**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-Q**

 

|                                                    | **(Mark  One)**                                                                                                                                                                |   |
|---------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                    |                                                                                                                                                                           |   |
|                                                    | **ý**                                                                                                                                                                     |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF  1934** |   |
|                                                    |                                                                                                                                                                           |   |
|                                                    | **For  the quarterly period ended March 31, 2004**                                                                                                                             |   |
|                                                    |                                                                                                                                                                           |   |
|                                                    | **OR**                                                                                                                                                                         |   |
|                                                    |                                                                                                                                                                           |   |
|                                                    | **o**                                                                                                                                                                          |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |   |
|                                                    |                                                                                                                                                                           |   |
|                                                    | **For  the transition period from              to             ** |   |
|                                                    |                                                                                                                                                                           |   |
|                                                    | **Commission  File Number 0-22871**                                                                                                                                            |   |
|                                                    |                                                                                                                                                                           |   |
| **OMTOOL,  LTD.**                                       |
| (Exact Name of  Registrant as Specified in Its Charter) |
|                                                    |
|                                                    | **Delaware**                                                                                                                                                                   |   | **02-0447481** |   |
|                                                    | (State or Other  Jurisdiction of  Incorporation or Organization)                                                                                                               |   | (I.R.S. Employer  Identification Number) |   |
|                                                    |                                                                                                                                                                           |   |   |   |
|                                                    | **8A Industrial Way, Salem, NH**                                                                                                                                               |   | **03079** |   |
|                                                    | (Address of Principal  Executive Offices)                                                                                                                                      |   | (Zip Code) |   |
|                                                    |                                                                                                                                                                           |   |   |   |
|                                                    | **(603) 898-8900**                                                                                                                                                             |   |
|                                                    | (Registrant’s Telephone  Number Including Area Code)                                                                                                                      |   |
|                                                         |                                                                                                                                                                                |        |  |  |  |  |

 

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

 

Yes   ý   No   o

 

Indicate by check mark whether the Registrant is anaccelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of1934).

 

Yes   o   No   ý

 

There were 3,840,592 shares of the Company’s CommonStock, par value $0.01, outstanding on May 12, 2004.

 

 

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**OMTOOL, LTD. ANDSUBSIDIARIES**

 

FORM 10-Q

For the Quarter Ended March 31, 2004

CONTENTS

 
| **Item Number**               |                                                                                                  |   |
|-------------------------------|-------------------------------------------------------------------------------------------------------|--------|
|                          |                                                                                                  |   |
| PART I: FINANCIAL INFORMATION |                                                                                                  |   |
|                          |                                                                                                  |   |
| Item 1.                       | Consolidated Financial Statements                                                                     |   |   |
|                          | Consolidated Balance Sheets as of March 31, 2004 (Unaudited) and  December 31, 2003                   |   |   |
|                          | Consolidated Statements of Operations for  the three months ended March 31, 2004 and 2003 (Unaudited) |   |   |
|                          | Consolidated Statements of Cash Flows for  the three months ended March 31, 2004 and 2003 (Unaudited) |   |   |
|                          | Notes to Consolidated Financial Statements                                                            |   |   |
|                          |                                                                                                  |   |   |
| Item 2.                       | Management’s Discussion and Analysis of  Financial Condition and Results of Operations           |   |   |
|                          |                                                                                                  |   |   |
| Item 3.                       | Quantitative and Qualitative Disclosures  About Market Risk                                           |   |   |
|                          |                                                                                                  |   |   |
| Item 4.                       | Controls and Procedures                                                                               |   |   |
|                          |                                                                                                  |   |
| PART II: OTHER INFORMATION    |                                                                                                  |   |
|                          |                                                                                                  |   |
| Item 2.                       | Changes in Securities, use of Proceeds and  Issuer Purchases of Equity Securities                     |   |   |
|                          |                                                                                                  |   |
| Item 6.                       | Exhibits and Reports on Form 8-K                                                                      |   |   |
|                          |                                                                                                  |   |
| Signatures                    |                                                                                                  |   |

 

2

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**PART I:  FINANCIALINFORMATION**

Item 1.  Consolidated Financial Statements

 

**OMTOOL, LTD. ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                                                                                                                                                     |   | **March 31,  2004** |       | **December  31,  2003** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|-------------------------|--------|
|                                                                                                                                                                                                                                                                     |   | **(Unaudited)**     |       |                    |   |
| **ASSETS**                                                                                                                                                                                                                                                               |   |                |       |                    |   |
| Current assets:                                                                                                                                                                                                                                                          |   |                |       |                    |   |
| Cash and cash equivalents                                                                                                                                                                                                                                                |   | $                   | 9,948,312  |                    | $      | 8,242,067 |   |
| Accounts receivable, less reserves of  $212,000 at March 31, 2004 and $367,000 at December 31, 2003                                                                                                                                                                      |   | 1,780,250           |       | 1,535,540               |   |
| Inventories, net                                                                                                                                                                                                                                                         |   | 27,501              |       | 37,632                  |   |
| Prepaid expenses and other current assets                                                                                                                                                                                                                                |   | 327,828             |       | 268,112                 |   |
| Total current assets                                                                                                                                                                                                                                                     |   | 12,083,891          |       | 10,083,351              |   |
| Property and equipment, net                                                                                                                                                                                                                                              |   | 329,877             |       | 394,623                 |   |
| Other assets                                                                                                                                                                                                                                                             |   | 13,962              |       | 13,962                  |   |
| Total assets                                                                                                                                                                                                                                                             |   | $                   | 12,427,730 |                    | $      | 10,491,936 |   |
|                                                                                                                                                                                                                                                                     |   |                |       |                    |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                            |   |                |       |                    |   |
| Current liabilities:                                                                                                                                                                                                                                                     |   |                |       |                    |   |
| Accounts payable                                                                                                                                                                                                                                                         |   | $                   | 918,769    |                    | $      | 883,583 |   |
| Accrued liabilities                                                                                                                                                                                                                                                      |   | 1,336,662           |       | 1,202,359               |   |
| Accrued restructuring                                                                                                                                                                                                                                                    |   | 300,057             |       | 443,830                 |   |
| Accrued state sales tax                                                                                                                                                                                                                                                  |   | 1,034,176           |       | 1,010,496               |   |
| Deferred revenue                                                                                                                                                                                                                                                         |   | 3,301,802           |       | 3,306,474               |   |
| Total current liabilities                                                                                                                                                                                                                                                |   | 6,891,466           |       | 6,846,742               |   |
| Long term liabilities:                                                                                                                                                                                                                                                   |   |                |       |                    |   |
| Deferred revenue, long-term                                                                                                                                                                                                                                              |   | 180,865             |       | 205,967                 |   |
| Total liabilities                                                                                                                                                                                                                                                        |   | 7,072,331           |       | 7,052,709               |   |
|                                                                                                                                                                                                                                                                     |   |                |       |                    |   |
| Stockholders’ equity:                                                                                                                                                                                                                                               |   |                |       |                    |   |
| Preferred Stock, $.01 par value —  Authorized — 2,000,000 shares; Issued and outstanding — none                                                                                                                                                           |   | —              |       | —                  |   |
| Common Stock, $.01 par value —  Authorized — 35,000,000 shares; Issued — 4,367,878 shares at March 31, 2004  and 3,716,878 at December 31, 2003, Outstanding — 3,816,092 and 3,500,500  shares at March 31, 2004 and December 31, 2003, respectively |   | 43,678              |       | 37,169                  |   |
| Additional paid-in capital                                                                                                                                                                                                                                               |   | 35,395,259          |       | 31,936,038              |   |
| Accumulated deficit                                                                                                                                                                                                                                                      |   | (27,237,844         | )          | (27,617,599             | )      |
| Treasury stock, at cost  (551,786 shares at March 31, 2004 and  216,378 shares at December 31, 2003)                                                                                                                                                                |   | (2,831,257          | )          | (877,934                | )      |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                     |   | (14,437             | )          | (38,447                 | )      |
| Total stockholders’ equity                                                                                                                                                                                                                                          |   | 5,355,399           |       | 3,439,227               |   |
|                                                                                                                                                                                                                                                                     |   |                |       |                    |   |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                          |   | $                   | 12,427,730 |                    | $      | 10,491,936 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

3

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**OMTOOL, LTD. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(Unaudited)

 
|                                                  |   | **Three  months ended  March 31,** |      |
|-------------------------------------------------------|--------|------------------------------------|-----------|
|                                                  |   | **2004**                           |      | **2003** |   |
| Revenues:                                             |   |                               |      |   |   |
| Software license                                      |   | $                                  | 1,171,898 |   | $ | 877,491 |   |
| Hardware                                              |   | 1,167,551                          |      | 506,208 |   |
| Service and other                                     |   | 1,688,629                          |      | 1,598,456 |   |
|                                                  |   |                               |      |   |   |
| Total revenues                                        |   | 4,028,078                          |      | 2,982,155 |   |
|                                                  |   |                               |      |   |   |
| Cost of revenues:                                     |   |                               |      |   |   |
| Software license                                      |   | 31,525                             |      | 54,035 |   |
| Hardware                                              |   | 674,243                            |      | 348,190 |   |
| Service and other                                     |   | 747,227                            |      | 791,754 |   |
|                                                  |   |                               |      |   |   |
| Total cost of revenues                                |   | 1,452,995                          |      | 1,193,979 |   |
|                                                  |   |                               |      |   |   |
| Gross profit                                          |   | 2,575,083                          |      | 1,788,176 |   |
|                                                  |   |                               |      |   |   |
| Operating expenses:                                   |   |                               |      |   |   |
| Sales and marketing                                   |   | 1,043,287                          |      | 1,331,848 |   |
| Research and development                              |   | 471,175                            |      | 584,605 |   |
| General and administrative                            |   | 699,391                            |      | 731,800 |   |
|                                                  |   |                               |      |   |   |
| Total operating expenses                              |   | 2,213,853                          |      | 2,648,253 |   |
|                                                  |   |                               |      |   |   |
| Income (loss) from operations                         |   | 361,230                            |      | (860,077 | ) |
|                                                  |   |                               |      |   |   |
| Interest and other income, net                        |   | 37,656                             |      | 39,268 |   |
|                                                  |   |                               |      |   |   |
| Income (loss) before tax provision  (benefit)         |   | 398,886                            |      | (820,809 | ) |
|                                                  |   |                               |      |   |   |
| Tax provision (benefit)                               |   | 19,131                             |      | (155,398 | ) |
|                                                  |   |                               |      |   |   |
| Net income (loss)                                     |   | $                                  | 379,755   |   | $ | (665,411 | ) |
|                                                  |   |                               |      |   |   |
| Net income (loss) per share                           |   |                               |      |   |   |
| Basic                                                 |   | $                                  | 0.11      |   | $ | (0.19 | ) |
| Diluted                                               |   | $                                  | 0.10      |   | $ | (0.19 | ) |
|                                                  |   |                               |      |   |   |
| Weighted average number of common shares  outstanding |   |                               |      |   |   |
| Basic                                                 |   | 3,514,438                          |      | 3,491,912 |   |
| Diluted                                               |   | 3,680,185                          |      | 3,491,912 |   |

