**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-Q**

 

**(Mark One)**

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

 

**Forthe quarterly period ended September 30, 2002**

 

**OR**

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

 

**Forthe transition period from          to       **

 

**CommissionFile Number 0-22871**

 

**OMTOOL,LTD.**

(Exact Name of Registrantas Specified in Its Charter)

 

| **Delaware**                                                     |   | **02-0447481**                           |
|------------------------------------------------------------------|--------|------------------------------------------|
| (State or Other  Jurisdiction of  Incorporation or Organization) |   | (I.R.S. Employer  Identification Number) |
|                                                             |   |                                     |
| **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 mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15 (d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

 

Yes ý    No o

 

Indicate by check mark whether the Registrant is anaccelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).

 

Yes  o      No ý

 

There were 12,211,793 shares of the Company’s CommonStock, par value $0.01, outstanding on November 12, 2002.

 

 

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**OMTOOL, LTD. AND SUBSIDIARIES**

 

FORM 10-Q

For the Quarter EndedSeptember 30, 2002

CONTENTS

 
| Item Number                                                                                                |
|------------------------------------------------------------------------------------------------------------|
|                                                                                                       |
| PART I: FINANCIAL  INFORMATION                                                                             |
|                                                                                                       |   |
| Item 1.  Consolidated Financial Statements                                                            |
|                                                                                                       | Consolidated Balance Sheets  as of September 30, 2002 (Unaudited) and December 31, 2001 |
|                                                                                                       | Consolidated  Statements of Operations for the three months and nine months ended September  30, 2002 and 2001 (Unaudited) |
|                                                                                                       | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2002 and  2001 (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 6.  Exhibits and Reports on Form 8-K                                                             |
|                                                                                                       |   |
| Signatures                                                                                                 |   |
|                                                                                                       |   |
| Certifications                                                                                             |   |
|                                                                                                            |  |  |

 

2

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**PART I:  FINANCIALINFORMATION**

Item 1.  Financial Statements

 

**OMTOOL, LTD. AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

 
|                                                                                                            |   | **September  30,  2002** |       | **December  31,  2001** |       |
|-----------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-------------------------|------------|
|                                                                                                            |   | **(Unaudited)**          |       |                    |       |
| **ASSETS**                                                                                                      |   |                     |       |                    |       |
| Current assets:                                                                                                 |   |                     |       |                    |       |
| Cash and cash  equivalents                                                                                      |   | $                        | 9,375,744  |                    | $          | 11,194,118 |   |
| Short-term  investments                                                                                         |   | —                   |       | 1,296,750               |       |
| Accounts  receivable, less reserves of $720,000 at September 30, 2002 and $630,000 at  December 31, 2001        |   | 1,406,652                |       | 1,867,332               |       |
| Inventory –  finished goods                                                                                |   | 150,733                  |       | 168,039                 |       |
| Prepaid expenses  and other current assets                                                                      |   | 468,973                  |       | 613,662                 |       |
| Deferred tax  asset                                                                                             |   | —                   |       | 1,225,350               |       |
| Total current  assets                                                                                           |   | 11,402,102               |       | 16,365,251              |       |
|                                                                                                            |   |                     |       |                    |       |
| Property and  equipment, net                                                                                    |   | 699,858                  |       | 836,366                 |       |
|                                                                                                            |   |                     |       |                    |       |
| Other assets                                                                                                    |   | 13,962                   |       | 13,962                  |       |
|                                                                                                            |   |                     |       |                    |       |
| Total assets                                                                                                    |   | $                        | 12,115,922 |                    | $          | 17,215,579 |   |
|                                                                                                            |   |                     |       |                    |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                  |   |                     | ** ** |                    | ** ** |
| Current  liabilities:                                                                                           |   |                     |       |                    |       |
| Accounts payable                                                                                                |   | $                        | 549,115    |                    | $          | 733,290 |   |
| Accrued  liabilities                                                                                            |   | 2,906,837                |       | 2,023,601               |       |
| Deferred revenue                                                                                                |   | 3,092,521                |       | 3,383,759               |       |
| Total current  liabilities                                                                                      |   | 6,548,473                |       | 6,140,650               |       |
|                                                                                                            |   |                     |       |                    |       |
| Stockholders’  equity:                                                                                     |   |                     |       |                    |       |
| Preferred Stock,  $.01 par value —  Authorized — 2,000,000 shares; Issued and outstanding — none |   | —                   |       | —                  |       |
| Common Stock,  $.01 par value —  Authorized — 35,000,000 shares; Issued — 13,009,372 shares      |   | 130,093                  |       | 130,093                 |       |
| Additional  paid-in capital                                                                                     |   | 31,879,212               |       | 31,924,984              |       |
| Accumulated  deficit                                                                                            |   | (25,425,634              | )          | (20,152,079             | )          |
| Treasury Stock  (797,579 shares at cost at September 30, 2002 and 320,305 shares at cost at  December 31, 2001) |   | (924,570                 | )          | (734,086                | )          |
| Cumulative  translation adjustment                                                                              |   | (91,652                  | )          | (93,983                 | )          |
| Total  stockholders’ equity                                                                                |   | 5,567,449                |       | 11,074,929              |       |
|                                                                                                            |   |                     |       |                    |       |
| Total  liabilities and stockholders’ equity                                                                |   | $                        | 12,115,922 |                    | $          | 17,215,579 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

3

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**OMTOOL, LTD. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited)

 
|                                                 |   | **Three  months ended  September 30,** |     | **Nine  months ended  September 30,** |   |
|------------------------------------------------------|--------|----------------------------------------|----------|---------------------------------------|--------|
|                                                 |   | **2002**                               |     | **2001**                              |   | **2002** |   | **2001** |   |
| Revenues:                                            |   |                                   |     |                                  |   |   |   |   |   |
| Software license                                     |   | $                                      | 899,656  |                                  | $      | 1,078,336 |   | $ | 3,041,068 |   | $ | 3,649,610 |   |
| Hardware                                             |   | 712,509                                |     | 688,534                               |   | 2,143,808 |   | 2,239,401 |   |
| Service and  other                                   |   | 1,925,714                              |     | 1,769,944                             |   | 5,607,134 |   | 5,362,857 |   |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Total revenues                                       |   | 3,537,879                              |     | 3,536,814                             |   | 10,792,010 |   | 11,251,868 |   |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Cost of  revenues:                                   |   |                                   |     |                                  |   |   |   |   |   |
| Software license                                     |   | 84,948                                 |     | 100,242                               |   | 237,793 |   | 321,031 |   |
| Hardware                                             |   | 437,355                                |     | 480,588                               |   | 1,398,172 |   | 1,471,175 |   |
| Service and  other                                   |   | 867,780                                |     | 879,871                               |   | 2,466,957 |   | 3,222,143 |   |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Total cost of  revenues                              |   | 1,390,083                              |     | 1,460,701                             |   | 4,102,922 |   | 5,014,349 |   |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Gross profit                                         |   | 2,147,796                              |     | 2,076,113                             |   | 6,689,088 |   | 6,237,519 |   |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Operating  expenses:                                 |   |                                   |     |                                  |   |   |   |   |   |
| Sales and  marketing                                 |   | 1,332,134                              |     | 1,602,744                             |   | 4,854,374 |   | 4,680,122 |   |
| Research and  development                            |   | 586,200                                |     | 725,083                               |   | 2,282,125 |   | 2,422,894 |   |
| General and  administrative                          |   | 1,089,262                              |     | 999,364                               |   | 3,748,405 |   | 2,648,037 |   |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Total operating  expenses                            |   | 3,007,596                              |     | 3,327,191                             |   | 10,884,904 |   | 9,751,053 |   |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Loss from  operations                                |   | (859,800                               | )        | (1,251,078                            | )      | (4,195,816 | ) | (3,513,534 | ) |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Interest income                                      |   | 49,940                                 |     | 126,370                               |   | 147,611 |   | 556,194 |   |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Loss before tax  provision                           |   | (809,860                               | )        | (1,124,708                            | )      | (4,048,205 | ) | (2,957,340 | ) |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Tax provision                                        |   | —                                 |     | —                                |   | 1,225,350 |   | — |   |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Net loss                                             |   | $                                      | (809,860 | )                                     | $      | (1,124,708 | ) | $ | (5,273,555 | ) | $ | (2,957,340 | ) |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Net loss per  share                                  |   |                                   |     |                                  |   |   |   |   |   |
| Basic and  Diluted                                   |   | $                                      | (0.06    | )                                     | $      | (0.09 | ) | $ | (0.42 | ) | $ | (0.23 | ) |
|                                                 |   |                                   |     |                                  |   |   |   |   |   |
| Weighted average number of common shares outstanding |   |                                   |     |                                  |   |   |   |   |   |
| Basic and  Diluted                                   |   | 12,617,482                             |     | 12,740,948                            |   | 12,674,557 |   | 12,746,149 |   |

