller.” This amount was paid in January 2007.

The promissory note that the Company issued to theSeller of BlueChip is payable in thirty-six equal monthly installments ofapproximately $47,000. The Company made the first principal and interestpayment in April 2007 and has made total payments of $204,120, consisting ofprincipal and interest, during the six month period ended June 30, 2007.

Goodwill in the accompanying consolidated balancesheets as of June 30, 2007 and December 31, 2006, represents the excess of thepurchase price over the net tangible and identifiable intangible assets for theacquisition of BlueChip.

The changes in the carrying amount of goodwill were asfollows:

|                                                 | ** ** | **Six Months  Ended  June 30,  2007** | ** ** | **Twelve Months  Ended  December 31,  2006** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------------|------------|
| Beginning of the  period                        |       | $                                               | 1,776,051  |                                                   | $          | — |   |
| Acquisition of  BlueChip                        |       | —                                          |       | 1,776,051                                              |       |
| Additional  purchase consideration for BlueChip |       | 107,045                                         |       | —                                                 |       |
| End of the period                               |       | $                                               | 1,883,096  |                                                   | $          | 1,776,051 |   |

Additionalpurchase consideration for BlueChip for the six month period ending June 30,2007 represents direct acquisition costs consisting of legal and accountingservices.

Gross carrying amounts and accumulated amortizationfor each intangible asset class was as follows:

|                                       | ** ** | **June 30, 2007**     | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Balances** | ** ** |
| Purchased  technology                 |       | $                               | 774,000    |   | $ | 93,828 |   | $ | 680,172 |   |
| Customer  contracts and relationships |       | 850,000                         |       | 140,602 |   | 709,398 |   |
| Trade names                           |       | 110,000                         |       | 11,242 |   | 98,758 |   |
| Non-compete  agreements               |       | 51,000                          |       | 8,500 |   | 42,500 |   |
|                                  |       | $                               | 1,785,000  |   | $ | 254,172 |   | $ | 1,530,828 |   |

 

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

The amortizationperiod for identifiable intangible assets ranges from three to ten years.

7

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The estimatedfuture amortization expense of identifiable intangible assets for the sixmonths ended December 31, 2007 and each of the next five years, thereafter isas follows:

| Year ending December 31, | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------|------------|
| 2007                                    |       | $          | 254,172    |   |
| 2008                                    |       | 376,249    |       |
| 2009                                    |       | 307,265    |       |
| 2010                                    |       | 237,778    |       |
| 2011                                    |       | 196,694    |       |
| 2012                                    |       | 61,176     |       |
| Thereafter                              |       | 97,494     |       |
| Total                                   |       | $          | 1,530,828  |   |

 

**(6) Stock-basedCompensation**

The Company’s 1996Stock Option Plan and 1997 Stock Plan, as amended, provide for the issuance ofcommon stock pursuant to the grant to employees of “incentive stock options”within the meaning of the Internal Revenue Code and the grant of nonqualifiedstock options, stock awards or opportunities to make direct purchases of stockin the Company to employees, consultants, directors, and officers of theCompany. The 1997 Stock Plan expired onApril 14, 2007. The Company’s 2007 Equity Compensation Incentive Plan (the “2007Plan”) was approved by the board of directors at the annual meeting of theCompany’s shareholders on May 22, 2007. The 2007 Plan provides for the issuanceof shares of common stock to employees, consultants, directors and officers ofthe Company much like the 1997 Stock Plan. The aggregate number of shares thatcan be issued pursuant to the 2007 Plan is 500,000. As of June 30, 2007, noshares had been issued under the 2007 Plan. Shares issued pursuant tothese plans are issued from treasury to the extent they are available. Stock-basedcompensation is accounted for in accordance with SFAS No. 123(R), “*Share-Based Payment*”**(“SFAS 123R”).

The Company incurredstock-based compensation expense for restricted common stock, stock options,and the employee stock purchase plan as follows:
| ** **                                                                      | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                      | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Stock-based  compensation expense included in cost of service and other revenue |       | $                                               | 2,615      |                                          | $          | 3,220 |   | $ | 4,727 |   | $ | 7,044 |   |
| Stock-based  compensation expense included in operating expenses                |       | 88,630                                          |       | 86,369                                        |       | 165,803 |   | 159,810 |   |
| Total stock-based  compensation expense                                         |       | $                                               | 91,245     |                                          | $          | 89,589 |   | $ | 170,530 |   | $ | 166,854 |   |

 

***Stock Options***

Under the terms ofthe Company’s 1996 Stock Option Plan, 1997 Stock Plan and 2007 Plan, optionsvest and become exercisable as determined by the Board of Directors and expire10 years after the date of grant. In 1997, the Company’s Board ofDirectors voted that no further options would be granted under the Company’s1996 Stock Option Plan. The 1997 Stock Plan expired on April 14, 2007, and nofurther options will be granted under the 1997 Stock Plan. In accordance withthe and 2007 Plan, stock options granted under the 2007 Plan that are canceledor expired are added back to the potential options available for futureissuance. Stock option compensationexpense calculated under the fair value approach is recognized ratably over thefour year vesting period. The fair value for granted options was estimated atthe time of grant using the Black-Scholes option-pricing model. Based uponhistorical information and management’s estimate of future voluntary turnoverrates, the Company has calculated this expense based on an annualized estimated forfeiture rate of5%. The Company trues-up estimated forfeitures to actual forfeitures at the endof each reporting period. The Company did not grant any stock options duringthe six months ended June 30, 2007 or June 30, 2006.  During the six months ended June 30, 2007,5,196 shares of common stock were exercised.

***Employee Stock Purchase Plan***

The 1997 EmployeeStock Purchase Plan (“ESPP”) provides for the issuance of a maximum of57,142 shares of common stock pursuant to the exercise of nontransferableoptions granted to participating employees. The exercise price for the optionfor each six-month purchase period is 85% of the lesser of the market price ofthe common stock on the first or last business day of the six-month 

8

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purchase period. Employee stock purchase plancompensation expense calculated under the fair value approach is recognizedratably over the six-month purchase period. The weighted average fair value ofthe shares subject to purchase under the employee stock purchase plan was $1.32for the six months ended June 30, 2007, based upon the following assumptions:

|                          | ** ** | **Six Months  Ended  June 30, 2007** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|
| Risk-free  interest rate |       | 5.1                                                 | %          |
| Volatility               |       | 57.0                                                | %          |
| Expected  dividend yield |       | 0.0                                                 |       |
| Expected life            |       | 0.5 Years                                           |       |

 

We relied on historical information about the Company to determine theexpected volatility assumptions. The expected life is equal to the six-monthpurchase period.

In July 2007, the Company terminated the ESPP.

***Restricted Common Stock***

The Companypreviously sold shares of restricted common stock (“restricted stock”)under the Company’s 1997 Stock Plan, to certain directors and employees of theCompany at a price per share of $0.01. The 1997 Stock Plan expired on April 14,2007. The Company intends to continue to issue shares of restricted stock in asimilar manner under the 2007 Plan. The shares of restricted stock vest ratablyover a four year service period. In the event that a restricted stockholderceases to provide services to the Company prior to the vesting of any of thethen unvested shares held by that stockholder, the restricted stockholder isrequired to sell any unvested shares of restricted stock back to the Company atthe original purchase price of $0.01 per share. Restricted stock-basedcompensation expense calculated under the fair value approach is based upon thecurrent stock price and is recognized ratably over the four-year vestingperiod. Based upon historical information and management’s estimate of futurevoluntary turnover rates, the Company has calculated this expense based on anannualized estimated forfeiture rate of 10%. The Company trues-up estimatedforfeitures to actual forfeitures at the end of each reporting period. Duringthe six months ended June 30, 2007 and June 30, 2006, the Company sold 128,675and 62,196 shares of restricted stock, respectively, under the Company’s 1997Stock Plan, as amended, to its Board of Directors and certain employees of theCompany at a price per share of $0.01.

**(7) AccruedLiabilities**

Accrued liabilitiesconsist of the following:

|                                    | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Accrued health  insurance expense  |       | $                       | 291,881    |                        | $          | 258,083 |   |
| Accrued state  sales tax           |       | 304,980                 |       | 343,212                     |       |
| Accrued salary  and salary-related |       | 580,418                 |       | 538,224                     |       |
| Accrued professional  fees         |       | 170,125                 |       | 154,306                     |       |
| Accrued  restructuring costs       |       | 57,540                  |       | —                      |       |
| Other accrued  expenses            |       | 178,183                 |       | 227,819                     |       |
|                               |       | $                       | 1,583,127  |                        | $          | 1,521,644 |   |

 

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

On May 1, 2006,the Company entered into a capital lease agreement in the amount of $491,000 tofinance the purchase of furniture and equipment for the Company’s headquarterslocated in Andover, Massachusetts. The lease has a five year term which expireson May 31, 2011 and is payable in 60 equal monthly installments. The interestrate on the capital lease is 6.2%. Total interest payments over the life of thelease are estimated to be $99,000. The lease contains a provision whereby theCompany is required to repay the outstanding principal balance should theCompany’s cash balance ever be less than $5,000,000. In January 2007, theCompany’s cash balance fell below $5,000,000 and therefore as of June 30, 2007and December 31, 2006, the entire principal balance of $399,338 and $442,438,respectively, may be required to be paid in full and has been classified as acurrent liability in the accompanying consolidated balance sheets.

**(9) NotePayable**

On December 29,2006, the Company issued a promissory note in the amount of $1,683,702 to theprincipal shareholder of BlueChip in partial consideration of all theoutstanding shares of BlueChip (See Note 5). The note is payable in thirty-sixequal 

9

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monthly principal installments of approximately$47,000 plus interest, commencing on March 30, 2007. The promissory note bearsinterest on the unpaid principal amount at a rate per annum equal to (a) thePrime Rate as set forth in the Wall Street Journal Money Rates column on thelast business day of each month, which rate shall be deemed to be in effect forthe entirety of such month; plus (b) one percent. During the six month periodended June 30, 2007, the Company made total payments of approximately $204,000,consisting of principal payments totaling $140,000 and accumulated interest of$64,000.

**(10) RestructuringCosts**

Since March 2007,the Company has reduced its headcount by thirty-one positions consisting of twelvepositions that were eliminated in a March 2007restructuring of certainoperations, four positions that were eliminated in a restructuring that theCompany initiated in May 2007 and an additional fifteen positions that wereeliminated due to non-replaced employee attrition.

As a result ofthese cost reduction activities, the Company recorded a pre-tax charge duringthe three and six month periods ended June 30, 2007 of $130,648 and $343,450,respectively. The total restructuring charge for the first half of fiscal 2007included $308,278 of severance-related costs and $35,172 of costs relating tothe closing of BlueChip’s former headquarters. The total cash impact of therestructuring was $343,450; of which $285,910 was paid during the six monthsended June 30, 2007 and the remaining balance of $57,540 is expected to be paidduring the third quarter of fiscal year 2007 and has been included in accruedliabilities in our consolidated balance sheet as of June 30, 2007.

**(11) Segmentand Geographic Information**

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

Total revenue frominternational sources was approximately $734,000 and $1,789,000 for the threemonths and six months ended June 30, 2007 and $512,000 and $950,000 for thethree and six months ended June 30, 2006, respectively.

