** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

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

** **

**For thequarterly period ended March 31, 2008**

** **

**OR**

** **

| **o****TRANSITION REPORT 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 ofRegistrant as Specified in Its Charter)

 

| **Delaware**                    | ** ** | **02-0447481**         |
|---------------------------------|------------|------------------------|
| (State or Other Jurisdiction of |       | (I.R.S. Employer       |
| Incorporation or Organization)  |       | Identification Number) |

 

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

 

**(978)327-5700**

(Registrant’s TelephoneNumber Including Area Code)

 

Indicate by check mark whether the Registrant (1) has filed allreports 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 whetherthe registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 

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

 

Indicate by check mark whether the Registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

 

Yes  o   No  x

 

There were 4,744,267 shares of the Company’s common stock, par value$0.01, outstanding on May 12, 2008.

 

 

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**OMTOOL,LTD. AND SUBSIDIARIES**

 

FORM 10-Q

For theQuarter Ended March 31, 2008

CONTENTS

 
| **Item Number**                     |                                                                                                        |   |
|-------------------------------------|-------------------------------------------------------------------------------------------------------------|--------|
|                                |                                                                                                        |   |
| PART I:  FINANCIAL INFORMATION |                                                                                                        |
|                                |                                                                                                        |   |
| Item 1.                             | Consolidated Financial Statements                                                                           |   |
|                                | Consolidated  Balance Sheets as of March 31, 2008 (Unaudited) and December 31,  2007              |   |
|                                | Consolidated  Statements of Operations for the three months ended March 31, 2008 and  2007 (Unaudited) |   |
|                                | Consolidated  Statements of Cash Flows for the three months ended March 31, 2008 and  2007 (Unaudited) |   |
|                                | Notes to  Consolidated Financial Statements                                                                 |   |
|                                |                                                                                                        |   |
| Item 2.                             | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                 |   |
|                                |                                                                                                        |   |
| Item 4.                             | Controls and Procedures                                                                                     |   |
|                                |                                                                                                        |   |
| PART II: OTHER INFORMATION     |                                                                                                        |
|                                |                                                                                                        |   |
| Item 1A.                            | Risk Factors                                                                                                |   |
|                                |                                                                                                        |   |
| Item 2.                             | Unregistered Sales of Equity Securities and  Use of Proceeds                                                |   |
|                                |                                                                                                        |   |
| Item 5.                             | Other Information                                                                                           |   |
|                                |                                                                                                        |   |
| Item 6.                             | Exhibits                                                                                                    |   |
|                                |                                                                                                        |   |
| Signatures                          |                                                                                                        |   |
|                                |                                                                                                        |   |
| Exhibit Index                  |                                                                                                        |   |
|                                |                                                                                                        |   |
| Exhibits                            |                                                                                                        |   |

 

2

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**PART I:  FINANCIAL INFORMATION**

 

**Item 1.  Consolidated FinancialStatements**

 

**OMTOOL,LTD. AND SUBSIDIARIES**

**ConsolidatedBalance Sheets**

 
| ** **                                                                                                                                                                                                                               | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                               | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                               | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                                                                          |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                |       | $                        | 2,443,626  |                        | $          | 2,328,033 |   |
| Accounts receivable, net of reserves of  $49,000 at March 31, 2008 and $45,000 at December 31, 2007,  respectively                                                                                                             |       | 2,066,111                |       | 2,132,950                   |       |
| Unbilled accounts receivable                                                                                                                                                                                                             |       | 380,904                  |       | 419,843                     |       |
| Inventory                                                                                                                                                                                                                                |       | 100,592                  |       | 75,959                      |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                |       | 357,341                  |       | 368,739                     |       |
| Total current assets                                                                                                                                                                                                                     |       | 5,348,574                |       | 5,325,524                   |       |
| Property and equipment, net                                                                                                                                                                                                              |       | 1,211,551                |       | 1,278,297                   |       |
| Goodwill                                                                                                                                                                                                                                 |       | 1,883,096                |       | 1,883,096                   |       |
| Intangible assets, net                                                                                                                                                                                                                   |       | 1,182,594                |       | 1,276,656                   |       |
| Unbilled accounts receivable, long-term                                                                                                                                                                                                  |       | 156,476                  |       | 216,997                     |       |
| Other assets                                                                                                                                                                                                                             |       | 291,568                  |       | 291,568                     |       |
| Total assets                                                                                                                                                                                                                             |       | $                        | 10,073,859 |                        | $          | 10,272,138 |   |
|                                                                                                                                                                                                                                     |       |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                            | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                                                                                     |       |                     |       |                        |       |
| Accounts payable                                                                                                                                                                                                                         |       | $                        | 831,680    |                        | $          | 949,941 |   |
| Accrued liabilities                                                                                                                                                                                                                      |       | 1,821,117                |       | 1,571,099                   |       |
| Deferred revenue, current                                                                                                                                                                                                                |       | 4,578,113                |       | 4,346,598                   |       |
| Capital lease obligations, current                                                                                                                                                                                                       |       | 96,401                   |       | 94,624                      |       |
| Note payable, current                                                                                                                                                                                                                    |       | 561,234                  |       | 561,234                     |       |
| Total current liabilities                                                                                                                                                                                                                |       | 7,888,545                |       | 7,523,496                   |       |
| Long term liabilities:                                                                                                                                                                                                                   |       |                     |       |                        |       |
| Deferred rent                                                                                                                                                                                                                            |       | 467,879                  |       | 467,660                     |       |
| Deferred revenue, long-term                                                                                                                                                                                                              |       | 550,507                  |       | 523,877                     |       |
| Capital lease obligations, long-term                                                                                                                                                                                                     |       | 235,201                  |       | 259,977                     |       |
| Note payable, long-term                                                                                                                                                                                                                  |       | 561,234                  |       | 701,543                     |       |
| Total liabilities                                                                                                                                                                                                                        |       | 9,703,366                |       | 9,476,553                   |       |
|                                                                                                                                                                                                                                     |       |                     |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                                                               |       |                     |       |                        |       |
| Preferred Stock, $0.01 par value —                                                                                                                                                                                                  |       |                     |       |                        |       |
| Authorized — 2,000,000 shares; Issued and  outstanding — none                                                                                                                                                                  |       | —                   |       | —                      |       |
| Common stock, $0.01 par value —                                                                                                                                                                                                     |       |                     |       |                        |       |
| Authorized — 35,000,000 shares; Issued —  4,743,209 shares at March 31, 2008 and December 31, 2007;  Outstanding — 4,704,267 shares at March 31, 2008 and 4,561,045 shares at  December 31, 2007 |       | 47,432                   |       | 47,432                      |       |
| Additional paid-in capital                                                                                                                                                                                                               |       | 35,671,624               |       | 36,683,169                  |       |
| Accumulated deficit                                                                                                                                                                                                                      |       | (34,978,016              | )          | (34,465,277                 | )          |
| Treasury stock, at cost, 38,942 shares at  March 31, 2008 and 182,164 shares at December 31, 2007                                                                                                                              |       | (299,075                 | )          | (1,399,071                  | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                     |       | (71,472                  | )          | (70,668                     | )          |
| Total stockholders’ equity                                                                                                                                                                                                          |       | 370,493                  |       | 795,585                     |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                          |       | $                        | 10,073,859 |                        | $          | 10,272,138 |   |

 

Theaccompanying notes are an integral part of these unaudited consolidatedfinancial statements.

 

3

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**OMTOOL,LTD. AND SUBSIDIARIES**

**ConsolidatedStatements of Operations**

(Unaudited)

 
| ** **                                               | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                               | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Revenue:                                                 |       |                                             |       |   |   |
| Software  license                                        |       | $                                                | 1,257,014  |   | $ | 1,047,313 |   |
| Hardware and  media                                      |       | 365,974                                          |       | 462,006 |   |
| Service and  other                                       |       | 2,329,046                                        |       | 2,323,795 |   |
|                                                     |       |                                             |       |   |   |
| Total  revenue                                           |       | 3,952,034                                        |       | 3,833,114 |   |
|                                                     |       |                                             |       |   |   |
| Cost of revenue:                                         |       |                                             |       |   |   |
| Software  license                                        |       | 91,350                                           |       | 101,275 |   |
| Hardware and  media                                      |       | 228,163                                          |       | 294,130 |   |
| Service and  other                                       |       | 951,474                                          |       | 1,068,375 |   |
|                                                     |       |                                             |       |   |   |
| Total cost  of revenue                                   |       | 1,270,987                                        |       | 1,463,780 |   |
|                                                     |       |                                             |       |   |   |
| Gross profit                                             |       | 2,681,047                                        |       | 2,369,334 |   |
|                                                     |       |                                             |       |   |   |
| Operating  expenses:                                     |       |                                             |       |   |   |
| Sales and  marketing                                     |       | 1,676,420                                        |       | 2,196,729 |   |
| Research and  development                                |       | 700,748                                          |       | 880,081 |   |
| General and  administrative                              |       | 790,068                                          |       | 996,945 |   |
| Restructuring  costs                                     |       | —                                           |       | 212,802 |   |
|                                                     |       |                                             |       |   |   |
| Total  operating expenses                                |       | 3,167,236                                        |       | 4,286,557 |   |
|                                                     |       |                                             |       |   |   |
| Loss from  operations                                    |       | (486,189                                         | )          | (1,917,223 | ) |
|                                                     |       |                                             |       |   |   |
| Interest and  other income                               |       | 17,812                                           |       | 20,488 |   |
| Interest  expense                                        |       | (26,238                                          | )          | (51,037 | ) |
|                                                     |       |                                             |       |   |   |
| Net loss                                                 |       | $                                                | (494,615   | ) | $ | (1,947,772 | ) |
|                                                     |       |                                             |       |   |   |
| Net loss per  share:                                     |       |                                             |       |   |   |
| Basic and  diluted                                       |       | $                                                | (0.11      | ) | $ | (0.43 | ) |
|                                                     |       |                                             |       |   |   |
| Weighted average  shares used in per share calculations: |       |                                             |       |   |   |
| Basic and  diluted                                       |       | 4,657,725                                        |       | 4,478,066 |   |

