**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

**ý**** ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2004**

 

**OR**

 

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

 

**For the transition period from                to               **

 

**Commission File Number 0-22871**

 

**OMTOOL, LTD.**

(Exact Name of Registrant as Specified in Its Charter)

 

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

 

Indicate by check markwhether the Registrant has: (1) filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

Yes ý   No o

 

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

 

Yes o   No ý

 

There were 3,851,472shares of the Company’s Common Stock, par value $0.01, outstanding on November12, 2004.

 

 

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**OMTOOL, LTD. AND SUBSIDIARIES**

 

FORM 10-Q

For the Quarter Ended September 30, 2004

CONTENTS

 
| **Item Number**                | ** **                                                                                                                 |   |
|--------------------------------|----------------------------------------------------------------------------------------------------------------------------|--------|
|                           |                                                                                                                       |
| PART I: FINANCIAL  INFORMATION |                                                                                                                       |
|                           |                                                                                                                       |
| Item 1.                        | Consolidated  Financial Statements                                                                                         |   |
|                           | Consolidated Balance Sheets  as of September 30, 2004 and December 31, 2003 (Unaudited)                                    |   |
|                           | Consolidated  Statements of Operations for the three months and nine months ended September  30, 2004 and 2003 (Unaudited) |   |
|                           | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2004 and  2003 (Unaudited)                  |   |
|                           | Notes to  Consolidated Financial Statements                                                                                |   |
|                           |                                                                                                                       |   |
| Item 2.                        | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                |   |
|                           |                                                                                                                       |   |
| Item  3.                       | Quantitative  and Qualitative Disclosures About Market Risk                                                                |   |
|                           |                                                                                                                       |   |
| Item 4.                        | Controls and Procedures                                                                                                    |   |
|                           |                                                                                                                       |   |
| PART II: OTHER INFORMATION     |                                                                                                                       |
|                           |                                                                                                                       |   |
| Item  5.                       | Other  Information                                                                                                         |   |
|                           |                                                                                                                       |   |
| Item 6.                        | Exhibits                                                                                                                   |   |
|                           |                                                                                                                       |
| Signatures                     |                                                                                                                       |
|                                |                                                                                                                            |        |  |  |

 

----

 

**PARTI:  FINANCIAL INFORMATION**

Item 1.  ConsolidatedFinancial Statements

 

**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Balance Sheets**

(Unaudited)

 

** **
| ** **                                                                                                                                                                                                                                                 | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
|                                                                                                                                                                                                                                                       |       |                    |       |                   |       |
| **ASSETS**                                                                                                                                                                                                                                                 |       |                    |       |                   |       |
| Current assets:                                                                                                                                                                                                                                            |       |                    |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                                                                                  |       | $                       | 10,032,239 |                   | $          | 8,242,067 |   |
| Accounts receivable, less reserves of  $123,000 at September 30, 2004 and $367,000 at December 31, 2003                                                                                                                                                    |       | 1,269,652               |       | 1,535,540              |       |
| Inventories                                                                                                                                                                                                                                                |       | 37,936                  |       | 37,632                 |       |
| Prepaid expenses and other current assets                                                                                                                                                                                                                  |       | 386,330                 |       | 268,112                |       |
| Total current assets                                                                                                                                                                                                                                       |       | 11,726,157              |       | 10,083,351             |       |
| Property and equipment, net                                                                                                                                                                                                                                |       | 242,128                 |       | 394,623                |       |
| Other assets                                                                                                                                                                                                                                               |       | 11,563                  |       | 13,962                 |       |
| Total assets                                                                                                                                                                                                                                               |       | $                       | 11,979,848 |                   | $          | 10,491,936 |   |
|                                                                                                                                                                                                                                                       |       |                    |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                              | ** ** | ** **              | ** ** | ** **             | ** ** |
| Current liabilities:                                                                                                                                                                                                                                       |       |                    |       |                   |       |
| Accounts payable                                                                                                                                                                                                                                           |       | $                       | 790,039    |                   | $          | 883,583 |   |
| Accrued liabilities                                                                                                                                                                                                                                        |       | 1,176,168               |       | 1,202,359              |       |
| Accrued restructuring                                                                                                                                                                                                                                      |       | —                  |       | 443,830                |       |
| Accrued state sales tax                                                                                                                                                                                                                                    |       | 828,076                 |       | 1,010,496              |       |
| Deferred revenue, short term                                                                                                                                                                                                                               |       | 2,833,599               |       | 3,306,474              |       |
| Total current liabilities                                                                                                                                                                                                                                  |       | 5,627,882               |       | 6,846,742              |       |
| Long term liabilities:                                                                                                                                                                                                                                     |       |                    |       |                   |       |
| Deferred revenue, long-term                                                                                                                                                                                                                                |       | 301,764                 |       | 205,967                |       |
| Total liabilities                                                                                                                                                                                                                                          |       | 5,929,646               |       | 7,052,709              |       |
|                                                                                                                                                                                                                                                       |       |                    |       |                   |       |
| 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 —  4,367,878 shares at September 30, 2004 and 3,716,878 shares at December 31,  2003;  Outstanding — 3,851,472 shares at September 30, 2004 and 3,500,500 shares at  December 31, 2003, respectively |       | 43,678                  |       | 37,169                 |       |
| Additional paid-in capital                                                                                                                                                                                                                                 |       | 35,259,708              |       | 31,936,038             |       |
| Accumulated deficit                                                                                                                                                                                                                                        |       | (26,565,955             | )          | (27,617,599            | )          |
| Treasury stock, at cost (516,406 shares at  September 30, 2004 and 216,378 shares at December 31, 2003)                                                                                                                                                    |       | (2,649,757              | )          | (877,934               | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                                       |       | (37,472                 | )          | (38,447                | )          |
| Total stockholders’ equity                                                                                                                                                                                                                            |       | 6,050,202               |       | 3,439,227              |       |
|                                                                                                                                                                                                                                                       |       |                    |       |                   |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                            |       | $                       | 11,979,848 |                   | $          | 10,491,936 |   |

 

The accompanying notes are an integral part of these unauditedconsolidated financial statements.

 

1

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements ofOperations**

(Unaudited)

 
| ** **                                            | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                            | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                             |       |                                  |       |                                 |       |   |   |   |   |
| Software license                                      |       | $                                     | 1,011,298  |                                 | $          | 983,595 |   | $ | 3,314,682 |   | $ | 2,971,873 |   |
| Hardware                                              |       | 696,715                               |       | 710,189                              |       | 2,312,461 |   | 1,827,528 |   |
| Service and other                                     |       | 1,739,991                             |       | 1,856,348                            |       | 5,216,520 |   | 5,064,671 |   |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Total revenues                                        |       | 3,448,004                             |       | 3,550,132                            |       | 10,843,663 |   | 9,864,072 |   |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Cost of revenues:                                     |       |                                  |       |                                 |       |   |   |   |   |
| Software license                                      |       | 32,659                                |       | 86,820                               |       | 150,833 |   | 237,635 |   |
| Hardware                                              |       | 404,545                               |       | 432,000                              |       | 1,393,065 |   | 1,231,520 |   |
| Service and other                                     |       | 676,073                               |       | 816,610                              |       | 2,067,721 |   | 2,414,010 |   |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Total cost of revenues                                |       | 1,113,277                             |       | 1,335,430                            |       | 3,611,619 |   | 3,883,165 |   |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Gross profit                                          |       | 2,334,727                             |       | 2,214,702                            |       | 7,232,044 |   | 5,980,907 |   |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Operating expenses:                                   |       |                                  |       |                                 |       |   |   |   |   |
| Sales and marketing                                   |       | 1,013,316                             |       | 1,038,515                            |       | 3,045,097 |   | 3,707,037 |   |
| Research and development                              |       | 478,108                               |       | 562,893                              |       | 1,431,273 |   | 1,735,014 |   |
| General and administrative                            |       | 527,364                               |       | 796,729                              |       | 1,799,052 |   | 2,354,947 |   |
| Restructuring                                         |       | —                                |       | 806,581                              |       | — |   | 806,581 |   |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Total operating expenses                              |       | 2,018,788                             |       | 3,204,718                            |       | 6,275,422 |   | 8,603,579 |   |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Income (loss) from operations                         |       | 315,939                               |       | (990,016                             | )          | 956,622 |   | (2,622,672 | ) |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Interest and other income, net                        |       | 30,476                                |       | 67,761                               |       | 104,931 |   | 121,124 |   |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Income (loss) before tax (benefit)  provision         |       | 346,415                               |       | (922,255                             | )          | 1,061,553 |   | (2,501,548 | ) |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Tax (benefit) provision                               |       | (47,794                               | )          | —                               |       | 9,909 |   | (155,398 | ) |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Net income (loss)                                     |       | $                                     | 394,209    |                                 | $          | (922,255 | ) | $ | 1,051,644 |   | $ | (2,346,150 | ) |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Net income (loss) per share                           |       |                                  |       |                                 |       |   |   |   |   |
| Basic                                                 |       | $                                     | 0.10       |                                 | $          | (0.26 | ) | $ | 0.28 |   | $ | (0.67 | ) |
| Diluted                                               |       | $                                     | 0.10       |                                 | $          | (0.26 | ) | $ | 0.27 |   | $ | (0.67 | ) |
|                                                  |       |                                  |       |                                 |       |   |   |   |   |
| Weighted  average number of common shares outstanding |       |                                  |       |                                 |       |   |   |   |   |
| Basic                                                 |       | 3,936,706                             |       | 3,493,696                            |       | 3,738,216 |   | 3,495,162 |   |
| Diluted                                               |       | 4,126,239                             |       | 3,493,696                            |       | 3,924,607 |   | 3,495,162 |   |

 

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

 

2

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements of CashFlows**

(Unaudited)

 
| ** **                                                                                               | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                               | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| Cash Flows from Operating Activities:                                                                    |       |                                 |       |   |   |
| Net income (loss)                                                                                        |       | $                                    | 1,051,644  |   | $ | (2,346,150 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by (used in) operating activities– |       |                                 |       |   |   |
| Depreciation                                                                                             |       | 188,477                              |       | 323,373 |   |
| Accounts receivable reserves                                                                             |       | (245,033                             | )          | (247,912 | ) |
| Changes in assets and liabilities–                                                                  |       |                                 |       |   |   |
| Accounts receivable                                                                                      |       | 522,434                              |       | 397,151 |   |
| Prepaid expenses and other current assets                                                                |       | (192,352                             | )          | 88,252 |   |
| Inventory                                                                                                |       | (272                                 | )          | 67,785 |   |
| Accounts payable                                                                                         |       | (98,125                              | )          | (226,053 | ) |
| Accrued liabilities                                                                                      |       | 44,170                               |       | (202,356 | ) |
| Accrued state sales tax                                                                                  |       | (182,420                             | )          | (338,558 | ) |
| Accrued restructuring                                                                                    |       | (443,830                             | )          | 725,677 |   |
| Other assets                                                                                             |       | 2,399                                |       | — |   |
| Deferred revenue                                                                                         |       | (384,430                             | )          | (96,071 | ) |
|                                                                                                     |       |                                 |       |   |   |
| Net cash provided by (used in) operating  activities                                                     |       | 262,662                              |       | (1,854,862 | ) |
|                                                                                                     |       |                                 |       |   |   |
| Cash Flows from Investing Activities:                                                                    |       |                                 |       |   |   |
| Purchases of property and equipment                                                                      |       | (35,758                              | )          | (180,338 | ) |
| Purchases of short-term investments                                                                      |       | —                               |       | (1,999,449 | ) |
| Proceeds from sale of short-term  investments                                                            |       | —                               |       | 3,596,604 |   |
|                                                                                                     |       |                                 |       |   |   |
| Net cash (used in) provided by investing  activities                                                     |       | (35,758                              | )          | 1,416,817 |   |
|                                                                                                     |       |                                 |       |   |   |
| Cash Flows from Financing Activities:                                                                    |       |                                 |       |   |   |
| Net proceeds from issuance of common stock                                                               |       | 3,570,856                            |       | 10,037 |   |
| Purchase of treasury stock                                                                               |       | (2,012,500                           | )          | — |   |
|                                                                                                     |       |                                 |       |   |   |
| Net cash provided by financing activities                                                                |       | 1,558,356                            |       | 10,037 |   |
|                                                                                                     |       |                                 |       |   |   |
| Exchange rate effect on cash                                                                             |       | 4,912                                |       | 18,133 |   |
|                                                                                                     |       |                                 |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                                    |       | 1,790,172                            |       | (409,875 | ) |
|                                                                                                     |       |                                 |       |   |   |
| Cash and cash equivalents, beginning of  period                                                          |       | 8,242,067                            |       | 8,192,523 |   |
|                                                                                                     |       |                                 |       |   |   |
| Cash and cash equivalents, end of period                                                                 |       | $                                    | 10,032,239 |   | $ | 7,782,648 |   |

 

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

 

3

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Notes to Consolidated FinancialStatements**

(Unaudited)

 

**(1)**** ****Basis of Presentation**

 

The accompanying unaudited consolidated financialstatements have been prepared by Omtool, Ltd. (the “Company” or “Omtool”) pursuantto the rules and regulations of the Securities and Exchange Commission (“SEC”)regarding interim financial reporting. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements and should be read in conjunction with the consolidated financialstatements and notes thereto for the year ended December 31, 2003 as filed withthe SEC on March 23, 2004. The accompanying consolidated financial statementsreflect all adjustments (consisting of normal recurring adjustments) which are,in the opinion of management, necessary for a fair presentation of results forthe interim periods presented.  Theresults of operations for the three and nine month period ended September 30,2004 are not necessarily indicative of the results to be expected for the fullfiscal year.