The following tablerepresents amounts relating to geographic locations: 
| ** **       | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **       | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Total revenue(1) | ** ** | ** **                                      | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States    |       | $                                               | 3,589,516  |                                          | $          | 2,556,467 |   | $ | 6,367,803 |   | $ | 5,455,134 |   |
| United Kingdom   |       | 132,225                                         |       | 164,692                                       |       | 717,548 |   | 336,306 |   |
| Canada           |       | 248,258                                         |       | 177,715                                       |       | 390,258 |   | 352,983 |   |
| South Africa     |       | 134,175                                         |       | 50,884                                        |       | 346,928 |   | 81,537 |   |
| Rest of World    |       | 170,928                                         |       | 118,798                                       |       | 285,679 |   | 179,100 |   |
|             |       | $                                               | 4,275,102  |                                          | $          | 3,068,556 |   | $ | 8,108,216 |   | $ | 6,405,060 |   |

 

|                       | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-----------------------|------------|-------------------------|------------|-----------------------------|------------|
| Long-lived  assets(2) |       |                    |       |                        |       |
| United States         |       | $                       | 5,203,478  |                        | $          | 5,549,313 |   |
| United Kingdom        |       | 24,735                  |       | 27,965                      |       |
|                  |       | $                       | 5,228,213  |                        | $          | 5,577,278 |   |

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

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

**(12) LegalProceedings.**

On or aboutSeptember 15, 2006, J. Patrick Mansfield, a former employee of BlueChip,predecessor-in-interest to Omtool Healthcare, LLC, a wholly-owned subsidiary ofthe Company, filed a complaint against BlueChip and William J. Rynkowski, Jr.,BlueChip’s then-current chief executive officer and a current employee anddirector of the Company (together with BlueChip, the “Defendants”), withthe Massachusetts Superior Court for Essex County (Civil Action No. 6-1756),asserting among other things breach of contract, violations of theMassachusetts Weekly Payment of Wages Act, breach of fiduciary duty,intentional misrepresentation, and breach of covenant of good faith and fairdealing for the alleged failure of Defendants to pay wages allegedly owed toMr. Mansfield, the alleged failure of Defendants to acknowledge Mr. Mansfield’salleged ownership interest in BlueChip, and the alleged improper termination ofMr. Mansfield’s employment. On or about June 7, 2007, Mr. Mansfield and theDefendants entered into a full settlement and release of claims that imposed nofinancial obligation on the Company.

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**Item2.**

**MANAGEMENT’S DISCUSSION AND ANALYSIS**

**OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations forthe three and six months ended June 30, 2007 should be read in conjunction withthe accompanying consolidated financial statements for the periods specifiedand the associated notes. Further reference should be made to our Annual Reporton Form 10-K for the year ended December 31, 2006, as filed with the SEC onMarch 26, 2007.

**Overview**

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

*Business*

In March 2007, weannounced a restructuring of certain of our operations and reduced ourworkforce by twelve positions. In May 2007, we reduced our workforce by anadditional four positions. Since March 2007, employee attrition and theelimination of additional positions has resulted in a reduction of fifteenpositions which when combined with the actions taken pursuant to our Marchrestructuring plan and other operating expense reductions, has resulted in atotal decrease of thirty-one positions and, we believe, an annual savings ofapproximately $4.0 million from first quarter 2007 expense levels. Our threegoals in undertaking these cost reduction measures and restructuring ouroperations are: one, to achieve financial results that will enable us to be ator near cash flow break even by the end of fiscal year 2007; two, to enable oursales force to focus on selling our products to customers in the legal andhealthcare vertical markets directly and also in partnership with indirectsales channels, while allowing our partners to focus on selling our products tocustomers in the financial services and other vertical markets; and three, tosupport our integration of the BlueChip business.

On August 2, 2007,our common stock was delisted from The Nasdaq Capital Market (“Nasdaq”)for our failure to comply with Nadaq’s continued listing requirements. Immediatelythereafter, our common stock was quoted on the Pink Sheets, an electronicquotation service for securities traded over-the-counter. Our common stock may,in the future, also be quoted on the Over-the-Counter Bulletin Board, which ismaintained by the National Association of Securities Dealers (the “NASD”),provided that a market maker in our common stock files the appropriateapplication with, and such application is cleared by, the NASD. We anticipatedisclosing further trading venue information for our common stock once suchinformation becomes available. The trading of our stock on the Pink Sheetsmakes ourstock significantly less liquid and may affect its value and couldsignificantly impair our ability to raise capital in the future should wechoose to do so.

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

We have remainingchallenges to address as we seek to expand our business including: increasingour software license revenue from AccuRoute® sales to help offset declines inour legacy fax business (including the hardware revenue associated with suchsales); expanding our sales in targeted vertical markets, such as legal,healthcare and financial services; promoting our products and technologiesthrough reseller and marketing relationships with leading multi-function deviceproviders; and improving our results outside of the Americas. As indicated byour recent operating results, we have invested in direct and indirect salesefforts, as well as marketing efforts, ahead of revenue attributed to theseexpenses.

In light of our currentand historical operating results and the continuing challenges we face, and inorder to maximize shareholder value, we are in an ongoing process ofexamining our operations as well as our strategic and financialalternatives. The strategic and financial options we may consider could includea variety of different business arrangements including, but not limited to:combinations with or a sale to another entity; equity or debt financings;strategic partnerships and joint ventures; the sale or spin off of certainassets; the acquisition of complementary businesses, technologies or productlines; investments in new businesses; reorganization, recapitalization, ordistribution alternatives; or other alternatives. We have engaged theinvestment banking firm of America’s Growth Capital to assist us with theexploration of strategic and financial alternatives. Changes, if any,implemented as a result of the strategic and financial alternatives reviewcould affect the basic nature of our Company.

*Products*

AccuRoute, our flagshipproduct, provides faster, more efficient document workflows, while reducingcost, complexity, and risk of losing documents. We also include full enterprisefax capabilities integrated within our AccuRoute product. These solutions areused worldwide by businesses in document-intensive industries and sectors suchas legal, financial services, government, and 

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healthcare that demand secure handling, integration,and tracking of documents in full compliance with a range of regulatoryrequirements.

Companies can deploy oursoftware products on heterogeneous, multi-platform networks, digital scanningdevices, and multi-function peripherals and integrate them with both desktopand enterprise software applications. To address customer needs, our productsare modular and scaleable. As a result, customers can add additionalcommunication capacity through the addition of system components and connectorsto keep pace with growing demands. In addition, due to this scalable, modulardesign, customers can add additional Omtool product servers to a configurationto provide failover redundancy, helping to ensure continuous operation.

OurGenifax product is a multi-tiered client/server solution for automatingand integrating fax communication throughout an enterprise. As a component ofan enterprise software system, our Genifax product is deployed onheterogeneous, multi-platform networks and integrates with desktop andenterprise software applications.

Our Genidocs product is a client/server messagingapplication that enables users to deliver documents — with comprehensivesecurity and tracking — through the Internet to external parties. Genidocsoffers the security features and functionality of traditional, paper-basedcommunications with the speed, efficiency, and cost advantages of electroniccommunications.

Fax Sr., our legacy network fax product, is aclient/server software solution for automating and integrating faxcommunication throughout an enterprise. As an integrated component of anenterprise software system, our Fax Sr. product is deployed on heterogeneous,multi-platform networks and integrates with desktop and enterprisesoftware applications.

We continue to maintain Genidocs and Fax Sr. and earnrecurring maintenance revenue from our installed base. At this time, however,we do not have plans to extend these technologies with new features or newreleases.

We resell certain hardware products (such asintelligent fax boards) and media products (such as admission labels andpatient wristbands), which we purchase from third-party vendors as aconvenience to our customers, who alternatively can opt to obtain hardware andmedia directly from third-party vendors. We sell support contracts for thesoftware products that we license to our customers and offer certainconsulting, training, installation and implementation services for ourproducts.

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

Our December 2006 acquisition of BlueChip brought usdocument workflow solutions for the healthcare vertical market, as well asforms processing and document archiving technologies for other verticalmarkets. BlueChip also brings deep domain expertise and longstanding customerrelationships in the healthcare vertical market that will help to accelerateour penetration in that market. We intend to incorporate BlueChip’s forms automationand document archiving functionalities into our AccuRoute product line.

This acquisition will enable us to extend ourAccuRoute product line to include the BlueChip solutions for document imagingand workflow systems for hospital admissions and billing functions, as well asBlueChip’s document archive product. The end result will be a robust suite ofproducts that are well-suited to handle the workflows of healthcare documents. Omtool’sHealthcare Suite of products includes:

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

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

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

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

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

·                  **Image-In Queue**- a document viewer****thatenables administrators to manage, view, and disseminate electronic documents tothe proper departments and/or patient files.

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

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

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*VerticalMarket Focus*

Two years ago, weintroduced AccuRoute 2.0, our innovative document handling platform forenterprise document routing and managing the distributed capture, processing,distribution, and archiving of both paper and electronic documents. AccuRoute’sfeatures are horizontal in nature and apply to many different markets,including the legal, healthcare, and financial services vertical markets. Werecently issued an extension to AccuRoute that provides greater functionalityin support of the e-filing requirements that are critical to many of our legalcustomers. Earlier this year, we announced expanded support for additionallitigation and document support systems as we continue to focus on improvingthe quality of and customer satisfaction with our products.

Our position indocument handling in the legal vertical market will continue to be an area ofprimary focus for us, but in order to grow our business, we will expand on thisfocus. Based on our success in the legal vertical market, the industryaccolades about AccuRoute that we continue to receive from third parties(including industry experts), and the fact that AccuRoute sales presentlyrepresent approximately 80****percent of oursoftware license revenue, we see a large market opportunity for AccuRoute inother vertical market segments.

While we haveinvested considerable resources to penetrate further the financial servicesvertical market and we have created and are pursuing opportunities within thatvertical market, we have found that sales opportunities for our AccuRouteproduct in the financial services vertical market, though significant, arelonger term opportunities. Therefore, while we will continue to pursue theseopportunities, primarily working with our large strategic and channel partners,we believe the best opportunities for replicating our continued success in thelegal vertical market is in the healthcare vertical market. Similar to ourviews on the legal vertical market, and based on the high level of focus byhealthcare providers on electronic medical records, we see a significantopportunity to present AccuRoute as the solution of choice to the challenge ofcapturing the paper documents that are endemic in healthcare systems.

We anticipate thatthe structure and buying patterns in the healthcare vertical market willpresent us with more near-term opportunities than the financial servicesvertical market. Based on this view, in December 2006, we acquiredBlueChip, a privately held provider of electronic forms automation, documentimaging, and object archiving solutions for the healthcare vertical market. BlueChipprovides complementary value to us through vertical market-specific documentworkflow solutions for healthcare providers, as well as forms processing anddocument archiving technologies for other markets. Moreover, BlueChip bringsdeep domain expertise and longstanding customer relationships in the healthcarevertical market that will help to accelerate our penetration in that market. Weintend to incorporate BlueChip forms automation and document archivingfunctionalities into our AccuRoute product line.

