** **

** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-Q**

 

(Mark One)

 

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

**Forthe quarterly period ended September 30, 2003**

** **

**OR**

** **

**o TRANSITION REPORT PURSUANT TO SECTION 13 OR15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**Forthe transition period from          to**

** **

**CommissionFile Number 0-22871**

 

**OMTOOL,LTD.**

(Exact Name of Registrantas Specified in Its Charter)

 

 

| **Delaware**                                                      | **02-0447481**                           |
|-------------------------------------------------------------------|------------------------------------------|
| (State  or Other Jurisdiction of

Incorporation  or Organization) | (I.R.S. Employer

Identification Number) |
|                                                              |                                     |
| **8A Industrial Way, Salem, NH**                                  | **03079**                                |
| (Address of Principal  Executive Offices)                         | (Zip Code)                               |
|                                                              |                                     |
| **(603) 898-8900**                                                |
| (Registrant’s Telephone  Number Including Area Code)         |
|                                                              |

 

Indicate by check mark whether the Registrant 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 1,749,964 shares of the Company’s CommonStock, par value $0.01, outstanding on November 11, 2003.

 

----

 

 

**OMTOOL, LTD. AND SUBSIDIARIES**

 

FORM 10-Q

For the Quarter EndedSeptember 30, 2003

CONTENTS

 
| Item Number                                                                                                                |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                       |   |
| PART I: FINANCIAL  INFORMATION                                                                                             |   |
|                                                                                                                       |   |
| Item  1.  Consolidated Financial Statements                                                                           |   |
| Consolidated Balance  Sheets as of September 30, 2003 (Unaudited) and December 31, 2002                                    |   |
| Consolidated  Statements of Operations for the three months and nine months ended September  30, 2003 and 2002 (Unaudited) |   |
| Consolidated  Statements of Cash Flows for the nine months ended September 30, 2003 and  2002 (Unaudited)                  |   |
| Notes to  Consolidated Financial Statements                                                                                |   |
|                                                                                                                       |   |
| Item 2.   Management’s Discussion and Analysis of Financial Condition and  Results of Operations                 |   |
|                                                                                                                       |   |
| Item 3.   Quantitative and Qualitative Disclosures About Market Risk                                                  |   |
|                                                                                                                       |   |
| Item 4.   Controls and Procedures                                                                                     |   |
|                                                                                                                       |   |
| PART II: OTHER INFORMATION                                                                                                 |   |
|                                                                                                                       |   |
| Item 6.   Exhibits and Reports on Form 8-K                                                                            |   |
|                                                                                                                       |   |
| Signatures                                                                                                                 |   |

 

2

----

**PART I:  FINANCIALINFORMATION**

Item 1.  ConsolidatedFinancial Statements

 

**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Balance Sheets**

 

** **
|                                                                                                                                                                                                                                   |   | **September  30,   2003** |       | **December  31, 2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|------------|------------------------|--------|
|                                                                                                                                                                                                                                   |   |                      |       |
|                                                                                                                                                                                                                                   |   | **(Unaudited)**           |       |                   |   |
| **Assets**                                                                                                                                                                                                                             |   |                      |       |                   |   |
| Current assets:                                                                                                                                                                                                                        |   |                      |       |                   |   |
| Cash and cash  equivalents                                                                                                                                                                                                             |   | $                         | 7,782,648  |                   | $      | 8,192,523 |   |
| Short-term  investments                                                                                                                                                                                                                |   | —                    |       | 1,597,155              |   |
| Accounts  receivable, less reserves of $372,000 at September 30, 2003 and $615,000 at  December 31, 2002                                                                                                                               |   | 1,525,438                 |       | 1,664,849              |   |
| Inventory —  finished goods                                                                                                                                                                                                       |   | 120,654                   |       | 187,918                |   |
| Prepaid expenses  and other current assets                                                                                                                                                                                             |   | 333,673                   |       | 420,083                |   |
| Total current  assets                                                                                                                                                                                                                  |   | 9,762,413                 |       | 12,062,528             |   |
|                                                                                                                                                                                                                                   |   |                      |       |                   |   |
| Property and  equipment, net                                                                                                                                                                                                           |   | 473,739                   |       | 615,703                |   |
| Other assets                                                                                                                                                                                                                           |   | 13,962                    |       | 13,962                 |   |
|                                                                                                                                                                                                                                   |   |                      |       |                   |   |
| Total assets                                                                                                                                                                                                                           |   | $                         | 10,250,114 |                   | $      | 12,692,193 |   |
|                                                                                                                                                                                                                                   |   |                      |       |                   |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                                          |   |                      |       |                   |   |
| Current  liabilities:                                                                                                                                                                                                                  |   |                      |       |                   |   |
| Accounts payable                                                                                                                                                                                                                       |   | $                         | 796,828    |                   | $      | 1,019,584 |   |
| Accrued  liabilities                                                                                                                                                                                                                   |   | 1,470,842                 |       | 1,665,046              |   |
| Accrued state  sales tax                                                                                                                                                                                                               |   | 937,177                   |       | 1,275,735              |   |
| Accrued  restructuring                                                                                                                                                                                                                 |   | 725,677                   |       | —                 |   |
| Deferred revenue                                                                                                                                                                                                                       |   | 3,315,404                 |       | 3,397,568              |   |
| Total current  liabilities                                                                                                                                                                                                             |   | 7,245,928                 |       | 7,357,933              |   |
|                                                                                                                                                                                                                                   |   |                      |       |                   |   |
| 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 — 1,858,439 shares at September 30, 2003 and  December 31, 2002, Outstanding —   1,749,964 and 1,744,500 shares at September 30, 2003 and December 31,  2002, respectively |   | 18,585                    |       | 18,585                 |   |
| Additional  paid-in capital                                                                                                                                                                                                            |   | 31,956,442                |       | 31,990,720             |   |
| Accumulated  deficit                                                                                                                                                                                                                   |   | (28,017,984               | )          | (25,671,834            | )      |
| Treasury stock,  at cost  (108,475 shares at September  30, 2003 and 113,939 shares at December 31, 2002)                                                                                                                         |   | (880,254                  | )          | (924,570               | )      |
| Accumulated  other comprehensive loss                                                                                                                                                                                                  |   | (72,603                   | )          | (78,641                | )      |
| Total  stockholders’ equity                                                                                                                                                                                                       |   | 3,004,186                 |       | 5,334,260              |   |
|                                                                                                                                                                                                                                   |   |                      |       |                   |   |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                       |   | $                         | 10,250,114 |                   | $      | 12,692,193 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

3

----

 

**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements ofOperations**

(Unaudited)

 
|                                                  |   | **Three  months ended   September 30,** |     | **Nine  months ended   September 30,** |   |
|-------------------------------------------------------|--------|-----------------------------------------|----------|----------------------------------------|--------|
|                                                  |   | **2003**                                |     | **2002**                               |   | **2003** |   | **2002** |   |
| Revenues:                                             |   |                                    |     |                                   |   |   |   |   |   |
| Software license                                      |   | $                                       | 983,595  |                                   | $      | 899,656 |   | $ | 2,971,873 |   | $ | 3,041,068 |   |
| Hardware                                              |   | 710,189                                 |     | 712,509                                |   | 1,827,528 |   | 2,143,808 |   |
| Service and  other                                    |   | 1,856,348                               |     | 1,925,714                              |   | 5,064,671 |   | 5,607,134 |   |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Total revenues                                        |   | 3,550,132                               |     | 3,537,879                              |   | 9,864,072 |   | 10,792,010 |   |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Cost of  revenues:                                    |   |                                    |     |                                   |   |   |   |   |   |
| Software license                                      |   | 86,820                                  |     | 84,948                                 |   | 237,635 |   | 237,793 |   |
| Hardware                                              |   | 432,000                                 |     | 437,355                                |   | 1,231,520 |   | 1,398,172 |   |
| Service and  other                                    |   | 816,610                                 |     | 867,780                                |   | 2,414,010 |   | 2,466,957 |   |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Total cost of  revenues                               |   | 1,335,430                               |     | 1,390,083                              |   | 3,883,165 |   | 4,102,922 |   |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Gross profit                                          |   | 2,214,702                               |     | 2,147,796                              |   | 5,980,907 |   | 6,689,088 |   |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Operating  expenses:                                  |   |                                    |     |                                   |   |   |   |   |   |
| Sales and  marketing                                  |   | 1,038,515                               |     | 1,332,134                              |   | 3,707,037 |   | 4,854,374 |   |
| Research and  development                             |   | 562,893                                 |     | 586,200                                |   | 1,735,014 |   | 2,282,125 |   |
| General and  administrative                           |   | 796,729                                 |     | 1,089,262                              |   | 2,354,947 |   | 3,748,405 |   |
| Restructuring                                         |   | 806,581                                 |     | —                                 |   | 806,581 |   | — |   |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Total operating  expenses                             |   | 3,204,718                               |     | 3,007,596                              |   | 8,603,579 |   | 10,884,904 |   |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Loss from  operations                                 |   | (990,016                                | )        | (859,800                               | )      | (2,622,672 | ) | (4,195,816 | ) |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Interest and  other income, net                       |   | 67,761                                  |     | 49,940                                 |   | 121,124 |   | 147,611 |   |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Loss before tax  (benefit) provision                  |   | (922,255                                | )        | (809,860                               | )      | (2,501,548 | ) | (4,048,205 | ) |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Tax (benefit)  provision                              |   | —                                  |     | —                                 |   | (155,398 | ) | 1,225,350 |   |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Net loss                                              |   | $                                       | (922,255 | )                                      | $      | (809,860 | ) | $ | (2,346,150 | ) | $ | (5,273,555 | ) |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Net loss per  share                                   |   |                                    |     |                                   |   |   |   |   |   |
| Basic and  Diluted                                    |   | $                                       | (0.53)   |                                   | $      | (0.45) |   | $ | (1.34) |   | $ | (2.91) |   |
|                                                  |   |                                    |     |                                   |   |   |   |   |   |
| Weighted  average number of common shares outstanding |   |                                    |     |                                   |   |   |   |   |   |
| Basic and  diluted                                    |   | 1,746,848                               |     | 1,802,497                              |   | 1,747,581 |   | 1,810,651 |   |

 

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

 

