**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

**FORM10-Q**

 

**(Mark One)**

 

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

 

**For thequarterly period ended June 30, 2005**

 

**OR**

 

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

 

**For thetransition 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 has: (1) filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes  ý  No  o

 

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

 

Yes  o  No  ý

 

There were 3,918,381 shares of the Company’s common stock, par value$0.01, outstanding on July 27, 2005.

 

 

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**OMTOOL,LTD. AND SUBSIDIARIES**

 

FORM 10-Q

For the Quarter Ended June30, 2005

CONTENTS

 
| **Item Number**                | ** **                                                                                                           | ** ** |
|--------------------------------|----------------------------------------------------------------------------------------------------------------------|------------|
|                           |                                                                                                                 |       |
| PART I: FINANCIAL  INFORMATION |                                                                                                                 |
|                           |                                                                                                                 |       |
| Item 1.                        | Consolidated  Financial Statements                                                                                   |       |
|                           | Consolidated Balance Sheets  as of June 30, 2005 (Unaudited) and December 31, 2004                                   |       |
|                           | Consolidated  Statements of Operations for the three months and six months ended June 30,  2005 and 2004 (Unaudited) |       |
|                           | Consolidated  Statements of Cash Flows for the six months ended June 30, 2005 and 2004  (Unaudited)                  |       |
|                           | Notes to  Consolidated Financial Statements                                                                          |       |
|                           |                                                                                                                 |       |
| Item 2.                        | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                          |       |
|                           |                                                                                                                 |       |
| Item  3.                       | Quantitative  and Qualitative Disclosures About Market Risk                                                          |       |
|                           |                                                                                                                 |       |
| Item 4.                        | Controls and Procedures                                                                                              |       |
|                           |                                                                                                                 |       |
| PART II: OTHER  INFORMATION    |                                                                                                                 |
|                           |                                                                                                                 |       |
| Item  5.                       | Other  Information                                                                                                   |       |
|                           |                                                                                                                 |       |
| Item 6.                        | Exhibits                                                                                                             |       |
|                           |                                                                                                                 |       |
| Signatures                     |                                                                                                                 |
|                                |                                                                                                                      |            |  |

 

----

 

**PART I:  FINANCIAL INFORMATION**

Item 1. Consolidated Financial Statements

 

**OMTOOL,LTD. AND SUBSIDIARIES**

**ConsolidatedBalance Sheets**

 
| ** **                                                                                                                                                                                                                                                       | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                                       | ** ** | **(Unaudited)**    | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                       |       |               |       |                   |       |
| Current assets:                                                                                                                                                                                                                                                  |       |               |       |                   |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                       |       | $                  | 11,125,017 |                   | $          | 10,655,121 |   |
| Accounts  receivable, less reserves of $43,000 at June 30, 2005 and $82,000 at December  31, 2004                                                                                                                                                                |       | 1,350,188          |       | 1,802,784              |       |
| Inventories                                                                                                                                                                                                                                                      |       | 17,774             |       | 137,992                |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                                                       |       | 320,549            |       | 278,972                |       |
| Total current  assets                                                                                                                                                                                                                                            |       | 12,813,528         |       | 12,874,869             |       |
| Property and  equipment, net                                                                                                                                                                                                                                     |       | 190,741            |       | 213,512                |       |
| Other assets                                                                                                                                                                                                                                                     |       | 11,562             |       | 11,562                 |       |
| Total assets                                                                                                                                                                                                                                                     |       | $                  | 13,015,831 |                   | $          | 13,099,943 |   |
|                                                                                                                                                                                                                                                             |       |               |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                   | ** ** | ** **         | ** ** | ** **             | ** ** |
| Current  liabilities:                                                                                                                                                                                                                                            |       |               |       |                   |       |
| Accounts payable                                                                                                                                                                                                                                                 |       | $                  | 867,276    |                   | $          | 849,572 |   |
| Accrued  liabilities                                                                                                                                                                                                                                             |       | 1,265,984          |       | 1,258,672              |       |
| Accrued state  sales tax                                                                                                                                                                                                                                         |       | 595,890            |       | 699,816                |       |
| Deferred  revenue, short term                                                                                                                                                                                                                                    |       | 3,077,306          |       | 3,205,072              |       |
| Total current  liabilities                                                                                                                                                                                                                                       |       | 5,806,456          |       | 6,013,132              |       |
| Long term  liabilities:                                                                                                                                                                                                                                          |       |               |       |                   |       |
| Deferred  revenue, long-term                                                                                                                                                                                                                                     |       | 380,332            |       | 455,604                |       |
| Total  liabilities                                                                                                                                                                                                                                               |       | 6,186,788          |       | 6,468,736              |       |
|                                                                                                                                                                                                                                                             |       |               |       |                   |       |
| Stockholders’  equity:                                                                                                                                                                                                                                      |       |               |       |                   |       |
| Preferred Stock,  $0.01 par value — Authorized — 2,000,000 shares; Issued and outstanding —  none                                                                                                                                                 |       | —             |       | —                 |       |
| Common Stock,  $0.01 par value — Authorized — 35,000,000 shares; Issued — 4,367,878 shares  at June 30, 2005 and December 31, 2004; Outstanding — 3,915,763 shares at June  30, 2005 and 3,851,472 shares at December 31, 2004, respectively |       | 43,679             |       | 43,679                 |       |
| Deferred  compensation                                                                                                                                                                                                                                           |       | (404,791           | )          | —                 |       |
| Additional  paid-in capital                                                                                                                                                                                                                                      |       | 35,402,861         |       | 35,259,706             |       |
| Accumulated  deficit                                                                                                                                                                                                                                             |       | (25,864,207        | )          | (26,018,011            | )          |
| Treasury stock,  at cost (452,115 shares at June 30, 2005 and 516,406 shares at December 31,  2004)                                                                                                                                                              |       | (2,319,875         | )          | (2,649,756             | )          |
| Accumulated  other comprehensive loss                                                                                                                                                                                                                            |       | (28,624            | )          | (4,411                 | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                 |       | 6,829,043          |       | 6,631,207              |       |
|                                                                                                                                                                                                                                                             |       |               |       |                   |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                                 |       | $                  | 13,015,831 |                   | $          | 13,099,943 |   |

 

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

 

1

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**OMTOOL,LTD. AND SUBSIDIARIES**

**ConsolidatedStatements of Operations**

(Unaudited)

 
| ** **                                            | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                            | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                                             |       |                             |       |                           |       |   |   |   |   |
| Software license                                      |       | $                                | 1,138,060  |                           | $          | 1,131,485 |   | $ | 2,455,689 |   | $ | 2,303,384 |   |
| Hardware                                              |       | 721,963                          |       | 448,195                        |       | 1,559,307 |   | 1,615,746 |   |
| Service and  other                                    |       | 1,710,276                        |       | 1,787,900                      |       | 3,416,787 |   | 3,476,529 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Total revenues                                        |       | 3,570,299                        |       | 3,367,580                      |       | 7,431,783 |   | 7,395,659 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Cost of  revenues:                                    |       |                             |       |                           |       |   |   |   |   |
| Software license                                      |       | 50,435                           |       | 86,649                         |       | 71,202 |   | 118,174 |   |
| Hardware                                              |       | 483,703                          |       | 314,277                        |       | 1,027,380 |   | 988,520 |   |
| Service and  other                                    |       | 681,752                          |       | 644,421                        |       | 1,399,127 |   | 1,391,648 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Total cost of  revenues                               |       | 1,215,890                        |       | 1,045,347                      |       | 2,497,709 |   | 2,498,342 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Gross profit                                          |       | 2,354,409                        |       | 2,322,233                      |       | 4,934,074 |   | 4,897,317 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Operating  expenses:                                  |       |                             |       |                           |       |   |   |   |   |
| Sales and  marketing                                  |       | 1,140,936                        |       | 988,494                        |       | 2,320,252 |   | 2,031,781 |   |
| Research and  development                             |       | 520,700                          |       | 481,990                        |       | 1,037,690 |   | 953,165 |   |
| General and  administrative                           |       | 726,137                          |       | 572,296                        |       | 1,501,308 |   | 1,271,688 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Total operating  expenses                             |       | 2,387,773                        |       | 2,042,780                      |       | 4,859,250 |   | 4,256,634 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Income (loss)  from operations                        |       | (33,364                          | )          | 279,453                        |       | 74,824 |   | 640,683 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Interest and  other income, net                       |       | 45,128                           |       | 36,799                         |       | 85,757 |   | 74,455 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Income before  tax provision                          |       | 11,764                           |       | 316,252                        |       | 160,581 |   | 715,138 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Tax provision                                         |       | —                           |       | 38,572                         |       | 6,777 |   | 57,703 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Net income                                            |       | $                                | 11,764     |                           | $          | 277,680 |   | $ | 153,804 |   | $ | 657,435 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Net income per  share                                 |       |                             |       |                           |       |   |   |   |   |
| Basic                                                 |       | $                                | 0.00       |                           | $          | 0.07 |   | $ | 0.04 |   | $ | 0.18 |   |
| Diluted                                               |       | $                                | 0.00       |                           | $          | 0.07 |   | $ | 0.04 |   | $ | 0.17 |   |
|                                                  |       |                             |       |                           |       |   |   |   |   |
| Weighted average  number of common shares outstanding |       |                             |       |                           |       |   |   |   |   |
| Basic                                                 |       | 3,914,874                        |       | 3,833,896                      |       | 3,903,982 |   | 3,677,865 |   |
| Diluted                                               |       | 4,047,807                        |       | 4,054,874                      |       | 4,050,652 |   | 3,862,484 |   |

 

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

 

2

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**OMTOOL,LTD. AND SUBSIDIARIES**

**ConsolidatedStatements of Cash Flows**

(Unaudited)

 
| ** **                                                                                        | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                        | ** ** | **2005**                       | ** ** | **2004** | ** ** |
| Cash Flows from  Operating Activities:                                                            |       |                           |       |   |   |
| Net income                                                                                        |       | $                              | 153,804    |   | $ | 657,435 |   |
| Adjustments to  reconcile net income to net cash (used in) provided by operating activities– |       |                           |       |   |   |
| Depreciation                                                                                      |       | 85,773                         |       | 131,583 |   |
| Accounts  receivable reserves                                                                     |       | (37,565                        | )          | (207,363 | ) |
| Amortization of  deferred compensation                                                            |       | 47,656                         |       | — |   |
| Changes in  assets and liabilities–                                                          |       |                           |       |   |   |
| Accounts  receivable                                                                              |       | 473,510                        |       | 491,102 |   |
| Prepaid expenses  and other current assets                                                        |       | (62,213                        | )          | (49,996 | ) |
| Inventory                                                                                         |       | 120,218                        |       | 4,774 |   |
| Accounts payable                                                                                  |       | 22,246                         |       | (392,493 | ) |
| Accrued  liabilities                                                                              |       | 35,083                         |       | 160,084 |   |
| Accrued state  sales tax                                                                          |       | (103,926                       | )          | (65,765 | ) |
| Accrued  restructuring                                                                            |       | —                         |       | (285,583 | ) |
| Other assets                                                                                      |       | —                         |       | 2,399 |   |
| Deferred revenue                                                                                  |       | (178,177                       | )          | 62,626 |   |
|                                                                                              |       |                           |       |   |   |
| Net cash  provided by operating activities                                                        |       | 556,409                        |       | 508,803 |   |
|                                                                                              |       |                           |       |   |   |
| Cash Flows from  Investing Activities:                                                            |       |                           |       |   |   |
| Purchases of  property and equipment                                                              |       | (63,594                        | )          | (27,405 | ) |
|                                                                                              |       |                           |       |   |   |
| Net cash used in  investing activities                                                            |       | (63,594                        | )          | (27,405 | ) |
|                                                                                              |       |                           |       |   |   |
| Cash Flows from  Financing Activities:                                                            |       |                           |       |   |   |
| Net proceeds  from issuance of common stock                                                       |       | 20,589                         |       | 3,565,184 |   |
| Purchase of  treasury stock                                                                       |       | —                         |       | (2,012,500 | ) |
|                                                                                              |       |                           |       |   |   |
| Net cash  provided by financing activities                                                        |       | 20,589                         |       | 1,552,684 |   |
|                                                                                              |       |                           |       |   |   |
| Exchange rate  effect on cash                                                                     |       | (43,508                        | )          | (5,949 | ) |
|                                                                                              |       |                           |       |   |   |
| Net increase in  cash and cash equivalents                                                        |       | 469,896                        |       | 2,028,133 |   |
|                                                                                              |       |                           |       |   |   |
| Cash and cash  equivalents, beginning of period                                                   |       | 10,655,121                     |       | 8,242,067 |   |
|                                                                                              |       |                           |       |   |   |
| Cash and cash  equivalents, end of period                                                         |       | $                              | 11,125,017 |   | $ | 10,270,200 |   |

 

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

 

3

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**OMTOOL,LTD. AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements**

(Unaudited)

 

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

 

Omtool, Ltd. (“Omtool” or the “Company”) providesenterprise document messaging applications that streamline workflows, reducecosts and ensure secure, confidential e-document exchange.  The accompanying unaudited consolidatedfinancial statements have been prepared by Omtool pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”) regarding interimfinancial reporting.  Accordingly, they do not include all of theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements and should be read in conjunction with theconsolidated financial statements and notes thereto for the year ended December31, 2004 as filed with the SEC on March 29, 2005. The accompanying consolidatedfinancial statements reflect all adjustments (consisting of normal recurringadjustments) that are, in the opinion of management, necessary for a fairpresentation of results for the interim periods presented.  The results ofoperations for the three and six month periods ended June 30, 2005 are notnecessarily indicative of the results to be expected for the full fiscal year.