*OperatingResults*

Our revenue consists primarily of software licenserevenue, hardware and media revenue, and service and other revenue, all asfurther described below. The following table is a presentation of our totalrevenue for the periods indicated:
| ** **                                    | ** ** | **Total Revenue** | ** ** | **Net Loss**    | ** ** | **Software License  Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|----------------------|------------|------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $4,275,102             |       | $(778,577)           |       | $1,281,462                         |       |
| Three months  ended June 30, 2006             |       | $3,068,556             |       | $(1,797,497)         |       | $925,896                           |       |
| Change over same  period of prior fiscal year |       | $1,206,546  or 39.3%   |       | $1,018,920  or 56.7% |       | $355,566  or 38.4%                 |       |
| ** **                                    | ** ** | ** **             | ** ** | ** **           | ** ** | ** **                         | ** ** |
| Six months ended  June 30, 2007               |       | $8,108,216             |       | $(2,726,349)         |       | $2,328,775                         |       |
| Six months ended  June 30, 2006               |       | $6,405,060             |       | $(3,165,499)         |       | $1,957,715                         |       |
| Change over same period  of prior fiscal year |       | $1,703,156  or 26.6%   |       | $439,150  or 13.9%   |       | $371,060  or 19.0%                 |       |

 

During the first sixmonths of 2007 as compared to the first six months of 2006 our revenueincreased by approximately $1.7 million and our loss decreased fromapproximately $3.2 million to approximately $2.7 million. Our gross profit forthe six months ended June 30, 2007 increased by approximately $959,000 ascompared to the same period in the prior fiscal year due to an increase inrevenue from our customers in the healthcare vertical market.  Our operating expenses increased byapproximately $511,000 in the first half of 2007 as compared to the same periodin 2006 due to a restructuring charge of approximately $343,000 resulting fromour restructuring plan adopted in March 2007 as well an increase in personnelduring the first half of 2007 associated with our acquisition of BlueChip. Weexperienced the benefit of some of these cost cutting measures as our net lossdecreased from $1,947,772 in the first fiscal quarter of 2007 to $778,577 inthe second fiscal quarter of 2007. Total operating expenses excludingrestructuring costs decreased by approximately $619,000 over the same period.

The increase in totalrevenue of approximately $1.7 million during the six months ended June 30, 2007as compared to the same period of 2006 was primarily due to the increase inAccuRoute revenue as well as the revenue associated with the new healthcarecustomers we gained as a result of our acquisition of BlueChip in December2006. The revenue from these customers accounted for approximately $1.2 millionof our total revenue during the first six months of fiscal year 2007. Thecontractual 

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practices that we inherited from BlueChip results in adelay in revenue recognition related to those contracts because they arewritten in such a way that, when combined with their selling practices, theylack vendor-specific objective evidence (“*VSOE*”) for allelements in the customers’ orders. Thus, we do not recognize software licenserevenue until the products we sell to these customers are actually installedand operating at the customer site. During the second quarter of fiscal 2007,we fulfilled some customer contracts we entered into during the first quarterof fiscal 2007 and therefore were able to recognize the revenue associated withthose orders. As of June 30, 2007, our order backlog which consists of invoicedand uninvoiced orders received but for which could not recognize revenue, wasapproximately $311,000. We are working towards modifying those practices sothat we can take this revenue in a more timely fashion in future quarters.

We experienced a 66%increase in AccuRoute software license revenue due to increased sales in thelegal and healthcare vertical markets and a 43% decrease in our legacy faxproduct line for the six months ended June 30, 2007 as compared to the sameperiod in the prior fiscal year. We continue to experience general marketacceptance of our AccuRoute product in the legal vertical market while thedemand for and marketing of our legacy fax product has continued to decrease.We experienced an increase in service and other revenue for the six monthsended June 30, 2007 as compared to the same period in the prior fiscal year dueto the service and other revenue associated with the new customers that wegained as a result of our acquisition of BlueChip and a 54% increase in supportrevenue for our AccuRoute product.

Any decrease in demandfor our products would likely result in decreased revenue, which would, inturn, have a significant negative impact on our financial results because asignificant portion of our operating costs such as personnel, rent, anddepreciation are fixed in advance of a particular quarter. As a result, ourcosts for sales and marketing, research and development, and general andadministrative could continue to increase as a percentage of revenue, therebynegatively affecting our operating results.

In the coming months, ourprimary focus will be to penetrate further vertical and geographic marketsthrough sales and marketing investments, primarily in the healthcare and legalvertical markets. At the same time, we will continue developing our strategicrelationships in those markets, the financial services vertical market, andother vertical markets. We will continue these efforts through direct sales andour strategic and channel partners, all with the goal of increasing AccuRoutesales opportunities in other vertical markets.

Sales from our Europeanoperations, which were in a steady decline for several years, have increased by45% during the first six months of 2007 compared to the first six months of2006. We remain optimistic that we will continue to see improvements outsidethe Americas, but for now, we will rely primarily on our U.S. salesorganization for our shorter-term growth. While total revenue from our legacyfax business continues to decline, we expect that the maintenance component ofthat business will remain stable over time. The recent stabilization of themaintenance component of our legacy fax business and the continued growth ofour AccuRoute business gives us confidence that our planned investments arewarranted, as we believe they will produce significant improvements in ourfinancial results over time when combined with our cost savings plan describedherein.

The following is apresentation of our domestic and international revenue:
| ** **                                    | ** ** | **Total Revenue** | ** ** | **United States Revenue**    | ** ** | **Non-United States Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|----------------------------------------|------------|-----------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $4,275,102             |       | $3,589,516  or 84.0% of Total  Revenue |       | $685,586  or 16.0% of Total  Revenue    |       |
|                                          |       |                   |       |                                   |       |                                    |       |
| Three months  ended June 30, 2006             |       | $3,068,556             |       | $2,556,467  or 83.3% of Total  Revenue |       | $512,089  or 16.7% of Total  Revenue    |       |
|                                          |       |                   |       |                                   |       |                                    |       |
| Change from same  period of prior fiscal year |       | $1,206,546             |       | $1,033,049                             |       | $173,497                                |       |
| ** **                                    | ** ** | ** **             | ** ** | ** **                             | ** ** | ** **                              | ** ** |
| Six months ended  June 30, 2007               |       | $8,108,216             |       | $6,367,803  or 78.5% of Total  Revenue |       | $1,740,413  or 21.5% of Total  Revenue  |       |
|                                          |       |                   |       |                                   |       |                                    |       |
| Six months ended  June 30, 2006               |       | $6,405,060             |       | $5,455,134  or 85.2% of Total  Revenue |       | $949,926  or 14.8% of Total  Revenue    |       |
|                                          |       |                   |       |                                   |       |                                    |       |
| Change from same period  of prior fiscal year |       | $1,703,156             |       | $912,669                               |       | $790,487                                |       |

 

We have historicallyderived a majority of our total revenue from sales within the United States. Revenuefrom outside of the United States increased by approximately $173,000 and $790,000,respectively, during the three and six months ended June 30, 2007 as comparedto the same periods in 2006. This increase for the three month period endedJune 30, 2007 is due to improved sales bookings while the increase for thesix-month period ended June 30, 2007 is due primarily to the receipt of onesoftware license, service and other order from a customer located in the UnitedKingdom. We will continue to leverage our AccuRoute base in Europe, as well asour indirect channel relationships in Europe, to focus sales resources on thelegal and financial services 

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vertical markets. However, we expect that in theshort-term U.S. sales are likely to constitute a greater percentage of revenuethan sales outside the US and there can be no assurance that we will be able toincrease international sales of our products and the failure to do so may havea material adverse effect on our business, financial condition, and results ofoperations.

Our United Kingdomsubsidiary, Omtool Europe Limited, transacts business primarily in its localcurrency. We then translate results generated by that entity into United Statesdollars and consolidate them with our domestic results for reporting purposes. Aswe sell our products to customers in a variety of countries, significantcurrency exchange rate fluctuations could have a material impact on our resultsof operations. We manage our foreign currency exchange exposure by monitoringour net monetary position using natural hedges of our assets and liabilitiesdenominated in local currencies. There can be no assurance that this policywill eliminate all foreign currency exchange exposure. Foreign currencyexposure has not been material to our financial position or results ofoperations to date. If the volume of our business denominated in foreigncurrencies increases, we may be required to use derivatives to hedge foreigncurrency exposure.

We will continue toleverage our existing distribution channels, where appropriate, to broaden ourreach to our target vertical markets and further penetrate our installedcustomer base. We are pursuing sales opportunities through oursolution/reseller channels, as well as focusing sales efforts on specificmarket segments, in order to facilitate acceptance of our products. However, asshown in the following table, in recent periods, more of our sales resourceshave been focused on the direct model and we have consequently derived asignificant portion of our revenue from direct sales:

 
| ** **                                    | ** ** | **Total Software  License,  Hardware and  Media  Revenue** | ** ** | **Software License,  Hardware and Media  Revenue from  Indirect Distribution  Channel Sales** | ** ** | **Software License,  Hardware and Media  Revenue From  Indirect Distribution  Channel Sales as a  Percentage of Total  Software License,  Hardware and  Media Revenue** |
|-----------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Three months  ended June 30, 2007             |       | $1,875,147                                                 |       | $536,174                                                                                      |       | 28.6%                                                                                                                                                                                                                     |
| Three months  ended June 30, 2006        |       | $1,332,563                                                 |       | $719,313                                                                                      |       | 54.0%                                                                                                                                                                                                                     |
| Change from same  period of prior fiscal year |       | $542,584                                                   |       | $(183,139)                                                                                    |       | (25.4)  percentage  points (“ppt”)                                                                                                                                                                              |
|                                          |       | or 40.7%                                                   |       | or (25.5)%                                                                                    |       |                                                                                                                                                                                                                      |
| ** **                                    | ** ** | ** **                                                 | ** ** | ** **                                                                                    | ** ** | ** **                                                                                                                                                                                                                |
| Six months ended  June 30, 2007               |       | $3,384,466                                                 |       | $966,132                                                                                      |       | 28.5%                                                                                                                                                                                                                     |
| Six months ended  June 30, 2006          |       | $2,921,782                                                 |       | $1,290,594                                                                                    |       | 44.2%                                                                                                                                                                                                                     |
| Change from same  period of prior fiscal year |       | $462,684                                                   |       | $(324,462)                                                                                    |       | (15.7)ppt                                                                                                                                                                                                                 |
|                                          |       | or 15.8%                                                   |       | or (25.1)%                                                                                    |       |                                                                                                                                                                                                                      |

 

**CriticalAccounting Policies and Estimates**

We have identified thepolicies and estimates below as critical to our business operations and theunderstanding of our results of operations. The impact and any associated risksrelated to these policies on our reported and expected financial results andbusiness operations are discussed in appropriate sections throughout Management’sDiscussion and Analysis of Financial Condition and Results of Operations. Ourpreparation of this Form 10-Q required us to make estimates andassumptions that affect the reported amount of assets and liabilities, thedisclosure of contingent assets and liabilities as of the date of the financialstatements included herein and the reported amounts of revenue and expensesduring the period covered by this report. There can be no assurance that actualresults will not differ materially from those estimates.