4

----

**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements of CashFlows**

(Unaudited)

 
|                                                                              |   | **Nine  months ended   September 30,** |       |
|-----------------------------------------------------------------------------------|--------|----------------------------------------|------------|
|                                                                              |   | **2003**                               |       | **2002** |   |
| Cash Flows from  Operating Activities:                                            |   |                                   |       |   |   |
| Net loss                                                                          |   | $                                      | (2,346,150 | ) | $ | (5,273,555 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities— |   |                                   |       |   |   |
| Depreciation and  amortization                                                    |   | 323,373                                |       | 388,632 |   |
| Deferred taxes                                                                    |   | —                                 |       | 1,225,350 |   |
| Accounts  receivable reserve                                                      |   | (247,912                               | )          | 80,000 |   |
| Changes in  assets and liabilities—                                          |   |                                   |       |   |   |
| Accounts  receivable                                                              |   | 397,151                                |       | 400,915 |   |
| Prepaid expenses  and other current assets                                        |   | 88,252                                 |       | 138,332 |   |
| Inventory                                                                         |   | 67,785                                 |       | 18,435 |   |
| Accounts payable                                                                  |   | (226,053                               | )          | (194,847 | ) |
| Accrued  liabilities                                                              |   | (202,356                               | )          | (98,354 | ) |
| Accrued state  sales tax                                                          |   | (338,558                               | )          | 971,894 |   |
| Accrued  restructuring                                                            |   | 725,677                                |       | — |   |
| Deferred revenue                                                                  |   | (96,071                                | )          | (323,219 | ) |
|                                                                              |   |                                   |       |   |   |
| Net cash used in  operating activities                                            |   | (1,854,862                             | )          | (2,666,417 | ) |
|                                                                              |   |                                   |       |   |   |
| Cash Flows from  Investing Activities:                                            |   |                                   |       |   |   |
| Purchases of  property and equipment                                              |   | (180,338                               | )          | (247,309 | ) |
| Purchases of  short-term investments                                              |   | (1,999,449                             | )          | — |   |
| Proceeds from  sale of short-term investments                                     |   | 3,596,604                              |       | 1,296,750 |   |
|                                                                              |   |                                   |       |   |   |
| Net cash  provided by investing activities                                        |   | 1,416,817                              |       | 1,049,441 |   |
|                                                                              |   |                                   |       |   |   |
| Cash Flows from  Financing Activities:                                            |   |                                   |       |   |   |
| Net proceeds  from issuance of common stock                                       |   | 10,037                                 |       | 19,083 |   |
| Purchases of  treasury stock                                                      |   | —                                 |       | (255,339 | ) |
|                                                                              |   |                                   |       |   |   |
| Net cash  provided by (used in) financing activities                              |   | 10,037                                 |       | (236,256 | ) |
|                                                                              |   |                                   |       |   |   |
| Foreign exchange  effect on cash                                                  |   | 18,133                                 |       | 34,858 |   |
|                                                                              |   |                                   |       |   |   |
| Net decrease in  cash and cash equivalents                                        |   | (409,875                               | )          | (1,818,374 | ) |
|                                                                              |   |                                   |       |   |   |
| Cash and cash  equivalents, beginning of period                                   |   | 8,192,523                              |       | 11,194,118 |   |
|                                                                              |   |                                   |       |   |   |
| Cash and cash  equivalents, end of period                                         |   | $                                      | 7,782,648  |   | $ | 9,375,744 |   |

 

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

 

5

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Notes to Consolidated FinancialStatements**

(Unaudited)

 

**(1)     Basis of Presentation**

 

The accompanying unaudited consolidated financial statements have beenprepared by Omtool, Ltd. (the “Company” or “Omtool”) pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”) regarding interimfinancial reporting.  Accordingly, theydo not include all of the information and footnotes required by generallyaccepted accounting principles for complete financial statements and should beread in conjunction with the consolidated financial statements and notesthereto for the year ended December 31, 2002 as filed with the SEC on March 11,2003. The accompanying consolidated financial statements reflect alladjustments (consisting of normal recurring adjustments) which are, in theopinion of management, necessary for a fair presentation of results for theinterim periods presented.  The resultsof operations for the nine month period ended September 30, 2003 are notnecessarily indicative of the results to be expected for the full fiscal year.

 

The Company’s total revenues for the first nine monthsof 2003 declined 9% from total revenues for the first nine months of 2002primarily due to the general decline in information technology spending and adecrease in demand for enterprise software solutions as well as a decrease inservice revenues related to the Company’s legacy fax products.  This decrease in demand for enterprisesoftware solutions reflected the overall sluggishness of the United Stateseconomy in the first nine months of 2003 causing customers and prospectivecustomers to defer technology purchases. The Company’s net loss improved from $5.3 million for the nine monthsended September 30, 2002 to $2.3 million for the nine months ended September30, 2003 due primarily to reduced operating expenses associated with thereduction in the Company’s workforce and a $1.2 million tax provisionrecognized in the second quarter of 2002. The Company has experienced continued operating losses over an extendedperiod of time.  As a result of thelosses incurred and the anticipation of a continuing decline in the UnitedStates economy, the Company reduced its work force by 13 people during the thirdquarter of 2003.  Additionally, theCompany closed its Oregon office in September 2003.  These actions reduced the overall expected cost of operations byapproximately $1.5 million annually. Based upon the current economic environment, general softness ininformation technology spending, products that may not achieve marketacceptance, and limited forecasting visibility, the Company cannot predict thatthe financial and operating performance, financial position or cash flow willimprove over the next twelve months. The Company’s cash and cash equivalents at September 30, 2003 were$7.8 million. The Company anticipates that its balance of cash and cashequivalents will be approximately $7 million to $8 million at the end of 2003.The Company believes that its existing cash and cash equivalents will besufficient to meet the Company’s working capital and capital expenditures forat least the next twelve months.

 

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

 

                The Company reports earnings pershare in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 128,*Earnings per Share*.  Dilutedweighted average shares outstanding for the three months ended September 30,2003 and September 30, 2002 exclude the potential common shares related to370,222 and 386,038, respectively, outstanding stock options because to includethem would have been antidilutive for the periods presented.

 

**(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 continuedeconomic uncertainty, the Company has provided a full valuation allowanceagainst all of its net deferred tax assets and will do so until it returns toan appropriate level of taxable income. The ultimate realization of these deferred tax assets depends upon theCompany’s ability to generate sufficient future taxable income. If the Companyis successful in generating sufficient future taxable income, the Company willreduce the valuation allowance through a reduction in income tax expense in thefuture.

 

6

----

 

During the nine months ended September 30, 2003, the Company recorded$155,398 of tax benefit due to a tax refund that its United Kingdom subsidiaryreceived during the first quarter of 2003. This subsidiary had incurred a loss for the year ended December 31, 1999which resulted in an income tax benefit. The tax benefit was carried back to prior years’ taxes paid and resultedin a tax refund.  Because the subsidiarywas undergoing an Inland Revenue audit for tax year 1999, there existed doubtabout 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.

 

During the quarter ended September 30, 2002, the Company recorded anadditional valuation allowance of $1.2 million against all of its net deferredtax assets. As a result of the downturn in the economy in the first half of2002, the Company had incurred significant and previously unanticipated lossesand the outlook indicated that significant uncertainty would continue for theremainder of that fiscal year and into the following fiscal year. Thesecumulative losses, together with the Company’s prior losses, resulted inmanagement’s decision that it was more likely than not that all of its deferredtax assets would not be realized in the then foreseeable future.  Accordingly, the remaining net deferred taxasset was written off in the second quarter of 2002.

 

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

 

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

 
|                                      |   | **Three  months ended   September 30,** |     | **Nine  months ended   September 30,** |   |
|-------------------------------------------|--------|-----------------------------------------|----------|----------------------------------------|--------|
|                                      |   | **2003**                                |     | **2002**                               |   | **2003** |   | **2002** |   |
| Net loss                                  |   | $                                       | (922,255 | )                                      | $      | (809,860 | ) | $ | (2,346,150 | ) | $ | (5,273,555 | ) |
| Foreign currency  translation adjustments |   | 7,883                                   |     | 3,976                                  |   | 6,038 |   | 2,331 |   |
| Comprehensive  loss                       |   | $                                       | (914,372 | )                                      | $      | (805,884 | ) | $ | (2,340,112 | ) | $ | (5,271,224 | ) |

 

**(5)       Stock Based Compensation**

 

The Company accounts for stock-based compensation foremployees under the recognition and measurement principles of APB Opinion No.25, *Accountingfor Stock Issued to Employees,* and related interpretations.  The following table illustrates the effecton net loss and net loss per share if the Company had applied the fair valuerecognition provisions of FASB Statement No. 123, *Accounting for Stock-BasedCompensation,* to stock-based employee compensation.

 
|                                                                                                       |   | **Three  months Ended   September 30,** |       | **Nine  months Ended   September 30,** |   |
|------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|------------|----------------------------------------|--------|
|                                                                                                       |   | **2003**                                |       | **2002**                               |   | **2003** |   | **2002** |   |
|                                                                                                       |   |                                    |       |                                   |   |   |   |   |   |
| Net loss, as reported                                                                                      |   | $                                       | (922,255   | )                                      | $      | (809,860 | ) | $ | (2,346,150 | ) | $ | (5,573,555 | ) |
| Deduct: Total stock-based employee compensation expense determined  under fair value method for all awards |   | (134,974                                | )          | (243,039                               | )      | (575,156 | ) | (752,896 | ) |
| Pro forma net loss                                                                                         |   | $                                       | (1,057,229 | )                                      | $      | (1,052,899 | ) | $ | (2,921,306 | ) | $ | (6,326,451 | ) |
|                                                                                                       |   |                                    |       |                                   |   |   |   |   |   |
| Net loss per share:                                                                                        |   |                                    |       |                                   |   |   |   |   |   |
| Basic and diluted, as reported                                                                             |   | $                                       | (0.53      | )                                      | $      | (0.45 | ) | $ | (1.34 | ) | $ | (2.91 | ) |
| Basic and diluted, pro forma                                                                               |   | $                                       | (0.60      | )                                      | $      | (0.58 | ) | $ | (1.67 | ) | $ | (3.49 | ) |

 

**(6)           RestructuringCosts**

 

In the third quarter of 2003, the Company announced a restructuring ofcertain of its operations, and recorded a non-recurring pretax charge of$806,581 in accordance with SFAS No. 146, *Accounting for Costs Associated with Exit or DisposalActivities.* Thenon-recurring charge includes severance-related costs associated with theworkforce reduction in the Company’s domestic operations and costs associatedwith the closing of its Oregon office. The reduction in workforce consisted of three employees in the Company’ssales 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 the closure of the Company’s Oregon facility.

 

7

----

 

 

The following table summarizes the accrualand usage of the restructuring charges in 2003:

* *
|                                |   | **Lease** |   | **Severance** |   | **Total** |   |
|-------------------------------------|--------|-----------|--------|---------------|--------|-----------|--------|
| Total charge                        |   | $         | 17,420 |          | $      | 789,161   |   | $ | 806,581 |   |
| Cash payments                       |   | (5,332    | )      | (75,572       | )      | (80,904   | )      |
| Ending balance,  September 30, 2003 |   | $         | 12,088 |          | $      | 713,589   |   | $ | 725,677 |   |

 

The total cash impact of the restructuring is$806,581 which the Company anticipates will be paid by the end of the thirdquarter of 2004.  As of September 30,2003, the Company paid $80,904, and has a remaining liability of $725,677.