 

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

 

The Companyreports earnings per share in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 128,*Earningsper Share*.  The dilutive effect of potential common sharesconsisting of outstanding stock options and a stock warrant is determined usingthe treasury stock method, in accordance with SFAS No. 128.  For the threemonths and six months ended June 30, 2005, the dilutive calculation excludes 151,824and 151,682 shares of common stock, respectively, potentially issuable upon theexercise of outstanding stock options that have an anti-dilutive effect sincetheir exercise price exceeds the market value of the Company’s commonstock.  For the three months and sixmonths ended June 30, 2004, the dilutive calculation excludes 49,374 and 126,408shares of common stock, respectively, potentially issuable upon the exercise ofoutstanding stock options that have an anti-dilutive effect since theirexercise price exceeds the market value of the Company’s common stock.  Areconciliation of basic and diluted common shares outstanding is as follows:

 
| ** **                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                     | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted average  number of common shares outstanding          |       | 3,914,874                        |       | 3,833,896                      |       | 3,903,982 |   | 3,677,865 |   |
| Potential common  shares pursuant to stock options and warrant |       | 132,933                          |       | 220,978                        |       | 146,670 |   | 184,619 |   |
| Diluted weighted  average shares                               |       | 4,047,807                        |       | 4,054,874                      |       | 4,050,652 |   | 3,862,484 |   |
| Basic net income  per common share                             |       | $                                | 0.00       |                           | $          | 0.07 |   | $ | 0.04 |   | $ | 0.18 |   |
| Diluted net income  per common and potential common share      |       | $                                | 0.00       |                           | $          | 0.07 |   | $ | 0.04 |   | $ | 0.17 |   |

 

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

 

SFAS No. 109,*Accounting for Income Taxes,* requires theCompany to record a valuation allowance against deferred tax assets when it ismore likely than not that some or all of the deferred tax assets will not berealized.  As a result of cumulative losses in recent years and continuedeconomic uncertainty, the Company has provided a full valuation allowanceagainst all of its net deferred tax assets and will continue to do so until itreturns to an appropriate level of sustained taxable income.  The ultimaterealization of these deferred tax assets depends upon the Company’s ability togenerate sufficient future taxable income. If the Company is successful in generatingsufficient future taxable income, the Company will reduce the valuationallowance through a reduction in income tax expense in the future.

 

During the sixmonths ended June 30, 2005, the Company recorded a net tax provision of $6,777 forexpected tax liability in the United States. There was no tax provision required for the Company’s United Kingdomsubsidiary, Omtool Europe Limited (“OEL”) for the six months ended June 30,2005.

 

During the sixmonths ended June 30, 2004, the Company recorded a net tax provision of $57,703for expected tax liability due to Alternative Minimum Tax in the United Statesand for expected tax liability related to OEL. The provision for the first six months of 2004 is net of a $28,800adjustment related to a fiscal year 2003 transfer pricing adjustment.

 

4

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**(4)**** ComprehensiveIncome (Loss)**

 

The components ofthe Company’s comprehensive income (loss) are as follows:

 
| ** **                                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                                |       | $                                | 11,764     |                           | $          | 277,680 |   | $ | 153,804 |   | $ | 657,435 |   |
| Foreign currency  translation adjustments |       | (14,077                          | )          | (34,294                        | )          | (24,213 | ) | (10,283 | ) |
| Comprehensive  income (loss)              |       | $                                | (2,313     | )                              | $          | 243,386 |   | $ | 129,591 |   | $ | 647,152 |   |

 

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

 

The Companyaccounts for stock-based compensation for employees under the recognition andmeasurement principles of Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees,*and related interpretations.  The following table illustrates the effecton net income and net income per share if the Company had applied the fairvalue recognition provisions of Financial Accounting Standards Board Statement(“FAS”) No. 123,*Accounting for Stock-BasedCompensation,* as amended by FAS No. 148,*Accounting for Stock-Based Compensation — Transition and Disclosure*to stock-based employee compensation.  InDecember 2004, the FASB issued SFAS No. 123(R) *Share-BasedPayment. *SFAS No. 123(R)amends SFAS No. 123.  The Company will berequired to adopt FAS 123(R) in the first fiscal quarter of 2006 and does notexpect it to have a material impact on its future results of operations.

 
| ** **                                                                                                  | ** ** | **Three months Ended  June 30,** | ** ** | **Six months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                  | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                        |       |                             |       |                           |       |   |   |   |   |
| Net income, as  reported                                                                                    |       | $                                | 11,764     |                           | $          | 277,680 |   | $ | 153,804 |   | $ | 657,435 |   |
| Add: Stock  compensation included in net income                                                             |       | 28,241                           |       | —                         |       | 47,656 |   | — |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value method  for all awards |       | (42,562                          | )          | (51,065                        | )          | (88,266 | ) | (122,970 | ) |
| Pro forma net  income (loss)                                                                                |       | $                                | (2,557     | )                              | $          | 226,615 |   | $ | 113,046 |   | $ | 534,465 |   |
|                                                                                                        |       |                             |       |                           |       |   |   |   |   |
| Net income per  share:                                                                                      |       |                             |       |                           |       |   |   |   |   |
| Basic, as  reported                                                                                         |       | $                                | 0.00       |                           | $          | 0.07 |   | $ | 0.04 |   | $ | 0.18 |   |
| Diluted, as  reported                                                                                       |       | $                                | 0.00       |                           | $          | 0.07 |   | $ | 0.04 |   | $ | 0.17 |   |
| Basic, pro forma                                                                                            |       | $                                | 0.00       |                           | $          | 0.06 |   | $ | 0.03 |   | $ | 0.15 |   |
| Diluted, pro  forma                                                                                         |       | $                                | 0.00       |                           | $          | 0.06 |   | $ | 0.03 |   | $ | 0.14 |   |

 

**(6)****           AccruedLiabilities**

 

Accruedliabilities consist of the following:

 
| ** **                         | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------|------------|--------------------|------------|------------------------|------------|
| Accrued health  insurance expense  |       | $                  | 146,682    |                   | $          | 178,464 |   |
| Accrued salary  and salary-related |       | 768,777            |       | 688,622                |       |
| Accrued  professional fees         |       | 98,046             |       | 141,322                |       |
| Other accrued  expenses            |       | 252,479            |       | 250,264                |       |
|                               |       | $                  | 1,265,984  |                   | $          | 1,258,672 |   |

 

**(7)****  Equity Transactions**

 

In January 2005, the Company sold a total of58,684 shares of restricted common stock under its 1997 Stock Plan, as

 

5

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amended, to the members of its Board of Directors and certain employeesof the Company at a price per share of $0.01. The shares of restricted commonstock vest ratably over the four-year service period, so long as the restrictedstockholder continues to provide services to the Company. During 2005, theCompany recorded deferred compensation of approximately $451,000 for theintrinsic value of the shares of restricted common stock. The Company willrecognize deferred compensation as compensation expense over the expected fouryear vesting period. In the event that a restricted stockholder ceases toprovide services to the Company prior to the vesting of any of the thenunvested shares held by that stockholder, the restricted stockholder isrequired to sell all such unvested shares of restricted common stock back tothe Company at the original purchase price of $0.01 per share.

 

On March 30, 2004, the Company raised $3.6 millionthrough the private placement to institutional and other accredited investorsof 600,000 shares of common stock at a price of $6.00 per share.  The feesassociated with issuing the shares in connection with the private placementwere approximately $147,000 and were recorded as a reduction of additionalpaid-in capital.  Furthermore, Omtool issued 51,000 shares of common stockand a warrant to purchase an additional 51,000 shares of common stock,exercisable over a five-and-a-half-year period at a price of $6.00 per share,to its financial advisor or the advisor’s designees as payment for advisoryservices related to the private placement.

 

On March 30, 2004,Omtool’s Board of Directors approved a two-for-one stock split of the Company’scommon stock in the form of a dividend effective April 27, 2004 payable to eachstockholder of record as of April 7, 2004.  All references in theconsolidated financial statements referring to shares, share prices, per shareamounts and stock plans have been adjusted retroactively for this two-for-onestock split.

 

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

 

**(8)**** Segment andGeographic Information**

 

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

 

Total revenuesfrom international sources were $807,000 and $1.3 million for the three months andsix months ended June 30, 2005 and $691,000 and $2.0 million for the threemonths and six months ended June 30, 2004, respectively.  The Company’srevenues from international sources were primarily generated from customerslocated in Europe. The following table represents amounts relating to geographiclocations:

 
| ** **             | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **             | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Total revenues  (1)    | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States          |       | $                                | 2,763,512  |                           | $          | 2,676,863 |   | $ | 6,169,920 |   | $ | 5,361,663 |   |
| United Kingdom         |       | 313,610                          |       | 128,771                        |       | 495,532 |   | 820,971 |   |
| Rest of World          |       | 493,177                          |       | 561,946                        |       | 766,331 |   | 1,213,025 |   |
|                   |       | $                                | 3,570,299  |                           | $          | 3,367,580 |   | $ | 7,431,783 |   | $ | 7,395,659 |   |
|                   |       |                             |       |                           |       |   |   |   |   |
| ** **             | ** ** | **June 30,  2005**               | ** ** | **December 31,  2004**         | ** ** | ** ** | ** ** | ** ** | ** ** |
|                   | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Long-lived  assets (2) | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States          |       | $                                | 194,128    |                           | $          | 215,879 |   | ** ** | ** ** | ** ** | ** ** |
| United Kingdom         |       | 8,175                            |       | 9,195                          |       | ** ** | ** ** | ** ** | ** ** |
|                   |       | $                                | 202,303    |                           | $          | 225,074 |   | ** ** | ** ** | ** ** | ** ** |

 

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(1) Revenues are attributed to geographic regions based on location ofcustomer.

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

 

6

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Item 2.

**MANAGEMENT’SDISCUSSION AND ANALYSIS**

**OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations shouldbe read in conjunction with the accompanying consolidated financial statementsfor the periods specified and the associated notes.  Further referenceshould be made to our Annual Report on Form 10-K for the year ended December31, 2004 as filed with the SEC on March 29, 2005.

 

**Overview**

 

We provideenterprise document messaging applications that streamline workflows, reducecosts and ensure secure, confidential e-document exchange. We accomplish thisby providing products that integrate with industry-leading e-mail messaging,enterprise resource and document management systems to add secure delivery andhigh volume fax functionality to a company’s existing communicationinfrastructure. Because paper remains an integral part of many businessprocesses, we also provide technology that incorporates electronic delivery,security and billing functionality into industry-leading multi-function andscanning devices.

 

AccuRoute®, ourdocument routing and distribution software, integrates with many digitalscanning and multi-functional devices to allow paper documents to be digitized,distributed and archived. In addition, our AccuRoute software provides for themovement of electronic documents and information, enabling companies to captureand distribute hard copy documents in electronic form and comply with privacyregulations related to health, financial or other confidential information.GenifaxTM, our enterprise fax software, offers a scalable, server-based featureset and shares a common Windows® server-based architecture with the GenidocsTMproduct line. Genidocs, our secure document delivery application, integrateswith existing e-mail systems and provides multiple options for content andattachment encryption, authentication, audit trail, delivery confirmation anddigital signatures. Our AccuRoute software further unifies the code bases andarchitecture of our Genidocs and Genifax product lines. Further, with itsrouting capabilities, the AccuRoute software provides a customer specificproduct that easily manages documents, both paper and electronic, with littleor no user training required.

 

Our softwareproducts can be deployed on heterogeneous, multi-platform networks and digitalscanning and multi-functional devices and can be integrated with both desktopand enterprise software applications such as e-mail and groupwaresystems.  We license our products on a combination server/seat basis or ona server only or seat only basis. To address customer needs, our products aremodular and scaleable; communication capacity can be implemented and added overtime through the addition of system components and connectors as needed to keeppace with an enterprise’s growing demand. Additional Omtool servers can beadded to a configuration to provide failover through redundancy, helping toensure continuous operation.