*RevenueRecognition and Accounts Receivable Reserves.**  *We derive our revenue primarilyfrom two sources: (i) product revenue, which includes software license,hardware, and media revenue, and (ii) service and support revenue, whichincludes software maintenance and support, installation, implementation,training, and consulting revenue. We license our software products on aperpetual basis. We generate revenue from licensing the rights to use oursoftware products and sales of hardware directly to end-users and indirectlythrough resellers. Our resellers order products from us based on purchaseorders received from end-users and do not order stock. We generally sell ourproducts to resellers and directly to end-users without any specifically statedrights of return. Occasionally, however, in our sole discretion, we will accepta product return if the end-user finds that the product does not fit its needs.We sell hardware and media products, which are provided by a third-party, atcost plus an additional mark-up, directly to end-users and, in the case ofhardware, indirectly through resellers as well. The hardware products that weresell are not functional without our software. To support our softwareproducts, we sell software maintenance and support, installation,implementation, training, and consulting services directly to end-users andindirectly through resellers.

We apply the provisions of Statement of Position (“SOP”)97-2,**“*SoftwareRevenue Recognition*,” as amended by SOP 98-9,Modification of SOP 97-2,**“*SoftwareRevenue Recognition with Respect to Certain Transactions*” (“SOP98-9”), to all transactions involving the sale of multiple elementsincluding software, hardware and service revenue. We apply the provisions ofStatement of 

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Financial Accounting Standards (“*SFAS*”)No. 48,**“*Revenue Recognition When Right ofReturn Exists*,” with respect to providing for potentialfuture product returns. As described below, we must make and use significantjudgments and estimates in connection with the revenue recognized in anyaccounting period. Material differences may have resulted in the amount andtiming of our revenue if we had made different judgments or utilized differentestimates.

We recognize revenue from the sale of softwareproducts, hardware and media to both end-users and resellers when persuasiveevidence of an arrangement exists, the products have been delivered, the fee isfixed or determinable, collection of the resulting receivable is probable, andthere are no uncertainties regarding customer acceptance. We maintain a reservefor potential product returns. We sell monthly, annual, and multiple-yearmaintenance contracts and the associated revenue is recognized over the term ofthe related maintenance period, beginning on the date of delivery. We recognizeother service revenue as we perform the associated services. If an arrangementincludes an acceptance provision and acceptance is uncertain, then we will deferall revenue until the customer accepts the products purchased. Acceptance inthese instances generally occurs upon the earlier of receipt of a writtencustomer acceptance or expiration of the acceptance period. If an arrangementincludes an acceptance provision tied to determination that our product meetspublished specifications and there are no uncertainties with regard to thecustomer’s acceptance, then we will recognize revenue at the time of sale,provided that all of the other previously mentioned revenue recognitioncriteria have been met and the acceptance period is of short duration.

Our transactions frequently involve the sale ofsoftware, hardware, and related services under multiple element arrangements. Revenueunder multiple element arrangements is allocated to each element, to the extentVSOE of fair value exists, under the residual method, in accordance with SOP 98-9.Under this method, revenue is allocated first to all undelivered elements, suchas services, based on the fair value of those elements, which is calculated tobe the price charged when these elements are sold separately and unaccompaniedby other elements. Our services generally are not essential to thefunctionality of the software, as these services do not alter the capabilitiesof the software and do not carry a significant degree of risk to perform. Theamount allocated to the delivered elements, such as software license andhardware revenue, is the difference between the total arrangement value and theamount allocated to the undelivered elements. If the delivered elements includeboth software and hardware, the amount allocated to hardware revenue is basedon the price charged to us by the third party vendor plus an additional markup, with the remainder allocated to software revenue. To the extent that adiscount is offered in the arrangement, the entire discount is allocated to thedelivered element or elements. If the delivered elements include hardware andsoftware, the discount is allocated to the hardware and software based on theirrespective list prices.

For our newly acquired suite of products for thehealthcare vertical market, we have established VSOE of fair value for oursupport services but not for the software license or implementation servicesprovided to our customers. Whenever the software license, implementationservices, and support services are sold together, we first allocate revenue tothe support services based upon the respective fair value. The remainingrevenue is then allocated to the software license and implementation services. Recognitionof revenue from software licenses sold with implementation services isrecognized once the software license has been delivered and the implementationservices have been completed and accepted by the customer.

For all sales, we use a binding purchase order, asigned contract, or a credit card authorization as evidence of an arrangement. Salesthrough our resellers are evidenced by a master agreement governing therelationship between us and the reseller, together with binding purchase orderson a transaction-by-transaction basis.

At the time of a transaction, we assess whether thefee associated with the transaction is fixed or determinable and whether or notcollection is probable. If a significant portion of a fee is due beyond ournormal payment terms, which are thirty to sixty days from invoice date, weaccount for the fee as not being fixed or determinable. In these cases, werecognize revenue as the fees become due. We assess collectability based on anumber of factors, including past transaction history with the customer and thecreditworthiness of the customer. We review Dunn & Bradstreet creditreports for all of our resellers and adjust our credit limits with thoseresellers accordingly. If a particular reseller does not have a favorablereport or if we do not have enough credit information to determine whether thereseller is creditworthy then we would typically sell to that reseller on cashon delivery terms. We do not request collateral from our customers. If wedetermine that collection of a fee is not reasonably assured, the fee isdeferred and revenue is recognized at the time collection becomes probable,which is generally upon receipt of payment.

We maintain reserves for potential product returns andmake adjustments to these reserves as needed based on historical product returnrates. We also consider the impact of new product introductions, changes incustomer demand, and acceptance of our products on the adequacy of thesereserves. Our calculation of the estimated return reserve is based upon(1) an account-specific review of potential returns, where a returnprobability is known, and (2) an estimate based upon past historicalreturns as a percentage of revenue. We must make and use significant judgmentsand estimates in connection with establishing the product returns reserve inany accounting period. Material differences may have resulted in the amount andtiming of revenue for this or any prior period if we made different judgmentsor utilized different estimates.

As with the product return reserve, we must makeestimates of our ability to collect on our accounts receivable. We record tradeaccounts receivable at the invoiced amount and these accounts do not bearinterest. We specifically analyze accounts receivable, historical bad debts,customer creditworthiness, current economic trends, and changes in customerpayment patterns when evaluating the adequacy of our allowance for doubtfulaccounts. We review our allowance for doubtful accounts on a 

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monthly basis. Our calculation of the estimatedaccounts receivable reserve is also based upon (1) an account-specificreview of potential uncollectible accounts, where a bad debt probability isknown, and (2) an estimate based upon past historical bad debts as apercentage of accounts receivable. We do not have any off-balance-sheet creditexposure to our customers.

Our combined accounts receivable and product returnsreserve was $29,000 and $14,000 at June 30, 2007 andDecember 31, 2006, respectively. Both components of calculating theestimated reserve — specific identification and historic experience —are material judgments that we make. We base these judgments on historictrends, taking into consideration current business and economic conditions,which could change materially, thus changing the required reserve levelmaterially. The potential change to the size of our required reserve could bepositive, in the event the reserve estimate proves unnecessary, or negative, ifthe reserve proves inadequate.

Our deferred revenue is comprised mainly of revenuethat is deferred for software maintenance and support contracts as well assales of our products targeted to the healthcare vertical market that involveboth the sale of software and implementation services for which theimplementation services have not yet been performed and accepted by thecustomer. The other components of deferred revenue are amounts from salestransactions that were deferred because they did not meet all of the provisionsof our revenue recognition policy.

*SoftwareDevelopment Costs.** *Weconsider software development costs for capitalization when technologicalfeasibility is established in accordance with SFAS No. 86,**“*Accounting for the Costs of Computer Software To BeSold, Leased or Otherwise Marketed*.” We sell software in amarket that is subject to rapid technological change, new productintroductions, and changing customer needs. Accordingly, we have determinedthat we cannot ascertain technological feasibility until the development stateof the product is nearly complete. The time period during which cost could becapitalized from the point of reaching technological feasibility until the timeof general product release is very short and, consequently, the amounts thatmight be capitalized are not material to our consolidated financial position orresults of operations. Therefore, we charge all software development costs tooperations in the period incurred.

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

*We account for intangible assets inaccordance with SFAS No. 144 “*Accounting for the Impairmentor Disposal of Long-Lived Assets.” Intangibleassets include customer contracts and relationships, purchased technology,trade names, and non-compete agreements. The carrying amount of the intangibleassets is reviewed whenever events or changes in circumstances indicate thatthe carrying value of an asset may not be recoverable. Recoverability of theseintangible assets is measured by comparison of the carrying amount of the assetto the future undiscounted cash flows the asset is expected to generate. If theintangible asset is considered to be impaired, the amount of any impairment ismeasured as the difference between the carrying value and the fair value of theimpaired asset.

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

*Stock Based Compensation. *Effective January 1, 2006,we adopted the provisions of SFAS 123R, using the modified prospective method. SFAS123R requires us to measure the cost of employee services in exchange for anaward of an equity instrument based on the grant-date fair value of the awardand to recognize expense over the requisite service period. Under the modifiedprospective method, financial statements for periods prior to the date of adoptionare not adjusted for the change in accounting, thus, prior period financialstatements have not been restated. However, compensation expense is recognizedfor (a) all share-based payments granted after the effective date and (b) allawards granted to employees prior to the effective date that remain unvested onthe effective date. Based upon historical information and management’s estimateof future voluntary turnover rates, we have calculated our stock-basedcompensation expense using an annualized estimated forfeiture rate of 10% forrestricted stock and 5% for stock options. Estimated forfeitures are trued-upto actual forfeitures at the end of each reporting period.

On November 10, 2005, FASB issued FASB Staff PositionFAS 123R-3 “*Transition Election Related to Accounting for TaxEffects of Share-Based Payment Awards.*” The Company has elected toadopt the alternative transition method provided by the FASB Staff Position forcalculating the tax effects (if any) of stock-based compensation expense pursuantto SFAS 123R. The alternative transition method includes simplified methods toestablish the beginning balance of the additional paid-in-

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capital pool related to the tax effects of employeestock-based compensation, and to determine the subsequent impact to theadditional paid-in-capital pool and the consolidated statements of operationsand cash flows of the tax effects of employee stock-based compensation awardsthat are outstanding upon adoption of SFAS 123R.

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

We assess our deferred tax assets for each reportingperiod to determine whether it is more likely than not that we will recoverfrom future taxable income. In making this assessment, we include assumptionsregarding ongoing tax planning strategies. We establish a valuation allowancefor assets when their recovery is not certain. We include changes to thevaluation allowance as an expense or benefit within the tax provision in ourstatement of operations.

We provide a full valuation allowance against all ofour net deferred tax assets and will continue to do so until we return to anappropriate level of sustained taxable income. The ultimate realization ofthese deferred tax assets depends upon our ability to generate sufficientfuture taxable income. If we are successful in generating sufficient futuretaxable income, we will reduce the valuation allowance through a reduction inincome tax expense in the future.

We estimate accrued state sales taxes for eachreporting period based on tax rates in effect for the reporting periods in eachof the states where we have a potential nexus and for the time period duringwhich we have that nexus. The assumptions and estimates used to determine thisliability are subject to change as they are difficult to measure or value. Inthe event that actual results differ from these estimates, our state salestaxes expense could be materially impacted.

