Tableof Contents

 

 

 

**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

** **

**FORM 10-Q**

** **
| **(Mark One)**                                              | ** ** | ** **                                                                                               |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| ** **                                                  | ** ** | ** **                                                                                               |
| **x**                                                       | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
| ** **                                                  | ** ** | ** **                                                                                               |
| **For the quarterly period ended September 30,  2008** |
| ** **                                                  | ** ** | ** **                                                                                               |
| **OR**                                                      |
| ** **                                                  | ** ** | ** **                                                                                               |
| **o**                                                       | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15  (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**For the transition periodfrom             to             **

** **

**Commission File Number 0-22871**

** **

**OMTOOL, LTD.**

(Exact Name ofRegistrant as Specified in Its Charter)

 

| **Delaware**                                                     | ** ** | **02-0447481**                            |
|------------------------------------------------------------------|------------|-------------------------------------------|
| (State  or Other Jurisdiction of  Incorporation or Organization) |       | (I.R.S.  Employer  Identification Number) |
|                                                             |       |                                      |
| **6 Riverside Drive, Andover, MA**                               | ** ** | **01810**                                 |
| (Address  of Principal Executive Offices)                        |       | (Zip  Code)                               |

 

**(978) 327-5700**

(Registrant’sTelephone Number Including Area Code)

 

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

 

Yes x  No o

 

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company.  See the definitions of “large acceleratedfiler”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| Large accelerated filer o     |                                           | Accelerated filer o |
|-------------------------------|------------------------------------------------|--------------------------|
| Non-accelerated  filer o | (Do not check if a  smaller reporting company) |                     | Smaller reporting  company x |
|                               |                                                |                          |  |

 

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

 

Yes o  No x

 

There were 4,742,060shares of the Company’s common stock, par value $0.01, outstanding on November 10,2008.

 

 

 

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Table ofContents

 

**OMTOOL, LTD. AND SUBSIDIARIES**

 

FORM 10-Q

For the Quarter Ended September 30, 2008

CONTENTS

 

**Item Number**

 
| PART I: FINANCIAL  INFORMATION |                                                                                                                             |
|-------------------------------------|----------------------------------------------------------------------------------------------------------------------------------|
|                                |                                                                                                                             |
| Item 1.                             | Consolidated Financial  Statements                                                                                               |   |
|                                | Consolidated Balance Sheets as of  September 30, 2008 (Unaudited) and December 31, 2007                                |   |
|                                | Consolidated Statements of  Operations for the three months and nine months ended September 30, 2008  and  2007 (Unaudited) |   |
|                                | Consolidated Statements of  Cash Flows for the nine months ended September 30, 2008 and 2007  (Unaudited)                   |   |
|                                | Notes to Consolidated  Financial Statements                                                                                      |   |
|                                |                                                                                                                             |   |
| Item 2.                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                      |   |
|                                |                                                                                                                             |
| Item 4T.                            | Controls and  Procedures                                                                                                         |   |
|                                |                                                                                                                             |
| PART II: OTHER  INFORMATION    |                                                                                                                             |
|                                |                                                                                                                             |
| Item 1A.                            | Risk Factors                                                                                                                     |   |
|                                |                                                                                                                             |
| Item 2.                             | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                     |   |
|                                |                                                                                                                             |
| Item 6.                             | Exhibits                                                                                                                         |   |
|                                |                                                                                                                             |
| Signatures                          |                                                                                                                             |
|                                |                                                                                                                             |
| Exhibit Index                  |                                                                                                                             |
|                                |                                                                                                                             |
| Exhibits                            |                                                                                                                             |

 

2

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**PART I:  FINANCIAL INFORMATION**

 

**Item 1.  Consolidated Financial Statements**

 

**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                                                                                                            | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                            | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                                                                                                       |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                            |       | $                            | 2,032,079  |                        | $          | 2,328,033 |   |
| Accounts  receivable, net of reserves of $43,000 at September 30, 2008 and $45,000  at December 31, 2007, respectively                                                                                                                                      |       | 3,019,913                    |       | 2,132,950                   |       |
| Unbilled  accounts receivable                                                                                                                                                                                                                                         |       | 366,033                      |       | 419,843                     |       |
| Inventory                                                                                                                                                                                                                                                             |       | 83,492                       |       | 75,959                      |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                                                            |       | 518,616                      |       | 368,739                     |       |
| Total current  assets                                                                                                                                                                                                                                                 |       | 6,020,133                    |       | 5,325,524                   |       |
| Property and  equipment, net                                                                                                                                                                                                                                          |       | 1,135,987                    |       | 1,278,297                   |       |
| Goodwill                                                                                                                                                                                                                                                              |       | 1,883,096                    |       | 1,883,096                   |       |
| Intangible  assets, net                                                                                                                                                                                                                                               |       | 994,469                      |       | 1,276,656                   |       |
| Unbilled  accounts receivable, long-term                                                                                                                                                                                                                              |       | 38,463                       |       | 216,997                     |       |
| Other assets                                                                                                                                                                                                                                                          |       | 291,568                      |       | 291,568                     |       |
| Total assets                                                                                                                                                                                                                                                          |       | $                            | 10,363,716 |                        | $          | 10,272,138 |   |
|                                                                                                                                                                                                                                                                  |       |                         |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ (DEFICIT) EQUITY**                                                                                                                                                                                                              | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current  liabilities:                                                                                                                                                                                                                                                 |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                                                                                                                      |       | $                            | 1,225,817  |                        | $          | 949,941 |   |
| Accrued  liabilities                                                                                                                                                                                                                                                  |       | 1,723,524                    |       | 1,571,099                   |       |
| Deferred revenue                                                                                                                                                                                                                                                      |       | 5,291,743                    |       | 4,346,598                   |       |
| Capital lease  obligations                                                                                                                                                                                                                                            |       | 100,058                      |       | 94,624                      |       |
| Note payable                                                                                                                                                                                                                                                          |       | 561,234                      |       | 561,234                     |       |
| Total current  liabilities                                                                                                                                                                                                                                            |       | 8,902,376                    |       | 7,523,496                   |       |
| Long term  liabilities:                                                                                                                                                                                                                                               |       |                         |       |                        |       |
| Deferred rent                                                                                                                                                                                                                                                         |       | 468,319                      |       | 467,660                     |       |
| Deferred revenue                                                                                                                                                                                                                                                      |       | 565,014                      |       | 523,877                     |       |
| Capital lease  obligations                                                                                                                                                                                                                                            |       | 184,241                      |       | 259,977                     |       |
| Note payable                                                                                                                                                                                                                                                          |       | 280,617                      |       | 701,543                     |       |
| Total  liabilities                                                                                                                                                                                                                                                    |       | 10,400,567                   |       | 9,476,553                   |       |
|                                                                                                                                                                                                                                                                  |       |                         |       |                        |       |
| Stockholders’  (deficit) equity:                                                                                                                                                                                                                                 |       |                         |       |                        |       |
| Preferred Stock,  $0.01 par value —                                                                                                                                                                                                                              |       |                         |       |                        |       |
| Authorized —  2,000,000 shares; Issued and outstanding — none                                                                                                                                                                                               |       | —                       |       | —                      |       |
| Common stock,  $0.01 par value —                                                                                                                                                                                                                                 |       |                         |       |                        |       |
| Authorized —  35,000,000 shares; Issued — 4,744,267 shares at September 30, 2008 and  4,743,209 shares at December 31, 2007; Outstanding — 4,743,241  shares at September 30, 2008 and 4,561,045 shares at December 31,  2007 |       | 47,443                       |       | 47,432                      |       |
| Additional  paid-in capital                                                                                                                                                                                                                                           |       | 35,631,902                   |       | 36,683,169                  |       |
| Accumulated  deficit                                                                                                                                                                                                                                                  |       | (35,691,810                  | )          | (34,465,277                 | )          |
| Treasury stock,  at cost, 1,026 shares at September 30, 2008 and 182,164 shares at  December 31, 2007                                                                                                                                                       |       | (2,462                       | )          | (1,399,071                  | )          |
| Accumulated  other comprehensive loss                                                                                                                                                                                                                                 |       | (21,924                      | )          | (70,668                     | )          |
| Total  stockholders’ (deficit) equity                                                                                                                                                                                                                            |       | (36,851                      | )          | 795,585                     |       |
| Total  liabilities and stockholders’ (deficit) equity                                                                                                                                                                                                            |       | $                            | 10,363,716 |                        | $          | 10,272,138 |   |

 

The accompanying notes are an integral part of theseunaudited consolidated financial statements.

 

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements of Operations**

(Unaudited)

 
| ** **                                               | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                               | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenue:                                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Software license                                         |       | $                                                    | 821,970    |                                                | $          | 1,212,104 |   | $ | 3,115,659 |   | $ | 3,540,879 |   |
| Hardware and  media                                      |       | 622,269                                              |       | 514,626                                             |       | 1,348,537 |   | 1,570,317 |   |
| Service and  other                                       |       | 2,662,740                                            |       | 2,381,855                                           |       | 7,392,773 |   | 7,105,605 |   |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Total revenue                                            |       | 4,106,979                                            |       | 4,108,585                                           |       | 11,856,969 |   | 12,216,801 |   |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of revenue:                                         |       |                                                 |       |                                                |       |   |   |   |   |
| Software license                                         |       | 94,699                                               |       | 103,427                                             |       | 292,764 |   | 311,972 |   |
| Hardware and  media                                      |       | 404,505                                              |       | 314,006                                             |       | 871,290 |   | 1,008,144 |   |
| Service and  other                                       |       | 993,251                                              |       | 888,001                                             |       | 2,885,124 |   | 2,900,280 |   |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Total cost of  revenue                                   |       | 1,492,455                                            |       | 1,305,434                                           |       | 4,049,178 |   | 4,220,396 |   |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Gross profit                                             |       | 2,614,524                                            |       | 2,803,151                                           |       | 7,807,791 |   | 7,996,405 |   |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Operating  expenses:                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Sales and  marketing                                     |       | 1,571,595                                            |       | 1,555,984                                           |       | 4,717,984 |   | 5,622,928 |   |
| Research and  development                                |       | 713,380                                              |       | 624,390                                             |       | 2,107,336 |   | 2,234,152 |   |
| General and  administrative                              |       | 677,366                                              |       | 686,590                                             |       | 2,177,313 |   | 2,538,534 |   |
| Restructuring  costs                                     |       | —                                               |       | —                                              |       | — |   | 343,450 |   |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Total operating  expenses                                |       | 2,962,341                                            |       | 2,866,964                                           |       | 9,002,633 |   | 10,739,064 |   |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Loss from  operations                                    |       | (347,817                                             | )          | (63,813                                             | )          | (1,194,842 | ) | (2,742,659 | ) |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Interest and  other income                               |       | 19,666                                               |       | 21,504                                              |       | 53,085 |   | 69,536 |   |
| Interest expense                                         |       | (18,935                                              | )          | (40,261                                             | )          | (66,652 | ) | (135,796 | ) |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss                                                 |       | $                                                    | (347,086   | )                                                   | $          | (82,570 | ) | $ | (1,208,409 | ) | $ | (2,808,919 | ) |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss per  share:                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Basic and  diluted                                       |       | $                                                    | (0.08      | )                                                   | $          | (0.02 | ) | $ | (0.28 | ) | $ | (0.62 | ) |
|                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average  shares used in per share calculations: |       |                                                 |       |                                                |       |   |   |   |   |
| Basic and  diluted                                       |       | 4,353,228                                            |       | 4,557,292                                           |       | 4,321,370 |   | 4,526,510 |   |

 

The accompanying notes are an integral part of theseunaudited consolidated financial statements*.*

 

