**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM10-Q**

 

**(Mark One)**

 

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

 

**For the quarterly period ended March 31, 2005**

 

**OR**

 

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

 

**For the transition periodfrom               to               **

 

**Commission File Number 0-22871**

 

**OMTOOL,LTD.**

(Exact Name of Registrant as Specified in Its Charter)

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

 

Indicateby check mark whether the Registrant has: (1) filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes  ý   No   o

 

Indicateby check mark whether the Registrant is an accelerated filer (as defined inRule 12b-2 of the Securities Exchange Act of 1934).

 

Yes  o  No  ý

 

Therewere 3,915,763 shares of the Company’s common stock, par value $0.01,outstanding on May 11, 2005.

 

 

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**OMTOOL, LTD. AND SUBSIDIARIES**

 

FORM 10-Q

For the Quarter Ended March 31, 2005

CONTENTS

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

 

2

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**PARTI:  FINANCIAL INFORMATION**

**Item 1.  Consolidated Financial Statements**

 

**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                                                                              | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                              | ** ** | **(Unaudited)**     | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                                                                              |       |                |       |                   |       |
| Current assets:                                                                                                                                                                                                                         |       |                |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                                                               |       | $                   | 10,468,733 |                   | $          | 10,655,121 |   |
| Accounts receivable, less reserves of  $58,000 at March 31, 2005 and $82,000 at December 31, 2004                                                                                                                                       |       | 2,399,466           |       | 1,802,784              |       |
| Inventories                                                                                                                                                                                                                             |       | 155,658             |       | 137,992                |       |
| Prepaid expenses and other current assets                                                                                                                                                                                               |       | 358,143             |       | 278,972                |       |
| Total current assets                                                                                                                                                                                                                    |       | 13,382,000          |       | 12,874,869             |       |
| Property and equipment, net                                                                                                                                                                                                             |       | 194,326             |       | 213,512                |       |
| Other assets                                                                                                                                                                                                                            |       | 11,562              |       | 11,562                 |       |
| Total assets                                                                                                                                                                                                                            |       | $                   | 13,587,888 |                   | $          | 13,099,943 |   |
|                                                                                                                                                                                                                                    |       |                |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                           | ** ** | ** **          | ** ** | ** **             | ** ** |
| Current liabilities:                                                                                                                                                                                                                    |       |                |       |                   |       |
| Accounts payable                                                                                                                                                                                                                        |       | $                   | 989,691    |                   | $          | 849,572 |   |
| Accrued liabilities                                                                                                                                                                                                                     |       | 1,236,844           |       | 1,258,672              |       |
| Accrued state sales tax                                                                                                                                                                                                                 |       | 674,377             |       | 699,816                |       |
| Deferred revenue, short term                                                                                                                                                                                                            |       | 3,492,299           |       | 3,205,072              |       |
| Total current liabilities                                                                                                                                                                                                               |       | 6,393,211           |       | 6,013,132              |       |
| Long term liabilities:                                                                                                                                                                                                                  |       |                |       |                   |       |
| Deferred revenue, long-term                                                                                                                                                                                                             |       | 393,412             |       | 455,604                |       |
| Total liabilities                                                                                                                                                                                                                       |       | 6,786,623           |       | 6,468,736              |       |
|                                                                                                                                                                                                                                    |       |                |       |                   |       |
| Stockholders’ equity:                                                                                                                                                                                                              |       |                |       |                   |       |
| Preferred Stock, $0.01 par value —                                                                                                                                                                                                 |       |                |       |                   |       |
| Authorized — 2,000,000 shares; Issued and  outstanding — none                                                                                                                                                                 |       | —              |       | —                 |       |
| Common stock, $0.01 par value —                                                                                                                                                                                                    |       |                |       |                   |       |
| Authorized — 35,000,000 shares; Issued —  4,367,878 shares at March 31, 2005 and December 31, 2004;  Outstanding — 3,913,263 shares at March 31, 2005 and 3,500,500 shares at  December 31, 2004, respectively |       | 43,679              |       | 43,679                 |       |
| Deferred compensation                                                                                                                                                                                                                   |       | (433,032            | )          | —                 |       |
| Additional paid-in capital                                                                                                                                                                                                              |       | 35,413,836          |       | 35,259,706             |       |
| Accumulated deficit                                                                                                                                                                                                                     |       | (25,875,971         | )          | (26,018,011            | )          |
| Treasury stock, at cost (454,615 shares at  March 31, 2005 and 516,406 shares at December 31, 2004)                                                                                                                                     |       | (2,332,700          | )          | (2,649,756             | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                    |       | (14,547             | )          | (4,411                 | )          |
| Total stockholders’ equity                                                                                                                                                                                                         |       | 6,801,265           |       | 6,631,207              |       |
|                                                                                                                                                                                                                                    |       |                |       |                   |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                         |       | $                   | 13,587,888 |                   | $          | 13,099,943 |   |

 

The accompanying notes are an integral part of these unauditedconsolidated financial statements.

 

3

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements of Operations**

(Unaudited)

 
| ** **                                            | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                            | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| Revenues:                                             |       |                              |       |   |   |
| Software license                                      |       | $                                 | 1,317,629  |   | $ | 1,171,898 |   |
| Hardware                                              |       | 837,344                           |       | 1,167,551 |   |
| Service and other                                     |       | 1,706,511                         |       | 1,688,629 |   |
|                                                  |       |                              |       |   |   |
| Total revenues                                        |       | 3,861,484                         |       | 4,028,078 |   |
|                                                  |       |                              |       |   |   |
| Cost of revenues:                                     |       |                              |       |   |   |
| Software license                                      |       | 20,767                            |       | 31,525 |   |
| Hardware                                              |       | 543,677                           |       | 674,243 |   |
| Service and other                                     |       | 717,375                           |       | 747,227 |   |
|                                                  |       |                              |       |   |   |
| Total cost of revenues                                |       | 1,281,819                         |       | 1,452,995 |   |
|                                                  |       |                              |       |   |   |
| Gross profit                                          |       | 2,579,665                         |       | 2,575,083 |   |
|                                                  |       |                              |       |   |   |
| Operating expenses:                                   |       |                              |       |   |   |
| Sales and marketing                                   |       | 1,179,316                         |       | 1,043,287 |   |
| Research and development                              |       | 516,990                           |       | 471,175 |   |
| General and administrative                            |       | 775,171                           |       | 699,391 |   |
|                                                  |       |                              |       |   |   |
| Total operating expenses                              |       | 2,471,477                         |       | 2,213,853 |   |
|                                                  |       |                              |       |   |   |
| Income from operations                                |       | 108,188                           |       | 361,230 |   |
|                                                  |       |                              |       |   |   |
| Interest and other income, net                        |       | 40,629                            |       | 37,656 |   |
|                                                  |       |                              |       |   |   |
| Income before tax provision                           |       | 148,817                           |       | 398,886 |   |
|                                                  |       |                              |       |   |   |
| Tax provision                                         |       | 6,777                             |       | 19,131 |   |
|                                                  |       |                              |       |   |   |
| Net income                                            |       | $                                 | 142,040    |   | $ | 379,755 |   |
|                                                  |       |                              |       |   |   |
| Net income per share                                  |       |                              |       |   |   |
| Basic                                                 |       | $                                 | 0.04       |   | $ | 0.11 |   |
| Diluted                                               |       | $                                 | 0.04       |   | $ | 0.10 |   |
|                                                  |       |                              |       |   |   |
| Weighted average number of common shares  outstanding |       |                              |       |   |   |
| Basic                                                 |       | 3,853,933                         |       | 3,514,438 |   |
| Diluted                                               |       | 4,055,264                         |       | 3,680,185 |   |

 

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

 

4

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Consolidated Statements of Cash Flows**