 

The Company’s financialresults for the first nine months of 2004 improved from the first nine monthsof 2003 as the Company generated a net profit of $1.1 million in the first ninemonths of 2004 as compared to a net loss of $2.3 million in the first ninemonths of 2003.  The improvement infinancial results was due primarily to an increase of approximately $1.0 million,or 10%, in total revenues as well as realized operating cost savings resultingfrom the restructuring charge in 2003. Management believes that the increase in revenues during this period isdue to increased demand for enterprise software solutions which has led to anincrease in information technology spending and is also due to greater marketacceptance of the AccuRouteTM product, both of which resulted in increased salesbookings for the Company.  Furthermore,management believes that the financial results for the fourth quarter of fiscalyear 2004 will exhibit improvement compared to the same period in the prioryear.  This belief is based on theCompany’s current expected level of sales bookings and corresponding revenuegrowth combined with lower expected operating expenses as a direct result ofthe Company’s third quarter 2003 restructuring. However, this expectation may change if the current economic environmentchanges and softness in information technology spending returns or if theCompany’s products do not achieve further market acceptance.  During the nine months ended September 30,2004, the Company raised $3.6 million through the sale of 600,000 shares ofcommon stock, at a price of $6.00 per share, in a private placement toinstitutional and other accredited investors. The proceeds of the privateplacement are being used for additional working capital and other generalcorporate purposes.  Also during the ninemonths ended September 30, 2004, the Company repurchased 350,000 shares of itsoutstanding common stock from ASA International Ltd., an existing shareholder,in a private transaction at a price of $5.75 per share. The shares werepurchased with the use of generally available corporate funds and will be heldin treasury.  These activities along withcash generated from operations resulted in an increase in cash and cashequivalents of approximately $1.8 million for the nine months ended September30, 2004. The Company’s cash and cash equivalents at September 30, 2004 were$10.0 million. The Company believes that its existing cash and cashequivalents will be sufficient to meet its working capital and capitalexpenditures for at least the next twelve months.

 

***(2)***  **Net Income (Loss) per Common Share**

 

TheCompany reports earnings per share in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 128, *Earnings per Share*.  The dilutive effect of potential commonshares in 2004, consisting of outstanding stock options and a stock warrant, isdetermined using the treasury stock method, in accordance with SFASNo. 128.  Diluted weighted averageshares outstanding for the three months and nine months ended September 30,2003 exclude 740,444 potential common shares from stock options because toinclude them would have been anti-dilutive for the period presented as the Companyreported a net loss during the period. For the three months and nine months ended September 30, 2004, thedilutive calculation excludes the potential common shares related to 126,278and 175,738, respectively, outstanding stock options which have an anti-dilutiveeffect since their exercise price exceeds the market value of the Company’scommon stock.  A reconciliation of basicand diluted common shares outstanding is as follows:

 

4

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| ** **                                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                       | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Weighted average number of common shares  outstanding            |       | 3,936,706                             |       | 3,493,696                            |       | 3,738,216 |   | 3,495,162 |   |
| Potential common shares pursuant to stock  options and warrants  |       | 189,533                               |       | —                               |       | 186,391 |   | — |   |
| Diluted weighted average shares                                  |       | 4,126,239                             |       | 3,493,696                            |       | 3,924,607 |   | 3,495,162 |   |
| Basic net income (loss) per common share                         |       | $                                     | 0.10       |                                 | $          | (0.26 | ) | $ | 0.28 |   | $ | (0.67 | ) |
| Diluted net income (loss) per common and  potential common share |       | $                                     | 0.10       |                                 | $          | (0.26 | ) | $ | 0.27 |   | $ | (0.67 | ) |

 

**(3)****  IncomeTaxes**

 

SFAS No. 109, *Accounting for IncomeTaxes,* requires a valuation allowance to be recorded againstdeferred tax assets when it is more likely than not that some or all of thedeferred tax assets will not be realized. As a result of cumulative losses in recent years and continued economicuncertainty, the Company has provided a full valuation allowance against all ofits net deferred tax assets and will do so until it returns to an appropriatelevel of sustained taxable income.  Theultimate realization of these deferred tax assets depends upon the Company’sability to generate sufficient future taxable income. If the Company issuccessful in generating sufficient future taxable income, the Company willreduce the valuation allowance through a reduction in income tax expense in thefuture.

 

During the three months ended September 30, 2004, theCompany recorded a net tax benefit of $47,794 resulting primarily from adecrease in the Company’s estimated taxes payable as a result of a revisedinternational transfer pricing agreement with its United KingdomSubsidiary.  The resulting net taxprovision required for the consolidated entity for the nine months endedSeptember 30, 2004, was $9,909 for expected tax liability in the United Statesand for expected tax liability related to its United Kingdom subsidiary.  The provision for the first nine months of2004 is net of a $28,800 adjustment related to a fiscal year 2003 transfer pricingadjustment.

 

During the nine months ended September 30, 2003, theCompany recorded $155,398 of tax benefit due to a tax refund that its UnitedKingdom subsidiary received during the first quarter of 2003. This subsidiaryhad incurred a loss for the year ended December 31, 1999 which resulted in theincome tax benefit.  The tax benefit wascarried back to prior years’ taxes paid and resulted in a tax refund.  Because the subsidiary was undergoing anInland Revenue audit for the 1999 tax year, doubt existed about therealizability of this refund and the Company did not record the benefit on itsbooks until the audit was cleared and the cash was received, both of whichoccurred in the first quarter of 2003.

 

**(4)**** ****Comprehensive Income (Loss)**

 

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

 
| ** **                               | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                               | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss)                        |       | $                                     | 394,209    |                                 | $          | (922,255 | ) | $ | 1,051,644 |   | $ | (2,346,150 | ) |
| Foreign currency translation adjustments |       | 11,259                                |       | 7,883                                |       | 976 |   | 6,038 |   |
| Comprehensive income (loss)              |       | $                                     | 405,468    |                                 | $          | (914,372 | ) | $ | 1,052,620 |   | $ | (2,340,112 | ) |
|                                          |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |

 

**(5)**** ****Stock Based Compensation**

 

The Company accounts forstock-based compensation for employees under the recognition and measurementprinciples of Accounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees,* and related interpretations.  The following table illustrates the effect onnet income (loss) and net income (loss) per share if the Company had appliedthe fair value recognition provisions of Financial Accounting Standards BoardStatement (“FAS”) No. 123, *Accounting for Stock-BasedCompensation,* as amended by FAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure* tostock-based employee compensation.

 

5

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| ** **                                                                                                 | ** ** | **Three months Ended  September 30,** | ** ** | **Nine months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                       |       |                                  |       |                                 |       |   |   |   |   |
| Net income (loss), as reported                                                                             |       | $                                     | 394,209    |                                 | $          | (922,255 | ) | $ | 1,051,644 |   | $ | (2,346,150 | ) |
| Deduct: Total stock-based employee  compensation expense determined under fair value method for all awards |       | (46,452                               | )          | (134,974                             | )          | (169,422 | ) | (575,156 | ) |
| Pro forma net income (loss)                                                                                |       | $                                     | 347,757    |                                 | $          | (1,057,229 | ) | $ | 882,222 |   | $ | (2,921,306 | ) |
|                                                                                                       |       |                                  |       |                                 |       |   |   |   |   |
| Net income (loss) per share:                                                                               |       |                                  |       |                                 |       |   |   |   |   |
| Basic, as reported                                                                                         |       | $                                     | 0.10       |                                 | $          | (0.26 | ) | $ | 0.28 |   | $ | (0.67 | ) |
| Diluted, as reported                                                                                       |       | $                                     | 0.10       |                                 | $          | (0.26 | ) | $ | 0.27 |   | $ | (0.67 | ) |
| Basic, pro forma                                                                                           |       | $                                     | 0.09       |                                 | $          | (0.30 | ) | $ | 0.24 |   | $ | (0.84 | ) |
| Diluted, pro forma                                                                                         |       | $                                     | 0.08       |                                 | $          | (0.30 | ) | $ | 0.22 |   | $ | (0.84 | ) |

 

**(6)****      ****Accrued Liabilities**

 

Accrued liabilities consistof the following:

 
| ** **                        | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------|------------|-------------------------|------------|------------------------|------------|
| Accrued health insurance expense  |       | $                       | 185,621    |                   | $          | 205,547 |   |
| Accrued salary and salary-related |       | 561,785                 |       | 466,903                |       |
| Accrued professional fees         |       | 160,885                 |       | 145,962                |       |
| Other accrued expenses            |       | 267,877                 |       | 383,947                |       |
|                              |       | $                       | 1,176,168  |                   | $          | 1,202,359 |   |

 

**(7)**** ****Restructuring Costs**

** **

**In the third quarter of 2003, the Company announced arestructuring of certain of its operations, and recorded a pre-tax charge of$806,581 in accordance with SFAS No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities*.  The charge includes severance-related costsassociated with the workforce reduction in the Company’s domestic operationsand costs associated with closing its Oregon office.  The reduction in workforce consisted of threeemployees in the Company’s sales and marketing department, two employeesperforming general and administrative functions, three employees performingtechnical support and five employees in the Company’s research and developmentdepartment.  The balance of this chargeconsists of costs incurred as a result of closing the Company’s Oregonoffice.  All of the costs associated withclosing the Company’s Oregon office were paid as of December 31, 2003.**

** **

**The following table summarizes the restructuring activityfor the nine months ended September 30, 2004:**

*** ***

| ** **                          | ** ** | **Severance** | ** ** |
|-------------------------------------|------------|---------------|------------|
| Ending balance at December 31, 2003 |       | $             | 443,830    |   |
| Cash payments                       |       | (443,830      | )          |
| Ending balance, September 30, 2004  |       | $             | —     |   |

** **

**The total cash impact of the restructuring is $806,581, allof which was paid by the end of the third quarter of 2004.**

 

6

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**(8)**** ****Equity Transactions**

 

**On March 30, 2004, the Company raised $3.6 million through thesale of 600,000 shares of common stock, at a price of $6.00 per share in aprivate placement to institutional and other accredited investors.  The fees associated with issuing the sharesin connection with the private placement were approximately $147,000 and wererecorded as a reduction of additional paid-in capital.  Furthermore, Omtool issued 51,000 shares ofcommon stock and a warrant to purchase an additional 51,000 shares of commonstock, exercisable over a five-and-a-half-year period at a price of $6.00 pershare, to its financial advisor or its designees for advisory services relatedto the private placement.**

** **

**On March 30, 2004, Omtool’s Board of Directors approved atwo-for-one stock split of the Company’s Common Stock in the form of a dividendeffective April 27, 2004 for each stockholder of record as of April 7,2004.  All references in the consolidatedfinancial statements referring to shares, share prices, per share amounts andstock plans have been adjusted retroactively for the two-for-one stock split.**

** **

**On March 31, 2004, the Company repurchased 350,000 sharesof its outstanding common stock from ASA International Ltd., an existingshareholder, in a private transaction at a price of $5.75 per share. The350,000 shares that were repurchased have been recorded and are held astreasury stock.**

 

**(9)**** ****Segmentand Geographic Information**

 

To date, theCompany has viewed its operations and manages its business as principally onesegment, software and hardware sales and associated services. As a result, thefinancial information disclosed herein represents all of the material financialinformation related to the Company’s principal operating segment in accordancewith SFAS No. 131, *Disclosures About Segmentsof an Enterprise and Related Information*.