**NewAccounting Pronouncements**

In September 2006, theFASB issued Statement No. 157 “*Fair Value Measurements*”**(“SFAS 157”), which establishes a framework formeasuring fair value in generally accepted accounting principles and expandsdisclosures about fair value financial instruments. SFAS 157 becomes effectivefor fiscal years beginning after November 15, 2007. We will adopt thisstatement prospectively once it is effective and applicable to us. We do notexpect SFAS 157 to have a material impact on our financial position or resultsof operations.

In February 2007, the FASB issued SFAS No. 159 “*The FairValue Option for Financial Assets and Financial Liabilities*”**(“SFAS 159”), which permits entities to choose tomeasure many financial instruments and certain other items at fair value. SFAS159 becomes effective for fiscal years beginning after November 15, 2007. Wewill adopt this statement prospectively once it is effective and applicable tous. We do not expect the adoption ofSFAS 159 to have a material impact on our financial position or results ofoperations.

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**Resultsof Operations**

The followingtable sets forth certain financial data for the periods indicated as apercentage of total revenue:
| ** **                  | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                  | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenue:                    |       |                                            |       |                                          |       |   |   |   |   |
| Software license            |       | 30.0                                            | %          | 30.2                                          | %          | 28.7 | % | 30.6 | % |
| Hardware and media          |       | 13.9                                            |       | 13.2                                          |       | 13.0 |   | 15.0 |   |
| Service and other           |       | 56.1                                            |       | 56.6                                          |       | 58.3 |   | 54.4 |   |
| Total revenue               |       | 100.0                                           |       | 100.0                                         |       | 100.0 |   | 100.0 |   |
| Cost of revenue:            |       |                                            |       |                                          |       |   |   |   |   |
| Software license            |       | 2.5                                             |       | 1.7                                           |       | 2.6 |   | 1.3 |   |
| Hardware and media          |       | 9.3                                             |       | 8.8                                           |       | 8.5 |   | 9.6 |   |
| Service and other           |       | 22.1                                            |       | 28.7                                          |       | 24.8 |   | 24.9 |   |
| Total cost of revenue       |       | 33.9                                            |       | 39.2                                          |       | 35.9 |   | 35.8 |   |
| Gross profit                |       | 66.1                                            |       | 60.8                                          |       | 64.1 |   | 64.2 |   |
| Operating expenses:         |       |                                            |       |                                          |       |   |   |   |   |
| Sales and marketing         |       | 43.7                                            |       | 70.4                                          |       | 50.2 |   | 65.7 |   |
| Research and  development   |       | 17.1                                            |       | 23.6                                          |       | 19.9 |   | 22.4 |   |
| General and  administrative |       | 20.0                                            |       | 26.6                                          |       | 22.8 |   | 26.8 |   |
| Restructuring costs         |       | 3.1                                             |       | 0.0                                           |       | 4.2 |   | 0.0 |   |
| Total operating  expenses   |       | 83.9                                            |       | 120.6                                         |       | 97.1 |   | 114.9 |   |
| Loss from operations        |       | (17.8                                           | )          | (59.8                                         | )          | (33.0 | ) | (50.7 | ) |
| Interest and other  income  |       | 0.6                                             |       | 1.4                                           |       | 0.6 |   | 1.4 |   |
| Interest expense            |       | (1.0                                            | )          | (0.2                                          | )          | (1.2 | ) | (0.1 | ) |
|                        |       |                                            |       |                                          |       |   |   |   |   |
| Net loss                    |       | (18.2                                           | )%         | (58.6                                         | )%         | (33.6 | )% | (49.4 | )% |
|                        |       |                                            |       |                                          |       |   |   |   |   |
| Gross profit:               |       |                                            |       |                                          |       |   |   |   |   |
| Software license            |       | 91.6                                            | %          | 94.4                                          | %          | 91.0 | % | 95.7 | % |
| Hardware and media          |       | 32.6                                            |       | 33.7                                          |       | 34.2 |   | 36.2 |   |
| Service and other           |       | 60.7                                            |       | 49.2                                          |       | 57.4 |   | 54.2 |   |

 

**Revenue**

*Software License. *During the three and six months ended June 30, 2007, we experienced an increasein our software license revenue as compared to the same periods in the priorfiscal year, due to an increase in revenue from sales of our AccuRoute product,due in part to the addition of former BlueChip customers, which was offset inpart by a decrease in revenue from sales of our legacy fax products.  We continue to experience general marketacceptance of our AccuRoute product in the legal vertical market while thedemand for and our marketing of our legacy fax product has continued todecrease.

During the three months and six months ended June 30,2007, our software license revenue by product category, as compared to the sameperiod in the prior fiscal year was as follows:
| ** **                                    | ** ** | **Total  Revenue**   | ** ** | **Software  License  Revenue** | ** ** | **AccuRoute  License  Revenue** | ** ** | **Legacy Fax  License  Revenue** | ** ** | **Freight and  Allowances  for Returns** | ** ** |
|-----------------------------------------------|------------|----------------------|------------|--------------------------------|------------|---------------------------------|------------|---------------------------------------|------------|----------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $4,275,102           |       | $1,281,462                     |       | $1,028,797                      |       | $250,004                              |       | $2,661                                             |       |
| Three months  ended June 30, 2006             |       | $3,068,556           |       | $925,896                       |       | $600,474                        |       | $323,261                              |       | $2,161                                             |       |
| Change from same  period of prior fiscal year |       | $1,206,546  or 39.3% |       | $355,566  or 38.4%             |       | $428,323  or 71.3%              |       | $(73,257)  or (22.7)%                 |       | $500  or 23.1%                                     |       |
|                                          |       |                 |       |                           |       |                            |       |                                  |       |                                               |       |
| Six months ended  June 30, 2007               |       | $8,108,216           |       | $2,328,775                     |       | $1,864,512                      |       | $469,915                              |       | $(5,652)                                           |       |
| Six months ended  June 30, 2006               |       | $6,405,060           |       | $1,957,715                     |       | $1,122,363                      |       | $822,241                              |       | $13,111                                            |       |
| Change from same  period of prior fiscal year |       | $1,703,156  or 26.6% |       | $371,060  or 19.0%             |       | $742,149  or 66.1%              |       | $(352,326)  or (42.8)%                |       | $(18,763)  or (143.1)%                             |       |

 

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During the three monthsand six months ended June 30, 2007, our software license revenue represented adecreased percentage of our total revenue as compared to the same periods in2006, due primarily to an increase in service and other revenue as discussedfurther below.

|                                               | ** ** | **Software License Revenue as a  Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | 30.0%                                                                                             |       |
| Three months  ended June 30, 2006             |       | 30.2%                                                                                             |       |
| Change from same  period of prior fiscal year |       | (0.2)ppt                                                                                          |       |
| ** **                                    | ** ** | ** **                                                                                        | ** ** |
| Six months ended  June 30, 2007               |       | 28.7%                                                                                             |       |
| Six months ended  June 30, 2006               |       | 30.6%                                                                                             |       |
| Change from same period  of prior fiscal year |       | (1.9)ppt                                                                                          |       |

 

The results for the three months and six months endedJune 30, 2007 and June 30, 2006 demonstrate that our software license revenuecontinues to shift towards our AccuRoute product, as displayed in the tablebelow, which summarizes revenue from each of our major product lines and othercomponents of revenue as a percentage of our total software license revenue:
| ** **                                    | ** ** | **AccuRoute License Revenue as  a Percentage of Software  License Revenue** | ** ** | **Legacy Fax License  Revenue as a Percentage of  Software License Revenue** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | 80.3%                                                                                                          |       | 19.5%                                                                                                                |       |
| Three months  ended June 30, 2006             |       | 64.9%                                                                                                          |       | 34.9%                                                                                                                |       |
| Change from same  period of prior fiscal year |       | 15.4ppt                                                                                                        |       | (15.4)ppt                                                                                                            |       |
| ** **                                    | ** ** | ** **                                                                                                     | ** ** | ** **                                                                                                           | ** ** |
| Six months ended  June 30, 2007               |       | 80.1%                                                                                                          |       | 20.2%                                                                                                                |       |
| Six months ended  June 30, 2006               |       | 57.3%                                                                                                          |       | 42.0%                                                                                                                |       |
| Change from same period  of prior fiscal year |       | 22.8ppt                                                                                                        |       | (21.8)ppt                                                                                                            |       |

 

Thisshift toward AccuRoute revenue is due primarily to the continued marketacceptance of AccuRoute in the legal vertical market and also to the decline inour legacy fax business as well as the increase in revenue from our newlyacquired healthcare customers, whose revenue is part of our AccuRoute productline.

*Hardware and Media.* Hardware and media revenue increased during the three and six month periodsended June 30, 2007 as compared to the same periods in 2006.  Included in hardware and media revenue forthe three and six month periods ended June 30, 2007 is $144,000 and $314,000,respectively, of media revenue that we added during these periods as a resultof our acquisition of BlueChip.  Theincrease in hardware and media revenue for the first half of fiscal year 2007was due primarily to the addition of the media component of our revenue whereasthe increase in the three month period ended June 30, 2007 was due to both theaddition of the media component of our revenue and an increase in hardwaresales accompanying our legacy fax products, which sales are the main driver forour hardware revenue.
| ** **                                    | ** ** | **Hardware and Media  Revenue** | ** ** | **Hardware and Media  Revenue as a  Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $593,685                                  |       | 13.9%                                                                                                |       |
| Three months  ended June 30, 2006             |       | $406,667                                  |       | 13.3%                                                                                                |       |
| Change from same  period of prior fiscal year |       | $187,018  or 46.0%                        |       | 0.6ppt                                                                                               |       |
|                                          |       |                                      |       |                                                                                                 |       |
| Six months ended  June 30, 2007               |       | $1,055,691                                |       | 13.0%                                                                                                |       |
| Six months ended  June 30, 2006               |       | $964,067                                  |       | 15.1%                                                                                                |       |
| Change from same  period of prior fiscal year |       | $91,624  or 9.5%                          |       | (2.1)ppt                                                                                             |       |

 

*Service and Other. *Service and other revenue, which consists primarily of the sale of supportcontracts to complement software products sold to customers and, to a lesser extent,consulting, training, and installation services, increased in the three and sixmonth periods ended June 30, 2007 as compared to the same periods in the priorfiscal year.  This increase was due to the addition of service and otherrevenue that resulted from our December 2006 acquisition of BlueChip, as wellas an increase of 57% and 54% for the quarter and six month period ended June30, 2007, respectively, in support revenue from our AccuRoute product.