(Unaudited)

 
| ** **                                                                                   | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                   | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| Cash Flows from Operating Activities:                                                        |       |                              |       |   |   |
| Net income                                                                                   |       | $                                 | 142,040    |   | $ | 379,755 |   |
| Adjustments to reconcile net income to net  cash (used in) provided by operating activities: |       |                              |       |   |   |
| Depreciation                                                                                 |       | 46,581                            |       | 78,473 |   |
| Accounts receivable reserves                                                                 |       | (23,408                           | )          | (154,124 | ) |
| Amortization of deferred compensation                                                        |       | 19,415                            |       | — |   |
| Changes in assets and liabilities—                                                      |       |                              |       |   |   |
| Accounts receivable                                                                          |       | (576,946                          | )          | (65,422 | ) |
| Prepaid expenses and other current assets                                                    |       | (103,653                          | )          | (53,182 | ) |
| Inventory                                                                                    |       | (17,666                           | )          | 10,202 |   |
| Accounts payable                                                                             |       | 141,120                           |       | 25,172 |   |
| Accrued liabilities                                                                          |       | 4,229                             |       | 119,524 |   |
| Accrued state sales tax                                                                      |       | (25,439                           | )          | 23,680 |   |
| Accrued restructuring                                                                        |       | —                            |       | (143,772 | ) |
| Deferred revenue                                                                             |       | 230,518                           |       | (45,845 | ) |
|                                                                                         |       |                              |       |   |   |
| Net cash (used in) provided by operating  activities                                         |       | (163,209                          | )          | 174,461 |   |
|                                                                                         |       |                              |       |   |   |
| Cash Flows from Investing Activities:                                                        |       |                              |       |   |   |
| Purchases of property and equipment                                                          |       | (27,525                           | )          | (13,237 | ) |
|                                                                                         |       |                              |       |   |   |
| Net cash (used in) investing activities                                                      |       | (27,525                           | )          | (13,237 | ) |
|                                                                                         |       |                              |       |   |   |
| Cash Flows from Financing Activities:                                                        |       |                              |       |   |   |
| Net proceeds from issuance of common stock                                                   |       | 18,739                            |       | 3,524,907 |   |
| Purchase of treasury stock                                                                   |       | —                            |       | (2,012,500 | ) |
|                                                                                         |       |                              |       |   |   |
| Net cash provided by financing activities                                                    |       | 18,739                            |       | 1,512,407 |   |
|                                                                                         |       |                              |       |   |   |
| Exchange rate effect on cash                                                                 |       | (14,393                           | )          | 32,614 |   |
|                                                                                         |       |                              |       |   |   |
| Net (decrease) increase in cash and cash  equivalents                                        |       | (186,388                          | )          | 1,706,245 |   |
|                                                                                         |       |                              |       |   |   |
| Cash and cash equivalents, beginning of  period                                              |       | 10,655,121                        |       | 8,242,067 |   |
|                                                                                         |       |                              |       |   |   |
| Cash and cash equivalents, end of period                                                     |       | $                                 | 10,468,733 |   | $ | 9,948,312 |   |

 

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

 

5

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**OMTOOL, LTD. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

(Unaudited)

 

**(1) Basis of Presentation**

 

Theaccompanying unaudited consolidated financial statements have been prepared byOmtool, Ltd. (the “Company” or “Omtool”) pursuant to the rules and regulationsof the Securities and Exchange Commission (“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, 2004 asfiled with the SEC on March 29, 2005. The accompanying 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 forthe three month period ended March 31, 2005 are not necessarily indicative ofthe results to be expected for the full fiscal year.

 

 

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

 

TheCompany reports earnings per share in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 128,*Earnings per Share*.  The dilutive effect of potential commonshares consisting of outstanding stock options and a stock warrant isdetermined using the treasury stock method, in accordance with SFASNo. 128.  For the fiscal quarters ended March 31, 2004 and 2005, thedilutive calculation excludes the potential common shares related to 220,774and 112,560 outstanding stock options, respectively, that have an anti-dilutiveeffect since their exercise price exceeds the market value of the Company’scommon stock.  A reconciliation of basicand diluted common shares outstanding is as follows:

 
| ** **                                                     | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                     | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| Weighted average number of common shares  outstanding          |       | 3,853,933                         |       | 3,514,438 |   |
| Potential common shares pursuant to stock  options and warrant |       | 201,331                           |       | 165,747 |   |
| Diluted weighted average shares                                |       | 4,055,264                         |       | 3,680,185 |   |
| Basic net income per common share                              |       | $                                 | 0.04       |   | $ | 0.11 |   |
| Diluted net income per common and potential  common share      |       | $                                 | 0.04       |   | $ | 0.10 |   |

 

**(3)  Income Taxes**

 

SFASNo. 109,*Accounting for Income Taxes,*requires a valuation allowance to be recorded against deferred tax assets whenit is more likely than not that some or all of the deferred tax assets will notbe realized.  As a result of cumulative losses in recent years andcontinued economic uncertainty, the Company has provided a full valuationallowance against all of its net deferred tax assets and will do so until itreturns to an appropriate level of sustained taxable income.  The ultimaterealization of these deferred tax assets depends upon the Company’s ability togenerate sufficient future taxable income. If the Company is successful ingenerating sufficient future taxable income, the Company will reduce thevaluation allowance through a reduction in income tax expense in the future.

 

Duringthe three months ended March 31, 2005, the Company recorded a net tax provisionof $6,777 for expected tax liability in the United States.

 

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

 

6

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**(4)  ComprehensiveIncome**

 

Thecomponents of the Company’s comprehensive income are as follows:

 
| ** **                               | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------|------------|-----------------------------------|------------|
| ** **                               | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| Net income                               |       | $                                 | 142,040    |   | $ | 379,755 |   |
| Foreign currency translation adjustments |       | (10,136                           | )          | 24,011 |   |
| Comprehensive income                     |       | $                                 | 131,904    |   | $ | 403,766 |   |
|                                          |            |                                   |            |  |  |  |  |  |  |

 

**(5) Stock Based Compensation**

 

TheCompany accounts for stock-based compensation for employees under therecognition and measurement principles of Accounting Principles Board OpinionNo. 25,*Accounting for Stock Issued toEmployees,* and related interpretations.  The following tableillustrates the effect on net income and net income per share if the Companyhad applied the fair value recognition provisions of Financial AccountingStandards Board Statement (“FAS”) No. 123,*Accounting for Stock-Based Compensation,* as amended by FAS No. 148,*Accounting for Stock-Based Compensation — Transitionand Disclosure* to stock-based employee compensation. InDecember 2004, the FASB issued SFAS No. 123(R) *Share-Based Payment*. SFASNo. 123(R) amends SFAS No. 123. The Company will be required to adopt FAS 123R in the first fiscalquarter of 2006 and does not expect it to have a material impact on its futureresults of operations.

 
| ** **                                                                                                 | ** ** | **Three months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                 | ** ** | **2005**                          | ** ** | **2004** | ** ** |
|                                                                                                       |       |                              |       |   |   |
| Net income, as reported                                                                                    |       | $                                 | 142,040    |   | $ | 379,755 |   |
| Add: Stock compensation included in net  income                                                            |       | 19,415                            |       | — |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value method for all awards |       | (45,704                           | )          | (71,905 | ) |
| Pro forma net income                                                                                       |       | $                                 | 115,751    |   | $ | 307,850 |   |
|                                                                                                       |       |                              |       |   |   |
| Net income per share:                                                                                      |       |                              |       |   |   |
| Basic, as reported                                                                                         |       | $                                 | 0.04       |   | $ | 0.11 |   |
| Diluted, as reported                                                                                       |       | $                                 | 0.04       |   | $ | 0.10 |   |
| Basic, pro forma                                                                                           |       | $                                 | 0.03       |   | $ | 0.09 |   |
| Diluted, pro forma                                                                                         |       | $                                 | 0.03       |   | $ | 0.08 |   |
|                                                                                                            |            |                                   |            |  |  |  |  |  |

 

**(6)  AccruedLiabilities**

 

Accruedliabilities consist of the following:

 
| ** **                        | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------|------------|---------------------|------------|------------------------|------------|
| Accrued health insurance expense  |       | $                   | 178,464    |                   | $          | 178,464 |   |
| Accrued salary and salary-related |       | 569,059             |       | 688,622                |       |
| Accrued professional fees         |       | 184,381             |       | 141,322                |       |
| Other accrued expenses            |       | 304,940             |       | 250,264                |       |
|                              |       | $                   | 1,236,844  |                   | $          | 1,258,672 |   |

 

**(7)  EquityTransactions**

 

InJanuary 2005, the Company sold a total of 58,684 restricted common stockshares under the Company’s 1997 Stock Plan, as amended, to its Board ofDirectors and certain employees of the Company for $0.01 per share. Therestricted common stock shares vest

 

7

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ratably over the service periodof four years, so long as the restricted stockholder continues to provideservices to the Company. During 2005, the Company recorded deferredcompensation of approximately $451,000 for the intrinsic value of the shares ofrestricted common stock. The Company will recognize deferred compensation ascompensation expense over the expected four year vesting period. In the eventthat a restricted stockholder ceases to provide services to the Company priorto the vesting of any of the then unvested shares held by that stockholder, therestricted stockholder is required to sell all such unvested shares ofrestricted common stock back to the Company at the original purchase price of$0.01 per share.

