**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

 

**FORM 10-Q**

 

**(Mark One)**

 

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

** **

**Forthe quarterly period ended September 30, 2001**

** **

**OR**

 

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

** **

**Forthe transition period from _________ to _______**

** **

** **

**CommissionFile Number 0-22871**

** **

 

**OMTOOL,LTD.**

(Exact Name of Registrantas Specified in Its Charter)

 

 

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

 

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15 (d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

 

Yes  ý     No o

 

There were 12,689,067 shares of the Company’s CommonStock, par value $0.01, outstanding on November 12, 2001.

 

 

**OMTOOL, LTD. AND SUBSIDIARIES**

 

FORM 10-Q

For the Quarter EndedSeptember 30, 2001

CONTENTS

 
| Item Number                |                                                                                                                       |   |
|----------------------------|----------------------------------------------------------------------------------------------------------------------------|--------|
|                       |                                                                                                                       |
| PART I:                    | FINANCIAL INFORMATION                                                                                                      |   |
|                       |                                                                                                                       |
| Item 1.          | Consolidated Financial Statements                                                                                          |   |
|                       | Consolidated Balance Sheets  as of September 30, 2001 (Unaudited) and December 31, 2000                                    |   |
|                       | Consolidated  Statements of Operations for the three months and nine months ended September  30, 2001 and 2000 (Unaudited) |   |
|                       | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2001 and  2000 (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                                                                |   |
|                       |                                                                                                                       |
| PART II: OTHER INFORMATION |                                                                                                                       |
|                       |                                                                                                                       |
| Item 1.               | Litigation                                                                                                                 |   |
|                       |                                                                                                                       |
| Item 6.               | Exhibits and  Reports on Form 8-K                                                                                          |   |
|                       |                                                                                                                       |
| Signatures                 |                                                                                                                       |
|                            |                                                                                                                            |        |  |  |  |

 

 

 

** **

** **

**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Balance Sheets**

 

** **
|                                                                                                    |   | **September 30, 2001** |          | **December 31, 2000** |   |
|---------------------------------------------------------------------------------------------------------|--------|------------------------|---------------|-----------------------|--------|
|                                                                                                    |   | **(Unaudited)**        |          |                  |   |
| **Assets**                                                                                              |   |                   |          |                  |   |
| Current assets:                                                                                         |   |                   |          |                  |   |
| Cash and cash  equivalents                                                                              |   | $                      | 12,905,308    |                  | $      | 14,599,350 |   |
| Short-term  investments                                                                                 |   | -                      |          | 3,283,708             |   |
| Accounts  receivable, less reserves of $640,000 and $980,000 in 2001 and 2000,  respectively            |   | 1,042,169              |          | 1,563,373             |   |
| Prepaid expenses  and other current assets                                                              |   | 768,592                |          | 506,187               |   |
| Deferred tax  asset                                                                                     |   | 1,225,350              |          | 1,258,978             |   |
| Total current  assets                                                                                   |   | 15,941,419             |          | 21,211,596            |   |
|                                                                                                    |   |                   |          |                  |   |
| Property and equipment, net                                                                             |   | 939,649                |          | 1,236,745             |   |
|                                                                                                    |   |                   |          |                  |   |
| Other assets,  net                                                                                      |   | 13,962                 |          | 14,425                |   |
|                                                                                                    |   |                   |          |                  |   |
| Total assets                                                                                            |   | $                      | 16,895,030    |                  | $      | 22,462,766 |   |
| **Liabilities  and Stockholders’ Equity**                                                          |   |                   |          |                  |   |
| Current  liabilities:                                                                                   |   |                   |          |                  |   |
| Accounts payable                                                                                        |   | $                      | 355,121       |                  | $      | 633,413 |   |
| Accrued  liabilities                                                                                    |   | 1,663,447              |          | 3,972,231             |   |
| Deferred revenue                                                                                        |   | 3,046,672              |          | 2,966,716             |   |
| Total current  liabilities                                                                              |   | 5,065,240              |          | 7,572,360             |   |
|                                                                                                    |   |                   |          |                  |   |
| Contingencies  (Note 5)                                                                                 |   |                   |          |                  |   |
|                                                                                                    |   |                   |          |                  |   |
| Stockholders’  equity:                                                                             |   |                   |          |                  |   |
| Preferred Stock, $.01  par value — Authorized — 2,000,000; Issued and outstanding — none |   | -                      |          | -                     |   |
| Common Stock, $.01 par  value — Authorized — 35,000,000; Issued   13,009,372 shares      |   | 130,093                |     | 130,093               |   |
| Additional  paid-in capital                                                                             |   | 31,924,984             |          | 32,074,193            |   |
| Accumulated  deficit                                                                                    |   | (19,401,138            | )             | (16,443,798           | )      |
| Treasury Stock  (320,305 shares and 272,144 shares at cost respectively)                                |   | (734,086               | )             | (778,636              | )      |
| Cumulative  translation adjustment                                                                      |   | (90,063                | )             | (91,446               | )      |
| Total  stockholders’ equity                                                                        |   | 11,829,790             |          | 14,890,406            |   |
|                                                                                                    |   |                   |          |                  |   |
| Total  liabilities and stockholders’ equity                                                        |   | $                      | 16,895,030    |                  | $      | 22,462,766 |   |
|                                                                                                         |        |                        |               |                       |        |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

 

** **

**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements ofOperations**

(Unaudited)

 
|                                                  |   | **Three months ended September 30,** |          | **Nine months ended September 30,** |          |
|-------------------------------------------------------|--------|--------------------------------------|---------------|-------------------------------------|---------------|
|                                                  |   | **2001**                             |          | **2000**                            |          | **2001** |   | **2000** |   |
| Revenues:                                             |   |                                 |          |                                |          |   |   |   |   |
| Software license                                      |   | $                                    | 1,078,336     |                                | $             | 1,298,264 |   | $ | 3,649,610 |   | $ | 4,506,488 |   |
| Hardware                                              |   | 688,534                              |          | 1,439,543                           |          | 2,239,401 |   | 3,339,391 |   |
| Service and  other                                    |   | 1,769,944                            |          | 1,581,626                           |          | 5,362,857 |   | 5,021,687 |   |
|                                                  |   |                                 |          |                                |          |   |   |   |   |
| Total revenues                                        |   | 3,536,814                            |          | 4,319,433                           |          | 11,251,868 |   | 12,867,566 |   |
|                                                  |   |                                 |          |                                |          |   |   |   |   |
| Cost of  revenues:                                    |   |                                 |          |                                |          |   |   |   |   |
| Software license                                      |   | 100,242                              |          | 85,975                              |          | 321,031 |   | 271,162 |   |
| Hardware                                              |   | 480,588                              |          | 1,051,007                           |          | 1,471,175 |   | 2,320,506 |   |
| Service and  other                                    |   | 879,871                              |          | 1,046,426                           |          | 3,222,143 |   | 3,188,377 |   |
|                                                  |   |                                 |          |                                |          |   |   |   |   |
| Total cost of  revenues                               |   | 1,460,701                            |          | 2,183,408                           |          | 5,014,349 |   | 5,780,045 |   |
|                                                  |   |                                 |          |                                |          |   |   |   |   |
| Gross profit                                          |   | 2,076,113                            |          | 2,136,025                           |          | 6,237,519 |   | 7,087,521 |   |
|                                                  |   |                                 |          |                                |          |   |   |   |   |
| Operating  expenses:                                  |   |                                 |          |                                |          |   |   |   |   |
| Sales and  marketing                                  |   | 1,602,744                            |          | 1,233,345                           |          | 4,680,122 |   | 5,097,730 |   |
| Research and  development                             |   | 725,083                              |          | 874,224                             |          | 2,422,894 |   | 3,015,499 |   |
| General and  administrative                           |   | 999,364                              |          | 991,571                             |          | 2,648,037 |   | 3,226,622 |   |
| Gain on sale of  AS/400 product line                  |   | ---                                  |          | (149,831                            | )             | --- |   | (299,831 | ) |
|                                                  |   |                                 |          |                                |          |   |   |   |   |
| Total operating  expenses                             |   | 3,327,191                            |          | 2,949,309                           |          | 9,751,053 |   | 11,040,020 |   |
|                                                  |   |                                 |          |                                |          |   |   |   |   |
| Loss from  operations                                 |   | (1,251,078                           | )             | (813,284                            | )             | (3,513,534 | ) | (3,952,499 | ) |
|                                                  |   |                                 |          |                                |          |   |   |   |   |
| Interest income                                       |   | 126,370                              |          | 287,506                             |          | 556,194 |   | 811,186 |   |
| Net loss                                              |   | $                                    | (1,124,708    | )                                   | $             | (525,778 | ) | $ | (2,957,340 | ) | $ | (3,141,313 | ) |
|                                                  |   |                                 |          |                                |          |   |   |   |   |
| Net loss per  share                                   |   |                                 |          |                                |          |   |   |   |   |
| Basic and  Diluted                                    |   | $                                    | (0.09         | )                                   | $             | (0.04 | ) | $ | (0.23 | ) | $ | (0.25 | ) |
|                                                  |   |                                 |          |                                |          |   |   |   |   |
| Weighted  average number of common shares outstanding |   |                                 |          |                                |          |   |   |   |   |
| Basic and  Diluted                                    |   | 12,740,948                           |     | 12,730,388                          |     | 12,746,149 |     | 12,695,649 |     |
|                                                       |        |                                      |               |                                     |               |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