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements of Cash Flows**

(Unaudited)

 
| ** **                                                                                 | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| Cash Flows from  Operating Activities:                                                     |       |                                                |       |   |   |
| Net loss                                                                                   |       | $                                                   | (1,208,409 | ) | $ | (2,808,919 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                                                |       |   |   |
| Depreciation and  amortization                                                             |       | 494,921                                             |       | 600,913 |   |
| Accounts  receivable reserves                                                              |       | (261                                                | )          | 41,099 |   |
| Stock-based  compensation                                                                  |       | 368,733                                             |       | 265,484 |   |
| Changes in  assets and liabilities:                                                        |       |                                                |       |   |   |
| Accounts  receivable                                                                       |       | (901,681                                            | )          | (104,274 | ) |
| Unbilled  accounts receivable                                                              |       | 232,344                                             |       | 363,891 |   |
| Prepaid expenses  and other current assets                                                 |       | (154,959                                            | )          | 40,557 |   |
| Inventory                                                                                  |       | (7,533                                              | )          | 61,431 |   |
| Other assets                                                                               |       | —                                              |       | (229,609 | ) |
| Accounts payable                                                                           |       | 284,988                                             |       | (993,118 | ) |
| Accrued  liabilities                                                                       |       | 126,172                                             |       | 185,413 |   |
| Deferred revenue                                                                           |       | 1,074,534                                           |       | 293,017 |   |
| Deferred rent                                                                              |       | 659                                                 |       | (30,908 | ) |
|                                                                                       |       |                                                |       |   |   |
| Net cash  provided by (used in) operating activities                                       |       | 309,508                                             |       | (2,315,023 | ) |
|                                                                                       |       |                                                |       |   |   |
| Cash Flows from  Investing Activities:                                                     |       |                                                |       |   |   |
| Additional  purchase consideration for prior period acquisition                            |       | —                                              |       | (669,135 | ) |
| Purchases of  property and equipment                                                       |       | (72,266                                             | )          | (42,463 | ) |
|                                                                                       |       |                                                |       |   |   |
| Net cash used in  investing activities                                                     |       | (72,266                                             | )          | (711,598 | ) |
|                                                                                       |       |                                                |       |   |   |
| Cash Flows from  Financing Activities:                                                     |       |                                                |       |   |   |
| Net proceeds  from issuance of common stock                                                |       | 4,530                                               |       | 17,974 |   |
| Net proceeds  from issuance of restricted common stock                                     |       | 2,048                                               |       | 1,452 |   |
| Forfeiture of  restricted common stock                                                     |       | (89                                                 | )          | (305 | ) |
| Principal  payments for note payable                                                       |       | (420,925                                            | )          | (280,617 | ) |
| Principal  payments for capital lease obligations                                          |       | (70,303                                             | )          | (65,260 | ) |
|                                                                                       |       |                                                |       |   |   |
| Net cash used in  financing activities                                                     |       | (484,739                                            | )          | (326,756 | ) |
|                                                                                       |       |                                                |       |   |   |
| Exchange rate  effect on cash and cash equivalents                                         |       | (48,457                                             | )          | (8,618 | ) |
|                                                                                       |       |                                                |       |   |   |
| Net decrease in  cash and cash equivalents                                                 |       | (295,954                                            | )          | (3,361,995 | ) |
|                                                                                       |       |                                                |       |   |   |
| Cash and cash  equivalents, beginning of period                                            |       | 2,328,033                                           |       | 5,469,366 |   |
|                                                                                       |       |                                                |       |   |   |
| Cash and cash  equivalents, end of period                                                  |       | $                                                   | 2,032,079  |   | $ | 2,107,371 |   |
| Supplemental  Disclosure of Cash Flow Information:                                         |       |                                                |       |   |   |
| Cash paid during  the period for interest                                                  |       | $                                                   | 71,125     |   | $ | 125,565 |   |

 

The accompanying notes are an integral part of theseunaudited consolidated financial statements*.*

 

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

(Unaudited)

 

**(1) Basis of Presentation**

 

Omtool, Ltd. (“Omtool”or the “Company”) provides document and information handling softwaresolutions that control document-based business communications and integratepaper and electronic documents into enterprise information systems andworkflows. The Company’s software products streamline the capture, conversionand communication of both paper and electronic information, enabling fast,secure and simultaneous distribution to multiple destinations in multipleformats.

 

The accompanyingunaudited consolidated financial statements have been prepared by Omtoolpursuant to the rules and regulations of the Securities and ExchangeCommission (“SEC”) regarding interim financialreporting. Accordingly, they do not include all of the information andfootnotes required by generally accepted accounting principles for completefinancial statements and should be read in conjunction with the consolidatedfinancial statements and notes thereto for the year ended December 31,2007 as filed with the SEC as part of the Company’s Annual Report on Form 10-Kon March 28, 2008. The accompanying unaudited consolidated financialstatements reflect all adjustments (consisting of normal recurring adjustments)that are, in the opinion of management, necessary for a fair presentation ofresults for the interim periods presented. The results of operations for thethree- and nine-month periods ended September 30, 2008 are not necessarilyindicative of the results to be expected for the full fiscal year.

 

**(2) Net Loss Per Share**

 

TheCompany reports net loss per share in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 128,**“*Earnings per Share*.”Diluted weighted average shares outstanding for the three- and nine-month periodsended September 30, 2008 and September 30, 2007 exclude 494,539 and432,660, respectively of potential common shares from stock options and a stockwarrant because to include them would have been anti-dilutive for the periodspresented, as the Company reported a net loss during the periods.

 

**(3) Income Taxes**

 

SFAS No. 109,**“*Accountingfor Income Taxes*,” requires a valuation allowance to be recordedagainst deferred tax assets when it is more likely than not that some or all ofthe deferred tax assets will not be realized. As a result of cumulativelosses in recent years and continued economic uncertainty, the Company hasprovided a full valuation allowance against its net deferred tax assets andwill do so until it returns to an appropriate level of sustained taxableincome. The ultimate realization of these deferred tax assets depends uponthe Company’s ability to generate sufficient future taxable income. If theCompany is successful in generating sufficient future taxable income, theCompany will reduce the valuation allowance through a reduction in income taxexpense in the future.

 

FinancialAccounting Standards Board (“FASB”) Interpretation No. 48 “*Accounting for Uncertainty in Income Taxes, aninterpretation of FAS 109*” (“FIN 48”) clarifies the criteriathat an individual tax position must satisfy for some or all of the benefits ofthat position to be recognized in a company’s financial statements. As of September 30,2008 and December 31, 2007, the Company had no unrecognized tax benefits.The Company has not, as yet, conducted a study of its R&D creditcarryforwards. This study may result in an increase or decrease to the Company’sR&D credit carryforwards; however, until a study is completed and anyadjustment is known, no amounts are being presented as an uncertain taxposition under FIN 48. A full valuation allowance has been provided against theCompany’s R&D credits and, if an adjustment is required, this adjustmentwould be offset by an adjustment to the valuation allowance. As a result, therewould be no impact to the consolidated balance sheet, statement of operationsor cash flows if an adjustment were required.

 

During the three- andnine-month periods ended September 30, 2008 and September 30, 2007,the Company did not record an income tax benefit associated with any pre-taxloss due to the uncertainty regarding future taxable income.

 

**(4) Comprehensive Loss**

 

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

 

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** **
| ** **                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net loss                                  |       | $                                                    | (347,086   | )                                                   | $          | (82,570 | ) | $ | (1,208,409 | ) | $ | (2,808,919 | ) |
| Foreign currency  translation adjustments |       | 51,129                                               |       | (11,168                                             | )          | 48,744 |   | (23,391 | ) |
| Comprehensive  loss                       |       | $                                                    | (295,957   | )                                                   | $          | (93,738 | ) | $ | (1,159,665 | ) | $ | (2,832,310 | ) |

 

**(5) Acquisition**

 

On December 29,2006, the Company acquired all of the outstanding shares of Blue ChipTechnologies Ltd. (“BlueChip”) for $562,090 in cash, $1,683,702 in apromissory note issued to BlueChip’s principal shareholder (“Seller”),375,331 shares of the Company’s common stock (valued at $1,478,804), theissuance of vested options to purchase the Company’s common stock insubstitution for outstanding BlueChip stock options (valued at $368,090), anddirect acquisition costs of $563,838, which consisted primarily of financialadvisory, legal and accounting services. The Company acquired BlueChip in orderto strengthen and expand its presence in the healthcare vertical market.

 

The promissorynote that the Company issued to the Seller of BlueChip is payable in thirty-sixequal monthly installments of approximately $47,000 (See Note 9).

 

Goodwill in theaccompanying consolidated balance sheets as of September 30, 2008 and December 31,2007, represents the excess of the purchase price over the net tangible andidentifiable intangible assets for the acquisition of BlueChip.

 

**(6) Stock-based Compensation**

 

The Company’s 1996Stock Option Plan and 1997 Stock Plan, as amended, provided for the issuance ofcommon stock pursuant to the grant to employees of “incentive stock options”within the meaning of the Internal Revenue Code of 1986, as amended, the grantof nonqualified stock options, stock awards or opportunities to make directpurchases of stock in the Company to employees, consultants, directors andofficers of the Company. In 1997, the Company’s Board of Directors voted thatno further options would be granted or issued under the Company’s 1996 StockOption Plan, and on April 14, 2007, the Company’s 1997 Stock Plan expired.The Company’s 2007 Equity Compensation Incentive Plan (“2007 Plan”) wasapproved by the Board of Directors on April 16, 2007 and the Company’sshareholders at the annual meeting of shareholders on May 22, 2007. The2007 Plan provides for the issuance of shares of common stock to employees,consultants, directors and officers of the Company much like the 1997 StockPlan. The aggregate number of shares that can be issued pursuant to the 2007Plan is 500,000 and any shares granted under the 2007 Plan that are canceled orexpired are added back to the 2007 Plan for future issuance. As of September 30,2008, 270,300 shares had been issued under the 2007 Plan. Shares issuedpursuant to this plan are issued from treasury to the extent they areavailable. Stock-based compensation is accounted for in accordance with SFAS No. 123(R),“*Share-Based Payment*.”

 

During the three- andnine-month periods ended September 30, 2008 and September 30, 2007,the Company incurred stock-based compensation expense for restricted commonstock (“restricted stock”) and stock options.  The Company also incurred stock-basedcompensation expense for the employee stock purchase plan (the “ESPP”)during the nine-month period ended September 30, 2007. The ESPP wasterminated on July 1, 2007.

 
| ** **                                                                      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Stock-based compensation  expense included in cost of service and other revenue |       | $                                                    | 4,480      |                                                | $          | 2,178 |   | $ | 10,871 |   | $ | 6,905 |   |
| Stock-based  compensation expense included in operating expenses                |       | 130,799                                              |       | 92,776                                              |       | 357,862 |   | 258,579 |   |
| Total  stock-based compensation expense                                         |       | $                                                    | 135,279    |                                                | $          | 94,954 |   | $ | 368,733 |   | $ | 265,484 |   |

 

***Stock Options***

 

Underthe terms of the Company’s 2007 Plan, options vest and become exercisable asdetermined by the Board of Directors and expire 10 years after the date ofgrant. Stock option compensation expense calculated under the fair valueapproach is recognized ratably over the four-year vesting period. The fairvalue for granted options is estimated at the time of grant using theBlack-Scholes option-pricing model. During the nine-month period ended September 30,2008, the Company granted 45,000 stock options to certain employees of theCompany, and the Company did not grant any stock options during the nine-monthperiod ended September 30, 2007.  Asof September 30, 2008, there was approximately $60,000 of unrecognizedstock-based compensation expense related to stock options to be recognized over4 years.