 

The accompanying notesare an integral part of these consolidated financial statements*.*

 

4

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**OMTOOL, LTD. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited)

 
|                                                                              |   | **Nine  months ended  September 30,** |       |
|-----------------------------------------------------------------------------------|--------|---------------------------------------|------------|
|                                                                              |   | **2002**                              |       | **2001** |   |
| Cash Flows from  Operating Activities:                                            |   |                                  |       |   |   |
| Net loss                                                                          |   | $                                     | (5,273,555 | ) | $ | (2,957,340 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities– |   |                                  |       |   |   |
| Depreciation and  amortization                                                    |   | 388,632                               |       | 536,223 |   |
| Deferred taxes                                                                    |   | 1,225,350                             |       | 33,628 |   |
| Changes in  assets and liabilities–                                          |   |                                  |       |   |   |
| Accounts  receivable                                                              |   | 480,915                               |       | 513,348 |   |
| Prepaid expenses  and other current assets                                        |   | 138,332                               |       | (420,254 | ) |
| Inventory                                                                         |   | 18,435                                |       | 89,711 |   |
| Accounts payable                                                                  |   | (194,847                              | )          | (275,138 | ) |
| Accrued  liabilities                                                              |   | 873,540                               |       | (2,267,212 | ) |
| Deferred revenue                                                                  |   | (323,219                              | )          | 87,431 |   |
|                                                                              |   |                                  |       |   |   |
| Net cash used in  operating activities                                            |   | (2,666,417                            | )          | (4,659,603 | ) |
|                                                                              |   |                                  |       |   |   |
| Cash Flows from  Investing Activities:                                            |   |                                  |       |   |   |
| Purchases of  property and equipment                                              |   | (247,309                              | )          | (240,774 | ) |
| Proceeds from  sale of short-term investments                                     |   | 1,296,750                             |       | 3,283,113 |   |
|                                                                              |   |                                  |       |   |   |
| Net cash  provided by investing activities                                        |   | 1,049,441                             |       | 3,042,339 |   |
|                                                                              |   |                                  |       |   |   |
| Cash Flows from  Financing Activities:                                            |   |                                  |       |   |   |
| Net proceeds  from issuance of common stock                                       |   | 19,083                                |       | 63,573 |   |
| Purchases of  treasury stock                                                      |   | (255,339                              | )          | (168,232 | ) |
| Net cash used in  financing activities                                            |   | (236,256                              | )          | (104,659 | ) |
|                                                                              |   |                                  |       |   |   |
| Foreign exchange  effect on cash                                                  |   | 34,858                                |       | 27,881 |   |
|                                                                              |   |                                  |       |   |   |
| Net decrease in  cash and cash equivalents                                        |   | (1,818,374                            | )          | (1,694,042 | ) |
|                                                                              |   |                                  |       |   |   |
| Cash and cash  equivalents, beginning of period                                   |   | 11,194,118                            |       | 14,599,350 |   |
|                                                                              |   |                                  |       |   |   |
| Cash and cash  equivalents, end of period                                         |   | $                                     | 9,375,744  |   | $ | 12,905,308 |   |

 

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

 

5

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**OMTOOL, LTD. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

(Unaudited)

 

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

 

The accompanying unaudited consolidated financial statements have beenprepared by Omtool, Ltd. (the “Company” or “Omtool”) pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”) regarding interimfinancial reporting.  Accordingly, theydo not include all of the information and footnotes required by generallyaccepted accounting principles for complete financial statements and should beread in conjunction with the consolidated financial statements and notesthereto for the year ended December 31, 2001 as filed with the SEC on March 22,2002. The accompanying consolidated financial statements reflect alladjustments (consisting of normal recurring adjustments) which are, in theopinion of management, necessary for a fair presentation of results for theinterim periods presented.  The resultsof operations for the three month and nine month periods ended September 30,2002 are not necessarily indicative of the results to be expected for the fullfiscal year.

 

The Company’s financial results for the first nine months of 2002declined substantially from financial results for the first nine months of 2001primarily due to the general economic softness in information technologyspending as reflected in a decrease in demand for enterprise softwaresolutions.  This decrease reflected thedeclining economic climate in the United States in the first nine months of2002 as compared to that of 2001 causing customers and prospective customers todefer technology purchases. As a result of this decrease in demand, theCompany’s revenues for the nine months ended September 30, 2002 decreased4% from revenues for the nine months ended September 30, 2001, and theCompany’s net loss increased from $2.9 million for the nine months endedSeptember 30, 2001 to a net loss of $5.3 million for the nine monthsended September 30, 2002.  The Companyhas experienced declining revenues and increasing operating losses over anextended period of time.  Based upon thecurrent economic environment, general softness in information technologyspending, products that may not achieve market acceptance, and shortforecasting visibility, the Company cannot estimate that the financial andoperating performance, financial position or cash flow will improve over thenext twelve months.  As a result of thelosses incurred and the anticipation of a continuing decline in the United Stateseconomy, the Company reduced its work force and office space in June 2002 tolower the overall cost of operations by approximately $750,000 annually.  Although the Company’s operating cash flowfor the nine months ended September 30, 2002 resulted in a use of cash of$2.7 million, the Company’s cash and cash equivalents at September 30,2002 were approximately $9.4 million. The Company anticipates that itsbalance of cash and cash equivalents will be approximately $8 million at theend of the fourth quarter of 2002. The Company believes that its existing cashand cash equivalents will be sufficient to meet the Company’s working capitaland capital expenditures for at least the next twelve months.

 

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

 

The Company reports earnings per share in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 128,*Earnings per Share*.  Diluted weighted average shares outstandingfor the three and nine months ended September 30, 2002 and September 30, 2001exclude the potential common shares related to 2,702,263 and 2,341,638,respectively, outstanding stock options because to include them would have beenantidilutive for the periods presented.

 

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

 

During the quarter ended June 30, 2002, the Company recorded anadditional valuation allowance of approximately $1.2 million against all of itsnet deferred tax assets. SFAS No. 109, *Accounting for Income Taxes* requires avaluation allowance to be recorded against deferred tax assets when it is morelikely than not that some or all of the deferred tax assets will not berealized. As a result of the downturn in the economy, the Company incurredsignificant and previously unanticipated losses in the first half of thecurrent fiscal year, and the current outlook indicates that significantuncertainty will continue for the remainder of this fiscal year and into thenext fiscal year. These cumulative losses, together with the Company’s priorlosses, resulted in management’s decision that it is more likely than not thatall of its deferred tax assets will

 

6

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not be realized inthe foreseeable future.  Accordingly,the remaining net deferred tax asset was written off in the second quarter of2002.

 

The Company will continue to provide a valuation allowance against allof its net deferred tax assets until it returns to an appropriate level oftaxable income. The ultimate realization of these deferred tax assets dependsupon the Company’s ability to generate sufficient future taxable income. If theCompany is successful in generating sufficient future taxable income, theCompany will reduce the valuation allowance through a reduction in income taxexpense in the future.

 

**(4)**               **Comprehensive L****oss**

 

The components of the Company’s comprehensiveloss are as follows:

 
|                                      |   | **Three  months ended  September 30,** |     | **Nine  months ended  September 30,** |   |
|-------------------------------------------|--------|----------------------------------------|----------|---------------------------------------|--------|
|                                      |   | **2002**                               |     | **2001**                              |   | **2002** |   | **2001** |   |
| Net loss                                  |   | $                                      | (809,860 | )                                     | $      | (1,124,708 | ) | $ | (5,273,555 | ) | $ | (2,957,340 | ) |
| Foreign currency  translation adjustments |   | 3,976                                  |     | (1,697                                | )      | 2,331 |   | 1,383 |   |
| Comprehensive  loss                       |   | $                                      | (805,884 | )                                     | $      | (1,126,405 | ) | $ | (5,271,224 | ) | $ | (2,955,957 | ) |

 

**(5)**               **Segment and Geographic Information**

 

To date, the Company has viewed its operations and managesits business as principally one segment, software sales and associatedservices. As a result, the financial information disclosed herein, representsall of the material financial information related to the Company’s principaloperating segment in accordance with SFAS No. 131, *Disclosures About Segments of an Enterpriseand Related Information*.