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

**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements of CashFlows**

(Unaudited)
|                                                                              |   | **Nine months ended September 30,** |       |
|-----------------------------------------------------------------------------------|--------|-------------------------------------|------------|
|                                                                              |   | **2001**                            |       | **2000** |   |
| Cash Flows from  Operating Activities:                                            |   |                                |       |   |   |
| Net loss                                                                          |   | $                                   | (2,957,340 | ) | $ | (3,141,313 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities– |   |                                |       |   |   |
| Depreciation and  amortization                                                    |   | 536,223                             |       | 571,248 |   |
| Deferred taxes                                                                    |   | 33,628                              |       | - |   |
| Changes in  assets and liabilities–                                          |   |                                |       |   |   |
| Accounts  receivable                                                              |   | 513,348                             |       | 1,660,819 |   |
| Prepaid expenses  and other current assets                                        |   | (330,543                            | )          | 269,075 |   |
| Income tax  receivable                                                            |   | -                                   |       | 439,737 |   |
| Accounts payable                                                                  |   | (275,138                            | )          | (151,133 | ) |
| Accrued  liabilities                                                              |   | (2,267,212                          | )          | (859,720 | ) |
| Deferred revenue                                                                  |   | 87,431                              |       | (502,529 | ) |
|                                                                              |   |                                |       |   |   |
| Net cash used in  operating activities                                            |   | (4,659,603                          | )          | (1,713,816 | ) |
|                                                                              |   |                                |       |   |   |
| Cash Flows from  Investing Activities:                                            |   |                                |       |   |   |
| Purchases of  property and equipment                                              |   | (240,774                            | )          | (282,826 | ) |
| Purchases of  short-term investments                                              |   | (72,815,994                         | )          | (136,342,767 | ) |
| Proceeds from  sale of short-term investments                                     |   | 76,098,644                          |       | 137,192,745 |   |
| Decrease in  other assets                                                         |   | 463                                 |       | 214,099 |   |
|                                                                              |   |                                |       |   |   |
| Net cash  provided by investing activities                                        |   | 3,042,339                           |       | 781,251 |   |
|                                                                              |   |                                |       |   |   |
| Cash Flows from  Financing Activities:                                            |   |                                |       |   |   |
| Net proceeds  from issuance of common stock                                       |   | 63,573                              |       | 282,234 |   |
| Purchases of  treasury stock                                                      |   | (168,232                            | )          | - |   |
| Net cash (used  in) provided by financing activities                              |   | (104,659                            | )          | 282,234 |   |
|                                                                              |   |                                |       |   |   |
| Foreign exchange  effect on cash                                                  |   | 27,881                              |       | 13,553 |   |
|                                                                              |   |                                |       |   |   |
| Net decrease in  cash and cash equivalents                                        |   | (1,694,042                          | )          | (636,778 | ) |
|                                                                              |   |                                |       |   |   |
| Cash and cash  equivalents, beginning of period                                   |   | 14,599,350                          |       | 1,576,283 |   |
|                                                                              |   |                                |       |   |   |
| Cash and cash  equivalents, end of period                                         |   | $                                   | 12,905,308 |   | $ | 939,505 |   |

 

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

 

**OMTOOL, LTD. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

(Unaudited)

 

**(1)     Basis of Presentation**

 

The accompanying unaudited consolidated financial statements have beenprepared by Omtool, Ltd. (the “Company” or “Omtool”) pursuant to the rules andregulations of the Securities and Exchange Commission 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, 2000. The accompanying consolidatedfinancial statements reflect all adjustments (consisting of normal recurringadjustments), which are, in the opinion of management, necessary for a fair presentationof results for the interim periods presented. The results of operations for the three month and nine month periodsended September 30, 2001 are not necessarily indicative of the results to beexpected for the full fiscal year.

 

**(2)     Summary of SignificantAccounting Policies**

 

*(a)    Cash and Cash Equivalents*

 

The Company considers all highly liquid investments with maturities ofthree months or less at the time of purchase to be cash equivalents.  Cash equivalents consist primarily ofinvestments in money market funds.  Inaccordance with Statement of FinancialAccounting Standards (SFAS) No. 115, *Accounting for Investments in Certain Debt and EquitySecurities*, the Company’s cash equivalents are classified asheld-to-maturity securities.

 

* (b)   ForeignCurrency Translation*

 

The Company translates the financial statementsof its foreign subsidiaries in accordance with SFAS No. 52, *ForeignCurrency Translation*. Accordingly, assets and liabilities are translated at exchange rates ineffect at the end of the period, and revenues and expenses are translated atthe average exchange rates during the period. All cumulative translation gains or losses from the translation into theCompany’s reporting currency are included as a separate component of stockholders’equity in the accompanying consolidated balance sheets.

* *

* (c)    NetLoss per Common Share*

 

                The Company reports earnings pershare in accordance with SFAS No. 128. Diluted weighted average shares outstanding for the three and ninemonths ended September 30, 2001 and September 30, 2000 exclude the potentialcommon shares related to 2,341,638 and 1,385,784, respectively, of outstandingstock options because to include them would have been antidilutive for theperiods presented.

 

**(3)     ComprehensiveIncome (Loss)**

 

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

 
|                                      |   | **Three months ended September 30,** |       | **Nine months ended September 30,** |   |
|-------------------------------------------|--------|--------------------------------------|------------|-------------------------------------|--------|
|                                      |   | **2001**                             |       | **2000**                            |   | **2001** |   | **2000** |   |
| Net loss                                  |   | $                                    | (1,124,708 | )                                   | $      | (525,778 | ) | $ | (2,957,340 | ) | $ | (3,141,313 | ) |
| Foreign currency  translation adjustments |   | (1,697                               | )          | 9,999                               |   | 1,383 |   | (10,412 | ) |
| Comprehensive  loss                       |   | $                                    | (1,126,405 | )                                   | $      | (515,779 | ) | $ | (2,955,957 | ) | $ | (3,151,725 | ) |

 

**(4)    ****Segment and Geographic Information**

 

  To date, the Company has viewed itsoperations and manages its business as principally one segment, software salesand associated services. As a result, the financial information disclosedherein, represents all of the material financial information related to theCompany's principal operating segment in accordance with SFAS No. 131.