 

Total revenues frominternational sources were $403,000 and $2.4 million for the three months andnine months ended September 30, 2004 and $624,000 and $1.8 million for thethree months and nine months ended September 30, 2003, respectively.  The Company’s revenues from internationalsources were primarily generated from customers located in Europe. Thefollowing table represents amounts relating to geographic locations:

 
| ** **          | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **          | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Total  revenues (1) | ** ** | ** **                            | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States       |       | $                                     | 3,044,993  |                                 | $          | 2,926,623 |   | $ | 8,406,656 |   | $ | 8,083,275 |   |
| United Kingdom      |       | 131,190                               |       | 237,986                              |       | 952,161 |   | 949,410 |   |
| Rest of World       |       | 271,821                               |       | 385,523                              |       | 1,484,846 |   | 831,387 |   |
|                |       | $                                     | 3,448,004  |                                 | $          | 3,550,132 |   | $ | 10,843,663 |   | $ | 9,864,072 |   |
|                     |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |

 
| ** **             | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------|------------|-------------------------|------------|------------------------|------------|
| Long-lived  assets (2) | ** ** | ** **              | ** ** | ** **             | ** ** |
| United States          |       | $                       | 242,465    |                   | $          | 392,801 |   |
| United Kingdom         |       | 11,226                  |       | 15,784                 |       |
|                   |       | $                       | 253,691    |                   | $          | 408,585 |   |
|                        |            |                         |            |                        |            |  |  |  |  |

 

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(1) Revenues are attributed to geographicregions based on location of customer.

(2) Long-lived assets include property andequipment and other assets.

 

7

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Item 2.

**MANAGEMENT’S DISCUSSION AND ANALYSIS**

**OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations shouldbe read in conjunction with the accompanying consolidated financial statementsfor the periods specified and the associated notes.  Further reference should be made to the Company’sAnnual Report on Form 10-K for the year ended December 31, 2003 as filed withthe SEC on March 23, 2004.

 

**Overview**

 

Omtool is a leading providerof electronic document delivery and management software that enables efficient,secure, confirmed and cost-efficient document exchange between businesses.  The Company was incorporated inMarch 1991 and shipped its initial facsimile software products in 1991.Omtool’s products provide users with an extensive, flexible feature set thatconverts, transmits, receives, and automatically archives documents inelectronic formats.  Included in theCompany’s products is a suite of utility and control functions that enables theconversion of paper documents to standard electronic formats and integrateswith industry recognized document and records management systems.  Omtool’s products enable the integration ofbusiness processes that include the exchange of hard copy and electronicdocuments such as legal contracts, financial transactions, medical records andpurchase order processing.  Omtool’sproducts minimize risks by preserving the security of high value documentswhile facilitating increased productivity, reducing costs and fulfillingemerging business requirements. AccuRouteTM, Omtool’s document routing and distribution software,integrates with many digital scanning and multifunctional devices to allowpaper documents to be digitized, distributed and archived.  In addition, Omtool’s AccuRoute softwareprovides capture, distribution and compliance for movement of electronicdocuments and information.  GenifaxTM,Omtool’s enterprise fax software, offers a scalable, server-based feature setand shares a common Windows server-based architecture with the Genidocs productline.  GenidocsTM, the Company’s securedocument delivery application, integrates with existing e-mail systems andprovides multiple options for content and attachment encryption,authentication, audit trail and delivery confirmation, and digitalsignatures.  The Company’s AccuRoutesoftware further unifies the codes base and architecture of the Genidocs andGenifax products, coupled with the routing capabilities of AccuRoute’s softwareplatform to provide a truly unique customer specific product to easily managedocuments, both paper and electronic, with little or no user trainingrequired.  A significant portion of theCompany’s revenue is derived from licensing the rights to use itsfax software products directly to end-users and indirectly throughresellers.

 

The Company resells, fromthird-party vendors, certain hardware products, including intelligent faxboards and fax modems, to its customers. Hardware sales are undertaken as aconvenience to the Company’s customers; and hardware is not required to bepurchased from the Company and can be alternatively obtained from a third-partyvendor.  The fax boards and fax modemsthat are resold are not functional without the Company’s software and theCompany is not in the business of selling fax boards and modems. The Companypurchases these hardware products as needed to ship to its customers and theCompany maintains a minimal inventory of these hardware products.  Management believes that the Company has agood business relationship with suppliers of these products and that supply ofthese products is stable.

 

Service and other revenueshave consisted primarily of the sale of support contracts.  The Company generates a smaller portion ofits service and other revenues from consulting, training and installationservices.

 

The Company’s financialresults for the first nine months of 2004 improved from the first nine monthsof 2003 as the Company generated a net profit of $1.1 million in the first ninemonths of 2004 as compared to a net loss of $2.3 million in the first ninemonths of 2003.  The improvement infinancial results was due primarily to an increase of approximately $1.0million, or 10%, in total revenues as well as realized operating cost savingsresulting from the restructuring charge in 2003.  Management believes that the increase inrevenues during this period is due to increased demand for enterprise softwaresolutions which has led to an increase in information technology spending andis also due to greater market acceptance of the AccuRoute product, both ofwhich resulted in increased sales bookings for the Company.  Furthermore, management believes that thefinancial results for the fourth quarter of fiscal year 2004 will exhibitimprovement compared to the same period in the prior year.  This belief is based on the Company’s currentexpected level of sales bookings and corresponding revenue growth combined withlower expected operating expenses as a direct result of the Company’s thirdquarter 2003 restructuring.  However,this expectation may change if the current economic environment changes andsoftness in information technology

 

8

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spending returns or if the Company’s products do not achieve furthermarket acceptance.  During the ninemonths ended September 30, 2004, the Company raised $3.6 million through thesale of 600,000 shares of common stock, at a price of $6.00 per share, in aprivate placement to institutional and other accredited investors. The proceedsof the private placement are being used for additional working capital andother general corporate purposes.  Alsoduring the nine months ended September 30, 2004, the Company repurchased350,000 shares of its outstanding common stock from ASA International Ltd., anexisting shareholder, in a private transaction at a price of $5.75 per share.The shares were purchased with the use of generally available corporate fundsand will be held in treasury.  Theseactivities along with cash generated from operations resulted in an increase incash and cash equivalents of approximately $1.8 million for the nine monthsended September 30, 2004. The Company’s cash and cash equivalents at September30, 2004 were $10.0 million. The Company believes that its existing cashand cash equivalents will be sufficient to meet its working capital and capitalexpenditures for at least the next twelve months.

 

Although the Companybelieves that there has been some recent improvement in the demand forenterprise software solutions and market acceptance of our product, it cannotpredict whether or when that market will soften or if market acceptance willchange.  If the market or the marketacceptance of our product changes, the Company cannot predict whether, and towhat extent, the demand for its products will increase or decrease.  Any decrease in demand for the Company’sproducts would likely result in decreased revenue which would, in turn, have asignificant impact on the Company’s financial results because a significantportion of the Company’s operating costs (such as personnel, rent anddepreciation) are fixed in advance of a particular quarter. As a result,despite savings realized from the Company’s September 2003 restructuring, theCompany’s costs for sales and marketing, research and development and generaland administrative could continue to increase as a percentage of revenues,thereby affecting the Company’s operating results.

 

The Company’s future revenues and operating results may fluctuate fromquarter to quarter based on the number and size of sales transactions that theCompany enters into with customers, the adequacy of provisions for losses,general economic conditions and other factors. In addition, revenue from alarge order may constitute a significant portion of the Company’s totalrevenues in a particular quarter.

 

TheCompany has historically derived a substantial portion of its total revenuesfrom sales within North America. Sales outside of North America (primarily inEurope) represented 18% and 14% of the Company’s total revenues for the ninemonths ended September 30, 2004 and 2003, respectively.  The Company’s gross profit on these salesapproximates the gross profit on sales within North America.  The increase in the percent of sales outsideof North America is a result of the Company’s strategy to expand itsinternational presence (primarily in Europe) by increasing investments in salesand marketing efforts directed toward international markets.

 

TheCompany’s United Kingdom subsidiary transacts business primarily in its localcurrency. The Company manages its foreign exchange exposure by monitoring itsnet monetary position using natural hedges of its assets and liabilitiesdenominated in local currencies. There can be no assurance that this policywill eliminate all currency exposure. If the Company’s business denominated inforeign currencies increases, the Company may be required to use derivatives tohedge foreign currency exposure.

 

TheCompany will continue to leverage its existing distribution channels whereappropriate to broaden its reach to the target vertical markets and furtherpenetrate its installed base.  TheCompany is pursuing sales opportunities via its solution/reseller channel aswell as focusing sales efforts on specific market segments in order tofacilitate product acceptance.  Salesthrough the Company’s indirect distribution channels represented 19% and 25% ofthe Company’s total revenues for the nine months ended September 30, 2004 and2003, respectively.

 

**CriticalAccounting Policies and Estimates**

 

The Company has identifiedthe policies and estimates below as critical to its business operations and theunderstanding of its results of operations. The impact and any associated risksrelated to these policies on the Company’s business operations is discussedthroughout Management’s Discussion and Analysis of Financial Condition andResults of Operations where such policies affect the Company’s reported andexpected financial results. Note that the Company’s preparation of thisQuarterly Report on Form 10-Q requires management to make estimates andassumptions that affect the reported amount of assets and liabilities,disclosure of contingent assets and liabilities at the date of the Company’sfinancial statements, and the reported amounts of revenue and expenses duringthe reporting period. There can be no assurance that actual results will notdiffer from those estimates.

 

9

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*Revenue Recognition and Accounts Receivable Reserves.*  TheCompany derives its revenue from primarily two sources (i) product revenue,which includes software license and hardware revenue and (ii) services andsupport revenue, which includes software maintenance and support, installation,training and consulting revenue. The Company licenses its software products ona perpetual basis.  The Company generatesrevenue from licensing the rights to use its software products and sales ofhardware directly to end-users and indirectly through resellers.   The Company’s resellers order products fromthe Company based on purchase orders received from end-users and do not orderstock.  The Company’s products are soldto resellers and directly to end-users without any specifically stated rightsof return. Occasionally, however, the Company, in its sole discretion, willaccept a product return if the end-user finds that the product does not fit itsneeds. The Company also sells hardware products, which are provided by athird-party, on a pass through basis, plus an additional mark-up, to end-usersand indirectly through resellers. The hardware products that are resold are notfunctional without the Company’s software. To support its software products, the Company sells software maintenanceand support, installation, training and consulting services to end-users andindirectly through resellers.

 

TheCompany applies the provisions of Statement of Position (“SOP”) 97-2, *Software Revenue Recognition*, as amended by SOP 98-9,Modification of SOP 97-2, *Software RevenueRecognition, With Respect to Certain Transactions*, to alltransactions involving the sale of multiple elements including software,hardware and service revenue.  TheCompany applies the provisions of SFAS No. 48, *RevenueRecognition When Right of Return Exists*, with respect to providingfor potential future product returns.  As described below, significant management judgments and estimates mustbe made and used in connection with the revenue recognized in any accountingperiod.  Material differences may resultin the amount and timing of the Company’s revenue if management made differentjudgments or utilized different estimates.