 

**(7)      ****Segment and Geographic Information**

 

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

 

Totalrevenues from international sources were $624,000 and $1.8 million for thethree months and nine months ended September 30, 2003, respectively, and$711,000 and $2.0 million for the three months and nine months ended September30, 2002, respectively. The Company’s revenues from international sources wereprimarily generated from customers located in Europe. The following tablerepresents amounts relating to geographic locations:

 
|                      |   | **Three  months ended   September 30, ,** |      | **Nine  months ended   September 30** |   |
|---------------------------|--------|-------------------------------------------|-----------|---------------------------------------|--------|
| **Total  revenues (1)**   |   | **2003**                                  |      | **2002**                              |   | **2003** |   | **2002** |   |
|                      |   |                                      |      |                                  |   |   |   |   |   |
| United States             |   | $                                         | 2,926,623 |                                  | $      | 2,826,718 |   | $ | 8,083,275 |   | $ | 8,815,399 |   |
| Europe                    |   | 375,682                                   |      | 336,969                               |   | 1,259,890 |   | 1,175,156 |   |
| Rest of World             |   | 247,827                                   |      | 374,192                               |   | 520,907 |   | 801,457 |   |
|                      |   | $                                         | 3,550,132 |                                  | $      | 3,537,879 |   | $ | 9,864,072 |   | $ | 10,792,012 |   |
|                      |   |                                      |      |                                  |   |   |   |   |   |   |   |   |   |
| **Long-lived assets (2)** |   | **September 30,   2002**                  |      | **December  31,   2003**         |   |   |
| United States             |   | $                                         | 469,754   |                                  | $      | 600,116 |   |   |
| United Kingdom            |   | 17,947                                    |      | 29,549                                |   |   |
|                      |   | $                                         | 487,701   |                                  | $      | 629,665 |   |   |

 

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

(2) Long-lived assets include all long-term assets except those specificallyexcluded under SFAS No. 131 such as deferred income taxes and financialinstruments.

 

 

**(8)       Guarantees**

 

In November 2002, the FASBissued FASB Interpretation 45,*Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*(“FIN 45”). FIN 45 elaborates on the existing disclosure requirements for mostguarantees, including loan guarantees such as standby letters of credit. Italso clarifies that at the time a company issues a guarantee, the company mustrecognize an initial liability for the fair value, or market value, and of theobligations it assumes under the guarantee and must disclose that informationin its interim and annual financial statements. The provisions related torecognizing a liability at inception of the guarantee for the fair value of theguarantor’s obligations does not apply to product warranties or to guaranteesaccounted for as derivatives. The disclosure requirements are effective forfinancial statements issued after December 15, 2002 and therecognition/measurement requirements are effective on a prospective basis for 

 

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guarantees issued or modified after December 31, 2002. The following is a summary of theCompany’s agreements that it has determined are within the scope of FIN 45.

                As permitted underDelaware law, the Company has agreements whereby it indemnifies its officersand directors for certain events or occurrences while the officer or directoris, or was serving, at the Company’s request in such capacity. The term of theindemnification period is for the officer’s or director’s lifetime. The maximumpotential amount of future payments the Company could be required to make underthese indemnification agreements is unlimited; however, the Company has a Directorand Officer insurance policy that limits its exposure and enables it to recovera portion of any future amounts paid. As a result of its insurance policycoverage, the Company believes that the estimated fair value of theseindemnification agreements is minimal.

 

The Company enters into standard indemnificationagreements in its ordinary course of business. Pursuant to these agreements,the Company indemnifies, holds harmless, and agrees to reimburse theindemnified party for losses suffered or incurred by the indemnified party,generally its resellers or certain customers, in connection with any U.S.patent, or any copyright or other intellectual property infringement claim byany third party with respect to its products. The term of these indemnificationagreements is generally perpetual any time after execution of the agreement.The maximum potential amount of future payments the Company could be requiredto make under these indemnification agreements is unlimited. The Company hasnever incurred costs to defend lawsuits or settle claims related to theseindemnification agreements. As a result, the Company believes that theestimated fair value of these agreements is minimal.

                The Company warrants thatits software products will perform in all material respects in accordance withits standard published specifications in effect at the time of delivery of thelicensed products to certain of its customers for the life of the product. Ifnecessary, the Company would provide for the estimated cost of product warrantybased on specific warranty claims and claim history, however, the Company hasnever incurred significant expense under its product warranty. As a result, theCompany believes that the estimated fair value of these agreements is minimal.

 

**(9)           Recently Issued Accounting Standards**

                In November 2002, the FASBEmerging Issues Task Force released Issue No. 00-21, *Accounting for Revenue Arrangementswith Multiple Deliverables* (“EITF 00-21”). EITF 00-21 addressescertain aspects of the accounting by a vendor for arrangements under which itwill perform multiple revenue-generating activities. EITF 00-21 establishesthree principles: (a) revenue arrangements with multiple deliverables should bedivided into separate units of accounting; (b) arrangement consideration shouldbe allocated among the separate units of accounting based on their relativefair values; and (c) revenue recognition criteria should be consideredseparately for separate units of accounting. EITF 00-21 is effective for allarrangements entered into in fiscal periods beginning after June 15, 2003, withearly adoption permitted. The Company has reviewed and evaluated the scope ofEITF 00-21 and determined that  EITF00-21 does not impact  the  Company’s financial statements (seediscussion below).

                In August 2003, the FASBEmerging Issues Task Force released Issue No. 03-5, *Applicability of AICPA Statement ofPosition 97-2 to Non-Software Deliverables in an Arrangement ContainingMore-Than-Incidental Software* (“EITF 03-05”). EITF 03-05 focusessolely on whether non-software deliverables included in arrangements thatcontain more-than-incidental software are included within the scope of SOP97-2. EITF 03-05 is effective for all arrangements entered into in fiscalperiods beginning after August 13, 2003. The Company has determined that all of its deliverables are consideredsoftware and software-related elements and therefore are within the scope ofSOP 97-2. Therefore, the Company does not believe that  EITF 03-05 will have an impact on the Company’sfinancial statements.

 

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**Item2.**

**MANAGEMENT’SDISCUSSION AND ANALYSIS**

**OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

                Management’sDiscussion and Analysis of Financial Condition and Results of Operations shouldbe read in conjunction with the accompanying consolidated financial statementsfor the periods specified and the associated notes.  Further reference should be made to the Company’s Annual Reporton Form 10-K as filed with the Securities Exchange Commission on March 11,2003.

 

**Overview**

 

                Omtool, Ltd. is a leading provider of e-mail andfax-based messaging software that enables secure, confirmed document exchangebetween businesses. The Company wasincorporated in March 1991 and shipped its initial facsimile softwareproducts in 1991. Omtool’s GenidocsTM product family enables users throughout anenterprise to deliver confidential and secure e-mail over the Internet.  Omtool’s AccuRouteTM software enables usersto deliver a hardcopy document from certain digital scanning andmultifunctional devices to multiple recipients, via multiple channels,simultaneously using a method that is as simple as using a photocopier. Themultiple channels consist of fax, e-mail, or a document management system.Omtool’s Fax Sr.TM, LegalFaxTM and GenifaxTM product families provide userswith an extensive, flexible feature set for transmitting and receiving faxesand improve an organization’s management of its fax communications process byproviding a suite of utility and control functions. A significant portion ofthe Company’s revenues is derived from licensing rights to use its Genifax andFax Sr. software products directly to end-users and indirectly throughresellers.

 

The Company’s total revenues for the first nine monthsof 2003 declined 9% from total revenues for the first nine months of 2002primarily due to the general decline in information technology spending and adecrease in demand for enterprise software solutions.  This decrease reflected the overall sluggishness of the UnitedStates economy in the first nine months of 2003 causing customers andprospective customers to defer technology purchases.  The Company’s net loss improved from $5.3 million for the ninemonths ended September 30, 2002 to $2.3 million for the nine months endedSeptember 30, 2003 due primarily to reduced operating expenses associated withthe reduction in the Company’s workforce and a $1.2 million tax provisionrecognized in the second quarter of 2002. The Company has experienced operating losses over an extended period oftime.  As a result of the lossesincurred and the anticipation of a continuing decline in the United Stateseconomy, the Company reduced its work force by 13 people during the thirdquarter of 2003.  Additionally, theCompany closed its Oregon office in September 2003.  These actions reduced the overall expected cost of operations byapproximately $1.5 million annually. Based upon the current economic environment, general softness in informationtechnology spending, products that may not achieve market acceptance, and limitedforecasting visibility, the Company cannot predict that the financial andoperating performance, financial position or cash flow will improve over thenext twelve months.  The Company’s cashand cash equivalents at September 30, 2003 were $7.8 million. The Companyanticipates that its balance of cash and cash equivalents will be approximately$7 million to $8 million at the end of 2003. The Company believes that itsexisting cash and cash equivalents will be sufficient to meet the Company’sworking capital and capital expenditures for at least the nexttwelve months.

 

                The Company cannot predict when themarket for enterprise software solutions will improve. When the market doesimprove, the Company cannot predict whether, and to what extent, the demand forits products will increase.  The Companybelieves that the current lack of demand for enterprise software solutions willcontinue for the foreseeable future, and that its operations and financialresults will continue to be negatively affected during that period. Anycontinued decline in the Company’s revenues will have a significant impact onthe Company’s financial results, particularly because a significant portion ofthe Company’s operating costs (such as personnel, rent and depreciation) arefixed in advance of a particular quarter. As a result, the Company’s costs forsales and marketing, research and development and general and administrativecould continue to increase as a percentage of revenues, thereby affecting theCompany’s operating results.

 

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                TheCompany’s future revenues and operating results may fluctuate from quarter toquarter based on the number and size of sales transactions the Company entersinto with customers, the adequacy of provisions for losses, general economicconditions and other factors. In addition, revenue from a large order mayconstitute a significant portion of the Company’s total revenues in aparticular quarter.

 

The Company hashistorically derived a substantial portion of its total revenues from saleswithin North America. Sales outside of North America (primarily in Europe)represented 14% and 13% of the Company’s total revenues for the nine monthsended September 30, 2003 and 2002, respectively.

 

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 policy willeliminate 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 Companycontinues to actively recruit value-added resellers (“VARs”), systemsintegrators, resellers and distributors to expand its indirect distributionchannel. The Company is pursuing sales opportunities via its solution/resellerchannel as well as focusing sales efforts on specific market segments in orderto facilitate product acceptance.  Salesthrough the Company’s indirect distribution channels represented 25% and 20% ofthe Company’s total revenues for the nine months ended September 30, 2003 and2002, respectively.

 

## **Critical AccountingPolicies and Estimates**

 

                The Company hasidentified 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.

 

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

 

The Company applies the provisions of Statement ofPosition (“SOP”) 97-2, *Software Revenue Recognition*, as amendedby SOP 98-9, Modification of SOP 97-2, *Software Revenue Recognition, With Respect to CertainTransactions*, to all transactions involving the sale of multipleelements including software, hardware and service revenue.  In December 1999, the SEC issued StaffAccounting Bulletin (“SAB”) No. 101, *Revenue Recognition in Financial Statements*.This bulletin establishes guidelines for revenue recognition. The Company’srevenue recognition policy complies with this pronouncement as well.  The Company applies the provisions of SFASNo. 48, *RevenueRecognition When Right of Return Exists*, with respect to providingfor potential future product returns. As described below, significantmanagement judgments and estimates must be made and used in connection with therevenue recognized in any accounting period. Material differences may result in the amount and timing of theCompany’s revenue if management made different judgments or utilized differentestimates.