 

Totalrevenues from international sources were approximately $514,582 and $1,714,854for the three months and nine months ended September 30, 2001, respectively and$630,000 and $2.4 million for the three months and nine months ended September30, 2000, 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)   |   | **2001**                              |      | **2000**                             |   | **2001** |   | **2000** |   |
| United States        |   | $                                     | 3,022,232 |                                 | $      | 3,688,564 |   | $ | 9,537,014 |   | $ | 10,436,937 |   |
| United Kingdom       |   | 218,380                               |      | 289,602                              |   | 726,704 |   | 1,155,778 |   |
| Other North  America |   | 211,118                               |      | 124,575                              |   | 667,975 |   | 572,140 |   |
| Other                |   | 85,084                                |      | 216,692                              |   | 320,175 |   | 702,711 |   |
|                 |   | $                                     | 3,536,814 |                                 | $      | 4,319,433 |   | $ | 11,251,868 |   | $ | 12,867,566 |   |

 
| Long-lived  assets (2) |   | **September 30,****2001** |    | **December 31,****2000** |   |
|------------------------|--------|---------------------------|---------|--------------------------|--------|
| North America          |   | $                         | 880,940 |                     | $      | 1,154,219 |   |
| Europe                 |   | 72,671                    |    | 96,951                   |   |
|                   |   | $                         | 953,611 |                     | $      | 1,251,170 |   |

 

----

| (1) Revenues are  attributed to geographic regions based on location of customer.                                                                                   |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| (2) Long-lived  assets include all long-term assets except those specifically excluded under  SFAS No. 131 such as deferred income taxes and financial instruments. |   |

 

 

**(5)    ****Litigation**

 

                On October 5,1999, a purported securities class action complaint was filed against theCompany and certain officers and directors of the Company.  As of March 31, 2001, the Company reached anagreement-in-principle to settle the lawsuit. On June 28, 2001, the parties filed a definitive settlement agreementwith the United States District Court for the District of New Hampshire (the“Court”).  On July 6, 2001, the Courtpreliminarily approved the proposed terms of the definitive settlementagreement.  On October 23, 2001, theCourt ordered final approval of the settlement.  Pursuant to the terms of the Court’s order, final judgment andfull dismissal of the class action litigation against all defendants willbecome effective as early as November 25, 2001.  The terms of the proposed $6 million settlement include acontribution by the Company's directors' and officers' liability insurancecarriers of $4.3 million, and a contribution by the Company of $1.7 million.  The Company accrued its portion of the settlementas of December 31, 2000.  The Companycontinues to believe that the lawsuit is without merit, and, in the unlikelyevent final judgment does not become effective, the Company intends to continuedefending the lawsuit vigorously.

 

**(6)     RecentAccounting Pronouncements**

 

In July 2001, the Financial Accounting Standards Board(FASB) issued SFAS No. 141, *Business Combinations*.  SFAS No. 141 requires all businesscombinations initiated after June 30, 2001 to be accounted for using thepurchase method.  This statement iseffective for all business combinations initiated after June 30, 2001.

 

                In July 2001, theFASB issued SFAS No. 142, *Goodwill and Other Intangible Assets*.  This statement applies to goodwill andintangible assets acquired after June 30, 2001, as well as goodwill andintangible assets previously acquired. Under this statement goodwill as well as certain other intangibleassets, determined to have an infinite life, will no longer be amortized,instead these assets will be reviewed for impairment on a periodic basis. Thisstatement is effective for the Company for the first quarter in the fiscal yearended December 2002. Management is currently evaluating the impact that thisstatement will have on the Company's financial statements.

 

In June 2001, the FASB issued SFAS No. 143, Accountingfor Asset Retirement Obligations.  Thisstatement addresses financial accounting and reporting for obligationsassociated with the retirement of tangible long-lived assets and the associatedasset retirement costs. This statement applies to all entities. It applies tolegal obligations associated with the retirement of long-lived assets thatresult from the acquisition, construction, development and (or) the normaloperation of a long-lived asset, except for certain obligations oflessees.  This statement amends FASBStatement No. 19 and is effective for financial statements issued for fiscalyears beginning after June 15, 2002. The Company is currently evaluating the ultimateimpact of this statement on its results of operations or financial positionuntil such time as its provisions are applied.

 

In August 2001, the FASB issued SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets.  This statement supercedes FASB Statement No.121, Accounting for the Impairment of Long-Lived Assets and for Long-LivedAssets to Be Disposed Of, and the accounting and reporting provisions of APBOpinion No. 30, Reporting the Results of Operations, Reporting the Effects ofDisposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions. Under this statement it isrequired that one accounting model be used for long-lived assets to be disposedof by sale, whether previously held and used or newly acquired, and it broadensthe presentation of discontinued operations to include more disposaltransactions.  The provisions of thisstatement are effective for financial statements issued for fiscal yearsbeginning after December 15, 2001, and interim periods within those fiscalyears, with early adoption permitted. The Company is currently evaluating whether it will early adopt theprovisions of SFAS No. 144, and management will not be able to determine theultimate impact of this statement on its results of operations or financialposition until such time as its provisions are applied.

 

** **

**Item2.**

**MANAGEMENT’SDISCUSSION AND ANALYSIS**

**OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

 

Management’s Discussion and Analysis of FinancialCondition and Results of Operations should be read in conjunction with theaccompanying consolidated financial statements for the periods specified andthe associated notes.  Further referenceshould be made to the Company’s Annual Report on Form 10-K as filed with theSecurities Exchange Commission on April 2, 2001.

 

**Overview**

 

Omtool, Ltd. (“Omtool” or the “Company”) designs, develops, markets andsupports open, client/server software solutions that enable securebusiness-to-business electronic document exchange. The Company was incorporatedin March 1991 and shipped its initial facsimile software products in 1991.Omtool's Genidocs product family enables users throughout an enterprise todeliver confidential and secure e-mail over the Internet. Omtool's Fax Sr.,LegalFax and Genifax product families provide users with an extensive, flexiblefeature set for transmitting and receiving faxes, and improve an organization'smanagement of its fax communications process by providing a suite of utilityand control functions. A significant portion of the Company's revenues isderived from licensing the rights to use its Fax Sr. software product directlyto end-users and indirectly through resellers.

 

Revenues from software licenses are recognized upon shipment of thesoftware if there are no significant post-delivery obligations and collectionof the resulting receivable is deemed probable. Payments received in advancefor services or products are initially recorded as deferred revenue. TheCompany reserves for potential product returns and allowances at the time ofshipment.  Historically, the Company hasadequately reserved for such potential returns and allowances.

 

The Company hashistorically derived substantially all of its total revenues from sales withinNorth America. Sales outside of North America (primarily in Europe) representedapproximately 9% and 14% of the Company's total revenues for the nine monthsended September 30, 2001 and 2000, respectively.

 

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

 

Historically, theCompany has marketed and sold its products principally through its directtelesales force. However, the Company continues to actively recruit VARs,systems integrators, resellers and distributors to expand its indirect distributionchannel. The Company intends to pursue sales opportunities via itssolution/reseller channel as well as focusing sales efforts on specific marketsegments in order to facilitate product acceptance. Sales through the Company'sindirect distribution channels represent approximately 42% and 62% of theCompany's total revenues for the nine months ended September 30, 2001 and 2000,respectively.