 

TheCompany recognizes revenue from the sale of software products and hardware toboth end-users and resellers when persuasive evidence of an arrangement exists,the products have been delivered, the fee is fixed or determinable, collectionof the resulting receivable is reasonably assured and there are nouncertainties regarding customer acceptance. The Company maintains a reservefor potential product returns. Software maintenance and support revenue isrecognized ratably over the term of the related maintenance period.  Typically this is a one-year period, butoccasionally the Company sells multiple-year maintenance contracts, in whichcase the associated revenue is recognized over the multiple-year term of thecontract.  Other services revenue isrecognized as the services are performed. If an arrangement includes anacceptance provision and acceptance is uncertain then the Company will deferall revenue until the customer accepts the products.  Acceptance in these instances generallyoccurs upon the earlier of receipt of a written customer acceptance orexpiration of the acceptance period.  Ifan arrangement includes an acceptance provision regarding the Company’s productmeeting published specifications and there are no uncertainties with regard tothe customer’s acceptance then the Company will recognize revenue at the timeof sale, provided that all other revenue recognition criteria previously mentionedhave been met and the acceptance period is of short duration.

 

TheCompany’s transactions frequently involve the sales of software, hardware andrelated services under multiple element arrangements.   Revenue under multiple element arrangementsis allocated to each element under the residual method, in accordance with SOP98-9, Modification of SOP 97-2,*Software RevenueRecognition, With Respect to Certain Transactions*. Under thismethod, revenue is allocated first to all undelivered elements, such asservices, based on the fair value of those elements, which is the price chargedwhen these elements are sold separately and unaccompanied by otherelements.  The Company’s services are notessential to the functionality of the software as these services do not alterthe capabilities of the software and do not carry a significant degree of riskto perform. The amount allocated to the delivered elements, such as softwarelicense and hardware revenue, is the difference between the total arrangementvalue and the amount allocated to the undelivered elements. If the deliveredelements include both software and hardware, the amount allocated to hardwarerevenue is based on the price charged to the Company by the third party vendorplus an additional mark up, with the remainder allocated to software revenue.To the extent that a discount is offered in the arrangement, the entirediscount is allocated to the delivered element or elements. If the deliveredelements include hardware and software, the discount is allocated to thehardware and software based on their respective list prices.

 

Forall sales, the Company uses a binding purchase order, a signed contract or acredit card authorization as evidence of an arrangement.  Sales through the Company’s resellers are evidencedby a master agreement governing the relationship, together with bindingpurchase orders, on a transaction-by-transaction basis.

 

Atthe time of the transaction, the Company assesses whether the fee associatedwith the transaction is fixed or determinable and whether or not collection isreasonably assured.  If a significantportion of a fee is due beyond the Company’s normal payment terms, which arethirty to sixty days from invoice date, the Company accounts for the fee as notbeing fixed or determinable.  In thesecases, the Company recognizes revenue as the fees become due. The Companyassesses

 

10

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collection based on a number of factors,including past transaction history with the customer and the credit-worthinessof the customer.  The Company reviewsD&B credit reports for all of its resellers and adjusts its credit limitswith those resellers accordingly.  If thereseller does not have a favorable report or the Company does not have enoughcredit information to determine if the reseller is credit-worthy then theCompany predominantly sells to such resellers on C.O.D. terms.  The Company does not request collateral fromits customers.  If the Company determinesthat collection of a fee is not reasonably assured, the fee is deferred andrevenue is recognized at the time collection becomes reasonably assured, whichis generally upon receipt of payment.

 

The Companyreserves for potential product returns and makes adjustments to the reserve asneeded, based on historical product return rates, and considers the impact ofnew product introductions, changes in customer demand and acceptance of theCompany’s products.  Management’scalculation of the estimated return reserve is based upon (1) an account specificreview of potential returns, where a return probability is known, and (2) ageneral estimate based upon past historical returns as a percentage ofrevenue.   Significant managementjudgments and estimates must be made and used in connection with establishingthe sales returns reserve in any accounting period. Material differences mayresult in the amount and timing of revenue for any period if management madedifferent judgments or utilized different estimates.  Similarly, management must make estimates ofthe Company’s ability to collect on its accounts receivable.  The Company records trade accounts receivableat the invoiced amount; these accounts do not bear interest.  Management specifically analyzes accountsreceivable and historical bad debts, customer credit-worthiness, currenteconomic trends and changes in customer payment patterns when evaluating theadequacy of the allowance for doubtful accounts.  The Company reviews the allowance fordoubtful accounts on a monthly basis. Management’s calculation of the estimated accounts receivable reserve isbased upon (1) an account specific review of potential uncollectible accounts,where a bad debt probability is known, and (2) a general estimate based uponpast historical bad debts as a percentage of accounts receivable.  The Company does not have anyoff-balance-sheet credit exposure to its customers.

 

TheCompany’s combined accounts receivable and returns reserve was approximately$123,000 and $367,000 at September 30, 2004 and December 31, 2003, respectively.  Both components of calculating the estimatedreserve, specific identification and historic experience, are materialjudgments.  These judgments are based onhistoric trends, taking into consideration current business and economicconditions, which could change materially, thus changing the required reservelevel materially.  The potential changecould be positive, in the event the reserve estimate proves unnecessary, ornegative, if the reserve proves inadequate.

 

The Company’s deferred revenue is comprised mainly ofrevenue that is deferred for software maintenance and support contracts.  The other components of deferred revenue arethe amounts from sales transactions****that weredeferred because they did not meet all of the provisions of the Company’srevenue recognition policy.

 

*Software Development Costs*. Software development costs are considered for capitalization whentechnological feasibility is established in accordance with SFAS No. 86, *Accounting for the Costs of Computer Software To Be Sold, Leased or**Otherwise Marketed*. The Company sellssoftware in a market that is subject to rapid technological change, new productintroductions and changing customer needs. Accordingly, the Company hasdetermined that it cannot determine technological feasibility until thedevelopment state of the product is nearly complete. The time period duringwhich cost could be capitalized from the point of reaching technologicalfeasibility until the time of general product release is very short and,consequently, the amounts that might be capitalized are not material to theCompany’s consolidated financial position or results of operations. Therefore,the Company charges all software development costs to operations in the periodincurred.

 

*Taxes*.  TheCompany is required to estimate its income and state sales taxes. This processinvolves estimating the Company’s actual current tax obligations together withassessing differences resulting from the different treatment of items for taxand accounting purposes which result in deferred income tax assets andliabilities and accrued state sales tax liabilities. The Company has deferredincome tax assets and liabilities and accrued state sales tax liabilitiesincluded within its balance sheet.

 

TheCompany’s deferred tax assets are assessed for each reporting period as towhether it is more likely than not that they will be recovered from futuretaxable income, including assumptions regarding on going tax planningstrategies. To the extent the Company believes that recovery is uncertain, theCompany must establish a valuation allowance for assets not expected to berecovered. Changes to the valuation allowance are included as an expense orbenefit within the tax provision in the statement of operations.

 

The Company provides a fullvaluation allowance against all of its net deferred tax assets and willcontinue to do so until it returns to an appropriate level of taxable income.The ultimate realization of these deferred tax assets depends upon the

 

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Company’s ability to generate sufficientfuture taxable income. If the Company is successful in generating sufficientfuture taxable income, the Company will reduce the valuation allowance througha reduction in income tax expense in the future.

 

Accrued state sales taxesare estimated for each reporting period based on tax rates in effect for thereporting periods in each of the states where the Company has potential nexusand for the time period that the Company has nexus. The assumptions andestimates used to determine this liability are subject to change as they aredifficult to measure or value.  In theevent that actual results differ from these estimates, the Company’s statesales taxes expense could be materially impacted.

 

**Resultsof Operations**

 

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

 
| ** **                     | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                     | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenues:                      |       |                                  |       |                                 |       |   |   |   |   |
| Software license               |       | 29.3                                  | %          | 27.7                                 | %          | 30.6 | % | 30.1 | % |
| Hardware                       |       | 20.2                                  |       | 20.0                                 |       | 21.3 |   | 18.5 |   |
| Service and other              |       | 50.5                                  |       | 52.3                                 |       | 48.1 |   | 51.4 |   |
| Total revenues                 |       | 100.0                                 |       | 100.0                                |       | 100.0 |   | 100.0 |   |
| Cost of revenues:              |       |                                  |       |                                 |       |   |   |   |   |
| Software license               |       | 1.0                                   |       | 2.4                                  |       | 1.4 |   | 2.4 |   |
| Hardware                       |       | 11.7                                  |       | 12.2                                 |       | 12.8 |   | 12.5 |   |
| Service and other              |       | 19.6                                  |       | 23.0                                 |       | 19.1 |   | 24.5 |   |
| Total cost of revenues         |       | 32.3                                  |       | 37.6                                 |       | 33.3 |   | 39.4 |   |
| Gross profit                   |       | 67.7                                  |       | 62.4                                 |       | 66.7 |   | 60.6 |   |
| Operating expenses:            |       |                                  |       |                                 |       |   |   |   |   |
| Sales and marketing            |       | 29.4                                  |       | 29.3                                 |       | 28.1 |   | 37.5 |   |
| Research and development       |       | 13.9                                  |       | 15.9                                 |       | 13.2 |   | 17.6 |   |
| General and administrative     |       | 15.3                                  |       | 22.4                                 |       | 16.6 |   | 23.9 |   |
| Restructuring                  |       | —                                |       | 22.7                                 |       | — |   | 8.2 |   |
| Total operating expenses       |       | 58.6                                  |       | 90.3                                 |       | 57.9 |   | 87.2 |   |
| Income (loss) from operations  |       | 9.1                                   |       | (27.9                                | )          | 8.8 |   | (26.6 | ) |
| Interest and other income, net |       | 0.9                                   |       | 1.9                                  |       | 1.0 |   | 1.2 |   |
| Tax (benefit) provision        |       | (1.4                                  | )          | —                               |       | 0.1 |   | 1.6 |   |
|                           |       |                                  |       |                                 |       |   |   |   |   |
| Net income (loss)              |       | 11.4                                  | %          | (26.0                                | )%         | 9.7 | % | (23.8 | )% |
|                           |       |                                  |       |                                 |       |   |   |   |   |
| Gross profit:                  |       |                                  |       |                                 |       |   |   |   |   |
| Software license               |       | 96.8                                  | %          | 91.2                                 | %          | 95.4 | % | 92.0 | % |
| Hardware                       |       | 41.9                                  |       | 39.2                                 |       | 39.8 |   | 32.6 |   |
| Service and other              |       | 61.1                                  |       | 56.0                                 |       | 60.4 |   | 52.3 |   |

 

**ThreeMonths Ended September 30, 2004 and 2003**

 

*Revenues*

 

*Total Revenues.*  TheCompany’s total revenue was $3.4 million and $3.6 million for the threemonths ended September 30, 2004 and 2003, respectively.

 

*Software License.* Software license revenue was $1,011,000 and $984,000 for the threemonths ended September 30, 2004 and September 30, 2003, respectively.  Software license revenue accounted for 29%and 28% of total revenues for each respective period.  Included in software license revenue for thethree months ended September 30, 2004 and 2003 is a reduction of $19,000 and$55,000, respectively, in the sales returns and allowance reserve relatingprimarily to specific

 

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accounts where the Company has determinedthat the risk of a return is no longer present. Software license revenues for the three month period ended September 30,2004 reflected an overall increase in demand for the Company’s AccuRouteproduct while the Company’s legacy fax product line exhibited a declinecompared to the three month period ended September 30, 2003.  Revenues from the Company’s AccuRouteproduct, which requires no hardware related components, represented 46% and 19%of software sales for the three month period ended September 30, 2004 and 2003,respectively.  Software revenues from theCompany’s legacy fax product line represented 54% and 81% of software sales forthe three month period ended September 30, 2004 and 2003, respectively.  The growth of the AccuRoute product line is aresult of greater market acceptance of the product.  Though the Company cannot accurately predictthe exact mix of products that will be sold in the future, it expects thatsoftware license revenue will constitute a larger percentage of its totalrevenue if demand for its newer products which do not require the purchase ofadditional hardware, such as AccuRoute, continue to gain additional marketacceptance.