 

Theaccompanying notes are an integral part of these unaudited consolidatedfinancial statements*.*

 

4

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**OMTOOL,LTD. AND SUBSIDIARIES**

**ConsolidatedStatements of Cash Flows**

(Unaudited)

 
| ** **                                                                                 | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Cash Flows from Operating Activities:                                                      |       |                                             |       |   |   |
| Net loss                                                                                   |       | $                                                | (494,615   | ) | $ | (1,947,772 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |       |                                             |       |   |   |
| Depreciation and amortization                                                              |       | 164,789                                          |       | 200,015 |   |
| Accounts receivable reserves                                                               |       | 3,723                                            |       | 14,846 |   |
| Stock-based compensation                                                                   |       | 109,769                                          |       | 79,285 |   |
| Changes in assets and liabilities:                                                         |       |                                             |       |   |   |
| Accounts receivable                                                                        |       | 63,241                                           |       | (5,338 | ) |
| Unbilled accounts receivable                                                               |       | 99,460                                           |       | 196,704 |   |
| Prepaid expenses and other current assets                                                  |       | 11,440                                           |       | 59,405 |   |
| Inventory                                                                                  |       | (24,633                                          | )          | (68,900 | ) |
| Other assets                                                                               |       | —                                           |       | 11,562 |   |
| Accounts payable                                                                           |       | (118,334                                         | )          | (196,365 | ) |
| Accrued liabilities                                                                        |       | 204,306                                          |       | 321,845 |   |
| Deferred revenue                                                                           |       | 257,409                                          |       | 723,612 |   |
| Deferred rent                                                                              |       | 219                                              |       | (31,348 | ) |
|                                                                                       |       |                                             |       |   |   |
| Net cash provided by (used in) operating  activities                                       |       | 276,774                                          |       | (642,449 | ) |
|                                                                                       |       |                                             |       |   |   |
| Cash Flows from Investing Activities:                                                      |       |                                             |       |   |   |
| Additional purchase consideration for  BlueChip acquisition                                |       | —                                           |       | (107,045 | ) |
| Cash paid for BlueChip acquisition                                                         |       | —                                           |       | (562,090 | ) |
| Purchases of property and equipment                                                        |       | (3,965                                           | )          | (20,451 | ) |
|                                                                                       |       |                                             |       |   |   |
| Net cash used in investing activities                                                      |       | (3,965                                           | )          | (689,586 | ) |
|                                                                                       |       |                                             |       |   |   |
| Cash Flows from Financing Activities:                                                      |       |                                             |       |   |   |
| Net proceeds from issuance of common stock                                                 |       | 4,530                                            |       | 7,105 |   |
| Net proceeds from issuance of restricted  common stock                                     |       | 1,648                                            |       | 1,287 |   |
| Forfeiture of restricted common stock                                                      |       | (89                                              | )          | (171 | ) |
| Principal payments for note payable                                                        |       | (140,309                                         | )          | — |   |
| Principal payments for capital lease obligations                                           |       | (22,999                                          | )          | (21,350 | ) |
|                                                                                       |       |                                             |       |   |   |
| Net cash used in financing activities                                                      |       | (157,219                                         | )          | (13,129 | ) |
|                                                                                       |       |                                             |       |   |   |
| Exchange rate effect on cash and cash  equivalents                                         |       | 3                                                |       | (14,294 | ) |
|                                                                                       |       |                                             |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                      |       | 115,593                                          |       | (1,359,458 | ) |
|                                                                                       |       |                                             |       |   |   |
|  Cash and cash equivalents, beginning  of period                                      |       | 2,328,033                                        |       | 5,469,366 |   |
|                                                                                       |       |                                             |       |   |   |
| Cash and cash equivalents, end of period                                                   |       | $                                                | 2,443,626  |   | $ | 4,109,908 |   |
| Supplemental Disclosure of Cash Flow  Information:                                         |       |                                             |       |   |   |
| Cash paid during the period for interest                                                   |       | $                                                | 29,074     |   | $ | 8,128 |   |

 

Theaccompanying notes are an integral part of these unaudited consolidatedfinancial statements*.*

 

5

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**OMTOOL,LTD. AND SUBSIDIARIES**

**Notesto Consolidated Financial Statements**

(Unaudited)

 

**(1) Basis of Presentation**

 

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

 

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

 

**(2) Net Loss Per Share**

 

The Company reports net loss per share in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 128,**“*Earnings per Share*.” Dilutedweighted average shares outstanding for the fiscal quarter ended March 31,2008 and March 31, 2007 exclude 475,255 and 498,055, respectively, ofpotential common shares from stock options and a stock warrant because toinclude them would have been anti-dilutive for the periods presented as theCompany reported a net loss during the periods.

 

**(3) Income Taxes**

 

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

 

Financial AccountingStandards Board (“FASB”) Interpretation No. 48 “*Accounting for Uncertainty inIncome Taxes, an interpretation of FAS 109*” (“FIN 48”) clarifies the criteria that an individual taxposition must satisfy for some or all of the benefits of that position to berecognized in a company’s financial statements. As of March 31, 2008 and December 31,2007, the Company had no unrecognized tax benefits. The Company has not, asyet, conducted a study of its R&D credit carryforwards. This study mayresult in an increase or decrease to the Company’s R&D creditcarryforwards, however, until a study is completed and any adjustment is known,no amounts are being presented as an uncertain tax position under FIN 48. Afull valuation allowance has been provided against the Company’s R&Dcredits and, if an adjustment is required, this adjustment would be offset byan adjustment to the valuation allowance. As a result, there would be no impactto the consolidated balance sheet, statement of operations or cash flows if anadjustment were required.

 

During the three monthsended March 31, 2008 and March 31, 2007, the Company did not recordan income tax benefit associated with any pre-tax loss due to the uncertaintyregarding future taxable income.

 

**(4) Comprehensive Loss**

 

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

 

6

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| ** **                                | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Net loss                                  |       | $                                                | (494,615   | ) | $ | (1,947,772 | ) |
| Foreign  currency translation adjustments |       | (804                                             | )          | (1,663 | ) |
| Comprehensive  loss                       |       | $                                                | (495,419   | ) | $ | (1,949,435 | ) |

 

**(5) Acquisition**

 

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

 

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

 

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

 

**(6) Stock-based Compensation**

 

The Company’s 1996 StockOption Plan and 1997 Stock Plan, as amended, provided for the issuance ofcommon stock pursuant to the grant to employees of “incentive stock options”within the meaning of the Internal Revenue Code of 1986, as amended, the grantof nonqualified stock options, stock awards or opportunities to make directpurchases of stock in the Company to employees, consultants, directors andofficers of the Company. In 1997, the Company’s Board of Directors voted thatno further options would be granted or issued under the Company’s 1996 StockOption Plan and on April 14, 2007, the Company’s 1997 Stock Plan expired.The Company’s 2007 Equity Compensation Incentive Plan (“2007 Plan”) wasapproved by the Board of Directors on April 16, 2007 and the Company’sshareholders at the annual meeting of shareholders on May 22, 2007. The2007 Plan provides for the issuance of shares of common stock to employees,consultants, directors and officers of the Company much like the 1997 StockPlan. The aggregate number of shares that can be issued pursuant to the 2007Plan is 500,000 and any shares granted under the 2007 Plan that are canceled orexpired are added back to the 2007 Plan for future issuance. As of March 31,2008, 185,300 shares had been issued under the 2007 Plan. Shares issuedpursuant to this plan are issued from treasury to the extent they areavailable. Stock-based compensation is accounted for in accordance with SFAS No. 123(R),“*Share-Based Payment*”**(“SFAS123R”).