 

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                The Companyrecognizes revenue from the sale of software products and hardware to bothend-users and resellers when persuasive evidence of an arrangement exists, theproducts have been delivered, the fee is fixed or determinable, collection ofthe resulting receivable is reasonably assured and there are no customeracceptance provisions. The Company maintains a reserve for potential productreturns. Software maintenance and support revenue is recognized ratably overthe term of the related maintenance period, typically one-year.  Other services revenue is recognized as theservices are performed. If an arrangement includes an acceptance provision, theCompany will defer all revenue until the customer accepts the products.  Acceptance generally occurs upon the earlierof receipt of a written customer acceptance or expiration of the acceptanceperiod.                The Company’s transactionsfrequently involve the sales of software, hardware and related services undermultiple element arrangements. Revenue under multiple element arrangements isallocated to each element under the residual method, in accordance with SOP98-9, Modification of SOP 97-2,*Software Revenue Recognition, With Respect toCertain Transactions*. Under this method, revenue is allocated firstto all undelivered elements, such as services, based on the fair value of thoseelements, which is the price charged when these elements are sold separatelyand unaccompanied by other elements. The Company’s services are not essential to the functionality of thesoftware as these services do not alter the capabilities of the software and donot carry a significant degree of risk to perform. The amount allocated to thedelivered elements, such as software license and hardware revenue, is thedifference between the total arrangement value and the amount allocated to theundelivered elements. If the delivered elements include both software andhardware, the amount allocated to hardware revenue is based on the pricecharged to the Company by the third party vendor plus an additional mark up,with the remainder allocated to software revenue. To the extent that a discountis offered in the arrangement, the entire discount is allocated to thedelivered element or elements. If the delivered elements include hardware andsoftware, the discount is allocated to the hardware and software based on theirrespective list prices.

                For all sales, the Companyuses 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 reports forall 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 forpotential product returns and makes adjustments to the reserve as needed, basedon historical product return rates, and considers the impact of new productintroductions, changes in customer demand and acceptance of the Company’sproducts.  Management’s calculation ofthe estimated return reserve is based upon (1) an account specific review ofpotential returns, where a return probability is known, and (2) a generalestimate based upon past historical returns as a percentage of revenue.Significant management judgments and estimates must be made and used inconnection with establishing the sales returns reserve in any accountingperiod. Material differences may result in the amount and timing of revenue forany period if management made different judgments or utilized differentestimates.  Similarly, management mustmake estimates of the uncollectability of the Company’s accountsreceivable.  Management specificallyanalyzes accounts receivable and historical bad debts, customercredit-worthiness, current economic trends and changes in customer paymentpatterns when evaluating the adequacy of the allowance for doubtful accounts.  Management’s calculation of the estimatedaccounts receivable reserve is based upon (1) an account specific review ofpotential uncollectible accounts, where a bad debt probability is known and (2)a general estimate based upon past historical bad debts as a percentage ofaccounts receivable.

 

                The Company’scombined accounts receivable and returns reserve was $372,000 and $720,000 asof September 30, 2003 and 2002, respectively. Both components of calculating the estimated reserve, specificidentification and historic ratio, are material judgments.  These judgments are based on historictrends, taking into consideration current business and economic 

 

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conditions, which could change materially, thus changing the requiredreserve level materially.  The potentialchange could be positive, in the event the reserve estimate proves unnecessary,or negative, 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 considered for capitalization whentechnological feasibility is established in accordance with SFAS No. 86, *Accountingfor the Costs of Computer Software To Be Sold, Leased or**OtherwiseMarketed*. The Company sells software in a market that is subject torapid technological change, new product introductions and changing customerneeds. Accordingly, the Company has determined that it cannot determinetechnological feasibility until the development state of the product is nearlycomplete. The time period during which cost could be capitalized from the pointof reaching technological feasibility until the time of general product releaseis very short and, consequently, the amounts that might be capitalized are notmaterial to the Company’s consolidated financial position or results ofoperations. Therefore, the Company charges all software development costs tooperations in the period incurred.

 

*Taxes*. The Company is required to estimate its income and state sales taxes.This process involves estimating the Company’s actual current tax obligationstogether with assessing differences resulting from the different treatment ofitems for tax and accounting purposes which result in deferred income taxassets and liabilities and accrued state sales tax liabilities. The Company hasdeferred income tax assets and liabilities and accrued state sales taxliabilities 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 will continue to provide a valuationallowance against all of its net deferred tax assets until it returns to an appropriatelevel of taxable income. The ultimate realization of these deferred tax assetsdepends upon the Company’s ability to generate sufficient future taxableincome. If the Company is successful in generating sufficient future taxableincome, the Company will reduce the valuation allowance through a reduction inincome tax expense in the future.

 

**               **Accrued state sales taxes are estimatedfor each reporting period based on tax rates in effect for the reportingperiods in each of the states where the Company has potential nexus. In theevent that actual results differ from these estimates, the Company’s statesales taxes expense could be materially impacted.

 

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**Resultsof Operations**

 

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

 
|                            |   | **Three  months ended   September 30,** |   | **Nine  months ended   September 30,** |   |
|---------------------------------|--------|-----------------------------------------|--------|----------------------------------------|--------|
|                            |   | **2003**                                |   | **2002**                               |   | **2003** |   | **2002** |   |
| Revenues:                       |   |                                    |   |                                   |   |   |   |   |   |
| Software license                |   | 27.7                                    | %      | 25.4                                   | %      | 30.1 | % | 28.1 | % |
| Hardware                        |   | 20.0                                    |   | 20.2                                   |   | 18.5 |   | 19.9 |   |
| Service and  other              |   | 52.3                                    |   | 54.4                                   |   | 51.4 |   | 52.0 |   |
| Total revenues                  |   | 100.0                                   |   | 100.0                                  |   | 100.0 |   | 100.0 |   |
| Cost of  revenues:              |   |                                    |   |                                   |   |   |   |   |   |
| Software license                |   | 2.4                                     |   | 2.4                                    |   | 2.4 |   | 2.2 |   |
| Hardware                        |   | 12.2                                    |   | 12.4                                   |   | 12.5 |   | 13.0 |   |
| Service and  other              |   | 23.0                                    |   | 24.5                                   |   | 24.5 |   | 22.9 |   |
| Total cost of  revenues         |   | 37.6                                    |   | 39.3                                   |   | 39.4 |   | 38.1 |   |
| Gross profit                    |   | 62.4                                    |   | 60.7                                   |   | 60.6 |   | 61.9 |   |
| Operating  expenses:            |   |                                    |   |                                   |   |   |   |   |   |
| Sales and  marketing            |   | 29.3                                    |   | 37.7                                   |   | 37.5 |   | 45.0 |   |
| Research and  development       |   | 15.9                                    |   | 16.6                                   |   | 17.6 |   | 21.1 |   |
| General and  administrative     |   | 22.4                                    |   | 30.8                                   |   | 23.9 |   | 34.7 |   |
| Restructuring                   |   | 22.7                                    |   | 0.0                                    |   | 8.2 |   | 0.0 |   |
| Total operating  expenses       |   | 90.3                                    |   | 85.1                                   |   | 87.2 |   | 100.8 |   |
| Loss from  operations           |   | (27.9                                   | )      | (24.4                                  | )      | (26.6 | ) | (38.9 | ) |
| Interest and  other income, net |   | 1.9                                     |   | 1.4                                    |   | 1.2 |   | 1.4 |   |
| Tax benefit  (provision)        |   | —                                  |   | —                                 |   | 1.6 |   | (11.4 | ) |
|                            |   |                                    |   |                                   |   |   |   |   |   |
| Net loss                        |   | (26.0                                   | )%     | (23.0                                  | )%     | (23.8 | )% | (48.9 | )% |
|                            |   |                                    |   |                                   |   |   |   |   |   |
| Gross profit:                   |   |                                    |   |                                   |   |   |   |   |   |
| Software license                |   | 91.2                                    | %      | 90.6                                   | %      | 92.0 | % | 92.2 | % |
| Hardware                        |   | 39.2                                    |   | 38.6                                   |   | 32.6 |   | 34.8 |   |
| Service and  other              |   | 56.0                                    |   | 54.9                                   |   | 52.3 |   | 56.0 |   |
|                                 |        |                                         |        |                                        |        |  |  |  |  |  |  |  |

 

**ThreeMonths Ended September 30, 2003 and 2002**

## ***Revenues***

 

*Total Revenues.* The Company’s total revenues were $3.6 million and $3.5 million forthe three months ended September 30, 2003 and 2002, respectively.

 

*Software License.* Software license revenues for thethree months ended September 30, 2003 are comprised of the following:  81% from the Company’s fax related productlines and 19% from its non-fax related product lines.  Revenues for the three months ended September 30, 2002 arecomprised of the following:  90% fromthe Company’s fax related product lines and 10% from its non-fax relatedproduct lines.  Software licenserevenues were $984,000 for the three months ended September 30, 2003 and$900,000 for the three months ended September 30, 2002, representing anincrease of 9%.  Software licenserevenues accounted for 28% and 25% of total revenues for each respectiveperiod.  Included in software licenserevenue is a reduction in the sales returns and allowance reserve of $55,000relating to specific accounts where the risk of a return is no longer present.

 

*Hardware.* Hardware revenues were $710,000 for the three months ended September 30,2003 and $713,000 for the three months ended September 30, 2002, representing adecrease of less than 1%. Included in the September 30, 2003 revenue numbers is$19,000 of revenue associated with a reduction in the sales and returnsallowance reserve relating to specific 

 

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accounts where therisk of a return is no longer present. Hardware revenues accounted for 20% oftotal revenues for each respective period. The decrease in hardware revenues was due primarily to a change in theparticular mix of products sold in the three month period ended September 30,2003 resulting in a decrease in accompanying hardware sales. Hardware revenuesremained consistent as a percentage of total revenues due to the combinedeffect of an increase in software revenues and a decrease in service and otherrevenues for the three months ended September 30, 2003.

 

*Service and Other.* Service and other revenues decreased by 4% for the three months endedSeptember 30, 2003 compared to the three months ended September 30, 2002.  Service and other revenues were$1.9 million for each of the three months ended September 30, 2003 and2002. Service and other revenues accounted for 52% and 54% of total revenuesfor each respective period. The decrease in service and other revenues is dueto a decrease of maintenance revenue associated with the customer’s legacy faxproducts.  The decrease in service andother revenues as a percent of total revenues is due primarily to the increasein software license revenue, resulting in a decreased percentage in servicerevenue to total revenue.

 

*Cost of Revenues*

 

*Software License.* Cost of software license revenues consists primarily of the costs ofsublicensing third-party software products, product media and productduplication.  Cost of software licenserevenues was $87,000 and $85,000 for the three months ended September 30, 2003and 2002, respectively, representing an increase of 2%.  The increase is due to the increase insoftware sales as software license gross margin percentages were 91% for eachrespective period.