**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,** |   |
|---------------------------------|--------|--------------------------------------|--------|-------------------------------------|--------|
|                            |   | **2001**                             |   | **2000**                            |   | **2001** |   | **2000** |   |
| Revenues:                       |   |                                 |   |                                |   |   |   |   |   |
| Software license                |   | 30.5                                 | %      | 30.1                                | %      | 32.4 | % | 35.0 | % |
| Hardware                        |   | 19.5                                 |   | 33.3                                |   | 19.9 |   | 26.0 |   |
| Service and  other              |   | 50.0                                 |   | 36.6                                |   | 47.7 |   | 39.0 |   |
| Total revenues                  |   | 100.0                                |   | 100.0                               |   | 100.0 |   | 100.0 |   |
| Cost of  revenues:              |   |                                 |   |                                |   |   |   |   |   |
| Software license                |   | 2.8                                  |   | 2.0                                 |   | 2.9 |   | 2.1 |   |
| Hardware                        |   | 13.6                                 |   | 24.3                                |   | 13.1 |   | 18.0 |   |
| Service and  other              |   | 24.9                                 |   | 24.2                                |   | 28.6 |   | 24.8 |   |
| Total cost of revenues          |   | 41.3                                 |   | 50.5                                |   | 44.6 |   | 44.9 |   |
| Gross profit                    |   | 58.7                                 |   | 49.5                                |   | 55.4 |   | 55.1 |   |
| Operating  expenses:            |   |                                 |   |                                |   |   |   |   |   |
| Sales and  marketing            |   | 45.3                                 |   | 28.5                                |   | 41.6 |   | 39.6 |   |
| Research and  development       |   | 20.5                                 |   | 20.2                                |   | 21.5 |   | 23.4 |   |
| General and  administrative     |   | 28.3                                 |   | 23.0                                |   | 23.5 |   | 25.1 |   |
| Gain on sale of  AS/400 product |   | -                                    |   | (3.4                                | )      | - |   | (2.3 | ) |
| Total operating  expenses       |   | 94.1                                 |   | 68.3                                |   | 86.6 |   | 85.8 |   |
| Loss from  operations           |   | (35.4                                | )      | (18.8                               | )      | (31.2 | ) | (30.7 | ) |
| Interest income                 |   | 3.6                                  |   | 6.7                                 |   | 4.9 |   | 6.3 |   |
|                            |   |                                 |   |                                |   |   |   | - |   |
| Net loss                        |   | (31.8%                               | )      | (12.1%                              | )      | (26.3% | ) | (24.4% | ) |
|                            |   |                                 |   |                                |   |   |   |   |   |
| Gross profit:                   |   |                                 |   |                                |   |   |   |   |   |
| Software license                |   | 90.7                                 | %      | 93.4                                | %      | 91.2 | % | 94.0 | % |
| Hardware                        |   | 30.2                                 |   | 27.0                                |   | 34.3 |   | 30.5 |   |
| Service and  other              |   | 50.3                                 |   | 33.8                                |   | 39.9 |   | 36.5 |   |

 

**ThreeMonths Ended September 30, 2001 and 2000**

## ***Revenues***

 

*Total Revenues.*  The Company's revenues are currently derived fromlicensing fees of the Company's software products and from related sales ofhardware and services. The Company's total revenues were $3.5 millionand $4.3 million for the three months ended September 30, 2001 and 2000,respectively, representing a decrease of 18%.

 

*Software License.*  The Company's software license revenues arederived primarily from the licensing of the Company's Fax Sr. product.  Software license revenues were $1.1 millionfor the three months ended September 30, 2001 and $1.3 million for the threemonths ended September 30, 2000, representing a decrease of 17%.  Software license revenues accounted for 31%and 30% of total revenues for each respective three-month period endedSeptember 30, 2001 and September 30, 2000. The decline in software license revenues can be attributed to a numberof factors which include softness in demand for enterprise fax solutions and adecline in the growth rate of the overall U.S. economy causing customers andprospective customers to defer technology purchases.  The Company did not recognize a significant amount of revenuefrom its Genidocs products.

 

*Hardware.* Hardware revenues are derived from the resale of third–partyhardware products sold to the Company's customers in conjunction with thelicensing of the Company's software. Hardware revenues were $689,000 for thethree months ended September 30, 2001 and $1.4 million for the three monthsended September 30, 2000, representing a decrease of 52%. Hardware revenuesaccounted for 20% and 33% of total revenues for each respective period.  The decrease in hardware revenues was dueprimarily to the decrease in the number of software sales made in the thirdquarter of 2001 resulting in a decrease in accompanying hardware sales.

 

*Service and Other.* Service and other revenues are primarily comprised of fees frommaintenance contracts. Service and other revenues were $1.8 million for thethree months ended September 30, 2001 and $1.6 million for the three monthsended September 30, 2000, representing an increase of 12%. Service and otherrevenues accounted for 50% and 37% of total revenues for each respectiveperiod. The increase in service and other revenues is due to the increase in supportrenewals from the Company’s increased installed customer base, resulting in anincrease in service and other revenues as a percentage of total revenues.

 

*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 $100,000 and $86,000 for the three months ended September 30, 2001and 2000, respectively, representing 9% and 7% of software license revenues foreach respective period.  Softwarelicense gross margin percentages decreased to 91% for the three months endedSeptember 30, 2001 from 93% for the three months ended September 30, 2000.  The decrease in gross margin is due to increasedproduct duplication costs and increased royalty payments as a result ofincreased sales of product with associated royalty payments.

 

*Hardware.* Cost of hardware revenues consists primarily of the costs of third–partyhardware products. Cost of hardware revenues was $481,000 and $1.1 million forthe three months ended September 30, 2001 and 2000, respectively, representing70% and 73% of hardware revenues for each respective period. The decrease indollar amount for the cost of hardware revenues was due primarily to thedecrease of hardware unit sales accompanying the Company's products.  The gross margin percentage for hardwaresales was 30% and 27% for the three months ended September 30, 2001 and 2000,respectively. The increase in gross margin is due mainly to a change in the mixof the particular hardware products sold.

 

*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 $880,000 and $1.0 million for the three monthsended September 30, 2001 and 2000, respectively, representing 50% and 66% ofservice and other revenues for each respective period.  The gross margin percentage for service andother revenues was 50% and 34% for each of the three-month periods endedSeptember 30, 2001 and 2000. The decrease in dollar amount of cost of serviceand other revenues and the improvement in gross margins was due primarily tothe reduced number of employees within the customer service department.

 

*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$1.6 million and $1.2 million for the three months ended September 30, 2001 and2000, respectively, or 45% and 29% of total revenues for each respectiveperiod. The increase in dollar amount and as a percentage of revenue was dueprimarily to an increase in trade show and advertising expenditures during thethree months ended September 30, 2001, offset by a reduction in commissions asa result of reduced sales.  The Companyexpects sales and marketing expenses are likely to increase in absolute termsdue to new product introductions.

 

*Research and Development.* Research and development expenses includeexpenses associated with the continued development of products, enhancements ofexisting products and quality assurance activities, and consist primarily ofemployee salaries, benefits, and associated overhead costs as well asconsulting expenses and the cost of software development tools. Research anddevelopment expenses were $725,000 for the three months ended September 30,2001 and $874,000 for the three months ended September 30, 2000, representing21% and 20% of total revenues for each respective period.  Thedecrease in the dollar amount and in the expenses as a percentage of revenuewas due to lower wages paid per employee in the research and developmentdepartment.  The Company expectsresearch and development expenses to remain consistent in absolute terms.

 

*General and Administrative.* General and administrative expenses consist primarily of employeesalaries and benefits for administrative, executive and finance personnel andassociated overhead costs, as well as consulting, accounting and legalexpenses. General and administrative expenses were $999,000 and $992,000 forthe three months ended September 30, 2001 and 2000, respectively, or 28% and23% of total revenues for each respective period. The increase as a percentageof total revenues is due to decreased revenues.  The Company expects general and administrative expenses to remainconsistent in absolute terms.