 

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***Restricted Common Stock***

*** ***

Priorto April 14, 2007, the Company sold shares of restricted stock under theCompany’s 1997 Stock Plan, as amended, to its Board of Directors and certainemployees of the Company at a price per share of $0.01. The Company hascontinued to issue shares of restricted stock in a similar manner under the2007 Plan. The shares of restricted stock vest ratably over a three- orfour-year service period. In the event that a restricted stockholder ceases toprovide services to the Company prior to the vesting of any of the thenunvested shares held by that stockholder, the restricted stockholder isrequired to sell any unvested shares of restricted stock back to the Company atthe original purchase price of $0.01 per share. Restricted stock-basedcompensation expense calculated under the fair value approach is based upon thecurrent stock price and is recognized ratably over the three- or four-yearvesting period. Based upon historical information and management’s estimate offuture voluntary turnover rates, the Company has calculated this expense basedon an annualized estimated forfeiture rate of 10%. The Company trues-upestimated forfeitures to actual forfeitures at the end of each reportingperiod. During the nine months ended September 30, 2008, the Company sold204,800 shares of restricted stock to its Board of Directors and certainemployees of the Company at a price of $.01 per share under the Company’s 2007Plan. During the nine months ended September 30, 2007, the Company sold atotal of 145,175 shares of restricted stock, to its Board of Directors andcertain employees of the Company at a price of $0.01per share, of which 128,675shares were issued under the Company’s 1997 Stock Plan, as amended, and 16,500shares were issued under the 2007 Plan. As of September 30, 2008, there was approximately $907,000 ofunrecognized stock-based compensation expense related to restricted stock to berecognized over 4 years.

 

Thefollowing is a summary of the Company’s unvested restricted stock awards:

 
| ** **                         | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|------------------------------------|------------|----------------------------|------------|---------------------------------------------------------|------------|
| Unvested,  December 31, 2007  |       | 258,167                    |       | $                                                       | 4.44       |   |
| Granted                            |       | 204,800                    |       | 3.15                                                    |       |
| Vested                             |       | (63,882                    | )          | 4.96                                                    |       |
| Forfeited                          |       | (8,849                     | )          | 4.11                                                    |       |
| Unvested,  September 30, 2008 |       | 390,236                    |       | $                                                       | 3.69       |   |

 

**(7) Accrued Liabilities**

 

Accruedliabilities consist of the following:

 
| ** **                         | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Accrued health  insurance expense  |       | $                            | 300,841    |                        | $          | 300,841 |   |
| Accrued state  sales tax           |       | 373,784                      |       | 344,906                     |       |
| Accrued salary  and salary-related |       | 697,426                      |       | 568,339                     |       |
| Accrued  professional fees         |       | 119,652                      |       | 145,420                     |       |
| Other accrued  expenses            |       | 231,821                      |       | 211,593                     |       |
|                               |       | $                            | 1,723,524  |                        | $          | 1,571,099 |   |

 

**(8) Capital Lease Obligations**

 

On May 1,2006, the Company entered into a capital lease agreement in the amount of$491,000 to finance the purchase of furniture and equipment for the Company’sheadquarters located in Andover, Massachusetts. The lease has a five year termwhich expires on May 31, 2011 and is payable in 60 equal monthlyinstallments. The interest rate on the capital lease is 6.2%. Total interestpayments over the life of the lease are estimated to be $99,000.

 

The leasecontained a provision whereby the Company would be required to repayimmediately the outstanding principal balance should the Company’s cash balanceever be less than $5,000,000. On August 6, 2007, the Company entered intoan amendment to the aforementioned capital lease which lowered the Company’srequired minimum cash balance to $2,100,000. In addition, on August 30,2007, the Company entered into a pledge and security agreement with thecapital  financing provider that requiresa minimum balance of cash and cash equivalents of no less than $250,000 (“pledgedcollateral”) and in the event that Company’s cash balance falls below $250,000the Company will immediately provide the amount necessary to cover suchshortfall to the capital financing provider. In the event of default inmaintaining the required amount of pledged collateral or the making of anylease payments, the pledged collateral will first be used as payment for costsand expenses incurred to enforce the security and pledge agreement and secondfor payment in full of the outstanding principal loan balance. The minimumrequired cash balance of $2,100,000 includes the pledged collateral. As of September 30,2008 and December 31, 2007, the pledged collateral of $250,000 isrestricted cash and has been classified as “other assets” in the accompanyingbalance sheet.

 

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**(9) Note Payable**

 

On December 29,2006, the Company issued a promissory note in the amount of $1,683,702 to theprincipal shareholder of BlueChip in partial consideration of all theoutstanding shares of BlueChip (See Note 5). The note is payable in thirty-sixequal monthly principal installments of approximately $47,000 plus interest,commencing on March 30, 2007. The promissory note bears interest on the unpaidprincipal amount at a rate per annum equal to (a) the Prime Rate as setforth in the Wall Street Journal Money Rates column on the last business day ofeach month, which rate shall be deemed to be in effect for the entirety of suchmonth; plus (b) one percent. During the nine-month period ended September 30,2008, the Company made total payments of approximately $474,000, consisting ofprincipal payments totaling $421,000 and accumulated interest of $53,000, basedupon an average interest rate of 6.5%.

 

**(10) Restructuring Costs**

 

In March 2007,the Company announced a restructuring of certain of its operations and reducedits workforce.  As a result of theseactivities, the Company recorded a pre-tax charge during the nine-month periodended September 30, 2007 of $343,450 in accordance with SFAS No. 146,“*Accounting for Costs Associated with Exitor Disposal Activities.*”**Thetotal restructuring charge for the first nine months of fiscal 2007 included$308,278 of severance-related costs and $35,172 as a result of closing BlueChip’sformer headquarters.

 

Thetotal cash impact of the restructuring was $343,450; and all of these amountswere paid in full during the nine-month period ended September 30, 2007.

 

**(11) Segment and Geographic Information**

 

To date, theCompany has viewed its operations and manages its business as principally onesegment: software, hardware and media sales, and associated services. As aresult, the financial information disclosed herein represents all of thematerial financial information related to the Company’s principal operatingsegment in accordance with SFAS No. 131,**“*Disclosures About Segments of anEnterprise and Related Information*.”

 

Totalrevenue from international sources was approximately $662,000 and $2,117,000for the three and nine months ended September 30, 2008 and $704,000 and$2,444,000 for the three and nine months ended September 30, 2007,respectively.

 

The followingtable represents amounts relating to geographic locations:

 
| ** **       | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **       | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Total revenue(1) | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States    |       | $                                                    | 3,445,061  |                                                | $          | 3,405,061 |   | $ | 9,740,026 |   | $ | 9,772,864 |   |
| United Kingdom   |       | 84,409                                               |       | 218,657                                             |       | 655,666 |   | 936,205 |   |
| Canada           |       | 330,968                                              |       | 247,225                                             |       | 860,146 |   | 637,483 |   |
| South Africa     |       | 128,541                                              |       | 192,257                                             |       | 247,495 |   | 392,313 |   |
| Rest of World    |       | 118,000                                              |       | 45,385                                              |       | 353,636 |   | 477,936 |   |
|             |       | $                                                    | 4,106,979  |                                                | $          | 4,108,585 |   | $ | 11,856,969 |   | $ | 12,216,801 |   |

 
| ** **            | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-----------------------|------------|------------------------------|------------|-----------------------------|------------|
| Long-lived  assets(2) |       |                         |       |                        |       |
| United States         |       | $                            | 4,333,559  |                        | $          | 4,928,660 |   |
| United Kingdom        |       | 10,024                       |       | 17,954                      |       |
|                  |       | $                            | 4,343,583  |                        | $          | 4,946,614 |   |

 

----

| (1)    | Revenue is  attributed to geographic regions based on location of customer.                                                                       |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                              |
| (2)    | Long-lived  assets include net property and equipment, goodwill, net intangible assets,  long-term unbilled accounts receivable and other assets. |

 

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**Item2.**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS**

**OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

 

Management’s Discussionand Analysis of Financial Condition and Results of Operations for the three-and nine-month periods ended September 30, 2008 should be read in conjunctionwith the accompanying consolidated financial statements for the periodsspecified and the associated notes. Further reference should be made to ourAnnual Report on Form 10-K for the year ended December 31, 2007, asfiled with the SEC on March 28, 2008.

 

**Overview**

 

We are a provider ofdocument and information handling software solutions that controldocument-based business communications and integrate paper and electronicdocuments into enterprise information systems and workflows. Our software productsstreamline the capture, conversion and communication of both paper andelectronic information, enabling fast, secure and simultaneous distribution tomultiple destinations in multiple formats.

 

*Business*

 

Despite a decline in ourAccuRoute® software license revenue during the three- and nine-month periodsended September 30, 2008, due in part to the soft economic conditions,total AccuRoute revenue, which includes software license and service and otherrevenue, increased by 11% and 10%, respectively, as compared to the sameperiods in 2007. These increases reflect a larger installed customer base ascompared to that of 2007.  We plan toinvest further in our partner relationships, building upon the recent close ofa contract valued in excess of $1.0 million through one of our large partners,which contract is classified as deferred revenue for the current quarter.Challenges we face as we seek to expand our business include expanding oursales in the legal and professional services, healthcare and financial servicesvertical markets; promoting our products and technologies through reseller andmarketing relationships with leading multi-function device providers; andimproving our results outside of the United States. Although we achievedprofitability for the quarter ended December 31, 2007, we have incurredquarterly losses for all other quarters since the quarter ended September 30,2005, and may continue to incur losses in future quarters.

 

We experienced thebenefit of cost cutting measures associated with the restructurings weundertook in 2007, as our operating expenses decreased by approximately $1.4million (excluding the $343,450 restructuring charge incurred in the first halfof 2007) in the nine months ended September 30, 2008 as compared to the ninemonths ended September 30, 2007. This led to our net loss decreasing from$2.8 million in the nine months ended September 30, 2007, to $1.2 millionin the nine months ended September 30, 2008.

 

In light of our currentand historical operating results and the continuing challenges we face, and inorder to maximize shareholder value, we are in an ongoing process ofexamining our operations as well as our strategic and financialalternatives. The strategic and financial alternatives we may consider could includea variety of different business arrangements including, but not limited to:combinations with or a sale to another entity; equity or debt financings;strategic partnerships and joint ventures; the sale or spin off of certainassets; the acquisition of complementary businesses, technologies or productlines; investments in new businesses; reorganization, recapitalization, ordistribution alternatives; deregistering as a public company; or otheralternatives. We have engaged the investment banking firm of America’s GrowthCapital to assist us with the exploration of strategic and financialalternatives. Changes, if any, implemented as a result of the strategic andfinancial alternatives review could affect the basic nature of our Company. Forexample, deregistering our common stock from the public company requirementsunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”)could have an adverse effect on the market price of our common stock and wouldlikely mean that there would be less information about us available toshareholders and potential investors than what is currently contained in theperiodic reports we file pursuant to the Exchange Act.

 

*Products*

 

AccuRoute,our flagship product, provides faster, more efficient document workflows andincreased worker productivity, while reducing cost, complexity and the risk oflosing documents. We also include full enterprise fax capabilities integratedwithin our AccuRoute product. These solutions are used worldwide by businessesin document-intensive industries and sectors (such as legal, financialservices, government and healthcare) that demand secure handling, integrationand tracking of documents in full compliance with a range of regulatoryrequirements. Companies can deploy our software products on heterogeneous,multi-platform networks, digital scanning devices and multi-functionperipherals and integrate them with both desktop and enterprise softwareapplications. To address customer needs, our products are modular andscaleable. As a result, customers can add additional communication capacitythrough the addition of system components and connectors to keep pace withgrowing demands. In addition, due to this scalable, modular design, customerscan add additional Omtool product servers to a configuration to providefailover redundancy, helping to ensure continuous operation.

 

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OurGenifaxTM product is a multi-tiered client/server solution for automating andintegrating fax communication throughout an enterprise. As a component of anenterprise software system, our Genifax product is deployed on heterogeneous,multi-platform networks and integrates with desktop and enterprise softwareapplications.

 

OurGenidocsTM product is a client/server messaging application that enables usersto deliver documents through the Internet with comprehensive security andtracking to external parties. Genidocs offers the security features andfunctionality of traditional, paper-based communications with the speed,efficiency and cost advantages of electronic communications. Fax Sr., ourlegacy network fax product, is a client/server software solution for automatingand integrating fax communication throughout an enterprise. As an integratedcomponent of an enterprise software system, our Fax Sr. product is deployed onheterogeneous, multi-platform networks and integrates with desktop andenterprise software applications. We continue to maintain Genidocs and Fax Sr.and earn recurring maintenance revenue from our installed base, although wehave not sold these products in recent periods. At this time, however, we donot have plans to extend these technologies with new features or new releases.