 

We intend tomaintain a leadership position in our traditional market  – secureelectronic document exchange – while continuing to consolidate thefunctionality of all our products into a single, configurable platform, expandthe level of integration with complimentary technologies such as document andrecords management tools and extend our document capture capability to includevirtually all multi-functional devices and scanners. In doing so, we will bepursuing a leadership position in the broader document delivery/exchange andmanagement market, which we believe will grow in response to increasinglyregulated communications and stringent privacy requirements. We will continueto focus on those vertical markets where regulations or business practicesrequire confidentiality, timely electronic delivery and archiving of criticaldocuments in electronic and paper format.

 

We resell, fromthird-party vendors, certain hardware products, including intelligent faxboards and fax modems, to our customers. We undertake these hardware sales as aconvenience to our customers, who alternatively can opt to obtain hardware froma third-party vendor. The fax boards and fax modems that we resell are notfunctional without our software and we are not generally in the business ofselling fax boards and modems. We purchase these hardware products as needed toship to our customers and we maintain a minimal inventory of these hardwareproducts. We believe that we have a good business relationship with oursuppliers of these products and that supply of these products is stable.

 

Service and otherrevenues have historically consisted primarily of the sale of support contractsto compliment software products sold to customers. We generate a smallerportion of our service and other revenues from consulting, training andinstallation services.

 

We grew totalrevenues by $36,000 for the first six months of 2005 as compared to the firstsix months of 2004 and we earned a net profit of $153,000 and $657,000 for the sixmonths ended June 30, 2005 and 2004, respectively.  Consistent with the strategy we outlinedearlier this year we have increased our expenditures on sales and marketing andother operating areas to introduce AccuRoute first into the financial verticalmarket and, shortly thereafter, the healthcare vertical market.  The decrease in net income

 

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during the second quarter of 2005 is the result of this increased spending,as well as previously anticipated increased Sarbanes-Oxley compliance relatedexpenditures.  We remain encouraged bythe increase in our software license revenues, as that is the primarymeasurement that we use to gauge the market traction and prospects of oursoftware products and, in particular, our AccuRoute product.  During the firstsix months of 2005, software license revenues increased by approximately $152,000,or 7%, from the first six months of 2004 led by a 53% increase in AccuRouterevenue in the first six months of 2005.  We believe that this continuedincrease in software license revenues validates our AccuRoute product and thereception it has received in the legal vertical market to date.

 

Building on the currentversion of our AccuRoute product within the legal vertical market since itsintroduction in 2004, we have begun to broaden our sales and marketing strategyto encompass first the financial vertical market and, shortly thereafter, thehealthcare vertical market.  We anticipate that the additionalexpenditures necessary to enter these markets will be approximately $1.8million for the balance of 2005.  We do not anticipate that theseincreased expenditures will produce a sufficient increase in sales over thebalance of 2005 to offset the associated expenses over the same period. These expenses, along with our anticipated Sarbanes-Oxley compliance relatedexpenses, will therefore continue to exert pressure on earnings for theremainder of 2005.  However, we believe that the profits realized from oursales of AccuRoute in the legal vertical market and from our legacy faxbusiness will allow us to absorb most of the incremental expenses without asignificant loss for 2005.  Our cash and cash equivalents at June 30, 2005were at a three year high balance of $11.1 million.  We believe that our existing cash and cashequivalents will be sufficient to meet our working capital and capitalexpenditure needs for at least the next twelve months.

 

Although webelieve that there has been some recent improvement in the demand forenterprise software solutions and increased market acceptance of our products,we cannot predict whether or when that market will soften or if marketacceptance of our products will occur. If the market or the market acceptanceof our products changes, we cannot predict whether, and to what extent, thedemand for our products will increase or decrease. Any decrease in demand forour products would likely result in decreased revenue, which would, in turn,have a significant negative impact on our financial results because a significantportion of our operating costs (such as personnel, rent and depreciation) arefixed in advance of a particular quarter. As a result, our costs for sales andmarketing, research and development and general and administrative couldcontinue to increase as a percentage of revenues, thereby negatively affectingour operating results.

 

Our future revenues and operating results may fluctuate from quarter toquarter based on the number and size of sales transactions we enter into withcustomers, the adequacy of provisions for losses, general economic conditionsand other factors. In addition, revenues from one or more large orders mayconstitute a significant portion of our total revenues in a particular quarter,further exacerbating fluctuations in quarterly results.

 

We have historically derived a majority of our totalrevenues from sales within the United States. Sales outside of the UnitedStates (primarily in Europe) represented approximately 17% and 23% ofour total revenues for the six months ended June 30, 2005 and 2004 respectively. For the six months ended June 30, 2005 and 2004, our gross profitpercentage on these sales approximated the gross profit percentage on saleswithin the United States. Revenues on our European operations decreased in thefirst six months of 2005 as compared to the first six months of 2004, due to adecrease in Europe of sales of our legacy fax software.  We will continue to leverage our AccuRoutebase in Europe, as well as its indirect channel relationships, to focus sales resourceson the legal vertical market and we expect that the European results will startto improve over the remainder of 2005. There can be no assurance that we willbe able to increase international sales of our products and the failure to doso may have a material adverse effect on our business, financial condition andresults of operations.

 

Our United Kingdom,Omtool Europe Limited, subsidiary transacts business primarily in its localcurrency and we then translate those results into U.S. dollars and consolidate themwith our domestic results for reporting purposes. As we make sales to customersin a variety of countries, significant currency exchange rate fluctuationscould have a material impact on our results of operations. We manage ourforeign currency exchange exposure by monitoring our net monetary positionusing natural hedges of our assets and liabilities denominated in localcurrencies. There can be no assurance that this policy will eliminate allforeign currency exchange exposure. Foreign currency exposure has not beenmaterial to our financial position or results of operations to date. If thevolume of our business denominated in foreign currencies increases, we may berequired to use derivatives to hedge foreign currency exposure.

 

We will continue to leverage our existingdistribution channels, where appropriate, to broaden our reach to our targetvertical markets and further penetrate our installed base.  We are pursuing sales opportunities via oursolution/reseller channel, as well as focusing sales efforts on specific marketsegments, in order to facilitate acceptance of our products. Sales through our indirectdistribution channels represented approximately 19% and 20% of our totalrevenues for the six months ended June 30, 2005 and 2004, respectively.

 

**Critical Accounting Policies andEstimates**

 

We have identifiedthe policies and estimates below as critical to our business operations and theunderstanding of our results

 

8

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of operations. The impact and any associated risks related to thesepolicies on our reported and expected financial results and business operationsare discussed in appropriate sections throughout Management’s Discussion andAnalysis of Financial Condition and Results of Operations. Our preparation ofthis Form 10-Q required us to make estimates and assumptions that affectthe reported amount of assets and liabilities, the disclosure of contingentassets and liabilities as of the date of the financial statements included herein,and the reported amounts of revenue and expenses during the period covered bythis report. There can be no assurance that actual results will not differmaterially from those estimates.

 

*RevenueRecognition and Accounts Receivable Reserves.*  We deriveour revenue primarily from two sources (i) product revenue, which includessoftware license and hardware revenue, and (ii) services and supportrevenue, which includes software maintenance and support, installation,training and consulting revenue. We license our software products on aperpetual basis. We generate revenue from licensing the rights to use oursoftware products and sales of hardware directly to end-users and indirectlythrough resellers. Our resellers order products from us based on purchaseorders received from end-users and do not order stock. We sell our products toresellers and directly to end-users without any specifically stated rights ofreturn. Occasionally, however, we, in our sole discretion, will accept aproduct return if the end-user finds that the product does not fit its needs.We also sell hardware products, which are provided by a third-party, at cost plusan additional mark-up, to end-users and indirectly through resellers. Thehardware products that we resell are not functional without our software. Tosupport our software products, we sell software maintenance and support,installation, training and consulting services to end-users and indirectlythrough resellers.

 

We apply theprovisions of Statement of Position (“SOP”) 97-2,*Software Revenue Recognition*, as amended by SOP 98-9,Modification of SOP 97-2,*Software RevenueRecognition, With Respect to Certain Transactions*, to alltransactions involving the sale of multiple elements including software,hardware and service revenue. We apply the provisions of Statement of FinancialAccounting Standards (“SFAS”) No. 48,*Revenue Recognition When Right of Return Exists*, with respect toproviding for potential future product returns. As described below, we mustmake and use significant judgments and estimates in connection with the revenuerecognized in any accounting period. Material differences may have resulted inthe amount and timing of our revenue if we had made different judgments orutilized different estimates.

 

We recognizerevenue from the sale of software products and hardware to both end-users andresellers when persuasive evidence of an arrangement exists, the products havebeen delivered, the fee is fixed or determinable, collection of the resultingreceivable is reasonably assured and there are no uncertainties regardingcustomer acceptance. We maintain a reserve for potential product returns. Werecognize software maintenance and support revenue over the term of the relatedmaintenance period, which is typically a one-year period.  On thoseoccasions when we sell multiple-year maintenance contracts, we recognize theassociated revenue over the multiple-year term of the maintenance contract. Werecognize other services revenue as we perform the services. If an arrangementincludes an acceptance provision and acceptance is uncertain, then we willdefer all revenue until the customer accepts the products purchased. Acceptancein these instances generally occurs upon the earlier of receipt of a writtencustomer acceptance or expiration of the acceptance period. If an arrangementincludes an acceptance provision tied to determination that our product meetspublished specifications and there are no uncertainties with regard to thecustomer’s acceptance, then we will recognize revenue at the time of sale,provided that all other revenue recognition criteria previously mentioned havebeen met and the acceptance period is of short duration.

 

Our transactionsfrequently involve the sale of software, hardware and related services undermultiple element arrangements. Revenue under multiple element arrangements isallocated to each element under the residual method, in accordance with SOP98-9, Modification of SOP 97-2,*SoftwareRevenue Recognition, With Respect to Certain Transactions*. Underthis method, revenue is allocated first to all undelivered elements, such asservices, based on the fair value of those elements, which is calculated to bethe price charged when these elements are sold separately and unaccompanied byother elements. Our services are not essential to the functionality of thesoftware, as these services do not alter the capabilities of the software anddo not carry a significant degree of risk to perform. The amount allocated tothe delivered elements, such as software license and hardware revenue, is thedifference between the total arrangement value and the amount allocated to theundelivered elements. If the delivered elements include both software andhardware, the amount allocated to hardware revenue is based on the pricecharged to us by the third party vendor plus an additional mark up, with theremainder allocated to software revenue. To the extent that a discount isoffered in the arrangement, the entire discount is allocated to the deliveredelement or elements. If the delivered elements include hardware and software,the discount is allocated to the hardware and software based on theirrespective list prices.

 

For all sales, weuse a binding purchase order, a signed contract or a credit card authorizationas evidence of an arrangement. Sales through our resellers are evidenced by amaster agreement governing the relationship, together with binding purchaseorders, on a transaction-by-transaction basis.

 

At the time of atransaction, we assess whether the fee associated with the transaction is fixedor determinable and whether or not collection is reasonably assured. If asignificant portion of a fee is due beyond our normal payment terms, which arethirty to sixty days from invoice date, we account for the fee as not beingfixed or determinable. In these cases, we recognize revenue as the fees becomedue. We assess collection based on a number of factors, including pasttransaction history with the customer and the credit-

 

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worthiness of the customer. We review Dunn & Bradstreet creditreports for all of our resellers and adjust our credit limits with thoseresellers accordingly. If a particular reseller does not have a favorablereport or if we do not have enough credit information to determine if thereseller is credit-worthy then we predominantly sell to those resellers on cashon delivery terms. We do not request collateral from our customers. If wedetermine that collection of a fee is not reasonably assured, the fee isdeferred and revenue is recognized at the time collection becomes reasonablyassured, which is generally upon receipt of payment.

 

We maintainreserves for potential product returns and make adjustments to these reservesas needed based on historical product return rates.  We also consider theimpact of new product introductions, changes in customer demand and acceptanceof our products on the adequacy of these reserves. Our calculation of theestimated return reserve is based upon (1) an account specific review ofpotential returns, where a return probability is known, and (2) a generalestimate based upon past historical returns as a percentage of revenue. We mustmake and use significant judgments and estimates in connection with establishingthe product returns reserve in any accounting period. Material differences mayhave resulted in the amount and timing of revenue for this or any prior periodif we made different judgments or utilized different estimates.

 

As with theproduct return reserve, we must make estimates of our ability to collect on ouraccounts receivable. We record trade accounts receivable at the invoicedamount; these accounts do not bear interest. We specifically analyze accountsreceivable and historical bad debts, customer credit-worthiness, currenteconomic trends and changes in customer payment patterns when evaluating theadequacy of the allowance for doubtful accounts. We review the allowance fordoubtful accounts on a monthly basis. Our calculation of the estimated accountsreceivable reserve is also based upon (1) an account specific review ofpotential uncollectible accounts, where a bad debt probability is known, and(2) a general estimate based upon past historical bad debts as apercentage of accounts receivable. We do not have any off-balance-sheet creditexposure to our customers.