 

Total revenues from international sources were approximately$711,000 and $2.0 million for the three months and nine months ended September 30, 2002,respectively, and $515,000 and $1.7 million for the three months and nine monthsended September 30, 2001, respectively. The Company’s revenues frominternational sources were primarily generated from customers located inEurope. The following table represents amounts relating to geographiclocations:

 
|                                |   | **Three  months ended  September 30,** |      | **Nine  months ended  September 30,** |   |
|-------------------------------------|--------|----------------------------------------|-----------|---------------------------------------|--------|
| **Total  revenues (1)**             |   | **2002**                               |      | **2001**                              |   | **2002** |   | **2001** |   |
| United States                       |   | $                                      | 2,826,718 |                                  | $      | 3,022,232 |   | $ | 8,815,399 |   | $ | 9,537,014 |   |
| United Kingdom                      |   | 239,405                                |      | 218,380                               |   | 929,477 |   | 726,704 |   |
| Other North  America                |   | 249,384                                |      | 211,118                               |   | 580,064 |   | 667,975 |   |
| Other Europe                        |   | 97,564                                 |      | 73,591                                |   | 245,679 |   | 232,898 |   |
| Latin America /  Pacific Rim        |   | 124,808                                |      | 135                                   |   | 171,499 |   | 20,162 |   |
| Middle East /  Far East / Australia |   | —                                 |      | 11,358                                |   | 49,894 |   | 67,115 |   |
|                                |   | $                                      | 3,537,879 |                                  | $      | 3,536,814 |   | $ | 10,792,012 |   | $ | 11,251,868 |   |

 
| **Long-lived assets (2)** |   | **September 30,  2002** |    | **December  31,  2001** |   |
|---------------------------|--------|-------------------------|---------|------------------------------|--------|
| North America             |   | $                       | 674,685 |                         | $      | 789,915 |   |
| Europe                    |   | 39,135                  |    | 60,413                       |   |
|                      |   | $                       | 713,820 |                         | $      | 850,328 |   |

 

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

(2)  Long-lived assets includeall long-term assets except those specifically excluded under SFAS No. 131 suchas deferred income taxes andfinancial instruments.

 

7

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**(6)**               **R****ecently Issued Accounting****Pronouncements**

 

In July 2002, theFinancial Accounting Standards Board issued SFAS No. 146, *Accounting for Costs Associated withExit or Disposal Activities*. SFAS No. 146 addresses financial accounting and reporting for costsassociated with exit or disposal activities and nullifies Emerging Issues TaskForce Issue No. 94-3, *Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (including CertainCosts Incurred in a Restructuring)*. SFAS No. 146 requires that a liability be recognized when it is incurredand should initially be measured and recorded at fair value.  This statement is effective for exit ordisposal activities that are initiated after December 31, 2002 and the adoptionis not expected to have a material impact on the consolidated financialstatements of the Company.

 

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**Item2.**

**MANAGEMENT’S DISCUSSIONAND ANALYSIS**

**OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

 

Management’s Discussion and Analysis of FinancialCondition and Results of Operations should be read in conjunction with theaccompanying consolidated financial statements for the periods specified andthe associated notes.  Further referenceshould be made to the Company’s Annual Report on Form 10-K as filed with theSecurities Exchange Commission on March 22, 2002.

 

**Overview**

 

Omtool, Ltd.is a leading provider of e-mail and fax-based messaging software that enablessecure, confirmed document exchange between businesses. The Company was incorporated in March 1991 and shipped itsinitial facsimile software products in 1991. Omtool’s GenidocsTM product family enables users throughout anenterprise to deliver confidential and secure e-mail over the Internet.  Omtool’s Fax Sr.TM, LegalFaxTM andGenifaxTM product families provide users with an extensive, flexible feature setfor transmitting and receiving faxes and improve an organization’s managementof its fax communications process by providing a suite of utility and controlfunctions. A significant portion of the Company’s revenues is derived fromlicensing rights to use its Genifax and Fax Sr. software products directlyto end-users and indirectly through resellers.

 

The Company’s financialresults for the first nine months of 2002 declined substantially from financialresults for the first nine months of 2001, due primarily to the generaleconomic softness in information technology spending as reflected in a decreasein demand for enterprise software solutions. This decrease reflected the declining economic climate in the UnitedStates in the first nine months of 2002 as compared to that of 2001 causingcustomers and prospective customers to defer technology purchases. As a resultof this decrease in demand, the Company’s revenues for the nine months ended September 30,2002 decreased 4% from revenues for the nine months ended September 30,2001, and the Company’s net loss increased from $2.9 million for the ninemonths ended September 30, 2001 to a net loss of $5.3 million for thenine months ended September 30, 2002. The Company has experienced declining revenues and increasing operatinglosses over an extended period of time. Based upon the current economic environment, general softness ininformation technology spending, products that may not achieve marketacceptance, and short forecasting visibility, the Company cannot estimate thatthe financial and operating performance, financial position or cash flow willimprove over the next twelve months.  Asa result of the losses incurred and the anticipation of a continuing decline inthe United States economy, the Company reduced its work force and office spacein June 2002 to lower the overall cost of operations by approximately $750,000annually. Although the Company’s operating cash flow for the nine months endedSeptember 30, 2002 resulted in a use of cash of $2.7 million, theCompany’s cash and cash equivalents at September 30, 2002 were approximately$9.4 million.  The Companyanticipates that its balance of cash and cash equivalents will be approximately$8 million at the end of the fourth quarter of 2002. The Company believes thatits existing cash and cash equivalents will be sufficient to meet the Company’sworking capital and capital expenditures for at least the nexttwelve months.

 

The Company cannot predictwhen the market for enterprise software solutions will improve. When the marketdoes improve, the Company cannot predict whether, and to what extent, thedemand for its products will increase. The Company believes that the current lack of demand for enterprisesoftware solutions will continue during the remainder of 2002, and that itsoperations and financial results will continue to be negatively affected duringthat period. Any continued decline in the Company’s revenues will have asignificant impact on the Company’s financial results, particularly because asignificant portion of the Company’s operating costs (such as personnel, rentand depreciation) are fixed in advance of a particular quarter. As a result,despite cost savings realized from the Company’s June 2002 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.

 

9

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

 

The Company hashistorically derived a substantial portion of its total revenues from saleswithin North America. Sales outside of North America (primarily in Europe)represented approximately 13% and 9% of the Company’s total revenues for thenine months ended September 30, 2002 and 2001, respectively.

 

The Company’s UnitedKingdom subsidiary transacts business primarily in its local currency. TheCompany manages its foreign exchange exposure by monitoring its net monetaryposition using natural hedges of its assets and liabilities denominated inlocal currencies. There can be no assurance that this policy will eliminate allcurrency exposure. Foreign currency exposure has not been material to theCompany’s financial position or results of operations to date. If the Company’sbusiness denominated in foreign currencies increases, the Company may berequired to use derivatives to hedge foreign currency exposure.

 

The Company continues toactively recruit value-added resellers (“VARs”), systems integrators, resellersand distributors to expand its indirect distribution channel. The Company ispursuing sales opportunities via its solution/reseller channel as well asfocusing sales efforts on specific market segments in order to facilitateproduct acceptance.  Sales through theCompany’s indirect distribution channels represent approximately 20% and 22% ofthe Company’s total revenues for the nine months ended September 30, 2002 and2001, respectively.