20

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| ** **                                    | ** ** | **Service and Other Revenue** | ** ** | **Service and Other Revenue as  a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $2,399,955                                   |       | 56.1%                                                                                                   |       |
| Three months  ended June 30, 2006             |       | $1,735,993                                   |       | 56.6%                                                                                                   |       |
| Change from same  period of prior fiscal year |       | $663,962  or 38.3%                           |       | (0.5)ppt                                                                                                |       |
| ** **                                    | ** ** | ** **                                   | ** ** | ** **                                                                                              | ** ** |
| Six months ended  June 30, 2007               |       | $4,723,750                                   |       | 58.3%                                                                                                   |       |
| Six months ended  June 30, 2006               |       | $3,483,278                                   |       | 54.4%                                                                                                   |       |
| Change from same period  of prior fiscal year |       | $1,240,472  or 35.6%                         |       | 3.9ppt                                                                                                  |       |

 

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

**Cost of Revenue**

*SoftwareLicense. * Cost of software license revenue consistsprimarily of the costs we incur in sublicensing third-party software products,purchasing product media, and contracting for product duplication, as well asthe amortization of purchased technology.  Cost of software licenserevenue for the three month and six month periods ended June 30, 2007 increasedas compared to the corresponding period in the previous fiscal year.  Thisincrease is due primarily to the amortization of purchased technologyassociated with our acquisition of BlueChip, which is being amortized over itsestimated future life of five years.  Toa lesser extent, our cost of software license revenue increased due to a changein the mix of software license products sold, resulting in higher royaltyfees.  We may license additional third-partysoftware components in the future and, if that were to happen, we would expectthat our cost of software license revenue as a percentage of software licenserevenue would increase slightly.

As a result of theincrease in the cost of software license revenue that we incurred during thefirst six months of 2007, we incurred a decrease in our software license grossmargin percentage as set forth in the following table:
| ** **                                    | ** ** | **Cost of Software License Revenue** | ** ** | **Software License Gross Margin** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|--------------------------------------------------|------------|
| Three months ended  June 30, 2007             |       | $107,270                                                 |       | 91.6%                                            |       |
| Three months  ended June 30, 2006             |       | $52,000                                                  |       | 94.4%                                            |       |
| Change from same  period of prior fiscal year |       | $55,270  or 106.3%                                       |       | (2.8)ppt                                         |       |
| ** **                                    | ** ** | ** **                                               | ** ** | ** **                                       | ** ** |
| Six months ended  June 30, 2007               |       | $208,545                                                 |       | 91.0%                                            |       |
| Six months ended  June 30, 2006               |       | $83,441                                                  |       | 95.7%                                            |       |
| Change from same  period of prior fiscal year |       | $125,104  or 149.9%                                      |       | (4.7)ppt                                         |       |

 

*Hardware and Media. *Cost of hardware and media revenue consists primarily of the costs we incur inpurchasing third-party hardware and media products.  During the three andsix month periods ended June 30, 2007 cost of hardware and media increased andthe gross margin decreased as compared to the three and six month periods endedJune 30, 2006 due primarily to the costs associated with the media sales thatwe are now making as a result of our acquisition of BlueChip.  Our hardware and media gross marginpercentage decreased during the three and six month periods ended June 30, 2007as compared to the same periods in the prior fiscal year due to an unfavorablechange in the mix of particular hardware products that we sold, offset in partby an increase in the gross margin related to media sales, which had a highergross margin than our hardware.  We donot expect significant changes in unit prices for the remainder of 2007.
| ** **                                    | ** ** | **Cost of Hardware and Media Revenue** | ** ** | **Hardware and Media Gross   Margin** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $400,008                                                        |       | 32.6%                                                     |       |
| Three months  ended June 30, 2006             |       | $269,604                                                        |       | 33.7%                                                     |       |
| Change from same  period of prior fiscal year |       | $130,404  or 48.4%                                              |       | (1.1)ppt                                                  |       |
| ** **                                    | ** ** | ** **                                                      | ** ** | ** **                                                | ** ** |
| Six months ended  June 30, 2007               |       | $694,138                                                        |       | 34.2%                                                     |       |
| Six months ended  June 30, 2006               |       | $614,682                                                        |       | 36.2%                                                     |       |
| Change from same  period of prior fiscal year |       | $79,456  or 12.9%                                               |       | (2.0)ppt                                                  |       |

 

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* *

*Service and Other. *Cost of service and other revenue consists primarily of the costs we incur inproviding telephone support, installation as well as other miscellaneouscustomer service-related expenses.  Weexperienced an increase in cost of service and other revenue in absolute dollarsand gross margin during the three and six month periods ended June 30, 2007 ascompared to the same periods in fiscal year 2006.  The increase inabsolute dollars is primarily due to the addition of former BlueChip employeesin December 2006 to our service department. The increase in gross margin is dueto the increase in support income from BlueChip customers.  In addition, the increase in cost of serviceand other revenue during the second quarter of fiscal year 2007 was offset inpart by a reduction in expenses, including wages and recruiting, as a result ofour 2007 restructuring.
| ** **                                    | ** ** | **Cost of Service and Other  Revenue** | ** ** | **Gross Margin for Service  and Other Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $943,904                                                   |       | 60.7%                                                                    |       |
| Three months  ended June 30, 2006             |       | $881,684                                                   |       | 49.2%                                                                    |       |
| Change from same  period of prior fiscal year |       | $62,220  or 7.1%                                           |       | 11.5ppt                                                                  |       |
| ** **                                    | ** ** | ** **                                                 | ** ** | ** **                                                               | ** ** |
| Six months ended  June 30, 2007               |       | $2,012,279                                                 |       | 57.4%                                                                    |       |
| Six months ended  June 30, 2006               |       | $1,594,783                                                 |       | 54.2%                                                                    |       |
| Change from same  period of prior fiscal year |       | $417,496  or 26.2%                                         |       | 3.2ppt                                                                   |       |

 

**Operating Expenses**

*Salesand Marketing. * Sales and marketing expenses consistprimarily of employee salaries, benefits, commissions, and associated overheadcosts, as well as the cost of marketing programs such as direct mailings,public relations, trade shows, seminars, and related communication costs. Sales and marketing expenses decreased in absolute dollars and as a percentageof total revenue in the three and six month periods ending June 30, 2007 ascompared to the same periods in 2006 due to a reduction in headcount as aresult of our recently completed restructuring plan, which resulted indecreased wage and commission expenses and other costs associated withsupporting those employees ,offset in part by the addition of former BlueChipemployees to our sales and marketing departments.  We expect our sales and marketing expenses todecrease in absolute dollars for the remainder of fiscal year 2007. 
| ** **                                    | ** ** | **Sales and Marketing Expenses** | ** ** | **Sales and Marketing Expenses as  a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $1,870,215                                      |       | 43.7%                                                                                                      |       |
| Three months  ended June 30, 2006             |       | $2,158,993                                      |       | 70.4%                                                                                                      |       |
| Change from same  period of prior fiscal year |       | $(288,778)  or (13.4)%                          |       | (26.7)ppt                                                                                                  |       |
|                                          |       |                                            |       |                                                                                                       |       |
| Six months ended  June 30, 2007               |       | $4,066,944                                      |       | 50.2%                                                                                                      |       |
| Six months ended  June 30, 2006               |       | $4,211,200                                      |       | 65.7%                                                                                                      |       |
| Change from same  period of prior fiscal year |       | $(144,256)  or (3.4)%                           |       | (15.5)ppt                                                                                                  |       |

 

*Research and Development.* Research and development expenses include expenses associated with thedevelopment of new products, enhancements of existing products, and qualityassurance activities.  These expenses consist primarily of employeesalaries, benefits, associated overhead costs, consulting expenses, and thecost of software development tools.  Forthe three and six months ended June 30, 2007, our research and developmentexpenses increased in absolute dollars as compared to the same periods in theprior fiscal year due to an increase in expenses resulting from new researchand development personnel hired through our acquisition of BlueChip.  As a result of our recent restructuring, weexpect our research and development expenses to decrease in absolute dollarsfor the remainder of fiscal year 2007. Research and development expenses as a percentage of total revenue decreasedin both the three and six month periods ended June 30, 2007 as compared to thesame periods in 2006, due to an increase in revenue as discussed above.

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| ** **                                    | ** ** | **Research and Development  Expenses** | ** ** | **Research and Development  Expenses as a Percentage of  Total Revenue** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $729,681                                         |       | 17.1%                                                                                                       |       |
| Three months  ended June 30, 2006             |       | $724,302                                         |       | 23.6%                                                                                                       |       |
| Change from same  period of prior fiscal year |       | $5,379  or 0.7%                                  |       | (6.5)ppt                                                                                                    |       |
| ** **                                    | ** ** | ** **                                       | ** ** | ** **                                                                                                  | ** ** |
| Six months ended  June 30, 2007               |       | $1,609,762                                       |       | 19.9%                                                                                                       |       |
| Six months ended  June 30, 2006               |       | $1,431,554                                       |       | 22.4%                                                                                                       |       |
| Change from same  period of prior fiscal year |       | $178,208  or 12.4%                               |       | (2.5)ppt                                                                                                    |       |

 

*General and Administrative. *General and administrative expenses consist primarily of employee salaries,benefits for administrative, executive and finance personnel, and associatedcorporate, general, and administrative expenses.  During the three and sixmonths ended June 30, 2007 our general and administrative expenses increased inabsolute dollars but decreased as a percentage of total revenue as compared tothe same periods in the prior fiscal year. The increase in general and administrative expenses is due to anincrease in consulting expenses and in legal and accounting fees relatedprimarily to work associated with public company reporting requirements and areview of our existing commercial and licensing agreements.  The decrease in general and administrativeexpenses as a percentage of total revenue for both periods is due to anincrease in revenue.  We expect ourgeneral and administrative expenses to decrease in the second half of fiscalyear 2007.
| ** **                                    | ** ** | **General and Administrative  Expenses** | ** ** | **General and Administrative Expenses  as a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $854,999                                           |       | 20.0%                                                                                                             |       |
| Three months  ended June 30, 2006             |       | $818,486                                           |       | 26.7%                                                                                                             |       |
| Change from same  period of prior fiscal year |       | $36,513  or 4.5%                                   |       | (6.7)ppt                                                                                                          |       |
|                                          |       |                                               |       |                                                                                                              |       |
| Six months ended  June 30, 2007               |       | $1,851,944                                         |       | 22.8%                                                                                                             |       |
| Six months ended  June 30, 2006               |       | $1,718,428                                         |       | 26.8%                                                                                                             |       |
| Change from same  period of prior fiscal year |       | $133,516  or 7.8%                                  |       | (4.0)ppt                                                                                                          |       |

 

*RestructuringCosts.*  In March 2007, we announced arestructuring of certain of our operations and reduced our workforce by twelvepositions.  In May 2007, we reduced ourworkforce by an additional four positions. Since March 2007, employee attrition and the elimination of additionalpositions has resulted in a reduction of fifteen positions and when combinedwith the actions taken pursuant to our March restructuring plan and otheroperating expense reductions, has resulted in a total decrease of thirty-one positionsand, we believe, an annual savings of approximately $4.0 million from ourexpense levels during the first quarter of 2007.  Our three goals in undertaking these costreduction measures and restructuring our operations are: one, to achievefinancial results that will enable us to be at or near cash flow break-even bythe end of fiscal year 2007; two, to enable our sales force to focus on sellingproducts to customers in the legal and healthcare vertical markets directly andalso in partnership with indirect sales channels, while allowing our partnersto focus on selling our products to customers in the financial services andother vertical markets; and three, to support our integration of the BlueChipbusiness.