 

Weresell certain hardware products (such as intelligent fax boards) and mediaproducts (such as admission labels and patient wristbands), which we purchasefrom third-party vendors as a convenience to our customers, who alternativelycan opt to obtain hardware and media directly from third-party vendors. We sellsupport contracts for the software products that we license to our customersand offer certain consulting, training, installation and implementationservices for our products.

 

*OmtoolHealthcare Suite*

 

Our December 2006acquisition of BlueChip brought into our product family document workflowsolutions for the healthcare vertical market, which we combined with ourAccuRoute technology to create the Omtool Healthcare Suite of products.

 

The Omtool Healthcare Suite streamlinesthe registration, inpatient care and post-discharge reimbursement cyclesthrough sophisticated document imaging and workflow for hospital admissions andbilling functions.

 

·                  **ADT eFormsTM** - a production system thatprovides hospitals with on-demand ADT (admissions, discharge and transfer)electronic forms for registration and patient identification.

 

·                  **eForms StationTM** - an electronic formslibrary that gives immediate access to a hospital’s custom library ofelectronic and printable forms.

 

·                  **Image-InTM Direct Capture (ID-Capture)**- animage capture system that scans images of common non-clinical documents such asinsurance cards, driver’s licenses, referral forms and HIPAA notices anddisplays them on a desktop paneled window.

 

·                  **Image-In Business** - a document and formcapture system that converts paper-based business documents to electronicrecords.

 

·                  **Image-In Clinical** - a medical records scanfacility that enables users to capture fully the entire patient file afterdischarge.

 

·                  **Image-In Queue** - a document viewer thatenables administrators to manage, view and disseminate electronic documents tothe proper departments and/or patient files.

 

·                  **AccuRoute** - a document-handling platformthat supports distributed document capture for scanning, routing and archivingmedical information throughout the patient service cycle and provides documentdistribution into the document workflow products found in Omtool’s HealthcareSuite.

 

·                  **ObjectArchiveTM** - an electronic archive thatprovides the foundation to securely store information designed, developed andcaptured through any of the Omtool Healthcare Suite products.

 

*VerticalMarket Focus*

 

While AccuRoute’sfeatures are horizontal in nature, they apply to many different verticalmarkets, including the legal and professional services, healthcare andfinancial services vertical markets. We continue to add extensions to AccuRoutethat provide the greater functionality that is critical to many of ourcustomers. To provide more effective document and information-handlingsolutions, we continue to advance our document processing functionality whileincrementally adding support for electronic information systems such as e-mailsystems, enterprise content management systems, records management systems andarchival systems. We released Omtool Swiftwriter Plug-In for Adobe 3.0, a free,one-click solution that integrates Adobe PDF documents with popular documentmanagement systems such as OpenText/Hummingbird or Interwoven WorkSite.Swiftwriter for Adobe simplifies 

 

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the opening, closing andcheck-in/check-out processes for users. We offer a set of tailored supportoptions to generate revenue in this market.

 

We aim to extend ourposition as a provider of enterprise-class document-handling software solutionsand become a leading provider of electronic document exchange solutions thatcapture, process and distribute paper or electronically formatted documents. Toreinforce the Omtool brand in enterprise-class document handling and exchangesolutions, while maintaining our strong position as an enterprise-level fax softwareprovider, we intend to take advantage of our penetration of the legal andprofessional services vertical market, extend our presence in the healthcarevertical market and broaden our customer base, industry partnerships andextensive knowledge of enterprise content management.

 

While we have investedconsiderable resources to penetrate further the financial services verticalmarket and have created and are pursuing opportunities within that verticalmarket, we have found that sales opportunities for our AccuRoute product inthat vertical market, though significant, are longer term opportunities bestachieved through continued focus on our partner relationships. We believe thebest opportunities for replicating our successes in the legal and professionalservices vertical market are in the healthcare vertical market. Similar to ourviews on the legal and professional services vertical market and based on thehigh level of focus by healthcare providers on electronic medical records, wesee a significant opportunity to present AccuRoute as the solution of choice tothe challenge of capturing the paper documents that are endemic in healthcaresystems.

 

*OperatingResults*

 

Our revenue consists primarily of software license revenue, hardwareand media revenue, and service and other revenue, all as further describedbelow. The following table is a presentation of our total revenue for theperiods indicated:

 
| ** **                                    | ** ** | **Total Revenue** | ** ** | **Net Loss** | ** ** | **Software License  Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-------------------|------------|------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $4,106,979             |       | $(347,086)        |       | $821,970                           |       |
| Three months  ended September 30, 2007   |       | $4,108,585             |       | $(82,570)         |       | $1,212,104                         |       |
| Change over same  period of prior fiscal year |       | $(1,606)               |       | $(264,516)        |       | $(390,134)                         |       |
|                                          |       | or (0.0)%              |       | or (320.4)%       |       | or (32.2)%                         |       |
| ** **                                    | ** ** | ** **             | ** ** | ** **        | ** ** | ** **                         | ** ** |
| Nine months  ended September 30, 2008    |       | $11,856,969            |       | $(1,208,409)      |       | $3,115,659                         |       |
| Nine months  ended September 30, 2007    |       | $12,216,801            |       | $(2,808,919)      |       | $3,540,879                         |       |
| Change over same  period of prior fiscal year |       | $(359,832)             |       | $1,600,510        |       | $(425,220)                         |       |
|                                          |       | or (2.9)%              |       | or 57.0%          |       | or (12.0)%                         |       |

 

During the third quarterof 2008, total revenue remained even with the third quarter of 2007, butdecreased during the nine-month period ended September 30, 2008 ascompared to the nine-month period ended September 30, 2007. During bothperiods we experienced a decrease in software license revenue from our legacyfax products as well as from our AccuRoute product. However, during the thirdquarter of 2008 we entered into a contract with one of our large partners toprovide products and services to a large financial services company. The totalcontract value is in excess of $1.0 million and is comprised primarily ofsoftware licenses and certain associated services related entirely to ourAccuRoute product line. We have classified the contract in deferred revenue forthe current quarter and expect to recognize the revenue for this contract overthe ensuing fiscal quarters. Our operating expenses decreased by approximately$1.4 million (excluding the $343,450 restructuring charge incurred in the firsthalf of 2007) in the first nine months of 2008 as compared to the same periodin 2007 as a result of the restructuring plan we adopted in March 2007.

 

Although we experienced adecline in total revenue and software license revenue, we continue toexperience general market acceptance of our AccuRoute product as softwarelicense revenue and service and other revenue from our AccuRoute productrevenue grew by approximately 10% during the nine months ended September 30,2008 as compared to the same period in 2007. Any decrease in demand for our products would likely result in decreasedrevenue, which would, in turn, have a significant negative impact on ourfinancial results because a significant portion of our operating costs such aspersonnel, rent and depreciation are fixed in advance of a particular quarter.As a result, our costs for sales and marketing, research and development, andgeneral and administrative could continue to increase as a percentage ofrevenue, thereby negatively affecting our operating results.

 

In the coming months, ourprimary focus will be to increase our AccuRoute sales opportunities tocustomers in the legal and professional services, healthcare and financialservices vertical markets through investments in direct and indirect sales andmarketing resources. At the same time, we will continue developing ourstrategic relationships in those markets to further our penetration.

 

Sales from our Europeanoperations, which were in a steady decline for several years, increased by 29%during the twelve months ended December 31, 2007 as compared to twelvemonths ended December 31, 2006. Although our European operationsexperienced a 6% decrease in revenue in the first nine months of 2008 comparedto the first nine months of 2007, we remain optimistic that we will continue tosee improvements outside the United States. For now, we will rely primarily onour U.S. sales organization for our shorter-term growth. We will continue toleverage our European AccuRoute base and indirect channel 

 

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relationships to focus sales resources overseas.However, we expect that, in the short-term, U.S. sales are likely to constitutea greater percentage of revenue than sales outside the U.S. and there can be noassurances that we will be able to increase international sales of ourproducts. This failure to increase international sales may have a materialadverse effect on our business, financial condition and results of operations.

 

Our United Kingdomsubsidiary, Omtool Europe Limited, transacts business primarily in its localcurrency. We then translate results generated by that entity into United Statesdollars and consolidate them with our domestic results for reporting purposes.As we make sales to customers in a variety of countries, significant currencyexchange rate fluctuations could have a material impact on our results ofoperations. Foreign currency exposure has not been material to our financialposition or results of operations to date. If the volume of our businessdenominated in foreign currencies increases, we may be required to usederivatives to hedge foreign currency exposure.

 

The following is a presentationof our domestic and international revenue:

 
| ** **                                    | ** ** | **Total Revenue** | ** ** | **United States Revenue**    | ** ** | **Non-United States Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|----------------------------------------|------------|-----------------------------------------|------------|
| Three months ended  September 30, 2008   |       | $4,106,979             |       | $3,445,061  or 83.9% of Total  Revenue |       | $661,918  or 16.1% of Total  Revenue    |       |
|                                          |       |                   |       |                                   |       |                                    |       |
| Three months ended  September 30, 2007   |       | $4,108,585             |       | $3,405,061  or 82.9% of Total  Revenue |       | $703,524  or 17.1% of Total  Revenue    |       |
|                                          |       |                   |       |                                   |       |                                    |       |
| Change from same period  of prior fiscal year |       | $(1,606)               |       | $40,000                                |       | $(41,606)                               |       |
| ** **                                    | ** ** | ** **             | ** ** | ** **                             | ** ** | ** **                              | ** ** |
| Nine months ended  September 30, 2008    |       | $11,856,969            |       | $9,740,026  or 82.1% of Total  Revenue |       | $2,116,943  or 17.9% of Total  Revenue  |       |
|                                          |       |                   |       |                                   |       |                                    |       |
| Nine months ended  September 30, 2007    |       | $12,216,801            |       | $9,772,864  or 80.0% of Total  Revenue |       | $2,443,937  or 20.0% of Total  Revenue  |       |
|                                          |       |                   |       |                                   |       |                                    |       |
| Change from same period  of prior fiscal year |       | $(359,832)             |       | $(32,838)                              |       | $(326,994)                              |       |

 

We will continue to leverage our existing distributionchannels, where appropriate, to broaden our reach to our target verticalmarkets and further penetrate our installed customer base. We are pursuingsales opportunities through our solution/reseller channels, as well as focusingsales efforts on specific market segments, in order to facilitate acceptance ofour products. In particular, we are focusing considerable attention andresources on the promotion of sales of our products through our establishedrelationships with leading hardware, computer system and software vendors, inadvance of significant revenue from these vendors. However, as shown in thefollowing table, in recent periods, more of our sales have been derived fromdirect sales:

 
| ** **                                   | ** ** | **Total Software  License,  Hardware and  Media  Revenue** | ** ** | **Software License,  Hardware and Media  Revenue from  Indirect Distribution  Channel Sales** | ** ** | **Software License,  Hardware and Media  Revenue From  Indirect Distribution  Channel Sales as a  Percentage of Total  Software License,  Hardware and  Media Revenue** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Three months ended September 30, 2008   |       | $1,444,239                                                           |       | $613,874                                                                                                                    |       | 42.5%                                                                                                                                                                                                                                    |       |
| Three months ended  September 30, 2007  |       | $1,726,730                                                           |       | $481,709                                                                                                                    |       | 27.9%                                                                                                                                                                                                                                    |       |
| Change from same period of prior fiscal year |       | $(282,491)                                                           |       | $132,165                                                                                                                    |       | 14.6 percentage                                                                                                                                                                                                                          |       |
|                                         |       | or (16.4)%                                                           |       | or 27.4%                                                                                                                    |       | points (“ppt”)                                                                                                                                                                                                                 |       |
|                                         |       |                                                                 |       |                                                                                                                        |       |                                                                                                                                                                                                                                     |       |
| Nine months ended September 30, 2008    |       | $4,464,196                                                           |       | $1,536,283                                                                                                                  |       | 34.4%                                                                                                                                                                                                                                    |       |
| Nine months ended  September 30, 2007   |       | $5,111,196                                                           |       | $1,447,841                                                                                                                  |       | 28.3%                                                                                                                                                                                                                                    |       |
| Change from same period of prior fiscal year |       | $(647,000)                                                           |       | $88,442                                                                                                                     |       | 6.1ppt                                                                                                                                                                                                                                   |       |
|                                         |       | or (12.7)%                                                           |       | or 6.1%                                                                                                                     |       |                                                                                                                                                                                                                                     |       |

 

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**Critical Accounting Policies and Estimates**

** **

We have identified thepolicies and estimates below as critical to our business operations and theunderstanding of our results of operations. The impact of and any risksassociated with these policies on our reported and expected financial resultsand business operations are discussed in appropriate sections throughoutManagement’s Discussion and Analysis of Financial Condition and Results ofOperations. Our preparation of this Form 10-Q required us to makeestimates and assumptions that affect the reported amount of assets andliabilities, the disclosure of contingent assets and liabilities as of the dateof the financial statements included herein and the reported amounts of revenueand expenses during the period covered by this report. There can be noassurance that actual results will not differ materially from those estimates.