 

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**Resultsof Operations**

 

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

 
|                        |   | **Three  months ended  September 30,** |   | **Nine  months ended  September 30,** |   |
|-----------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                        |   | **2002**                               |   | **2001**                              |   | **2002** |   | **2001** | ** ** |
| Revenues:                   |   |                                   |   |                                  |   |   |   |   |   |
| Software license            |   | 25.4                                   | %      | 30.5                                  | %      | 28.1 | % | 32.4 | % |
| Hardware                    |   | 20.2                                   |   | 19.5                                  |   | 19.9 |   | 19.9 |   |
| Service and  other          |   | 54.4                                   |   | 50.0                                  |   | 52.0 |   | 47.7 |   |
| Total revenues              |   | 100.0                                  |   | 100.0                                 |   | 100.0 |   | 100.0 |   |
| Cost of  revenues:          |   |                                   |   |                                  |   |   |   |   |   |
| Software license            |   | 2.4                                    |   | 2.8                                   |   | 2.2 |   | 2.9 |   |
| Hardware                    |   | 12.4                                   |   | 13.6                                  |   | 13.0 |   | 13.1 |   |
| Service and  other          |   | 24.5                                   |   | 24.9                                  |   | 22.9 |   | 28.6 |   |
| Total cost of  revenues     |   | 39.3                                   |   | 41.3                                  |   | 38.1 |   | 44.6 |   |
| Gross profit                |   | 60.7                                   |   | 58.7                                  |   | 61.9 |   | 55.4 |   |
| Operating  expenses:        |   |                                   |   |                                  |   |   |   |   |   |
| Sales and  marketing        |   | 37.7                                   |   | 45.3                                  |   | 45.0 |   | 41.6 |   |
| Research and  development   |   | 16.6                                   |   | 20.5                                  |   | 21.1 |   | 21.5 |   |
| General and  administrative |   | 30.8                                   |   | 28.3                                  |   | 34.7 |   | 23.5 |   |
| Total operating  expenses   |   | 85.1                                   |   | 94.1                                  |   | 100.8 |   | 86.6 |   |
| Loss from  operations       |   | (24.4                                  | )      | (35.4                                 | )      | (38.9 | ) | (31.2 | ) |
| Interest income             |   | 1.4                                    |   | 3.6                                   |   | 1.4 |   | 4.9 |   |
| Tax provision               |   | —                                 |   | —                                |   | (11.4 | ) | — |   |
|                        |   |                                   |   |                                  |   |   |   |   |   |
| Net loss                    |   | (23.0                                  | )%     | (31.8                                 | )%     | (48.9 | )% | (26.3 | )% |
|                        |   |                                   |   |                                  |   |   |   |   |   |
| Gross profit:               |   |                                   |   |                                  |   |   |   |   |   |
| Software license            |   | 90.6                                   | %      | 90.7                                  | %      | 92.2 | % | 91.2 | % |
| Hardware                    |   | 38.6                                   |   | 30.2                                  |   | 34.8 |   | 34.3 |   |
| Service and  other          |   | 54.9                                   |   | 50.3                                  |   | 56.0 |   | 39.9 |   |

 

**ThreeMonths Ended September 30, 2002 and 2001**

 

## ***Revenues***

 

*Total Revenues.*  TheCompany’s revenues are currently derived from licensing fees of the Company’ssoftware products and from sales of related hardware and services. TheCompany’s total revenues were $3.5 million for each of the three monthsended September 30, 2002 and 2001.

 

*Software License.*  TheCompany’s software license revenues are derived primarily from the licensing ofthe Company’s Fax Sr. and Genifax products.  Software license revenues were $900,000 forthe three months ended September 30, 2002 and $1.1 million for thethree months ended September 30, 2001, representing a decrease of17%.  Software license revenuesaccounted for 25% and 31% of total revenues for each respective period.  The decline in software license revenues canbe attributed to a number of factors that include the general softness ininformation technology spending which is reflected in a decrease in demand forenterprise software solutions and a decline in the growth rate of the overallUnited States economy causing customers and prospective customers to defertechnology purchases.  The decrease insoftware license revenue as a percentage of total revenues is primarilyattributable to the decrease in software revenues combined with the relativestability of the level of service and other revenues.  The Company did not recognize a significant amount of revenuefrom its Genidocs products.

 

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*Hardware.*  Hardware revenues are derived from theresale of third-party hardware products sold to the Company’s customers inconjunction with the licensing of the Company’s software. Hardware revenueswere $713,000 for the three months ended September 30, 2002 and $689,000for the three months ended September 30, 2001, representing an increase of4%. Hardware revenues accounted for 20% and 19% of total revenues for eachrespective period.  The increase inhardware revenues was due primarily to a change in the particular mix ofsoftware sales made in the third quarter of 2002 resulting in a correspondingincrease in accompanying hardware sales.

 

*Service and Other.*  Service and other revenues are primarilycomprised of fees from software maintenance contracts. Service and otherrevenues were $1.9 million for the three months ended September 30,2002 and $1.8 million for the three months ended September 30, 2001,representing an increase of 9%. Service and other revenues accounted for 54%and 50% of total revenues for each respective period.  The increase in dollar amount and in service and other revenue asa percentage of total revenues is due to the support renewals from theCompany’s increased installed customer base.

 

*Cost of Revenues*

 

*Software License.*  Cost of software license revenues consistsprimarily of the costs of sublicensing third–party software products,product media, and product duplication. Cost of software license revenues was $85,000 and $100,000 for the threemonths ended September 30, 2002 and 2001, respectively, representing 9% ofsoftware license revenues for each respective period.  Software license gross margin percentages remained constant at91% for the three months ended September 30, 2002 and for the three monthsended September 30, 2001.

 

*Hardware.*  Cost of hardware revenues consists primarilyof the costs of third–party hardware products. Cost of hardware revenueswas $437,000 and $481,000 for the three months ended September 30,2002 and 2001, respectively, representing 61% and 70% of hardware revenues foreach respective period. The gross margin percentage for hardware sales was 39%and 30% for the three months ended September 30, 2002 and 2001, respectively.The decrease in dollar amount for the cost of hardware revenues and theincrease in gross margin is due mainly to a change in the mix of the particularhardware products sold as well as the level of discounts at which the productsare sold.

 

*Service and Other.*  Cost of service and other revenues consistsprimarily of the costs incurred in providing technical support as well as othermiscellaneous customer service–related expenses.  Cost of service and other revenues was$868,000 and $880,000 for the three months ended September 30, 2002 and 2001,respectively, representing 45% and 50% of service and other revenues for each respectiveperiod.  The gross margin percentage forservice and other revenues was 55% and 50% for the three months ended September30, 2002 and 2001, respectively. The improved gross margin and the decrease indollar amount and as a percentage of service and other revenues was dueprimarily to the reduction of overhead costs associated with the elimination ofseveral positions within the department that occurred during fiscal 2001.

 

*Operating Expenses*

 

*Salesand Marketing.*  Sales and marketing expenses consist primarily ofemployee salaries, benefits, commissions, and associated overhead costs, thecost of marketing programs such as advertisements, direct mailings, publicrelations, trade shows, seminars and related communication costs.  Sales and marketing expenses were $1.3 millionand $1.6 million for the three months ended September 30, 2002 and 2001,respectively, or 38% and 45% of total revenues for each respective period.  Thedecrease in dollar amount and as a percentage of total revenues was due to andecrease in overhead costs associated with a decreased number of employees inthe sales and marketing departments as a result of a corporate restructuringwhich took place at the end of the second quarter of 2002.

 

*Researchand Development.* Research and development expenses includeexpenses associated with the development of new products, enhancements ofexisting products and quality assurance activities and consist primarily ofemployee salaries, benefits, and associated overhead costs as well asconsulting expenses and the cost of software development tools. Research anddevelopment expenses were $586,000 and $725,000 for the respective three monthperiods ended September 30, 2002 and September 30, 2001, representing 17% and21% of total revenues for each respective period.  In conjunction with acorporate restructuring, several positions were eliminated during the quarterended June 30, 2002. The decrease in dollaramount and as a percentage of total revenue is primarily attributable to thedecrease in overhead costs of supporting a decreased number of employees in theresearch and development department.

 

*General and Administrative.*  General and administrative expenses consistprimarily of employee salaries and benefits for administrative, executive andfinance personnel and associated overhead costs, as well as consulting,accounting and legal

 

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expenses. Generaland administrative expenses were $1.1 million and $999,000 for the three monthsended September 30, 2002 and 2001, respectively, or 31% and 28% of totalrevenues for each respective period. The increase in dollar amount and theexpenses as a percentage of total revenues is due mainly to an increase instate sales tax accruals offset by a decrease in other miscellaneous generaland administrative expenses.