 

*Hardware.* Hardware revenue was $697,000 for the three months ended September 30,2004 and $710,000 for the three months ended September 30, 2003, representing adecrease of 2%.  Hardware revenueaccounted for 20% of total revenue for each respective period.  The decrease in hardware revenue is primarilydriven by the fact that less of the Company’s legacy fax products were sold inthe three months ended September 30, 2004 than were sold in the three monthsended September 30, 2003 resulting in a decrease in accompanying hardwaresales. Hardware revenue for the three month period ended September 30, 2004 and2003, includes $6,000 and $19,000, respectively, of revenue associated with areduction in the sales returns and allowance reserve based on the Company’sdetermination of risk of potential returns related to specific customeraccounts.  Though the Company cannotaccurately predict the exact mix of products that will be sold in the future,it expects that hardware revenue will constitute a smaller percentage of itstotal revenue if demand for its newer products, such as AccuRoute, which doesnot require the purchase of additional hardware, continue to gain additionalmarket acceptance.

 

*Serviceand Other.*  Service and other revenue decreased by 6% forthe three months ended September 30, 2004 compared to the three months endedSeptember 30, 2003.  Service and otherrevenue was $1.7 million and $1.9 million for the three months ended September30, 2004 and 2003, respectively.  Serviceand other revenue accounted for 50% and 52% of total revenues for eachrespective period. The decrease in service and other revenue and as apercentage of total revenue is primarily due to a decrease of approximately$170,000 in consulting and installation revenues for the three months endedSeptember 30, 2004 as compared to the same period in 2003.  The Company cannot accurately predict thefuture demand for consulting and installation services but generally expectssuch revenues to correlate to software revenues in the future.

 

*Cost of Revenue*

 

*Software License.*  Costof software license revenue consists primarily of the costs of sublicensingthird-party software products, product media and product duplication.  Cost of software license revenue for thethree months ended September 30, 2004 decreased by 62% or $54,000 during thequarter to $33,000 compared to $87,000 during the corresponding period in2003.  The decrease is due primarily tothe fact that the Company replaced third-party software that was imbedded inits products with its own internally-developed solutions, thus reducing theroyalties that it must pay when a product containing that third-party softwareis sold.  This decrease is also reflectedin software license gross margin as it improved to 97% from 91%.  The Company has****recentlyadded additional third-party software into its products and expects that itssoftware license cost of revenue as a percent of software license revenue willincrease slightly in the future.

 

*Hardware.*  Costof hardware revenue consists primarily of the costs of third-party hardwareproducts. Cost of hardware revenue was $405,000 and $432,000 for the threemonths ended September 30, 2004 and 2003, respectively, representing 58% and61% of hardware revenues for each respective period. The decrease in dollaramount for the cost of hardware revenues was due primarily to the decrease ofhardware unit sales accompanying sales of the Company’s software products. Thegross margin percentage for hardware sales improved to 42% from 39% for thethree month periods ended September 30, 2004 and 2003 due to a change in theparticular mix of hardware products sold. The Company does not expect that its per unit cost of hardware productswill change significantly enough through the remainder of 2004 such that itwould have a material impact on hardware margins in the future.

 

*Service and Other.*  Costof service and other revenue consists primarily of the costs incurred inproviding telephone support as well as other miscellaneous customer service-relatedexpenses.  Cost of service and otherrevenues was $676,000 and $817,000 for the three months ended September 30,2004 and 2003, respectively, representing 39% and 44% of service and otherrevenues for each respective period.  Thegross margin percentage for service and other revenues increased to 61% for thethree months ended September 30, 2004, compared to 56% in the same period in2003.  The decrease in cost of serviceand other revenue and the increase in gross margin percentage is due to adecrease in the number of employees and the

 

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associated overhead costs resulting fromrestructuring that occurred in the third quarter of 2003.  The Company does not expect any significant variancesin its service and other gross margins during the fourth quarter of fiscal year2004.

 

*Operating Expenses*

 

*Sales and Marketing.*  Salesand marketing expenses consist primarily of employee salaries, benefits,commissions, and associated overhead costs, and the cost of marketing programssuch as advertisements, direct mailings, public relations, trade shows,seminars and related communication costs. Sales and marketing expenses were $1.0 million for each of thethree months ended September 30, 2004 and 2003, respectively, or 29% of totalrevenues for each respective period. The Company expects that its sales andmarketing expenses will increase in absolute dollars as additional sales staffis added during the year.

 

*Research and Development.* Research and development expenses includeexpenses associated with the development of new products, enhancements ofexisting products and quality assurance activities. These expenses consistprimarily of employee salaries, benefits, associated overhead costs, consultingexpenses and the cost of software development tools. Research and developmentexpenses were $478,000 for the three months ended September 30, 2004 and$563,000 for the three months ended September 30, 2003, representing 14% and16% of total revenues for each respective period.  The decrease in the expense and in researchand development expenses as a percent of total revenues is a result of feweremployees in the research and development department and the associated costsof supporting such personnel due to the restructuring that occurred in thethird quarter of 2003.  Management doesnot believe that the decrease in the number of employees will have a materialadverse effect on its ability to develop new products and updated versions ofits existing products.  The Companyexpects research and development expenses to increase in absolute dollars as itcontinues to invest in its products.

 

*General and Administrative.*  General and administrativeexpenses consist primarily of employee salaries, benefits for administrative,executive and finance personnel and associated corporate general andadministrative expenses. General and administrative expenses were $527,000 and$797,000 for the three months ended September 30, 2004 and 2003, respectively,or 15% and 22% of total revenues for each period. The decrease in dollar amountand percentage of total revenues is due to the reduction in general andadministrative personnel and overhead costs associated with supporting suchpersonnel and a decrease in professional expenses.  The decrease is also due to a $67,000reduction in the Company’s accrual for state sales and other local taxes forthe three month period ended September 30, 2004.  The Company expects that it may experienceincreases to general and administrative expenses in the form of professionalfees and consulting expenditures in the fourth quarter of 2004 as it continuesto prepare for compliance with Section 404 of the Sarbanes-Oxley Act of 2002.

 

*Interest and other Income.* Interest and other income consist principally of interest income earnedon cash and cash equivalent balances. Interest and other income, net was $30,000 for the three months endedSeptember 30, 2004 and $68,000 for the three months ended September 30,2003.  Included in the $68,000 for thethree months ended September 30, 2003 was $51,000 from the sale of common stockof Verso Technologies, Inc. (“Verso”). The remaining increase in interest andother income (excluding proceeds from the sale of Verso stock) is due to ahigher rate of return on the Company’s investments. The Company expects thatinterest and other income will be relatively stable for the fourth quarter of2004.

 

*Provision for IncomeTaxes.*  During the three months ended September 30,2004, the Company recorded a net tax benefit of $47,794 as a result of adecrease in the Company’s estimated taxes payable resulting from a revisedinternational transfer pricing agreement with its United KingdomSubsidiary.  The Company did not record atax provision during the three months ended September 30, 2003 as the Companywas in a loss position.

 

**NineMonths Ended September 30, 2004 and 2003**

 

*Revenues*

 

*Total Revenues.*  TheCompany’s total revenue was $10.8 million and $9.9 million for the ninemonths ended September 30, 2004 and 2003, respectively.

 

*Software License.* Software license revenue was $3.3 million for the nine months endedSeptember 30, 2004 and $3.0 million for the nine months ended September 30,2003, representing an increase of 12%. Software license revenue accounted for 31% and 30% of total revenues foreach respective period.  The increase insoftware license revenue is due to an improvement in the demand for enterprisesoftware solutions resulting in higher software revenue for the Company.  Software license revenue for the nine monthperiod ended September 30, 2004 reflect an overall increase in demand for theCompany’s

 

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AccuRoute product while the Company’s legacyfax product line exhibited a decline compared to the nine month period endedSeptember 30, 2003.  Revenues from theCompany’s AccuRoute product represented 39% and 10% of software license revenuefor the nine month period ended September 30, 2004 and 2003, respectively.  Software license revenue from the Company’slegacy fax product line represented 61% and 88% of software license revenue forthe nine month period ended September 30, 2004 and 2003, respectively.  Genidocs and Swiftwriter account for theother 2% of software license revenue for the nine month period ended September30, 2004.  The growth of the AccuRouteproduct line is a result of greater market acceptance of the product.  Included in software license revenue for thenine months ended September 30, 2004 and 2003 is a net reduction of $159,000and $160,000, respectively, in the sales returns and allowance reserve relatingprimarily to specific accounts where the Company has determined that the riskof a return is no longer present.  Thoughthe Company cannot accurately predict the exact mix of products that will besold in the future, it expects that software license revenue will constitute alarger percentage of its total revenue in the future if demand for its newerproducts, such as AccuRoute, which does not require the purchase of additionalhardware, continues to gain additional market acceptance.

 

*Hardware.* Hardware revenue was $2.3 million for the nine months ended September30, 2004 and $1.8 million for the nine months ended September 30, 2003,representing an increase of 27%.  Hardwarerevenue accounted for 21% and 19% of total revenue for each respectiveperiod.  The increase in hardware revenueis due to an increase in demand from existing customers who have upgradedinformation systems hardware in their worldwide locations.  Included in hardware revenue for the ninemonths ended September 30, 2004 and 2003 is a reduction of $50,000 and $53,000,respectively, in the sales returns and allowance reserve relating primarily tospecific accounts where the Company has determined that the risk of a return isno longer present.  Though the Companycannot accurately predict the exact mix of products that will be sold in thefuture, it expects that hardware revenue will constitute a smaller percentageof its total revenue if demand for its newer products, such as AccuRoute, whichdoes not require the purchase of additional hardware, continue to gainadditional market acceptance.

 

*Service and Other.* Service and other revenue increased by 3% for the nine months endedSeptember 30, 2004 compared to the nine months ended September 30, 2003.  Service and other revenue was$5.2 million and $5.1 million for the nine months ended September 30, 2004and 2003, respectively.  Service andother revenue accounted for 48% and 51% of total revenues for each respectiveperiod.  The increase in service andother revenue is primarily due an increase in maintenance revenues from alarger installed customer base.  Thedecrease in service and other revenue as a percent of total revenues is dueprimarily to the increase in both software license and hardware revenue.

 

*Cost of Revenue*

 

*Software License.*  Costof software license revenue for the nine months ended September 30, 2004decreased by 37% or $87,000 to $151,000 compared to $238,000 during thecorresponding period in 2003.  Thedecrease is due primarily to the fact that the Company replaced third-partysoftware that was imbedded in its products with its own internally-developedsolutions, thus reducing the royalties that it must pay when a productcontaining that third-party software is sold. This decrease is also reflected in software license gross margin as itimproved to 95% from 92%.  The Companyhas recently added additional third-party software into its products andexpects that its software license cost of sales as a percent of softwarelicense revenue will increase slightly in the future.

 

*Hardware.*  Costof hardware revenues was $1.4 million and $1.2 million for the nine monthsended September 30, 2004 and 2003, respectively, representing 60% and 67% ofhardware revenues for each respective period. The increase in dollar amount forthe cost of hardware revenues was due primarily to the increase of hardwareunit sales.  The gross margin percentagefor hardware sales improved to 40% from 33% for the nine month periods endedSeptember 30, 2004 and 2003 due to a change in the particular mix of hardwareproducts sold.  The Company does notexpect that its per unit cost of hardware products will change significantlyenough through the remainder of 2004 such that it would have a material impacton hardware margins in the future.