 

*Revenue Recognition and Accounts Receivable Reserves.***We derive our revenue primarily from twosources: (i) product revenue, which includes software license, hardwareand media revenue, and (ii) service and support revenue, which includessoftware maintenance and support, installation, implementation, training andconsulting revenue. We license our software products on a perpetual basis. Wegenerate revenue from licensing the rights to use our software products andsales of hardware directly to end-users and indirectly through resellers. Ourresellers order products from us based on purchase orders received fromend-users and do not order stock. We generally sell our products to resellersand directly to end-users without any specifically stated rights of return.Occasionally, however, in our sole discretion, we will accept a product returnif the end-user finds that the product does not fit its needs. We sell hardwareand media products, which are provided by a third-party, at cost plus anadditional mark-up, directly to end-users and, in the case of hardware,indirectly through resellers as well. The hardware products that we resell arenot functional without our software. To support our software products, we sellsoftware maintenance and support, installation, implementation, training andconsulting services directly to end-users and indirectly through resellers.

 

We apply the provisionsof Statement of Position (“SOP”) 97-2,**“*Software Revenue Recognition*,”as amended by SOP 98-9, Modification of SOP 97-2,**“*Software RevenueRecognition with Respect to Certain Transactions*” (“SOP 98-9”),to all transactions involving the sale of multiple elements including software,hardware and service revenue. We apply the provisions of Statement of FinancialAccounting Standards (“SFAS”) No. 48,**“*Revenue RecognitionWhen Right of Return Exists*,” with respect to providing forpotential future product returns. As described below, we must make and usesignificant judgments and estimates in connection with the revenue recognizedin any accounting period. Material differences may have resulted in the amountand timing of our revenue if we had made different judgments or utilizeddifferent estimates.

 

We recognize revenue fromthe sale of software products, hardware and media to both end-users andresellers when persuasive evidence of an arrangement exists, the products havebeen delivered, the fee is fixed or determinable, collection of the resultingreceivable is probable and there are no uncertainties regarding customeracceptance. We maintain a reserve for potential product returns. We sellmonthly, annual and multiple-year maintenance contracts and the revenueassociated therewith is recognized over the term of the related maintenanceperiod, beginning on the date of delivery. We recognize other service revenueas we perform the associated services. If an arrangement includes an acceptanceprovision and acceptance is uncertain, then we will defer all revenue until thecustomer accepts the products it purchased. Acceptance in these instancesgenerally occurs upon the earlier of receipt of a written customer acceptanceor expiration of the acceptance period. If an arrangement includes anacceptance provision tied to determination that our product meets publishedspecifications and there are no uncertainties with regard to the customer’sacceptance, then we will recognize revenue at the time of sale, provided thatall of the other previously mentioned revenue recognition criteria have beenmet and the acceptance period is of short duration.

 

Our transactionsfrequently involve the sale of software, hardware and related services undermultiple element arrangements. Revenue under multiple element arrangements isallocated to each element, to the extent vendor specific objective evidence offair value exists, under the residual method, in accordance with SOP 98-9.Under this method, revenue is allocated first to all undelivered elements, suchas services, based on the fair value of those elements, which is calculated tobe the price charged when these elements are sold separately and unaccompaniedby other elements. Our services generally are not essential to thefunctionality of the software, as these services do not alter the capabilitiesof the software and do not carry a significant degree of risk to perform. Theamount allocated to the delivered elements, such as software license andhardware revenue, is the difference between the total arrangement value and theamount allocated to the undelivered elements. If the delivered elements includeboth software and hardware, the amount allocated to hardware revenue is basedon the price charged to us by the third-party vendor plus an additional markup, with the remainder allocated to software revenue. To the extent that adiscount is offered in the arrangement, the entire discount is allocated to thedelivered element or elements. If the delivered elements include hardware andsoftware, the discount is allocated to the hardware and software based on theirrespective list prices. For all sales, we use a binding purchase order, asigned contract, or a credit card authorization as evidence of an arrangement.Sales through our resellers are evidenced by a master agreement governing therelationship between us and the reseller, together with binding purchase orderson a transaction-by-transaction basis.

 

At the time of atransaction, we assess whether the fee associated with the transaction is fixedor determinable and whether or not collection is probable. If a significantportion of a fee is due beyond our normal payment terms, which are thirty toninety days from invoice date, we account for the fee as not being fixed or determinable.In these cases, we recognize revenue as the fees become due. We assesscollectability based on a number of factors, including past transaction historywith the customer and the 

 

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creditworthiness of thecustomer. We review Dunn & Bradstreet credit reports for our resellersand adjust our credit limits with those resellers accordingly. If a particularreseller does not have a favorable report or if we do not have enough creditinformation to determine if the reseller is credit-worthy then we typicallysell to that reseller on cash on delivery terms. We do not request collateralfrom our customers. If we determine that collection of a fee is not reasonablyassured, the fee is deferred and revenue is recognized at the time collectionbecomes probable, which is generally upon receipt of payment.

 

We maintain reserves forpotential product returns and make adjustments to these reserves as neededbased on historical product return rates. We also consider the impact of newproduct introductions, changes in customer demand and acceptance of ourproducts on the adequacy of these reserves. Our calculation of the estimatedreturn reserve is based upon (1) an account specific review of potentialreturns, where a return probability is known, and (2) an estimate basedupon past historical returns as a percentage of revenue. We must make and usesignificant judgments and estimates in connection with establishing the productreturns reserve in any accounting period. Material differences may haveresulted in the amount and timing of revenue for this or any prior period if wemade different judgments or utilized different estimates.

 

As with the productreturn reserve, we must make estimates of our ability to collect on ouraccounts receivable. We record trade accounts receivable at the invoiced amountand these accounts do not bear interest. We specifically analyze accountsreceivable, historical bad debts, customer creditworthiness, current economictrends and changes in customer payment patterns when evaluating the adequacy ofour allowance for doubtful accounts. We review our allowance for doubtful accountson a monthly basis. Our calculation of the estimated accounts receivablereserve is also based upon (1) an account-specific review of potentialuncollectible accounts, where a bad debt probability is known; and (2) anestimate based upon past historical bad debts as a percentage of accountsreceivable. We do not have any off-balance-sheet credit exposure to ourcustomers.

 

Our combined accountsreceivable and product returns reserve was $43,000 and $45,000 on September 30,2008 and December 31, 2007, respectively. Both components ofcalculating the estimated reserve—specific identification and historicexperience—are material judgments that we make. We base these judgments onhistoric trends, taking into consideration current business and economic conditions,which could change materially, thus changing the required reserve levelmaterially. The potential change to the size of our required reserve could bepositive in the event the reserve estimate proves unnecessary, or negative, ifthe reserve proves inadequate.

 

Our deferred revenue iscomprised mainly of revenue that is deferred for software maintenance andsupport contracts as well as sales of our products targeted to the healthcarevertical market that involve both the sale of software and implementationservices for which the implementation services have not yet been performed. Theother components of deferred revenue are amounts from sales transactions thatwere deferred because they did not meet all of the provisions of our revenuerecognition policy.

 

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

 

*Goodwilland Intangible Assets.*We account for goodwill in accordancewith SFAS No. 142 “*Goodwill and OtherIntangible Assets*” (“SFAS 142”). Goodwill represents theexcess of purchase price in a business combination over the fair value of nettangible and intangible assets acquired. In accordance with SFAS 142, goodwillamounts are not amortized, but rather are tested for impairment at leastannually. Intangible assets that are not considered to have an indefiniteuseful life are amortized over their useful lives, which range from three toten years.

 

*We account for intangible assets in accordance with SFAS No. 144,“*Accounting for the Impairment or Disposal of Long-LivedAsset.” Intangible assets include customercontracts and relationships, purchased technology, trade names and non-competeagreements. The carrying amount of the intangible assets is reviewed wheneverevents or changes in circumstances indicate that the carrying value of an assetmay not be recoverable. Recoverability of these intangible assets is measuredby comparison of the carrying amount of the asset to the future undiscounted cashflows the asset is expected to generate. If the intangible asset is consideredto be impaired, the amount of any impairment is measured as the differencebetween the carrying value and the fair value of the impaired asset.

* *

We account for businesscombinations in accordance with SFAS No. 141, “*Business Combinations*”**(“SFAS 141”), which requiresthe use of the purchase method of accounting for business combinations. Inaccordance with SFAS 141, we determine the recognition of intangibleassets based on the following criteria: (i) the intangible asset arisesfrom contractual or other rights; or (ii) the 

 

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intangible is separable or divisible from the acquiredentity and capable of being sold, transferred, licensed, returned or exchanged.In accordance with SFAS 141, we allocate the purchase price of ourbusiness combinations to the tangible assets, liabilities and intangible assetsacquired, including in-process research and development, based on theirestimated fair values. The excess purchase price over those fair values isrecorded as goodwill.

 

*StockBased Compensation.*We account for stock-based compensationin accordance with SFAS No. 123R, “*Share-BasedPayment*” (“SFAS 123R”), using the modified prospectivemethod. SFAS 123R requires us to measure the cost of employee services inexchange for an award of an equity instrument based on the grant-date fairvalue of the award and to recognize expense over the requisite service period.Compensation expense is recognized for (a) all share-based paymentsgranted after the effective date and (b) all awards granted to employeesprior to the effective date that remain unvested on the effective date. Wecalculate this expense based upon an annualized estimated forfeiture ratedetermined by historical information and management’s estimate of futurevoluntary turnover rates and we true-up estimated forfeitures to actual at theend of each reporting period.

 

On November 10,2005, the Financial Accounting Standards Board (“FASB”) issued FASBStaff Position FAS 123R-3 “*TransitionElection Related to Accounting for Tax Effects of Share-Based Payment Awards*.”The Company elected to adopt the alternative transition method provided by theFASB Staff Position for calculating the tax effects (if any) of stock-basedcompensation expense pursuant to SFAS 123R. The alternative transition methodincludes simplified methods to establish the beginning balance of theadditional paid-in capital pool related to the tax effects of employeestock-based compensation and to determine the subsequent impact to theadditional paid-in-capital pool and the consolidated statements of operationsand cash flows of the tax effects of employee stock-based compensation awardsthat are outstanding upon adoption of SFAS 123R.

 

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

 

We assess our deferredtax assets for each reporting period to determine whether it is more likelythan not that we will recover from future taxable income. In making thisassessment, we include assumptions regarding ongoing tax planning strategies.We establish a valuation allowance for assets when their recovery is notcertain. We include changes to the valuation allowance as an expense or benefitwithin the tax provision in our statement of operations.

 

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

 

FASB Interpretation No. 48,“*Accounting for Uncertainty in Income Taxes,an interpretation of FAS 109*,” clarifies the criteria that anindividual tax position must satisfy for some or all of the benefits of thatposition to be recognized in a company’s financial statements. As of September 30,2008 and December 31, 2007, the Company had no unrecognized tax benefits.