 

OnMarch 30, 2004, the Company raised $3.6 million through the private placementto institutional and other accredited investors of 600,000 shares of commonstock, at a price of $6.00 per share.  The fees associated with issuingthe shares in connection with the private placement were approximately $147,000and were recorded as a reduction of additional paid-in capital. Furthermore, Omtool issued 51,000 shares of common stock and a warrant topurchase an additional 51,000 shares of common stock, exercisable over afive-and-a-half-year period, at a price of $6.00 per share, to its financial advisoror its designees for advisory services related to the private placement.

 

OnMarch 30, 2004, Omtool’s Board of Directors approved a two-for-one stock splitof the Company’s common stock in the form of a dividend effective April 27,2004 payable to each stockholder of record as of April 7, 2004.  Allreferences in the consolidated financial statements referring to shares, shareprices, per share amounts and stock plans have been adjusted retroactively forthis two-for-one stock split.

 

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

 

**(8) Segment and Geographic Information**

 

Todate, the Company has viewed its operations and manages its business asprincipally one segment, software and hardware sales and associated services.As a result, 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 an Enterprise and Related Information*.

 

Totalrevenues from international sources were $455,000 and $1.3 million for thethree months ended March 31, 2005 and 2004, respectively.  The Company’srevenues from international sources were primarily generated from customerslocated in Europe. The following table represents amounts relating togeographic locations:

 
| ** **         | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------|------------|-----------------------------------|------------|
| ** **         | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| Total revenues (1) | ** ** | ** **                        | ** ** | ** ** | ** ** |
| United States      |       | $                                 | 3,406,408  |   | $ | 2,684,800 |   |
| United Kingdom     |       | 181,922                           |       | 692,199 |   |
| Rest of World      |       | 273,154                           |       | 651,079 |   |
|               |       | $                                 | 3,861,484  |   | $ | 4,028,078 |   |

 
| ** **            | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------|------------|---------------------|------------|------------------------|------------|
| Long-lived assets (2) | ** ** | ** **          | ** ** | ** **             | ** ** |
| United States         |       | $                   | 199,452    |                   | $          | 215,879 |   |
| United Kingdom        |       | 6,436               |       | 9,195                  |       |
|                  |       | $                   | 205,888    |                   | $          | 225,074 |   |

 

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

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

 

8

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**Item 2.**

**MANAGEMENT’S DISCUSSION AND ANALYSIS**

**OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations forthe three months ended March 31, 2005 should be read in conjunction with theaccompanying consolidated financial statements for the periods specified andthe associated notes.  Further reference should be made to our AnnualReport on Form 10-K for the year ended December 31, 2004, as filed with the SECon March 29, 2005.

 

**Overview**

 

We provide enterprisedocument messaging applications that streamline workflows, reduce costs andensure secure, confidential e-document exchange. We accomplish this byproviding products that integrate with industry-leading e-mail messaging,enterprise resource and document management systems to add secure delivery andhigh volume fax functionality to a company’s existing communication infrastructure.Because paper remains an integral part of many business processes, we alsoprovide technology that incorporates electronic delivery, security and billingfunctionality into industry-leading multi-function and scanningdevices.

 

AccuRoute®, our documentrouting and distribution software, integrates with many digital scanning andmulti-functional devices to allow paper documents to be digitized,distributed and archived. In addition, our AccuRoute software provides for themovement of electronic documents and information, enabling companies to captureand distribute hard copy documents in electronic form and comply with privacyregulations related to health, financial or other confidential information.GenifaxTM, our enterprise fax software, offers a scalable, server-basedfeature set and shares a common Windows® server-based architecture withthe GenidocsTM product line. Genidocs, our secure document delivery application,integrates with existing e-mail systems and provides multiple options forcontent and attachment encryption, authentication, audit trail, deliveryconfirmation and digital signatures. Our AccuRoute software further unifies thecode bases and architecture of our Genidocs and Genifax product lines. With itsrouting capabilities, the AccuRoute software provides a customer specificproduct that easily manages documents, both paper and electronic, with littleor no user training required.

 

Our software products can bedeployed on heterogeneous, multi-platform networks and digital scanningand multi-functional devices and can be integrated with both desktop andenterprise software applications such as e-mail and groupware systems.  We license our products on a combinationserver/seat basis or on a server only or seat only basis. To address customerneeds, our products are modular and scaleable; communication capacity can beimplemented and added over time through the addition of system components andconnectors as needed to keep pace with an enterprise’s growing demand.Additional Omtool servers can be added to a configuration to provide failoverthrough redundancy, helping to ensure continuous operation.

 

Weintend to maintain a leadership position in our traditional market  – secure electronic document exchange – whilecontinuing to consolidate the functionality of all our products into a single,configurable platform, expand the level of integration with complimentarytechnologies such as document and records management tools and extend ourdocument capture capability to include virtually all multi-functionaldevices and scanners. In doing so, we will be pursuing a leadership position inthe broader document delivery/exchange and management market, which we believewill grow in response to increasingly regulated communications and stringentprivacy requirements. We will continue to focus on those vertical markets whereregulations or business practices require confidentiality, timely electronicdelivery and archiving of critical documents in electronic and paper format.

 

We resell, from third-partyvendors, certain hardware products, including intelligent fax boards and faxmodems, to our customers. We undertake these hardware sales as a convenience toour customers, who alternatively can opt to obtain hardware from a third-partyvendor. The fax boards and fax modems that we resell are not functional withoutour software and we are not generally in the business of selling fax boards andmodems. We purchase these hardware products as needed to ship to our customersand we maintain a minimal inventory of these hardware products. We believe thatwe have a good business relationship with our suppliers of these products andthat supply of these products is stable.

 

Service and other revenueshave historically consisted primarily of the sale of support contracts tocompliment software products sold to customers. We generate a smaller portionof our service and other revenues from consulting, training and installationservices.

 

 Ourfinancial results for the first quarter of 2005 decreased as compared to thefirst quarter of 2004, with a net profit of $142,000 in the first quarter of2005 as compared to a net profit of $380,000 in the first quarter of2004.  The decrease in financial results was due primarily to an increaseof approximately $257,000 in total operating expenses, as well as lower overallrevenues.  The primary reason that revenues decreased was that hardwarerevenue decreased by approximately $330,000, or 28%, due to a decline in ourlegacy fax business in the first quarter of 2005 as compared to the firstquarter of 2004.  We, however, experienced increases in the two othercategories of revenues – software license revenues and service and otherrevenues.  We were particularly encouraged by

 

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the increase in softwarelicense revenues, as that is the primary measurement that we use to gauge themarket traction and prospects of our software products, in particular ourAccuRoute product.  During the first quarter of 2005, software licenserevenues increased by approximately $146,000, or 12%, from the first quarter of2004 led by a 19% increase in AccuRoute revenue as compared to the fourthquarter of 2004.  This continued increase in software license revenuesvalidates our AccuRoute product and the reception it has received in the legalvertical market to date.  The increase inoperating expenses during the first quarter of 2005 was driven by previouslyanticipated Sarbanes-Oxley related expenses and increases in sales andmarketing expenses associated with our AccuRoute sales and marketing strategy,which has been to sell AccuRoute solely to the legal vertical market.