 

During the three-monthperiods ended March 31, 2008 and March 31, 2007, the Company incurredstock-based compensation expense for restricted common stock (“restrictedstock”) and stock options. The Company also incurred stock-basedcompensation expense for the employee stock purchase plan (the “ESPP”) duringthe three-month period ended March 31, 2007. The ESPP was terminated on July 1,2007.

 
| ** **                                                                      | ** ** | **Three months ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Stock-based  compensation expense included in cost of service and other revenue |       | $                                                | 2,541      |   | $ | 2,112 |   |
| Stock-based  compensation expense included in operating expenses                |       | 107,228                                          |       | 77,173 |   |
| Total  stock-based compensation expense                                         |       | $                                                | 109,769    |   | $ | 79,285 |   |

 

***Stock Options***

 

Under the terms of the Company’s 1996 Stock Option Plan and 1997 StockPlan, options vest and become exercisable as determined by the Board ofDirectors and expire 10 years after the date of grant. Stock option compensation expense calculatedunder the fair value approach is recognized ratably over the four-year vestingperiod. The fair value for granted options was estimated at the time of grantusing the Black-Scholes option-pricing model. During the three-month periodsended March 31, 2008 and March 31, 2007, the Company recognized $182and $3,353, respectively, of stock-based compensation expense related to stockoptions. As of March 31, 2008, there was no unrecognized stock-basedcompensation 

 

7

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expenserelated to stock options. The Company did not grant any stock options during thethree-month periods ended March 31, 2008 and March 31, 2007.

 

***RestrictedCommon Stock***

*** ***

Prior to April 14, 2007, the Company sold shares of restrictedstock under the Company’s 1997 Stock Plan, as amended, to its Board ofDirectors and certain employees of the Company at a price per share of $0.01.The Company has continued to issue shares of restricted stock in a similarmanner under the 2007 Plan. The shares of restricted stock vest ratably over athree- or 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 three- or four-yearvesting period. Based upon historical information and management’s estimate offuture voluntary turnover rates, the Company has calculated this expense basedon an annualized estimated forfeiture rate of 12%. The Company trues-upestimated forfeitures to actual forfeitures at the end of each reportingperiod. During the three months ended March 31, 2008, the Company sold164,800 shares of restricted stock to its Board of Directors and certainemployees of the Company at a price of $.01 per share under the Company’s 2007Plan. During the three months ended March 31, 2007, the Company sold128,675 shares of restricted stock, under the Company’s 1997 Stock Plan, asamended, to its Board of Directors and certain employees of the Company at aprice per share of $0.01.

 

The following is a summary of the Company’s unvested restricted stockawards:

 
| ** **                        | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|-----------------------------------|------------|---------------------------------|------------|------------------------------------------------------------------------|------------|
| Unvested,  December 31, 2007 |       | 258,167                         |       | $                                                                      | 4.44       |   |
| Granted                           |       | 164,800                         |       | 3.24                                                                   |       |
| Vested                            |       | (57,424                         | )          | 5.05                                                                   |       |
| Forfeited                         |       | (8,849                          | )          | 4.11                                                                   |       |
| Unvested, March 31,  2008    |       | 356,694                         |       | $                                                                      | 3.80       |   |

 

**(7) Accrued Liabilities**

 

Accrued liabilitiesconsist of the following:

 
| ** **                         | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Accrued  health insurance expense  |       | 300,841                  |       | $                           | 300,841    |   |
| Accrued  state sales tax           |       | 371,784                  |       | 344,906                     |       |
| Accrued salary  and salary-related |       | 799,645                  |       | 568,339                     |       |
| Accrued  professional fees         |       | 136,064                  |       | 145,420                     |       |
| Other  accrued expenses            |       | 212,783                  |       | 211,593                     |       |
|                               |       | $                        | 1,821,117  |                        | $          | 1,571,099 |   |
|                                    |            |                          |            |                             |            |  |  |

 

**(8) Capital Lease Obligations**

 

On May 1, 2006, the Company entered into a capital lease agreementin the amount of $491,000 to finance the purchase of furniture and equipmentfor the Company’s headquarters located in Andover, Massachusetts. The lease hasa five year term which expires on May 31, 2011 and is payable in 60 equalmonthly installments. The interest rate on the capital lease is 6.2%. Totalinterest payments over the life of the lease are estimated to be $99,000.

 

The lease contained aprovision whereby the Company would be required to immediately repay theoutstanding principal balance should the Company’s cash balance ever be lessthan $5,000,000. On August 6, 2007, the Company entered into an amendmentto the aforementioned capital lease which lowered the Company’s requiredminimum cash balance to $2,100,000. In addition, on August 30, 2007, theCompany entered into a pledge and security agreement with the capital financingprovider that requires a minimum balance of cash and cash equivalents of noless than $250,000 (“pledged collateral”) and in the event that Company’scash balance falls below $250,000 the Company will immediately provide the 

 

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amount necessary to cover such shortfall to thecapital financing provider. In the event of default in maintaining the requiredamount of pledged collateral or the making of any lease payments, the pledgedcollateral will first be used as payment for costs and expenses incurred toenforce the security and pledge agreement and second for payment in full of theoutstanding principal loan balance. The minimum required cash balance of$2,100,000 includes the pledged collateral. As of March 31, 2008 and December 31,2007, the pledged collateral of $250,000 is restricted cash and has beenclassified as “other assets” in the accompanying balance sheet.

 

**(9) Note Payable**

 

On December 29, 2006, the Company issued a promissory note in theamount of $1,683,702 to the principal shareholder of BlueChip in partialconsideration of all the outstanding shares of BlueChip (See Note 5). The noteis payable in thirty-six equal monthly principal installments of approximately$47,000 plus interest, commencing on March 30, 2007. The promissory notebears interest 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 three monthsended March 31, 2008, the Company made total payments of approximately$163,000, consisting of principal payments totaling $140,000 and accumulatedinterest of $23,000, based upon an average interest rate of  7.42%.

 

**(10) Restructuring Costs**

 

In March 2007, the Company announced a restructuring of certain ofits operations and reduced its workforce by twelve employees. In addition, tenother positions were eliminated during the first quarter of fiscal year 2007.As a result of these activities, the Company recorded a pre-tax charge of$212,802 during the three-month period ended March 31, 2007 in accordancewith SFAS No. 146, “*Accounting for CostsAssociated with Exit or Disposal Activities.*”**Thecharge included $177,630 of severance-related costs associated with a totalworkforce reduction of approximately twenty-two positions and $35,172 as aresult of closing BlueChip’s former headquarters located in Danvers,Massachusetts.

 

The total cash impact of the restructuring was $212,802; the remainingbalance of $148,913 was paid during the second quarter of fiscal year 2007 and isincluded in accrued liabilities in the accompanying consolidated balance sheetas of March 31, 2007.

 

**(11) Segment and Geographic Information**

 

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

 

Total revenue from international sources was approximately $672,000 and$1,055,000 for the three months ended March 31, 2008 and 2007,respectively.

 

The following tablerepresents amounts relating to geographic locations:

 
| ** **         | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------|------------|--------------------------------------------------|------------|
| ** **         | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Total  revenue (1) |       |                                             |       |   |   |
| United  States     |       | $                                                | 3,280,060  |   | $ | 2,778,287 |   |
| United  Kingdom    |       | 281,671                                          |       | 585,323 |   |
| Canada             |       | 190,808                                          |       | 142,000 |   |
| South Africa       |       | 56,178                                           |       | 212,753 |   |
| Rest of  World     |       | 143,317                                          |       | 114,751 |   |
|               |       | $                                                | 3,952,034  |   | $ | 3,833,114 |   |

 
| ** **             | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Long-lived  assets (2) |       |                     |       |                        |       |
| United  States         |       | $                        | 4,709,777  |                        | $          | 4,928,660 |   |
| United  Kingdom        |       | 15,508                   |       | 17,954                      |       |
|                   |       | $                        | 4,725,285  |                        | $          | 4,946,614 |   |

 

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(1) Revenue is attributed to geographic regions based on locationof customer.

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

 

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**Item 2.**

 

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

 

Management’s Discussion and Analysis of Financial Condition and Resultsof Operations for the three months ended March 31, 2008 should be read inconjunction with the accompanying consolidated financial statements for theperiods specified and the associated notes. Further reference should be made toour Annual Report on Form 10-K for the year ended December 31, 2007,as filed with the SEC on March 28, 2008.

 

**Overview**

 

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

 

*Business*

 

We are now benefitingfrom the investments we have made in our flagship product, AccuRoute®, sinceits inception in 2004, as total AccuRoute revenue has grown by approximately24% in the first quarter of 2008 compared to the same period in 2007 and nowaccounts for 60% of our total revenue. Our gains in AccuRoute revenue havesurpassed the declines in revenue from our legacy fax business. While ourgrowing revenue indicates the success of our strategic plan, we still havechallenges to address as we seek to expand our business, including expandingour sales in the legal and professional services, healthcare and financialservices vertical markets; promoting our products and technologies throughreseller and marketing relationships with leading multi-function deviceproviders; and improving our results outside of the Americas. Although weachieved profitability for the quarter ended December 31, 2007, we haveincurred quarterly losses from the quarter ended September 30, 2005 to thequarter ended September 30, 2007 as well as the quarter ended March 31,2008, and may continue to incur losses in future quarters.