 

We estimate accrued statesales taxes for each reporting period based on tax rates in effect for the reportingperiods in each of the states where we have a potential nexus and for the timeperiod during which we have that nexus. The assumptions and estimates used todetermine this liability are subject to change as they are difficult to measureor value. In the event that actual results differ from these estimates, ourstate sales taxes expense could be materially impacted.

 

**New Accounting Pronouncements**

** **

In September 2006,the FASB issued SFAS No. 157, “*FairValue Measurements*” (“SFAS 157”), which defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles and expands disclosures about fair value measurements.SFAS 157 applies to other existing accounting pronouncements that require orpermit fair value measurements. SFAS 157 does not require any new fair valuemeasurements. However, the application of this statement may change the currentpractice for fair value measurements. SFAS 157 is effective for fiscal yearsbeginning after November 15, 2007, and interim periods within those fiscalyears. However, in February 2008, the FASB issued a final Staff Positionto allow filers to defer the effective date of SFAS 157 for one year fornonfinancial assets and nonfinancial liabilities that are recognized or disclosedat fair value in the financial statements on a nonrecurring basis. The FASBStaff Position does not defer recognition and disclosure requirements forfinancial assets and financial liabilities or for nonfinancial assets andnonfinancial liabilities that are remeasured at least annually. The Company iscurrently evaluating the impact this statement will have on its financialposition and results of operations.

 

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In December 2007, the FASB issued SFAS No. 141R,“*Business Combinations*”**(“SFAS 141R”), which improves therelevance, representational faithfulness and comparability of the informationthat a reporting entity provides in its financial reports about a businesscombination and its effects. SFAS 141R applies prospectively to businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008. Wewill adopt this statement once it is effective and applicable. SFAS 141R willnot have an impact on our financial position or results of operations.

 

In December 2007, the FASB issued SFAS No. 160,“*Noncontrolling Interests in ConsolidatedFinancial Statements—an amendment of Accounting Research Bulletin No. 51*”(“SFAS 160”). SFAS 160 clarifies the classification in a company’sconsolidated balance sheet and the accounting for and disclosure oftransactions between the company and holders of noncontrolling interests. SFAS160 is effective for us as of January 1, 2009. Early adoption is notpermitted. We do not expect the adoption of SFAS 160 to have a material impacton our financial position or results of operations.

 

**Results of Operations**

 

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

 
| ** **                  | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                  | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenue:                    |       |                                                 |       |                                                |       |   |   |   |   |
| Software license            |       | 20.0                                                 | %          | 29.5                                                | %          | 26.3 | % | 29.0 | % |
| Hardware and  media         |       | 15.2                                                 |       | 12.5                                                |       | 11.4 |   | 12.9 |   |
| Service and  other          |       | 64.8                                                 |       | 58.0                                                |       | 62.3 |   | 58.1 |   |
| Total revenue               |       | 100.0                                                |       | 100.0                                               |       | 100.0 |   | 100.0 |   |
| Cost of revenue:            |       |                                                 |       |                                                |       |   |   |   |   |
| Software license            |       | 2.3                                                  |       | 2.5                                                 |       | 2.5 |   | 2.5 |   |
| Hardware and  media         |       | 9.8                                                  |       | 7.7                                                 |       | 7.4 |   | 8.3 |   |
| Service and  other          |       | 24.2                                                 |       | 21.6                                                |       | 24.3 |   | 23.7 |   |
| Total cost of  revenue      |       | 36.3                                                 |       | 31.8                                                |       | 34.2 |   | 34.5 |   |
| Gross profit                |       | 63.7                                                 |       | 68.2                                                |       | 65.8 |   | 65.5 |   |
| Operating  expenses:        |       |                                                 |       |                                                |       |   |   |   |   |
| Sales and  marketing        |       | 38.3                                                 |       | 37.9                                                |       | 39.8 |   | 46.0 |   |
| Research and  development   |       | 17.4                                                 |       | 15.2                                                |       | 17.8 |   | 18.3 |   |
| General and  administrative |       | 16.5                                                 |       | 16.7                                                |       | 18.3 |   | 20.8 |   |
| Restructuring  costs        |       | —                                               |       | —                                              |       | — |   | 2.8 |   |
| Total operating  expenses   |       | 72.2                                                 |       | 69.8                                                |       | 75.9 |   | 87.9 |   |
| Loss from  operations       |       | (8.5                                                 | )          | (1.6                                                | )          | (10.1 | ) | (22.4 | ) |
| Interest and  other income  |       | 0.5                                                  |       | 0.5                                                 |       | 0.4 |   | 0.5 |   |
| Interest expense            |       | (0.5                                                 | )          | (0.9                                                | )          | (0.5 | ) | (1.1 | ) |
|                        |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss                    |       | (8.5                                                 | )%         | (2.0                                                | )%         | (10.2 | )% | (23.0 | )% |
|                        |       |                                                 |       |                                                |       |   |   |   |   |
| Gross profit:               |       |                                                 |       |                                                |       |   |   |   |   |
| Software license            |       | 88.5                                                 | %          | 91.5                                                | %          | 90.6 | % | 91.2 | % |
| Hardware and  media         |       | 35.0                                                 |       | 39.0                                                |       | 35.4 |   | 35.8 |   |
| Service and  other          |       | 62.7                                                 |       | 62.7                                                |       | 61.0 |   | 59.2 |   |

 

**Revenue**

 

*Software License. *During the three- and nine-month periods ended September 30, 2008 ascompared to the same periods in 2007 we experienced a decrease in our softwarelicense revenue as our legacy fax software license revenue declined.  In addition, we believe that software licenserevenue was affected adversely by the general United States economic conditionsin the third quarter of 2008.   We alsoexperienced a decline in our AccuRoute software license revenue in the three-and nine-month periods ended September 30, 2008 as compared to sameperiods in 2007, partly as a result of United States economic conditions.During the third quarter of 2008 we entered into a contract with one of ourlarge partners to provide products and services to a large financial servicescompany. The total contract value is in excess of $1.0 million and is comprisedprimarily of software licenses and certain associated services related entirelyto our AccuRoute product line. We have classified the contract in deferredrevenue for the current quarter and expect to recognize the revenue for thiscontract over the ensuing fiscal quarters.

 

During the three and nine months ended September 30,2008, our software license revenue by product category, as compared to the sameperiods in the prior fiscal year, was as follows:

 

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| ** **                                    | ** ** | **Total  Revenue**    | ** ** | **Software  License  Revenue** | ** ** | **AccuRoute  Software  License  Revenue** | ** ** | **Legacy Fax  Software  License  Revenue** | ** ** | **Freight and  Allowances  for Returns** | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|--------------------------------|------------|-------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $4,106,979            |       | $821,970                       |       | $701,870                                  |       | $145,514                                        |       | $(25,414)                                          |       |
| Three months  ended September 30, 2007   |       | $4,108,585            |       | $1,212,104                     |       | $896,444                                  |       | $299,711                                        |       | $15,949                                            |       |
| Change from same  period of prior fiscal year |       | $(1,606)  or (0.0)%   |       | $(390,134)  or (32.2)%         |       | $(194,574)  or (21.7)%                    |       | $(154,197)  or (51.4)%                          |       | $(41,363)  or (259.3)%                             |       |
|                                          |       |                  |       |                           |       |                                      |       |                                            |       |                                               |       |
| Nine months  ended September 30, 2008    |       | $11,856,969           |       | $3,115,659                     |       | $2,639,338                                |       | $416,782                                        |       | $59,539                                            |       |
| Nine months  ended September 30, 2007    |       | $12,216,801           |       | $3,540,879                     |       | $2,760,956                                |       | $769,626                                        |       | $10,297                                            |       |
| Change from same  period of prior fiscal year |       | $(359,832)  or (2.9)% |       | $(425,220)  or (12.0)%         |       | $(121,618)  or (4.4)%                     |       | $(352,844)  or (45.8)%                          |       | $49,242  or 478.2%                                 |       |

 

During the three- and nine-month periods ended September 30,2008, our software license revenue represented a decreased percentage of ourtotal revenue as compared to the same period in 2007, due to a decrease insoftware license revenue.

 
| ** **                                    | ** ** | **Software License Revenue as a  Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | 20.0                                                                                              | %          |
| Three months  ended September 30, 2007   |       | 29.5                                                                                              | %          |
| Change from same  period of prior fiscal year |       | (9.5                                                                                              | )ppt       |
| ** **                                    | ** ** | ** **                                                                                        | ** ** |
| Nine months  ended September 30, 2008    |       | 26.3                                                                                              | %          |
| Nine months  ended September 30, 2007    |       | 29.0                                                                                              | %          |
| Change from same  period of prior fiscal year |       | (2.7                                                                                              | )ppt       |

 

The results for the three and nine months ended September 30,2008 and September 30, 2007 demonstrate that our software license revenuecontinues to shift toward our AccuRoute product. The table below summarizesrevenue from each of our major product lines and other components of revenue asa percentage of our total software license revenue:

 
| ** **                                    | ** ** | **AccuRoute License Revenue as  a Percentage of Software  License Revenue** | ** ** | **Legacy Fax License  Revenue as a Percentage of  Software License Revenue** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | 85.4                                                                                                           | %          | 17.7                                                                                                                 | %          |
| Three months  ended September 30, 2007   |       | 74.0                                                                                                           | %          | 24.7                                                                                                                 | %          |
| Change from same  period of prior fiscal year |       | 11.4                                                                                                           | ppt        | (7.0                                                                                                                 | )ppt       |
| ** **                                    | ** ** | ** **                                                                                                     | ** ** | ** **                                                                                                           | ** ** |
| Nine months  ended September 30, 2008    |       | 84.7                                                                                                           | %          | 13.4                                                                                                                 | %          |
| Nine months ended  September 30, 2007    |       | 78.0                                                                                                           | %          | 21.7                                                                                                                 | %          |
| Change from same  period of prior fiscal year |       | 6.7                                                                                                            | ppt        | (8.3                                                                                                                 | )ppt       |

 

*Hardware and Media.* Hardware and media revenue increased during the third quarter of 2008 ascompared to the third quarter of 2007 due primarily to certain existingcustomers updating their information technology infrastructure. Hardware andmedia revenue decreased during the nine-month period ended September 30,2008 as compared to the same period in 2007 due to a decrease in our legacy faxproduct sales, which are the main driver for our hardware sales.

 
| ** **                                    | ** ** | **Hardware and Media  Revenue** | ** ** | **Hardware and Media  Revenue as a  Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $622,269                                  |       | 15.2%                                                                                                |       |
| Three months  ended September 30, 2007   |       | $514,626                                  |       | 12.5%                                                                                                |       |
| Change from same  period of prior fiscal year |       | $107,643  or 20.9%                        |       | 2.7ppt                                                                                               |       |
|                                          |       |                                      |       |                                                                                                 |       |
| Nine months  ended September 30, 2008    |       | $1,348,537                                |       | 11.4%                                                                                                |       |
| Nine months  ended September 30, 2007    |       | $1,570,317                                |       | 12.9%                                                                                                |       |
| Change from same  period of prior fiscal year |       | $(221,780)  or (14.1)%                    |       | (1.5)ppt                                                                                             |       |

 

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*Service and Other. *Service and other revenue, which consists primarily of the sale of supportcontracts to complement software products sold to customers and, to a lesserextent, consulting, training and installation services, increased in the three-and nine-month periods ended September 30, 2008 as compared to the sameperiods in the prior fiscal year primarily due to a large consulting projectthat was completed during the third quarter of 2008, and to a lesser extent, anincrease in the renewal of support contracts with existing customers.  Service and other revenue as a percentage oftotal revenue increased in both periods compared to the same periods in 2007due to the increase in service and other revenue.

 
| ** **                                    | ** ** | **Service and Other Revenue** | ** ** | **Service and Other Revenue as  a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $2,662,740                                   |       | 64.8%                                                                                                   |       |
| Three months  ended September 30, 2007   |       | $2,381,855                                   |       | 58.0%                                                                                                   |       |
| Change from same  period of prior fiscal year |       | $280,885  or 11.8%                           |       | 6.8ppt                                                                                                  |       |
| ** **                                    | ** ** | ** **                                   | ** ** | ** **                                                                                              | ** ** |
| Nine months  ended September 30, 2008    |       | $7,392,773                                   |       | 62.3%                                                                                                   |       |
| Nine months  ended September 30, 2007    |       | $7,105,605                                   |       | 58.2%                                                                                                   |       |
| Change from same  period of prior fiscal year |       | $287,168  or 4.0%                            |       | 4.1ppt                                                                                                  |       |

 

We continue to focus on improving the renewal rate ofsoftware maintenance contracts with our existing customer base in the UnitedStates, Europe and other non-U.S. locations, and on generating additionalservice and other revenue in future quarters.