 

Our combinedaccounts receivable and product returns reserve was $43,000 and $82,000 at June30, 2005 and December 31, 2004, respectively. Both components of calculatingthe estimated reserve – specific identification and historic experience – arematerial judgments made by us. We base these judgments on historic trends,taking into consideration current business and economic conditions, which couldchange materially, thus changing the required reserve level materially. Thepotential change to the size of our required reserve could be positive, in theevent the reserve estimate proves unnecessary, or negative, if the reserveproves inadequate.

 

Our deferredrevenue is comprised mainly of revenue that is deferred for softwaremaintenance and support contracts. The other components of deferred revenue areamounts from sales transactions that were deferred because they did not meetall of the provisions of our revenue recognition policy.

 

*SoftwareDevelopment Costs.*  Software development costs areconsidered for capitalization when technological feasibility is established inaccordance with SFAS No. 86,*Accountingfor the Costs of Computer Software To Be Sold, Leased or Otherwise Marketed*.We sell software in a market that is subject to rapid technological change, newproduct introductions and changing customer needs. Accordingly, we havedetermined that we cannot ascertain technological feasibility until thedevelopment state of the product is nearly complete. The time period duringwhich cost could be capitalized from the point of reaching technologicalfeasibility until the time of general product release is very short and,consequently, the amounts that might be capitalized are not material to ourconsolidated financial position or results of operations. Therefore, we chargeall software development costs to operations in the period incurred.

 

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

 

We assess ourdeferred tax assets for each reporting period to determine whether it is morelikely than not that they will be recovered from future taxable income. Inmaking this assessment, we include assumptions regarding ongoing tax planningstrategies. We establish a valuation allowance for assets when their recoveryis not certain.  Changes to the valuation allowance are included as anexpense or benefit within the tax provision in our statement of operations.

 

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

 

We estimateaccrued state sales taxes for each reporting period based on tax rates ineffect for the reporting periods in each of the states where we have apotential nexus and for the time period during which we have that nexus. Theassumptions and estimates used to determine this liability are subject tochange as they are difficult to measure or value. In the event that actualresults differ

 

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from these estimates, our state sales taxes expense could be materiallyimpacted.

 

**New Accounting Pronouncements**

 

In May 2005, theFASB issued FASB Statement No. 154, “Accounting Changes and Error Corrections,a replacement of APB Opinion No. 20 and FASB Statement No. 3” (SFAS No. 154).  Previously, APB No. 20, “Accounting Changes”and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”required the inclusion of the cumulative effect of changes in accountingprinciple in net income of the period of the change.  SFAS No. 154 requires companies to recognize achange in accounting principle, including a change required by a new accountingpronouncement when the pronouncement does not include specific transitionprovisions, retrospectively to prior periods’ financial statements. We willassess the impact of a retrospective application of a change in accountingprinciple in accordance with SFAS No. 154 when such a change arises after theeffective date of January 1, 2006.

 

InDecember 2004, the FASB issued SFAS No. 123(R),*Share-Based Payment*. SFAS No. 123(R)amends SFAS No. 123 to require that companies record as expense the effectof equity-based compensation, including stock options over the applicablevesting period. We currently disclose the effect on income that stock optionswould have were they recorded as expense. SFAS No. 123(R) also requiresmore extensive disclosures concerning stock options than required under currentstandards. The new rule applies to option grants made after a company’sadoption of the standard, as well as options that are not vested at the date ofadoption. SFAS No. 123(R) becomes effective in our case not later than thebeginning of the fiscal year that begins after December 15, 2005. We donot currently expect to elect early adoption of this standard and have notdetermined whether we will apply this new standard prospectively in the firstquarter of 2006, retroactively from the beginning of 2006, or on a restatedbasis for all prior periods on a comparable basis. We do not expect that the adoptionof SFAS No. 123(R) will have a material impact on our future results ofoperations.

 

InNovember 2004, the FASB issued SFAS No. 151,*Inventory Costs, An amendment of ARB No. 43,Chapter 4.* SFAS No. 151 modifies the accounting for abnormalinventory costs and the manner in which companies allocate fixed overheadexpenses to inventory. SFAS No. 151 is effective for inventory costsincurred during annual periods beginning after June 15, 2005. We do notexpect SFAS No. 151 to have a material impact on our financial positionand results of operations.

 

**Results of Operations**

 

The following table sets forth certain financial data for the periodsindicated as a percentage of total revenues:

 
| ** **                      | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                      | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues:                       |       |                             |       |                           |       |   |   |   |   |
| Software license                |       | 31.9                             | %          | 33.6                           | %          | 33.0 | % | 31.2 | % |
| Hardware                        |       | 20.2                             |       | 13.3                           |       | 21.0 |   | 21.8 |   |
| Service and  other              |       | 47.9                             |       | 53.1                           |       | 46.0 |   | 47.0 |   |
| Total revenues                  |       | 100.0                            |       | 100.0                          |       | 100.0 |   | 100.0 |   |
| Cost of  revenues:              |       |                             |       |                           |       |   |   |   |   |
| Software license                |       | 1.4                              |       | 2.6                            |       | 1.0 |   | 1.6 |   |
| Hardware                        |       | 13.5                             |       | 9.3                            |       | 13.8 |   | 13.4 |   |
| Service and  other              |       | 19.2                             |       | 19.1                           |       | 18.8 |   | 18.8 |   |
| Total cost of  revenues         |       | 34.1                             |       | 31.0                           |       | 33.6 |   | 33.8 |   |
| Gross profit                    |       | 65.9                             |       | 69.0                           |       | 66.4 |   | 66.2 |   |
| Operating  expenses:            |       |                             |       |                           |       |   |   |   |   |
| Sales and  marketing            |       | 31.9                             |       | 29.4                           |       | 31.2 |   | 27.4 |   |
| Research and  development       |       | 14.6                             |       | 14.3                           |       | 14.0 |   | 12.9 |   |
| General and  administrative     |       | 20.4                             |       | 17.0                           |       | 20.2 |   | 17.2 |   |
| Total operating  expenses       |       | 66.9                             |       | 60.7                           |       | 65.4 |   | 57.5 |   |
| Income (loss)  from operations  |       | (1.0                             | )          | 8.3                            |       | 1.0 |   | 8.7 |   |
| Interest and  other income, net |       | 1.3                              |       | 1.1                            |       | 1.2 |   | 1.0 |   |
| Tax provision                   |       | 0.0                              |       | 1.2                            |       | 0.1 |   | 0.8 |   |
|                            |       |                             |       |                           |       |   |   |   |   |
| Net income                      |       | 0.3                              | %          | 8.2                            | %          | 2.1 | % | 8.9 | % |
|                            |       |                             |       |                           |       |   |   |   |   |
| Gross profit:                   |       |                             |       |                           |       |   |   |   |   |
| Software license                |       | 95.6                             | %          | 92.3                           | %          | 97.1 | % | 94.9 | % |
| Hardware                        |       | 33.0                             |       | 29.9                           |       | 34.1 |   | 38.8 |   |
| Service and  other              |       | 60.1                             |       | 64.0                           |       | 59.1 |   | 60.0 |   |

 

**Three Months Ended June 30, 2005 and2004**

 

*Revenues*

 

*TotalRevenues.*  Our totalrevenue was $3.6 million and $3.4 million for the three months ended June30, 2005 and 2004,

 

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respectively.

 

*SoftwareLicense.*  Softwarelicense revenues were $1.1 million for each of the three month periods ended June30, 2005 and 2004, respectively. Software license revenues accounted for 32% and 34% of total revenuesfor each respective period.  Revenues fromour AccuRoute product represented 50% and 52% of software license revenues forthe three months ended June 30, 2005 and 2004, respectively. These percentagesreflect the continued market acceptance of our AccuRoute product.  Software revenues from our legacy fax productline represented 46% of software license revenues for each of the three monthsended June 30, 2005 and 2004.  Variousother components of software license revenues including sales returns andallowance adjustments and sales of our other software products such as Genidocsand Swiftwriter comprise 4% and 2% of software license revenues for the threemonth period ended June 30, 2005 and 2004, respectively.  Included in software license revenue for thethree months ended June 30, 2005 and 2004 is a reduction of $3,000 and $30,000,respectively, in the sales returns and allowance reserve relating primarily tospecific accounts where we determined that the risk of a return is no longerpresent.  Although we cannot accuratelypredict the exact mix of products that will be sold in the future, we expectthat software license revenue will constitute a larger percentage of our totalrevenues in the future if demand for AccuRoute, which generally does notrequire the purchase of additional hardware, continues to gain additionalmarket acceptance.

 

*Hardware.*  Hardware revenues were $722,000 for the threemonths ended June 30, 2005 as compared to $448,000 for the three months ended June30, 2004, representing an increase of 61%. Hardware revenues accounted for 20% and 13% of total revenues for eachrespective period.  The increase inhardware revenues is due to an increase in demand from existing customers whohave upgraded information systems hardware in their worldwide locations. Included in hardware revenue for the three months ended June 30, 2005 and 2004is a reduction of $1,000 and $8,000, respectively, in the sales returns andallowance reserve relating primarily to specific accounts where we havedetermined that the risk of a return is no longer present.  Although wecannot accurately predict the exact mix of products that we will sell in thefuture, we expect that hardware revenues will constitute a smaller percentageof our total revenues if demand for AccuRoute, which does not require thepurchase of additional hardware, continues to increase due to gains in marketacceptance for this product.

 

*Serviceand Other.*  Service andother revenues were $1.7 million and $1.8 million for the three month periodsended June 30, 2005 and 2004, respectively, representing a decrease of 4%. Serviceand other revenue accounted for 50% and 53% of total revenues for eachrespective period.  The fact that serviceand other revenue decreased slightly is primarily due to reduced maintenancerevenues from our subsidiary in the United Kingdom for the three months ended June30, 2005 as compared to the three months ended June 30, 2004.  This decrease was partially offset by increasedoverall service revenues from installation, consulting and training servicesfor the same periods.   The decrease in service and other revenues asa percent of total revenues is due primarily to the increases in hardwarerevenues.  We are focused on improving the renewal rate of softwaremaintenance contracts with our existing customer base in both our NorthAmerican and European operations.

 

*Costof Revenues*

 

*SoftwareLicense.*  Cost ofsoftware license revenues consists primarily of the costs of sublicensing third-partysoftware products, product media and product duplication.  Cost of software license revenues for thethree months ended June 30, 2005 decreased by 42% or $36,000 during the quarterto $50,000 compared to $87,000 during the corresponding period in 2004.  The decrease is due primarily to decreased royaltypayments associated with sales of royalty-bearing products.  This decrease is also reflected in softwarelicense gross margin as it improved to 96% from 92%.  We have recently added third-party softwareinto our products and we expect that our software license cost as a percentageof software license revenues will increase slightly in the future.

 

*Hardware.*  Cost of hardware revenues consists primarilyof the costs of third-party hardware products. Cost of hardware revenueswas $484,000 and $314,000 for the three months ended June 30, 2005 and 2004,respectively, representing 67% and 70% of hardware revenues for each respectiveperiod. The increase in dollar amount for the cost of hardware revenues was dueprimarily to the increase in hardware unit sales.  The gross margin percentage for hardware salesincreased to 33% from 30% for the three month periods ended June 30, 2005 and2004 due to a change in the mix of particular hardware products sold.  We do not expect significant changes in unitprices for the remainder of 2005.

 

*Serviceand Other.*  Cost ofservice and other revenues consists primarily of the costs incurred inproviding telephone support as well as other miscellaneous customer service-relatedexpenses.  Cost of service and otherrevenues was $682,000 and $644,000 for the three months ended June 30, 2005 and2004, respectively, representing 40% and 36% of service and other revenues foreach respective period.  The gross marginpercentage for service and other revenues decreased to 60% for the three monthsended June 30, 2005, compared to 64% in the same period in 2004.  The decrease in gross margin is due to an increasein the wages related expenses and associated overhead costs of employees in thesupport department.  We do not expect any significant variances in ourservice and other gross margins for the remainder of fiscal year 2005.

 

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*OperatingExpenses*

 

*Salesand Marketing.*  Sales and marketing expenses consist primarily ofemployee salaries, benefits, commissions, and associated overhead costs, andthe cost of marketing programs such as advertisements, direct mailings, publicrelations, trade shows, seminars and related communication costs.  Sales and marketing expenses were $1.1million and $988,000 for the three months ended June 30, 2005 and 2004,respectively, or 32% and 29% of total revenues for each respective period.  The increasein sales and marketing expenses is due to an increased number of employees in oursales and marketing departments and the associated costs of supporting thoseemployees.   Additionally, we increased ourgeneral advertising and trade show expenses during the second quarter of 2005as compared to the second quarter of 2004. Both of these expense increases reflect our initiative to furtherpenetrate the legal vertical market with our AccuRoute product.  Building on the success of the currentversion of our AccuRoute product within the legal vertical market since itsintroduction in 2004, we intend to continue broadening our current sales andmarketing strategy, which we began in the second quarter of 2005, to encompass firstthe finance vertical market and, shortly thereafter, the healthcare verticalmarket.  We anticipate that the additional expenditures necessary to enterthese markets will be approximately $1.8 million for the balance of 2005. Much of these additional expenses will be sales and marketing related.Consequently, we expect that our sales and marketing expenses will increase inabsolute dollars as we hire additional sales staff during the balance of thisyear.