 

We experienced thebenefit of cost cutting measures associated with the restructurings weundertook in 2007, as our operating expenses decreased by approximately$907,000 (excluding the $212,802 restructuring charge incurred in the firstquarter of 2007) in the three months ended March 31, 2008 as compared tothe three months ended March 31, 2007. This combined with an increase inrevenue of $119,000 for the same period led to our net loss decreasing from$1.9 million in the three months ended March 31, 2007, to $495,000 in thethree months ended March 31, 2008.

 

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

 

*Products*

 

AccuRoute, our flagshipproduct, provides faster, more efficient document workflows and increasedworker productivity, while reducing cost, complexity and the risk of losingdocuments. We also include full enterprise fax capabilities integrated withinour AccuRoute product. These solutions are used worldwide by businesses indocument-intensive industries and sectors (such as legal and professionalservices, financial services, government and healthcare) that demand securehandling, integration and tracking of documents in full compliance with a rangeof regulatory requirements. Companies can deploy our software products onheterogeneous, multi-platform networks, digital scanning devices andmulti-function peripherals and integrate them with both desktop and enterprisesoftware applications. To address customer needs, our products are modular andscaleable. As a result, customers can add additional communication capacitythrough the addition of system components and connectors to keep pace withgrowing demands. In addition, due to this scalable, modular 

 

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design, customers can add additional Omtool productservers to a configuration to provide failover redundancy, helping to ensurecontinuous operation.

 

Our GenifaxTM product is a multi-tieredclient/server solution for automating and integrating fax communicationthroughout an enterprise. As a component of an enterprise software system, ourGenifax product is deployed on heterogeneous, multi-platform networks andintegrates with desktop and enterprise software applications.

 

Our GenidocsTM product is a client/servermessaging application that enables users to deliver documents through theInternet with comprehensive security and tracking 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 legacynetwork fax product, is a client/server software solution for automating andintegrating fax communication throughout an enterprise. As an integratedcomponent of an enterprise software system, our Fax Sr. product is deployed onheterogeneous, multi-platform networks and integrates with desktop andenterprise software applications.

 

We continue to maintainGenidocs and Fax Sr. and earn recurring maintenance revenue from our installedbase, although we have not sold these products in recent periods. At this time,however, we do not have plans to extend these technologies with new features ornew releases.

 

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

 

*Omtool Healthcare Suite*

 

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

 

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

 

·                     **ADT eFormsTM** - a production system thatprovides hospitals with on-demand ADT (admissions, discharge and transfer)electronic forms for registration and patient identification.

 

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

 

·                     **Image-InTM Point of Service** - an imagecapture system that scans images of common non-clinical documents such asinsurance cards, driver’s licenses, referral forms and HIPAA notices anddisplays them on a desktop paneled window.

 

·                     **Image-In Business** - a document and formcapture system that converts paper-based business documents to electronicrecords.

 

·                     **Image-In Clinical** - a medical records scanfacility that enables users to capture fully the entire patient file afterdischarge.

 

·                     **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 platformthat supports distributed document capture for scanning, routing and archivingmedical information throughout the patient service cycle and provides documentdistribution into the document workflow products found in Omtool’s HealthcareSuite.

 

·                     **ObjectArchiveTM** - an electronic archive thatprovides the foundation to securely store information designed, developed andcaptured through any of the Omtool Healthcare Suite products.

 

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*Vertical Market Focus*

 

While AccuRoute’s features are horizontal innature, they apply to many different vertical markets, including the legal andprofessional services, healthcare and financial services vertical markets. Wecontinue to add extensions to AccuRoute that provide the greater functionalitythat is critical to many of our customers. To provide more effective documentand information-handling solutions, we continue to advance our documentprocessing functionality while incrementally adding support for electronicinformation systems such as e-mail systems, enterprise content managementsystems, records management systems and archival systems. Earlier this year, wereleased Omtool Swiftwriter Plug-In for Adobe 3.0, a free, one-click solutionthat integrates Adobe PDF documents with popular document management systemssuch as OpenText/Hummingbird or Interwoven WorkSite. Swiftwriter for Adobesimplifies the opening, closing and check-in/check-out processes for users. Weoffer a set of tailored support options to generate revenue in this market.

 

We aim to extend our position as a provider of enterprise-classdocument-handling software solutions and become a leading provider ofelectronic document exchange solutions that capture, process and distributepaper or electronically formatted documents. To reinforce the Omtool brand inenterprise-class document handling and exchange solutions, while maintainingour strong position as an enterprise-level fax software provider, we intend totake advantage of our penetration of the legal and professional servicesvertical market, extend our presence in the healthcare vertical market andbroaden our customer base, industry partnerships and extensive knowledge ofenterprise content management.

 

While we have investedconsiderable resources to penetrate further the financial services verticalmarket and have created and are pursuing opportunities within that verticalmarket, we have found that sales opportunities for our AccuRoute product in thatvertical market, though significant, are longer term opportunities. Therefore,while we will continue to pursue these opportunities, primarily working withour large strategic and channel partners, we believe the best opportunities forreplicating our successes in the legal and professional services verticalmarket are in the healthcare vertical market. Similar to our views on the legaland professional services vertical market and based on the high level of focusby healthcare 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.

 

*Operating Results*

 

Our revenue consistsprimarily of software license revenue, hardware and media revenue, and serviceand other revenue, all as further described below. The following table is apresentation of our total revenue for the periods indicated:

 
| ** **                                    | ** ** | **Total Revenue** | ** ** | **Net Loss** | ** ** | **Software License  Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-------------------|------------|------------------------------------|------------|
| Three months  ended March 31, 2008       |       | $                      | 3,952,034  |              | $          | (494,615                           | )          | $ | 1,257,014 |   |
| Three months  ended March 31, 2007       |       | $                      | 3,833,114  |              | $          | (1,947,772                         | )          | $ | 1,047,313 |   |
| Change over  same period of prior fiscal year |       | $                      | 118,920    |              | $          | (1,453,157                         | )          | $ | 209,701 |   |
|                                          |       | or 3.1                 | %          | or (74.6          | )%         | or 20.0                            | %          |
|                                               |            |                        |            |                   |            |                                    |            |  |  |  |  |  |  |

 

During the three monthsended March 31, 2008 as compared to the three months ended March 31,2007, our revenue increased by approximately $119,000 and our net lossdecreased by approximately $1.5 million. Our gross profit for the three monthsended March 31, 2008 increased by approximately $312,000 as compared tothe same period in the prior fiscal year due primarily to an increase insoftware license revenue and a decrease in cost of sales for service and otherrelated to the restructuring we undertook in the first quarter of last year.

 

The increase in totalrevenue of approximately $119,000 during the three months ended March 31,2008 as compared to the same period in 2007 was primarily due to an increase insoftware license revenue from our customers in the healthcare and legal andprofessional services vertical markets. As a result of this and our continuedsuccess in the legal and professional services vertical market, for the quarterended March 31, 2008 we experienced a 20% increase in software licenserevenue led by a 31% increase in AccuRoute software license revenue as comparedto the same period in the prior fiscal year. This increase in AccuRoutesoftware license revenue was offset by a 40% decrease in our legacy fax productsoftware license revenue for the three months ended March 31, 2008 ascompared to the same period in the prior fiscal year. We continue to experiencegeneral market acceptance of our AccuRoute product in the legal andprofessional services vertical market while the demand for and our marketing ofour legacy fax product has continued to decrease.

 

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 costs are fixed in advance of a particular quarter. As a result,the costs we incur for sales and marketing, 

 

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research and development, and general andadministrative could continue to increase as a percentage of our revenue,thereby negatively affecting our operating results.

 

Sales from our Europeanoperations, which were in a steady decline for several years, increased by 29%during the twelve months ended December 31, 2007 as compared to twelvemonths ended December 31, 2006. Although we experienced a 20% decrease inrevenue in the first quarter of 2008 compared to the first quarter of 2007, weremain optimistic that we will continue to see improvements outside theAmericas. For now, however, we will rely primarily on our U.S. salesorganization for our shorter-term growth. We will continue to leverage ourEuropean AccuRoute base and indirect channel relationships to focus sales resourceson the overseas legal and financial services vertical markets. However, weexpect that in the short-term, U.S. sales are likely to constitute a greaterpercentage of revenue than sales outside the U.S. and there can be noassurances that we will be able to increase international sales of ourproducts. This failure to increase international sales may have a materialadverse effect on our business, financial condition and results of operations.