 

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

 

4

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**OMTOOL, LTD. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(Unaudited)

 
|                                                                                       |   | **Three  months ended  March 31,** |      |
|--------------------------------------------------------------------------------------------|--------|------------------------------------|-----------|
|                                                                                       |   | **2004**                           |      | **2003** |   |
| Cash Flows from Operating Activities:                                                      |   |                               |      |   |   |
| Net income (loss)                                                                          |   | $                                  | 379,755   |   | $ | (665,411 | ) |
| Adjustments to reconcile net income (loss)  to net cash used in operating activities– |   |                               |      |   |   |
| Depreciation                                                                               |   | 78,473                             |      | 113,747 |   |
| Accounts receivable reserves                                                               |   | (154,124                           | )         | (166,799 | ) |
| Changes in assets and liabilities                                                          |   |                               |      |   |   |
| Accounts receivable                                                                        |   | (65,422                            | )         | 602,816 |   |
| Prepaid expenses and other current assets                                                  |   | (53,182                            | )         | 94,381 |   |
| Inventory                                                                                  |   | 10,202                             |      | (61,064 | ) |
| Accounts payable                                                                           |   | 25,172                             |      | 82,966 |   |
| Accrued liabilities                                                                        |   | 119,524                            |      | (304,065 | ) |
| Accrued state sales tax                                                                    |   | 23,680                             |      | (365,081 | ) |
| Accrued restructuring                                                                      |   | (143,772                           | )         | — |   |
| Deferred revenue                                                                           |   | (45,845                            | )         | (50,170 | ) |
|                                                                                       |   |                               |      |   |   |
| Net cash provided by (used in) operating  activities                                       |   | 174,461                            |      | (718,680 | ) |
|                                                                                       |   |                               |      |   |   |
| Cash Flows from Investing Activities:                                                      |   |                               |      |   |   |
| Purchases of property and equipment                                                        |   | (13,237                            | )         | (123,762 | ) |
| Purchases of short-term investments                                                        |   | —                             |      | (1,999,449 | ) |
| Proceeds from sale of short-term  investments                                              |   | —                             |      | 1,597,155 |   |
|                                                                                       |   |                               |      |   |   |
| Net cash used in investing activities                                                      |   | (13,237                            | )         | (526,056 | ) |
|                                                                                       |   |                               |      |   |   |
| Cash Flows from Financing Activities:                                                      |   |                               |      |   |   |
| Net proceeds from issuance of common stock                                                 |   | 3,524,907                          |      | 2,640 |   |
| Purchase of treasury stock                                                                 |   | (2,012,500                         | )         | — |   |
|                                                                                       |   |                               |      |   |   |
| Net cash provided by financing activities                                                  |   | 1,512,407                          |      | 2,640 |   |
|                                                                                       |   |                               |      |   |   |
| Exchange rate effect on cash                                                               |   | 32,614                             |      | (41,453 | ) |
|                                                                                       |   |                               |      |   |   |
| Net increase (decrease) in cash and cash  equivalents                                      |   | 1,706,245                          |      | (1,283,549 | ) |
|                                                                                       |   |                               |      |   |   |
| Cash and cash equivalents, beginning of  period                                            |   | 8,242,067                          |      | 8,192,523 |   |
|                                                                                       |   |                               |      |   |   |
| Cash and cash equivalents, end of period                                                   |   | $                                  | 9,948,312 |   | $ | 6,908,974 |   |

 

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

 

5

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**OMTOOL, LTD. ANDSUBSIDIARIES**

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

(Unaudited)

 

**(1)     Basis of Presentation**

 

The accompanying unaudited consolidated financial statements have beenprepared by Omtool, Ltd. (the “Company” or “Omtool”) pursuant to the rules and regulationsof the Securities and Exchange Commission (“SEC”) regarding interim financialreporting.  Accordingly, they do notinclude all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements and should be read inconjunction with the consolidated financial statements and notes thereto forthe year ended December 31, 2003 as filed with the SEC on March 23, 2004. Theaccompanying consolidated financial statements reflect all adjustments (consistingof normal recurring adjustments) which are, in the opinion of management,necessary for a fair presentation of results for the interim periodspresented.  The results of operationsfor the three month period ended March 31, 2004 are not necessarily indicativeof the results to be expected for the full fiscal year.

 

The Company’sfinancial results for the first quarter of 2004 improved from the first quarterof 2003; the Company generated a net profit of $380,000 in the first quarter of2004 as compared to a net loss of $655,000 in the first quarter of 2003.  The improvement in financial results was dueprimarily to an increase of over $1.0 million, or 35%, in total revenues and adecrease in operating expenses associated with ongoing cost controls.  The Company has experienced five consecutivequarters of revenue growth.  Managementbelieves that the growth during this period is due to increased demand forenterprise software solutions which has led to an increase in informationtechnology spending and resulting sales bookings for the Company.  Furthermore, management believes that thefinancial results for the remainder of fiscal year 2004 will exhibitimprovements compared to the same period in the prior year.  This belief is based on the Company’s currentexpected level of sales bookings and corresponding revenue growth combined withlower expected operating expenses as a direct result of the Company’s thirdquarter restructuring activity in 2003. However, this expectation may change if the current economic environmentchanges and softness in information technology spending returns or if theCompany’s products do not achieve market acceptance.  During the quarter ended March 31, 2004, the Company raised $3.6million through the sale of 600,000 shares of common stock, at a price of $6.00per share, in a private placement to institutional and other accreditedinvestors. The proceeds of the private placement will be used for additionalworking capital and other general corporate purposes.  Also during the quarter, the Company repurchased 350,000 sharesof its outstanding common stock from ASA International Ltd., an existingshareholder, in a private transaction at a price of $5.75 per share. The shareswere purchased with the use of generally available corporate funds and will beheld in treasury.  These activitiesalong with first quarter operations resulted in an increase in cash and cashequivalents of approximately $1.7 million for the quarter ended March 31, 2004.  The Company’s cash and cash equivalents atMarch 31, 2004 were $9.9 million. The Company believes that its existingcash and cash equivalents will be sufficient to meet its working capital andcapital expenditures for at least the next twelve months.

 

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

 

The Companyreports earnings per share in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 128, *Earnings per Share*.  The dilutive effect of potential commonshares in 2004, consisting of outstanding stock options and a stock warrant, isdetermined using the treasury stock method, in accordance with SFASNo. 128.  Diluted weighted averageshares outstanding for the three months ended March 31, 2003 exclude 753,300potential common shares from stock options because to include them would havebeen anti-dilutive for the period presented as the Company reported a net lossduring the period.  For the quarterended March 31, 2004, the dilutive calculation excludes the potential commonshares related to 220,774 outstanding stock options which have an anti-dilutiveeffect since their exercise price exceeds the market value of the Company’scommon stock.  A reconciliation of basicand diluted common shares outstanding is as follows:

 

6

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|                                                             |   | **Three Months  ended March 31,** |   |
|------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                             |   | **2004**                          |   | **2003** |   |
| Weighted average number of common shares  outstanding            |   | 3,514,438                         |   | 3,491,912 |   |
| Potential common shares pursuant to stock  options and warrants  |   | 165,747                           |   | — |   |
| Diluted weighted average shares                                  |   | 3,680,185                         |   | 3,491,912 |   |
| Basic net income (loss) per common share                         |   | $                                 | 0.11   |   | $ | (0.19 | ) |
| Diluted net income (loss) per common and  potential common share |   | $                                 | 0.10   |   | $ | (0.19 | ) |

 

**(3)     Income Taxes**

 

SFAS No. 109, *Accounting for Income Taxes,* requires avaluation allowance to be recorded against deferred tax assets when it is morelikely than not that some or all of the deferred tax assets will not berealized.  As a result of cumulativelosses in recent years and continued economic uncertainty, the Company hasprovided a full valuation allowance against all of its net deferred tax assetsand will do so until it returns to an appropriate level of sustained taxableincome.  The ultimate realization ofthese deferred tax assets depends upon the Company’s ability to generatesufficient future taxable income. If the Company is successful in generatingsufficient future taxable income, the Company will reduce the valuationallowance through a reduction in income tax expense in the future.

 

During the three months ended March 31, 2004, the Company recorded anet tax provision of $19,131 for expected tax liability in the United Statesand for expected tax liability related to its United Kingdom subsidiary, OmtoolEurope Limited (“OEL”).  The provisionfor the 2004 quarter is net of a $28,800 adjustment related to a fiscal year2003 transfer pricing adjustment.

 

During the three months ended March 31, 2003, the Company recorded$155,398 of tax benefit due to a tax refund that OEL received during the firstquarter of 2003. OEL had incurred a loss for the year ended December 31, 1999which resulted in the income tax benefit. The tax benefit was carried back to prior years’ taxes paid and resultedin a tax refund.  Because the subsidiarywas undergoing an Inland Revenue audit for the 1999 tax year, doubt existedabout the realizability of this refund and the Company did not record thebenefit on its books until the audit was cleared and the cash was received,both of which occurred in the first quarter of 2003.