 

*Researchand Development.* Research and development expenses includeexpenses associated with the development of new products, enhancements ofexisting products and quality assurance activities. These expenses consistprimarily of employee salaries, benefits, associated overhead costs, consultingexpenses and the cost of software development tools. Research and developmentexpenses were $521,000 for the three months ended June 30, 2005 and $482,000for the three months ended June 30, 2004, representing 15% and 14% of totalrevenues for each respective period.  Theincrease in research and development expenses in dollars and as a percent oftotal revenues is a result of an increased number of employees in the researchand development department during 2005 as compared with the comparable periodin 2004 and the associated costs of supporting such personnel.  We expectresearch and development expenses will increase in absolute dollars as we hireadditional engineers to support our expansion of our AccuRoute product intoother vertical markets.

 

*Generaland Administrative.* General and administrative expenses consist primarily of employeesalaries, benefits for administrative, executive and finance personnel andassociated corporate general and administrative expenses. General andadministrative expenses were $726,000 and $572,000 for the three months ended June30, 2005 and 2004, respectively, or 20% and 17% of total revenues for eachperiod. The increase in dollar amount and as a percentage of total revenues isdue to the increase in general and administrative personnel and overhead costsassociated with supporting such personnel and an increase in managementconsulting expenses related to our ongoing compliance with the Sarbanes-OxleyAct of 2002. We expect that we may continue to experience increases to generaland administrative expenses in the form of professional fees and consultingexpenditures during the remainder of 2005 as we continue to comply with Section404 of the Sarbanes-Oxley Act of 2002.

 

*Interestand Other Income.*  Interest and other income consist principallyof interest income earned on cash and cash equivalent balances.  Interest and other income, net was $45,000for the three months ended June 30, 2005 and $37,000 for the three months endedJune 30, 2004.  The increase in interestincome is a result of a higher cash balance and interest rates earned on our investmentaccounts during the three months ended June 30, 2005 as compared to the threemonths ended June 30, 2004.

 

*Provision for Income Taxes.*  Duringthe three months ended June 30, 2005, we did not record a net tax provision forexpected tax liability in the United States. During the three months ended June 30, 2004, we recorded a net taxprovision of $38,572 for expected tax liability in the United States and forexpected tax liability related to our United Kingdom subsidiary, Omtool EuropeLimited.

 

**SixMonths Ended June 30, 2005 and 2004**

 

*Revenues*

 

*TotalRevenues.*  Our totalrevenues were $7.4 million for each of the six month periods ended June 30, 2005and 2004.

 

*SoftwareLicense.*  Softwarelicense revenues were $2.5 million for the six months ended June 30, 2005 and$2.3 million for the six months ended June 30, 2004, representing an increaseof 7%.  Software license revenuesaccounted for 33% and 31% of total revenues for each respective period.  The increase in software license revenuesreflected an overall increase in demand for our AccuRoute product, but our licenserevenues were offset by a decline in demand for our legacy fax product line ascompared to the six months ended June 30, 2004. Revenues from our AccuRouteproduct represented 48% and 33% of software license revenues for the six monthperiod ended June 30, 2005 and 2004, respectively.  Software license revenues from our legacy faxproduct line represented 50% and 60% of software license revenue for the sixmonth period ended June 30, 2005 and 2004, respectively.  The growth of our AccuRoute product line is aresult of greater market acceptance of our product.  Various other components of software license

 

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revenues, including sales returns and allowance adjustments and salesof our other software products such as Genidocs and Swiftwriter, comprise 2%and 7% of software license revenues for the six month period ended June 30,2005 and 2004, respectively.  Included insoftware license revenues for the six months ended June 30, 2005 and 2004 is anet reduction of $21,000 and $140,000, respectively, in the sales returns andallowance reserve relating primarily to specific accounts where we havedetermined that the risk of a return is no longer present.  Although we cannot accurately predict theexact mix of products that will be sold in the future, we expect that softwarelicense revenue will constitute a larger percentage of our total revenues inthe future if demand for AccuRoute, which generally does not require thepurchase of additional hardware, continues to gain additional marketacceptance.

 

*Hardware.*  Hardware revenues were $1.6 million for eachof the six months periods ended June 30, 2005 and June 30, 2004.  Hardware revenues accounted for 21% and 22%of total revenue for each respective period. Included in hardware revenues for the six months ended June 30, 2005 and2004 is a reduction of $7,000 and $44,000, respectively, in the sales returns andallowance reserve relating primarily to specific accounts where we havedetermined that the risk of a return is no longer present.  Although we cannot accurately predict theexact mix of products that we will sell in the future, we expect that hardware revenueswill constitute a smaller percentage of our total revenues if demand forAccuRoute, which does not require the purchase of additional hardware,continues to increase due to gains in market acceptance for this product.

 

*Serviceand Other.*  Service andother revenues decreased by 2% for the six months ended June 30, 2005 comparedto the six months ended June 30, 2004. Service and other revenues were $3.4 million and $3.5 million forthe six months ended June 30, 2005 and 2004, respectively, accounting for 46%and 47% of total revenues for each respective period.  The decrease in service and other revenues indollars and as a percentage of total revenues is primarily due to a decrease inmaintenance revenues from our United Kingdom subsidiary during the six monthsended June 30, 2005 as compared to the same period in 2004.

 

*Costof Revenue*

 

*SoftwareLicense.*  Cost ofsoftware license revenues for the six months ended June 30, 2005 decreased by 40%or $47,000 to $71,000 compared to $118,000 during the corresponding period in2004.  The decrease is due primarily todecreased royalty payments associated with sales of royalty-bearing products.  This decrease is also reflected in softwarelicense gross margin, which improved to 97% from 95%.  We have recently added third-party softwareinto our products and we expect that our software license cost as a percentageof software license revenues will increase slightly in the future.

 

*Hardware.*  Cost of hardware revenues was $1.0 millionand $989,000 for the six months ended June 30, 2005 and 2004,respectively, representing 66% and 61% of hardware revenues for each respectiveperiod. The gross margin percentage for hardware sales decreased to 34% from 39%for the six month periods ended June 30, 2005 and 2004.  The increase in dollar amount for the cost ofhardware revenues and the decrease in gross margin percentage were dueprimarily to the particular mix of hardware products sold.  We do not expect that our per unit cost ofhardware products will change significantly enough through the remainder of 2005to have a material impact on our hardware margins in the future.

 

*Serviceand Other.*  Cost ofservice and other revenues was $1.4 million for each of the six month periodsended June 30, 2005 and 2004, respectively, representing 41% and 40% of serviceand other revenues for each respective period. The gross margin percentage for service and other revenues decreased to 59%for the six months ended June 30, 2005, compared to 60% in the same period in2004. We do not expect any significant variances in our service and other grossmargins for the remainder of fiscal year 2005.

 

*OperatingExpenses*

 

*Salesand Marketing.*  Salesand marketing expenses were $2.3 million and $2.0 million for the sixmonths ended June 30, 2005 and 2004, respectively, or 31% and 27% of totalrevenues for each respective period.  The increase in sales and marketing expensesis due to an increased number of employees in the sales and marketingdepartments and the associated costs of supporting those employees.  Additionally, we increased our generaladvertising and trade show expenses during the first six months of 2005 ascompared to the first six months of 2004. Both of these expense increases reflect our initiative to furtherpenetrate the legal vertical market with our AccuRoute product.  Building on the success of AccuRoutewithin the legal vertical market since the introduction of the current versionof this product in 2004, we intend to continue broadening our current sales andmarketing strategy, which we began in the second quarter of 2005, to encompass firstthe finance vertical market and, shortly thereafter, the healthcare verticalmarket.  We anticipate that the additional expenditures necessary to enterthese markets will be approximately $1.8 million for the balance of 2005. Much of these additional expenses will be sales and marketing related.Consequently, we expect that our sales and marketing expenses will increase inabsolute dollars as we hire additional sales and marketing staff during thebalance of this year.

 

*Researchand Development.* Research and development expenses were $1.0million for the six months ended June 30, 2005 and $953,000 for the six monthsended June 30, 2004, representing 14% and 13% of total revenues for eachrespective period.  The increase inresearch and development expenses in dollars and as a percent of total revenuesis a result of an increased number of

 

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employees in the research and development department during 2005 andthe associated costs of supporting such personnel.  We expect research anddevelopment expenses will increase in absolute dollars as we hire additionalengineers to support our expansion of AccuRoute into other vertical markets.

 

*Generaland Administrative.* General and administrative expenses were $1.5 million and $1.3 millionfor the six months ended June 30, 2005 and 2004, respectively, or 20% and 17%of total revenues for each period. The increase in dollar amount and as apercentage of total revenues is due to the increase in general andadministrative personnel and overhead costs associated with supporting suchpersonnel and an increase in management consulting expenses related to ourongoing compliance with the Sarbanes-Oxley Act of 2002. We expect that we maycontinue to experience increases to general and administrative expenses in theform of professional fees and consulting expenditures during the remainder of2005 as we continue to comply with Section 404 of the Sarbanes-Oxley Act of2002.

 

*Interestand Other Income.*  Interest and other income consistsprincipally of interest income earned on cash and cash equivalent balances.  Interest and other income, net was $86,000for the six months ended June 30, 2005 and $74,000 for the six months endedJune 30, 2004.  This increase is a resultof a higher cash balance in the Company’s investment accounts for the sixmonths ended June 30, 2005.  Included in interestand other income for the six months ended June 30, 2004 is other income of$5,000 related to the fair value of a warrant to purchase 8,580 shares ofcommon stock of Verso Technologies (“Verso”). We mark the fair value of this warrant to market in each financialreporting period.  Therefore, for theduration of time that we hold the Verso warrant, which expires in November2005, we may be forced to record future changes in the fair value of thatsecurity in our income and other expenses. We expect that interest and other income will be relatively stablequarter over quarter for the remainder of 2005.

 

*Provision for Income Taxes.*  Duringthe six months ended June 30, 2005, the Company recorded a net tax provision of$6,777 for expected tax liability in the United States and for expected taxliability related to our United Kingdom subsidiary.

 

During the sixmonths ended June 30, 2004, the Company recorded a net tax provision of $57,703for expected tax liability in the United States and for expected tax liabilityrelated to our United Kingdom subsidiary. The provision for the first six months of 2004 is net of a $28,800adjustment related to a fiscal year 2003 transfer pricing adjustment.

 

*Inflation*

 

During the fiscalyears ended December 31, 2004, 2003 and 2002 and the first and second fiscalquarters of 2005, neither inflation nor changing prices have had a materialimpact on our net sales, revenues or income from continuing operations.

 

**Liquidity and Capital Resources**

 

Since 1996, wehave financed our operations primarily through cash flow from operations,private sales of preferred stock and common stock and our initial publicoffering of common stock completed in August 1997. As of June 30, 2005, wehad cash and cash equivalents of $11.1 million and working capital of $7.0million.  We believe that our existingcash and cash equivalents will be sufficient to meet our working capital,capital expenditures and other liquidity requirements for at least the nexttwelve months.

 

Our operating activities provided cash of $556,000 and$509,000 for the six months ended June 30, 2005 and 2004, respectively.  We believethat the additional resources being allocated to improve the success of ourAccuRoute product in the legal vertical market and its expansion first into thefinance vertical market and, shortly thereafter, the healthcare vertical market,plus the increase in general and administrative expenses associated withcompliance with the Sarbanes-Oxley Act of 2002 and related regulations,will put pressure on our earnings during the remainder of 2005, but that ourexisting cash is sufficient for at least the next twelve months.  Net cash provided during the six monthsended June 30, 2005 consisted primarily of net income from operations and the non-casheffects of depreciation and amortization, decreases to accounts receivable andinventory offset by decreases to the accounts receivable reserve and deferredrevenue and an increase to prepaid expenses and other current assets.  The decrease to accounts receivable isprimarily due to timely payment remittances by customers.  The decrease in inventory is due to therelease of inventory associated with previously deferred revenue that becamerecognizable during the quarter.  The decreaseto the accounts receivable reserve relates primarily to specific accounts wherewe have determined that the risk of a return is no longer present.  The decrease in deferred revenues relates tospecific sales transactions on which revenue had not been previously recognizedbecause they did not meet all of our criteria for revenue recognition until thesecond quarter of 2005. The increase in prepaid expenses and other currentassets is due primarily to cash paid for the support of certain internally usedinformation systems software.  Net cash provided during the six monthsended June 30, 2004 consisted primarily of a net profit from operations,depreciation and amortization, an increase in accrued liabilities and adecrease in accounts receivable partially offset by a decrease to the accountsreceivable reserve and a decrease in accrued restructuring and accounts payable.