 

*Hardware.* Cost of hardware revenues consists primarily of the costs of third-partyhardware products. Cost of hardware revenues was $432,000 and $437,000 forthe three months ended September 30, 2003 and 2002, respectively, representing61% of hardware revenues for each respective period. The decrease in dollaramount for the cost of hardware revenues was due primarily to the decrease ofhardware unit sales accompanying the Company’s products. The gross marginpercentage for hardware sales was 39% for each of the three month periods endedSeptember 30, 2003 and 2002.

 

*Service and Other.* Cost of service and other revenues consists primarily of the costsincurred in providing telephone support as well as other miscellaneous customerservice-related expenses.  Cost ofservice and other revenues was $817,000 and $868,000 for the three months endedSeptember 30, 2003 and 2002, respectively, representing 44% and 45% of serviceand other revenues for each respective period. The gross margin percentage for service and other revenues increased to56% for the three months ended September 30, 2003, compared to 55% in the sameperiod in 2002.  The increase in grossmargin is due to a decrease in wages as a result of the restructuring as wellas a decrease to travel related expenses in the installation services area.

 

*Operating Expenses*

 

*Sales and Marketing.*  Sales and marketing expenses consist primarily ofemployee salaries, benefits, commissions, and associated overhead costs, andthe cost of marketing programs such as advertisements, direct mailings, publicrelations, trade shows, seminars and related communication costs.  Sales and marketing expenses were$1.0 million and $1.3 million for the three months ended September30, 2003 and 2002, respectively, or 29% and 38% of total revenues for eachrespective period.  The decrease in sales and marketing expensesis due to decreased wages, commissions, and travel costs resulting from fewerpersonnel in the department as a result of the restructuring. Additionally, theCompany reduced its advertising expenses during the third quarter of 2003. TheCompany expects sales and marketing expenses to remain consistent in absolutedollars.

 

*Research and Development.* Research and development expensesinclude expenses associated with the development of new products, enhancementsof existing products and quality assurance activities. These expenses consistprimarily of employee salaries, benefits, associated overhead costs, consultingexpenses and the cost of software development tools. Research and developmentexpenses were $563,000 for the three months ended September 30, 2003 and$586,000 for the three months ended September 30, 2002, representing 16% and17% of total revenues for each respective period.  The decrease in the expenseand in research and development expenses as a percent of total revenues is aresult of fewer employees in the research and development department and theassociated costs of supporting such personnel.  The Company expects research and development expenses to decreasein absolute dollars.

 

*Generaland 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 $797,000 and $1.1 million for thethree months ended September 30, 2003 and 2002, respectively, or 22% and 31% oftotal revenues for each period. The decrease in dollar amount and percent oftotal revenues is 

 

 

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due to the reduction in general and administrative personnel andoverhead costs associated with supporting such personnel, a decrease inmanagement consulting expenses and a decrease in state sales tax accrualsduring the quarter.  The Company expectsgeneral and administrative expenses to remain consistent in absolute dollars.

 

*Restructuringcosts*  In the third quarter of 2003, the Company announced arestructuring of certain of its operations, and recorded a non-recurring pretaxcharge of $806,581 in accordance with SFAS No. 146, *Accounting for Costs Associated withExit or Disposal Activities.* The non-recurring charge includes severance-related costsassociated with the workforce reduction, primarily in the Company’s domesticoperations, and costs associated with closing of its Oregon office.  The reduction in workforce consisted ofthree employees in the sales and marketing department, two employees performinggeneral and administrative functions, three employees performing technicalsupport services and five employees in the research and development department.

 

The following table summarizes the accrualand usage of the restructuring charges in 2003:

* *

|                                |   | **Lease** |   | **Severance** |   | **Total** |   |
|-------------------------------------|--------|-----------|--------|---------------|--------|-----------|--------|
| Total charge                        |   | $         | 17,420 |          | $      | 789,161   |   | $ | 806,581 |   |
| Cash payments                       |   | (5,332    | )      | (75,572       | )      | (80,904   | )      |
| Ending balance,  September 30, 2003 |   | $         | 12,088 |          | $      | 713,589   |   | $ | 725,677 |   |

 

The total cash impact of the restructuring is$806,581 which the Company anticipates will be paid by the end of the thirdquarter of 2004.  As of September 30,2003, the Company paid out $80,904, and has a remaining liability of $725,677.

 

*Interest and other Income, net.*  Interest and other income, net typicallyconsists principally of interest income earned on cash balances. Interest and other income, net was $68,000 for the three months endedSeptember 30, 2003 and $50,000 for the three months ended September 30,2002.  Included in the $68,000 is$51,000 from the sale of common stock of Verso Technologies, Inc. (“Verso”) asdescribed below. The remaining decline in interest and other income, net(excluding the proceeds from the sale of Verso stock) is due to changes inprincipal balances of the Company’s investments.

 

                InApril 1999, the Company purchased 262,346 shares of Series BPreferred Stock (“Preferred Stock”) of.comfax, Inc. (which later changedits name to MessageClick, Inc. (“MessageClick”)) a development-stagecompany that developed and marketed Internet-based facsimile communicationsdevices. As part of the transaction, the Company purchased a patent, U.S.Patent No. 5,872,845, entitled Method and Apparatus for Interfacing FaxMachines to Digital Communication Networks from MessageClick. The Company paid$850,000 for the Preferred Stock and the patent.

 

The Company initially recorded its investment inMessageClick at the total purchase price of $850,000 and placed no value on thepatent. The Company has not used the patent. At the end of each subsequentquarter, the Company evaluated the carrying cost of this investment andadjusted the balance, if it was deemed appropriate, to what the Companybelieved to be its realizable value. In making this decision, the Companyreviewed the most recent MessageClick financial statements that were madeavailable to the Company’s management, had discussions with MessageClick’smanagement, and reviewed documents relating to subsequent rounds of financingreceived by MessageClick. Based on the aforementioned, the Company determinedthat as of December 31, 1999, the carrying value of the investment was$708,335. During each of the first, second and third quarters of fiscal 2000,the Company reduced the carrying value of the investment by $70,833. During thefourth quarter of 2000, the Company wrote-off the entire remaining carryingvalue of the investment. The decision to write-off the investment is describedbelow.

 

On November 3, 2000, MessageClick was acquired byVerso, a company publicly traded on the Nasdaq National Market under the symbolVRSO. The Company received 45,487 shares of Verso common stock, $243.47 cash,which included cash the Company was entitled to and cash in lieu of fractionalshares of Verso, and a warrant to purchase 8,580 shares of Verso common stockin exchange for its 262,346 shares of Preferred Stock. The 45,487 shares ofVerso common stock received by the Company were unregistered and the Companywas restricted from selling these shares for twelve months from the date of theacquisition. Additionally, the Company only had “piggy back” registrationrights for those shares of Verso common stock. Furthermore, the Companypotentially would receive an additional 20,642 shares of Verso common stock ifcertain conditions of the purchase agreement were met.

 

At the time of the acquisition, Verso was trading at$3.38 per share and at December 31, 2000, Verso was trading at $1.50($68,230.50 value for the 45,487 shares). Additionally, as of March 30,2001

 

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(prior to the Company filing its Form 10-K for the year endedDecember 31, 2000), Verso was trading at $0.75 a share, thus providing atrading value as of March 30, 2001 of the Company’s investment of$34,115.25. Due to the rapid and significant decline in Verso’s common stock,the restriction on sale of the stock, the uncertainty of the ultimaterealizability of the stock and the immateriality of the value of the shares,the Company decided to write-off the entire carrying value of $708,335 of theinvestment as of December 31, 2000.

 

In 2002, the Company sold 45,487 of its VersoCommon Stock for approximately $11,000 and recorded the realized value inInterest and Other Income at that time.

 

On July 18, 2003, the Company received an additional11,029 shares of Verso Common Stock as certain conditions described in thepurchase agreement were met.  TheCompany sold those shares on September 8, 2003 for $4.63 per share for totalgross proceeds of $51,000. The Company does not expect to receive anyadditional shares of Verso common stock. The Company’s warrant to purchase 8,580 shares of Verso common stockexpires in November 2005.  The fairvalue of the warrant is  not  material to the Company’s financialstatements.

 

**NineMonths Ended September 30, 2003 and 2002**

## ***Revenues***

 

*Total Revenues.* The Company’s total revenues were $9.9 million for the nine monthsended September 30, 2003 and $10.8 million for the nine months ended September30, 2002.

 

*Software License.* Software license revenues for thenine months ended September 30, 2003 are comprised of the following:  88% from its fax related product lines and12% from its non-fax related product lines. Revenues for the nine months ended September 30, 2002 are comprised ofthe following:  90% from its fax relatedproduct lines and 10% from its non-fax related product lines.  Software license revenues remainedconsistent at $3.0 million for each of the nine months ended September 30, 2003and September 30, 2002.  Included insoftware license revenue for the nine months ended September 30, 2003 is areduction in the  sales returns andallowance reserve of $160,000 relating to specific accounts where the risk of areturn is no longer present. The 2002 revenues are decreased by $80,000 for theaddition of reserves that management felt were necessary.  Software license revenues accounted for 30%and 28% of total revenues for each respective nine month period.  The increase in software license revenue asa percentage of total revenues is a result of lower relative service and otherrevenues in the first three quarters of 2003 compared to the first threequarters of 2002.

 

*Hardware.* Hardware revenues were $1.8 million for the nine months ended September30, 2003 and $2.1 million for the nine months ended September 30, 2002,representing a decrease of 15%. Hardware revenues accounted for 19% and 20% oftotal revenues for each respective period. Included in the 2003 revenues is a reduction in the  sales returns and allowance reserve of$53,000 relating to specific accounts where the risk of a return is no longerpresent.  The decrease in hardwarerevenues was due primarily to a change in the particular mix of hardwareproducts sold. The decrease in hardware revenue as a percentage of totalrevenues is a result of lower hardware revenues in the first three quarters of2003 compared to the first three quarters of 2002, as well as the consistentlevel of software license revenue.

 

*Service and Other.* Service and other revenues were $5.1 million for the nine monthsended September 30, 2003 and $5.6 million for the nine months ended September30, 2002, representing a decrease of 10%. Service and other revenues accountedfor 51% and 52% of total revenues for each respective period. The decrease inservice and other revenues is due primarily to decreases in softwaremaintenance and support revenues for the Company’s legacy fax products. Serviceand other revenues decreased as a percent of total revenues due to the declinein service and other revenues in the first three quarters of 2003 compared tothe first three quarters of 2002.

 

*Cost of Revenues*

 

*Software License.* Cost of software license revenues was $238,000 for each of the ninemonths ended September 30, 2003 and 2002, respectively. Cost of softwarelicense revenues as a percentage of software license revenue was 8% for eachrespective period.  Software licensegross margin percentages were 92% for each of the nine month periods endedSeptember 30, 2003 and September 30, 2002.

 

*Hardware.*  Cost of hardware revenues was $1.2 million and $1.4million for the nine months ended September 30, 2003 and 2002,respectively, representing 67% and 65% of hardware revenues for each respectiveperiod. The decrease in dollar amount for the cost of hardware revenues was dueprimarily to the decrease of hardware unit sales accompanying the Company’s 

 

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products. Thegross margin percentage for hardware sales was 33% and 35% for each of the ninemonth periods ended September 30, 2003 and 2002 which represents a change inthe mix of hardware products sold and a $20,000 reserve for potentiallyobsolete inventory that was booked during the first nine months of 2003.