 

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

 

The components of the Company’s comprehensiveincome (loss) are as follows:

 
|                                     |   | **Three  months ended March 31,** |    |
|------------------------------------------|--------|-----------------------------------|---------|
|                                     |   | **2004**                          |    | **2003** |   |
| Net income (loss)                        |   | $                                 | 379,755 |   | $ | (665,411 | ) |
| Foreign currency translation adjustments |   | 24,011                            |    | (33,860 | ) |
| Comprehensive income (loss)              |   | $                                 | 403,766 |   | $ | (699,271 | ) |

 

**(5)     Stock Based Compensation**

 

The Companyaccounts for stock-based compensation for employees under the recognition andmeasurement principles of Accounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees,* and related interpretations.  The following table illustrates the effecton net income (loss) and net income (loss) per share if the Company had appliedthe fair value recognition provisions of Financial Accounting Standards BoardStatement No. 123, *Accounting for Stock-Based Compensation,*to stock-based employee compensation.

 

7

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|                                                                                                       |   | **Three  months Ended  March 31,** |    |
|------------------------------------------------------------------------------------------------------------|--------|------------------------------------|---------|
|                                                                                                       |   | **2004**                           |    | **2003** |   |
|                                                                                                       |   |                               |    |   |   |
| Net income (loss), as reported                                                                             |   | $                                  | 379,755 |   | $ | (665,411 | ) |
| Deduct: Total stock-based employee  compensation expense determined under fair value method for all awards |   | (71,905                            | )       | (265,994 | ) |
| Pro forma net income (loss)                                                                                |   | $                                  | 307,850 |   | $ | (931,405 | ) |
|                                                                                                       |   |                               |    |   |   |
| Net income (loss) per share:                                                                               |   |                               |    |   |   |
| Basic, as reported                                                                                         |   | $                                  | 0.11    |   | $ | (0.19 | ) |
| Diluted, as reported                                                                                       |   | $                                  | 0.10    |   | $ | (0.19 | ) |
| Basic, pro forma                                                                                           |   | $                                  | 0.09    |   | $ | (0.27 | ) |
| Diluted, pro forma                                                                                         |   | $                                  | 0.08    |   | $ | (0.27 | ) |

 

**(6)     Restructuring Costs**

 

**In thethird quarter of 2003, the Company announced a restructuring of certain of itsoperations, and recorded a pre-tax charge of $806,581 in accordance with SFASNo. 146, *Accountingfor Costs Associated with Exit or Disposal Activities*.  The charge includes severance-related costsassociated with the workforce reduction in the Company’s domestic operationsand costs associated with closing its Oregon office.  The reduction in workforce consisted of three employees in theCompany’s sales and marketing department, two employees performing general andadministrative functions, three employees performing technical support and fiveemployees in the Company’s research and development department.  The balance of this charge consists of costsincurred as a result of closing the Company’s Oregon office.  All of the costs associated with closing theCompany’s Oregon office were paid as of December 31, 2003.**

 

**Thefollowing table summarizes the restructuring activity for the three monthsended March 31, 2004:**

 
|                                |   | **Severance** |    |
|-------------------------------------|--------|---------------|---------|
| Ending balance at December 31, 2003 |   | $             | 443,830 |   |
| Cash payments                       |   | (143,773      | )       |
| Ending balance, March 31, 2004      |   | $             | 300,057 |   |

 

**Thetotal cash impact of the restructuring is $806,581 which the Companyanticipates will be paid by the end of the third quarter of 2004.**

 

**(7)     Equity Transactions**

 

**OnMarch 30, 2004, the Company raised $3.6 million through the sale of 600,000 sharesof common stock, at a price of $6.00 per share in a private placement toinstitutional and other accredited investors. The fees associated with issuing the shares in connection with theprivate placement are estimated to be approximately $107,000 and were recordedas a reduction of additional paid-in capital. Furthermore, Omtool issued 51,000 shares of common stock and a warrantto purchase an additional 51,000 shares of common stock, exercisable over afive-and-a-half-year period at a price of $6.00 per share, to its financialadvisor or its nominees for advisory services related to the private placement.**

 

**OnMarch 31, 2004, the Company repurchased 350,000 shares of its outstandingcommon stock from ASA International Ltd., an existing shareholder, in a privatetransaction at a price of $5.75 per share. The 350,000 shares that wererepurchased have been recorded and are held as treasury stock.**

 

**(8)     Subsequent Event**

 

**OnMarch 30, 2004, Omtool’s Board of Directors approved a two-for-one stock splitof the Company’s Common Stock in the form of a dividend effective April 27,2004.  All references in theconsolidated financial statements referring to shares, share prices, per shareamounts and stock plans have been adjusted retroactively for the two-for-onestock split.**

 

**(9)     Segment and Geographic Information**

 

To date, the Company has viewed itsoperations and manages its business as principally one segment, software andhardware sales and associated services. As a result, the financial informationdisclosed herein represents all of the material

 

8

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financial information related to theCompany’s principal operating segment in accordance with SFAS No. 131, *DisclosuresAbout Segments of an Enterprise and Related Information*.

 

Total revenues from international sources were $1.3million for the three months ended March 31, 2004 and $441,000 for the threemonths ended March 31, 2003. The Company’s revenues from international sourceswere primarily generated from customers located in Europe. The following tablerepresents amounts relating to geographic locations:

 
|                  |   | **Three  months ended  March 31,** |       |
|-----------------------|--------|------------------------------------|------------|
|                  |   | **2004**                           |       | **2003** |   |
| Total revenues (1)    |   |                               |       |   |   |
| United States         |   | $                                  | 2,684,800  |   | $ | 2,541,377 |   |
| United Kingdom        |   | 692,199                            |       | 265,809 |   |
| Rest of World         |   | 651,079                            |       | 174,969 |   |
|                  |   | $                                  | 4,028,078  |   | $ | 2,982,155 |   |
|                  |   |                               |       |   |   |
|                  |   | **March 31,  2004**                | ** ** | **December 31,  2003** | ** ** |
| Long-lived assets (2) |   |                               |       |   |   |
| United States         |   | $                                  | 328,240    |   | $ | 392,801 |   |
| United Kingdom        |   | 15,600                             |       | 15,784 |   |
|                  |   | $                                  | 343,840    |   | $ | 408,585 |   |
|                       |        |                                    |            |  |  |  |  |  |

 

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(1)  Revenues are attributed to geographic regions based on locationof customer.

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

 

**Item2.**

 

**MANAGEMENT’SDISCUSSION AND ANALYSIS**

**OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

 

Management’s Discussionand Analysis of Financial Condition and Results of Operations should be read inconjunction with the accompanying consolidated financial statements for theperiods specified and the associated notes. Further reference should be made to the Company’s Annual Report on Form10-K as filed with the Securities and Exchange Commission on March 23, 2004.

 

**Overview**

 

Omtool is a leading provider of electronic document delivery andmanagement software that enables efficient, secure, confirmed and cost-efficientdocument exchange between businesses. The Company was incorporated in March 1991 and shipped its initialfacsimile software products in 1991. Omtool’s products provide users with anextensive, flexible feature set that converts, transmits, receives, andautomatically archives documents in electronic formats.  Included in the Company’s products is asuite of utility and control functions that enables the conversion of paperdocuments to standard electronic formats and integrates with industry recognizeddocument and records management systems. Omtool’s products enable the integration of business processes thatinclude the exchange of hard copy and electronic documents such as legalcontracts, financial transactions, medical records and purchase order processing.  Omtool’s products minimize risks bypreserving the security of high value documents while facilitating increasedproductivity, reducing costs and fulfilling emerging businessrequirements.  AccuRouteTM, Omtool’sdocument routing and distribution software, integrates with many digitalscanning and multifunctional devices to allow paper documents to be digitized,distributed and archived.  In addition,Omtool’s AccuRoute software provides capture, distribution and compliance formovement of electronic documents and information.  GenifaxTM, Omtool’s enterprise fax software, offers a scalable,server-based feature set and shares a common Windows server-based architecturewith the Genidocs product line. GenidocsTM, the Company’s secure document delivery application,integrates with existing e-mail systems and provides multiple options forcontent and attachment encryption, authentication, audit trail and deliveryconfirmation, and digital signatures. The Company’s AccuRoute software further unifies the codes base andarchitecture of the Genidocs and Genifax products, coupled with the routingcapabilities of AccuRoute’s software platform to

 

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provide a truly unique customer specific product to easily managedocuments, both paper and electronic documents with little or no user trainingrequired.  A significant portion of theCompany’s revenue is derived from licensing the rights to use itsfax software products directly to end-users and indirectly throughresellers.

 

The Company resells, from third-party vendors, certain hardwareproducts, including intelligent fax boards and fax modems, to its customers.Hardware sales are undertaken as a convenience to the Company’s customers andhardware is not required to be purchased from the Company and can bealternatively obtained from a third-party vendor.  The fax boards and fax modems that are resold are not functionalwithout the Company’s software and the Company is not in the business ofselling fax boards and modems. The Company purchases these hardware products asneeded to ship to its customers and the Company maintains a minimal inventoryof these hardware products.  Managementbelieves that the Company has a good business relationship with suppliers ofthese products and that supply of these products is stable.

 

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

 

The Company’sfinancial results for the first quarter of 2004 improved from the first quarterof 2003 as it generated a net profit of $380,000 in the first quarter of 2004as compared to a net loss of $655,000 in the first quarter of 2003.  The improvement in financial results was dueprimarily to an increase of over $1.0 million, or 35%, in total revenues and adecrease in operating expenses associated with ongoing cost controls. TheCompany has experienced five consecutive quarters of revenue growth.  Management believes that the growth duringthis period is due to increased demand for enterprise software solutions whichhas led to an increase in information technology spending and resulting salesbookings for the Company.  Furthermore,management believes that the financial results for the remainder of fiscal year2004 will exhibit improvements compared to the same period in the prioryear.  This belief is based on theCompany’s current expected level of sales bookings and corresponding revenuegrowth combined with lower expected operating expenses as a direct result ofthe Company’s third quarter restructuring activity in 2003.  However, this expectation may change if thecurrent economic environment changes and softness in information technologyspending returns or if the Company’s products do not achieve marketacceptance.  During the quarter endedMarch 31, 2004, the Company raised $3.6 million through the sale of 600,000shares of common stock, at a price of $6.00 per share, in a private placementto institutional and other accredited investors. The proceeds of the privateplacement will be used for additional working capital and other generalcorporate purposes.  Also during thequarter, the Company repurchased 350,000 shares of its outstanding common stockfrom ASA International Ltd., an existing shareholder, in a private transactionat a price of $5.75 per share. The shares were purchased with the use ofgenerally available corporate funds and will be held in treasury.  These activities along with first quarteroperations resulted in an increase in cash and cash equivalents ofapproximately $1.7 million for the quarter ended March 31, 2004.  The Company’s cash and cash equivalents atMarch 31, 2004 were $9.9 million. The Company believes that its existingcash and cash equivalents will be sufficient to meet its working capital andcapital expenditures for at least the next twelve months.