 

*Interest Income.*  Interestincome consists principally of interest income earned on cash balances.  Interest income was $50,000 for the threemonths ended September 30, 2002 and $126,000 for the three months endedSeptember 30, 2001.  The decreaseis due to a reduction in cash balances and an approximate 51% reduction ininterest rates the Company was earning on its investments.

 

**NineMonths Ended September 30, 2002 and 2001**

 

## ***Revenues***

 

*TotalRevenues*.  The Company’stotal revenues were $10.8 million and $11.3 million for the nine months endedSeptember 30, 2002 and 2001, respectively, representing a decrease of 4%.

 

*SoftwareLicense. *Softwarelicense revenues were $3.0 million for the nine months ended September 30, 2002and $3.6 million for the nine months ended September 30, 2001, representing adecrease of 17%.  Software licenserevenues accounted for 28% and 32% of total revenues for each respectiveperiod. The decline in software license revenue can be attributed to a numberof factors that include the general softness in information technology spendingwhich is reflected in a decrease in demand for enterprise software solutionsand a decline in the growth rate of the overall U.S. economy causing customersand prospective customers to defer technology purchases. The decrease insoftware license revenue as a percent of total revenue is primarilyattributable to the decrease in software revenues.

 

*Hardware. *Hardware revenues were$2.1 million for the nine months ended September 30, 2002 and $2.2 million forthe nine months ended September 30, 2001, representing a decrease of 4%.  Hardware revenues accounted for 20% of totalrevenues for each respective period. The decrease in hardware revenues was due primarily to the decrease inthe number of software sales made in the nine months ended September 30, 2002resulting in a decrease in accompanying hardware sales.

 

*Service and Other. *Service and other revenueswere $5.6 million for the nine months ended September 30, 2002 and $5.4 millionfor the nine months ended September 30, 2001, representing an increase of5%.  Service and other revenuesaccounted for 52% and 48% of total revenues for each respective period.  The increase in support revenue as apercentage of total revenues is due to the decrease in software and hardwaresales combined with an increase in customer installation revenue during thefirst nine months of 2002.

 

## ***Cost of Revenues***

 

*Software License*.  Cost of software license revenues was$238,000 and $321,000 for the nine months ended September 30, 2002 and 2001,respectively, representing 8% and 9% of software license revenues for eachrespective period, resulting in respective gross margins of 92% and 91%. Thedecrease in dollar amount and the improvement in gross margin are attributableto decreased product duplication costs and decreased royalty payments due tolower sales volume of products with associated royalty payments.

 

*Hardware.*  Cost of hardware revenues was $1.4 millionand $1.5 million for the nine months ended September 30, 2002 and 2001,respectively, representing 65% and 66% of hardware revenues for each respectiveperiod.  The decrease in dollar amountfor the cost of hardware revenues for the nine months ended September 30, 2002was due primarily to the decrease of hardware unit sales accompanying theCompany’s software products.  The grossmargin percentage for hardware sales was 35% for the nine months endedSeptember 30, 2002 compared to 34% in the same period in 2001.  The increase in gross margin percentage isdue mainly to the overall decrease in hardware costs.

 

*Serviceand Other.*  Cost ofservice and other revenue was $2.5 million and $3.2 million for the nine monthsended September 30, 2002 and 2001, respectively, representing 44% of serviceand other revenues versus 60% for the same period last year. The gross marginpercentage for service and other revenues improved from 40% to 56% for the ninemonth-periods ended September 30, 2001 and 2002, respectively.  The decrease in dollar amount of cost ofservices and the improvement in gross

 

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margin during the period are due primarily to the fewer number ofsupport personnel within the department and the associated overhead costs ofsupporting such personnel.

## ** **

## ***Operating Expenses***

 

*Salesand Marketing.*  Salesand marketing expenses were $4.9 million and $4.7 million for the nine monthsended September 30, 2002 and 2001, respectively, or 45% and 42% of totalrevenues for each respective period. The increase in dollar amount and as apercentage of total revenues was due to an increase in the number of employeesin the sales and marketing departments offset by a decrease in advertisingexpenses for the nine months ended September 30, 2002. However, in conjunctionwith a corporate restructuring, several positions were eliminated during thequarter ended June 30, 2002. The severance paid to those employees ofapproximately $128,000 also contributed to the increase in expenses during thatsame period.

 

*Researchand Development.* Research and development expenses were $2.3 million and $2.4 million forthe nine months ended September 30, 2002 and 2001, respectively, or 21% and 22%of total revenues for each respective period. The decrease in dollar amount and as a percentage of total revenue isdue primarily to the fewer number of employees in the research and developmentdepartment and the reduction in associated overhead costs.

 

*Generaland Administrative.* General and administrative expenses were $3.7 million and $2.6 millionfor the nine months ended September 30, 2002 and 2001, respectively, or 35% and24% of total revenues for each respective period.  The increase in dollar amount was primarily attributable to anincrease in management consulting expenses and an increase in state sales taxaccruals.

 

*InterestIncome.*Interest incomeconsists principally of interest income earned on cash balances. Interestincome was $148,000 for the nine months ended September 30, 2002 and $556,000for the nine months ended September 30, 2001. The decrease is due to a reduction in cash balances and an approximate59% reduction in interest rates the Company was earning on its investments.

 

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

 

### **Liquidity andCapital Resources**

 

Since 1996, theCompany has financed its operations primarily through cash flow fromoperations, the private sales of preferred stock and the Company’s initialpublic offering of Common Stock completed in August 1997. AtSeptember 30, 2002, the Company had cash and cash equivalents of $9.4million and working capital of $4.9 million.

 

The Company’soperating activities used cash of $2.7 million and $4.7 million for the ninemonths ended September 30, 2002 and 2001, respectively. Net cash usedduring the nine months ended September 30, 2002 consisted primarily of anet loss from operations and a decrease in deferred revenues and accountspayable offset by depreciation and amortization, a decrease in accountsreceivable and an increase in accrued liabilities.   Net cash used during the nine months ended September 30, 2001resulted from a net loss from operations and a decrease in accrued liabilitiesoffset by depreciation and amortization and a decrease to accountsreceivable.  Due to the anticipation ofcontinuing economic softness, the Company anticipates that it will useapproximately $1.1 million of cash per quarter for at least the next fourquarters.

 

Investingactivities provided cash of $1.0 million and $3.0 million during the ninemonths ended September 30, 2002 and 2001, respectively.  During the nine months endedSeptember 30, 2002 and 2001, the principal uses were purchases of propertyand equipment, offset by proceeds from the sale of short-term investments.

 

Financingactivities used cash of $236,000 and $105,000 for the nine months endedSeptember 30, 2002 and 2001, respectively, due primarily to the purchases oftreasury stock.

 

AtSeptember 30, 2002, the Company did not have any material commitments forcapital expenditures.

 

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The Company hasexperienced declining revenues and increasing operating losses over an extendedperiod of time.  Based upon the currenteconomic environment, general softness in information technology spending, the releaseof new and emerging products that may not achieve market acceptance, andshortened forecasting visibility, the Company cannot estimate that thefinancial and operating performance, financial position or cash flow willimprove over the next twelve months. Subject to the factors contained herein, the Company believes that ithas sufficient liquidity and cash available to meet the operating needs of thecompany for at least the next twelve months. There can be no assurance that any necessary additional financing willbe available to the Company on commercially reasonable terms, or at all.

 

In August andSeptember 2002, the Nasdaq National Market (“Nasdaq”) informed the Company thatit was not in compliance with Nadsaq’s minimum bid price and market valuelisting requirements, respectively. The Company has determined that its abilityto comply with the listing requirements is unlikely. As such, on October 29,2002, the Company applied to transfer from the Nasdaq National Market to theSmallCap Market. As of the date of this filing, Nasdaq has not made adetermination on the application.  TheCompany cannot predict the impact, if any, of a change in listing to theSmallCap Market. If the application is not accepted and the stock is delisted,the Company’s common stock will be traded on the Over-The-Counter market. Thedelisting of the Company’s common stock could significantly impair theCompany’s ability to raise capital in the future.