 

*Gain on Sale of AS/400 Product Line.*On January 4,2000, the Company sold to International Presence PLC (“IPP”) certain businessassets consisting of intellectual property, goodwill, customer lists, customercontracts, equipment and other assets related to the Company’s softwareproducts and third party hardware products for facsimile and othercommunication applications for the IBM AS/400 product line which were acquiredin the Company’s acquisition of CMA Ettworth. The Company recorded a loss of$2.7 million related to this sale as of December 31, 1999. During the thirdquarter of 2000, the Company received a payment of $149,831 from the buyer andrecorded that amount as a gain in the quarter ended September 30, 2000.

 

*Interest Income.*  Interest income consists principally ofinterest income earned on excess cash.  Interestincome was $126,000 for the three months ended September 30, 2001 and $288,000for the three months ended September 30, 2000. The decrease is due to changes in principal balances and interest rates.

 

*Income Taxes.*  The Company has not provided a benefit forincome taxes as the Company believes realizability of net operating losses isuncertain.

 

**NineMonths Ended September 30, 2001 and 2000**

## ***Revenues***

 

*TotalRevenues*.  The Company’s total revenues were $11.3million and $12.9 million for the nine months ended September 30, 2001 and2000, respectively, representing a decrease of 13%.

 

*SoftwareLicense. *Software license revenues were $3.6million for the nine months ended September 30, 2001 and $4.5 million for thenine months ended September 30, 2000, representing a decrease of 19%.  Software license revenues accounted for 32%and 35% of total revenues for each respective period. The decline in softwarelicense revenue can be attributed to a number of factors which include softnessin demand for enterprise fax solutions and a decline in the growth rate of theoverall U.S. economy causing customers and prospective customers to defertechnology purchases. The Company did not recognize a significant amount ofrevenue from its Genidocs products.  Thedecrease in software license revenue as a percentage of total revenues is primarilyattributable to the decrease in software revenues.

 

*Hardware. *Hardware revenues were $2.2 million for the ninemonths ended September 30, 2001 and $3.3 million for the nine months endedSeptember 30, 2000, representing a decrease of 33%.  Hardware revenues accounted for 20% and 26% of total revenues foreach respective period.  The decrease inthe dollar amount of hardware revenues and as a percent of total revenues wasdue primarily to the decrease in the number of software sales made in the ninemonths ended September 30, 2001 resulting in a decrease in accompanyinghardware sales.

 

*Service and Other. *Service and other revenues were $5.4 million for thenine months ended September 30, 2001 and $5.0 million for the nine months endedSeptember 30, 2000, representing an increase of 7%.  Service and other revenues accounted for 48% and 39% of totalrevenues for each respective period. The increase in service and other revenuesis due to the increase in support renewals from the Company’s increased installedcustomer base. The increase in service and other revenues as a percentage oftotal revenues is due to the increase in service and other revenues for thenine months ended September 30, 2001.

 

## ***Cost of Revenues***

 

*Software License*. Cost of software license revenues was $321,000 and $271,000 for the ninemonths ended September 30, 2001 and 2000, respectively, representing 9% and 6%of software license revenues for each respective period, resulting inrespective gross margins of 91% and 94%. The increase in dollar amount and thedecrease in gross margin is attributable to increased product duplication costsand increased royalty payments as a result of increased sales of product withassociated royalty payments.

 

*Hardware.* Cost of hardware revenues was $1.5 million and $2.3 million for the ninemonths ended September 30, 2001 and 2000, respectively, representing 66% and69% of hardware revenues for each respective period.  The decrease in dollar amount for the cost of hardware revenuesfor the nine months ended September 30, 2001 was due primarily to the decreaseof hardware unit sales accompanying the Company’s software products.  The gross margin percentage for hardwaresales was 34% for the nine months ended September 30, 2001 compared to 31% inthe same period in 2000.  The increasein gross margin is due mainly to a change in the mix of the particular hardwareproducts sold.

 

*Serviceand Other.*  Cost of service and other revenue was $3.2million for the nine months ended September 30, 2001 and 2000, representing 60%of service and other revenues versus 63% for the same period last year. Thegross margin percentage for service and other revenues increased to 40% from37% for the nine month periods ended September 30, 2001 and 2000, respectively.The increase in gross margin percentage during the period was due primarily tothe reduced costs associated with a fewer number of employees in the customerservice department combined with the increase in revenues.

## ** **

## ***Operating Expenses***

 

*Salesand Marketing.*  Sales and marketing expenses were $4.7 million and $5.1 million for the nine monthsended September 30, 2001 and 2000, respectively, or 42% and 40% of totalrevenues for each respective period. The decrease in dollar amount was due to lower commissions paid and theincrease in the percentage of total revenues was due to lower sales during thefirst nine months of 2001.

 

*Researchand Development.*  Research and development expenses were $2.4million and $3.0 million for the nine months ended September 30, 2001 and 2000,respectively, or 22% and 23% of total revenues for each respective period.  The decrease in dollar amount and as apercentage of revenue is due to lower wages paid per employee in the researchand development department.

 

*Generaland Administrative.*  General and administrative expenses were$2.6 million and $3.2 million for the nine months ended September 30, 2001 and2000, respectively, or 24% and 25% of total revenues for each respectiveperiod.  The decrease in dollar amountand expenses as a percentage of total revenues was primarily attributable tothe fewer number of executive level personnel and the overhead costs associatedwith supporting such personnel.

 

*Gain onSale of AS/400 Product Line.*  As notedabove, the gain on sale of the AS/400 product line recognized in the quarterended September 30, 2000 represents the payment received from IPP in April2000.

 

*InterestIncome.*Interest income consists principally of interest incomeearned on excess cash.  Interest income was $556,000 for the ninemonths ended September 30, 2001 and $811,000 for the nine months endedSeptember 30, 2000.  The decrease is dueto changes in principal balances and interest rates.

 

*IncomeTaxes.*  The Company has not provided abenefit for income taxes as the Company believes realizability of net operatinglosses is uncertain.

 

### **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, 2001, the Company hadcash and cash equivalents of $12.9 million and working capital of $10.9million.

 

                The Company's operatingactivities used cash of $4.7 million and $1.7 million for the nine months endedSeptember 30, 2001 and 2000, respectively. Net cash used during the nine monthsended September 30, 2001 consisted primarily of a net loss from operations anda decrease in accrued liabilities offset by depreciation and amortization and adecrease in accounts receivable.   Netcash used during the nine months ended September 30, 2000 resulted from a netloss from operations and decreases in accounts payable, accrued liabilities anddeferred revenue offset by depreciation and amortization and a decrease inaccounts receivable and income tax receivable.

 

                Investing activities providedcash of $3.0 million and $781,000 during the nine months ended September 30,2001 and 2000, respectively.  During thenine months ended September 30, 2001 and 2000, the principal uses werepurchases of short-term investments and purchases of property and equipment,offset by proceeds from the sale of short-term investments.

 

                During the nine months endedSeptember 30, 2001, financing activities used cash of  $105,000 due primarily to the purchases of treasury stock. Duringthe nine months ended September 30, 2000 financing activities provided cashof  $282,000 due primarily to the netproceeds from the issuance of common stock.

 

                At September 30, 2001, theCompany did not have any material commitments for capital expenditures.

 

                Subject to the factors discussedbelow, the Company believes that the existing cash balances, short-terminvestments and cash generated from operations will be sufficient to financethe Company's operations for the next twelve months. Although operatingactivities may provide cash in certain periods, to the extent the Company growsin the future, its operating and investing activities may use cash. There canbe no assurance that any necessary additional financing will be available tothe Company on commercially reasonable terms, or at all.

 

**Recent Accounting Pronouncements**

 

                In July 2001, theFinancial Accounting Standards Board (FASB) issued SFAS No. 141, *BusinessCombinations*.  SFAS No. 141requires all business combinations initiated after June 30, 2001 to beaccounted for using the purchase method. This statement is effective for all business combinations initiatedafter June 30, 2001.