 

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

 

The Company’s future revenues and operating resultsmay fluctuate from quarter to quarter based on the number and size of salestransactions that the Company enters into with customers, the adequacy ofprovisions for losses, general economic conditions and other factors. Inaddition, revenue from a large order may constitute a significant portion of theCompany’s total revenues in a particular quarter.

 

The Companyhas historically derived a substantial portion of its total revenues from saleswithin North America. Sales outside of North America (primarily in Europe)represented 31% and 13% of the Company’s total revenues for the three monthsended March 31, 2004 and 2003, respectively. The Company’s gross profit on these sales approximates the gross profiton sales within North America.  Theincrease in the percent of sales outside of North America is a result of theCompany’s strategy to expand its international presence (primarily in Europe)by increasing investments in sales and marketing efforts directed towardinternational markets.

 

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

 

The Companywill continue to leverage its existing distribution channels where appropriateto broaden its reach to the target vertical markets and further penetrate itsinstalled base.  The Company is pursuingsales opportunities via its solution/reseller channel as well as focusing salesefforts on specific market segments in order to facilitate productacceptance.  Sales through the Company’sindirect distribution channels represented 10% and 22% of the Company’s totalrevenues for the three months ended March 31, 2004 and 2003, respectively.

 

## **Critical Accounting Policies and Estimates**

 

The Companyhas identified the policies and estimates below as critical to its businessoperations and the understanding of its results of operations. The impact andany associated risks related to these policies on the Company’s businessoperations is discussed throughout Management’s Discussion and Analysis ofFinancial Condition and Results of Operations where such policies affect theCompany’s reported and expected financial results. Note that the Company’spreparation of this Form 10-Q requires management to make estimates andassumptions that affect the reported amount of assets and liabilities,disclosure of contingent assets and liabilities at the date of the Company’sfinancial statements, and the reported amounts of revenue and expenses duringthe reporting period. There can be no assurance that actual results will notdiffer from those estimates.

 

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

 

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

 

The Companyrecognizes revenue from the sale of software products and hardware to bothend-users and resellers when persuasive evidence of an arrangement exists, theproducts have been delivered, the fee is fixed or determinable, collection ofthe resulting receivable is reasonably assured and there are no customeracceptance provisions. The Company maintains a reserve for potential productreturns. Software maintenance and support revenue is recognized ratably overthe term of the related maintenance period. Typically this is a one-year period, but occasionally the Company sellsmultiple-year maintenance contracts, in which case the associated revenue isrecognized over the multiple-year term of the contract.  Other services revenue is recognized as theservices are performed. If an arrangement includes an acceptance provision, theCompany will defer all revenue until the customer accepts the products.  Acceptance generally occurs upon the earlierof receipt of a written customer acceptance or expiration of the acceptanceperiod.

 

The Company’stransactions frequently involve the sales of software, hardware and relatedservices under multiple element arrangements.  Revenue under multiple element arrangements is allocated to each elementunder the residual method,

 

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in accordance with SOP 98-9, 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 the price chargedwhen these elements are sold separately and unaccompanied by other elements.  The Company’s services are not essential tothe functionality of the software as these services do not alter thecapabilities of the software and do not carry a significant degree of risk toperform. The amount allocated to the delivered elements, such as softwarelicense and hardware revenue, is the difference between the total arrangementvalue and the amount allocated to the undelivered elements. If the deliveredelements include both software and hardware, the amount allocated to hardwarerevenue is based on the price charged to the Company by the third party vendorplus an additional mark up, with the remainder allocated to software revenue.To the extent that a discount is offered in the arrangement, the entirediscount is allocated to the delivered element or elements. If the deliveredelements include hardware and software, the discount is allocated to thehardware and software based on their respective list prices.

 

For all sales,the Company uses a binding purchase order, a signed contract or a credit card authorizationas evidence of an arrangement.  Salesthrough the Company’s resellers are evidenced by a master agreement governingthe relationship, together with binding purchase orders, on atransaction-by-transaction basis.

 

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

 

The Company reserves for potential product returns andmakes adjustments to the reserve as needed, based on historical product returnrates, and considers the impact of new product introductions, changes incustomer demand and acceptance of the Company’s products.  Management’s calculation of the estimatedreturn reserve is based upon (1) an account specific review of potentialreturns, where a return probability is known, and (2) a general estimate basedupon past historical returns as a percentage of revenue.   Significant management judgments andestimates must be made and used in connection with establishing the salesreturns reserve in any accounting period. Material differences may result inthe amount and timing of revenue for any period if management made differentjudgments or utilized different estimates. Similarly, management must make estimates of the uncollectability of theCompany’s accounts receivable. Management specifically analyzes accounts receivable and historical baddebts, customer credit-worthiness, current economic trends and changes incustomer payment patterns when evaluating the adequacy of the allowance fordoubtful accounts.  Management’scalculation of the estimated accounts receivable reserve is based upon (1) anaccount specific review of potential uncollectible accounts, where a bad debtprobability is known, and (2) a general estimate based upon past historical baddebts as a percentage of accounts receivable.

 

The Company’scombined accounts receivable and returns reserve was approximately $212,000 and$367,000 at March 31, 2004 and December 31, 2003, respectively.  Both components of calculating the estimatedreserve, specific identification and historic experience, are materialjudgments.  These judgments are based onhistoric trends, taking into consideration current business and economicconditions, which could change materially, thus changing the required reservelevel materially.  The potential changecould be positive, in the event the reserve estimate proves unnecessary, ornegative, if the reserve proves inadequate.

 

The Company’s deferred revenue is comprised mainly of revenue that isdeferred for software maintenance and support contracts.  The other components of deferred revenue arethe amounts from sales transactions****that were deferred because they did notmeet all of the provisions of the Company’s revenue recognition policy.

 

* Software Development Costs*.  Software development costs are consideredfor capitalization when technological feasibility is established in accordancewith SFAS No. 86, *Accounting for the Costs of Computer Software To Be Sold, Leased or**OtherwiseMarketed*. The Company sells software in a market that is subject torapid technological change, new product introductions and changing customerneeds. Accordingly, the Company has determined that it cannot determinetechnological feasibility until the development state of the product is nearlycomplete. The time period during which cost could be

 

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capitalized from the point ofreaching technological feasibility until the time of general product release isvery short and, consequently, the amounts that might be capitalized are notmaterial to the Company’s consolidated financial position or results ofoperations. Therefore, the Company charges all software development costs tooperations in the period incurred.

 

*Taxes*.    The Company is required to estimate itsincome and state sales taxes. This process involves estimating the Company’sactual current tax obligations together with assessing differences resulting fromthe different treatment of items for tax and accounting purposes which resultin deferred income tax assets and liabilities and accrued state sales taxliabilities. The Company has deferred income tax assets and liabilities andaccrued state sales tax liabilities included within its balance sheet.

 

The Company’sdeferred tax assets are assessed for each reporting period as to whether it ismore likely than not that they will be recovered from future taxable income,including assumptions regarding on going tax planning strategies. To the extentthe Company believes that recovery is uncertain, the Company must establish avaluation allowance for assets not expected to be recovered. Changes to thevaluation allowance are included as an expense or benefit within the taxprovision in the statement of operations.

 

The Company provides a full valuation allowance against all of its netdeferred tax assets and will continue to do so until it returns to anappropriate level of taxable income. The ultimate realization of these deferredtax assets depends upon the Company’s ability to generate sufficient futuretaxable income. If the Company is successful in generating sufficient futuretaxable income, the Company will reduce the valuation allowance through areduction in income tax expense in the future.

 

Accrued state sales taxes are estimated for each reporting period basedon tax rates in effect for the reporting periods in each of the states wherethe Company has potential nexus and for the time period that the Company hasnexus. The assumptions and estimates used to determine this liability aresubject to change as they are difficult to measure or value.  In the event that actual results differ fromthese estimates, the Company’s state sales taxes expense could be materiallyimpacted.

 

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**Results of Operations**

 

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

 
|                           |   | **Three  months ended  March 31,** |   |
|--------------------------------|--------|------------------------------------|--------|
|                           |   | **2004**                           |   | **2003** |   |
| Revenues:                      |   |                               |   |   |   |
| Software license               |   | 29.1                               | %      | 29.4 | % |
| Hardware                       |   | 29.0                               |   | 17.0 |   |
| Service and other              |   | 41.9                               |   | 53.6 |   |
| Total revenues                 |   | 100.0                              |   | 100.0 |   |
| Cost of revenues:              |   |                               |   |   |   |
| Software license               |   | 0.8                                |   | 1.8 |   |
| Hardware                       |   | 16.7                               |   | 11.7 |   |
| Service and other              |   | 18.6                               |   | 26.5 |   |
| Total cost of revenues         |   | 36.1                               |   | 40.0 |   |
| Gross profit                   |   | 63.9                               |   | 60.0 |   |
| Operating expenses:            |   |                               |   |   |   |
| Sales and marketing            |   | 25.9                               |   | 44.7 |   |
| Research and development       |   | 11.7                               |   | 19.6 |   |
| General and administrative     |   | 17.4                               |   | 24.5 |   |
| Total operating expenses       |   | 55.0                               |   | 88.8 |   |
| Income (loss) from operations  |   | 8.9                                |   | (28.8 | ) |
| Interest and other income, net |   | 0.9                                |   | 1.3 |   |
| Tax provision (benefit)        |   | 0.5                                |   | (5.2 | ) |
|                           |   |                               |   |   |   |
| Net income (loss)              |   | 9.3                                | %      | (22.3 | )% |
|                           |   |                               |   |   |   |
| Gross profit:                  |   |                               |   |   |   |
| Software license               |   | 97.3                               | %      | 93.8 | % |
| Hardware                       |   | 42.3                               |   | 31.2 |   |
| Service and other              |   | 55.7                               |   | 50.5 |   |
|                           |   |                               |   |   |   |

 

**Three Months Ended March 31, 2004 and 2003**

 

## ***Revenues***

 

*Total Revenues.*  The Company’s total revenue was$4.0 million and $3.0 million for the three months ended March 31, 2004and 2003, respectively.