 

Buildingon the success of the current version of our AccuRoute product within the legalvertical market since its introduction in 2004, we intend to broaden ourcurrent sales and marketing strategy beginning in the second quarter of 2005 toencompass the finance and healthcare vertical markets.  We anticipate thatthe additional expenditures necessary to enter these markets will beapproximately $2.0 million for the balance of 2005.  We do not anticipatethat these increased expenditures will produce a sufficient increase in salesover the balance of 2005 to offset the associated expenses over the sameperiod.  These expenses, along with the Sarbanes-Oxley related expenses,will therefore continue to exert pressure on earnings for the remainder of2005.  However, we believe that the profits realized from our sales ofAccuRoute in the legal vertical market and from our legacy fax business willallow us to absorb most of the incremental expenses without a significant lossfor 2005.  Our cash and cash equivalents at March 31, 2005 were$10.5 million.  We believe that ourexisting cash and cash equivalents will be sufficient to meet our workingcapital and capital expenditure needs for at least the next twelve months.

 

Although we believe thatthere has been some recent improvement in the demand for enterprise softwaresolutions and increased market acceptance of our products, we cannot predictwhether or when that market will soften or if market acceptance of our productswill occur. If the market or the market acceptance of our products changes, wecannot predict whether, and to what extent, the demand for our products willincrease or decrease. Any decrease in demand for our products would likelyresult in decreased revenue, which would, in turn, have a significant negativeimpact on our financial results because a significant portion of our operatingcosts (such as personnel, rent and depreciation) are fixed in advance of aparticular quarter. As a result, our costs for sales and marketing, researchand development and general and administrative could continue to increase as apercentage of revenues, thereby negatively affecting our operating results.

 

Our future revenues andoperating results may fluctuate from quarter to quarter based on the number andsize of sales transactions we enter into with customers, the adequacy ofprovisions for losses, general economic conditions and other factors. Inaddition, revenues from a large order may constitute a significant portion ofour total revenues in a particular quarter, further exacerbating fluctuationsin quarterly results.

 

We have historically deriveda majority of our total revenues from sales within the United States. Salesoutside of the United States (primarily in Europe) represented approximately 9%and 31% of our total revenues for the three months ended March 31, 2005 and2004 respectively.  For the three monthsended March 31, 2005 and 2004, our gross profit percentage on these non-U.S.sales approximated the gross profit percentage on sales within the UnitedStates. Revenues on our European operations decreased in the first quarter of2005 as compared to the first quarter of 2004 due to a decrease in demand inEurope for our fax software.  We willcontinue to leverage our AccuRoute base in Europe, as well as our indirectchannel relationships, to focus sales resources on the legal vertical market andexpect that the European results will start to improve over the remainder of2005. There can be no assurance that we will be able to increase internationalsales of our products and the failure to do so may have a material adverseeffect on our business, financial condition and results of operations.

 

Our United Kingdomsubsidiary transacts business primarily in its local currency. Our UnitedKingdom subsidiary operating results are translated into U.S. dollars andconsolidated for reporting purposes. Significant currency exchange ratefluctuations could have a material impact on our results of operations. Wemanage our foreign currency exchange exposure by monitoring our net monetaryposition using natural hedges of our assets and liabilities denominated inlocal currencies. There can be no assurance that this policy will eliminate allforeign currency exchange exposure. Foreign currency exposure has not beenmaterial to our financial position or results of operations to date. If thevolume of our business denominated in foreign currencies increases, we may berequired to use derivatives to hedge foreign currency exposure.

 

We will continue to leverageour existing distribution channels, where appropriate, to broaden our reach toour target vertical markets and further penetrate our installed base. We arepursuing sales opportunities via our solution/reseller channel, as well asfocusing sales efforts on specific market segments, in order to facilitateproduct acceptance. Sales through our indirect distribution channelsrepresented approximately 16% and 10% of our total revenues for the threemonths ended March 31, 2005 and 2004, respectively.

 

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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 and any associated risksrelated to these policies on our reported and expected financial results andbusiness operations are discussed in appropriate sections throughout Management’sDiscussion and Analysis of Financial Condition and Results of Operations. Ourpreparation of this Form 10-Q required management to make estimates andassumptions that affect the reported amount of assets and liabilities,disclosure of contingent assets and liabilities as of the date of our financialstatements included herein, and the reported amounts of revenue and expensesduring the period covered by this report. There can be no assurance that actualresults will not differ materially from those estimates.

 

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

 

We apply the provisions ofStatement of Position (“SOP”) 97-2, *SoftwareRevenue Recognition*, as amended by SOP 98-9, Modification of SOP97-2, *Software Revenue Recognition, WithRespect to Certain Transactions*, to all transactions involving thesale of multiple elements including software, hardware and service revenue. Weapply the provisions of Statement of Financial Accounting Standards (“SFAS”)No. 48, *Revenue Recognition When Rightof Return Exists*, with respect to providing for potential futureproduct returns. As described below, we must make and use significant judgmentsand estimates in connection with the revenue recognized in any accountingperiod. Material differences may have resulted in the amount and timing of ourrevenue if we had made different judgments or utilized different estimates.

 

We recognize revenue fromthe sale of software products and hardware to both end-users and resellers whenpersuasive evidence of an arrangement exists, the products have been delivered,the fee is fixed or determinable, collection of the resulting receivable isreasonably assured and there are no uncertainties regarding customeracceptance. We maintain a reserve for potential product returns. We recognizesoftware maintenance and support revenue over the term of the relatedmaintenance period, which is typically a one-year period.  On those occasions when we sell multiple-yearmaintenance contracts, we recognize the associated revenue over the multiple-yearterm of the maintenance contract. We recognize other services revenue as weperform the services. If an arrangement includes an acceptance provision andacceptance is uncertain, then we will defer all revenue until the customeraccepts the products purchased. Acceptance in these instances generally occursupon the earlier of receipt of a written customer acceptance or expiration ofthe acceptance period. If an arrangement includes an acceptance provision tiedto determination that our product meets published specifications and there areno uncertainties with regard to the customer’s acceptance, then we willrecognize revenue at the time of sale, provided that all other revenuerecognition criteria previously mentioned have been met and the acceptanceperiod is of short duration.

 

Our transactions frequentlyinvolve the sale of software, hardware and related services under multipleelement arrangements. Revenue under multiple element arrangements is allocatedto each element under the residual method, in accordance with SOP 98-9,Modification of SOP 97-2, *Software RevenueRecognition, With Respect to Certain Transactions*. Under thismethod, revenue is allocated first to all undelivered elements, such asservices, based on the fair value of those elements, which is calculated to bethe price charged when these elements are sold separately and unaccompanied byother elements. Our services are not essential to the functionality of thesoftware, as these services do not alter the capabilities of the software anddo not carry a significant degree of risk to perform. The amount allocated tothe delivered elements, such as software license and hardware revenue, is thedifference between the total arrangement value and the amount allocated to theundelivered elements. If the delivered elements include both software andhardware, the amount allocated to hardware revenue is based on the pricecharged to us by the third party vendor plus an additional mark up, with theremainder allocated to software revenue. To the extent that a discount isoffered in the arrangement, the entire discount is allocated to the deliveredelement or elements. If the delivered elements include hardware and software,the discount is allocated to the hardware and software based on theirrespective list prices.

 

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

 

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

 

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credit-worthiness of thecustomer. We review Dunn & Bradstreet credit reports for all of ourresellers and adjust our credit limits with those resellers accordingly. If aparticular reseller does not have a favorable report or if we do not haveenough credit information to determine if the reseller is credit-worthythen we predominantly sells to those resellers on cash on delivery terms. We donot request collateral from our customers. If we determine that collection of afee is not reasonably assured, the fee is deferred and revenue is recognized atthe time collection becomes reasonably assured, which is generally upon receiptof payment.