As a result ofthese cost reduction activities, we recorded a pre-tax charge of $343,450 forthe six months ended June 30, 2007, which charge included $308,278 ofseverance-related costs and $35,172 of costs relating to the closing ofBlueChip’s former headquarters.  Thetotal cash impact of the restructuring was $343,450; $285,910 was paid duringthe six months ended June 30, 2007 and the remaining balance of $57,540 isexpected to be paid during the third quarter of fiscal year 2007 and has beenincluded in accrued liabilities in our consolidated balance sheet as of June30, 2007.
| ** **                                    | ** ** | **Restructuring Costs** | ** ** | **Restructuring Costs  as a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $130,648                     |       | 3.1%                                                                                    |       |
| Three months  ended June 30, 2006             |       | $0                           |       | 0.0%                                                                                    |       |
| Change from same  period of prior fiscal year |       | $130,648  or 100.0%          |       | 3.1ppt                                                                                  |       |
| ** **                                    | ** ** | ** **                   | ** ** | ** **                                                                              | ** ** |
| Six months ended  June 30, 2007               |       | $343,450                     |       | 4.2%                                                                                    |       |
| Six months ended  June 30, 2006               |       | $0                           |       | 0.0%                                                                                    |       |
| Change from same  period of prior fiscal year |       | $343,450  or 100.0%          |       | 4.2ppt                                                                                  |       |

 

*Interestand other Income and Interest Expense. * Interest andother income consists primarily of interest income earned on cash and cashequivalent balances.  The decrease ininterest and other income is a result of a lower average investment balanceduring the first half of fiscal year 2007 as compared to the first half offiscal year 2006.  Interest expenserepresents the interest associated 

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with the capital lease that we entered into in May2006 to finance the purchase of furniture and equipment for our newheadquarters, as well as interest expense associated with the promissory noteissued to the seller of BlueChip.

We expect interest income and interest expense toremain relatively stable for each quarter of the remainder of fiscal year2007.  
| ** **                                    | ** ** | **Interest and  Other Income** | ** ** | **Interest  Expense**   | ** ** | **Interest and Other  Income  as a Percentage   of Total Revenue** | ** ** | **Interest Expense  as a Percentage  of Total Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------------------|------------|-------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| Three months  ended June 30, 2007             |       | $27,544                                  |       | $(44,498)               |       | 0.6%                                                                                                  |       | (1.0)%                                                                           |       |
| Three months  ended June 30, 2006             |       | $44,058                                  |       | $(5,042)                |       | 1.4%                                                                                                  |       | (0.2)%                                                                           |       |
| Change from same  period of prior fiscal year |       | $(16,514)  or (37.5)%                    |       | $(39,456)  or (782.5)%  |       | (0.8)ppt                                                                                              |       | (0.8)ppt                                                                         |       |
|                                          |       |                                     |       |                    |       |                                                                                                  |       |                                                                             |       |
| Six months ended  June 30, 2007               |       | $48,032                                  |       | $(95,535)               |       | 0.6%                                                                                                  |       | (1.2)%                                                                           |       |
| Six months ended  June 30, 2006               |       | $88,631                                  |       | $(5,102)                |       | 1.4%                                                                                                  |       | (0.1)%                                                                           |       |
| Change from same  period of prior fiscal year |       | $(40,599)  or (45.8)%                    |       | $(90,433  or (1,772.5)% |       | (0.8)ppt                                                                                              |       | (1.1)ppt                                                                         |       |

 

**Inflation**

During the fiscal years ended December 31, 2004, 2005and 2006 and the six months ended June 30, 2007, neither inflation nor changingprices have had a material impact on our net sales, revenue or income fromcontinuing operations.

**Liquidityand Capital Resources**

Since 1996, we have financed our operations primarilythrough cash flow from operations and private and public sales ofsecurities.  As of June 30, 2007, we hadcash and cash equivalents of $2.6 million and a net working deficit of $2.6million.  We believe that our existing cash and cash equivalents will besufficient to meet our working capital, capital expenditures, and other liquidityrequirements for at least the next twelve months. 
| ** **                                    | ** ** | **Cash Used In**    | ** ** |
|-----------------------------------------------|------------|-------------------------------|------------|
| ** **                                    | ** ** | **Operating Activities** | ** ** | **Investing Activities** | ** ** | **Financing Activities** | ** ** |
| Six months ended  June 30, 2007               |       | $(1,985,565)                  |       | $(130,880) |   | $(729,492) |   |
| Six months ended  June 30, 2006               |       | $(2,609,441)                  |       | $(920,861) |   | $(150,534) |   |
| Change from same  period of prior fiscal year |       | $623,876  or 23.9%            |       | $789,981  or 85.8% |   | $(578,958)  or (384.6)% |   |

 

Our operating activities used cash of $2.0 million and$2.6 million for the six months ended June 30, 2007 and 2006, respectively. We believe that the resources we are allocating to improve the success of ourAccuRoute product in the legal vertical market and its expansion into thehealthcare and financial services vertical markets will continue to putpressure on our earnings during the remainder of 2007, but that our existingcash is sufficient for at least the next twelve months.

Net cash used during the six months ended June 30,2007 consisted primarily of a net loss from operations and a decrease inaccounts payable, offset in part by an increase in deferred revenue, a decreasein unbilled accounts receivable as well as by the non-cash effects ofdepreciation and amortization and stock-based compensation, predominately forvesting of restricted stock shares.

The decrease in accountspayable is primarily due to the payment of financial advisory, legal, andaccounting expenses associated with our acquisition of BlueChip as well as thetiming of other vendor payments.  Theincrease in deferred revenue is primarily due to deferred implementationservices for BlueChip customers that were recorded as deferred revenue forpurposes of purchase accounting, as well as the deferral of sales orders forour healthcare customers for which services had not yet been performed andaccepted.  The decrease in unbilledaccounts receivable is due to the fulfillment of contracts that had not beencompleted by BlueChip prior to our acquisition. The increase in depreciation and amortization expense is due to theamortization related to the net identifiable intangible assets recorded inconnection with our December 2006 acquisition of BlueChip.

Net cash used during thesix months ended June 30, 2006 consisted primarily of net loss from operationsand an increase in accounts receivable, inventory, prepaids and other currentassets, offset in part by an increase in accounts payable, deferred rent anddeferred revenue as well as the non-cash effects of stock-based compensationand depreciation.

Investing activities used cash of $131,000 and$921,000 during the six months ended June 30, 2007 and 2006,respectively.  The primary use of cash for investing activities during thefirst six months of 2007 was for additional legal and accounting fees 

24

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related to our December 2006 acquisition ofBlueChip.  The sole use of cash duringthe first six months of 2006 was for the purchases of furniture, equipment andconstruction costs associated with the moving of our headquarters in 2006.

Financing activities used cash of $729,000 and$151,000 during the six months ended June 30, 2007 and June 30, 2006,respectively.  The primary use of cashduring the six months ended June 30, 2007 consisted of the $562,000 cashpayment and $140,000 for principal payments made to the Seller of BlueChip aspart of the purchase consideration for BlueChip and for the repayment ofcapital lease obligations.  Cash usedduring the six months ended June 30, 2006 consisted primarily of the purchaseof stock from an unaffiliated stockholder.

Based on our performance for the six months ended June30, 2007 and current expectations for the remainder of 2007, we believe thatour current cash and cash equivalents balance, as well as the cash expected tobe generated from operations for the remainder of the year, will satisfy ourworking capital needs, capital expenditures, and other liquidity requirementsassociated with our operations through at least the next twelve months.  We expect that principal uses of cash will befor operations, repayment of capital lease obligations, and notes payable.  While there can be no assurance that anynecessary additional financing will be available to us on commerciallyreasonable terms, or at all.  Theissuance of additional equity or equity-related securities would be dilutive toour stockholders.  If we cannot raisefunds on acceptable terms, or at all, we may not be able to develop or enhanceour products or respond appropriately to competitive pressures, which wouldseriously limit our ability to increase our revenue and grow our business.

The followingtable represents the approximate amounts of payments due under specifiedcontractual obligations as of June 30, 2007:
| **Contractual Obligations**  | ** ** | **Total** | ** ** | **Less than  one year** | ** ** | **One to  Three years** | ** ** | **Three to  five years** | ** ** | **More than  Five years** | ** ** |
|-----------------------------------|------------|-----------|------------|-----------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|-------------------------------------|------------|
|                              |       |      |       |                              |       |                              |       |                               |       |                                |       |
| Operating lease  obligations(1,2) |       | $         | 3,713,747  |                              | $          | 510,652                           |       | $                                  | 310,492    |                                | $          | 302,472 |   | $ | 2,590,131 |   |
| Capital lease  obligations(3)     |       | 461,812   |       | 461,812                           |       | —                            |       | —                             |       | —                              |       |
| Note payable(4)                   |       | 1,745,643 |       | 734,545                           |       | 1,011,098                         |       | —                             |       | —                              |       |
| Total contractual  obligations    |       | $         | 5,921,202  |                              | $          | 1,707,009                         |       | $                                  | 1,321,590  |                                | $          | 302,472 |   | $ | 2,590,131 |   |

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(1)             Operatinglease requirements consist mainly of lease payments for our offices in Andover,Massachusetts and London, England, United Kingdom and BlueChip’s formerheadquarters in Danvers, Massachusetts. The lease for the Danvers, Massachusetts facility terminated on July 31,2007.  As of June 30, 2007, we did nothave any long-term debt obligations, material commitments for capitalexpenditures, or other long-term liabilities for which payments are required.

(2)             Excludessublease rental income of $369,000 through February 2011.

(3)             TheCompany entered into a capital lease agreement in the amount of $491,000 on May1, 2006 to finance the purchase of furniture and equipment for the Company’sheadquarters located in Andover, Massachusetts. The lease, which has a five year term, expires on May 31, 2011 and ispayable in 60 equal monthly installments. The lease contains a provision whereby the Company may be required torepay immediately the outstanding principal balance under the lease should theCompany’s cash balance fall below $5.0 million. In January 2007, the Company’s cash balance fell below $5.0 million andtherefore the entire principal balance of $399,338 may be required to be paidin full in 2007.

(4)             Thenote, which was issued to BlueChip’s sole shareholder as part of theconsideration for BlueChip, is payable in 36 monthly principal installments of$47,000 plus interest.

**Off-BalanceSheet Arrangements**

We do not have anyrelationships with unconsolidated entities or financial partnerships, such asentities often referred to as structured finance or special purpose entities,that would have been established for the purpose of facilitating off-balancesheet arrangements (as that term is defined in Item 303(a)(4)(ii) of RegulationS-K) or other contractually narrow or limited purposes.  As such, we arenot exposed to any financing, liquidity, market or credit risk that could ariseif we had engaged in those types of relationships.

**Item3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

*Derivative Financial Instruments,Other Financial Instruments, and Derivative Commodity Instruments. *As of June 30, 2007,the Company did not participate in any derivative financial instruments orother financial and commodity instruments for which fair value disclosure wouldbe required under SFAS No. 133, “*Accounting for DerivativeInstruments and Hedging Activities.*” All of 

25

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the Company’s investments consist of money marketfunds and commercial paper that are carried on the Company’s books at amortizedcost, which approximates fair market value. Accordingly, the Company has no quantitative information concerning themarket risk of participating in such investments.