 

*Software License.*  Software license revenue was $1.2 millionfor the three months ended March 31, 2004 and $877,000 for the three monthsended March 31, 2003, representing an increase of 34%.  Software license revenue accounted for 29%of total revenues for each respective period. The increase in software license revenue is due to an improvement in thedemand for enterprise software solutions resulting in higher software revenuefor the Company.   Included in softwarelicense revenue for the three months ended March 31, 2004 and 2003 is areduction of $110,000 and $83,000, respectively, in the sales returns andallowance reserve relating primarily to specific accounts where the Company hasdetermined that the risk of a return is no longer present.  Though the Company cannot accurately predictthe exact mix of products that will be sold in the future, it expects thatsoftware license revenue would constitute a larger percentage of its totalrevenue in the future if demand for its newer products, such as AccuRoute, gainadditional market acceptance.

 

*Hardware.*  Hardware revenue was $1.2 million for thethree months ended March 31, 2004 and $506,000 for the three months ended March31, 2003, representing an increase of 131%. Hardware revenue accounted for 29% and 17% of total revenue for eachrespective period.  The increase inhardware revenue is primarily driven by the increase in software sales, whichare

 

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generally accomplished byhardware sales.  The increase inhardware revenue as a percent of total revenue is due to an increase in demandfrom existing customers who have upgraded information systems hardware in theirworldwide locations.  Included inhardware revenue for the three months ended March 31, 2004 and 2003 is areduction of $36,000 and $30,000, respectively, in the sales returns andallowance reserve relating primarily to specific accounts where the Company hasdetermined that the risk of a return is no longer present.  Though the Company cannot accurately predictthe exact mix of products that will be sold in the future, it expects thathardware revenue will constitute a smaller percentage of its total revenue ifdemand for its newer products, such as AccuRoute, gain additional market acceptance.

 

*Service and Other.*  Service and other revenue increased by 6% for the three monthsended March 31, 2004 compared to the three months ended March 31, 2003.  Service and other revenue was $1.7 millionand $1.6 million for the three months ended March 31, 2004 and 2003,respectively.  Service and other revenueaccounted for 42% and 54% of total revenues for each respective period. Theincrease in service and other revenue is primarily due to an increase in supportrevenue bookings as a result of the increase in software license revenue duringthe quarter.  The decrease in serviceand other revenue as a percent of total revenues is due primarily to theincrease in both software license and hardware bookings, which tend to resultin current period revenue as opposed to support revenue, which is recognizedratably over the period for which those services are being provided, which istypically one year.

 

*Cost of Revenue*

 

*Software License.*  Cost of software license revenue consistsprimarily of the costs of sublicensing third-party software products, productmedia and product duplication.  Cost ofsoftware license revenue for the three months ended March 31, 2004 decreased by42% or $22,000 during the quarter to $32,000 compared to $54,000 during thecorresponding period in 2003.  Thedecrease is due primarily to the fact that the Company has replaced third partysoftware that was imbedded in its products with its own internally-developedsolutions, thus reducing the royalties that it must pay when a product containingthat third-party software is sold.  Thisdecrease is also reflected in software license gross margin as it improved to97% from 94%.

 

*Hardware.*  Cost of hardware revenue consists primarilyof the costs of third-party hardware products. Cost of hardware revenues was$674,000 and $348,000 for the three months ended March 31, 2004 and 2003,respectively, representing 58% and 69% of hardware revenues for each respectiveperiod. The increase in dollar amount for the cost of hardware revenues was dueprimarily to the increase of hardware unit sales accompanying sales of theCompany’s software products. The gross margin percentage for hardware salesimproved to 42% from 31% for the three month periods ended March 31, 2004 and2003 due to a change in the mix of particular hardware products sold.  The Company does not expect that its perunit cost of hardware products will change significantly enough through theremainder of 2004 such that it would have a material impact on hardware marginsin the future.

 

*Service and Other.*  Cost of service and other revenue consistsprimarily of the costs incurred in providing telephone support as well as othermiscellaneous customer service-related expenses.  Cost of service and other revenues was $747,000 and $792,000 forthe three months ended March 31, 2004 and 2003, respectively, representing 44%and 50% of service and other revenues for each respective period.  The gross margin percentage for service andother revenues increased to 56% for the three months ended March 31, 2004,compared to 50% in the same period in 2003. The increase in gross margin is due to a decrease in the number ofemployees and the associated overhead costs. The Company does not expect any significant variances in its service andother gross margins for the remainder of fiscal year 2004.

 

*Operating Expenses*

 

*Sales and Marketing.*  Sales and marketing expenses consistprimarily of employee salaries, benefits, commissions, and associated overheadcosts, and the cost of marketing programs such as advertisements, directmailings, public relations, trade shows, seminars and related communicationcosts.  Sales and marketing expenseswere $1.0 million and $1.3 million for the three months ended March31, 2004 and 2003, respectively, or 26% and 45% of total revenues for eachrespective period.  The decrease insales and marketing expenses is due to decreased wages, commissions, and travelcosts resulting from fewer management level personnel in the department as aresult of the restructuring that occurred in the third quarter of 2003.   Additionally, the Company reduced its tradeshow expenses during the first quarter of 2004 as compared to the first quarterof 2003.  The Company expects that itssales and marketing expenses will increase in absolute dollars as additionalsales staff is added during the year.

 

*Research and Development.*Research and development expenses include expenses associated with thedevelopment of new products, enhancements of existing products and qualityassurance activities. These expenses consist primarily of employee salaries,benefits, associated overhead costs, consulting expenses and the cost ofsoftware development tools. Research and

 

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development expenses were$471,000 for the three months ended March 31, 2004 and $585,000 for the threemonths ended March 31, 2003, representing 12% and 20% of total revenues foreach respective period.  The decrease inthe expense and in research and development expenses as a percent of total revenuesis a result of fewer employees in the research and development department andthe associated costs of supporting such personnel due to the restructuring thatoccurred in the third quarter of 2003. Management does not believe that the decrease in the number of employeeswill have a material adverse effect on its ability to develop new products andupdated versions of its existing products. The Company expects research and development expenses to remain consistentin absolute dollars.

 

*General and Administrative.*  General and administrative expenses consistprimarily of employee salaries, benefits for administrative, executive andfinance personnel and associated corporate general and administrative expenses.General and administrative expenses were $699,000 and $732,000 for the threemonths ended March 31, 2004 and 2003, respectively, or 17% and 25% of totalrevenues for each period. The decrease in dollar amount and percentage of totalrevenues is due to the reduction in general and administrative personnel andoverhead costs associated with supporting such personnel and a decrease inmanagement consulting expenses.  TheCompany expects that it may experience increases to general and administrativeexpenses in the form of professional fees and consulting expenditures in theremaining quarters of 2004 as it continues to comply with the Sarbanes-OxleyAct of 2002.

 

*Interest and other Income.*  Interest and other income consistsprincipally of interest income earned on cash and cash equivalentbalances.  Interest and other income,net was $38,000 for the three months ended March 31, 2004 and $39,000 for thethree months ended March 31, 2003.  Alsoincluded in the three months ended March 31, 2004 interest and other income isother income of $5,000 related to the fair value of a warrant to purchase 8,580shares of common stock of Verso Technologies (“Verso”).  The fair value of the warrant is marked tomarket in each financial reporting period resulting in future changes in fairvalue which are recorded in income and other expenses.  The Company’s warrant to purchase 8,580shares of Verso common stock expires in November 2005.

 

*Provision for Income Taxes.*  During the three months ended March 31,2004, the Company recorded a net tax provision of $19,131 for expected taxliability in the United States and for expected tax liability related to itsUnited Kingdom subsidiary, Omtool Europe Limited (“OEL”).  The provision for the 2004 quarter is net ofa $28,800 adjustment related to a fiscal year 2003 transfer pricing adjustment.

 

During thethree months ended March 31, 2003, the Company recorded $155,398 of tax benefitdue to a tax refund that OEL received during the first quarter of 2003. OEL hadincurred a loss for the year ended December 31, 1999 which resulted in anincome tax benefit.  The tax benefit wascarried back to prior years’ taxes paid and resulted in a tax refund.  Because the subsidiary was undergoing anInland Revenue audit for tax year 1999, doubt existed about the realizabilityof this refund and the Company did not record the benefit on its books untilthe audit was cleared and the cash was received, both of which occurred in thefirst quarter of 2003.

 

### **Liquidity andCapital Resources**

 

Since 1996,the Company has financed its operations primarily through cash flow fromoperations, the private sales of preferred stock and common stock and theCompany’s initial public offering of Common Stock completed inAugust 1997. At March 31, 2004, the Company had cash and cash equivalentsof $9.9 million and working capital of $5.2 million.

 

The Company’soperating activities provided cash of $174,000 for the three months ended March31, 2004 and used cash of $719,000 for the three months ended March 31,2003.  Management restructured theorganization in September 2003 to reduce operating expenses and help preservecash.  Management believes that thesereductions, which are anticipated to total approximately $1.6 million annually,along with the revenue assumptions used for the remainder of the Company’s 2004budget, will lead to sufficient cash for at least the next twelve months.  Net cash provided during the first quarterof March 31, 2004 consisted primarily of a net profit from operations and anincrease in accrued liabilities partially offset by a decrease in accruedrestructuring and increases in accounts receivable and prepaid expenses andother current assets.  The increase inaccounts receivable is due primarily to the increased revenues during the firstquarter of 2004, and management continues to focus on improving working capitalby decreasing its days sales outstanding. The increase to prepaid and other current assets is due primarily tocash paid for the support of certain internally used information systems software.  The increase to accrued liabilities isprimarily the result of an increase in wage-related accruals due to the timingof payroll and an increase in the accruals for the expenses associated with theprivate placement to institutional and other accredited investors on March 30,2004.  Net cash used during the threemonths ended March 31, 2003 resulted from a net loss from operations anddecreases in accrued liabilities and accrued sales tax partially offset bydepreciation and amortization and a decrease in accounts receivable.