 

We maintain reserves forpotential product returns and makes adjustments to these reserves as neededbased on historical product return rates. We also consider the impact of new product introductions, changes in customerdemand and acceptance of our products on the adequacy of these reserves. Ourcalculation of the estimated return reserve is based upon (1) an accountspecific review of potential returns, where a return probability is known, and(2) a general estimate based upon past historical returns as a percentageof revenue. We must make and use significant judgments and estimates inconnection with establishing the product returns reserve in any accountingperiod. Material differences may have resulted in the amount and timing ofrevenue for this or any prior period if we made different judgments or utilizeddifferent estimates.

 

As with the product returnreserve, we must make estimates of our ability to collect on our accountsreceivable. We record trade accounts receivable at the invoiced amount; theseaccounts do not bear interest. We specifically analyze accounts receivable andhistorical bad debts, customer credit-worthiness, current economic trendsand changes in customer payment patterns when evaluating the adequacy of theallowance for doubtful accounts. We review the 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) ageneral estimate based upon past historical bad debts as a percentage ofaccounts receivable. We do not have any off-balance-sheet credit exposureto our customers.

 

Our combined accountsreceivable and product returns reserve was $58,000 and $82,000 at March 31,2005 and December 31, 2004, respectively. Both components ofcalculating the estimated reserve – specific identification and historicexperience – are material judgments made by us. We base these judgments onhistoric trends, taking into consideration current business and economicconditions, which could change materially, thus changing the required reservelevel materially. The potential change to the size of our required reservecould be positive, in the event the reserve estimate proves unnecessary, ornegative, if the reserve proves inadequate.

 

Our deferred revenue iscomprised mainly of revenue that is deferred for software maintenance andsupport contracts. The other components of deferred revenue are amounts fromsales transactions that were deferred because they did not meet all of theprovisions of our revenue recognition policy.

 

*Software Development Costs.* Software development costs are considered for capitalization whentechnological feasibility is established in accordance with SFAS No. 86, *Accounting for the Costs of Computer Software To BeSold, Leased or Otherwise Marketed*. We sell software in a marketthat is subject to rapid technological change, new product introductions andchanging customer needs. Accordingly, we have determined that we cannotascertain technological feasibility until the development state of the productis nearly complete. The time period during which cost could be capitalized fromthe point of reaching technological feasibility until the time of generalproduct release is very short and, consequently, the amounts that might becapitalized are not material to our consolidated financial position or resultsof operations. Therefore, we charge all software development costs to operationsin the period incurred.

 

*Taxes.*  We are required to estimate ourincome and state sales taxes. This process involves estimating our actualcurrent tax obligations, while also assessing differences resulting from thedifferent treatment of items for tax and accounting purposes that result indeferred income tax assets and liabilities and accrued state sales taxliabilities. We include deferred income tax assets and liabilities and accruedstate sales tax liabilities in our balance sheet.

 

We assess our deferred taxassets for each reporting period to determine whether it is more likely thannot that they will be recovered 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.  Changes to the valuationallowance are included as an expense or benefit within the tax provision in ourstatement of operations.

 

We provide a full valuationallowance against all of our net deferred tax assets and will continue to do sountil we return to an appropriate level of sustained taxable income. Theultimate realization of these deferred tax assets depends upon our ability togenerate sufficient future taxable income. If we are successful in generatingsufficient future taxable income, we will reduce the valuation allowancethrough a reduction in income tax expense in the future.

 

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.

 

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**New Accounting Pronouncements**

 

In December 2004, theFASB issued SFAS No. 123(R) *Share-BasedPayment*. SFAS No. 123(R) amends SFAS No. 123 to requirethat companies record as expense the effect of equity-based compensation,including stock options over the applicable vesting period. We currentlydisclose the effect on income that stock options would have were they recordedas expense. SFAS No. 123(R) also requires more extensive disclosuresconcerning stock options than required under current standards. The new ruleapplies to option grants made after a company’s adoption of the standard, aswell as options that are not vested at the date of adoption. SFASNo. 123(R) becomes effective in our case not later than the beginning ofthe fiscal year that begins after December 15, 2005. We do not currentlyexpect to elect early adoption of this standard and have not determined whetherwe will apply this new standard prospectively in the first quarter of 2006,retroactively from the beginning of 2006, or on a restated basis for all priorperiods on a comparable basis. We do not expect that the adoption of SFASNo. 123(R) will have a material impact on our future results ofoperations.

 

In November 2004, theFASB issued SFAS No. 151, *InventoryCosts, an amendment of ARB No. 43, Chapter 4.* SFAS No. 151modifies the accounting for abnormal inventory costs, and the manner in whichcompanies allocate fixed overhead expenses to inventory. SFAS No. 151 iseffective for inventory costs incurred during annual periods beginning afterJune 15, 2005. We do not expect SFAS No. 151 to have a materialimpact on our financial position and results of operations.

 

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**Results of Operations**

 

Thefollowing table sets forth certain financial data for the periods indicated asa percentage of total revenues:

 
| ** **                     | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------------|------------|-----------------------------------|------------|
| ** **                     | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| Revenues:                      |       |                              |       |   |   |
| Software license               |       | 34.1                              | %          | 29.1 | % |
| Hardware                       |       | 21.7                              |       | 29.0 |   |
| Service and other              |       | 44.2                              |       | 41.9 |   |
| Total revenues                 |       | 100.0                             |       | 100.0 |   |
| Cost of revenues:              |       |                              |       |   |   |
| Software license               |       | 0.5                               |       | 0.8 |   |
| Hardware                       |       | 14.1                              |       | 16.7 |   |
| Service and other              |       | 18.7                              |       | 18.6 |   |
| Total cost of revenues         |       | 33.3                              |       | 36.1 |   |
| Gross profit                   |       | 66.7                              |       | 63.9 |   |
| Operating expenses:            |       |                              |       |   |   |
| Sales and marketing            |       | 30.5                              |       | 25.9 |   |
| Research and development       |       | 13.4                              |       | 11.7 |   |
| General and administrative     |       | 20.1                              |       | 17.4 |   |
| Total operating expenses       |       | 64.0                              |       | 55.0 |   |
| Income (loss) from operations  |       | 2.7                               |       | 8.9 |   |
| Interest and other income, net |       | 1.1                               |       | 0.9 |   |
| Tax (benefit) provision        |       | 0.2                               |       | 0.5 |   |
|                           |       |                              |       |   |   |
| Net income (loss)              |       | 3.6                               | %          | 9.3 | % |
|                           |       |                              |       |   |   |
| Gross profit:                  |       |                              |       |   |   |
| Software license               |       | 98.4                              | %          | 97.3 | % |
| Hardware                       |       | 35.1                              |       | 42.3 |   |
| Service and other              |       | 58.0                              |       | 55.7 |   |

 

**Three Months Ended March 31, 2005 and 2004**

 

*Revenues*

 

*Total Revenues.*  Our total revenue was$3.9 million and $4.0 million for the three months ended March 31, 2005and 2004, respectively.

 

*Software License.*  Software license revenues were$1.3 million and $1.2 million for the three months ended March 31, 2005 and2004, respectively, representing an increase of 12%.  Software license revenues accounted for 34%and 29% of total revenues for each respective period.  Software license revenues for the threemonths ended March 31, 2005 reflected an overall increase in demand for ourAccuRoute product, but were offset by a decline in demand for our legacy faxproduct line as compared to the three months ended March 31, 2004.  Revenues from our AccuRoute product,represented 46% and 17% of software license revenues for the three months endedMarch 31, 2005 and 2004, respectively. The growth of revenues derived from theAccuRoute product line is a result of greater market acceptance of the product.Software revenues from our legacy fax product line represented 52% and 81% ofsoftware license revenues for the three months ended March 31, 2005 and 2004,respectively.  The remaining 2% ofsoftware license revenues for each of the three months ended March 31, 2005 and2004 was comprised of various components including sales returns and allowanceadjustments and sales of our other software products such as Genidocs andSwiftwriterTM.  Included insoftware license revenue for the three months ended March 31, 2005 and 2004 isa reduction of $18,000 and $110,000, respectively, in the sales returns andallowance reserve relating primarily to specific accounts where we havedetermined that the risk of a return is no longer present.  Although we cannot accurately predict theexact mix of products that we will sell in the future, we expect that softwarelicense revenue would continue to constitute a larger percentage of our totalrevenue in the future if demand for AccuRoute, which generally does not requirethe purchase of additional hardware, continues to increase due to gains inmarket acceptance for this product.