 

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

 

The following is apresentation of our domestic and international revenue:

 
| ** **                                    | ** ** | **Total Revenue** | ** ** | **United States Revenue**          | ** **                                    | **Non-United States Revenue**       | ** **                                  |
|-----------------------------------------------|------------|------------------------|------------|----------------------------------------------|-----------------------------------------------|-----------------------------------------------|---------------------------------------------|
| Three months ended March 31, 2008        |       | $                      | 3,952,034  |                                         | $ 3,280,060   or 83.0% of Total  Revenue |                                          | $ 671,974   or 17.0% of Total  Revenue |   |
| Three months ended March 31, 2007        |       | 3,833,114              |       | $ 2,778,287  or 72.5% of Total  Revenue |                                          | $ 1,054,827   or 27.5% of Total  Revenue |                                        |
| Change from same period of prior fiscal  year |       | $                      | 118,920    |                                         | $                                             | 501,773                                       |                                        | $ | (382,853 | ) |
|                                               |            |                        |            |                                              |                                               |                                               |                                             |  |  |  |

 

We will continue toleverage our existing distribution channels, where appropriate, to broaden ourreach to our target vertical markets and further penetrate our installed base. Weare pursuing sales opportunities via our solution/reseller channels, as well asfocusing sales efforts on specific market segments, in order to facilitateacceptance of our products. However, as shown in the following table, in recentperiods, more of our sales resources have been focused on selling directly toour customers and we have consequently derived a significant portion of ourrevenue 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 March 31, 2008       |       | $                                                                    | 1,622,988  |                                                                                                                        | $          | 370,091                                                                                                                                                                                                                                        |       | 22.8% |   |   |
| Three months  ended March 31, 2007       |       | $                                                                    | 1,509,319  |                                                                                                                        | $          | 429,958                                                                                                                                                                                                                                        |       | 28.5% |   |   |
| Change from  same period of prior fiscal year |       | $                                                                    | 113,669    |                                                                                                                        | $          | (59,867                                                                                                                                                                                                                                        | )          | (5.7) | percentage  points  (“ppt”) |   |
|                                          |       | or 7.5                                                               | %          | or (13.9                                                                                                                    | )%         |                                                                                                                                                                                                                                           |       |

 

**Critical AccountingPolicies 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 primarily from twosources: (i) product revenue, which includes software license, hardwareand media revenue, and (ii) service and support revenue, 

 

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which includes software maintenance and support, installation,implementation, training and consulting revenue. We license our softwareproducts on a perpetual basis. We generate revenue from licensing the rights touse our software products and sales of hardware directly to end-users andindirectly through resellers. Our resellers order products from us based onpurchase orders received from end-users and do not order stock. We generallysell our products to resellers and directly to end-users without anyspecifically stated rights of return. Occasionally, however, in our solediscretion, we will accept a product return if the end-user finds that the productdoes not fit its needs. We sell hardware and media products, which are providedby a third-party, at cost plus an additional mark-up, directly to end-usersand, in the case of hardware, indirectly through resellers as well. Thehardware products that we resell are not functional without our software. Tosupport our software products, we sell software maintenance and support,installation, implementation, training and consulting services directly toend-users and indirectly through resellers.

 

We apply the provisionsof Statement of Position (“SOP”) 97-2,**“*Software Revenue Recognition*,” as amended by SOP98-9, 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 Financial Accounting Standards (“SFAS”) 48,**“*Revenue Recognition When Right of Return Exists*,”with respect to providing for potential future product returns. As describedbelow, we must make and use significant judgments and estimates in connectionwith the revenue recognized in any accounting period. Material differences mayhave resulted in the amount and timing of our revenue if we had made differentjudgments or utilized different estimates.

 

We recognize revenue fromthe sale of software products, hardware and media to both end-users andresellers when persuasive evidence of an arrangement exists, the products havebeen delivered, the fee is fixed or determinable, collection of the resultingreceivable is probable and there are no uncertainties regarding customeracceptance. We maintain a reserve for potential product returns. We sellmonthly, annual and multiple-year maintenance contracts and the revenueassociated therewith is recognized over the term of the related maintenanceperiod, beginning on the date of delivery. We recognize other service revenueas we perform the associated services. If an arrangement includes an acceptanceprovision and acceptance is uncertain, then we will defer all revenue until thecustomer accepts the products it purchased. Acceptance in these instancesgenerally occurs upon the earlier of receipt of a written customer acceptanceor expiration of the acceptance period. If an arrangement includes anacceptance provision tied to determination that our product meets publishedspecifications and there are no uncertainties with regard to the customer’sacceptance, then we will recognize revenue at the time of sale, provided thatall of the other previously mentioned revenue recognition criteria have beenmet and the acceptance period is of short duration.

 

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

 

For all sales, we use abinding purchase order, a signed contract, or a credit card authorization asevidence of an arrangement. Sales through our resellers are evidenced by amaster agreement governing the relationship between us and the reseller,together with binding purchase orders on a transaction-by-transaction basis.

 

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

 

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not reasonably assured, the fee is deferred andrevenue is recognized at the time collection becomes probable, which isgenerally upon receipt of payment.

 

We maintain reserves forpotential product returns and make adjustments to these reserves as neededbased on historical product return rates. We also consider the impact of newproduct introductions, changes in customer demand and acceptance of ourproducts on the adequacy of these reserves. Our calculation of the estimatedreturn reserve is based upon (1) an account specific review of potentialreturns, where a return probability is known, and (2) an estimate basedupon past historical returns as a percentage of revenue. We must make and usesignificant judgments and estimates in connection with establishing the productreturns reserve in any accounting period. Material differences may haveresulted in the amount and timing of revenue for this or any prior period if wemade different judgments or utilized different estimates.

 

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

 

Our combined accountsreceivable and product returns reserve was $49,000 and $45,000 on March 31,2008 and December 31, 2007, respectively. Both components ofcalculating the estimated reserve—specific identification and historic experience—arematerial judgments that we make. We base these judgments on historic trends,taking into consideration current business and economic conditions, which couldchange materially, thus changing the required reserve level materially. Thepotential change to the size of our required reserve could be positive in theevent the reserve estimate proves unnecessary, or negative, if the reserveproves inadequate.

 

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

 

*Software Development Costs.***Weconsider software development costs for capitalization when technologicalfeasibility is established in accordance with SFAS No. 86,**“*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 product introductionsand changing customer needs. Accordingly, we have determined that we cannotascertain technological feasibility until the development state of the productis nearly complete. The time period during which cost could be capitalized fromthe point of reaching technological feasibility until the time of generalproduct release is very short and, consequently, the amounts that might becapitalized are not material to our consolidated financial position or resultsof operations. Therefore, we charge all software development costs tooperations in the period incurred.

 

*Goodwill and Intangible Assets.*Weaccount for goodwill in accordance with SFAS No. 142 “*Goodwill andOther Intangible Assets*” (“SFAS 142”). Goodwill representsthe excess of purchase price in a business combination over the fair value ofnet tangible and intangible assets acquired. In accordance with SFAS 142,goodwill amounts are not amortized, but rather are tested for impairment atleast annually. Intangible assets that are not considered to have an indefiniteuseful life are amortized over their useful lives, which range from three toten years.

 

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

* *

We account for businesscombinations in accordance with SFAS No. 141, “*Business Combinations*”**(“SFAS 141”), 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

 

15

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or other rights; or (ii) the intangible isseparable or divisible from the acquired entity and capable of being sold,transferred, licensed, returned or exchanged. In accordance with SFAS 141,we allocate the purchase price of our business combinations to the tangibleassets, liabilities and intangible assets acquired, including in-processresearch and development, based on their estimated fair values. The excesspurchase price over those fair values is recorded as goodwill.

 

*Stock Based Compensation.*Weaccount for stock-based compensation in accordance with SFAS No. 123(R), “*Share-Based Payment*” (“SFAS 123R”), using themodified prospective method. SFAS 123R requires us to measure the cost ofemployee services in exchange for an award of an equity instrument based on thegrant-date fair value of the award and to recognize expense over the requisiteservice period. Compensation expense is recognized for (a) all share-basedpayments granted after the effective date and (b) all awards granted toemployees prior to the effective date that remain unvested on the effectivedate. We calculate this expense based upon an annualized estimated forfeiturerate determined by historical information and management’s estimate of futurevoluntary turnover rates and we true-up estimated forfeitures to actual at theend of each reporting period.

 

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

 

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

 

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

 

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

 

FASB Interpretation No. 48“*Accounting for Uncertainty inIncome Taxes, an interpretation of FAS 109*” clarifies the criteria that an individual tax position must satisfy forsome or all of the benefits of that position to be recognized in a company’sfinancial statements. As of March 31, 2008 and December 31, 2007, theCompany had no unrecognized tax benefits.

 

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

 

**New AccountingPronouncements**

** **

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

 

16

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assets and nonfinancial liabilities that areremeasured at least annually. The Company is currently evaluating the impactthis statement will have on its financial position and results of operations.

 

In December 2007,the FASB issued SFAS No. 141R “*Business Combinations*”**(“SFAS 141R”), which improves the relevance,representational faithfulness and comparability of the information that areporting entity provides in its financial reports about a business combinationand its effects. SFAS 141R applies prospectively to business combinations forwhich the acquisition date is on or after the beginning of the first annualreporting period beginning on or after December 15, 2008. We will adoptthis statement once it is effective and applicable. SFAS 141R will not have animpact on our financial position or results of operations.