 

                In July 2001, the FASB issuedSFAS No. 142, *Goodwill and Other Intangible Assets*.  This statement applies to goodwill andintangible assets acquired after June 30, 2001, as well as goodwill andintangible assets previously acquired. Under this statement goodwill as well as certain other intangibleassets, determined to have an infinite life, will no longer be amortized,instead these assets will be reviewed for impairment on a periodic basis. Thisstatement is effective for the Company for the first quarter in the fiscal yearended December 2002. Management is currently evaluating the impact that thisstatement will have on the Company's financial statements.

 

                InJune 2001, the FASB issued SFAS No. 143, Accounting for Asset RetirementObligations.  This statement addressesfinancial accounting and reporting for obligations associated with theretirement of tangible long-lived assets and the associated asset retirementcosts. This statement applies to all entities. It applies to legal obligationsassociated with the retirement of long-lived assets that result from theacquisition, construction, development and (or) the normal operation of along-lived asset, except for certain obligations of lessees.  This statement amends FASB Statement No. 19and is effective for financial statements issued for fiscal years beginningafter June 15, 2002. The Company is currently evaluating the ultimate impact ofthis statement on its results of operations or financial position until suchtime as its provisions are applied.

 

                In August 2001,the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal ofLong-Lived Assets.  This statementsupercedes FASB Statement No. 121, Accounting for the Impairment of Long-LivedAssets and for Long-Lived Assets to Be DisposedOf, and the accounting and reporting provisions of APB Opinion No. 30,Reporting the Results of Operations, Reporting the Effects of Disposal of aSegment of a Business, and Extraordinary, Unusual and Infrequently OccurringEvents and Transactions. Under this statement it is required that one accountingmodel be used for long-lived assets to be disposed of by sale, whetherpreviously held and used or newly acquired, and it broadens the presentation ofdiscontinued operations to include more disposal transactions.  The provisions of this statement areeffective for financial statements issued for fiscal years beginning afterDecember 15, 2001, and interim periods within those fiscal years, with earlyadoption permitted.  The Company iscurrently evaluating whether it will early adopt the provisions of SFAS No.144, and management will not be able to determine the ultimate impact of thisstatement on its results of operations or financial position until such time asits provisions are applied.

 

**Certain Factors Affecting FutureOperating Results**

 

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

 

                Informationprovided by the Company from time to time including statements in this Form10-Q which are not historical facts are so-called "forward–lookingstatements" that involve risks and uncertainties, made pursuant to thesafe harbor provisions of the Private Securities Litigation Reform Act of 1995.In particular, 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 objectivesof management; expectations for sales and marketing, research and developmentand general and administrative expenses; developments relating to the Company'sproduct and service offerings, markets and acquisitions; anticipated trends inthe Company's business; and the Company's expected liquidity and capitalresources) may constitute forward–looking statements. These forward–lookingstatements are neither promises nor guarantees, but are subject to risk anduncertainties that could cause actual results to differ materially from theexpectations set forth in the forward–looking statements. Factors thatmay cause such differences include, but are not limited to, the factorsdiscussed below, and the other risks discussed from time to time in theCompany's other filings with the Securities and Exchange Commission.

 

*ProductConcentration.*  To date, muchof the Company's revenues have been attributable to licenses of the Company'sfacsimile based enterprise solutions and related products and services. TheCompany expects such products and related services to continue to account formuch of the Company's future revenues. However, recently the amount of revenuesattributable to the licenses of such products has declined and there can be noassurances that such decline will not continue. Furthermore, in June 2000, theCompany changed its strategic focus to the development of securebusiness-to-business electronic document exchange solutions. The Companyintroduced its secure business-to-business electronic document exchange products,Genidocs and Genifax, to the market in the fourth quarter of 2000.  To date, the Company has not recognized asignificant amount of revenues from its Genidocs product. The Company expectsthat Genidocs  may account for anincreasing portion of future revenues. However, there can be no assurances thatGenidocs will be financially successful or result in any significant revenues.Factors adversely affecting the pricing of or demand for such products, such ascompetition or technological change, could have a material adverse effect onthe Company's business, financial condition and results of operations. TheCompany's prospects must be considered in light of the risks and difficultiesfrequently encountered by companies dependent upon operating revenues from anew product line in an emerging and rapidly evolving market.

 

*New Productsand Technological Change.*  Themarkets for the Company's products are relatively new and are characterized byrapid technological change, evolving industry standards, changes in end-userrequirements and frequent new product introductions and enhancements. TheCompany's future success will depend upon its ability to enhance its currentproducts and to develop and introduce new products that keep pace withtechnological developments and respond to evolving end-user requirements. Therecan be no assurance that the Company will be successful in developing andmarketing new products or product enhancements on a timely basis, or that newproducts or product enhancements developed by the Company, such as Genidocs andGenifax, will achieve market acceptance. The introduction of products embodyingnew technologies and the emergence of new industry standards could render theCompany's existing products obsolete and unmarketable. From time to time, theCompany and its competitors may announce new products, capabilities ortechnologies that have the potential to replace or shorten the life cycle ofthe Company's existing product offerings. There can be no assurance thatannouncements of new product offerings by the Company or its competitors willnot cause customers to defer or forego the licensing of the Company's existingor planned products and have a material adverse effect on the Company'sbusiness, financial condition and results of operations.

 

 

*The MarketRisks for Secure Business-to-Business Electronic Document Exchange Solutions.*  The market for Genidocs, the Company'ssecure business-to-business electronic document exchange solution is new andevolving rapidly. The Company's success will depend upon the adoption and useby current and potential customers of secure business-to-business electronicdocument exchange solutions. The Company's success will also depend uponacceptance of its technology as the standard for providing these solutions. Theadoption and use of the Company's secure business-to-business electronicdocument exchange solution will involve changes in the manner in whichbusinesses have traditionally exchanged information. The Company's 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-business electronicdocument exchange solution, or its growth rate, if any. Moreover, the Companycannot predict whether the Company's secure business-to-business electronicdocument exchange solution will achieve any market acceptance. Any futureproducts or future product enhancements that are not favorably received bycustomers may not be profitable and, furthermore, could damage the Company'sreputation or brand name.

 

 *Dependence on Fax Sr. NT and the Windows NTEnvironment.*  The Companycurrently derives a substantial portion of its revenues from licenses of FaxSr. NT and related services and resale of related hardware. Continued marketacceptance of Fax Sr. NT is critical to the Company's future success. As aresult, any decline in demand for or failure to maintain broad marketacceptance of Fax Sr. NT as a result of competition, technological change orotherwise, would have a material adverse effect on the Company's business,financial condition and results of operations. The Company's future financialperformance will depend in large part on customer acceptance of new andenhanced versions of Fax Sr. NT. There can be no assurance that the Companywill continue to be successful in marketing Fax Sr. NT or any new or enhancedversions of Fax Sr. NT. In addition, there can be no assurance that the WindowsNT operating system will not be replaced by a new or enhanced operating system.There can be no assurance that the Company will be successful in developingproducts for new or enhanced operating systems such as Windows 2000 or WindowsXP, or that such systems will not obviate the need for the Company's products.If any new or enhanced operating system gains widespread use and the Companyfails to develop and provide its products for this operating system on a timelybasis, the Company's business, financial condition and results of operationswould be materially adversely affected.