 

## **CriticalAccounting Policies**

 

The Company hasidentified the policies 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 and Resultsof Operations where such policies affect the Company’s reported and expectedfinancial results. Note that the Company’s preparation of this Form 10-Qrequires management to make estimates and assumptions that affect the reportedamount of assets and liabilities, disclosure of contingent assets andliabilities at the date of the Company’s financial statements, and the reportedamounts of revenue and expenses during the reporting period. There can be noassurance that actual results will not differ from those estimates.

 

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

 

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

 

The Companyrecognizes revenue from the sale of software products and hardware to bothend-users and resellers when persuasive evidence of an arrangement exists, theproducts have been delivered, the fee is fixed or determinable, collection ofthe resulting receivable is reasonably assured and there are no customeracceptance provisions. The Company maintains a reserve for potential productreturns. Software maintenance and support revenue is recognized ratably overthe term of the related maintenance period, typically one-year.  Other services revenue is recognized as theservices are performed. If an arrangement includes an acceptance provision, theCompany will defer all revenue until the customer accepts the

 

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products.  Acceptance generally occurs upon the earlierof receipt of a written customer acceptance or expiration of the acceptanceperiod.

 

The Company’stransactions frequently involve the sales of software, hardware and relatedservices under multiple element arrangements.  Revenue under multiple element arrangements is allocated to each elementunder the residual method, in accordance with SOP 98-9, Modification of SOP97-2,*Software Revenue Recognition, With Respect to Certain Transactions*.Under this method, revenue is allocated first to all undelivered elements, suchas services, based on the fair value of those elements, which is the pricecharged when these elements are sold separately and unaccompanied by otherelements.  The Company’s services arenot essential to the functionality of the software as these services do notalter the capabilities of the software and do not carry a significant degree ofrisk to perform. The amount allocated to the delivered elements, such assoftware license and hardware revenue, is the difference between the totalarrangement value and the amount allocated to the undelivered elements. If thedelivered elements include both software and hardware, the amount allocated tohardware revenue is based on the price charged to the Company by the thirdparty vendor plus an additional mark up, with the remainder allocated tosoftware revenue. To the extent that a discount is offered in the arrangement,the entire discount is allocated to the delivered element or elements. If thedelivered elements include hardware and software, the discount is allocated tothe hardware and software based on their respective list prices.

 

For all sales, theCompany uses a binding purchase order, a signed contract or a credit cardauthorization as evidence of an arrangement. Sales through the Company’s resellers are evidenced by a masteragreement governing the relationship, together with binding purchase orders, ona transaction-by-transaction basis.

 

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

 

The Companyreserves for potential product returns and makes adjustments to the reserve asneeded, based on historical product return rates, and considers the impact ofnew product introductions, changes in customer demand and acceptance of theCompany’s products.  Significantmanagement judgments and estimates must be made and used in connection withestablishing the sales returns reserve in any accounting period.  Material differences may result in theamount and timing of revenue for any period if management made differentjudgments or utilized different estimates. Similarly, management must make estimates of the uncollectability of theCompany’s accounts receivables. Management specifically analyzes accounts receivable and historical baddebts, customer credit-worthiness, current economic trends and changes incustomer payment patterns when evaluating the adequacy of the allowance fordoubtful accounts.

 

The Company’sdeferred revenue is comprised mainly of revenue that is deferred for softwaremaintenance and support contracts.  Theother components of deferred revenue are the amounts from transactions thatwere deferred because they did not meet all of the provisions of the Company’srevenue recognition policy.

 

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

 

*IncomeTaxes*.  The Company isrequired to estimate its income taxes. This process involves estimating theCompany’s actual

 

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current tax obligations together with assessingdifferences resulting from the different treatment of items for tax andaccounting purposes which result in deferred tax assets and liabilities. TheCompany has deferred tax assets and liabilities included within its balancesheet. The Company’s deferred tax assets are assessed for each reporting periodas to whether it is more likely than not that they will be recovered fromfuture taxable 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. In the eventthat actual results differ from these estimates, the Company’s provision forincome taxes could be materially impacted.

 

*Recent Accounting Pronouncements*

 

In July 2002, the Financial Accounting Standards Boardissued SFAS No. 146, *Accounting for Costs Associated with Exit or DisposalActivities*.  SFAS No. 146 addressesfinancial accounting and reporting for costs associated with exit or disposalactivities and nullifies Emerging Issues Task Force Issue No. 94-3, *LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring*).  SFAS No. 146 requires that a liability berecognized when it is incurred and should initially be measured and recorded atfair value.  This statement is effectivefor exit or disposal activities that are initiated after December 31, 2002 andthe adoption is not expected to have a material impact on the consolidatedfinancial statements of the Company.

 

**Certain Factors Affecting FutureOperating Results**

 

The Companyoperates in a rapidly changing environment that involves a number of risks,some of which are beyond the Company’s control. The discussion highlights someof the risks that may affect future operating results.

 

Informationprovided by the Company from time to time including statements in this Form 10-Qwhich are not historical facts are so-called “forward-looking statements” thatinvolve risks and uncertainties, made pursuant to the safe harbor provisions ofthe Private Securities Litigation Reform Act of 1995.  In particular, statements contained in Management’s Discussionand Analysis of Financial Condition and Results of Operations and Notes toConsolidated Financial Statements which are not historical facts (including,but not limited to, statements concerning: the plans and objectives of management; expectations for sales andmarketing, research and development and general and administrative expenses;developments relating to the Company’s product and service offerings, marketsand acquisitions; anticipated trends in the Company’s future operating results;the Company’s strategic alliances; changes in the regulatory environment; andthe Company’s expected liquidity and capital resources) may constituteforward-looking statements. These forward-looking statements are neitherpromises nor guarantees, but are subject to risk and uncertainties that couldcause actual results to differ materially from the expectations set forth inthe forward-looking statements. Factors that may cause such differencesinclude, but are not limited to, the factors contained herein, and the otherrisks discussed from time to time in the Company’s other filings with theSecurities and Exchange Commission.

 

*FutureOperating Results Uncertain.* The Company incorporated and shipped its initial facsimile softwareproducts in 1991.  In the years endingDecember 31, 1999, 2000 and 2001 the Company had operating losses anddecreasing revenues and in the nine months ended September 30, 2002, theCompany had operating losses. There can be no assurance that the Company willbe able to increase its level of revenues or return to profitability in thefuture; as the Company’s operating history makes the prediction of futureoperating results difficult or impossible. Increases in operating expenses may continue and, together with pricingpressures and a continued decline in the growth rate of the overall U.S.economy, may result in a continued decrease in operating income and operatingmargin percentage.  The Company’sability to improve its operating results will depend upon, among other things,its ability to increase sales of the Company’s secure business-to-businesselectronic document exchange solutions and client/server facsimile solutions tonew customers as well as increased product penetration into existing customers.  The Company commenced its strategicexpansion into secure business-to-business electronic document exchangesolutions market in the fourth quarter of 2000, and has limited financial andoperating data and a limited operating history relevant to these solutions. Accordingly,it is difficult to evaluate the prospects for the level of acceptance of theCompany’s secure business-to-business electronic document exchange solutions.Future operating results will depend on many other factors, including, withoutlimitation, the degree and rate of growth of the markets in which the Companycompetes, the level of acceptance of the Windows NT, Windows 2000 and WindowsXP operating systems, the level of product and price competition, the abilityof the Company to establish strategic relationships and develop and market newand enhanced products and to control costs, the ability of the Company toexpand its direct sales force and indirect distribution channels bothdomestically and internationally and the ability of the Company to attract andretain key personnel. As a result, it is possible

 

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that in the future the Company’s operating results will be below theexpectations of public market analysts and investors.  In such event, the price of the Company’s common stock wouldlikely be materially adversely affected.

 

*ProductConcentration.*  Todate, much of the Company’s revenues have been attributable to licenses of theCompany’s facsimile-based enterprise solutions and related products andservices. The Company expects such products and related services to continue toaccount for much of the Company’s future revenues. However, recently the amountof revenues attributable to the licenses of such products has declined andthere can be no assurances that such decline will not continue. Furthermore, inSeptember 2000, the Company changed its strategic focus to the developmentof secure business-to-business electronic document exchange solutions. TheCompany introduced its secure business-to-business electronic document exchangeproducts, Genidocs and Genifax, to the market in the fourth quarter of2000.  To date, the Company has notrecognized a significant amount of revenues from its Genidocs product. TheCompany expects that its Genidocs product may account for an increasing portionof future revenues. However, there can be no assurances that the Genidocsproduct will be financially successful or result in any significant revenues.Factors adversely 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 operations. TheCompany’s prospects must be considered in light of the risks and difficulties frequentlyencountered by companies dependent upon operating revenues from a new productline in an emerging and rapidly evolving market.