 

*Service and Other.*  Costof service and other revenues was $2.1 million and $2.4 million for the ninemonths ended September 30, 2004 and 2003, respectively, representing 40% and48% of service and other revenues for each respective period.  The gross margin percentage for service andother revenues increased to 60% for the nine months ended September 30, 2004,compared to 52% in the same period in 2003. The increase in gross margin and the decrease in the cost of service andother revenues is due to a decrease in the number of employees and theassociated overhead costs resulting from the restructuring that occurred in thethird quarter of 2003.  The Company doesnot expect any significant variances in its service and other gross marginsduring the fourth quarter of fiscal year 2004.

 

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*Operating Expenses*

 

*Sales and Marketing.*  Salesand marketing expenses were $3.0 million and $3.7 million for thenine months ended September 30, 2004 and 2003, respectively, or 28% and 38% oftotal revenues for each respective period. The decrease in sales and marketing expenses is due to decreased wages,commissions, and travel costs resulting from fewer management level personnelin the department as a result of the restructuring that occurred in the thirdquarter of 2003.   Additionally, theCompany reduced its trade show expenses during the first nine months of 2004 ascompared to the first nine months of 2003. The Company expects that its sales and marketing expenses will increasein absolute dollars as additional sales staff is hired throughout the year.

 

*Research and Development.* Research and development expenses were $1.4million for the nine months ended September 30, 2004 and $1.7 million for thenine months ended September 30, 2003, representing 13% and 18% of totalrevenues for each respective period.  Thedecrease in the expense and in research and development expenses as a percentof total revenues is a result of fewer employees in the research anddevelopment department and the associated costs of supporting such personneldue to the restructuring that occurred in the third quarter of 2003.  Management does not believe that the decreasein the number of employees will have a material adverse effect on its abilityto develop new products and updated versions of its existing products.  The Company expects research and developmentexpenses to increase in absolute dollars as it continues to invest in itsproducts.

 

*General and Administrative.*  General and administrativeexpenses were $1.8 million and $2.4 million for the nine months ended September30, 2004 and 2003, respectively, or 17% and 24% of total revenues for eachperiod. The decrease in dollar amount and percentage of total revenues is dueto the reduction in general and administrative personnel and overhead costsassociated with supporting such personnel and a decrease in depreciation andmanagement consulting expenses.  Thedecrease is also due to a $123,000 reduction in the state sales tax accrual forthe nine month period ended September 30, 2004 resulting from a refinement inthe Company’s methodology for accrual of sales taxes based on activity in thestate as a basis for determining nexus.  The Company expects that it may experienceincreases to general and administrative expenses in the form of professionalfees and consulting expenditures in the remaining quarters of 2004 as itcontinues to prepare for compliance with Section 404 of the Sarbanes-Oxley Actof 2002.

 

*Interest and other Income.* Interest and other income consists principally of interest income earnedon cash and cash equivalent balances. Interest and other income, net was $105,000 for the nine months endedSeptember 30, 2004 and $121,000 for the nine months ended September 30,2003.  Also included in the nine monthsended September 30, 2004 interest and other income is other income of $2,000related to the fair value of a warrant to purchase 8,580 shares of common stockof Verso Technologies (“Verso”).  Thefair value of the warrant is marked to market in each financial reportingperiod resulting in future changes in fair value which are recorded in incomeand other expenses.  The Company’swarrant to purchase 8,580 shares of Verso common stock expires in November2005.  This increase in interest andother income is a result of a higher cash balance as well as a higher interestrate for the nine months ended September 30, 2004.  The Company expects that interest and otherincome will be relatively stable quarter over quarter for the remainder of2004.

 

*Provision for IncomeTaxes.*  During the three months ended September 30,2004, the company recorded a net tax benefit of $47,794 resulting primarilyfrom a decrease in the Company’s estimated taxes payable as a result of arevised international transfer pricing agreement with its United KingdomSubsidiary.  The resulting net taxprovision required for the consolidated entity for the nine months endedSeptember 30, 2004, was $9,909 for expected tax liability in the United Statesand for expected tax liability related to its United Kingdom subsidiary.  The provision for the first nine months of2004 is net of a $28,800 adjustment related to a fiscal year 2003 transferpricing adjustment.

 

During the nine months endedSeptember 30, 2003, the Company recorded $155,398 of tax benefit due to a taxrefund that its United Kingdom subsidiary received during the first quarter of2003. This subsidiary had incurred a loss for the year ended December 31, 1999which resulted in an income tax benefit. The tax benefit was carried back to prior years’ taxes paid and resultedin a tax refund.  Because the subsidiarywas undergoing an Inland Revenue audit for tax year 1999, doubt existed aboutthe realizability of this refund and the Company did not record the benefit onits books until the audit was cleared and the cash was received, both of whichoccurred in the first quarter of 2003.

 

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**Liquidityand Capital Resources**

 

Since 1996, the Company hasfinanced its operations primarily through cash flow from operations, theprivate sales of preferred stock and common stock and the Company’s initialpublic offering of Common Stock completed in August 1997. At September 30,2004, the Company had cash and cash equivalents of $10.0 million and workingcapital of $6.1 million.

 

TheCompany’s operating activities provided cash of $263,000 for the nine monthsended September 30, 2004 and used cash of $1.9 million for the nine monthsended September 30, 2003.  Managementrestructured the organization in September 2003 to reduce operating expensesand help preserve cash.  Managementbelieves that these reductions along with anticipated revenue for the remainderof fiscal year 2004, will lead to sufficient cash for at least the next twelvemonths.  Net cash provided during thenine months ended September 30, 2004 consisted primarily of a net profit fromoperations, depreciation and amortization and a decrease in accounts receivablepartially offset by an increase to prepaid expenses and other current assets adecrease to the accounts receivable reserve, a decrease in accruedrestructuring, and decreases in deferred revenue and accrued state sales tax.  The decrease in accounts receivable is dueprimarily to the continued efforts by management to continue to improve itsworking capital by expediting the collection of accounts receivable.  The increase in prepaid expenses and othercurrent assets is due to the payment of insurance premiums that are expensedthroughout the year.  The decrease in theaccounts receivable reserve relates primarily to specific accounts where theCompany has determined that the risk of a return is no longer present.  The decrease to deferred revenues is due tothe recognition during the first nine months of 2004 of previously deferredrevenues.  The decrease in accruedrestructuring reflects the final severance payments relating to the September2003 restructuring and the decrease to accrued state sales tax is a result ofcontinued settlement with states in which the Company may have nexus along witha refinement in the Company’s methodology for accrual of sales taxes based onactivity in the state as a basis for determining nexus.  Net cash used in operations during the ninemonths ended September 30, 2003 resulted from a net loss from operations anddecreases in accounts payable, accrued liabilities, accrued sales tax andaccounts receivable reserve offset by depreciation and amortization; an increasein accrued restructuring and a decrease to accounts receivable.

 

Investingactivities used cash of $36,000 and provided cash of $1.4 million during thenine months ended September 30, 2004 and 2003, respectively.  During the nine months ended September 30,2004, the sole use of cash was for purchases of property and equipment.Property and equipment purchases were predominately of computer relatedsoftware and hardware products. During the nine months ended September 30,2003, the principal uses were purchases of property and equipment andshort-term investments, offset by proceeds from the sale of short-terminvestments.  The Company does notcurrently anticipate any significant changes to its level and purpose of cashused in investing activities for the remainder of fiscal year 2004.

 

Financingactivities provided cash of $1.6 million and $10,000 for the nine months endedSeptember 30, 2004 and 2003, respectively. Cash provided for the nine months ended September 30, 2004 was due tothe net proceeds from the issuance of common stock.  On March 30, 2004, the Company completed thesale of 600,000 shares of common stock, at a price of $6.00 per share, in aprivate placement to institutional and other accredited investors. The proceedsof the private placement, which totaled $3.6 million, are to be used foradditional working capital and other general corporate purposes. This wasoffset by a cash usage of $2.0 million during the six months ended September30, 2004 as the Company repurchased 350,000 shares of its outstanding commonstock from ASA International Ltd., an existing shareholder, in a privatetransaction at a price of $5.75 per share. The shares were purchased with theuse of generally available corporate funds and will be held in treasury. Cashprovided by financing activities for the nine months ended September 30, 2003was due primarily to net proceeds from the issuance of common stock related tothe Company’s employee stock purchase program.

 

Basedon its first three quarters performance and current expectations for theremainder of 2004, the Company believes that the current cash and cashequivalents balance as well as the expected cash to be generated fromoperations for the remainder of the year will satisfy its working capitalneeds, capital expenditures and other liquidity requirements associated withits operations through at least the next twelve months.  The Company expects that principal uses ofcash will be for operations, working capital, payment of sales taxes andpurchases of property and equipment. Management currently has no plan to obtain additional financing if theseexpectations are not met. There can be no assurance that any necessaryadditional financing will be available to the Company on commerciallyreasonable terms, or at all.

 

The following tablerepresents the approximate amounts of payments due under specified contractualobligations as of September 30, 2004:

 
| **Contractual Obligations** | ** ** | **Total** | ** ** | **Less than  one year** | ** ** | **One to  Three years** | ** ** | **Three to  five years** | ** ** | **More than  Five years** | ** ** |
|-----------------------------|------------|-----------|------------|-------------------------|------------|-------------------------|------------|--------------------------|------------|---------------------------|------------|
|                        |       |      |       |                    |       |                    |       |                     |       |                      |       |
| Operating lease obligations |       | $         | 447,000    |                    | $          | 389,000                 |       | $                        | 58,000     |                      | —     |   | — |   |
|                             |            |           |            |                         |            |                         |            |                          |            |                           |            |  |  |  |

 

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Operating lease requirementsconsist mainly of lease payments for the Company’s offices in Salem, NH andLondon, England, United Kingdom. As of September 30, 2004, the Company did nothave any long-term debt obligations, material commitments for capitalexpenditures, capital lease obligations, or other long-term liabilities forwhich payments are required.

 

**CertainFactors Affecting Future Operating Results**

 

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

 

Informationprovided by the Company from time to time including statements in thisQuarterly Report on Form 10-Q which are not historical facts are so-called“forward-looking statements” that involve risks and uncertainties, madepursuant to the safe harbor provisions of the Private Securities LitigationReform Act of 1995. In particular, statements contained in Management’s Discussionand Analysis of Financial Condition and Results of Operations which are nothistorical facts (including, but not limited to, statements concerning:  the plans and objectives of management;expectations for sales and marketing, research and development and general andadministrative expenses; developments relating to the Company’s product andservice offerings, markets and acquisitions; anticipated trends in the Company’sbusiness; the Company’s strategic alliances; changes in the regulatoryenvironment; the Company’s expected liquidity and capital resources and theCompany’s critical accounting policies) may constitute forward-lookingstatements. These forward-looking statements are neither promises norguarantees, but are subject to risks and uncertainties that could cause actualresults to differ materially from the expectations set forth in the forward-lookingstatements. Factors that may cause such differences include, but are notlimited to, the factors discussed below, and the other risk factors discussedfrom time to time in the Company’s other filings with the SEC.

 

*Future Operating Results Uncertain.*  TheCompany incorporated and shipped its initial facsimile software products in1991.  In the years endingDecember 31, 2001, 2002 and 2003, the Company had operating losses anddecreasing revenues. There can be no assurance that the Company will be able toincrease its level of revenues or maintain profitability in the future; as theCompany’s operating history makes the prediction of future operating resultsdifficult or impossible.  Increases inoperating expenses may occur and, together with pricing pressures and a declinein the growth rate of the overall U.S. economy due to factors beyond theCompany’s control, may result in a decrease in operating income and operatingmargin percentage.  The Company’s abilityto improve its operating results will depend upon, among other things, itsability to increase sales of the AccuRoute, Genifax and Genidocs softwareproducts to new customers as well as increased product penetration intoexisting customers.

 

TheCompany recently commenced its strategic expansion into document routing anddistribution software, and has limited financial and operating data and alimited operating history relevant to this solution.  Accordingly, it is difficult to evaluate theprospects for the level of acceptance of this solution. Future operatingresults will depend on many other factors, including, without limitation, thedegree and rate of growth of the markets in which the Company competes, thelevel of acceptance of the Windows NT, Windows 2000, Windows XP and otheroperating systems, the level of product and price competition, the ability ofthe Company to establish strategic relationships and develop and market new andenhanced products and to control costs, the ability of the Company to expandits direct sales force and indirect distribution channels both domestically andinternationally and the ability of the Company to attract and retain keypersonnel. As a result, it is possible that in the future the Company’soperating results will be below the expectations of public market analysts andinvestors.  In such event, the price ofthe Company’s common stock would likely be materially adversely affected.