 

*Hardware.*  Hardware revenues were $837,000for the three months ended March 31, 2005 as compared to $1.2 million for thethree months ended March 31, 2004, representing a decrease of 28%.  Hardware revenues accounted for 22% and 29%of total

 

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revenues for each respectiveperiod.  The decrease in hardwarerevenues is due to a decrease in demand from existing customers who haveupgraded information systems hardware in their worldwide locations and adecrease in the volume of sales of our legacy fax products, which generallyrequire the purchase of additional hardware. Included in hardware revenue for the three months ended March 31, 2005and 2004 is a reduction of $6,000 and $36,000, respectively, in the salesreturns and allowance reserve relating primarily to specific accounts where wehave determined that the risk of a return is no longer present.  Although we cannot accurately predict theexact mix of products that we will sell in the future, we expect that hardwarerevenues will constitute a smaller percentage of our total revenues if demandfor AccuRoute, which does not require the purchase of additional hardware,continues to increase due to gains in market acceptance for this product.

 

*Service and Other.* Service and other revenues were $1.7 million for each of the three monthperiods ended March 31, 2005 and 2004.  Service and other revenue accounted for 44% and 42% of total revenuesfor each respective period.  The factthat service and other revenue remained flat is primarily due to an improvementin maintenance revenues for the three months ended March 31, 2005 as comparedto the three months ended March 31, 2004 that was offset by a decline inservice revenues from installation, consulting and training services for thesame periods.  The increase in serviceand other revenue as a percent of total revenues is due primarily to thedecreases in total revenue.  We arefocused on improving the renewal rate of software maintenance contracts withour existing customer base.

 

*Cost of Revenues*

 

*Software License.*  Cost of software licenserevenues consists primarily of the costs of sublicensing third-partysoftware products and product media and product duplication.  Cost of software license revenues for thethree months ended March 31, 2005 decreased by 34% or $11,000 during the fiscalquarter to $21,000, as compared to $32,000 during the corresponding period in2004.  The decrease is due primarily todecreased documentation and reproduction costs associated with the sales of oursoftware products.  This decrease is alsoreflected in software license gross margin, which improved to 98% from 97% inthe same respective periods.  We haverecently added third-party software into our products and expect that the costof software licenses as a percentage of software license revenues will increaseslightly in the future.

 

*Hardware.*  Cost of hardware revenuesconsists primarily of the costs of third-party hardware products. Cost ofhardware revenues was $544,000 and $674,000 for the three months endedMarch 31, 2005 and 2004, respectively, representing 65% and 58% of hardwarerevenues for each respective period. The decrease in dollar amount for the costof hardware revenues was due primarily to the decrease of hardware unit salesaccompanying sales of our software products. The gross margin percentage forhardware sales decreased to 35% from 42% for the three month periods endedMarch 31, 2005 and 2004 due to a change in the mix of particular hardwareproducts sold.  We do not expectsignificant changes in unit prices for the remainder of 2005.

 

*Service and Other.*  Cost of service and otherrevenues consists primarily of the costs incurred in providing telephonesupport as well as other miscellaneous customer service-relatedexpenses.  Cost of service and otherrevenues was $717,000 and $747,000 for the three months ended March 31, 2005and 2004, respectively, representing 42% and 44% of service and other revenuesfor each respective period.  The grossmargin percentage for service and other revenues increased to 58% for the threemonths ended March 31, 2005, compared to 56% in the same period in 2004.  The increase in gross margin is due to adecrease in the wages related expenses and associated overhead costs ofemployees in the support department.  Wedo not expect any significant variances in our service and other gross marginsfor the remainder of fiscal year 2005.

 

*Operating Expenses*

 

*Sales and Marketing.*  Salesand marketing expenses consist primarily of employee salaries, benefits,commissions, and associated overhead costs, and the cost of marketing programssuch as advertising, direct mailings, public relations, trade shows, seminarsand related communication costs.  Salesand marketing expenses were $1.2 million and $1.0 million for the threemonths ended March 31, 2005 and 2004, respectively, or 31% and 26% of totalrevenues for each respective period.  Theincrease in sales and marketing expenses is due to an increased number ofemployees in the sales and marketing departments and the associated costs ofsupporting those employees. Additionally, we increased our general advertisingexpenses during the first quarter of 2005 as compared to the first quarter of2004. Both of these expense increases reflect our initiative to furtherpenetrate the legal vertical market with our AccuRoute product. Building on thesuccess of the current version of the AccuRoute product within the legalvertical market since its introduction in 2004, we intend to broaden ourcurrent sales and marketing strategy beginning in the second quarter of 2005 toencompass the finance and healthcare vertical markets.  We anticipate thatthe additional expenditures necessary to enter these markets will beapproximately $2.0 million for the balance of 2005.  Much of these additional expenses will be salesand marketing related. Consequently, we expect that our sales and marketingexpenses will increase in absolute dollars as we hire additional sales staffduring the balance of this year.

 

*Research and Development.* Research and development expenses includeexpenses associated with the development of new products, enhancements ofexisting products and quality assurance activities. These expenses consistprimarily of employee salaries, benefits, associated overhead costs, consultingexpenses and the cost of software development tools. Research and development

 

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expenses were $517,000 for thethree months ended March 31, 2005 and $471,000 for the three months ended March31, 2004, representing 13% and 12% of total revenues for each respectiveperiod.  The increase in research anddevelopment expenses in dollars and as a percent of total revenues is a resultof an increased number of employees in the research and development departmentduring the first three months of 2005 and the associated costs of supportingsuch personnel.  We expect research anddevelopment expenses will increase in absolute dollars as we hire additionalengineers to support our expansion of AccuRoute into other vertical markets.

 

*General and Administrative.* General and administrative expenses consist primarily of employeesalaries, benefits for administrative, executive and finance personnel andassociated corporate general and administrative expenses. General andadministrative expenses were $775,000 and $699,000 for the three months endedMarch 31, 2005 and 2004, respectively, or 20% and 17% of total revenues foreach period. The increase in dollar amount and as a percentage of totalrevenues is due to the increase in general and administrative personnel andoverhead costs associated with supporting such personnel and an increase inmanagement consulting expenses related to our ongoing compliance with theSarbanes-Oxley Act of 2002. We expect that we may continue to experienceincreases to general and administrative expenses in the form of professionalfees and consulting expenditures during the remainder of 2005 as we continue tocomply with Section 404 of the Sarbanes-Oxley Act of 2002.

 

*Interest and other Income.* Interest and other income consist principally of interest income earnedon cash and cash equivalent balances. Interest and other income, net was $41,000 for the three months endedMarch 31, 2005 and $38,000 for the three months ended March 31, 2004.  Also included in the three months ended March31, 2004 interest and other income is other income of $5,000 related to thefair value of a warrant to purchase 8,580 shares of common stock of VersoTechnologies (“Verso”).  The fair valueof the warrant is marked to market in each financial reporting period resultingin future changes in fair value which are recorded in income and otherexpenses.  Our warrant to purchase 8,580shares of Verso common stock expires in November 2005.

 

*Provision for Income Taxes.* During the three months ended March 31, 2005, we recorded a net tax provisionof $6,777 for expected tax liability in the United States.  During the three months ended March 31, 2004,we recorded a net tax provision of $19,131 for expected tax liability in theUnited States and for expected tax liability related to our United Kingdomsubsidiary, Omtool Europe Limited.  Theprovision for the first quarter of 2004 is net of a $28,800 adjustment relatedto a fiscal year 2003 transfer pricing adjustment.

 

**Liquidity and Capital Resources**

 

Since1996, we have financed our operations primarily through cash flow fromoperations, private sales of preferred stock and common stock and our initialpublic offering of common stock completed in August 1997. As of March 31,2005, we had cash and cash equivalents of $10.5 million and working capital of$7.0 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.