 

*NewProducts and Technological Change.*  The markets for the Company’s products are relatively new and arecharacterized by rapid technological change, evolving industry standards,changes in end-user requirements and frequent new product introductions andenhancements. The Company’s future success will depend upon its ability toenhance its current products and to develop and introduce new products thatkeep pace with technological developments and respond to evolving end-userrequirements. There can be no assurance that the Company will be successful indeveloping and marketing new products or product enhancements on a timelybasis, or that new products or product enhancements developed by the Company,such as the Genidocs and Genifax products will achieve market acceptance. Theintroduction of products embodying new technologies and the emergence of newindustry standards could render the Company’s existing products obsolete andunmarketable. From time to time, the Company and its competitors may announcenew products, capabilities or technologies that have the potential to replaceor shorten the life cycle of the Company’s existing product offerings. Therecan be no assurance that announcements of new product offerings by the Companyor its competitors will not cause customers to defer or forego the licensing ofthe Company’s existing or planned products and have a material adverse effecton the Company’s business, financial condition and results of operations.

 

*TheMarket Risks for Secure Business-to-Business Electronic Document ExchangeSolutions.*  The marketfor Genidocs, the Company’s secure business-to-business electronic documentexchange solution is new and evolving rapidly. The Company’s success willdepend upon the adoption and use by current and potential customers of securebusiness-to-business electronic document exchange solutions. The Company’ssuccess will also depend upon acceptance of its technology as the standard forproviding these solutions. The adoption and use of the Company’s securebusiness-to-business electronic document exchange solution will involve changesin the manner in which businesses have traditionally exchanged information. TheCompany’s ability to influence usage of its secure business-to-businesselectronic document exchange solution by customers is limited. The Companyintends to spend considerable resources educating potential customers about thevalue of secure business-to-business electronic document exchange solutions. Itis difficult to assess, or to predict with any assurance, the present andfuture size of the potential market for the Company’s securebusiness-to-business electronic document exchange solution, 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.

 

*Dependenceon Fax Sr. NT and Genifax Product Lines and the Windows NT/2000Environment.*  TheCompany currently derives a significant portion of its revenues from licensesof the Fax Sr. NT and Genifax products and related services and resale ofrelated hardware. Continued market acceptance of the Fax Sr. NT andGenifax products are critical to the Company’s future success. As a result, anydecline in demand for or failure to maintain broad market acceptance of theFax Sr. NT and Genifax product lines as a result of competition,technological change or otherwise, would have a material adverse effect on theCompany’s business, financial condition and results of operations. TheCompany’s future financial performance will depend in large part on customeracceptance of the Fax Sr. NT product and new and enhanced versions of theGenifax product.  There can be no assurancethat the Company will continue to be successful in marketing the Fax Sr.NT and Genifax products or any new or enhanced versions of the Genifax product.In addition, there can be no assurance that the Windows NT operating systemwill not be replaced by a new or enhanced operating system. There can be noassurance that the Company

 

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will be successful in developing products for new or enhanced operatingsystems such as Windows 2000 or Windows XP, or that such systems will notobviate the need for the Company’s products. If any new or enhanced operatingsystem gains widespread use and the Company fails to develop and provide itsproducts for this operating system on a timely basis, the Company’s business,financial condition and results of operations would be materially adverselyaffected.

 

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

 

*RisksAssociated with Delisting From the Nasdaq National Market*.  In August 2002, the Nasdaq National Market(“Nasdaq”) informed the Company that its common stock had traded for 30consecutive trading days below the minimum bid price and that the Company haduntil November 4, 2002, to demonstrate compliance with Nasdaq’s listingrequirements by maintaining a bid price for its common stock of at least $1.00for a minimum of ten consecutive trading days. The Company has not regainedcompliance and on October 29, 2002, the Company applied to transfer from theNasdaq National Market to the SmallCap Market. As of the date of this Report, Nasdaq has not made a determination onthe application. The Company cannot predict the impact, if any, of a change inlisting to the SmallCap Market.  If theapplication is not accepted and the stock is delisted,  the Company’s common stock will be traded onthe Over-The-Counter market.  Thedelisting of the Company’s common stock from Nasdaq may materially impair thestockholder’s ability to buy and sell shares of the Company’s common stock andcould have an adverse effect on the market price of, and the efficiency of thetrading market for, the Company’s common stock.  Furthermore, the delisting of the Company’s common stock couldsignificantly impair the Company’s ability to raise capital should it desire todo so in the future.

 

*IntenseCompetition.*  Thesecure business-to-business electronic document exchange solution andenterprise, client/server facsimile solution markets are intensely competitiveand rapidly changing and the Company expects competition to continue toincrease. The Company believes its ability to compete successfully depends upona number of factors both within and beyond its control, including productperformance; reliability and features; product adoption; ease of use; productscalability; quality of support services; price/performance; timeliness ofenhancements and new product releases by the Company and its competitors; theemergence of new computer–based facsimile and secure business-to-businesselectronic document exchange solutions and standards; name recognition; theestablishment of strategic alliances with industry leaders and industry andgeneral economic trends.

 

The Company maynot be able to compete successfully against current and future competitors inthe secure business-to-business electronic document exchange solutions market,and the competitive pressures the Company faces could harm its business andprospects. The Company’s solutions provide an alternative to traditional mailand courier document delivery services, such as those offered, among others, byFederal Express, United Parcel Service or the U.S. Postal Service. TheCompany’s solution is also an alternative to general-purpose e-mailapplications and services. In the area of secure online document exchange, theCompany’s competition comes from secure online document exchange servicesproviders. Some of these providers have products that are intended to competewith the Company’s products. Examples of these companies include Pitney Bowes,Sigaba, Tumbleweed, the U.S. Postal Service and Zixit.  In addition, many companies with which theCompany does not presently compete may become competitors in the future. Thiscould occur either through the expansion of the Company’s products or throughother companies’ product development in the area of secure onlinecommunication. These companies could include Documentum, Hummingbird andiManage.  Additionally, companies suchas JetForm, PureEdge and Silanis may develop and deliver competitive digitalsignature products in the future.

 

The Companycompetes directly with a large number of vendors of facsimile products,including providers of facsimile software products for client/server networkssuch as RightFAX (a subsidiary of Captaris), Fenestrae, TopCall Internationaland Biscom. The Company also competes with vendors offering a range ofalternative facsimile solutions including outsourcing network facsimilesolutions, such as Mail.com; operating systems containing facsimile anddocument transmission features; low-end fax modem products; desktop faxsoftware; single-platform facsimile software products; and

 

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customizedproprietary software solutions. In addition, providers of operating systems orbusiness software applications may decide to bundle competitive facsimilesolutions as part of their broader product offerings.

 

Many of theCompany’s competitors and potential competitors have longer operating historiesand greater financial, technical, sales, marketing and other resources, as wellas greater name recognition and market acceptance of their products andtechnologies than the Company. In addition, there are relatively low barriersto entry in the markets in which the Company operates and intends to operate,and new competition may arise either from expansion by established companies orfrom new emerging companies or from resellers of the Company’s products. Therecan be no assurance that current or potential competitors of the Company willnot develop 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 inreduction in market share, pressure for price reductions and related reductionsin gross margins, any of which could materially adversely affect the Company’sability to achieve its financial and business goals. There can be no assurancethat in the future the Company will be able to successfully compete againstcurrent and future competitors.

 

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

 

In general,revenues are difficult to forecast because the market for securebusiness-to-business electronic document exchange and enterprise client/serverfacsimile solutions 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 toforecast, as no significant order backlog exists at the end of any quarterbecause the Company’s products typically are shipped upon receipt of customers’orders.

 

A substantialportion of the Company’s operating expense is related to personnel, facilities,equipment and marketing programs. The level of spending for such expense cannotbe adjusted quickly and is therefore fixed in the short term. The Company’sexpense levels for personnel, facilities, equipment and marketing programs arebased, in significant part, on the Company’s expectations of future revenues ona quarterly 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 theforegoing factors, it is likely that in some future periods the Company’sresults of operations will be below the expectations of securities analysts andinvestors. In such event, the price of the Company’s common stock would likelybe materially adversely affected.