 

*Service and Other.* Cost of service and other revenues was $2.4 million and $2.5 million forthe nine month periods ended September 30, 2003 and 2002, respectively,representing 48% and 44% of service and other revenues for each respectiveperiod.  The gross margin percentage forservice and other revenues decreased to 52% for the nine months ended September30, 2003, compared to 56% in the same period in 2002.  The decrease in gross margin percentage was due primarily to thedecrease in service and other revenue and an increase in service andinstallation costs in the first nine months of 2003 as compared to the firstnine months of 2002.

 

*Operating Expenses*

 

*Sales and Marketing.* Sales and marketing expenses were $3.7 million and$4.9 million for the nine months ended September 30, 2003 and 2002,respectively, or 38% and 45% of total revenues for each respective period.  Thedecrease in dollar amount was due to a decrease in the number of sales andmarketing personnel and their associated costs and a decrease in advertisingexpenses during the first three quarters of 2003.

 

*Research and Development.* Research and development expenses were $1.7 million for the nine monthsended September 30, 2003 and $2.3 million for the nine months ended September30, 2002, representing 18% and 21% of total revenues for each respectiveperiod.  The decrease in the expense and in the expense as a percent of totalrevenues was due to a decrease in the number of research and developmentpersonnel and the costs of supporting such personnel.

 

*Generaland Administrative.*  General and administrative expenses were$2.4 million and $3.7 million for the nine months ended September 30, 2003 and2002, respectively, or 24% and 35% of total revenues for each period. Thedecrease in dollar amount and as a percent of total revenues is due a reductionin the number of general and administrative personnel and overhead costsassociated with supporting such personnel, a decrease in professional servicesexpense, management consulting expenses and a decrease in state sales taxaccruals.

 

*Restructuringcost *In the third quarter of 2003, the Company announced arestructuring of certain of its operations, and recorded a non-recurring pretaxcharge of $806,581 in accordance with SFAS No. 146, *Accounting for Costs Associated withExit or Disposal Activities.* The non-recurring charge includes severance-related costsassociated with the workforce reduction, primarily in the Company’s domesticoperations, and costs associated with the closing of its Oregon office.  The reduction in workforce consisted ofthree employees in the sales and marketing department, two employees performinggeneral and administrative functions, three employees performing technicalsupport and five employees in the research and development department.

 

                The followingtable summarizes the accrual and usage of the restructuring charges in 2003:

* *

|                                |   | **Lease** |   | **Severance** |   | **Total** |   |
|-------------------------------------|--------|-----------|--------|---------------|--------|-----------|--------|
| Total charge                        |   | $         | 17,420 |          | $      | 789,161   |   | $ | 806,581 |   |
| Cash payments                       |   | (5,332    | )      | (75,572       | )      | (80,904   | )      |
| Ending balance,  September 30, 2003 |   | $         | 12,088 |          | $      | 713,589   |   | $ | 725,677 |   |

 

                Thetotal cash impact of the restructuring is $806,581 which the Companyanticipates  will be paid by the end ofthe third quarter of 2004.  As ofSeptember 30, 2003, the Company paid out $80,904, and has a remaining liabilityof $725,677.

 

*Interest and other Income, net.*  Interest and other income, net typicallyconsists principally of interest income earned on cash balances. Interest and other income, net was $121,000 for the nine months endedSeptember 30, 2003 and $148,000 for the nine months ended September 30,2002.  Included in the $121,000 is$51,000 from the sale of stock of Verso Technologies, Inc. (“Verso”) commonstock as described below. The remaining decline in interest and other income,net (excluding the proceeds from the sale of Verso stock) is due to changes inprincipal balances of the Company’s investments.

 

                InApril 1999, the Company purchased 262,346 shares of Series BPreferred Stock (“Preferred Stock”) of.comfax, Inc. (which later changedits name to MessageClick, Inc. (“MessageClick”)) a development-stagecompany that developed and marketed Internet-based facsimile communicationsdevices. As part of the transaction, the Company purchased

 

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a patent, U.S. Patent No. 5,872,845, entitled Method and Apparatusfor Interfacing Fax Machines to Digital Communication Networks fromMessageClick. The Company paid $850,000 for the Preferred Stock and the patent.

 

 The Company initially recorded its investment inMessageClick at the total purchase price of $850,000 and placed no value on thepatent. The Company has not used the patent. At the end of each subsequentquarter, the Company evaluated the carrying cost of this investment andadjusted the balance, if it was deemed appropriate, to what the Companybelieved to be its realizable value. In making this decision, the Companyreviewed the most recent MessageClick financial statements that were madeavailable to the Company’s management, had discussions with MessageClick’smanagement, and reviewed documents relating to subsequent rounds of financingreceived by MessageClick. Based on the aforementioned, the Company determinedthat as of December 31, 1999, the carrying value of the investment was$708,335. During each of the first, second and third quarters of Fiscal 2000,the Company reduced the carrying value of the investment by $70,833. During thefourth quarter of 2000, the Company wrote-off the entire remaining carryingvalue of the investment. The decision to write-off the investment is describedbelow.

 

On November 3, 2000, MessageClick was acquired byVerso, a company publicly traded on the Nasdaq National Market under the symbolVRSO. The Company received 45,487 shares of Verso common stock, $243.47 cash,which included cash the Company was entitled to and cash in lieu of fractionalshares of Verso, and a warrant to purchase 8,580 shares of Verso common stockin exchange for its 262,346 shares of Preferred Stock. The 45,487 shares ofVerso common stock received by the Company were unregistered and the Companywas restricted from selling these shares for twelve months from the date of theacquisition. Additionally, the Company only had “piggy back” registrationrights for those shares of Verso common stock. Furthermore, the Companypotentially would receive an additional 20,642 shares of Verso common stock ifcertain conditions of the purchase agreement were met.

 

At the time of the acquisition, Verso was trading at$3.38 per share and at December 31, 2000, Verso was trading at $1.50($68,230.50 value for the 45,487 shares). Additionally, as of March 30,2001 (prior to the Company filing its Form 10-K for the year endedDecember 31, 2000), Verso was trading at $0.75 a share, thus providing atrading value as of March 30, 2001 of the Company’s investment of$34,115.25. Due to the rapid and significant decline in Verso’s common stock,the restriction on sale of the stock, the uncertainty of the ultimaterealizability of the stock and the immateriality of the value of the shares,the Company decided to write-off the entire carrying value of $708,335 of theinvestment as of December 31, 2000.

 

In 2002, the Company sold 45,487 of its VersoCommon Stock for approximately $11,000 and recorded the realized value inInterest and Other Income at that time.

 

On July 18, 2003 the Company received an additional11,029 shares of Verso Common Stock as certain conditions described in thepurchase agreement were met.  TheCompany sold those shares on September 8, 2003 for $4.63 per share for totalgross proceeds of $51,000. The Company does not expect to receive anyadditional shares of Verso common stock. The Company’s warrant to purchase8,580 shares of Verso common stock expires in November 2005.  The fair value of the warrant is notmaterial to the Company’s financial statements.

 

*Tax Provision*.      Duringthe nine months ended September 30, 2003, the Company recorded a $155,398 taxbenefit which resulted from a tax refund that its United Kingdom subsidiaryreceived during the first quarter of 2003. This subsidiary had incurred a loss for the fiscal year ended December31, 1999 which resulted in an income tax benefit.  The tax benefit was carried back to prior years’ taxes paid andresulted in a tax refund.  Because thesubsidiary was undergoing an Inland Revenue audit for tax year 1999, therealizability of this refund was not certain and therefore the Company did notrecord the benefit on its books until the audit was cleared and the cash wasreceived, both of which occurred in the first quarter of 2003.

 

                The Company recorded a provisionof $1.2 million against the valuation of its net deferred tax asset in the ninemonths ended September 30, 2002. See also Note 3. Income Taxes of the Notes tothe Consolidated Financial Statements for more information.

 

### **Liquidity andCapital Resources**

 

                Since 1996, the Company hasfinanced its operations primarily through cash flow from operations, theprivate sales of preferred stock and the Company’s initial public offering ofCommon Stock completed in August 1997. At September 30, 2003, the Companyhad cash and cash equivalents of $7.8 million and working capital of $2.5million.

 

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The Company’soperating activities used cash of $1.9 million and $2.7 million for the ninemonths ended September 30, 2003 and 2002, respectively. Net cash used duringthe nine months ended September 30, 2003 consisted primarily of a net loss fromoperations and decreases in accounts payable, accrued liabilities, accruedsales tax and accounts receivable reserve offset by depreciation andamortization; an increase in accrued restructuring and a decrease to accountsreceivable.  The decrease in accountspayable is due primarily to the timing of vendor payments. The decrease toaccrued liabilities is due primarily to fewer accruals for bonuses during thefirst nine months of 2003 as compared to the same period in 2002.  The decrease to accrued sales tax is due topayments made to various states in the first three quarters of 2003 for salestaxes due.  The decrease to the accountsreceivable reserve is due primarily to the collection of certain accounts forwhich management had previously specifically reserved.  The decline in the accounts receivablebalance is a function of decreased sales activities as well as continuedefforts by management to continue to improve its working capital by expeditingthe collection of accounts receivable. Net cash used during the nine months ended September 30, 2002 resultedfrom a net loss from operations and a decrease in deferred revenues andaccounts payable offset by the deferred tax change, depreciation andamortization,  a decrease in accounts receivableand an increase in accrued state sales tax. In anticipation of continuing economic softness, the Company has takensteps to reduce its use of cash during the remainder of 2003 and into 2004 byrestructuring its workforce in the third quarter of 2003. As a result of therestructuring, the Company expects to reduce its operating expenses byapproximately $1.5 million annually and anticipates that its cash balance atthe end of 2003 will be between $7 million and $8 million.

 

Investingactivities provided cash of $1.4 million and $1.0 million during the ninemonths ended September 30, 2003 and 2002, respectively.  During the nine months ended September 30,2003, the principal uses were purchases of property and equipment andshort-term investments, offset by proceeds from the sale of short-terminvestments.  The Company’s investmentsare professionally managed and the Company has instructed its broker to earnthe highest interest rate possible for very low-risk securities.  The Company’s broker primarily purchasescash equivalent securities but may, on occasion, purchase short-terminvestments.  Property and equipmentpurchases were predominately of computer related software and hardwareproducts.

 

Financingactivities provided cash of $10,000 and used cash of $236,000 for the ninemonths ended September 30, 2003 and 2002, respectively.  Cash provided for the nine months endedSeptember 30, 2003 was due to the issuance of common stock pursuant to theCompany’s employee stock purchase program. Cash used for the nine months ended September 30, 2002 was primarily dueto the purchase of treasury stock.