 

Ouroperating activities used cash of $183,000 for the three months ended March 31,2005 and provided cash of $174,000 for the three months ended March 31,2004.  We believe that the additional resources being allocated to improvethe AccuRoute product’s success in the legal vertical market and its expansioninto the finance and healthcare vertical markets, plus the increase in generaland administrative expenses associated with compliance with the Sarbanes-OxleyAct of 2002 and related regulations, will put pressure on our earnings duringthe remainder of 2005. However, we believe that our existing cash is sufficientfor at least the next twelve months. Net cash used during the three monthsended March 31, 2005 consisted primarily of net income from operations and thenon-cash effects of depreciation and amortization and an increase in accountspayable and deferred revenue, offset by increases to accounts receivable andprepaid expenses and other current assets. The increase to accounts payable is due to the timing of vendorpayments, which we try to manage in an effort to improve our cash balance. Theincrease in deferred revenue was primarily due to sales transactions thatoccurred during the first quarter of 2005, but the revenue for which we willnot recognize until some future period because the transactions did not yetmeet all of our criteria for revenue recognition.  The increase in accounts receivable is dueprimarily to the fact that an unusually large transaction occurred at the endof the quarter, thus significantly increasing our accounts receivablebalance.  We continue to focus onimproving our cash balance by improving our days sales outstanding.  Theincrease in prepaid expenses and other current assets is due primarily to cashpaid for the support of certain internally used information systemssoftware.   Net cash provided duringthe first quarter of March 31, 2004 consisted primarily of a net profit fromoperations and an increase in accrued liabilities partially offset by adecrease in accrued restructuring and increases in accounts receivable, prepaidexpenses and other current assets.

 

Investingactivities used cash of $28,000 and $13,000 during the three months ended March31, 2005 and 2004, respectively.  The sole use of cash for investingactivities for each period was for purchases of property and equipmentcomprised predominately of computer related software and hardware products. Weexpect that we will increase our investments in computer related software andhardware products in 2005 in order to improve our information technologyinfrastructure so we can support newly hired employees.

 

Financingactivities provided cash of $19,000 and $1.5 million for the three months endedMarch 31, 2005 and 2004, respectively.  Cash realized during the threemonths ended March 31, 2005 consists of the net proceeds from the issuance ofcommon

 

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stock pursuant to our employeestock purchase program.  Cash providedfor the three months ended March 31, 2004 was due to net proceeds from our issuanceof common stock.  On March 30, 2004, we completed the sale of 600,000shares of common stock, at a price of $6.00 per share, in a private placementto institutional and other accredited investors. The proceeds of the privateplacement, which totaled $3.6 million, have been and will continue to be usedfor additional working capital and other general corporate purposes. This cashreceived from financing activities was offset by cash usage of $2.0 millionduring the six months ended September 30, 2004, as we repurchased 350,000shares of our outstanding common stock from ASA International Ltd., an existingshareholder, in a private transaction at a price of $5.75 per share. The shareswere purchased out of generally available corporate funds and will be held intreasury.

 

Basedon our first quarter performance and current expectations for the remainder of2005, 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 foroperations, working capital, payment of sales taxes and purchases of propertyand equipment.  We do not currently have a plan to obtain additionalfinancing if these expectations are not met. There can be no assurance that anynecessary additional financing will be available to us on commerciallyreasonable terms, or at all.

 

Thefollowing table represents the approximate amounts of payments due underspecified contractual obligations as of March 31, 2005:

 
| **Contractual Obligations** | ** ** | **Total** | ** ** | **Less than  one year** | ** ** | **One to  Three years** | ** ** | **Three to  five years** | ** ** | **More than  Five years** | ** ** |
|-----------------------------|------------|-----------|------------|-------------------------|------------|-------------------------|------------|--------------------------|------------|---------------------------|------------|
|                        |       |      |       |                    |       |                    |       |                     |       |                      |       |
| Operating lease obligations |       | $         | 258,000    |                    | $          | 240,000                 |       | $                        | 18,000     |                      | —     |   | — |   |
|                             |            |           |            |                         |            |                         |            |                          |            |                           |            |  |  |  |

 

Operatinglease requirements consist mainly of lease payments for our offices in Salem,NH and London, England, United Kingdom. As of March 31, 2005, we did not haveany long-term debt obligations, material commitments for capital expenditures,capital lease obligations, or other long-term liabilities for which paymentsare required. Our  lease for our Salem,NH location expires on December 31, 2005. We believe that this facility isadequate for our present operations.

 

**Off-Balance Sheet Arrangements**

 

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

 

**Certain Factors Affecting Future Operating Results**

 

We operate in a rapidlychanging environment that involves a number of risks, some of which are beyondour control.  The discussion belowhighlights some of the risks that may affect future operating results.

 

Information provided by usfrom time to time, including statements in this Form 10-Q that are not historicalfacts consists of so-called “forward-looking statements” that involverisks and uncertainties, made pursuant to the safe harbor provisions of thePrivate Securities Litigation Reform Act of 1995.  In particular, statements contained inManagement’s Discussion and Analysis of Financial Condition and Results ofOperations that are not historical facts (including, but not limited to,statements concerning:  the plans andobjectives of management; expectations for sales and marketing, research anddevelopment and general and administrative expenses; developments relating toour product and service offerings, markets and acquisitions; anticipated trendsin our business; our strategic alliances; changes in the regulatoryenvironment; our expected liquidity and capital resources and our criticalaccounting policies) may constitute forward-looking statements.  These forward-looking statements areneither promises nor guarantees, but are subject to risk and uncertainties thatcould cause actual results to differ materially from the expectations set forthin the forward-looking statements. Factors that may cause these kinds of differences include, but are notlimited to, the factors discussed below and the other risks discussed from timeto time in our other filings with the Securities and Exchange Commission.

 

***Our future operating results areuncertain and difficult to predict****.*  Weincorporated and shipped our initial facsimile software products in 1991.  Although we recorded an operating profit inthe year ended December 31, 2004, we had operating losses and decreasingrevenues in the years ending December 31, 2003 and 2002.  We introduced the initial version of ourAccuRoute product in the second quarter of 2002 and the current version in thefirst quarter of 2004. Ultimately, AccuRoute represented 40% of

 

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software revenues in 2004.  There can be no assurance that we will beable to increase our level of revenues or maintain our profitability in thefuture, as our operating history makes the accurate prediction of futureoperating results difficult or impossible. Increases in operating expenses are expected and, together with pricingpressures and any decline in the growth rate of the overall U.S. economy or ourindustry, may result in a decrease in operating income and operating marginpercentage.  Our ability to improve ouroperating results will depend upon, among other things, our ability to increasesales of the AccuRoute, Genifax and Genidocs software products to newcustomers, as well as our ability to increase product penetration into existingcustomers.  We recently expanded ourstrategic focus to include document routing and distribution software.  To date, we have limited financial andoperating data and a limited operating history relevant to this solution.  Accordingly, it is difficult to evaluate theprospects for the level of acceptance of this solution.  In addition, we plan to invest significantlyin the expansion of our AccuRoute product into new vertical markets,specifically the finance and healthcare vertical markets, in advance ofsignificant related revenues from those markets.  We cannot predict the timing or level ofrevenues resulting from these planned investments.  Future operating results will depend on manyother factors, including, without limitation, the degree and rate of growth ofthe markets in which we compete; the level of acceptance of the Windows NT®,Windows 2000® and Windows XP® operating systems; the level of product and pricecompetition; our ability to establish strategic relationships and develop andmarket new and enhanced products; our ability to control costs; our ability toexpand our direct sales force and indirect distribution channels bothdomestically and internationally; and our ability to attract and retain keypersonnel.  As a result, it is possiblethat in the future, our operating results will be below the expectations ofpublic market analysts and investors.  Inthat event, the price of our common stock would likely be materially adverselyaffected.