 

In December 2007,the FASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements—an amendment of Accounting Research Bulletin No. 51”(“SFAS 160”). SFAS 160 clarifies the classification in a company’s consolidatedbalance sheet and the accounting for and disclosure of transactions between thecompany and holders of noncontrolling interests. SFAS 160 is effective for usas of January 1, 2009. Early adoption is not permitted. We do not expectthe adoption of SFAS 160 to have a material impact on our financial position orresults of operations.

 

**Results of Operations**

 

Thefollowing table sets forth certain financial data for the periods indicated asa percentage of total revenue:

 
| ** **                 | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| Revenue:                   |       |                                             |       |   |   |
| Software license           |       | 31.8                                             | %          | 27.3 | % |
| Hardware and media         |       | 9.3                                              |       | 12.1 |   |
| Service and other          |       | 58.9                                             |       | 60.6 |   |
| Total revenue              |       | 100.0                                            |       | 100.0 |   |
| Cost of revenue:           |       |                                             |       |   |   |
| Software license           |       | 2.3                                              |       | 2.6 |   |
| Hardware and media         |       | 5.8                                              |       | 7.7 |   |
| Service and other          |       | 24.1                                             |       | 27.9 |   |
| Total cost of revenue      |       | 32.2                                             |       | 38.2 |   |
| Gross profit               |       | 67.8                                             |       | 61.8 |   |
| Operating expenses:        |       |                                             |       |   |   |
| Sales and marketing        |       | 42.4                                             |       | 57.3 |   |
| Research and development   |       | 17.7                                             |       | 23.0 |   |
| General and administrative |       | 20.0                                             |       | 26.0 |   |
| Restructuring costs        |       | 0.0                                              |       | 5.5 |   |
| Total operating expenses   |       | 80.1                                             |       | 111.8 |   |
| Loss from operations       |       | (12.3                                            | )          | (50.0 | ) |
| Interest and other income  |       | 0.5                                              |       | 0.5 |   |
| Interest expense           |       | (0.7                                             | )          | (1.3 | ) |
| Net loss                   |       | (12.5                                            | )%         | (50.8 | )% |
|                       |       |                                             |       |   |   |
| Gross margin:              |       |                                             |       |   |   |
| Software license           |       | 92.7                                             | %          | 90.3 | % |
| Hardware and media         |       | 37.7                                             |       | 36.3 |   |
| Service and other          |       | 59.1                                             |       | 54.0 |   |

 

**Revenue**

 

*SoftwareLicense. * During the three months ended March 31,2008, we experienced an increase in our software license revenue as compared tothe same period in the prior fiscal year, primarily due to a 31% increase inrevenue from sales of our AccuRoute product, which was offset by a decrease inrevenue from sales of our legacy fax products. We continue to experiencegeneral market acceptance of our AccuRoute product in the legal andprofessional services vertical market while the demand for and our marketing ofour legacy fax product has continued to decrease.

 

During the three monthsended March 31, 2008, our software license revenue by product category, ascompared to the same period in the prior fiscal year, was as follows:

 

17

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| ** **                                   | ** ** | **Total  Revenue** | ** **       | **Software License  Revenue** | ** ** | **AccuRoute  License  Revenue** | ** ** | **Legacy Fax  License  Revenue** | ** **        | **Freight and  Allowances for  Returns** | ** ** |
|----------------------------------------------|------------|--------------------|------------------|------------------------------------|------------|---------------------------------|------------|---------------------------------------|-------------------|----------------------------------------------------|------------|
| Three months ended March 31, 2008       |       | $                  | 3,952,034        |                               | $          | 1,257,014                       |       | $                                     | 1,097,598         |                                               | $          | 131,029 |   | $ | 28,387 |   |
| Three months ended March 31, 2007       |       | $                  | 3,833,114        |                               | $          | 1,047,313                       |       | $                                     | 835,715           |                                               | $          | 219,911 |   | $ | (8,313 | ) |
| Change from same period of prior fiscal year |       | $                  | 118,920  or 3.1% |                               | $          | 209,701    or 20.0%             |       | $                                     | 261,883  or 31.3% |                                               | $          | (88,882)  or (40.4)% |   | $ | 36,700  or 441.5% |   |
|                                              |            |                    |                  |                                    |            |                                 |            |                                       |                   |                                                    |            |  |  |  |  |  |  |  |  |  |  |

 

Due to the continuedmarket acceptance of AccuRoute and the associated resulting increase insoftware license revenue during the three months ended March 31, 2008, oursoftware license revenue as a percentage of our total revenue increased.

 
| ** **                                    | ** ** | **Software License Revenue as   a Percentage of Total   Revenue** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| Three months ended  March 31, 2008       |       | 31.8                                                                                  | %          |
| Three months ended  March 31, 2007       |       | 27.3                                                                                  | %          |
| Change from same period of  prior fiscal year |       | 4.5                                                                                   | ppt        |

 

The results for the threemonths ended March 31, 2008 and 2007 demonstrate that our software licenserevenue continues to shift towards our AccuRoute product, as displayed in thetable below, which summarizes revenue from each of our major product lines as apercentage of our total software license revenue:

 
| ** **                                    | ** ** | **AccuRoute License Revenue   as Percentage of Software  License Revenue** | ** ** | **Legacy Fax License  Revenue as a Percentage of  Software License Revenue** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| Three months ended  March 31, 2008       |       | 87.3                                                                                                     | %          | 10.4                                                                                                                 | %          |
| Three months ended  March 31, 2007       |       | 79.8                                                                                                     | %          | 21.0                                                                                                                 | %          |
| Change from same period of  prior fiscal year |       | 7.5                                                                                                      | ppt        | (10.6                                                                                                                | )ppt       |

 

*Hardwareand Media.*  Hardware and media revenue decreased inabsolute dollars and as a percentage of total revenue during the three-monthperiod ended March 31, 2008 as compared to the three-month period ended March 31,2007 due to a decrease in demand for the media product as well as a decrease insales of our legacy fax products, which sales are the main driver for ourhardware revenue.

 
| ** **                                    | ** ** | **Hardware and Media  Revenue** | ** **         | **Hardware and Media  Revenue as a  Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|--------------------|------------------------------------------------------------------------------------------------------|------------|
| Three months ended  March 31, 2008       |       | $                                         | 365,974            |                                                                                                 | 9.3        | % |
| Three months ended  March 31, 2007       |       | $                                         | 462,006            |                                                                                                 | 12.1       | % |
| Change from same period of  prior fiscal year |       | $                                         | (96,032)  or (20.8 | )%                                                                                                   | (2.8       | )ppt |
|                                               |            |                                           |                    |                                                                                                      |            |  |  |

 

*Serviceand Other. * Service and other revenue, which consistsprimarily of the sale of support contracts to complement software products soldto customers and, to a lesser extent, consulting, training and installationservices, remained relatively flat during three months ended March 31,2008 as compared to the same period in the prior fiscal year.

 
| ** **                                    | ** ** | **Service and Other Revenue** | ** **    | **Service and Other Revenue as  a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|---------------|---------------------------------------------------------------------------------------------------------|------------|
| Three months ended  March 31, 2008       |       | $                                            | 2,329,046     |                                                                                                    | 58.9       | % |
| Three months ended  March 31, 2007       |       | $                                            | 2,323,795     |                                                                                                    | 60.6       | % |
| Change from same period of  prior fiscal year |       | $                                            | 5,251  or 0.2 | %                                                                                                       | (1.7       | )ppt |

 

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

 

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**Cost of Revenue**

 

*SoftwareLicense. * Cost of software license revenue consistsprimarily of the costs we incur in sublicensing third-party software products,purchasing product media and contracting for product duplication, as well asthe amortization of purchased technology. Cost of software license revenue forthe three months ended March 31, 2008 decreased as compared to thecorresponding period in the previous fiscal year. This decrease is dueprimarily to a change in the mix of software license products sold, resultingin lower royalty fees. As a result of the decrease in the cost of softwarelicense revenue that we incurred during the first quarter of 2008, we incurredan increase in our software license gross margin percentage. We do not expect significant changes in ourcost software license revenue for the remainder of fiscal year 2008.

 
| ** **                                    | ** ** | **Cost of Software License Revenue** | ** **         | **Software License Gross Margin** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|--------------------|--------------------------------------------------|------------|
| Three months ended  March 31, 2008       |       | $                                                        | 91,350             |                                             | 92.7       | % |
| Three months ended  March 31, 2007       |       | $                                                        | 101,275            |                                             | 90.3       | % |
| Change from same period of  prior fiscal year |       | $                                                        | (9,925)    or (9.8 | )%                                               | 2.4        | ppt |
|                                               |            |                                                          |                    |                                                  |            |  |  |

 

*Hardwareand Media. * Cost of hardware and media revenue consistsprimarily of the costs we incur in purchasing third-party hardware and mediaproducts. During the first quarter of 2008, we experienced a decrease in costof hardware and media revenue due to a decline in our hardware and media sales.Our hardware and media gross margin percentage increased during the quarterended March 31, 2008 as compared to the same period in the prior fiscalyear due to a favorable change in the mix of particular hardware and mediaproducts that we sold. We do not expect significant changes in hardware andmedia gross margin percentage for the remainder of fiscal year 2008.