 

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Investingactivities used cash of $13,000 and $526,000 during the three months endedMarch 31, 2004 and 2003, respectively. During the three months ended March 31, 2004, the only use of cash wasfor purchases of property and equipment. Property and equipment purchases werepredominately of computer related software and hardware products. During thethree months ended March 31, 2003, the principal uses were purchases ofproperty and equipment and short-term investments, offset by proceeds from thesale of short-term investments.

 

Financingactivities provided cash of $1.5 million and $2,600 for the three months endedMarch 31, 2004 and 2003, respectively. Cash provided for the three months ended March 31, 2004 was due to thenet proceeds from the issuance of common stock. On March 30, 2004 the Companycompleted the sale of 600,000 shares of common stock, at a price of $6.00 pershare, in a private placement to institutional and other accredited investors.The proceeds of the private placement, which totaled $3.6 million, are to beused for additional working capital and other general corporate purposes. Thiswas offset by a cash usage of $2.0 million during the quarter as the Companyrepurchased 350,000 shares of its outstanding common stock from ASAInternational, an existing shareholder, in a private transaction at a price of$5.75 per share. The shares were purchased with the use of generally availablecorporate funds and will be held in treasury. Cash used for the three monthsended March 31, 2003 was due primarily to proceeds from the issuance of commonstock related to the Company’s employee stock purchase program.

 

Based on itsfirst quarter performance and current expectations for the remainder of 2004,the Company believes that the current cash and cash equivalents balance as wellas the expected cash to be generated from operations for the remainder of theyear will satisfy its working capital needs, capital expenditures and otherliquidity requirements associated with its operations through at least the nexttwelve months.  The Company expects thatprincipal uses of cash will be for operations, working capital, payment ofsales taxes and purchases of property and equipment.  Management currently has no plan to obtain additional financingif these expectations are not met. There can be no assurance that any necessaryadditional financing will be available to the Company on commerciallyreasonable terms, or at all.

 

The followingtable represents the approximate amounts of payments due under specifiedcontractual obligations as of March 31, 2004:

 
| **Contractual Obligations** |   | **Total** |    | **Less than  one year** |   | **One to  Three years** |   | **Three to  five years** |    | **More than  Five years** |   |
|-----------------------------|--------|-----------|---------|-------------------------|--------|-------------------------|--------|--------------------------|---------|---------------------------|--------|
|                        |   |      |    |                    |   |                    |   |                     |    |                      |   |
| Operating lease obligations |   | $         | 575,000 |                    | $      | 391,000                 |   | $                        | 184,000 |                      | — |   | — |   |
| Total obligations           |   | $         | 575,000 |                    | $      | 391,000                 |   | $                        | 184,000 |                      | — |   | — |   |

 

Operatinglease requirements consist mainly of lease payments for the Company’s officesin Salem, NH and London, England. As of March 31, 2004, the Company did nothave any long-term debt obligations, material commitments for capitalexpenditures, capital lease obligations, or other long-term liabilities forwhich payments are required.

 

**Certain Factors Affecting Future OperatingResults**

 

The Company operates in arapidly changing environment that involves a number of risks, some of which arebeyond the Company’s control. The discussion highlights some of the risks whichmay affect future operating results.

 

Information provided bythe Company from time to time including statements in this Form 10-Q whichare not historical facts are so-called “forward-looking statements” thatinvolve risks and uncertainties, made pursuant to the safe harbor provisions ofthe Private Securities Litigation Reform Act of 1995. In particular, statementscontained in Management’s Discussion and Analysis of Financial Condition andResults of Operations which are not historical facts (including, but notlimited to, statements concerning:  theplans and objectives of management; expectations for sales and marketing,research and development and general and administrative expenses; developmentsrelating to the Company’s product and service offerings, markets andacquisitions; anticipated trends in the Company’s business; the Company’s strategicalliances; changes in the regulatory environment; the Company’s expectedliquidity and capital resources and the Company’s critical accounting policies)may constitute forward-looking statements. These forward-looking statements areneither promises nor guarantees, but are subject to risks and uncertaintiesthat could cause actual results to differ materially from the expectations setforth in the forward-looking statements. Factors that may cause suchdifferences include, but are not limited to, the factors discussed

 

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below, and theother risk factors discussed from time to time in the Company’s other filingswith the Securities and Exchange Commission.

 

*Future Operating Results Uncertain.*  The Company incorporated and shipped itsinitial facsimile software products in 1991. In the years ending December 31, 2001, 2002 and 2003, the Companyhad operating losses and decreasing revenues. There can be no assurance thatthe Company will be able to increase its level of revenues or return toprofitability in the future; as the Company’s operating history makes theprediction of future operating results difficult or impossible.  Increases in operating expenses may occurand, together with pricing pressures and a decline in the growth rate of theoverall U.S. economy, may result in a decrease in operating income andoperating margin percentage.  TheCompany’s ability to improve its operating results will depend upon, amongother things, its ability to increase sales of the AccuRoute, Genifax andGenidocs software products to new customers as well as increased productpenetration into existing customers. The Company recently commenced its strategic expansion into documentrouting and distribution software, and has limited financial and operating dataand a limited operating history relevant to this solution.  Accordingly, it is difficult to evaluate theprospects for the level of acceptance of this solution. Future operatingresults will depend on many other factors, including, without limitation, thedegree and rate of growth of the markets in which the Company competes, thelevel of acceptance of the Windows NT, Windows 2000 and Windows XP operatingsystems, the level of product and price competition, the ability of the Companyto establish strategic relationships and develop and market new and enhancedproducts and to control costs, the ability of the Company to expand its directsales force and indirect distribution channels both domestically and internationallyand the ability of the Company to attract and retain key personnel. As aresult, it is possible that in the future the Company’s operating results willbe below the expectations of public market analysts and investors.  In such event, the price of the Company’scommon stock would likely be materially adversely affected.

 

*Product Concentration.*  To date, much of the Company’s revenues havebeen attributable to licenses of the Company’s facsimile-based enterprisesolutions and related products and services. The Company expects such productsand related services to continue to account for much of the Company’s futurerevenues. However, recently the amount of revenues attributable to the licensesof such products has declined and there can be no assurances that such declinewill not continue. Furthermore, the Company introduced its securebusiness-to-business electronic document exchange products, Genidocs andGenifax, to the market in the fourth quarter of 2000 and it introduced itsproprietary document and routing software, AccuRoute, in the second quarter of2002.  To date, the Company has notrecognized a significant amount of revenues from its Genidocs and AccuRouteproducts. The Company expects that its Genidocs and AccuRoute products mayaccount for an increasing portion of future revenues. However, there can be noassurances that the Genidocs and AccuRoute products will be financiallysuccessful or result in any significant revenues. Factors adversely affectingthe pricing of or demand for such products, such as competition ortechnological change, could have a material adverse effect on the Company’sbusiness, financial condition and results of operations. The Company’sprospects must be considered in light of the risks and difficulties frequentlyencountered by companies dependent upon operating revenues from a new productline in an emerging and rapidly evolving market.

 

*New Products and Technological Change.*  The markets for the Company’s products arerelatively new and are characterized by rapid technological change, evolvingindustry standards, changes in end-user requirements and frequent new productintroductions and enhancements. The Company’s future success will depend uponits ability to enhance its 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 the Company will besuccessful in developing and marketing new products or product enhancements ona timely basis, or that new products or product enhancements developed by theCompany, such as the Genidocs, Genifax and AccuRoute products will achievemarket acceptance. The introduction of products embodying new technologies andthe emergence of new industry standards could render the Company’s existingproducts obsolete and unmarketable. From time to time, the Company and itscompetitors may announce new products, capabilities or technologies that havethe potential to replace or shorten the life cycle of the Company’s existingproduct offerings. There can be no assurance that announcements of new productofferings by the Company or its competitors will not cause customers to deferor forego the licensing of the Company’s existing or planned products and havea material adverse effect on the Company’s business, financial condition andresults of operations.

 

*The Market Risks for SecureBusiness-to-Business Electronic Document Exchange Solutions.*  The market for Genidocs, the Company’ssecure business-to-business electronic document exchange solution is new andevolving rapidly. The Company’s success will depend upon the adoption and useby current and potential customers of secure business-to-business electronicdocument exchange solutions. The Company’s success will also depend uponacceptance of its technology as the standard for providing these solutions. Theadoption and use of the Company’s secure business-to-business electronicdocument exchange solution will involve changes in the manner in whichbusinesses have traditionally exchanged information. The Company’s

 

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ability to influence usage ofits secure business-to-business electronic document exchange solution bycustomers is limited. The Company intends to spend considerable resourceseducating potential customers about the value of secure business-to-businesselectronic document exchange solutions. It is difficult to assess, or topredict with any assurance, the present and future size of the potential marketfor the Company’s secure business-to-business electronic document exchangesolution, or its growth rate, if any. Moreover, the Company cannot predictwhether the Company’s secure business-to-business electronic document exchangesolution will achieve any market acceptance. Any future products or futureproduct enhancements that are not favorably received by customers may not beprofitable and, furthermore, could damage the Company’s reputation or brandname.

 

*Dependence on Genifax Product Line and theWindows 2000/XP environment.*  The Company currently derives a significant portion of itsrevenues from licenses of the Genifax product and related services and resaleof related hardware. Continued market acceptance of the Genifax  product is critical to the Company’s futuresuccess. As a result, any decline in demand for or failure to maintain broadmarket acceptance of the Genifax product line as a result of competition,technological change or otherwise, would have a material adverse effect on theCompany’s business, financial condition and results of operations. TheCompany’s future financial performance will depend in large part on new andenhanced versions of the Genifax product. There can be no assurance that theCompany will continue to be successful in marketing the Genifax product or anynew or enhanced versions of the Genifax product.  There can be no assurance that the Company will be successful indeveloping products for new or enhanced operating systems such as Windows 2000or Windows XP, or that such systems will not obviate the need for the Company’sproducts. If any new or enhanced operating system gains widespread use and theCompany fails to develop and provide its products for this operating system ona timely basis, the Company’s business, financial condition and results ofoperations would be materially adversely affected.