*Primary Market Risk Exposures. *The Company’s primarymarket risk exposures are in the areas of interest rate risk and foreigncurrency exchange rate risk.  The Company’scurrent investment portfolio of cash equivalents is subject to interest ratefluctuations, but the Company believes this risk is immaterial due to theshort-term nature of these investments. The Company’s exposure to currency exchange rate fluctuations has beenand is expected to continue to be modest due to the fact that the operations ofits United Kingdom subsidiary are almost exclusively conducted in the UnitedKingdom subsidiary’s local currency.  TheCompany translates the operating results of its United Kingdom subsidiary intoU.S. dollars and consolidates them for reporting purposes.  The impact of currency exchange ratemovements on intercompany transactions was immaterial for the quarter endedJune 30, 2007.  The Company manages itsforeign currency exchange risk by monitoring its net monetary position usingnatural hedges of its assets and liabilities denominated in localcurrencies.  There can be no assurancethat this approach will eliminate all foreign currency exchange rateexposure.  Currently, the Company doesnot engage in foreign currency hedging activities.

**Item4.  Controls and Procedures**

(a)             Evaluation ofdisclosure controls and procedures.

As of June 30, 2007 (the “Evaluation Date”),the Company, under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, evaluated the effectiveness of the design and operation of the Company’sdisclosure controls and procedures pursuant to Rule 13a-15(b)promulgated under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”).  Based upon that evaluation,the Company’s Chief Executive Officer and Chief Financial Officer concludedthat, as of the Evaluation Date, the Company’s disclosure controls andprocedures were effective in ensuring that information relating to the Company(including its consolidated subsidiaries) required to be disclosed by theCompany in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized, and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, includingensuring that this information is accumulated and communicated to the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

(b)            Changes in internalcontrol over financial reporting

There were no changes inthe Company’s internal control over financial reporting during the Company’sfiscal quarter ended June 30, 2007 or in other factors that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

**PARTII:  OTHER INFORMATION**

**Item1.  Legal Proceedings**

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

**Item1A.  Risk Factors**

**From time to time we update, revise and supplementthe risk factors described under the title “Risk Factors” in our Annual Reporton Form 10-K for the fiscal year ended December 31, 2006.  We updatedthose risk factors in connection with our filing of our Quarterly Report onForm 10-Q for the quarter ended March 31, 2007. There are no material changes to the risk factors described in the “RiskFactors” section in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2006, as updated by the risk factors described in ourQuarterly Report on Form 10-Q for the quarter ended March 31, 2007, other thanthe inclusion herein of two updated Risk Factors below entitled “*Wehave experienced operating losses and our future operating results areuncertain and difficult to predict***,”and “*Our common stock has been delisted from The NasdaqCapital Market**whichhas made our stock significantly less liquid and may affect its value and couldsignificantly impair our ability to raise capital***.”**

**Weoperate in a rapidly changing environment that involves a number of risks, someof which are beyond our control.  This discussion highlights some of therisks that may affect future operating results.  These are the risks anduncertainties we believe are most important for you to consider. Additional risks and uncertainties not presently known to us, which wecurrently deem immaterial or which are similar to those faced by othercompanies in our industry or business in general, may also impair our businessoperations.  If any of the following risks or uncertainties actuallyoccurs, our business, financial condition, and operating results would likelysuffer.**

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***We have experienced operating losses and our futureoperating results are uncertain and difficult to predict.****  *We had an operating loss forthe quarter ended June 30, 2007 and for the years ended December 31, 2006and 2005 and we last recorded an operating profit in the year endedDecember 31, 2004. As of June 30, 2007, we had cash and cash equivalentsof $2.6 million and a net working deficit of $2.6 million. There can be noassurance that we will be able to increase our level of revenue or becomeprofitable again in the future, as our operating history makes the accurateprediction of future operating results difficult or impossible. We do, however,anticipate increases in operating expenses and, together with any pricingpressures, failure to achieve broader market acceptance of our products anddecline in the growth rate of the overall United States economy or our industryin particular, we may experience continuing operating losses.

Our AccuRouteproduct represented 80%, 59%, and 50% of software license revenue for thequarter ended June 30, 2007 and the years ended December 31, 2006 and2005, respectively. Our ability to improve our operating results will dependupon, among other things, our ability to increase sales of our AccuRoute,Genifax and BlueChip products to new customers, as well as our ability toincrease product penetration into existing customers. We expanded our strategicfocus to include document routing and distribution software. To date, we havelimited financial and operating data and a limited operating history relevantto this strategy. Accordingly, it is difficult to evaluate the prospects forthe level of acceptance of this strategy. In addition, we plan to continueinvesting significantly in the expansion of our AccuRoute product into newvertical markets, including the healthcare and financial services verticalmarkets, in advance of significant related revenue from those markets. Wecannot predict the timing or level of revenue resulting from these investments.Future operating results will depend on many other factors, including, withoutlimitation, the degree and rate of growth of the markets in which we compete;the level of product and price competition; our ability to establish strategicrelationships and develop and market new and enhanced products; our ability tocontrol costs; our ability to expand our direct and indirect distributionchannel sales both domestically and internationally; our ability to integrateour products and cross-sell our solutions across vertical markets; and ourability to attract and retain key personnel. As a result, it is possible thatin the future, our operating results will be below the expectations of publicmarket analysts and investors. In that event, the price of our common stockwould likely be materially adversely affected.

***Our common stock has been delisted from The Nasdaq CapitalMarket which has made our stock significantly less liquid and may affect itsvalue and could significantly impair our ability to raise capital.***  Prior to August 2, 2007, our common stock was listed on The Nasdaq CapitalMarket (“Nasdaq”). Effective August 2, 2007, our common stock wasdelisted from Nasdaq as a result of our failure to comply with MarketplaceRule 4310(c)(2)(B), which requires issuers on Nasdaq to have (i) aminimum of $2,500,000 in stockholders’ equity; (ii) $35,000,000 marketvalue of listed securities; or (iii) $500,000 of net income fromcontinuing operations for the most recently completed fiscal year or two of thethree most recently completed fiscal years. Our common stock is currently beingtraded over-the-counter through the Pink Sheets electronic quotation service. Thetrading of our common stock on the Pink Sheets may reduce the price of ourcommon stock and the levels of liquidity available to our shareholders. Inaddition, the trading of our common stock on the Pink Sheets may materiallyadversely affect our access to the capital markets, and the limited liquidityand potentially reduced price of our common stock could materially adverselyaffect our ability to raise capital through alternative financing sources onterms acceptable to us or at all.

***Our business couldbe adversely affected if we were unable to comply fully with existing andfuture corporate governance requirements*****.**  We are subject to numerouscorporate governance requirements and, in particular, under currentregulations, we will be required to furnish the management report on internalcontrol over financial reporting as part of our annual report for the yearended December 31, 2007, pursuant to Section 404 of the Sarbanes-Oxley Act. Theprocess of complying with Section 404 is expensive and time-consuming andrequires significant management attention. Because our limited financial andmanagerial resources are focused on the pursuit of strategic and financialalternatives and company operations, it is possible that we will be unable to complyfully with Section 404 and other corporate governance requirements. If weare unable to comply fully with these requirements, our business and thetrading price and liquidity of our common stock would likely be adverselyaffected.

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

We held our AnnualMeeting of Stockholders on Tuesday, May 22, 2007 at our offices at 6 RiversideDrive, Andover, Massachusetts. The first of the two matters voted upon was theelection of each of Richard D. Cramer and William J. Rynkowski, Jr. as a ClassI director of the Company. The terms of office of Robert L. Voelk, Martin A.Schultz, Arnold E. Ditri, William J. Drummey and James P. O’Halloran continuedafter the meeting.

  Thetabulation with respect to each nominee for Class I director is as set forthbelow:
| **Nominee**                | ** ** | **Number of  Votes For** | ** ** | **Number of Votes  Withheld** | ** ** | **Number of  Abstentions** | ** ** | **Number of  Broker non-  votes** | ** ** |
|----------------------------|------------|------------------------------------|------------|-----------------------------------------|------------|---------------------------------|------------|---------------------------------------------|------------|
| Richard D.  Cramer         |       | 3,568,745                          |       | 34,352                                  |       | N/A                             |       | 0                                           |       |
| William J. Rynkowski,  Jr. |       | 3,570,059                          |       | 33,038                                  |       | N/A                             |       | 0                                           |       |

 

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The second of the two matters voted upon at our Annual Meeting ofStockholders was the approval of our 2007 Equity Compensation Incentive Plan(the “2007 Plan”). The tabulation with respect to the approval of the2007 Plan is as set forth below:

| Number of  Votes For | ** ** | **Number of Votes  Withheld** | ** ** | **Number of  Abstentions** | ** ** | **Number of  Broker non-  votes** | ** ** |
|--------------------------------|------------|-----------------------------------------|------------|---------------------------------|------------|---------------------------------------------|------------|
| 1,380,766                      |       | 57,330                                  |       | 3,914                           |       | 2,161,087                                   |       |

 

**Item5.  Other Information**

Effective August 2, 2007, our common stock wasdelisted from Nasdaq as a result of our failure to comply with MarketplaceRule 4310(c)(2)(B), which requires issuers on Nasdaq to have (i) aminimum of $2,500,000 in stockholders’ equity; (ii) $35,000,000 marketvalue of listed securities; or (iii) $500,000 of net income fromcontinuing operations for the most recently completed fiscal year or two of thethree most recently completed fiscal years. Our common stock is currently beingtraded over-the-counter through the Pink Sheets electronic quotation service.

There have been no changes to the procedures by whichsecurity holders may recommend nominees to the Company’s Board of Directorsduring the time period covered by this Quarterly Report on Form 10-Q.

**Item6.  Exhibits**

Exhibits
| 10.1   |   | Letter Agreement regarding Change of Control  Severance Eligibility, dated April 11, 2007, by and among Omtool, Ltd. and  Karen Cummings (filed as Exhibit 10.1 to Omtool, Ltd.’s Current Report on 8-K  filed with the Securities and Exchange Commission on April 16, 2007) |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                               |
| 31.1   |   | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                               |
| 31.2   |   | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                               |
| 32.1   |   | Certification of Chief Executive Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                               |
| 32.2   |   | Certification of Chief Financial Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                                               |

 

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OMTOOL, LTD.

**Signatures**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                      |   |   | OMTOOL, LTD. |
|----------------------|--------|--------|--------------|
|                 |   |   |         |
|                 |   |   | By:          |   | /s/ Daniel A. Coccoluto |   |
| August 2,  2007 |   |   |         | Daniel A. Coccoluto |
|                 |   |   |         | Chief Financial Officer, Secretary and Treasurer |
|                 |   |   |         | (Duly authorized officer and principal financial  officer) |

 

**ExhibitIndex**
| 10.1   |   | Letter Agreement regarding Change of Control  Severance Eligibility, dated April 11, 2007, by and among Omtool, Ltd. and  Karen Cummings (filed as Exhibit 10.1 to Omtool, Ltd.’s Current Report on 8-K  filed with the Securities and Exchange Commission on April 16, 2007) |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                               |
| 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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