 

**Cost of Revenue**

 

*Software License. *Cost of software license revenue consists primarily of the costs we incur insublicensing third-party software products, purchasing product media andcontracting for product duplication, as well as the amortization of purchasedtechnology. Cost of software license revenue for the three- and nine-monthperiods ended September 30, 2008 decreased as compared to the correspondingperiod in the previous fiscal year primarily due to a reduction in theamortization expense of purchased technology associated with our acquisition ofBlueChip, which technology is being amortized over its estimated future life offive years and is based upon patterns in which the economic benefits of suchassets are expected to be utilized. During these same two time periods, weexperienced a decrease in the software license gross margin percentage due tothe combined effect of having fixed price third-party royalty agreements anddecreasing software license revenue. We expect the cost of software licenserevenue to remain consistent with third quarter levels for the remainder of2008.

 
| ** **                                    | ** ** | **Cost of Software License Revenue** | ** ** | **Software License Gross Margin** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|--------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $94,699                                                  |       | 88.5%                                            |       |
| Three months  ended September 30, 2007   |       | $103,427                                                 |       | 91.5%                                            |       |
| Change from same  period of prior fiscal year |       | $(8,728)  or (8.4)%                                      |       | (3.0)ppt                                         |       |
| ** **                                    | ** ** | ** **                                               | ** ** | ** **                                       | ** ** |
| Nine months  ended September 30, 2008    |       | $292,764                                                 |       | 90.6%                                            |       |
| Nine months  ended September 30, 2007    |       | $311,972                                                 |       | 91.2%                                            |       |
| Change from same  period of prior fiscal year |       | $(19,208)  or (6.2)%                                     |       | (0.6)ppt                                         |       |

 

*Hardware and Media. *Cost of hardware and media revenue consists primarily of the costs we incur inpurchasing third-party hardware and media products. During the thirdquarter of 2008, as compared to the third quarter of 2007, cost of hardware andmedia revenue increased due to the increase in hardware unit sales. During thenine-month period ended September 30, 2008, cost of hardware and mediadecreased as compared to the same periods in 2007 primarily as a result of adecrease in our hardware unit sales. Our hardware and media gross marginpercentage decreased for the three- and nine-month periods ended September 30,2008 as compared to the same periods in 2007 due to a change in the mix ofproducts sold.  We do not expectsignificant changes in unit prices of hardware or media for the remainder of2008.

 
| ** **                                    | ** ** | **Cost of Hardware and Media Revenue** | ** ** | **Hardware and Media Gross  Margin** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $404,505                                                        |       | 35.0%                                               |       |
| Three months  ended September 30, 2007   |       | $314,006                                                        |       | 39.0%                                               |       |
| Change from same  period of prior fiscal year |       | $90,499  or 28.8%                                               |       | (4.0)ppt                                            |       |
| ** **                                    | ** ** | ** **                                                      | ** ** | ** **                                          | ** ** |
| Nine months  ended September 30, 2008    |       | $871,290                                                        |       | 35.4%                                               |       |
| Nine months  ended September 30, 2007    |       | $1,008,144                                                      |       | 35.8%                                               |       |
| Change from same  period of prior fiscal year |       | $(136,854)  or (13.6)%                                          |       | (0.4)ppt                                            |       |

 

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*Service and Other. *Cost of service and other revenue consists primarily of the costs we incur inproviding telephone support, installations and other miscellaneous customerservice-related expenses. Cost of service and other revenue increased duringthe third quarter of 2008 compared to the third quarter of 2007 due to anincrease in headcount resulting in increased wages expense and other costsassociated with supporting the additional employees. Despite this increase inabsolute dollars, service and other revenue gross margin percentage in thethird quarter of 2008 was consistent with the third quarter of 2007 due to theincrease in service and other revenue. We experienced a slight decrease in costof service and other revenue during the nine-month period ended September 30,2008 as compared to the same period in fiscal year 2007 due to a reduction intravel and consulting expenses resulting from the adoption of our March 2007restructuring plan, offset in part by an increase in headcount. This decreasein absolute dollars of cost of service and other revenue combined with theincrease in service and other revenue resulted in an increase in our serviceand other revenue gross margin percentage. We expect cost of service and otherrevenue to remain relatively consistent during the fourth quarter of 2008.

 
| ** **                                    | ** ** | **Cost of Service and Other  Revenue** | ** ** | **Gross Margin for Service  and Other Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $993,251                                                   |       | 62.7%                                                                    |       |
| Three months  ended September 30, 2007   |       | $888,001                                                   |       | 62.7%                                                                    |       |
| Change from same  period of prior fiscal year |       | $105,250  or 11.9%                                         |       | 0.0ppt                                                                   |       |
| ** **                                    | ** ** | ** **                                                 | ** ** | ** **                                                               | ** ** |
| Nine months  ended September 30, 2008    |       | $2,885,124                                                 |       | 61.0%                                                                    |       |
| Nine months  ended September 30, 2007    |       | $2,900,280                                                 |       | 59.2%                                                                    |       |
| Change from same  period of prior fiscal year |       | $(15,156)  or (0.5)%                                       |       | 1.8ppt                                                                   |       |

 

**Operating Expenses**

 

*Sales and Marketing. *Sales and marketing expenses consist primarily of employee salaries, benefits,commissions, and associated overhead costs, as well as the cost of marketingprograms such as direct mailings, public relations, trade shows, seminars andrelated communication costs. Sales and marketing expenses increasedslightly in absolute dollars and as a percentage of total revenue during thethird quarter of 2008 as compared to the third quarter of 2007 due to anincrease in expenses of certain marketing programs in support of our overallstrategy of increasing our AccuRoute sales opportunities to customers in thelegal and professional services, healthcare and financial services vertical marketsthrough investments in direct and indirect sales and marketing resources.During the nine-month period ended September 30, 2008, sales and marketingexpenses decreased in absolute dollars and as a percentage of total revenue ascompared to the same period in 2007 due to a reduction in headcount as a resultof our March 2007 restructuring plan, which resulted in decreased wagesand other costs associated with supporting those employees. In addition, ourmarketing program expenditures decreased in accordance with this plan. Weexpect that our sales and marketing expenses will increase modestly during thelast quarter of 2008.

 
| ** **                                    | ** ** | **Sales and Marketing Expenses** | ** ** | **Sales and Marketing Expenses as  a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $1,571,595                                      |       | 38.3%                                                                                                      |       |
| Three months  ended September 30, 2007   |       | $1,555,984                                      |       | 37.9%                                                                                                      |       |
| Change from same  period of prior fiscal year |       | $15,611  or 0.1%                                |       | 0.4ppt                                                                                                     |       |
|                                          |       |                                            |       |                                                                                                       |       |
| Nine months  ended September 30, 2008    |       | $4,717,984                                      |       | 39.8%                                                                                                      |       |
| Nine months  ended September 30, 2007    |       | $5,622,928                                      |       | 46.0%                                                                                                      |       |
| Change from same  period of prior fiscal year |       | $(904,944)  or (16.1)%                          |       | (6.2)ppt                                                                                                   |       |

 

*Research and Development.* Research and development expenses include expenses associated with thedevelopment of new products, enhancements of existing products and qualityassurance activities. These expenses consist primarily of employeesalaries, benefits, associated overhead costs, consulting expenses and the costof software development tools. During the quarter ended September 30,2008, research and development expenses increased in absolute dollars and as apercentage of total revenue primarily due to an increase in consultingexpenses. For the nine-month period ended September 30, 2008, our researchand development expenses decreased in absolute dollars and as a percentage oftotal revenue as compared to the same period in the prior fiscal year,primarily due to a reduction in headcount from the March 2007restructuring plan which resulted in decreased wages and other costs 

 

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associated with supporting those employees. We expectour research and development expenses will remain at current levels for the fourthquarter of 2008.

 
| ** **                                    | ** ** | **Research and Development  Expenses** | ** ** | **Research and Development  Expenses as a Percentage of  Total Revenue** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $713,380                                         |       | 17.4%                                                                                                       |       |
| Three months  ended September 30, 2007   |       | $624,390                                         |       | 15.2%                                                                                                       |       |
| Change from same  period of prior fiscal year |       | $88,990  or 14.3%                                |       | 2.2ppt                                                                                                      |       |
| ** **                                    | ** ** | ** **                                       | ** ** | ** **                                                                                                  | ** ** |
| Nine months  ended September 30, 2008    |       | $2,107,336                                       |       | 17.8%                                                                                                       |       |
| Nine months  ended September 30, 2007    |       | $2,234,152                                       |       | 18.3%                                                                                                       |       |
| Change from same  period of prior fiscal year |       | $(126,816)  or (5.7)%                            |       | (0.5)ppt                                                                                                    |       |

 

*General and Administrative. *General and administrative expenses consist primarily of employee salaries,benefits for administrative, executive and finance personnel, and associatedcorporate, general and administrative expenses. During the third quarterof 2008, general and administrative expenses remained relatively flat both inabsolute dollars and as a percentage of total revenue as compared to the thirdquarter of 2007. During the nine-month period ended September 30, 2008,our general and administrative expenses decreased in absolute dollars and as apercentage of total revenue as compared to the same period in the prior fiscalyear due to a reduction in headcount primarily within our European operationsresulting from our March 2007 restructuring plan. General andadministrative expenses also decreased due to a reduction in accounting andlegal expenses as a result of higher fees in 2007 related to the review of ourexisting commercial and licensing agreements. We expect general and administrativeexpenses for the fourth quarter of 2008 to remain consistent with the thirdquarter of 2008.

 
| ** **                                    | ** ** | **General and Administrative  Expenses** | ** ** | **General and Administrative Expenses  as a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $677,366                                           |       | 16.5%                                                                                                             |       |
| Three months  ended September 30, 2007   |       | $686,590                                           |       | 16.7%                                                                                                             |       |
| Change from same  period of prior fiscal year |       | $(9,224)  or (1.3)%                                |       | (0.2)ppt                                                                                                          |       |
|                                          |       |                                               |       |                                                                                                              |       |
| Nine months  ended September 30, 2008    |       | $2,177,313                                         |       | 18.4%                                                                                                             |       |
| Nine months  ended September 30, 2007    |       | $2,538,534                                         |       | 20.8%                                                                                                             |       |
| Change from same  period of prior fiscal year |       | $(361,221)  or (14.2)%                             |       | (2.4)ppt                                                                                                          |       |

 

*RestructuringCosts.*  In March 2007,we announced a restructuring of certain of our operations and reduced ourworkforce. As a result of these cost reduction activities, we recorded apre-tax charge of $343,450 for the nine months ended September 30, 2007,which charge included $308,278 of severance-related costs and $35,172 of costsrelating to the closing of BlueChip’s former headquarters.

 
| ** **                                    | ** ** | **Restructuring Costs** | ** ** | **Restructuring Costs  as a Percentage of Total Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $0                           |       | 0.0%                                                                                    |       |
| Three months  ended September 30, 2007   |       | $0                           |       | 0.0%                                                                                    |       |
| Change from same  period of prior fiscal year |       | $0  or 0.0%                  |       | 0.0ppt                                                                                  |       |
| ** **                                    | ** ** | ** **                   | ** ** | ** **                                                                              | ** ** |
| Nine months  ended September 30, 2008    |       | $0                           |       | 0.0%                                                                                    |       |
| Nine months  ended September 30, 2007    |       | $343,450                     |       | 2.8%                                                                                    |       |
| Change from same  period of prior fiscal year |       | $(343,450)  or (100.0)%      |       | (2.8)ppt                                                                                |       |

 

*Interest and other Income andInterest Expense. * Interest and other income consistsprimarily of interest income earned on cash and cash equivalent balances. Thedecrease in interest and other income during the three- and nine-month periodsended September 30, 2008, as compared to the same periods in 2007, is aresult of a lower average investment balance. Interest expense represents theinterest associated with the capital lease that we entered into in May 2006to finance the purchase of furniture and equipment for our new headquarters, aswell as interest expense associated with the promissory note issued to theSeller of BlueChip. Interest expense 

 

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decreased during the three- and nine-month periods endedSeptember 30, 2008 as compared to the same periods in fiscal 2007 due to areduction in the variable interest rate on the note payable and the decliningoutstanding principal balance.