 

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

 

*FutureOperating Results Uncertain.*  The Company was incorporated in March 1991 and shipped itsinitial facsimile software products in 1991. The Company does not believe thatprior growth rates are indicative of future operating results. In the yearsending December 31, 1999 and 2000, and the three quarters ended September 30,2001 the Company had operating losses and decreasing revenues. There can be noassurance that the Company will be able to increase its level of revenues orreturn to profitability in the future, as the Company's limited operatinghistory makes the prediction of future operating results difficult orimpossible. Increases in operating expenses, primarily sales and marketing, maycontinue and, together with pricing pressures and a continued decline in thegrowth rate of the overall U.S. economy, may result in a continued decrease inoperating income and operating margin percentage. The Company's ability toimprove its operating results will depend upon, among other things, its abilityto increase sales of the Company's secure business-to-business electronicdocument exchange solutions and client/server facsimile solutions to newcustomers as well as increased product penetration into existing customers. Asthe Company commenced its strategic expansion into secure business-to-businesselectronic document exchange solutions market in the fourth quarter of 2000,the Company has limited financial and operating data and a limited operatinghistory relevant to these solutions. Accordingly, it is difficult to evaluatethe prospects for the level of acceptance of the Company's securebusiness-to-business electronic document exchange solutions. In addition, theCompany's future operating results are subject to the risk that final judgmentof the definitive class action shareholder lawsuit in the federal districtcourt in New Hampshire may not become effective, and, in the event of continuedlitigation, the possibility of outcomes adverse to the Company. Futureoperating results will depend on many other factors, including, withoutlimitation, the degree and rate of growth of the markets in which the Companycompetes, the level of acceptance of the Windows NT, Windows 2000 and WindowsXP operating systems, the level of product and price competition, the abilityof the Company to establish strategic relationships and develop and market newand enhanced products and to control costs, the ability of the Company toexpand its direct telesales force and indirect distribution channels bothdomestically and internationally, and the ability of the Company to attract andretain key personnel. As a result, it is possible that in the future the Company'soperating results will be below the expectations of public market analysts andinvestors. In such event, the price of the Company's Common Stock would likelybe materially adversely affected.

 

 

*Risks Associated with Delisting Fromthe Nasdaq National Market*.  In June 2001the Nasdaq National Market informed the Company that it had failed to maintainthe Nasdaq National Market’s minimum bid price maintenance standard and thatthe Company had until September 10, 2001 to demonstrate compliance with the NasdaqNational Market listing requirements. On August 15, 2001, the Company received a letter from the NasdaqNational Market noting that the Company had regained compliance with the NasdaqNational Market’s listing standards and the matter was closed.  The delisting of the Company’s common stockfrom the Nasdaq National Market may materially impair the ability ofstockholders to buy and sell shares of the Company’s common stock and couldhave an adverse effect on the market price of, and the efficiency of thetrading market for, the Company’s common stock.  In addition, the delisting of the Company’s common stock couldsignificantly impair the Company’s ability to raise capital should it desire todo so in the future.  The Companyintends to take all reasonable measures to maintain compliance.  The Company’s listing on the Nasdaq NationalMarket is highly important to the Company.

 

 *Intense Competition.*  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 scaleability; quality of support services;price/performance; timeliness of enhancements and new product releases by theCompany and its competitors; the emergence of new computer–basedfacsimile and secure business-to-business electronic document exchangesolutions and standards; name recognition; the establishment of strategicalliances with industry leaders; and industry and general economic trends.

 

                The Company may not be able tocompete successfully against current and future competitors in the securebusiness-to-business electronic document exchange solutions market, and thecompetitive pressures the Company faces could harm its business and prospects.The Company’s solutions provide an alternative to traditional mail and courierdocument delivery services, such as those offered, among others, by FederalExpress, UPS or the U.S. Postal Service. The Company's solution is also analternative to general-purpose e-mail applications and services. In the area ofsecure online document exchange, the Company's competition comes from secureonline document exchange services providers. Some of these providers haveproducts that are intended to compete with the Company's products. Examples ofthese companies include Pitney Bowes, Sigaba, Tumbleweed, UPS, the U.S. PostalService and Zixit. In addition, many companies with which the Company does notpresently compete may become competitors in the future. This could occur eitherthrough the expansion of the Company's products or through other companies'product development in the area of secure online communication. These companiescould include Documentum, Hummingbird and iManage. Additionally, companies suchas JetForm, PureEdge and Silanis may develop and deliver competitive digitalsignature products in the future.

 

                The Company competes directlywith a large number of vendors of facsimile products, including providers offacsimile software products for client/server networks such as RightFAX (asubsidiary of Applied Voice Technology), Fenestrae, TopCall International andBiscom. The Company also competes with vendors offering a range of alternativefacsimile solutions including outsourcing network facsimile solutions, such asMail.com; operating systems containing facsimile and document transmissionfeatures; low-end fax modem products; desktop fax software; single–platformfacsimile software products; and customized proprietary software solutions. Inaddition, providers of operating systems or business software applications maybundle competitive facsimile solutions as part of their broader productofferings.

 

                Many of the Company'scompetitors and potential competitors have longer operating histories andgreater financial, technical, sales, marketing and other resources, as well asgreater name recognition and market acceptance of their products andtechnologies than the Company. In addition, there are relatively low barriersto entry in the markets in which the Company operates and intends to operate,and new competition may arise either from expansion by established companies orfrom new emerging companies or from resellers of the Company's products. Therecan be no assurance that current or potential competitors of the Company willnot develop products comparable or superior in terms of price and performancefeatures to those developed by the Company, adapt more quickly than the Companyto new or emerging technologies and changes in market opportunities or customerrequirements, establish alliances with industry leaders, or take advantage ofacquisition opportunities more readily than the Company. In addition, noassurance can be given that the Company will not be required to makesubstantial additional investments in connection with its research,development, engineering, marketing, sales and customer service efforts inorder to meet any competitive threat, or that such required investments willnot have a material adverse effect on operating margins. Increased competitionmay result in reduction in market share, pressure for price reductions andrelated reductions in gross margins, any of which could materially adverselyaffect the Company's ability to achieve its financial and business goals. Therecan be no assurance that in the future the Company will be able to successfullycompete against current and future competitors.

 

*Fluctuationsin Quarterly Results of Operations; Seasonality.*  The Company's quarterly revenues and results of operations havefluctuated significantly in the past and will likely fluctuate significantly inthe future. Causes of such fluctuations have included and may include, amongothers, the demand for the Company's products and services, the size and timingof orders, the number, timing and significance of new product announcements bythe Company and its competitors, the ability of the Company to develop,introduce, market and ship new and enhanced versions of the Company's currentand planned products on a timely basis, the level of product and pricecompetition, changes in operating expenses, changes in average selling pricesand mix of the Company's products, changes in the Company's sales incentivestrategy, the mix of direct and indirect sales, and general economic factors,including a continued decline in the growth rate of the overall U.S. economy.In addition, the sale of the Company's products often involves delays becausecustomers have tended to implement the products on a large scale and customersalso must establish certain minimum hardware capabilities. The Company'sproducts therefore often have a lengthy sales cycle while the customerevaluates and receives approvals for the purchase of the Company's products.During such sales cycles, the Company may expend substantial funds and managementefforts yet receive no revenues. It may be difficult to accurately predict thesales cycle of any large order. If one or more large orders fails to close asforecasted in a fiscal quarter, the Company's revenues and operating resultsfor such quarter could be materially adversely affected. Any one or more ofthese or other factors could have a material adverse effect on the Company'sbusiness, financial condition and results of operations. The potentialoccurrence of any one or more of these factors makes the prediction of revenuesand results of operations on a quarterly basis difficult and performanceforecasts derived from such predictions unreliable.

 

                The Company's business hasexperienced and is expected to continue to experience seasonality. The Companyhas historically had and expects to continue to have weaker sales in the monthsof July and August which may have an adverse affect on third quarter sales. TheCompany believes that these fluctuations are caused primarily by customerbudgeting and purchasing patterns.

 

                In general, revenues aredifficult to forecast because the market for secure business-to-businesselectronic document exchange and enterprise, client/server facsimile solutionssoftware is evolving rapidly and the Company's sales cycle, from the customer'sinitial evaluation through purchase of licenses and the related supportservices, varies substantially from customer to customer. License fee revenuesin any quarter depend 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 from quarter to quarter are difficult toforecast, as no significant order backlog exists at the end of any quarterbecause the Company's products typically are shipped upon receipt of customers'orders.