 
| ** **                                    | ** ** | **Cost of Hardware and Media Revenue** | ** **         | **Hardware and Media Gross  Margin** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------------------|--------------------|-----------------------------------------------------|------------|
| Three months ended  March 31, 2008       |       | $                                                               | 228,163            |                                                | 37.7       | % |
| Three months ended  March 31, 2007       |       | $                                                               | 294,130            |                                                | 36.3       | % |
| Change from same period of  prior fiscal year |       | $                                                               | (65,967)  or (22.4 | )%                                                  | 1.4        | ppt |

 

*Service and Other. * Cost of serviceand other revenue consists primarily of the costs we incur in providingtelephone support, installation, training and other miscellaneous customerservice-related expenses. Cost of service and other revenue decreased inabsolute dollars and the service and other revenue gross margin increasedduring the first three months of 2008 as compared to the same period in theprior fiscal year. The decrease in absolute dollars and increase in grossmargin is primarily due to a reduction in wages, consulting and travel expensesas a result of our March 2007 restructuring plan. We expect our serviceand other gross margin to remain relatively consistent on a quarterly basis forthe remainder of fiscal year 2008.

 
| ** **                                    | ** ** | **Cost of Service and Other  Revenue** | ** **          | **Gross Margin for Service  and Other Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------------|---------------------|--------------------------------------------------------------------------|------------|
| Three months ended  March 31, 2008       |       | $                                                          | 951,474             |                                                                     | 59.1       | % |
| Three months ended  March 31, 2007       |       | $                                                          | 1,068,375           |                                                                     | 54.0       | % |
| Change from same period of  prior fiscal year |       | $                                                          | (116,901)  or (10.9 | )%                                                                       | 5.1        | ppt |
|                                               |            |                                                            |                     |                                                                          |            |  |  |

 

**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. Salesand marketing expenses decreased in absolute dollars and decreased as apercentage of total revenue in the first quarter of 2008 as compared to thesame period in 2007 due to the adoption of our March 2007 restructuringplan which resulted in decreased wages, consulting and marketing programexpenditures. We expect our sales and marketing expenses to increase inabsolute dollars on a quarterly basis for the remainder of fiscal year 2008 aswe seek to expand our business.

 

 
| ** **                                    | ** ** | **Sales and Marketing Expenses** | ** **          | **Sales and Marketing Expenses as  a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|---------------------|------------------------------------------------------------------------------------------------------------|------------|
| Three months ended  March 31, 2008       |       | $                                               | 1,676,420           |                                                                                                       | 42.4       | % |
| Three months ended  March 31, 2007       |       | $                                               | 2,196,729           |                                                                                                       | 57.3       | % |
| Change from same period of  prior fiscal year |       | $                                               | (520,309)  or (23.7 | )%                                                                                                         | (14.9      | )ppt |

 

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*Researchand Development.*  Research and development expensesinclude expenses associated with the development of new products, enhancementsof existing products and quality assurance activities. These expenses consistprimarily of employee salaries, benefits, associated overhead costs, consultingexpenses and the cost of software development tools. For the quarter ended March 31,2008, our research and development expenses decreased in absolute dollars andas a percentage of total revenue as compared to the same period in the priorfiscal year due to a reduction in headcount from the March 2007restructuring plan which resulted in decreased wages and other costs associatedwith supporting those employees as well as a reduction in consulting expenses.We do not expect significant changes in our research and development expensesfor the remainder of fiscal year 2008.

 
| ** **                                   | ** ** | **Research and Development  Expenses** | ** **            | **Research and Development  Expenses as a Percentage of  Total Revenue** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|-----------------------|-------------------------------------------------------------------------------------------------------------|------------|
| Three months ended March 31, 2008       |       | $                                                | 700,748               |                                                                                                        | 17.7       | % |
| Three months ended March 31, 2007       |       | $                                                | 880,081               |                                                                                                        | 23.0       | % |
| Change from same period of prior fiscal year |       | $                                                | (179,333)    or (20.4 | )%                                                                                                          | (5.3       | )ppt |

 

*Generaland Administrative. * General and administrative expensesconsist primarily of employee salaries, benefits for administrative, executiveand finance personnel, and associated corporate, general and administrativeexpenses. In the most recently completed fiscal quarter, our general andadministrative expenses decreased in absolute dollars and as a percentage oftotal revenue as compared to the same period in the prior fiscal year due to areduction in headcount for our European operations resulting from our March 2007restructuring plan. To a lesser extent, general and administrative expensesdecreased due to a reduction in accounting and legal expenses and in consultingexpenses as a result of higher fees in 2007 related to the review of ourexisting commercial and licensing agreements and more work associated with ouryear-end regulatory filings with the Securities and Exchange Commission. Weexpect our general and administrative expenses to decrease in absolute dollarsduring the remainder of fiscal year 2008.

 
| ** **                                   | ** ** | **General and Administrative  Expenses** | ** **          | **General and Administrative Expenses  as a Percentage of Total Revenue** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------|---------------------|-------------------------------------------------------------------------------------------------------------------|------------|
| Three months ended March 31, 2008       |       | $                                                  | 790,068             |                                                                                                              | 20.0       | % |
| Three months ended March 31, 2007       |       | $                                                  | 996,945             |                                                                                                              | 26.0       | % |
| Change from same period of prior fiscal year |       | $                                                  | (206,877)  or (20.8 | )%                                                                                                                | (6.0       | )ppt |
|                                              |            |                                                    |                     |                                                                                                                   |            |  |  |

 

*Restructuring Costs.*  In March 2007, weannounced a restructuring of certain of our operations and reduced ourworkforce. As a result of these cost reduction activities, we recorded apre-tax charge of $212,802 which charge included $177,630 of severance-relatedcosts and $35,172 of costs relating to the closing of BlueChip’s formerheadquarters.

 
| ** **                                   | ** ** | **Restructuring Costs** | ** **             | **Restructuring Costs  as a Percentage of Total Revenue** | ** ** |
|----------------------------------------------|------------|------------------------------|------------------------|-----------------------------------------------------------------------------------------|------------|
| Three months ended March 31, 2008       |       | $                            | 0                      |                                                                                    | 0.0        | % |
| Three months ended March 31, 2007       |       | $                            | 212,802                |                                                                                    | 5.6        | % |
| Change from same period of prior fiscal year |       | $                            | (212,802)    or (100.0 | )%                                                                                      | (5.6       | )ppt |
|                                         |       |                         |                   |                                                                                    |       |
|                                              |            |                              |                        |                                                                                         |            |  |  |

 

*Interestand Other Income and Interest Expense. * Interest incomeconsists primarily of interest income earned on cash and cash equivalentbalances. Interest and other income decreased in the first three months of 2008compared to the same period in 2007 due to a lower average interest rate earnedduring the period.

 

Interest expenserepresents the interest associated with the capital lease for the purchase offurniture and equipment for our headquarters as well as interest expenseassociated with the promissory note issued to the seller of BlueChip. Interestexpense decreased in the first quarter of 2008 compared to the first quarter in2007 due to a decrease in the interest rate on the promissory note issued tothe seller of BlueChip.

 

We expect interest andother income and interest expense to remain relatively stable for each quarterof the remainder of fiscal year 2008.

 

20

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| ** **                                   | ** ** | **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 March 31, 2008       |       | $                               | 17,812              |                      | $          | (26,238                                                                                     | )          | 0.5                                                                              | %          | (0.7 | )% |
| Three months ended March 31, 2007       |       | $                               | 20,488              |                      | $          | (51,037                                                                                     | )          | 0.5                                                                              | %          | (1.3 | )% |
| Change from same period of prior fiscal year |       | $                               | (2,676)    or (13.1 | )%                        | $          | 24,799  or 48.6                                                                             | %          | 0.0                                                                              | ppt        | 0.6 | ppt |
|                                              |            |                                 |                     |                           |            |                                                                                             |            |                                                                                  |            |  |  |  |  |

 

*IncomeTax Benefit. * We did not record an income tax benefitassociated with any pre-tax loss for the three-month periods ended March 31,2008 or 2007 due to uncertainty regarding future taxable income.

 

**Inflation**

 

During the fiscal yearsended December 31, 2006 and 2007 and the three months ended March 31,2008, neither inflation nor changing prices have had a material impact on ournet sales, revenue or income from continuing operations.