 

Investing activities used cash of $64,000 and $27,000during the six months ended June 30, 2005 and 2004, respectively.  Thesole use of cash for investing activities for each period was for purchases ofproperty and equipment related to computer related

 

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software and hardware products. We expect that we will increase our investments in computer relatedsoftware and hardware products in 2005 in order to improve our informationtechnology infrastructure so we can support newly hired employees.

 

Financing activities provided cash of $20,000 and $1.6million for the six months ended June 30, 2005 and 2004, respectively.  Cashprovided for the six months ended June 30, 2005 was due to the net proceedsfrom the issuance of common stock from our employee stock purchase program. Cashprovided for the six months ended June 30, 2004 was due to the net proceedsfrom the issuance of common stock.  On March 30, 2004, we completed thesale of 600,000 shares of common stock, at a price of $6.00 per share, in aprivate placement to institutional and other accredited investors. The proceedsof the private placement, which totaled $3.6 million, are being used foradditional working capital and other general corporate purposes. The cash wereceived on the consummation of this private placement was offset by our usageof $2.0 million in cash during the six months ended September 30, 2004, when werepurchased 350,000 shares of our outstanding common stock from ASA InternationalLtd., an existing shareholder, in a private transaction at a price of $5.75 pershare. We purchased those shares from ASA International Ltd. with generallyavailable corporate funds and we will hold those shares in treasury.

 

Based on our performancefor the first six months of 2005 and current expectations for the remainder ofthe year, we believe that our current cash and cash equivalents balance, aswell as the cash expected to be generated from operations for the remainder ofthe year, will satisfy our working capital needs, capital expenditures andother liquidity requirements associated with our operations through at leastthe next twelve months.  We expect that principal uses of cash will be foroperations, working capital, payment of sales taxes and purchases of propertyand equipment.  We do not currently have a plan to obtain additionalfinancing if these expectations are not met. There can be no assurance that anynecessary additional financing will be available to us on commercially reasonableterms, or at all.

 

The following table represents the approximate amounts of payments dueunder specified contractual obligations as of June 30, 2005:

 
| **Contractual  Obligations** | ** ** | **Total** | ** ** | **Less than  one year** | ** ** | **One to  Three years** | ** ** | **Three to  five years** | ** ** | **More than  Five years** | ** ** |
|------------------------------|------------|-----------|------------|-------------------------|------------|-------------------------|------------|--------------------------|------------|---------------------------|------------|
|                         |       |      |       |                    |       |                    |       |                     |       |                      |       |
| Operating lease  obligations |       | $         | 153,000    |                    | $          | 129,000                 |       | $                        | 24,000     |                      | —     |   | — |   |
|                              |            |           |            |                         |            |                         |            |                          |            |                           |            |  |  |  |

 

Operating leaserequirements consist mainly of lease payments for our offices in Salem, NH andLondon, England, United Kingdom. As of June 30, 2005, we did not have anylong-term debt obligations, material commitments for capital expenditures,capital lease obligations, or other long-term liabilities for which paymentsare required. Our lease for our Salem, NH location expires on December 31,2005. We believe that this facility is adequate for our present operations.However, there can be no assurance that we will be able to renew this lease onsufficiently favorable terms and we may therefore have to relocate ourheadquarters location.

 

**Off-Balance Sheet Arrangements**

 

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

 

**Certain Factors Affecting FutureOperating Results**

 

We operate in arapidly changing environment that involves a number of risks, some of which arebeyond our control.  The discussion below highlights some of the risksthat may affect future operating results.

 

Informationprovided by us from time to time, including statements in this Form 10-Qthat are not historical facts, consists of so-called “forward-lookingstatements” that involve risks and uncertainties, made pursuant to the safeharbor provisions of the Private Securities Litigation Reform Act of1995.  In particular, statements contained in Management’s Discussion andAnalysis of Financial Condition and Results of Operations that are nothistorical facts (including, but not limited to, statements concerning:  ourplans and objectives; expectations for sales and marketing, research anddevelopment and general and administrative expenses; developments relating toour product and service offerings, markets and acquisitions; anticipated trendsin our business; our strategic alliances; changes in the regulatoryenvironment; our expected liquidity and capital resources and our criticalaccounting policies) may constitute forward-looking statements.  These forward-lookingstatements are neither promises nor guarantees, but are subject to risk anduncertainties that could cause actual results to differ materially from theexpectations set forth in the forward-looking statements.  Factors thatmay cause these kinds of differences include, but are not limited to, thefactors discussed below and the other risks discussed from time to time in ourother filings with the Securities and Exchange Commission.

 

***Our future operating results are uncertain and difficult to predict****.*  We incorporated and shipped ourinitial facsimile software products in 1991.  Although we recorded anoperating profit in the year ended December 31, 2004, we had operating lossesand decreasing revenues in the years ending December 31, 2003 and 2002. We introduced the initial version of our AccuRoute product in the secondquarter of 2002 and the current version in the first quarter of 2004.Ultimately, AccuRoute represented 40% of

software revenues in 2004.  There can be no assurance that we willbe able to increase our level of revenues or maintain our profitability in thefuture, as our operating history makes the accurate prediction of futureoperating results difficult or impossible.  Increases in operatingexpenses are expected and, together with pricing pressures and any decline inthe growth rate of the overall U.S. economy or our industry in particular, mayresult in a decrease in operating income and operating margin percentage. Our ability to improve our operating results will depend upon, among otherthings, our ability to increase sales of our AccuRoute, Genifax and Genidocssoftware products to new customers, as well as our ability to increase productpenetration into existing customers.  We recently expanded our strategicfocus to include document routing and distribution software.  To date, wehave limited financial and operating data and a limited operating historyrelevant to this solution.  Accordingly, it is difficult to evaluate theprospects for the level of acceptance of this solution.  In addition, weplan to invest significantly in the expansion of our AccuRoute product into newvertical markets, specifically first the finance vertical market and then thehealthcare vertical market, in advance of significant related revenues fromthose markets.  We cannot predict the timing or level of revenuesresulting from these planned investments.  Future operating results willdepend on many other factors, including, without limitation, the degree andrate of growth of the markets in which we compete; the level of acceptance ofthe Windows NT®, Windows 2000® and Windows XP® operating systems; the level ofproduct and price competition; our ability to establish strategic relationshipsand develop and market new and enhanced products; our ability to control costs;our ability to expand our direct sales force and indirect distribution channelsboth domestically and internationally; and our ability to attract and retainkey personnel.  As a result, it is possible that in the future, our operatingresults will be below the expectations of public market analysts andinvestors.  In that event, the price of our common stock would likely be materiallyadversely affected.

 

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***All of our products are concentrated in the electronicdocument exchange market****.* To date, much of our revenues have been attributable to licenses of ourfacsimile-based enterprise solutions and related products and services. Weexpect these products and related services to continue to account forsignificant amounts of our future revenues.  However, recently the amountof revenues attributable to licenses of these products has declined and therecan be no assurances that this decline will not continue.  Furthermore, weintroduced our secure business-to-business electronic document exchangeproducts, Genidocs and Genifax, to the market in the fourth quarter of 2000. Further,we introduced the initial version of our proprietary document and routingsoftware, AccuRoute, in the second quarter of 2002 and the current version ofthat product in the first quarter of 2004.  We have only recently begun torecognize a significant amount of revenues from our AccuRoute product.  Weexpect that this product may account for an increasing portion of futurerevenues.  However, there can be no assurances that our AccuRoute productwill be financially successful or result in any significant revenues in thefuture.  Factors adversely affecting the pricing of or demand for thisproduct, such as competition or technological change, could have a materialadverse effect on our business, financial condition and results of operations.All of our products are concentrated in the electronic document exchange marketand, therefore, any factors affecting demand for these sorts of solutions couldcause our operating results to decline.  Investors must evaluate ourprospects in light of the risks and difficulties frequently encountered bycompanies dependent upon operating revenues from a new product line in an emergingand rapidly evolving market.

 

***The markets for our products are subject to rapidtechnological change and we may not be able to keep pace with evolving industrystandards or end-user requirements****.*  The markets for our products arerelatively new and are characterized by rapid technological change, evolvingindustry standards, changes in end-user requirements and frequent new productintroductions and enhancements.  Our future success will depend upon ourability to enhance our current products and to develop and introduce newproducts that keep pace with technological developments and respond to evolvingend-user requirements.  There can be no assurance that we will besuccessful in developing and marketing new products or product enhancements ona timely basis, or that new products or product enhancements developed by us,such as our AccuRoute, Genidocs and Genifax products, will achieve marketacceptance.  The introduction of products embodying new technologies andthe emergence of new industry standards could render our existing productsobsolete and unmarketable.  From time to time, we and our competitors mayannounce new products, capabilities or technologies that have the potential toreplace or shorten the life cycle of our existing product offerings. There can be no assurance that announcements of new product offerings by us orour competitors will not cause customers to defer or forego the licensing ofour existing or planned products and have a material adverse effect on ourbusiness, financial condition and results of operations.

 

***The market for secure business-to-business document exchangesolutions is new and evolving rapidly and there can be no assurance that ourproducts will be successful in this market****.*  The market for Genidocs, oursecure business-to-business electronic document exchange solution is relativelynew and evolving rapidly.  Our success will depend upon the extent andtiming of adoption and use by current and potential customers of securebusiness-to-business electronic document exchange solutions.  Our successwill also depend upon acceptance of our technology as the standard forproviding these solutions.  The adoption and use of our securebusiness-to-business electronic document exchange solution will involve changesin the manner in which businesses have traditionally exchangedinformation.  Our ability to influence usage of our securebusiness-to-business electronic document exchange solution by customers islimited.  We intend to spend resources educating potential customers aboutthe value of secure business-to-business electronic document exchangesolutions.  It is difficult to assess or to predict with any assurance thepresent and future size of the potential market for our securebusiness-to-business electronic document exchange solution, or the growth rate,if any, for this market.  Moreover, we cannot predict whether our securebusiness-to-business electronic document exchange solution will achieve anymarket acceptance.  Sales of Genidocs, our client/server messaging application,were less than 2% of our total software revenue in the first six months of eachof 2004 and 2005.  If any of our future products or future productenhancements are not favorably received by our customers, we may be less or notprofitable and we may therefore suffer damage to our reputation or brand name.

 

***Were we to suffer an unexpectedly large decline in ourlegacy fax business, our results of operations would be significantly impairedand we might incur an operating loss****.*  We currently derive a significantthough declining portion of our revenues from licenses of our Genifax productand related services and resale of related hardware. However, sales of Genifax,our multi-tiered client/server software for automating and integrating faxcommunications throughout an enterprise, were lower in 2004 than they were in2003, a trend that continued in the first six months of 2005. Though we expectour sales of our legacy fax products to continue to decline in 2005, anunexpectedly large decline in the market acceptance of our Genifax productwould have a negative impact on our future success. As a result, anyunexpectedly large decline in demand for or failure to maintain expected marketacceptance of the Genifax product line as a result of competition, technologicalchange or otherwise, would have a material adverse effect on our business,financial condition and results of operations. Our future financial performancewill depend in part on new and enhanced versions of the Genifax product. Therecan be no assurance that we will continue to be successful in marketing theGenifax product or any new or enhanced versions of the Genifax product atexpected levels.  There can be no assurance that we will be successful indeveloping products for new or enhanced operating systems such as Windows 2000or Windows XP, or that these systems will not obviate the need for ourproducts. If any new or enhanced operating system gains widespread use and wefail to develop and provide our products for this operating system on a timelybasis, our business, financial condition and results of operations could bematerially adversely affected.

 

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***We depend on the revenues generated by sales of ourAccuRoute product and would be negatively impacted if market interest – whetherin the legal vertical market that we have already targeted or the finance andhealthcare vertical markets that we are now beginning to target – were todecline or fail to grow as expected****.*  We currently derive a significantportion of our revenues from licenses of our AccuRoute product and relatedservices. Sales of AccuRoute were higher in 2004 than they were in 2003, atrend that continued during the first six months of  2005. Continued market acceptance of our AccuRouteproduct is critical to our future success. As a result, any decline in demandfor or failure to maintain broad market acceptance of our AccuRoute productline as a result of competition, technological change or otherwise would have amaterial adverse effect on our business, financial condition and results ofoperations. Our future financial performance will depend in large part on newand enhanced versions of our AccuRoute product. There can be no assurance thatwe will continue to be successful in marketing our AccuRoute product in thelegal vertical market or that our marketing efforts in the finance andhealthcare vertical markets will be successful.  Further, there can be noassurance that any new or enhanced versions of our AccuRoute product will besuccessful.