 

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

 

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

 

*RisksAssociated with Acquisitions.*  The Company may augment its internal growth with acquisitions ofbusinesses, products and technologies that could complement or expand theCompany's business. Certain of these businesses may be marginally profitable orunprofitable. In order to achieve anticipated benefits from these acquisitions,the Company must successfully integrate the acquired businesses with itsexisting operations, and no assurance can be given that the Company will besuccessful in this regard. The Company has limited experience in integratingacquired companies into its operations, in expanding the scope of operations ofrequired businesses, in managing geographically dispersed operations, and inoperating internationally. In the past the Company has incurred one-time costsand expenses in connection with acquisitions and it is likely that similarone-time costs and expenses may be incurred in connection with futureacquisitions. In addition, attractive acquisitions are difficult to identifyand complete for a number of reasons, including competition among prospectivebuyers and the possible need to obtain regulatory approval. There can be noassurance that the Company will be able to complete future acquisitions. Inorder to finance such acquisitions, it may be necessary for the Company toraise additional funds either through public or private financings, includingbank borrowings. Any financing, if available at all, may be on terms which arenot favorable to the Company. The Company may also issue shares of its commonstock to acquire such businesses, which may result in dilution to the Company'sexisting stockholders.

 

*Ability toManage Growth.*  The Company hasexpanded its operations and anticipates that expansion will be required inorder to address potential market opportunities. The Company may continue toincrease the size of its sales and marketing and research and developmentexpenditures as necessary. There can be no assurance that such expansion willbe successfully completed or that it will generate sufficient revenues to coverthe Company's expenses. The Company will need to continue to attract and retainhighly qualified technical, sales and managerial personnel. There can be noassurance that the Company will be able to retain or continue to hire suchpersonnel in the future. The inability of the Company to effectively expandoperations and manage growth, if any, could have a material adverse effect onthe Company's business, financial condition and results of operations.

 

 *Expansion of Indirect Channels; Potential for ChannelConflict.*  The Companymarkets its products and services directly through telesales and indirectlythrough marketing channels such as value–added resellers("VARs"), systems integrators and distributors. Although the Companyhas historically focused its efforts on marketing through its telesales force,the Company is increasing resources dedicated to developing and expandingindirect marketing channels. There can be no assurance that the Company will beable to attract and retain a sufficient number of qualified VARs, systemsintegrators and distributors to market successfully the Company's products. Inaddition, there can be no assurance that the Company's resellers will notdevelop, acquire or market computer–based facsimile products competitivewith the Company's products. The failure to retain its VARs, systemsintegrators and distributors could have a material adverse effect on theCompany's business, financial condition and results of operations.

 

                The distributor agreementsgenerally provide that either party may terminate the agreement without causeupon 30 days written notice to the other party. The Company also resells itsproducts on a purchase order basis through other VARs, systems integrators anddistributors. Such relationships may be terminated by either party, at anytime, and therefore, there can be no assurance that any VAR, systems integratoror distributor will continue to represent the Company's products. The inabilityto retain certain VARs, systems integrators or distributors, or the developmentor marketing by VARs, systems integrators or distributors of competitiveofferings, could have a material adverse effect on the Company's business,financial condition and results of operations.

 

                Selling through indirectchannels may limit the Company's contacts with its customers. As a result, theCompany's ability to accurately forecast sales, evaluate customer satisfactionand recognize emerging customer requirements may be hindered. The Company'sstrategy of marketing its products directly to end-users and indirectly throughVARs, 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.

 

*Risks Associated with InternationalExpansion*.  A key element of the Company's strategy isto continue to increase its international sales. The Company expects to facecompetition from secure business-to-business electronic document exchangesolutions and local facsimile product providers in their native countries. Tosuccessfully expand international sales, the Company will need to recruit andretain additional international resellers and distributors. There can be noassurance that the Company will be able to maintain or increase internationalsales of its products or that the Company's international distribution channelswill be able to adequately market, service and support the Company's products.International operations generally are subject to certain risks, includingdependence on independent resellers, fluctuations in foreign currency exchangerates, compliance with foreign regulatory and market requirements, variabilityof foreign economic conditions and changing restrictions imposed by UnitedStates export laws. Additional risks inherent in the Company's internationalbusiness activities generally include unexpected changes in regulatoryrequirements, tariffs and other trade barriers, costs of localizing productsfor foreign countries, lack of acceptance of localized products in foreigncountries, longer accounts receivable payment cycles, difficulties in managinginternational operations, difficulties in enforcing intellectual propertyrights and the burdens of complying with a wide 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.

 

*Dependence on Key Personnel*. The Company's future performance depends, in significant part, upon thecontinued service of its key technical, sales and senior management personnel,none of whom is bound by an employment agreement or by a noncompetitionagreement. The loss of the services of one or more of the Company's executiveofficers or other key employees could have a material adverse effect on theCompany's business, financial condition and results of operations. TheCompany's future success also depends on its continuing ability to attract andretain highly qualified technical, sales and managerial personnel. Competitionfor such personnel is intense, and the Company has experienced difficulty inrecruiting 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.

 

Item 3. Quantitative and Qualitative Disclosures AboutMarket Risk

 

 

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

 

As of September30, 2001, 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. All of the Company'sinvestments consist of money market funds and municipal bonds that are carriedon the Company's books at amortized cost, which approximates fair market value.Accordingly, the Company has no quantitative information concerning the marketrisk of participating in such investments.

 

**Primary Market Risk Exposures**

 

The Company'sprimary market risk exposures are in the areas of interest rate risk andforeign currency exchange rate risk. The Company's investment portfolio of cashequivalent and short-term investments is subject to interest rate fluctuations,but the Company believes this risk is immaterial due to the short-term natureof these investments. The Company's exposure to currency exchange ratefluctuations has been and is expected to continue to be modest due to the factthat the operations of its United Kingdom subsidiary are almost exclusivelyconducted in its local currency. The United Kingdom subsidiary operatingresults are translated into U.S. dollars and consolidated for reportingpurposes. The impact of currency exchange rate movements on intercompanytransactions was immaterial for the quarter ended September 30, 2001. Currentlythe Company does not engage in foreign currency hedging activities.

 

 

 

**PARTII                                                 OTHERINFORMATION**

 

Item 1. Litigation

 

                On October 5,1999, a purported securities class action complaint was filed against theCompany and certain officers and directors of the Company.  As of March 31, 2001, the Company reached anagreement-in-principle to settle the lawsuit. On June 28, 2001, the parties filed a definitive settlement agreementwith the United States District Court for the District of New Hampshire (the“Court”).  On July 6, 2001, the Courtpreliminarily approved the proposed terms of the definitive settlementagreement.  On October 23, 2001, theCourt ordered final approval of the settlement.  Pursuant to the terms of the Court's order, final judgment andfull dismissal of the class action litigation against all defendants willbecome effective as early as November 25, 2001.  The terms of the proposed $6 million settlement include acontribution by the Company's directors’ and officers’ liability insurancecarriers of $4.3 million, and a contribution by the Company of $1.7million.  The Company accrued itsportion of the settlement as of December 31, 2000.  The Company continues to believe that the lawsuit is withoutmerit, and, in the unlike event final judgment does not become effective, theCompany intends to continue defending the lawsuit vigorously.

 

 

Item 6.        Exhibitsand Reports on Form 8-K

 

(a)       Exhibits

 

None

 

(b)       Reports on Form 8-K

 

None

 

 

 

 

 

 

OMTOOL, LTD.

 

 

Signatures

 

 

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

 

 

OMTOOL, LTD.

 

 
| November 13, 2001 | By:    | /s/ Kira A. Nelson                               |
|-------------------|--------|--------------------------------------------------|
|              |   | Kira A. Nelson                                   |
|              |   | Chief Financial Officer, Secretary and Treasurer |