 

**Liquidity and Capital Resources**

 

Since 1996, we havefinanced our operations primarily through cash flow from operations, privatesales of securities and our initial public offering. As of March 31, 2008,we had cash and cash equivalents of $2.4 million and a net working capitaldeficit of $2.5 million. We believe that our existing cash and cash equivalentswill be sufficient to meet our working capital, capital expenditures and otherliquidity requirements for at least the next twelve months.

 
| ** **                             | ** ** | **Cash Provided by (Used In)** | ** ** |
|----------------------------------------|------------|------------------------------------------|------------|
| ** **                             | ** ** | **Operating  Activities**                | ** ** | **Investing Activities** | ** ** | **Financing Activities** | ** ** |
| Three months ended March 31, 2008 |       | $                                        | 276,774    |   | $ | (3,965 | ) | $ | (157,219 | ) |
| Three months ended March 31, 2007 |       | $                                        | (642,449   | ) | $ | (689,586 | ) | $ | (13,129 | ) |
| Change from same period of prior       |       | $                                        | 919,223    |   | $ | 685,621 |   | $ | (144,090 | ) |
| fiscal year                            |       |                                     | or  143.1  | % |   | or  99.4 | % |   | or  (1,097.5 | )% |

 

Our operating activitiesprovided cash of $277,000 and used cash of $642,000 for the three months ended March 31,2008 and 2007, respectively. We believe that the resources we are allocating toimprove the success of our AccuRoute product in the legal and professionalservices vertical market and its expansion into the healthcare and financialservices vertical markets will continue to put pressure on our earnings andliquidity during the remainder of 2008, but that our existing cash issufficient for at least the next twelve months.

 

Net cash provided byoperating activities during the three months ended March 31, 2008consisted primarily of an increase in accrued liabilities and deferred revenueas well as the non-cash effects of depreciation and amortization and stock-basedcompensation for the vesting of restricted stock shares, offset in part by thenet loss from operations. The increase in accrued liabilities is due to thetiming of payroll payments and the increase in deferred revenue is due to theincrease in software maintenance contracts sold during the first quarter of2008.

 

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

 

Investing activities usedcash of $4,000 and $690,000 during the three months ended March 31, 2008and 2007, respectively. The sole use of cash for investing activities for thethree months ended March 31, 2008 was for the purchase of equipment. Theprimary use of cash for investing activities during the first quarter of 2007was the $562,090 cash payment made to the Seller of BlueChip as part of thepurchase consideration for BlueChip and for additional legal and accountingfees related to the acquisition of BlueChip.

 

Financing activities usedcash of $157,000 and $13,000 during the three months ended March 31, 2008and March 31, 2007, respectively. The primary use of cash for the firstquarter of 2008 was for the repayment of the note payable to the Seller ofBlueChip and for the repayment of capital lease obligations. The primary use ofcash during the three months ended March 31, 2007 was for the repayment ofcapital lease obligations.

 

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Basedon our performance for the three months ended March 31, 2008 and currentexpectations for fiscal year 2008, we believe that our current cash and cashequivalents balance will be sufficient to satisfy our working capital needs andother liquidity requirements associated with our operations through at leastthe next twelve months. We expect that principal uses of cash will be foroperations, repayment of capital lease obligations and notes payable. However,it is possible that we will seek additional financing and there can be noassurance that any necessary additional financing will be available to us oncommercially reasonable terms, or at all. The issuance of additional equity orequity-related securities would be dilutive to our stockholders. If we cannotraise funds on acceptable terms, or at all, we may not be able to develop or enhanceour products or respond appropriately to competitive pressures, which wouldseriously limit our ability to increase our revenue and grow our business.

 

**Off-Balance Sheet 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) ofRegulation S-K) or other contractually narrow or limited purposes. As such, weare not exposed to any financing, liquidity, market or credit risk that couldarise if we had engaged in those types of relationships.

 

**Item 4. Controls and Procedures**

 

(a)                   Evaluation ofdisclosure controls and procedures.

 

As of March 31, 2008(the “Evaluation Date”), the Company, under the supervision and with theparticipation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, evaluated the effectiveness ofthe design and operation of the Company’s disclosure controls and procedurespursuant to Rule 13a-15(b) promulgated under the Exchange Act . Basedupon that evaluation, the Company’s Chief Executive Officer and Chief FinancialOfficer concluded that, as of the Evaluation Date, the Company’s disclosurecontrols and procedures were effective in ensuring that information relating tothe Company (including its consolidated subsidiaries) required to be disclosedby the Company in the reports that it files or submits under the Exchange Actis recorded, processed, summarized, and reported within the time periodsspecified in the Securities and Exchange Commission’s rules and forms,including ensuring that this information is accumulated and communicated to theCompany’s management, including the Company’s Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosure.

 

(b)                  Changes ininternal control over financial reporting

 

There were no changes inthe Company’s internal control over financial reporting during the Company’sfiscal quarter ended March 31, 2008 or in other factors that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

**PART II:  OTHER INFORMATION**

 

**Item 1A.  RiskFactors**

 

**From time to time we may update,revise and supplement the risk factors described under the title “Risk Factors”in our Annual Report on Form 10-K for the fiscal year ended December 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 yearended December 31, 2007. **We note that,as a smaller reporting company, we are not required to provide this Item 1A inthis Quarterly Report on Form 10-Q. Accordingly, we undertake no duty toupdate these risk factors on a going-forward basis.

 

****Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds****

 

**The Company made the followingpurchases of equity securities during the fiscal quarter ended March 31,2008.**

 

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**ISSUER PURCHASES OFEQUITY SECURITIES**

 
| **Period**                                           | ** ** | **(a) Total Number of  Shares Purchased** | ** ** | **(b) Average Price   Paid per Share** | ** ** | **(c) Total Number of  Shares Purchased as  Part of Publicly   Announced Plans or  Programs** | ** ** | **(d) Maximum   Number of Shares   that May Yet be   Purchased Under the  Plans or Programs** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|
| January 1, 2008 —  January 31, 2008   |       | 2,432                                          | (1)        | $                                           | 3.25       |                                                                                                    | —     |                                                                                                    | —     |   |
| February 1, 2008 —  February 29, 2008 |       | 3,035                                          | (2)        | $                                           | 3.25       |                                                                                                    | —     |                                                                                                    | —     |   |
|                                                 |       | 8,576                                          | (3)        | $                                           | 2.50       |                                                                                                    | —     |                                                                                                    | —     |   |
| March 1, 2008 —  March 31, 2008       |       | 1,686                                          | (4)        | $                                           | 3.75       |                                                                                                    | —     |                                                                                                    | —     |   |

 

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(1)      OnJanuary 31, 2008, certain shares of restricted Common Stock of the Companyheld by certain employees vested. The vesting of the restricted stock imposedtax withholding obligations on the Company and, accordingly, the Companypurchased 2,432 shares of the vested Common Stock from the employees in orderto fulfill the withholding obligations. The Company purchased the shares tofulfill tax withholding obligations in accordance with Stock Purchase andRestriction Agreements between the Company and the respective employees. Allshares were purchased at $3.25, the closing price on January 31, 2008, thedate on which vesting occurred and the tax withholding obligations arose.

 

(2)      OnFebruary 1, 2008, certain shares of restricted Common Stock of the Companyheld by certain employees vested. The vesting of the restricted stock imposedtax withholding obligations on the Company and, accordingly, the Companypurchased 3,035 shares of the vested Common Stock from the employees in orderto fulfill the withholding obligations. The Company purchased the shares tofulfill tax withholding obligations in accordance with Stock Purchase andRestriction Agreements between the Company and the respective employees. Allshares were purchased at $3.25, the closing price on February 1, 2008, thedate on which vesting occurred and the tax withholding obligations arose.

 

(3)      OnFebruary 20, 2008, certain shares of restricted Common Stock of theCompany held by certain employees vested. The vesting of the restricted stockimposed tax withholding obligations on the Company and, accordingly, theCompany purchased 8,576 shares of the vested Common Stock from the employees inorder to fulfill the withholding obligations. The Company purchased the sharesto fulfill tax withholding obligations in accordance with Stock Purchase andRestriction Agreements between the Company and the respective employees. Allshares were purchased at $2.50, the closing price on February 20, 2008,the date on which vesting occurred and the tax withholding obligations arose.

 

(4)      OnMarch 6, 2008, certain shares of restricted Common Stock of the Companyheld by certain officers vested. The vesting of the restricted stock imposedtax withholding obligations on the Company and, accordingly, the Companypurchased 1,686 shares of the vested Common Stock from the officers, in orderto fulfill the withholding obligations. The Company purchased the shares tofulfill tax withholding obligations in accordance with Stock Purchase andRestriction Agreements between the Company and the respective officers. Allshares were purchased at $3.75, the closing price on March 6, 2008, thedate on which vesting occurred and the tax withholding obligations arose.

 

**Item5.  Other Information**

 

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

 

**Item 6. Exhibits**

 

Exhibits

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

 

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OMTOOL, LTD.

 

Signatures

 

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

 

 
|               | OMTOOL,  LTD. |
|--------------------|---------------|
|               |          |   |
|               |          |   |
| May 15,  2008 | By:           | /s/  Daniel A. Coccoluto |
|               |          | Daniel  A. Coccoluto |
|               |          | Chief  Financial Officer, Secretary and Treasurer |
|               |          | (Duly  authorized officer and principal financial officer) |

 

**Exhibit Index**

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

 

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