 

***We have historically depended on our sales of fax productsto generate revenue and could face a decline in overall revenues if thedeclines we face in this market are larger than expected***.Our enterprise client/server facsimile software products are intended to helporganizations efficiently manage their facsimile communications, utilizing aclient/server computing environment.  There can be no assurance thatorganizations will move away from the use of stand-alone fax machines or continueto adopt client/server environments, or that those of our customers who havebegun the migration to a client/server environment will broadly implement thismodel of computing.  Our future financial performance will depend in largepart on our ability to capture an expected portion of the market forclient/server applications.  The size of this market will depend in parton the growth in the number of organizations implementing client/servercomputing environments.  There can be no assurance that these markets willcontinue to grow or that we will be able to capture sales to or respondeffectively to the evolving requirements of these markets.  If the marketfor client/server application products and services does not grow in thefuture, grows more slowly than we anticipate, or if we fail to respondeffectively to evolving requirements of this market, our business, financialcondition and results of operations could be materially adversely affected.

 

***Our common stock is listed on the Nasdaq SmallCap Market andany failure to maintain that listing could significantly impair our stock priceand our ability to raise future capital.***  In August2002, the Nasdaq National Market (“Nasdaq”) informed us that our common stockhad traded for 30 consecutive trading days below Nasdaq’s minimum bid price andthat we had until November 4, 2002, to demonstrate compliance with Nasdaq’slisting requirements by maintaining a bid price for our common stock of atleast $1.00 for a minimum of ten consecutive trading days.  We did notregain compliance and on October 29, 2002, we applied to transfer from theNasdaq National Market to the Nasdaq SmallCap Market.  On November 26,2002, we transferred to the Nasdaq SmallCap Market and we were afforded theremainder of this market’s 180 calendar day grace period, or until February 3,2003, to regain compliance with the minimum bid price per sharerequirement.  On January 14, 2003, our Board of Directors andstockholders, at a special meeting, approved an amendment to our certificate ofincorporation to effect a one-for-seven reverse stock split.  On February5, 2003, Nasdaq notified us that we had regained compliance with the NasdaqSmallCap Market’s listing standards.  In addition, we cannot predict ourability to maintain our listing in the future on the Nasdaq SmallCapMarket.  The delisting of our common stock from the Nasdaq SmallCapMarket, if that were to occur, could materially impair stockholders’ ability tobuy and sell shares of our common stock and could have an adverse effect on themarket price of, and the efficiency of the trading market for, our commonstock.  Furthermore, the delisting of our common stock could significantlyimpair our ability to raise capital should we desire to do so in the future.

 

***The markets in which we sell our products are characterizedby intense and growing competition and our future success is dependent on ourability to distinguish our products from those of our competitors and reach ourtarget customers****.* In the distributed document capture and delivery market where our AccuRoutesoftware competes, we are likely to see competitive products being offered byhardware vendors such as Xerox, Canon, Ricoh, Lexmark and others.  In somecases these products are the result of partnerships with U.S.-based softwarecompanies.  We also expect competition in this market from a number ofindependent software vendors whose business focus was initially the high volumeproduction scanning segment such as Kofax and Captiva, or forms management andprocess routing companies such as Cardiff.  e-Copy, a former Omtoolbusiness partner, has formed a relationship with Canon and has embedded theirdocument capture and routing capabilities into the front panel of the CanonImageRunner Multifunction Printer (“MFP”) device.  Other potentialsoftware competitors include ScanSoft, as well as document management vendorslike Hummingbird and Interwoven/iManage who are seeking to develop, eitherthrough partnerships or internal resources, scan-to-archive capabilities usingstandard e-mail as the transport and a generic document profile as a means ofentering the content into their repository.  We believe that our abilityto compete successfully in the distributed document capture and delivery marketdepends upon a number of factors both within and beyond our control includingproduct performance; reliability and features; ease of use; productscalability; quality of support services; price/performance; timeliness ofenhancements and new product releases by us and our competitors.  Weexpect this market to mature and become increasingly competitive with successresulting from the formation of critical partnerships and alliances with bothselected hardware and software partners.

 

The market forclient/server computer-based facsimile solutions is also competitive and ismore established and mature than the markets in which the AccuRoute andGenidocs products compete.  We believe that our ability to competesuccessfully in the fax

 

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market depends upon a number of factors both within and beyond ourcontrol including product performance; reliability and features; ease of use;product scalability; quality of support services; price/performance; timelinessof enhancements and new product releases by us and our competitors.  Giventhese factors, we believe that in order to be successful, we must continue ourfocus on delivering a core, modular and scalable product on one of the mostprolific system platforms, Windows 2000/2003®, with features that appeal to thebroadest segment of the electronic document exchange market, which includes faxand all of the other document control and management features that we offer.

 

We competedirectly with a number of vendors of facsimile products, including providers offacsimile software products for client/server networks such asCaptaris/RightFax, Dicom/TopCall and Biscom.  We also compete withproviders offering a range of alternative facsimile solutions includingoutsourcing network facsimile solutions, such as Easylink Services and Xpedite;operating systems containing facsimile and document e-mail features; low-endfax modem products; providers of desktop fax software; single-platformfacsimile software products; and customized proprietary software solutions. In addition, providers of operating systems or business software applicationsmay bundle competitive facsimile solutions as part of their broader productofferings.

 

In the intenselycompetitive and rapidly changing business-to-business secure document exchangemarket, we compete directly with Authentica, Sigaba, Tumbleweed, and Zixit anda number of other providers.  There are also other categories oftechnology solutions that overlap and compete in certain ways with aspects ofour products.  These include:

 

•     Document management solutions from vendors such asEMC/Documentum, Hummingbird and Interwoven/iManage whose electroniccollaboration solutions compete with certain aspects of our solutions;

 

•      Electronic forms and electronicsignature solutions from vendors such as Adobe, PureEdge, Silanis that offerthe creation of electronic documents with electronic signatures; and

 

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

 

We expect the level of competition in the business-to-business securedocument exchange market to increase over time.

 

Many of ourcompetitors and potential competitors have longer operating histories andgreater financial, technical, sales, marketing and other resources, as well asgreater name recognition and market acceptance of their products andtechnologies than we do. In addition, there are relatively low barriers toentry in the markets in which we operate and intend to operate, and newcompetition may arise either from expansion by established companies or fromnew emerging companies or from resellers of our products. There can be noassurance that our current or potential competitors will not develop productscomparable or superior — in terms of price and performance features — to thosedeveloped by us.  Further, our competitors may adapt more quickly than wedo to new or emerging technologies and changes in market opportunities orcustomer requirements, establish alliances with industry leaders or takeadvantage of acquisition opportunities more readily than we can or do. Inaddition, no assurance can be given that we will not be required to makesubstantial additional investments in connection with our research,development, engineering, marketing, sales and customer service efforts inorder to meet any competitive threat, or that those required investments willnot have a material adverse effect on our operating margins.  Changes ingoverning laws and regulations may also affect our ability to remaincompetitive.  Increased competition may result in reduction in marketshare, pressure for price reductions and related reductions in gross margins,any of which could materially adversely affect our ability to achieve ourfinancial and business goals. There can be no assurance that, in the future, wewill be able to successfully compete against current and future competitors.

 

***Our business is subject to seasonality and fluctuations on aquarterly and annual basis due to the long sales cycle for our products andnumerous other factors and, therefore, our results may vary fromquarter-to-quarter and year-to-year****.* Our quarterly revenues and results ofoperations have fluctuated significantly in the past and will likely continueto fluctuate significantly in the future. Causes of these fluctuations haveincluded and may include, among others: the demand for our products andservices; the size and timing of orders; the number, timing and significance ofnew product announcements by us and our competitors; our ability to develop,introduce, market and ship new and enhanced versions of our current and plannedproducts on a timely basis; the level of product and price competition; changesin operating expenses; changes in average selling prices and mix of ourproducts; changes in our sales incentive strategy; the mix of direct andindirect sales; and general economic factors, including factors affecting theoverall U.S. economy and the demand for enterprise information technologysolutions. In addition, the sale of our products often involves delays becausecustomers tend to implement the products they purchase from us on a largescale, requiring them first to establish certain minimum hardware capabilities.Our products therefore often have a lengthy sales cycle while potentialcustomers evaluate and receive approvals for the purchase of our products.During these sales cycles, we may expend substantial funds and managementefforts, yet receive no revenues. It is difficult to accurately predict thesales cycle of any large order. If one or more large orders fail to close asforecasted in a fiscal quarter, our revenues and operating results for thatquarter could be materially adversely affected. Any one or more of these or otherfactors could have a material adverse effect on our business, financialcondition and results of

 

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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 thesepredictions unreliable.

 

In addition, wemay invest in research and development and marketing expenses in order topromote further our products within current or new vertical markets, includingour current plan to incur additional sales and marketing expenses as we firsttarget the finance vertical market and then, shortly thereafter, the healthcaremarket with our AccuRoute product.  Because we must make these investmentsin advance of related market acceptance of and revenue from our AccuRouteproduct in those vertical markets, any failure of our products to achieveplanned levels of acceptance would have a material adverse effect on ourbusiness, financial condition and results of operations on a quarter-to-quarterbasis and overall.

 

In general, it is difficultfor us to forecast revenues because the market for secure business-to-businesselectronic document exchange, enterprise client/server facsimile solutionssoftware and routing and distribution software is evolving rapidly and oursales cycle – from the customer’s initial evaluation through purchase oflicenses and the related support services – varies substantially from customerto customer. License fee revenues in any quarter depend on orders received andshipped in that quarter, with a significant percentage of orders in any quarterarriving in the last weeks of the quarter.  License fee revenues fromquarter to quarter are difficult to forecast, as no significant order backlogexists at the end of any quarter because our products typically are shippedupon receipt of customers’ orders.

 

A substantialportion of our operating expense is related to personnel, facilities, equipmentand marketing programs. The level of spending for these expenses cannot beadjusted quickly and is therefore fixed in the short term. Our expense levelsfor personnel, facilities, equipment and marketing programs are based, insignificant part, on our expectations of future revenues on a quarterly basis.If actual revenue levels on a quarterly basis are below our expectations, our resultsof operations are likely to be adversely affected by a similar amount because arelatively small amount of our expense varies with our revenue in the shortterm.

 

Due to all of theforegoing factors, it is likely that in some future periods our results ofoperations will be below the expectations of securities analysts and investors.In such event, the price of our common stock would likely be materiallyadversely affected.

 

***In addition to direct sales, we utilize indirect sales anddistribution channels and strategic alliances with compatible partners in orderto broaden sales of our products.  Anyfailure on our part to form and leverage relationships with these indirectsales and distribution channel partners could have a material adverse affect onour business and results of operations****.*  We market our products andservices directly through telesales and indirectly through marketing channelssuch as value added resellers (“VARs”), systems integrators, distributors andstrategic business partners. Although we have historically focused our effortson marketing through our sales force, we continue to utilize resources todevelop and expand indirect marketing channels. There can be no assurance thatwe will be able to attract and retain a sufficient number of qualified VARs,systems integrators, distributors and strategic business partners, or thatthose third parties will successfully market our products. In addition, therecan be no assurance that our resellers and strategic business partners will notdevelop, acquire or market computer-based electronic document exchange,document routing and distribution and facsimile products that are competitivewith our products. The failure to retain our VARs, systems integrators,distributors and strategic partners could have a material adverse effect on ourbusiness, financial condition and results of operations.

 

The distributoragreements governing our relationships with third party distribution chainpartners generally provide that either party may terminate the agreementwithout cause upon 30 days written notice to the other party.  Wealso resell our products on a purchase order basis through other VARs, systemsintegrators and distributors.  Generally, in those situations, eitherparty may terminate the relationship at any time, and therefore there can be noassurance that any VAR, systems integrator or distributor will continue torepresent and sell our products.  Furthermore, our strategic alliancesgenerally may be terminated by either party, at any time; there can thereforebe no assurances that these strategic alliances will continue.  Theinability to retain certain VARs, systems integrators, distributors orstrategic business partners, or the development or marketing by VARs,systems integrators, distributors or strategic business partners of competitiveofferings, could have a material adverse effect on our business, financialcondition and results of operations.

 

Selling throughindirect channels may limit our contacts with our customers, thereby hindering ourability to accurately forecast sales, evaluate customer satisfaction andrecognize emerging customer requirements. Our strategy of marketing ourproducts directly to end-users and indirectly through VARs, systems integratorsand distributors may result in distribution channel conflicts. Our direct salesefforts may compete with those of our indirect channels and, to the extentdifferent resellers target the same customers, resellers may also come intoconflict with each other. As we strive to expand our indirect distributionchannels, there can be no assurance that emerging channel conflicts will notmaterially adversely affect our relationships with existing VARs, systemsintegrators or distributors or adversely affect our ability to attract newVARs, systems integrators and distributors.