 

*Dependence on Client/Server Environment.*  The Company’s enterprise, client/serverfacsimile software products are intended to help organizations efficientlymanage their facsimile communications, utilizing a client/server computingenvironment. The client/server market is relatively new and there can be noassurance that organizations will move away from the use of stand-alone faxmachines or continue to adopt client/server environments, or that customers ofthe Company that have begun the migration to a client/server environment willbroadly implement this model of computing. The Company’s future financialperformance will depend in large part on continued growth in the market forclient/server applications, which in turn will depend in part on the growth inthe number of organizations implementing client/server computing environments.There can be no assurance that these markets will continue to grow or that theCompany will be able to respond effectively to the evolving requirements ofthese markets. If the market for client/server application products andservices does not grow in the future, grows more slowly than the Companyanticipates, or if the Company fails to respond effectively to evolvingrequirements of this market, the Company’s business, financial condition andresults of operations would be materially adversely affected.

 

*Risks Associated with Listing on the NasdaqSmallCap Market*. In August 2002, the Nasdaq National Market (“Nasdaq”) informed theCompany that its common stock had traded for 30 consecutive trading days belowthe minimum bid price and that the Company had until November 4, 2002, todemonstrate compliance with Nasdaq’s listing requirements by maintaining a bidprice for its common stock of at least $1.00 for a minimum of ten consecutivetrading days.  The Company did notregain compliance and on October 29, 2002, the Company applied to transfer fromthe Nasdaq National Market to the Nasdaq SmallCap Market. On November 26, 2002,the Company transferred to the Nasdaq SmallCap Market and it was 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 share requirement. OnJanuary 14, 2003, Omtool’s Board of Directors voted a one-for-seven stock splitof the Company’s Common Stock effective January 15, 2003 pursuant to a specialmeeting of stockholders that was held on the same day approving an amendment tothe Company’s Amended and Restated Certificate of Incorporation of the Companyto effect a reverse stock split.  OnFebruary 5, 2003, the Company was notified by Nasdaq that it had regainedcompliance.  The Company cannot predictthe impact, if any, of a change in listing to the SmallCap Market. In addition,the Company cannot predict the continuance of its listing status in the futureincluding the possibility of delisting from the Nasdaq Small Cap Market.  The delisting of the Company’s common stockfrom Nasdaq may materially impair the stockholder’s ability to buy and sellshares of the Company’s common stock and could have an adverse effect on themarket price of, and the efficiency of the trading market for, the Company’scommon stock.  Furthermore, the delistingof the Company’s common stock could significantly impair the Company’s abilityto raise capital should it desire to do so in the future.

 

*Intense Competition.*  The document routing and distributionsoftware, secure business-to-business electronic document exchange solution andenterprise, client/server facsimile solution markets are intensely competitiveand rapidly changing and the Company expects competition to continue toincrease. The Company believes its ability to compete successfully depends upona number of factors both within and beyond its control, including productperformance; reliability and features; product adoption; ease of use; productscalability; quality of support services; price/performance; timeliness ofenhancements and new

 

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product releases by the Companyand its competitors; the emergence of new computer-based facsimile and securebusiness-to-business electronic document exchange solutions and standards; namerecognition; the establishment of strategic alliances with industry leaders andindustry and general economic trends.

 

The Company may not be able to compete successfully against current andfuture competitors in the secure business-to-business electronic documentexchange solutions market, and the competitive pressures the Company facescould harm its business and prospects. In the intensely competitive and rapidlychanging business-to-business secure document exchange market, the Companycompetes directly with Authentica, Sigaba, Tumbleweed, and Zixit and a numberof other providers.  There are alsoother categories of technology solution that overlap and compete in certainways with aspects of the Company’s products. These include:

 

•                  Documentmanagement solutions from vendors such as Documentum, Hummingbird and iManagewhose electronic collaboration solutions compete with certain aspects of theCompany’s solutions;

•                  Electronicforms and electronic signature solutions from vendors such as Adobe, PureEdge,CreateForm and Silanis that offer the creation of electronic documents withelectronic signatures; and

•                  Securityinfrastructure solutions from vendors such as Verisign and Entrust whosesolutions can be used to build applications that enable secure documentcommunications.

 

The Company expects the competition in the business-to-business securedocument exchange market to increase over time.

 

The Company competes directly with a large number of vendors offacsimile products, including providers of facsimile software products forclient/server networks such as RightFAX (a subsidiary of Captaris), Fenestrae,TopCall International and Biscom. The Company also competes with providersoffering a range of alternative facsimile solutions including outsourcingnetwork facsimile solutions, such as Easylink Services; operating systemscontaining facsimile and document e-mail features; low-end fax modem products;providers of desktop fax software; single-platform facsimile software products;and customized proprietary software solutions. In addition, providers ofoperating systems or business software applications may bundle competitivefacsimile solutions as part of their broader product offerings.

 

Many of theCompany’s competitors and potential competitors have longer operating historiesand greater financial, technical, sales, marketing and other resources, as wellas greater name recognition and market acceptance of their products andtechnologies than the Company. In addition, there are relatively low barriersto entry in the markets in which the Company operates and intends to operate,and new competition may arise either from expansion by established companies orfrom new emerging companies or from resellers of the Company’s products. Therecan be no assurance that current or potential competitors of the Company willnot develop products comparable or superior—in terms of price and performancefeatures—to those developed by the Company, adapt more quickly than the Companyto new or emerging technologies and changes in market opportunities or customerrequirements, establish alliances with industry leaders, or take advantage ofacquisition opportunities more readily than the Company. In addition, noassurance can be given that the Company will not be required to makesubstantial additional investments in connection with its research,development, engineering, marketing, sales and customer service efforts inorder to meet any competitive threat, or that such required investments willnot have a material adverse effect on operating margins.  Changes in government laws and regulationsmay also affect our ability to maintain competitiveness.  Increased competition may result inreduction in market share, pressure for price reductions and related reductionsin gross margins, any of which could materially adversely affect the Company’sability to achieve its financial and business goals. There can be no assurancethat in the future the Company will be able to successfully compete againstcurrent and future competitors.

 

*Fluctuations in Quarterly Results ofOperations; Seasonality.*  The Company’s quarterly revenues and results of operations havefluctuated significantly in the past and will likely fluctuate significantly inthe future. Causes of such fluctuations have included and may include, amongothers, the demand for the Company’s products and services; the size and timingof orders; the number, timing and significance of new product announcements bythe Company and its competitors; the ability of the Company to develop,introduce, market and ship new and enhanced versions of the Company’s currentand planned products on a timely basis; the level of product and pricecompetition; changes in operating expenses; changes in average selling pricesand mix of the Company’s products; changes in the Company’s sales incentivestrategy; the mix of direct and indirect sales, and general economic factors,including a decline in the growth rate of the overall U.S. economy. Inaddition, the sale of the Company’s products often involves delays because customerstend to implement the products on a large scale and they also must establishcertain minimum hardware capabilities. The Company’s products therefore oftenhave a lengthy sales cycle while the customer evaluates and receives approvalsfor the purchase of the Company’s products. During such sales cycles, theCompany may expend substantial funds and management efforts yet receive norevenues. It is difficult to accurately predict the

 

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sales cycle of any large order.If one or more large orders fail to close as forecasted in a fiscal quarter,the Company’s revenues and operating results for such quarter could bematerially adversely affected. Any one or more of these or other factors couldhave a material adverse effect on the Company’s business, financial conditionand results of operations. The potential occurrence of any one or more of thesefactors makes the prediction of revenues and results of operations on aquarterly basis difficult and performance forecasts derived from suchpredictions unreliable.

 

In general,revenues are difficult to forecast because the market for securebusiness-to-business electronic document exchange, enterprise client/serverfacsimile solutions software and routing and distribution software is evolvingrapidly and the Company’s sales cycle—from the customer’s initial evaluationthrough purchase of licenses and the related support services—variessubstantially from customer to customer. License fee revenues in any quarter dependon orders received and shipped in that quarter with an increasing percentage oforders in any quarter being received in the last weeks of the quarter.  License fee revenues from quarter to quarterare difficult to forecast, as no significant order backlog exists at the end ofany quarter because the Company’s products typically are shipped upon receiptof customers’ orders.

 

A substantialportion of the Company’s operating expense is related to personnel, facilities,equipment and marketing programs. The level of spending for such expense cannotbe adjusted quickly and is therefore fixed in the short term. The Company’sexpense levels for personnel, facilities, equipment and marketing programs arebased, in significant part, on the Company’s expectations of future revenues ona quarterly basis. If actual revenue levels on a quarterly basis are belowmanagement’s expectations, results of operations are likely to be adverselyaffected by a similar amount because a relatively small amount of the Company’sexpense varies with its revenue in the short term.

 

Due to all ofthe foregoing factors, it is likely that in some future periods the Company’sresults of operations will be below the expectations of securities analysts andinvestors. In such event, the price of the Company’s common stock would likelybe materially adversely affected.

 

*Expansion of Indirect Channels; Potential forChannel Conflict; Strategic Alliances.*  The Company markets its products andservices directly through telesales and indirectly through marketing channelssuch as value added resellers (“VARs”), systems integrators, distributors andstrategic business partners. Although the Company has historically focused itsefforts on marketing through its sales force, the Company continues to utilizeresources to develop and expand indirect marketing channels. There can be noassurance that the Company will be able to attract and retain a sufficientnumber of qualified VARs, systems integrators, distributors and strategicbusiness partners to successfully market the Company’s products. In addition,there can be no assurance that the Company’s resellers and strategic businesspartners will not develop, acquire or market computer-based facsimile productsthat are competitive with the Company’s products. The failure to retain itsVARs, systems integrators, distributors and strategic partners could have amaterial adverse effect on the Company’s business, financial condition andresults of operations.

 

Thedistributor agreements generally provide that either party may terminate theagreement without cause upon 30 days written notice to the otherparty.  The Company also resells itsproducts on a purchase order basis through other VARs, systems integrators and distributors.  Either party may terminate suchrelationships, at any time, and therefore there can be no assurance that anyVAR, systems integrator or distributor will continue to represent the Company’sproducts.  Furthermore, the Company’sstrategic alliances may be terminated by either party, at any time; there canbe no assurances that such strategic alliances will continue.  The inability to retain certain VARs,systems integrators, distributors or strategic business partners, or thedevelopment or marketing by VARs, systems integrators, distributors orstrategic business partners of competitive offerings, could have a materialadverse effect on the Company’s business, financial condition and results ofoperations.