 

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

 

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                The following table representsthe approximate amounts of payments due under specified contractual obligationsas of September 30, 2003:

 

|                        |   | **Less than   one year** |    | **One to   three years** |   | **Three to   five years** |   | **More than   Five years** |   |
|-----------------------------|--------|--------------------------|---------|--------------------------|--------|---------------------------|--------|----------------------------|--------|
|                        |   |                     |    |                     |   |                      |   |                       |   |
| Operating lease obligations |   | $                        | 362,000 |                     | $      | 356,000                   |   | —                     |   | — |   |
| Total obligations           |   | $                        | 362,000 |                     | $      | 356,000                   |   | —                     |   | — |   |

 

                Operating lease requirementsconsist mainly of lease payments for the Company’s offices in Salem, NH andLondon, England. As of September 30, 2003, the Company did not have anylong-term debt obligations, material commitments for capital expenditures,capital lease obligations, or other long-term liabilities for which paymentsare required.

 

**RecentlyIssued Accounting Standards**

 

                In November 2002,the FASB Emerging Issues Task Force released Issue No. 00-21, *Accountingfor Revenue Arrangements with Multiple Deliverables* (“EITF 00-21”).EITF 00-21 addresses certain aspects of the accounting by a vendor forarrangements under which it will perform multiple revenue-generatingactivities. EITF 00-21 establishes three principles: (a) revenue arrangementswith multiple deliverables should be divided into separate units of accounting;(b) arrangement consideration should be allocated among the separate units ofaccounting based on their relative fair values; and (c) revenue recognitioncriteria should be considered separately for separate units of accounting. EITF00-21 is effective for all arrangements entered into in fiscal periodsbeginning after June 15, 2003, with early adoption permitted. The Company hasreviewed and evaluated the scope of EITF 00-21and determined that EITF 00-21does not impact  the  Company’s financial statements (seediscussion below).

 

                In August 2003,the FASB Emerging Issues Task Force released Issue No. 03-5, *Applicabilityof AICPA Statement of Position 97-2 to Non-Software Deliverables in an ArrangementContaining More-Than-Incidental Software* (“EITF 03-05”). EITF 03-05focuses solely on whether non-software deliverables included in arrangementsthat contain more-than-incidental software are included within the scope of SOP97-2. EITF 03-05 is effective for all arrangements entered into in fiscalperiods beginning after August 13, 2003. The Company has determined that all of its deliverables are consideredsoftware and software-related elements and therefore within the scope of SOP97-2. Therefore, the Company does not believe that  EITF 03-05 will have an impact on the Company’s financial statements.

 

**CertainFactors Affecting Future Operating Results**

 

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

 

                Informationprovided by the Company from time to time including statements in thisForm 10-Q which are not historical facts are so-called “forward-lookingstatements” that involve risks and uncertainties, made pursuant to the safeharbor provisions of the Private Securities Litigation Reform Act of 1995. Inparticular, statements contained in Management’s Discussion and Analysis ofFinancial Condition and Results of Operations which are not historical facts(including, but not limited to, statements concerning:  the plans and objectives of management;expectations for sales and marketing, research and development and general andadministrative expenses; developments relating to the Company’s product andservice offerings, markets and acquisitions; anticipated trends in theCompany’s business; the Company’s strategic alliances; changes in theregulatory environment; the Company’s expected liquidity and capital resourcesand the Company’s critical accounting policies) may constitute forward-lookingstatements. These forward-looking statements are neither promises norguarantees, but are subject to risk and uncertainties that could cause actualresults to differ materially from the expectations set forth in the forward-lookingstatements. Factors that may cause such differences include, but are notlimited to, the factors discussed below, and the other risk discussed from timeto time in the Company’s other filings with the Securities and ExchangeCommission.

 

*FutureOperating Results Uncertain.*  The Companyincorporated and shipped its initial facsimile software products in 1991.  In the years ending December 31, 2000,2001, 2002 and the nine months ending September 30, 2003, the Company had 

 

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operating losses and decreasing revenues. There can be no assurancethat the 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 continueand, together with pricing pressures and a continued decline in the growth rateof the overall U.S. economy, may result in a continued decrease in operatingincome and operating margin percentage. The Company’s ability to improve its operating results will depend upon,among other things, its ability to increase sales of the Company’s securebusiness-to-business electronic document exchange solutions and client/serverfacsimile solutions to new customers as well as increased product penetrationinto existing customers.  The Companycommenced its strategic expansion into secure business-to-business electronicdocument exchange solutions market in the fourth quarter of 2000, and haslimited financial and operating data and a limited operating history relevantto these solutions. Accordingly, it is difficult to evaluate the prospects forthe level of acceptance of the Company’s secure business-to-business electronicdocument exchange solutions. Future operating results will depend on many otherfactors, including, without limitation, the degree and rate of growth of themarkets in which the Company competes, the level of acceptance of the WindowsNT, Windows 2000 and Windows XP operating systems, the level of product andprice competition, the ability of the Company to establish strategicrelationships and develop and market new and enhanced products and to controlcosts, the ability of the Company to expand its direct sales force and indirectdistribution channels both domestically and internationally and the ability ofthe Company to attract and retain key personnel. As a result, it is possiblethat in the future the Company’s operating results will be below theexpectations of public market analysts and investors.  In such event, the price of the Company’s common stock wouldlikely be materially adversely affected.

 

*ProductConcentration.*  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, in September 2000, the Company changed itsstrategic focus to the development of secure business-to-business electronicdocument exchange solutions. 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 its proprietarydocument and routing software, Accuroute, in the second quarter of 2002.  To date, the Company has not recognized asignificant amount of revenues from its Genidocs and Accuroute products. TheCompany expects that its Genidocs and Accuroute products may account for anincreasing portion of future revenues however, there can be no assurances thatthese products will be financially successful or result in any significantrevenues. Factors adversely affecting the pricing of or demand for suchproducts, such as competition or technological change, could have a materialadverse effect on the Company’s business, financial condition and results ofoperations. The Company’s prospects must be considered in light of the risksand difficulties frequently encountered by companies dependent upon operatingrevenues from a new product line in an emerging and rapidly evolving market.

 

*NewProducts and Technological Change.*  The marketsfor the Company’s products are relatively new and are characterized by rapidtechnological change, evolving industry standards, changes in end-userrequirements and frequent new product introductions and enhancements. TheCompany’s future success will depend upon its ability to enhance its currentproducts and to develop and introduce new products that keep pace withtechnological developments and respond to evolving end-user requirements. Therecan be no assurance that the Company will be successful in developing andmarketing new products or product enhancements on a timely basis, or that newproducts or product enhancements developed by the Company, such as theGenidocs, Genifax and Accuroute products will achieve market acceptance. Theintroduction of products embodying new technologies and the emergence of newindustry standards could render the Company’s existing products obsolete andunmarketable. From time to time, the Company and its competitors may announcenew products, capabilities or technologies that have the potential to replaceor shorten the life cycle of the Company’s existing product offerings. Therecan be no assurance that announcements of new product offerings by the Companyor its competitors will not cause customers to defer or forego the licensing ofthe Company’s existing or planned products and have a material adverse effecton the Company’s business, financial condition and results of operations.

 

*TheMarket Risks for Secure Business-to-Business Electronic Document ExchangeSolutions.*  The 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 ability toinfluence usage of its secure business-to-business electronic document exchangesolution by customers is limited. The Company intends to spend considerableresources educating potential customers about the value of securebusiness-to-business electronic document exchange solutions. It is difficult toassess, or to predict with any assurance, the present and future size of thepotential market for the Company’s secure business-to-

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business electronic document exchange solution, or its growth rate, ifany. Moreover, the Company cannot predict whether the Company’s securebusiness-to-business electronic document exchange solution will achieve anymarket acceptance. Any future products or future product enhancements that arenot favorably received by customers may not be profitable and, furthermore,could damage the Company’s reputation or brand name.

 

*Dependenceon Genifax and Fax Sr. NT Product Lines and the Windows NT/2000 Environment.* The Company currently derives a significant portion of its revenues fromlicenses of the Genifax and Fax Sr. NT products and related services andresale of related hardware. Continued market acceptance of the Genifax and FaxSr. NT products are critical to the Company’s future success. As a result, anydecline in demand for or failure to maintain broad market acceptance of theGenifax and Fax Sr. NT product lines as a result of competition,technological change or otherwise, would have a material adverse effect on theCompany’s business, financial condition and results of operations. TheCompany’s future financial performance will depend in large part on new andenhanced versions of the Genifax product and customer acceptance of theFax Sr. NT product. There can be no assurance that the Company willcontinue to be successful in marketing the Genifax and Fax Sr. NT productsor any new or enhanced versions of the Genifax product. In addition, there canbe no assurance that the Windows NT operating system will not be replaced by anew or enhanced operating system. There can be no assurance that the Companywill be successful in developing products for new or enhanced operating systemssuch as Windows 2000 or Windows XP, or that such systems will not obviate theneed for the Company’s products. If any new or enhanced operating system gainswidespread use and the Company fails to develop and provide its products forthis operating system on a timely basis, the Company’s business, financialcondition and results of operations would be materially adversely affected.

 

*Dependenceon Client/Server Environment.*  The Company’senterprise, client/server facsimile software products are intended to helporganizations efficiently manage their facsimile communications, utilizing aclient/server computing environment. The client/server market is relatively newand there can be no assurance that organizations will move away from the use ofstand-alone fax machines or continue to adopt client/server environments,or that customers of the Company that have begun the migration to aclient/server environment will broadly implement this model of computing. TheCompany’s future financial performance will depend in large part on continuedgrowth in the market for client/server applications, which in turn will dependin part on the growth in the number of organizations implementing client/servercomputing environments. There can be no assurance that these markets willcontinue to grow or that the Company will be able to respond effectively to theevolving requirements of these markets. If the market for client/serverapplication products and services does not grow in the future, grows moreslowly than the Company anticipates, or if the Company fails to respondeffectively to evolving requirements of this market, the Company’s business,financial condition and results of operations would be materially adverselyaffected.

 

*RisksAssociated with Listing on the Nasdaq SmallCap 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. On January 14, 2003, Omtool’s Board of Directorsvoted a one-for-seven stock split of the Company’s Common Stock effectiveJanuary 15, 2003 pursuant to a special meeting of stockholders that was held onthe same day approving an amendment to the Company’s Amended and RestatedCertificate of Incorporation of the Company to effect a reverse stocksplit.  On February 5, 2003, theCompany was notified by Nasdaq that it had regained compliance.  The Company cannot predict the impact, ifany, of a change in listing to the SmallCap Market. In addition, the Companycannot predict the continuance of its listing status in the future includingthe possibility of delisting from the Nasdaq SmallCap 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, thedelisting of the Company’s common stock could significantly impair theCompany’s ability to raise capital should it desire to do so in the future.

 

*IntenseCompetition.*  The secure business-to-business electronicdocument exchange solution and enterprise, client/server facsimile solutionmarkets are intensely competitive and rapidly changing and the Company expectscompetition to continue to increase. The Company believes its ability tocompete successfully depends upon a number of factors both within and beyondits control, including product performance; reliability and features; productadoption; ease of use; product scalability; quality of support services;price/performance; timeliness of enhancements and new product releases by theCompany and its 

 

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competitors; the emergence of new computer-based facsimile andsecure business-to-business electronic document exchange solutions andstandards; name recognition; the establishment of strategic alliances withindustry leaders and industry and general economic trends.