 

We expect interest and other income to remainrelatively stable quarter over quarter for the remainder of 2008 and thatinterest expense will decrease quarter over quarter for the last quarter of2008.

 
| ** **                                    | ** ** | **Interest and  Other Income** | ** ** | **Interest  Expense** | ** ** | **Interest and Other  Income  as a Percentage  of Total Revenue** | ** ** | **Interest Expense  as a Percentage  of Total Revenue** | ** ** |
|-----------------------------------------------|------------|------------------------------------------|------------|-----------------------|------------|-------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| Three months  ended September 30, 2008   |       | $19,666                                  |       | $(18,935)             |       | 0.5%                                                                                            |       | (0.5)%                                                                           |       |
| Three months  ended September 30, 2007   |       | $21,504                                  |       | $(40,261)             |       | 0.5%                                                                                            |       | (1.0)%                                                                           |       |
| Change from same  period of prior fiscal year |       | $(1,838)  or (8.5)%                      |       | $21,326  or 53.0%     |       | (0.0)ppt                                                                                        |       | (0.5)ppt                                                                         |       |
|                                          |       |                                     |       |                  |       |                                                                                            |       |                                                                             |       |
| Nine months  ended September 30, 2008    |       | $53,085                                  |       | $(66,652)             |       | 0.4%                                                                                            |       | (0.6)%                                                                           |       |
| Nine months  ended September 30, 2007    |       | $69,536                                  |       | $(135,796)            |       | 0.6%                                                                                            |       | (1.1)%                                                                           |       |
| Change from same  period of prior fiscal year |       | $(16,451)  or (23.7)%                    |       | $69,144  or 50.9%     |       | 0.2ppt                                                                                          |       | 0.5ppt                                                                           |       |

 

**Inflation**

 

During the fiscal years ended December 31, 2006and 2007 and the nine months ended September 30, 2008, neither inflationnor changing prices have had a material impact on our net sales, revenue orincome from continuing operations.

 

**Liquidity and Capital Resources**

 

Since 1996, we have financed our operations primarilythrough cash flow from operations and private and public sales of securities.As of September 30, 2008, we had cash and cash equivalents of $2.0 millionand a net working capital deficit of $2.9 million. We believe that ourexisting cash and cash equivalents will be sufficient to meet our workingcapital, capital expenditures and other liquidity requirements for at least thenext twelve months.

 
| ** **                                    | ** ** | **Cash Used In**    | ** ** |
|-----------------------------------------------|------------|-------------------------------|------------|
| ** **                                    | ** ** | **Operating Activities** | ** ** | **Investing Activities** | ** ** | **Financing Activities** | ** ** |
| Nine months  ended September 30, 2008    |       | $309,508                      |       | $(72,266) |   | $(484,739) |   |
| Nine months  ended September 30, 2007    |       | $(2,315,023)                  |       | $(711,598) |   | $(326,756) |   |
| Change from same  period of prior fiscal year |       | $2,624,531  or 1,133.7%       |       | $639,332  or 89.8% |   | $(157,983)  or (48.3)% |   |

 

Our operating activities provided cash of $310,000 forthe nine months ended September 30, 2008 and used cash of approximately$2.3 million for the nine months ended September 30, 2007. We believethat the resources we are allocating to improve the success of our AccuRouteproduct in the legal and professional services vertical market and itsexpansion into the healthcare and financial services vertical markets willcontinue to put pressure on our earnings and liquidity during the remainder of2008 and into 2009, but that our existing cash is sufficient for at least thenext twelve months.

 

Net cash provided during the nine months ended September 30,2008 consisted primarily of an increase in deferred revenue and the noncasheffects of depreciation, amortization and stock-based compensation expense,predominantly for vesting of restricted stock shares, and an increase inaccounts payable offset in part by a net loss from operations and an increasein accounts receivable. The increases in deferred revenue and accountsreceivable are due to a large sales contract that was received at the end ofthe quarter for which the criteria for revenue recognition had not been met asof September 30, 2008, and the increase in accounts payable is due to thetiming of vendor payments.

 

Net cash used during thenine months ended September 30, 2007 consisted primarily of a net lossfrom operations and a decrease in accounts payable, offset in part by adecrease in unbilled accounts receivable, an increase in deferred revenue, aswell as by the non-cash effects of depreciation and amortization andstock-based compensation, predominately for vesting of shares of restrictedstock.

 

Investing activities used cash of $72,000 and $712,000during the nine months ended September 30, 2008 and 2007,respectively. The sole use of cash for the first nine months of 2008 wasfor the purchase of various software and computer equipment. The primary use ofcash for investing activities during the first nine months of 2007 consisted ofthe $562,090 cash payment made to the Seller of BlueChip for our December 2006acquisition as well as additional legal and accounting fees related to our December 2006acquisition of BlueChip.

 

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Financing activities used cash of $485,000 and$327,000 during the nine months ended September 30, 2008 and September 30,2007, respectively. The primary use of cash during these periods was forprincipal payments made to the Seller of BlueChip as part of the purchaseconsideration for BlueChip and for the repayment of capital lease obligations.

 

Based on our performance for the first nine months of2008 and current expectations for the remainder of 2008 and the beginning of2009, we believe that our current cash and cash equivalents balance, as well asthe cash expected to be generated from operations for the remainder of theyear, will satisfy our working capital needs, capital expenditures, and otherliquidity requirements associated with our operations through at least the nexttwelve months. We expect that principal uses of cash will be for operations,repayment of capital lease obligations and notes payable. There can be noassurance that any necessary additional financing will be available to us oncommercially reasonable terms, or at all. The issuance of additional equity orequity-related securities would be dilutive to our stockholders. If we cannotraise funds on acceptable terms, or at all, we may not be able to develop orenhance our products or respond appropriately to competitive pressures, whichwould seriously limit our ability to increase our revenue and grow ourbusiness.

 

Our capital lease agreement contains a provision,whereby we are required to maintain a minimum cash balance of $2.1 million. Inaddition, we have entered into a pledge and security agreement with the capitalfinancing provider that requires a minimum balance of cash and cash equivalentsof no less than $250,000 (“pledged collateral”) and in the event thatour cash balance falls below $250,000 we will immediately provide the amountnecessary to cover such shortfall to the capital financing provider. In theevent of default in maintaining the required amount of pledged collateral orthe making of any lease payments, the pledged collateral will first be used aspayment for costs and expenses incurred to enforce the security and pledgeagreement and second for payment in full of the outstanding principal loanbalance. The minimum required cash balance of $2.1 million includes the pledgedcollateral. As of September 30, 2008 and December 31, 2007, thepledged collateral of $250,000 is restricted cash and has been classified as “otherassets” in the accompanying balance sheet. In the event our cash balance fallsbelow the minimum requirement of $2.1 million, we will be required to pay theoutstanding principal balance. As of September 30, 2008, our totaloutstanding principal balance is approximately $284,000.

 

**Off-Balance Sheet Arrangements**

 

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

 

**Item4T.  Controls and Procedures**

 

(a)             Evaluationof disclosure controls and procedures.

 

As of September 30, 2008 (the “Evaluation Date”),the Company, under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, evaluated the effectiveness of the design and operation of the Company’sdisclosure controls and procedures pursuant to Rule 13a-15(b) promulgatedunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”).Based upon that evaluation, the Company’s Chief Executive Officer and ChiefFinancial Officer concluded that, as of the Evaluation Date, the Company’sdisclosure controls and procedures were effective in ensuring that informationrelating to the Company (including its consolidated subsidiaries) required tobe disclosed by the Company in the reports that it files or submits under theExchange Act is recorded, processed, summarized, and reported within the timeperiods specified in the Securities and Exchange Commission’s rules andforms, including ensuring that this information is accumulated and communicatedto the Company’s management, including the Company’s Chief Executive Officerand Chief Financial Officer, as appropriate to allow timely decisions regardingrequired disclosure.

 

(b)            Changesin internal control over financial reporting

 

There were no changes in the Company’s internalcontrol over financial reporting during the Company’s fiscal quarter ended September 30,2008 or in other factors that have materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.

 

**PART II: OTHER INFORMATION**

 

**Item1A.  Risk Factors**

 

**Fromtime to time we may update, revise and supplement the risk factors describedunder the title “Risk Factors” in our Annual Report on Form 10-K for thefiscal year ended December 31, 2007. There are no material changes to therisk factors described in the**

 

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**“Risk Factors” section in our AnnualReport on Form 10-K for the fiscal year ended December 31, 2007,other than those noted in the Company’s Quarterly Report on Form 10-Q forthe quarter ender June 30, 2008. **Wenote that, as a smaller reporting company, we are not required to provide thisItem 1A in this Quarterly Report on Form 10-Q. Accordingly, we undertakeno duty to update these risk factors on a going-forward basis.

 

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

**ISSUER PURCHASES OF EQUITYSECURITIES**

 
| **Period**                                             | ** ** | **(a) Total  Number of  Shares  Purchased** | ** ** | **(b) Average   Price  Paid per Share** | ** ** | **(c) Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **(d) Maximum  Number of Shares  that May Yet be  Purchased Under the  Plans or Programs** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | ** **                                            | ** ** | ** **                                                  | ** ** | ** **                                                                                                                                | ** ** | ** **                                                                                                                                   | ** ** |
| July 1,  2008 — July 31, 2008           |       | 1,026                                                 | (1)        | $                                                           | 2.40       |                                                                                                                                      | —     |                                                                                                                                         | —     |   |
| August 1,  2008 — August 31, 2008       |       | 0                                                     |       | $                                                           | —     |                                                                                                                                      | —     |                                                                                                                                         | —     |   |
| September 1,  2008 — September 30, 2008 |       | 0                                                     |       | $                                                           | —     |                                                                                                                                      | —     |                                                                                                                                         | —     |   |
|                                                   |       |                                                  |       |                                                        |       |                                                                                                                                      |       |                                                                                                                                         |       |
| Total                                                  |       | 1,026                                                 |       | $                                                           | 2.40       |                                                                                                                                      | —     |                                                                                                                                         | —     |   |

 

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(1)                   On July 20,2008, certain shares of restricted Common Stock of the Company held by certainemployees vested. The vesting of the restricted stock imposed tax withholdingobligations on the Company and, accordingly, the Company purchased 1,026 sharesof the vested Common Stock from the employees in order to fulfill thewithholding obligations. The Company purchased the shares to fulfill taxwithholding obligations in accordance with Stock Purchase and RestrictionAgreements between the Company and the respective employees. All shares werepurchased at $2.40, the closing price on July 18, 2008, the precedingbusiness day to the date on which vesting occurred and the tax withholdingobligations arose.

 

**Item6.  Exhibits**

 

Exhibits

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

 

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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. |
|-------------------------|--------------|
|                    |         |   |
|                    | By:          | /s/ Daniel A. Coccoluto |
| November  13, 2008 |         | Daniel A. Coccoluto |
|                    |         | Chief Financial  Officer, Secretary and Treasurer |
|                    |         | (Duly authorized officer  and principal financial |
|                    |         | officer) |

 

**Exhibit Index**

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

 

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