 

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

 

*Ability to obtain Additional Financing.** ***Weexpect our current cash, cash equivalents and investments will meet our normalworking capital and capital expenditure needs for at least the next twelvemonths.  We may need to raise additionalfunding at

 

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that time or earlier if wedecide to undertake more rapid expansion, including acquisitions of complementaryproducts or technologies, or if we increase our marketing and/or research anddevelopment efforts in order to respond to competitive pressures.  We cannot be certain that we will be able toobtain additional financing on favorable terms, if at all.  We may obtain additional financing byissuing shares of our common stock, which could dilute our existingstockholders.  If we cannot raise neededfunds on acceptable terms, or at all, we may not be able to develop or enhanceour products or respond appropriately to competitive pressures, which wouldseriously harm our business.

 

*Risks Associated with Acquisitions.*  The Company may augment its internal growthwith acquisitions of businesses, products and technologies that couldcomplement or expand the Company’s business. Certain of these businesses may bemarginally profitable or unprofitable. In order to achieve anticipated benefitsfrom these acquisitions, the Company must successfully integrate the acquiredbusinesses with its existing operations and no assurance can be given that theCompany will be successful in this regard. The Company has limited experiencein integrating acquired companies into its operations, in expanding the scopeof operations of required businesses, in managing geographically dispersedoperations and in operating internationally. In the past the Company hasincurred one-time costs and expenses in connection with acquisitions and it islikely that similar one-time costs and expenses would be incurred in connectionwith future acquisitions.  In addition,attractive acquisitions are difficult to identify and complete for a number ofreasons, including competition among prospective buyers and the possible needto obtain regulatory approval. There can be no assurance that the Company willbe able to complete future acquisitions. In order to finance such acquisitions,it may be necessary for the Company to raise additional funds either throughpublic or private financings, including bank borrowings.  Any financing, if available at all, may beon terms which are not favorable to the Company.  The Company may also issue shares of its common stock to acquiresuch businesses, which may dilute the Company’s existing stockholders.

 

*Ability to Manage Growth.*  The Company may expand its operations andanticipates that expansion may be required in order to address potential marketopportunities. The Company may increase the size of its sales and marketing andresearch and development expenditures as necessary. There can be no assurancethat such expansion would be completed successfully or that it would generatesufficient revenues to cover the Company’s expenses. The Company will need tocontinue to attract and retain highly qualified technical, sales and managerialpersonnel. There can be no assurance that the Company will be able to retain orcontinue to hire such personnel in the future. The inability of the Company toeffectively expand operations and manage growth, if any, could have a materialadverse effect on the Company’s business, financial condition and results ofoperations.

 

*RisksAssociated with the Use of Arthur Andersen as Independent Auditors. *Arthur Andersen LLP (“Andersen”), the Company’s former independentpublic accountants that audited the Company’s financial statements until June28, 2002, was found guilty by a jury on June 15, 2002 of federal obstruction ofjustice in connection with the government’s investigation of EnronCorporation.  Andersen ceased practicingbefore the SEC effective August 31, 2002. Although the Company has no reason to believe that those financialstatements are incorrect, it is possible that events arising out of theindictment may adversely affect Andersen’s ability to satisfy any claimsarising from its provision of auditing and other services to the Company,including claims that may arise out of Andersen’s audit of the Company’sfinancial statements.  The SEC hasindicated that it will continue accepting financial statements audited orreviewed by Andersen provided that the Company comply with the applicable rulesand orders issued by the SEC in March 2002 for such purpose.

* *

*Risks Associated with InternationalExpansion.*  Anelement of the Company’s strategy is to increase its international sales. TheCompany expects to face competition from secure business-to-business electronicdocument exchange solutions and local facsimile product providers in theirnative countries. To successfully maintain international sales, the Companyneeds to recruit and retain additional international resellers and distributors.There can be no assurance that the Company will be able to maintaininternational sales of its products or that the Company’s internationaldistribution channels will be able to adequately market, service and supportthe Company’s products. International operations generally are subject tocertain risks, including dependence on independent resellers, fluctuations inforeign currency exchange rates, compliance with foreign regulatory and marketrequirements, variability of foreign economic conditions and changingrestrictions imposed by United States export laws. Additional risks inherent inthe Company’s international business activities generally include unexpectedchanges in regulatory requirements, tariffs and other trade barriers, costs of localizingproducts for foreign countries, lack of acceptance of localized products inforeign countries, longer accounts receivable payment cycles, difficulties inmanaging international operations, difficulties in enforcing intellectualproperty rights and the burdens of complying with a wide variety of foreignlaws.  The Company has a sales officeoutside of the United States; such operations are subject to certain additionalrisks, including difficulties in staffing and managing such operations andpotentially adverse tax consequences including restrictions on the repatriationof earnings. There can be no assurance that such factors will not have amaterial adverse effect on the Company’s future international sales and,consequently, the Company’s business, financial condition and results ofoperations.

 

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To date, a majority of theCompany’s sales have been made in United States dollars and the Company has notengaged in any hedging transactions through the purchase of derivativesecurities or otherwise.

 

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

 

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Item 3. Quantitativeand Qualitative Disclosures About Market Risk

 

**Derivative Financial Instruments, OtherFinancial Instruments, and Derivative Commodity Instruments**

 

As of March31, 2004, the Company did not participate in any derivative financialinstruments or other financial and commodity instruments for which fair valuedisclosure would be required under SFAS No. 107,*Disclosures about Fair Value ofFinancial Instruments*. All of the Company’s investments consist ofmoney market funds and commercial paper that are carried on the Company’s booksat amortized cost, which approximates fair market value. Accordingly, theCompany has no quantitative information concerning the market risk ofparticipating in such investments.

 

**Primary Market Risk Exposures**

 

The Company’sprimary market risk exposures are in the areas of interest rate risk andforeign currency exchange rate risk. The Company’s investment portfolio of cashequivalents is subject to interest rate fluctuations, but the Company believesthis risk is immaterial due to the short-term nature of these investments. TheCompany’s exposure to currency exchange rate fluctuations has been and isexpected to continue to be modest due to the fact that the operations of itsUnited Kingdom subsidiary are almost exclusively conducted in its localcurrency. The United Kingdom subsidiary’s operating results are translated intoU.S. dollars and consolidated for reporting purposes. The impact of currencyexchange rate movements on intercompany transactions was immaterial for thequarter ended March 31, 2004. Currently, the Company does not engage in foreigncurrency hedging activities.

 

Item 4.Controls and Procedures

 

As of theend of the fiscal quarter (the “Evaluation Date”), the Company, under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and acting Chief Financial Officer,evaluated the effectiveness of the Company’s disclosure controls and procedurespursuant to Rule 13a-15(b) and 15d-15(b) promulgated under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”).  Based upon that evaluation, the Company’sChief Executive Officer and acting Chief Financial Officer concluded that, asof 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 Securities andExchange Commission’s rules and forms, including ensuring that such informationis accumulated and communicated to the Company’s management, including theCompany’s Chief Executive Officer and acting Chief Financial Officer, asappropriate to allow timely decisions regarding required disclosure.

 

There were no changes in theCompany’s internal controls over financial reporting during the Company’s lastfiscal quarter that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

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**PARTII:  OTHER INFORMATION**

 

Item 2.    Changes in Securities, use of Proceeds and IssuerPurchases of Equity Securities

 

*Private Placement*

 

On March 30, 2004, the Companysold 600,000 shares of common stock, at a price of $6.00 per share, in aprivate placement to institutional and other accredited investors.  In connection with that transaction, theCompany issued 51,000 shares of common stock at a price of $6.00 per share anda warrant to purchase an additional 51,000 shares of common stock, exercisableover a five-and-a-half-year period at a price of $6.00 per share, to itsfinancial advisor or its nominees for financial advisory services related tothe private placement.  The Companyintends to use the net proceeds of this private placement for additionalworking capital and general corporate purposes.

 

The offer and sale of securities in the transactiondescribed above was exempt from registration under the Securities Act inreliance upon Section 4(2) of the Securities Act of 1933, as amended (the“Securities Act”) and Regulation D promulgated thereunder, as a transaction byan issuer not involving any public offering. The shares in this transaction were offered and sold only to “accreditedinvestors,” as defined in Regulation D who represented their intentions toacquire the securities for investment only and not with a view to or for salein connection with any distribution thereof and appropriate legends wereaffixed to the securities issued in the private placement.

 

**ISSUER PURCHASES OFEQUITY SECURITIES**

 
| **Period**                                |   | **(a) Total  Number  of Shares   Purchased** |   | **(b)  Average Price    Paid per Share** |   | **(c) Total  Number of  Shares Purchased as Part  of Publicly Announced  Plans or Programs** |   | **(d)  Maximum Number  of Shares  that May Yet Be  Purchased Under the  Plans or Programs** |   |
|-------------------------------------------|--------|---------------------------------------------------|--------|-----------------------------------------------|--------|----------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------|--------|
| January 1, 2004 – January 31, 2004   |   | —                                            |   | —                                        |   | —                                                                                       |   | —                                                                                      |   |
| February 1, 2004 – February 29, 2004 |   | —                                            |   | —                                        |   | —                                                                                       |   | —                                                                                      |   |
| March 1, 2004 – March 31, 2004       |   | 350,000                                           | (1)    | $                                             | 5.75   |                                                                                         | — |                                                                                        | — |   |
| Total                                     |   | 350,000                                           |   | $                                             | 5.75   |                                                                                         | — |                                                                                        | — |   |

 

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(1) On March 31, 2004, the Company purchased 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.  The shares were purchased with the use ofgenerally available corporate funds and will be held in treasury.

 

Item 6.             Exhibitsand Reports on Form 8-K

 

(a)          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 |

 

(b)   Reports on Form 8-K

 

The Company furnisheda Report on Form 8-K, dated January 22, 2004, pursuant to Item 12 thereof furnishing the results of its operationsfor the quarter ended December 31, 2003.

 

25

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OMTOOL, LTD.

 

Signatures

 

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

 
|         | OMTOOL, LTD. |
|--------------|--------------|
|         |         |
| May 14, 2004 | By:          | /s/ Daniel  A. Coccoluto |   |
|         |         | Daniel A.  Coccoluto |
|         |         | Acting Chief  Financial Officer, Secretary and Treasurer |

 

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

 

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