 

*Product Concentration.*  To date, much of the Company’srevenues have been attributable to licenses of the Company’s facsimile-based enterprisesolutions and related products and services. The Company expects such productsand related services to continue to account for much of the Company’s futurerevenues. However, recently the amount of revenues attributable to the licensesof such products has declined and there can be no assurances that such declinewill not continue. Furthermore, the Company introduced its securebusiness-to-business electronic document exchange products, Genidocs andGenifax, to the market in the fourth quarter of 2000.  To date, the Company has not recognized asignificant amount of revenues from its Genidocs product. The Company expectsthat its Genidocs products may account for an increasing portion of futurerevenues. However, there can be no assurances that the Genidocs products willbe financially successful or result in any significant revenues. Factorsadversely affecting the pricing of or demand for such products, such ascompetition or technological change, could have a material adverse effect onthe Company’s business, financial condition and results of

 

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operations. The Company’s prospects must beconsidered in light of the risks and difficulties frequently encountered bycompanies dependent upon operating revenues from a new product line in anemerging and rapidly evolving market.

 

*New Products and Technological Change.*  Themarkets for the Company’s products are relatively new and are characterized byrapid technological change, evolving industry standards, changes in end-userrequirements and frequent new product introductions and enhancements. TheCompany’s future success will depend upon its ability to enhance its currentproducts and to develop and introduce new products that keep pace withtechnological developments and respond to evolving end-user requirements. Therecan be no assurance that the Company will be successful in developing andmarketing new products or product enhancements on a timely basis, or that newproducts or product enhancements developed by the Company, such as theGenidocs, Genifax and AccuRoute products will achieve continuing marketacceptance. The introduction of products embodying new technologies and theemergence of new industry standards could render the Company’s existing productsobsolete and unmarketable. From time to time, the Company and its competitorsmay announce new products, capabilities or technologies that have the potentialto replace or shorten the life cycle of the Company’s existing productofferings. There can be no assurance that announcements of new productofferings by the Company or its competitors will not cause customers to deferor forego the licensing of the Company’s existing or planned products and havea material adverse effect on the Company’s business, financial condition andresults of operations.

 

*The Market Risks for Secure Business-to-Business Electronic DocumentExchange Solutions.*  The market for Genidocs, the Company’s securebusiness-to-business electronic document exchange solution is new and evolvingrapidly. The Company’s success will depend upon the adoption and use by currentand potential customers of secure business-to-business electronic documentexchange solutions. The Company’s success will also depend upon acceptance ofits technology as the standard for providing these solutions. The adoption anduse of the Company’s secure business-to-business electronic document exchangesolution will involve changes in the manner in which businesses havetraditionally exchanged information. The Company’s ability to influence usageof its secure business-to-business electronic document exchange solution bycustomers is limited. The Company intends to spend considerable resourceseducating potential customers about the value of secure business-to-businesselectronic document exchange solutions. It is difficult to assess, or topredict with any assurance, the present and future size of the potential marketfor the Company’s secure business-to-business electronic document exchangesolution, or its growth rate, if any. Moreover, the Company cannot predict whether the Company’s securebusiness-to-business electronic document exchange solution will achieve anymarket acceptance. Any future products or future product enhancements that arenot favorably received by customers may not be profitable and, furthermore,could damage the Company’s reputation or brand name.

 

*Dependence on the Genifax and AccuRoute Product Lines and the Windows2000/XP environment.*  The Company currently derives a significantportion of its revenues from licenses of the Genifax product and relatedservices and resale of related hardware as well as licenses of the AccuRouteproduct. Continued market acceptance of the Genifax and AccuRoute products arecritical to the Company’s future success. As a result, any decline in demandfor or failure to maintain broad market acceptance of the Genifax and AccuRouteproduct lines as a result of competition, technological change or otherwise,would have a material adverse effect on the Company’s business, financialcondition and results of operations. The Company’s future financial performancewill depend in large part on new and enhanced versions of the Genifax andAccuRoute products. There can be no assurance that the Company will continue tobe successful in marketing the Genifax and AccuRoute products or any new orenhanced versions of the Genifax and AccuRoute products.  There can be no assurance that the Companywill be successful in developing products for new or enhanced operating systemssuch as Windows 2000 or Windows XP, or that such systems will not obviate theneed for the Company’s products. If any new or enhanced operating system gainswidespread use and the Company fails to develop and provide its products forthis operating system on a timely basis, the Company’s business, financialcondition and results of operations would be materially adversely affected.

 

*Dependence on Client/Server Environment.*  TheCompany’s enterprise, client/server facsimile software products are intended tohelp organizations efficiently manage their facsimile communications, utilizinga client/server computing environment. The client/server market is relativelynew and there can be no assurance that organizations will move away from theuse of stand-alone fax machines or continue to adopt client/serverenvironments, or that customers of the Company that have begun the migration toa client/server environment will broadly implement this model of computing. TheCompany’s future financial performance will depend in large part on continuedgrowth in the market for client/server applications, which in turn will dependin part on the growth in the number of organizations implementing client/servercomputing environments. There can be no assurance that these markets willcontinue to grow or that the Company will be able to respond effectively to theevolving requirements of these markets. If the market for client/serverapplication products and services does not grow in the future, grows moreslowly than the Company anticipates, or if the Company fails to respondeffectively to evolving

 

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requirements of this market, the Company’sbusiness, financial condition and results of operations would be materiallyadversely affected.

 

*Risks Associated withListing on the Nasdaq SmallCap Market*.  On November 26, 2002, theCompany transferred from the Nasdaq National Market to the Nasdaq SmallCapMarket.  The Company cannot predict thecontinuance of its listing status in the future including the possibility ofdelisting from the Nasdaq Small Cap Market. The delisting of the Company’s common stock from Nasdaq may materiallyimpair the stockholder’s ability to buy and sell shares of the Company’s commonstock and could have an adverse effect on the market price of, and theefficiency of the trading market for, the Company’s common stock.  Furthermore, the delisting of the Company’scommon stock could significantly impair the Company’s ability to raise capitalshould it desire to do so in the future. The Company’s listing on the Nasdaq Stock Market is highly important tothe Company and the Company intends to take reasonable measures to maintaincompliance.

 

*Intense Competition.*  The document routing anddistribution software, secure business-to-business electronic document exchangesolution and enterprise, and client/server facsimile solution markets areintensely competitive and rapidly changing and the Company expects competitionto continue to increase. The Company believes its ability to competesuccessfully depends upon a number of factors both within and beyond itscontrol, including product performance; reliability and features; productadoption; ease of use; product scalability; quality of support services;price/performance; timeliness of enhancements and new product releases by theCompany and its competitors; the emergence of new computer-based facsimile andsecure business-to-business electronic document exchange solutions andstandards; name recognition; the establishment of strategic alliances withindustry leaders and industry and general economic trends.

 

Thedocument routing and distribution software market includes competitive productsfrom vendors such as e-Copy, NotableSolutions, Inc., and Electronics For Imaging, Inc., as well as softwareproducts provided by scanning hardware vendors directly, such as Flowport fromXerox and Globalscan from Ricoh. Furthermore, these and additional hardware vendors may elect to includenew functionality in their hardware which could have the effect of renderingthe Company’s products less attractive to end users or distributionpartners.  The Company may not be able tocompete successfully against these current and future vendors of directlycompetitive products.  Additionally, manyother companies in the image acquisition, workflow, facsimile software, securemessaging software and document management markets have products withfunctionality that overlaps with, and which over time may become increasinglymore competitive with, the Company’s products.

 

The Company may not be ableto compete successfully against current and future competitors in the securebusiness-to-business electronic document exchange solutions market, and thecompetitive pressures the Company faces could harm its business and prospects.In the intensely competitive and rapidly changing business-to-business securedocument exchange market, the Company competes directly with Authentica,Sigaba, Tumbleweed, and Zixit and a number of other providers.  There are also other categories of technologysolution that overlap and compete in certain ways with aspects of the Company’sproducts.  These include:

 

•    Document management solutions from vendorssuch as Documentum, Hummingbird and iManage whose electronic collaboration solutionscompete with certain aspects of the Company’s solutions;

•    Electronic forms and electronic signaturesolutions from vendors such as Adobe, PureEdge, CreateForm and Silanis thatoffer the creation of electronic documents with electronic signatures; and

•    Security infrastructure solutions fromvendors such as Verisign and Entrust whose solutions can be used to buildapplications that enable secure document communications.

 

TheCompany expects the competition in the business-to-business secure documentexchange market to increase over time.

 

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

 

Many of the Company’s competitors and potential competitors have longeroperating histories and greater financial, technical, sales, marketing andother resources, as well as greater name recognition and market acceptance oftheir products

 

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and technologiesthan the Company. In addition, there are relatively low barriers to entry inthe markets in which the Company operates and intends to operate, and newcompetition may arise either from expansion by established companies or fromnew emerging companies or from resellers of the Company’s products. There canbe no assurance that current or potential competitors of the Company will notdevelop products comparable or superior-in terms of price and performancefeatures-to those developed by the Company, adapt more quickly than the Companyto new or emerging technologies and changes in market opportunities or customerrequirements, establish alliances with industry leaders, or take advantage ofacquisition opportunities more readily than the Company. In addition, noassurance can be given that the Company will not be required to makesubstantial additional investments in connection with its research,development, engineering, marketing, sales and customer service efforts inorder to meet any competitive threat, or that such required investments willnot have a material adverse effect on operating margins.  Changes in government laws and regulationsmay also affect our ability to maintain competitiveness.  Increased competition may result in reductionin market share, pressure for price reductions and related reductions in grossmargins, any of which could materially adversely affect the Company’s abilityto achieve its financial and business goals. There can be no assurance that inthe future the Company will be able to successfully compete against current andfuture competitors.

 

*Fluctuations in Quarterly Results of Operations; Seasonality.*  TheCompany’s quarterly revenues and results of operations have fluctuatedsignificantly in the past and will likely fluctuate significantly in thefuture. Causes of such fluctuations have included and may include, amongothers, the demand for the Company’s products and services; the size and timingof orders; the number, timing and significance of new product announcements bythe Company and its competitors; the ability of the Company to develop,introduce, market and ship new and enhanced versions of the Company’s currentand planned products on a timely basis; the level of product and pricecompetition; changes in operating expenses; changes in average selling pricesand mix of the Company’s products; changes in the Company’s sales incentive strategy;the mix of direct and indirect sales, and general economic factors, including adecline in the growth rate of the overall U.S. economy. In addition, the saleof the Company’s products often involves delays because customers tend toimplement the products on a large scale and they also must establish certainminimum hardware capabilities. The Company’s products therefore often have alengthy sales cycle while the customer evaluates and receives approvals for thepurchase of the Company’s products. During such sales cycles, the Company mayexpend substantial funds and management efforts yet receive no revenues. It isdifficult to accurately predict the sales cycle of any large order. If one ormore large orders fail to close as forecasted in a fiscal quarter, the Company’srevenues and operating results for such quarter could be materially adverselyaffected. Any one or more of these or other factors could have a materialadverse effect on the Company’s business, financial condition and results ofoperations. The potential occurrence of any one or more of these factors makesthe prediction of revenues and results of operations on a quarterly basisdifficult and performance forecasts derived from such predictions unreliable.

 

In general, revenues are difficultto forecast because the market for secure business-to-business electronicdocument exchange, enterprise client/server facsimile solutions software androuting and distribution software is evolving rapidly and the Company’s salescycle—from the customer’s initial evaluation through purchase of licenses andthe related support services—varies substantially from customer to customer.License fee revenues in any quarter depend on orders received and shipped inthat quarter with an increasing percentage of orders in any quarter beingreceived in the last weeks of the quarter. License fee revenues from quarter to quarter are difficult to forecast,as no significant order backlog exists at the end of any quarter because theCompany’s products typically are shipped upon receipt of customers’ orders.