 

                The Company may not be able to compete successfullyagainst current and future competitors in the secure business-to-businesselectronic document exchange solutions market, and the competitive pressuresthe Company faces could harm its business and prospects. In the intensely competitive and rapidly changingbusiness-to-business secure document exchange market, the Company competesdirectly with Authentica, Sigaba, Tumbleweed, and Zixit and a number of otherproviders.  There are also othercategories of technology solution that overlap and compete in certain ways withaspects 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.

 

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

 

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

 

                Many of 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 in orderto meet any competitive threat, or that such required investments will not havea material adverse effect on operating margins.  Changes in government laws and regulations may also affect ourability to maintain competitiveness. Increased competition may result in reduction in market share, pressurefor price reductions and related reductions in gross margins, any of whichcould materially adversely affect the Company’s ability to achieve itsfinancial and business goals. There can be no assurance that in the future theCompany will be able to successfully compete against current and futurecompetitors.

 

*Fluctuationsin Quarterly Results of Operations; Seasonality.*  The Company’squarterly revenues and results of operations have fluctuated significantly inthe past and will likely fluctuate significantly in the future. Causes of suchfluctuations have included and may include, among others, the demand for theCompany’s products and services; the size and timing of orders; the number,timing and significance of new product announcements by the Company and itscompetitors; the ability of the Company to develop, introduce, market and shipnew and enhanced versions of the Company’s current and planned products on atimely basis; the level of product and price competition; changes in operatingexpenses; changes in average selling prices and mix of the Company’s products;changes in the Company’s sales incentive strategy; the mix of direct andindirect sales, and general economic factors, including a continued decline inthe growth rate of the overall U.S. economy. In addition, the sale of theCompany’s products often involves delays because customers tend to implementthe products on a large scale and they also must establish certain minimumhardware capabilities. The Company’s products therefore often have a lengthysales cycle while the customer evaluates and receives approvals for thepurchase of the Company’s products. During such sales cycles, the Company mayexpend substantial funds and management efforts yet receive no revenues. It isdifficult to accurately 

 

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predict the sales cycle of any large order. If one or more large ordersfail to close as forecasted in a fiscal quarter, the Company’s revenues andoperating results for such quarter could be materially adversely affected. Anyone or more of these or other factors could have a material adverse effect onthe Company’s business, financial condition and results of operations. Thepotential occurrence of any one or more of these factors makes the predictionof revenues and results of operations on a quarterly basis difficult andperformance forecasts derived from such predictions 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 quarterdepend on orders received and shipped in that quarter with an increasingpercentage of orders in any quarter being received in the last weeks of thequarter.  License fee revenues fromquarter to quarter are difficult to forecast, as no significant order backlogexists at the end of any quarter because the Company’s products typically areshipped upon receipt of customers’ orders.

 

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

 

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

 

*Expansionof Indirect Channels; Potential for Channel Conflict; Strategic Alliances.* The Company markets its products and services directly through telesalesand indirectly through marketing channels such as VARs, systems integrators,distributors and strategic business partners. Although the Company hashistorically focused its efforts on marketing through its sales force, theCompany is increasing resources dedicated to developing and expanding indirectmarketing channels. There can be no assurance that the Company will be able toattract and retain a sufficient number of qualified VARs, systems integrators,distributors and strategic business partners to successfully market theCompany’s products. In addition, there can be no assurance that the Company’sresellers and strategic business partners will not develop, acquire or marketcomputer-based facsimile products that are competitive with the Company’sproducts. The failure to retain its VARs, systems integrators, distributors andstrategic partners could have a material adverse effect on the Company’sbusiness, financial condition and results of operations.

 

                The distributoragreements generally provide that either party may terminate the agreementwithout cause upon 30 days written notice to the other party.  The Company also resells its products on apurchase order basis through other VARs, systems integrators anddistributors.  Either party mayterminate such relationships, at any time, and therefore there can be noassurance that any VAR, systems integrator or distributor will continue to representthe Company’s products.  Furthermore,the Company’s strategic alliances may be terminated by either party, at anytime; there can be no assurances that such strategic alliances willcontinue.  The inability to retaincertain VARs, systems integrators, distributors or strategic business partners,or the development 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.

 

                Selling throughindirect channels may limit the Company’s contacts with its customers.  As a result, the Company’s ability toaccurately forecast sales, evaluate customer satisfaction and 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.

 

*RisksAssociated with Acquisitions.*  The Companymay augment its internal growth with acquisitions of businesses, products andtechnologies that could complement or expand the Company’s business. Certain ofthese businesses may be marginally 

 

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profitable or unprofitable. In order to achieve anticipated benefits fromthese 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.

 

*Abilityto 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 independent public accountants that audited the Company’sfinancial statements until June 28, 2002, was found guilty by a jury on June15, 2002 of federal obstruction of justice in connection with the government’sinvestigation of Enron Corporation. Andersen ceased practicing before the SEC effective August 31,2002.  Although the Company has noreason to believe that those financial statements are incorrect, it is possiblethat events arising out of the indictment may adversely affect Andersen’sability to satisfy any claims arising from its provision of auditing and otherservices to the Company, including claims that may arise out of Andersen’saudit of the Company’s financial statements. The SEC has indicated that it will continue accepting financialstatements audited or reviewed by Andersen provided that the Company complywith the applicable rules and orders issued by the SEC in March 2002 for suchpurpose.

 

*RisksAssociated with International Expansion.*  An element ofthe Company’s strategy is to continue to maintain its international sales. TheCompany expects to face competition from secure business-to-business electronicdocument exchange solutions and local facsimile product providers in theirnative countries. To successfully maintain international sales, the Companyneeds to recruit and retain additional international resellers anddistributors. There can be no assurance that the Company will be able tomaintain international sales of its products or that the Company’sinternational distribution channels will be able to adequately market, serviceand support the Company’s products. International operations generally aresubject to certain risks, including dependence on independent resellers,fluctuations in foreign currency exchange rates, compliance with foreignregulatory and market requirements, variability of foreign economic conditionsand changing restrictions imposed by United States export laws. Additionalrisks inherent in the Company’s international business activities generallyinclude unexpected changes in regulatory requirements, tariffs and other tradebarriers, costs of localizing products for foreign countries, lack ofacceptance of localized products in foreign countries, longer accounts receivablepayment cycles, difficulties in managing international operations, difficultiesin enforcing intellectual property rights and the burdens of complying with awide variety of foreign laws.  TheCompany has a sales office outside of the United States, such operations aresubject to certain additional risks, including difficulties in staffing andmanaging such operations and potentially adverse tax consequences includingrestrictions on the repatriation of earnings. There can be no assurance thatsuch factors will not have a material adverse effect on the Company’s futureinternational sales and, consequently, the Company’s business, financialcondition and results of operations. To date, a majority of the Company’s saleshave been made in United States dollars and the Company has not engaged in anyhedging transactions through the purchase of derivative securities orotherwise.

 

*Dependenceon Key Personnel.*  The Company’s future performance depends, insignificant part, upon the continued service of its key technical, sales andsenior management personnel, most of who are not bound by an employmentagreement or by a noncompetition agreement. The loss of the services of one ormore of the Company’s executive officers or other key employees could have amaterial adverse effect on the Company’s business, financial condition andresults of operations. The Company’s future success also depends on itscontinuing ability to attract and retain highly qualified technical, sales andmanagerial personnel. Competition for such personnel is intense, and theCompany has experienced difficulty in recruiting 

 

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qualified technical personnel. There can be no assurance that theCompany will be able to retain or continue to hire key technical, sales andmanagerial personnel in the future.

 

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Item3. Quantitativeand Qualitative Disclosures About Market Risk

 

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

 

As of September30, 2003, 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 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 September 30, 2003. Currently the Company does not engage inforeign currency hedging activities.

 

Item 4. Controls and Procedures

 

As of the end of the fiscal quarter (the“Evaluation Date”), the Company, under the supervision and with theparticipation of the Company’s management, including the Company’s ChiefExecutive Officer and acting Chief Financial Officer, evaluated theeffectiveness of the Company’s disclosure controls and procedures pursuant toRule 13a-15(b) and 15d-15(b) promulgated under the Securities Exchange Act of1934, as amended (the “Exchange Act”). Based upon that evaluation, the Company’s Chief Executive Officer andacting Chief Financial Officer concluded that, as of the Evaluation Date, theCompany’s disclosure controls and procedures are effective in ensuring thatinformation relating to the Company (including its consolidated subsidiaries)required to be disclosed by the Company in the reports that it files or submitsunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the Securities and Exchange Commission’s rulesand forms, including ensuring that such information is accumulated andcommunicated to the Company’s management, including the Company’s ChiefExecutive Officer and acting Chief Financial Officer, as appropriate to allowtimely decisions regarding required disclosure.

 

There were no changes in the Company’s internal controls over financialreporting during the Company’s last fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

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**PARTII:  OTHER INFORMATION**

 

Item6.        Exhibits and Reports on Form 8-K

 

(a)       Exhibits

 

| 10.13  | Severance Agreement with Robert L. Voelk, dated  August 29, 2003

                                                                                      |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                         |
| 10.14  | Severance Agreement with Daniel A. Coccoluto, dated  August 29, 2003

                                                                                  |
|   |                                                                                                                                                         |
| 10.15  | Severance Agreement and General Release with Michael  K. Sheehy, dated September 2, 2003

                                                              |
|   |                                                                                                                                                         |
| 10.16  | Severance Agreement and General Release with Timothy  P. Losik, dated September 2, 2003

                                                               |
|   |                                                                                                                                                         |
| 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 furnished a Reporton Form 8-K, dated July 25, 2003, pursuant to Item 12 thereof furnishingthe results of its operations for the quarter ended June 30, 2003.

 

                    The Company filed a report on Form 8-K datedSeptember 2, 2003 pursuant to Item 5 thereof to report the Companyissued a press release announcing a company-wide restructuring, including theresignation of three executives and the appointment of an acting ChiefFinancial Officer.

 

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OMTOOL, LTD.

 

 

Signatures

 

 

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

 

 

 

 
|              |   OMTOOL, LTD.                                 |
|-------------------|----------------------------------------------------------|
|              |                                                     |   |
|              |                                                     |   |
| November 11, 2003 | By:                                                      |  /s/ Daniel  A. Coccoluto |
|              | Daniel A. Coccoluto                                      |
|              | Acting Chief Financial Officer, Secretary and  Treasurer |

 

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**Exhibit Index**

** **

| 10.13  | Severance Agreement with Robert L. Voelk, dated  August 29, 2003

                                                                                      |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                         |
| 10.14  | Severance Agreement with Daniel A. Coccoluto, dated  August 29, 2003

                                                                                  |
|   |                                                                                                                                                         |
| 10.15  | Severance Agreement and General Release with Michael  K. Sheehy, dated September 2, 2003

                                                              |
|   |                                                                                                                                                         |
| 10.16  | Severance Agreement and General Release with Timothy  P. Losik, dated September 2, 2003

                                                               |
|   |                                                                                                                                                         |
| 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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