 

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*Expansionof Indirect Channels; Potential for Channel Conflict; Strategic Alliances.*  The Company markets its products andservices directly through telesales and indirectly through marketing channelssuch as VARs, systems integrators, distributors and strategic business partners.Although the Company has historically focused its efforts on marketing throughits sales force, the Company is increasing resources dedicated to developingand expanding indirect marketing channels. There can be no assurance that theCompany will be able to attract and retain a sufficient number of qualifiedVARs, systems integrators, distributors and strategic business partners tosuccessfully market the Company’s products. In addition, there can be noassurance that the Company’s resellers and strategic business partners will notdevelop, acquire or market computer-based facsimile products that arecompetitive with the Company’s products. The failure to retain its VARs,systems integrators, distributors and strategic partners could have a materialadverse effect on the Company’s business, financial condition and results ofoperations.

 

The distributoragreements generally provide that either party may terminate the agreementwithout cause upon 30 days written notice to the other party.  The Company also resells its products on apurchase order basis through other VARs, systems integrators anddistributors.  Either party mayterminate such relationships, at any time, and therefore there can be noassurance that any VAR, systems integrator or distributor will continue torepresent the Company’s products. Furthermore, the Company’s strategic alliances may be terminated byeither party, at any time; there can be no assurances that such strategicalliances will continue.  The inabilityto retain certain VARs, systems integrators, distributors or strategic businesspartners, or the development or marketing by VARs, systems integrators,distributors or strategic business partners of competitive offerings, couldhave a material adverse effect on the Company’s business, financial conditionand results of operations.

 

Selling throughindirect channels may limit the Company’s contacts with its customers.  As a result, the Company’s ability toaccurately forecast sales, evaluate customer satisfaction and recognize emergingcustomer requirements may be hindered. The Company’s strategy of marketing itsproducts directly to end-users and indirectly through VARs, systems integratorsand distributors may result in distribution channel conflicts. The Company’sdirect sales efforts may compete with those of its indirect channels and, tothe extent different resellers target the same customers, resellers may alsocome into conflict with each other. As the Company strives to expand itsindirect distribution channels, there can be no assurance that emerging channelconflicts will not materially adversely affect its relationships with existingVARs, systems integrators or distributors or adversely affect its ability toattract new VARs, systems integrators and distributors.

 

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

 

*Abilityto Manage Growth.*  TheCompany may expand its operations and anticipates that expansion may berequired in order to address potential market opportunities. The Company mayincrease the size of its sales and marketing and research and developmentexpenditures as necessary. There can be no assurance that such expansion wouldbe completed successfully or that it would generate sufficient revenues tocover the Company’s expenses. The Company will need to continue to attract andretain highly qualified technical, sales and managerial personnel. There can beno assurance that the Company will be able to retain or continue to hire suchpersonnel in the future. The inability of the Company to effectively expandoperations and manage growth, if any, could have a material adverse effect onthe Company’s business, financial condition and results of operations.

 

*RisksAssociated with International Expansion.*  An element of the Company’s strategy is tocontinue to maintain its international sales. The Company expects to facecompetition from secure business-to-business electronic document exchangesolutions and local facsimile product providers in their native countries. Tosuccessfully maintain international sales, the

 

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Company needs to recruit and retain additional international resellersand distributors. 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 of acceptanceof localized products in foreign countries, longer accounts receivable paymentcycles, difficulties in managing international operations, difficulties inenforcing intellectual property rights and the burdens of complying with a widevariety of foreign laws.  The Companyhas a sales office outside of the United States, such operations are subject tocertain additional risks, including difficulties in staffing and managing suchoperations and potentially adverse tax consequences including restrictions onthe repatriation of earnings. There can be no assurance that such factors willnot have a material adverse effect on the Company’s future international salesand, consequently, the Company’s business, financial condition and results ofoperations. To date, a majority of the Company’s sales have been made in UnitedStates dollars and the Company has not engaged in any hedging transactionsthrough the purchase of derivative securities or otherwise.

 

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

 

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Item 3. Quantitative and Qualitative Disclosures AboutMarket Risk

 

 

**Derivative Financial Instruments,Other Financial Instruments, and Derivative Commodity Instruments**

 

As ofSeptember 30, 2002, the Company did not participate in any derivativefinancial instruments or other financial and commodity instruments for whichfair value disclosure would be required under SFAS No. 107,*Disclosuresabout Fair Value of Financial Instruments*. All of the Company’sinvestments consist of money market funds and municipal bonds that are carriedon the Company’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 Risk Exposures**

 

The Company’sprimary market risk exposures are in the areas of interest rate risk andforeign currency exchange rate risk. The Company’s investment portfolio of cashequivalent and short-term investments is subject to interest rate fluctuations,but the Company believes this risk is immaterial due to the short-term natureof these investments. The Company’s exposure to currency exchange ratefluctuations has been and is expected to continue to be modest due to the factthat the operations of its United Kingdom subsidiary are almost exclusivelyconducted in its local currency. The United Kingdom subsidiary operatingresults are translated into U.S. dollars and consolidated for reportingpurposes. The impact of currency exchange rate movements on intercompanytransactions was immaterial for the quarter ended September 30, 2002.Currently the Company does not engage in foreign currency hedging activities.

 

Item 4. Controls and Procedures

 

(a) Evaluation of disclosure controls and procedures.

 

As of a date (the “Evaluation Date”) withinninety days prior to the filing date of this****Quarterly Report on Form10-Q, the Company, under the supervision and with the participation of theCompany’s management, including the Company’s Chief Executive Officer and ChiefFinancial Officer, evaluated the effectiveness of the design and operation ofthe Company’s disclosure controls and procedures pursuant to Rule 13a-15promulgated under the Securities Exchange Act of 1934, as amended (the“Exchange Act”).  Based upon thatevaluation, the Company’s Chief Executive Officer and Chief Financial Officerconcluded that, as of the Evaluation Date, the Company’s disclosure controlsand procedures are effective in ensuring that information relating to theCompany (including its consolidated subsidiaries) required to be disclosed bythe Company in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, including ensuringthat such information is accumulated and communicated to the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

(b) Changes in internal controls

There were no significant changes in the Company’s internal controls or inother factors that could significantly affect the Company’s internal controlssubsequent to the date of their evaluation, including any corrective actionswith regard to significant deficiencies and material weaknesses.

 

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**PARTII:  OTHER INFORMATION**

 

Item 6.                         Exhibitsand Reports on Form 8-K

 

(a)                      Exhibits
| 10.11  | Offer Letter with Michael Sheehy                                                                                                                     |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                 |
| 10.12  | Severence Eligibility Letter with Michael Sheehy                                                                                                     |
|   |                                                                                                                                                 |
| 99.1   | 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. |
|   |                                                                                                                                                 |
| 99.2   | Certification of Chief Financial Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

(b)                     Reportson Form 8-K

 

None

 

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OMTOOL, LTD.

 

Signatures

 

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

 
|              | OMTOOL, LTD. |
|-------------------|--------------|
|              |         |   |
|              |         |   |
| November 13, 2002 | By:          | /s/ Timothy P. Losik |   |
|              |         | Timothy P. Losik |
|              |         | Vice President, Chief Financial Officer, Chief  Operating  Officer, Secretary and Treasurer |
|                   |              |  |  |  |

 

 

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**CERTIFICATIONS**

 

I, Robert L. Voelk, certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q of Omtool, Ltd.;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      Presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors:

 

a)                                      Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weakness in internal controls; and

 

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b)                                     Anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date: November 13, 2002 |   |                    |
|-------------------------|--------|-------------------------|
|                    |   |                    |
|                    | By:    | /s/ Robert L. Voelk     |   |
|                    |   | Robert L. Voelk         |
|                    |   | Chief Executive Officer |

 

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I, Timothy P. Losik, certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q of Omtool, Ltd.;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      Presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors:

 

a)                                Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weakness in internal controls; and

 

b)                                     Anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date: November 13, 2002 |   |                    |
|-------------------------|--------|-------------------------|
|                    |   |                    |
|                    | By:    | /s/ Timothy P. Losik    |   |
|                    |   | Timothy P. Losik        |
|                    |   | Chief Financial Officer |

 

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