 

A substantial portion of theCompany’s operating expense is related to personnel, facilities, equipment andmarketing programs. The level of spending for such expense cannot be adjustedquickly and is therefore fixed in the short term. The Company’s expense levelsfor personnel, facilities, equipment and marketing programs are based, insignificant part, on the Company’s expectations of future revenues on aquarterly basis. If actual revenue levels on a quarterly basis are belowmanagement’s expectations, results of operations are likely to be adverselyaffected by a similar amount because a relatively small amount of the Company’sexpense varies with its revenue in the short term.

 

Due to all of the foregoingfactors, it is likely that in some future periods the Company’s results ofoperations will be below the expectations of securities analysts and investors.In such event, the price of the Company’s common stock would likely bematerially adversely affected.

 

*Expansion of Indirect Channels; Potential for Channel Conflict;Strategic Alliances.*  The Company markets its products and servicesdirectly through telesales and indirectly through marketing channels such asvalue added resellers (“VARs”), systems integrators, distributors and strategicbusiness partners. Although the Company has historically focused its efforts onmarketing through its sales force, the Company continues to utilize resourcesto develop and expand indirect marketing channels. There can be no assurancethat the Company will be able to attract and retain a sufficient number of

 

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qualified VARs, systems integrators,distributors and strategic business partners to successfully market the Company’sproducts. In addition, there can be no assurance that the Company’s resellersand strategic business partners will not develop, acquire or market computer-basedfacsimile products that are competitive with the Company’s products. Thefailure to retain its VARs, systems integrators, distributors and strategicpartners could have a material adverse effect on the Company’s business,financial condition and results of operations.

 

The distributor agreementsgenerally provide that either party may terminate the agreement without causeupon 30 days written notice to the other party.  The Company also resells its products on apurchase order basis through other VARs, systems integrators and distributors.  Either party may terminate suchrelationships, at any time, and therefore there can be no assurance that anyVAR, systems integrator or distributor will continue to represent the Company’sproducts.  Furthermore, the Company’sstrategic alliances may be terminated by either party, at any time; there canbe no assurances that such strategic alliances will continue.  The inability to retain certain VARs, systemsintegrators, distributors or strategic business partners, or the development ormarketing by VARs, systems integrators, distributors or strategic business partnersof competitive offerings, could have a material adverse effect on the Company’sbusiness, financial condition and results of operations.

 

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

 

*Ability to obtain Additional Financing.** ***The Company expects that its current cash,cash equivalents and investments will meet our normal working capital andcapital expenditure needs for at least the next twelve months.  The Company may need to raise additionalfunding at that time or earlier if it decides to undertake more rapidexpansion, including acquisitions of complementary products or technologies, orif it increases its marketing and/or research and development efforts in orderto respond to competitive pressures.  TheCompany cannot be certain that it will be able to obtain additional financingon favorable terms, if at all.  TheCompany may obtain additional financing by issuing shares of our common stock,which could dilute our existing stockholders. If the Company cannot raise needed funds on acceptable terms, or at all,it may not be able to develop or enhance our products or respond appropriatelyto competitive pressures, which would seriously harm its business.

 

*Risks Associated with Acquisitions.*  TheCompany may augment its internal growth with acquisitions of businesses,products and technologies that could complement or expand the Company’sbusiness. Certain of these businesses may be marginally profitable orunprofitable. In order to achieve anticipated benefits from these acquisitions,the Company must successfully integrate the acquired businesses with itsexisting operations and no assurance can be given that the Company will besuccessful in this regard. The Company has limited experience in integratingacquired companies into its operations, in expanding the scope of operations ofrequired businesses, in managing geographically dispersed operations and inoperating internationally. In the past the Company has incurred one-time costsand expenses in connection with acquisitions and it is likely that similarone-time costs and expenses would be incurred in connection with futureacquisitions.  In addition, attractiveacquisitions are difficult to identify and complete for a number of reasons,including competition among prospective buyers and the possible need to obtainregulatory approval. There can be no assurance that the Company will be able tocomplete future acquisitions. In order to finance such acquisitions, it may benecessary for the Company to raise additional funds either through public orprivate financings, including bank borrowings. Any financing, if available at all, may be on terms which are notfavorable to the Company.  The Companymay also issue shares of its common stock to acquire such businesses, which maydilute the Company’s existing stockholders.

 

*Ability to Manage Growth.*  The Company may expand itsoperations and anticipates that expansion may be required in order to addresspotential market opportunities. The Company may increase the size of its salesand marketing and research and development expenditures as necessary. There canbe no assurance that such expansion would be completed successfully or that itwould generate sufficient revenues to cover the Company’s expenses. The Companywill need to continue to attract and retain highly qualified technical, salesand managerial personnel. There can be no assurance that the Company will beable to retain or continue to hire such personnel in the future. The inabilityof the Company to effectively expand operations and manage growth, if any,could have a material adverse effect on the Company’s business, financialcondition and results of operations.

 

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*Risks Associated with the Use of Arthur Andersen asIndependent Auditors. *Arthur Andersen LLP (“Andersen”), the Company’sformer independent public accountants that audited the Company’s financialstatements until June 28, 2002, was found guilty by a jury on June 15, 2002 offederal obstruction of justice in connection with the government’sinvestigation of Enron Corporation. Andersen ceased practicing before the SEC effective August 31,2002.  Although the Company has no reasonto believe that those financial statements are incorrect, it is possible thatevents arising out of the indictment may adversely affect Andersen’s ability tosatisfy any claims arising from its provision of auditing and other services tothe Company, including claims that may arise out of Andersen’s audit of theCompany’s financial statements.  The SEChas indicated that it will continue accepting financial statements audited orreviewed by Andersen provided that the Company comply with the applicable rulesand orders issued by the SEC in March 2002 for such purpose.

 

*Risks Associated with International Expansion.*  Anelement of the Company’s strategy is to increase its international sales. TheCompany expects to face competition from secure business-to-business electronicdocument exchange solutions and local facsimile product providers in theirnative countries. To successfully maintain international sales, the Companyneeds to recruit and retain additional international resellers anddistributors. There can be no assurance that the Company will be able tomaintain international sales of its products or that the Company’sinternational distribution channels will be able to adequately market, serviceand support the Company’s products. International operations generally aresubject to certain risks, including dependence on independent resellers,fluctuations in foreign currency exchange rates, compliance with foreignregulatory and market requirements, variability of foreign economic conditionsand changing restrictions imposed by United States export laws. Additionalrisks inherent in the Company’s international business activities generallyinclude unexpected changes in regulatory requirements, tariffs and other tradebarriers, costs of localizing products for foreign countries, lack ofacceptance of localized products in foreign countries, longer accountsreceivable payment cycles, difficulties in managing international operations,difficulties in enforcing intellectual property rights and the burdens ofcomplying with a wide variety of foreign laws. The Company has a sales office outside of the United States; suchoperations are subject to certain additional risks, including difficulties instaffing and managing such operations and potentially adverse tax consequencesincluding restrictions on the repatriation of earnings. There can be noassurance that such factors will not have a material adverse effect on theCompany’s future international sales and, consequently, the Company’s business,financial condition and results of operations. To date, a majority of theCompany’s sales have been made in United States dollars and the Company has notengaged in any hedging transactions through the purchase of derivative securitiesor otherwise.

 

*Dependence on KeyPersonnel.*  The Company’s future performance depends, insignificant part, upon the continued service of its key technical, sales andsenior management personnel, most of whom are not bound by an employmentagreement or by a noncompetition agreement. The loss of the services of one ormore of the Company’s executive officers or other key employees could have amaterial adverse effect on the Company’s business, financial condition andresults of operations. The Company’s future success also depends on itscontinuing ability to attract and retain highly qualified technical, sales andmanagerial personnel. Competition for such personnel is intense, and theCompany has experienced difficulty in recruiting qualified technical personnel.There can be no assurance that the Company will be able to retain or continueto hire key technical, sales and managerial personnel in the future.

 

Item 3. Quantitative andQualitative Disclosures About Market Risk

 

*Derivative FinancialInstruments, Other Financial Instruments, and Derivative Commodity Instruments.*** **As of September 30,2004, the Company did not participate in any derivative financial instrumentsor other financial and commodity instruments for which fair value disclosurewould be required under SFAS No. 107,*Disclosures about FairValue of Financial Instruments*. All of the Company’s investmentsconsist of money market funds and commercial paper that are carried on theCompany’s books at amortized cost, which approximates fair market value.Accordingly, the Company has no quantitative information concerning the marketrisk of participating in such investments.

 

*Primary Market RiskExposures***. **The Company’s primary market risk exposures are in the areas ofinterest rate risk and foreign currency exchange rate risk. The Company’sinvestment portfolio of cash equivalents is subject to interest ratefluctuations, but the Company believes this risk is immaterial due to theshort-term nature of these investments. The Company’s exposure to currencyexchange rate fluctuations has been and is expected to continue to be modestdue to the fact that the operations of its United Kingdom subsidiary are almostexclusively conducted in its local currency. The United Kingdom subsidiary’soperating results are translated into U.S. dollars and consolidated forreporting purposes. The impact of currency exchange rate movements onintercompany transactions was immaterial for the quarter ended September 30,2004. Currently, the Company does not engage in foreign currency hedgingactivities.

 

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Item 4. Controls andProcedures

 

As of the end of the fiscal quarter (the “EvaluationDate”), the Company, under the supervision and with the participation of theCompany’s management, including the Company’s Chief Executive Officer andacting Chief Financial Officer, evaluated the effectiveness of the Company’sdisclosure controls and procedures pursuant to Rule 13a-15(b) and 15d-15(b)promulgated under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”).  Based upon that evaluation, theCompany’s Chief Executive Officer and acting Chief Financial Officer concludedthat, as of the Evaluation Date, the Company’s disclosure controls andprocedures are effective in ensuring that information relating to the Company(including its consolidated subsidiaries) required to be disclosed by theCompany in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, including ensuring that such information isaccumulated and communicated to the Company’s management, including the Company’sChief Executive Officer and acting Chief Financial Officer, as appropriate toallow timely decisions regarding required disclosure.

 

Therewere no changes in the Company’s internal controls over financial reportingduring the Company’s last fiscal quarter that has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

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**PART II:  OTHER INFORMATION**

 

Item 5.     OtherInformation

 

There havebeen no changes to the procedures by which security holders may recommendnominees to the Company’s Board of Directors during the time period covered bythis Quarterly Report on Form 10-Q.

 

Item 6.     Exhibits

 

Exhibits

 
| 10.17  |   | Form of Incentive Stock  Option Agreement                                                                                                            |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                 |
| 10.18  |   | Form of Incentive Stock  Option Agreement                                                                                                            |
|   |   |                                                                                                                                                 |
| 10.19  |   | Form of Non-Qualified  Stock Option Agreement                                                                                                        |
|   |   |                                                                                                                                                 |
| 10.20  |   | Form of Non-Qualified  Stock Option Agreement                                                                                                        |
|   |   |                                                                                                                                                 |
| 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. |
|-------------------------|---------------|
|                    |          |
|                    |          |
| November 15,  2004 | By:           | /s/  Daniel A. Coccoluto |   |
|                    |          | Daniel  A. Coccoluto |
|                    |          | Acting  Chief Financial Officer, Secretary and Treasurer |
|                    |          | (Duly  authorized officer and principal financial officer) |

 

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**Exhibit Index**

 
| 10.17  |   | Form of Incentive Stock  Option Agreement                                                                                                            |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                 |
| 10.18  |   | Form of Incentive Stock  Option Agreement                                                                                                            |
|   |   |                                                                                                                                                 |
| 10.19  |   | Form of Non-Qualified  Stock Option Agreement                                                                                                        |
|   |   |                                                                                                                                                 |
| 10.20  |   | Form of Non-Qualified  Stock Option Agreement                                                                                                        |
|   |   |                                                                                                                                                 |
| 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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