 

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***The success of our business is dependent on our ability toexpand our sales internationally, which will subject us to regulatory, exchangerate and other risks that might hinder our ability to meet our targets forinternational sales and might impair our results of operation****.*  An element of our strategy is toincrease our international sales.  We expect to face competition fromsecure business-to-business electronic document exchange solutions and localfacsimile product providers in their native countries.  To successfullymaintain international sales, we need to recruit and retain additionalinternational resellers and distributors.  There can be no assurance thatwe will be able to maintain international sales of our products or that ourinternational distribution channels will be able to adequately market, serviceand support our products.  International operations generally are subjectto certain risks, including dependence on independent resellers, fluctuationsin foreign currency exchange rates, compliance with foreign regulatory andmarket requirements, variability of foreign economic conditions and changingrestrictions imposed by United States export laws.  Additional risksinherent in our international business activities generally include unexpectedchanges in regulatory requirements, tariffs and other trade barriers, costs oflocalizing products for foreign countries, lack of acceptance of localizedproducts in foreign countries, longer accounts receivable payment cycles,difficulties in managing international operations, difficulties in enforcingintellectual property rights and the burdens of complying with a wide varietyof foreign laws.

 

We currently havea sales office in the United Kingdom.  Our non-United States presencesubjects us to certain additional risks including difficulties in staffing andmanaging these foreign operations and potentially adverse tax consequencesincluding restrictions on the repatriation of earnings.  There can be noassurance that these factors will not have a material adverse effect on ourfuture international sales and, consequently, our business, financial conditionand results of operations.  To date, a majority of our sales have beenmade in United States dollars and we have not engaged in any hedgingtransactions through the purchase of derivative securities orotherwise. Our United Kingdom subsidiary transacts business primarily inits local currency.  We translate our United Kingdom subsidiary’soperating results into U.S. dollars and consolidate them with our domesticresults for reporting purposes.  As we make sales to customers in avariety of countries, significant currency exchange rate fluctuations couldhave a material impact on our results of operations.

 

***Given the nature of our business, we may not be able toobtain sufficient or attractive financing, should that become necessary****.** ***We expect that our current cash, cash equivalents and investments will meet ournormal working capital and capital expenditure needs for at least the nexttwelve months.  We may, however, need to raise additional funding at thattime or earlier if we decide to undertake more rapid expansion, includingacquisitions of complementary products or technologies, or if we increase ourmarketing and/or research and development efforts in order to respond tocompetitive pressures.  We cannot be certain that we will be able toobtain additional financing on favorable terms, if at all.  We may obtainadditional financing by issuing shares of our common stock, which could diluteour existing stockholders.  If we cannot raise needed funds on acceptableterms, or at all, we may not be able to develop or enhance our products orrespond appropriately to competitive pressures, which would seriously harm ourbusiness.

 

***We may not successfully complete acquisitions or integrateacquisitions we do make, which could impair our ability to compete and couldharm our operating results.***  We may augment ourinternal growth with acquisitions of businesses, products and technologies thatcould complement or expand our business.  Certain of these businesses maybe only marginally profitable or even unprofitable.  In order to achieveanticipated benefits from these acquisitions, we will have to successfullyintegrate the acquired businesses with our existing operations.  We cannot assure you that we will besuccessful in this regard.  We have limited experience in integratingacquired companies into our operations, in expanding the scope of operations ofrequired businesses, in managing geographically dispersed operations and inoperating internationally.  In the past, we have incurred one-time costsand expenses in connection with acquisitions and it is likely that we couldincur similar one-time costs and expenses in connection with futureacquisitions.  In addition, we might be required to amortize significantintangible assets in connection with future acquisitions, which could adverselyaffect our operating results.  Further, attractive acquisitions aredifficult to identify and complete for a number of reasons, includingcompetition among prospective buyers and the possible need to obtain regulatoryapproval.  There can be no assurance that we will be able to completefuture acquisitions.  In order to finance potential future acquisitions,we may need to raise additional funds either through public or privatefinancings, including bank borrowings.  Any financing, if available atall, may be on terms that are not favorable to us.  Finally, we may alsoissue shares of our common stock to acquire attractive businesses, which maydilute our existing stockholders.

 

***Our future success depends on our ability to manage thegrowth and expansion of our business.***  We may expandour operations as we anticipate that expansion may be required in order toaddress potential market opportunities.  We may also increase

the size of our sales and marketing and research and developmentexpenditures as necessary.  There can be no assurance that we will be ableto complete this expansion successfully or that the expansion would generatesufficient revenues to cover our expenses.  We will need to continue toattract and retain highly qualified technical, sales and managerialpersonnel.  There can be no assurance that we will be able to retain orcontinue to hire this kind of personnel in the future or to retain this kind ofpersonnel in a sufficiently timely manner.  Our inability to effectivelyexpand operations and manage growth, if any, could have a material adverseeffect on our business, financial condition and results of operations.

 

***The effectiveness of our disclosure controls and proceduresand internal control over financial reporting may be limited.*** Pursuant to the requirements of the Sarbanes-Oxley Act of 2002, we mustmaintain and enhance our internal control over financial reporting. Presently, we are not an “accelerated filer” as that term is defined in theSecurities Act.  As a result, we are not required to

 

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deliver a report regarding our determination of the effectiveness ofour internal control over financial reporting until we file our annual reporton Form 10-K for the fiscal year ending December 31, 2006. Further, underSection 404 of Sarbanes-Oxley, in connection with our annual report on Form10-K for the fiscal year ending December 31, 2006, our independent registeredpublic accounting firm will be required to deliver an attestation reportregarding management’s assessment of the effectiveness of our internal controlover financial reporting.  As a result, during the fiscal years endingDecember 31, 2005 and 2006, our management will expend considerable time,attention and resources to determining the strength and effectiveness of our internalcontrol over financial reporting and, where appropriate, making improvements.

 

Our disclosurecontrols and procedures and internal control over financial reporting may notprevent all errors and intentional misrepresentations.  Any system ofinternal controls can only provide reasonable assurance that all controlobjectives have been and will continue to be met.  Some of the potentialrisks involved could include, without limitation, management judgments, simpleerrors or mistakes, willful misconduct regarding controls ormisinterpretation.  Though we believe that our disclosure controls andprocedures and internal control over financial reporting are effective, therecan be no guarantee that existing controls and procedures will prevent ordetect all material issues, errors or intentional misrepresentations. Further, our existing controls may not be effective in future situations. Any failure of our disclosure controls and procedures or internal control overfinancial reporting could have a material impact on our financial condition andresults of operation.  Our assessment of our internal control overfinancial reporting may identify weaknesses in our internal control overfinancial reporting that we need to remedy or may raise other issues of concernfor our investors.  Should we determine that a material weakness exists inour internal control over financial reporting, the price of our common stockmight decline.

 

***Our reliance on a sole hardware supplier could adverselyimpact our business****. *Wecurrently purchase hardware products for sale to our customers from a singlethird-party supplier.  We do not have a long-term, fixed-price or minimumvolume contract with this supplier.  Instead, we order hardware equipmentthrough purchase orders from time to time. We do not carry significantinventories of these hardware products and do not have a guaranteed supplyarrangement with this supplier.  Although we believe that we could securethese hardware products from alternative suppliers, in the event of adisruption of supply from this sole supplier, we might not be able to developan alternative source in a timely manner or at favorable prices.  Even ifwe were able to purchase these hardware components from alternative sources, wewould have little control over the costs of these products.  Were weforced to pay significantly higher prices for these hardware products, it mightlimit the mark-up over the price paid by us that we can reasonably charge ourcustomers.  Were we unable to provide this hardware to our customers,forcing our customers to buy this hardware directly from third parties, or werewe forced to decrease the size of our mark-up, our hardware and total revenueswould be negatively impacted.

 

***We may face additional expenses and disruption due to theupcoming expiration of the lease on our headquarters space, especially if weelect to relocate.***  We lease office space, used asour headquarters and primary business location, at 8A Industrial Way in Salem,New Hampshire.  Our current lease terminates on December 31, 2005. As a result, we have engaged a real estate agent to assist us in consideringour options.  At this time, we have not determined whether we will be ableto renew our lease at our present location on sufficiently favorable terms orwhether we will instead lease a new facility and relocate.  The process ofevaluating options and negotiating a new or renewed lease will require time andattention from members of our management.  Further, if we elect torelocate our operations to a new location, we will incur related expenses andwill encounter disruption of operations related to the move, all of which couldhave a material adverse effect on our financial condition and results ofoperation.

 

***We are dependent on our key personnel and any inability toretain or hire key personnel could impact our business and results ofoperations****.* Our future performance depends, in significant part, upon the continued serviceof our key technical, sales and senior management personnel, most of whom arenot bound by employment agreements or noncompetition agreements.  The lossof the services of one or more of our executive officers or other key employeescould have a material adverse effect on our business, financial condition andresults of operations.  Our future success also depends on our continuingability to attract and retain highly qualified technical, sales and managerialpersonnel, particularly in light of our expanded AccuRoute sales and marketingstrategy.

Competition for highly qualified personnel is intense and we havehistorically experienced difficulty in recruiting qualified technicalpersonnel.  There can be no assurance that we will be able to retain orcontinue to hire key technical, sales and managerial personnel in the future.

 

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

 

*DerivativeFinancial Instruments, Other Financial Instruments, and Derivative CommodityInstruments.*** **As of June 30 , 2005, 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,*Disclosures about Fair Value of FinancialInstruments*. All of the Company’s investments consist of moneymarket funds and commercial paper that are carried on the Company’s books atamortized cost, which approximates fair market value. Accordingly, the Companyhas no quantitative information concerning the market risk of participating insuch investments.

 

*PrimaryMarket Risk Exposure*s.* *The Company’s primary market risk exposures are in the areas of interest raterisk and

 

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foreign currency exchange rate risk. The Company’s investment portfolioof cash equivalents is subject to interest rate fluctuations, but the Companybelieves this risk is immaterial due to the short-term nature of theseinvestments. The Company’s exposure to currency exchange rate fluctuations hasbeen and is expected to continue to be modest due to the fact that theoperations of its United Kingdom subsidiary are almost exclusively conducted inits local currency. The United Kingdom subsidiary’s operating results aretranslated into U.S. dollars and consolidated for reporting purposes. Theimpact of currency exchange rate movements on intercompany transactions wasimmaterial for the quarter ended June , 2005. The Company manages its foreigncurrency exchange risk by monitoring its net monetary position using naturalhedges of its assets and liabilities denominated in local currencies. There can be no assurance that this approach will eliminate all foreigncurrency exchange rate exposure. Currently, the Company does not engage inforeign currency hedging activities.

 

**Item 4. Controls and Procedures**

 

As of the end ofthe fiscal quarter (the “Evaluation Date”), the Company, under the supervisionand with the participation of the Company’s management, including the Company’sChief Executive Officer and Chief Financial Officer, evaluated theeffectiveness of the Company’s disclosure controls and procedures pursuant toRule 13a-15(b) and 15d-15(b) promulgated under the Securities Exchange Act of1934, as amended (the “Exchange Act”).  Based upon that evaluation, theCompany’s Chief Executive Officer and Chief Financial Officer concluded that,as of the Evaluation Date, the Company’s disclosure controls and procedures areeffective in ensuring that information relating to the Company (including itsconsolidated subsidiaries) required to be disclosed by the Company in thereports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms, including ensuring that such information is accumulated andcommunicated to the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure.

 

There was nochange in the Company’s internal control over financial reporting during theCompany’s last fiscal quarter that has materially affected, or is reasonablylikely to materially affect, the Company’s internal control over financialreporting.

 

**PART II:  OTHER INFORMATION**

 

Item 4.  Submission of Matters toa Vote of Security Holders.

 

We held our Annual Meeting of Stockholders on Tuesday,May 24, 2005 at our offices at 8A Industrial Way, Salem, New Hampshire.  The only matters voted upon were theelections of Arnold E. Ditri and James O’Halloran as Class II directors of theCompany.  The tabulation with respect toeach nominee is as set forth below:

 
| **Nominee**           | ** ** | **Number of  Votes For** | ** ** | **Number of Votes  Withheld** | ** ** | **Number of  Abstentions** | ** ** | **Number of  Broker non-  votes** | ** ** |
|-----------------------|------------|--------------------------|------------|-------------------------------|------------|----------------------------|------------|-----------------------------------|------------|
| Arnold E. Ditri       |       | 3,305,343                |       | 9,340                         |       | N/A                        |       | 0                                 |       |
| James O’Halloran |       | 3,305,343                |       | 9,340                         |       | N/A                        |       | 0                                 |       |

 

Item 5.    Other Information

 

There have been no changes to the procedures by which security holdersmay recommend nominees to the Company’s Board of Directors during the timeperiod covered by this Quarterly Report on Form 10-Q.

 

Item 6.     Exhibits

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

 

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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. |
|---------------|--------------|
|          |         |
|          |         |
| July 28, 2005 | By:          | /s/ Daniel A. Coccoluto |   |
|          |         | Daniel A. Coccoluto |
|          |         | Chief Financial Officer, Secretary and Treasurer |
|          |         | (Duly authorized officer and principal financial  officer) |

 

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**ExhibitIndex**

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

 

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