 

***All of our products are concentratedin the electronic document exchange market****.*  Todate, much of our revenues have been attributable to licenses of ourfacsimile-based enterprise solutions and related products and services. Weexpect these products and related services to continue to account forsignificant amounts of our future revenues. However, recently the amount of revenues attributable to licenses ofthese products has declined and there can be no assurances that this declinewill not continue.  Furthermore, weintroduced our secure business-to-business electronic document exchangeproducts, Genidocs and Genifax, to the market in the fourth quarter of 2000,  the initial version of our proprietarydocument and routing software, AccuRoute, in the second quarter of 2002 and thecurrent version of that product in the first quarter of 2004.  We have only recently begun to recognize asignificant amount of revenues from our AccuRoute product.  We expect that this product may account foran increasing portion of future revenues. However, there can be no assurances that the AccuRoute product will befinancially successful or result in any significant revenues in the future.  Factors adversely affecting the pricing of ordemand for this product, such as competition or technological change, couldhave a material adverse effect on our business, financial condition and resultsof operations. All of our products are concentrated in the electronic documentexchange market and, therefore, any factors affecting demand for these sorts ofsolutions could cause our operating results to decline.  Investors must evaluate our prospects inlight of the risks and difficulties frequently encountered by companiesdependent upon operating revenues from a new product line in an emerging andrapidly evolving market.

 

***The markets for our products aresubject to rapid technological change and we may not be able to keep pace withevolving industry standards or end-user requirements****.*  Themarkets for our products are relatively new and are characterized by rapidtechnological change, evolving industry standards, changes in end-userrequirements and frequent new product introductions and enhancements.  Our future success will depend upon our abilityto enhance our current products and to develop and introduce new products thatkeep pace with technological developments and respond to evolving end-userrequirements.  There can be no assurancethat we will be successful in developing and marketing new products or productenhancements on a timely basis, or that new products or product enhancementsdeveloped by us, such as the AccuRoute, Genidocs and Genifax products, willachieve market acceptance.  The introductionof products embodying new technologies and the emergence of new industrystandards could render our existing products obsolete and unmarketable.  From time to time, we and our competitors mayannounce new products, capabilities or technologies that have the potential toreplace or shorten the life cycle of our existing product offerings.  There can be no assurance that announcementsof new product offerings by us or our competitors will not cause customers todefer or forego the licensing of our existing or planned products and have amaterial adverse effect on our business, financial condition and results ofoperations.

 

***The market for securebusiness-to-business document exchange solutions is new and evolving rapidlyand there can be no assurance that our products will be successful in thismarket****.*  The market for Genidocs, our securebusiness-to-business electronic document exchange solution is relatively newand evolving rapidly.  Our success willdepend upon the extent and timing of adoption and use by current and potentialcustomers of secure business-to-business electronic document exchangesolutions.  Our success will also dependupon acceptance of our technology as the standard for providing thesesolutions.  The adoption and use of oursecure business-to-business electronic document exchange solution will involvechanges in the manner in which businesses have traditionally exchangedinformation.  Our ability to influenceusage of our secure business-to-business electronic document exchange solutionby customers is limited.  We intend tospend resources educating potential customers about the value of securebusiness-to-business electronic document exchange solutions.  It is difficult to assess or to predict withany assurance the present and future size of the potential market for oursecure business-to-business electronic document exchange solution, or thegrowth rate, if any, for this market. Moreover, we cannot predict whether our secure business-to-businesselectronic document exchange solution will achieve any market acceptance.  Sales of Genidocs, our client/server messagingapplication, were less than 2% of our total software revenue in the firstfiscal quarter of 2004 and 2005.  Anyfuture products or future product enhancements that are not favorably receivedby customers may not be profitable and could therefore damage our reputation orbrand name.

 

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***Were we to suffer an unexpectedlylarge decline in our legacy fax business, our results of operations would besignificantly impaired and we might incur an operating loss****.*  Wecurrently derive a significant though declining portion of our revenues fromlicenses of our Genifax product and related services and resale of relatedhardware. However, sales of Genifax, our multi-tiered client/server softwarefor automating and integrating fax communications throughout an enterprise,were lower in 2004 than they were in 2003, a trend that continued in the firstquarter of 2005. Though we expect our sales of our legacy fax products to continueto decline in 2005, an unexpectedly large decline in the market acceptance ofour Genifax product would have a negative impact on our future success. As aresult, any unexpectedly large decline in demand for or failure to maintainexpected market acceptance of the Genifax product line as a result ofcompetition, technological change or otherwise, would have a material adverseeffect on our business, financial condition and results of operations. Ourfuture financial performance will depend in part on new and enhanced versionsof the Genifax product. There can be no assurance that we will continue to besuccessful in marketing the Genifax product or any new or enhanced versions ofthe Genifax product at expected levels. There can be no assurance that we will be successful in developingproducts for new or enhanced operating systems such as Windows 2000 or WindowsXP, or that these systems will not obviate the need for our products. If anynew or enhanced operating system gains widespread use and we fail to developand provide our products for this operating system on a timely basis, ourbusiness, financial condition and results of operations could be materiallyadversely affected.

 

***We depend on the revenues generatedby sales of our AccuRoute product and would be negatively impacted if marketinterest – whether in the legal vertical market that we have already targetedor the finance and healthcare vertical markets that we are now planning totarget – were to decline or fail to grow as expected****.*  Wecurrently derive a significant portion of our revenues from licenses of theAccuRoute product and related services. Sales of AccuRoute were higher in 2004than they were in 2003, a trend that continued during the first quarter of2005. Continued market acceptance of the AccuRoute product is critical to ourfuture success. As a result, any decline in demand for or failure to maintainbroad market acceptance of the AccuRoute product line as a result ofcompetition, technological change or otherwise would have a material adverseeffect on our business, financial condition and results of operations. Ourfuture financial performance will depend in large part on new and enhancedversions of the AccuRoute product. There can be no assurance that we willcontinue to be successful in marketing the AccuRoute product in the legalvertical market or that our marketing efforts in the finance and healthcaremarkets will be successful.  Further,there can be no assurance that any new or enhanced versions of the AccuRouteproduct will be successful.

 

***We have historically depended on oursales of fax products to generate revenue and could face a decline in overallrevenues if the declines we face in this market are larger than expected***. Our enterprise client/server facsimilesoftware products are intended to help organizations efficiently manage theirfacsimile communications, utilizing a client/server computing environment.  There can be no assurance that organizationswill move away from the use of stand-alone fax machines or continue toadopt client/server environments, or that those of our customers who have begunthe migration to a client/server environment will broadly implement this modelof computing.  Our future financialperformance will depend in large part on our ability to capture an expectedportion of the market for client/server applications.  The size of this market will depend in parton the growth in the number of organizations implementing client/servercomputing environments.  There can be noassurance that these markets will continue to grow or that we will be able tocapture sales to or respond effectively to the evolving requirements of thesemarkets.  If the market for client/serverapplication products and services does not grow in the future, grows moreslowly than we anticipate, or if we fail to respond effectively to evolvingrequirements of this market, our business, financial condition and results ofoperations could be materially adversely affected.

 

    ***Our common stock is listed on theNasdaq SmallCap Market and any failure to maintain that listing couldsignificantly impair our stock price and our ability to raise future capital.*** In August 2002, the Nasdaq National Market (“Nasdaq”)informed us that our common stock had traded for 30 consecutive trading daysbelow Nasdaq’s minimum bid price and that we had until November 4, 2002, todemonstrate compliance with Nasdaq’s listing requirements by maintaining a bidprice for our common stock of at least $1.00 for a minimum of ten consecutivetrading days.  We did not regaincompliance and on October 29, 2002, we applied to transfer from the NasdaqNational Market to the Nasdaq SmallCap Market. On November 26, 2002, we transferred to the Nasdaq SmallCap Market andwe were afforded the remainder of this market’s 180 calendar day grace period,or until February 3, 2003, to regain compliance with the minimum bid price pershare requirement.  On January 14, 2003,our Board of Directors and stockholders, at a special meeting, approved anamendment to our certificate of incorporation to effect a one-for-seven reversestock split.  On February 5, 2003, Nasdaqnotified us to inform us that we had regained compliance with Nasdaq’s listingstandards.  In addition, we cannotpredict our ability to maintain our listing in the future on the NasdaqSmallCap Market.  The delisting of ourcommon stock from the Nasdaq SmallCap Market, if that were to occur, couldmaterially impair stockholders’ ability to buy and sell shares of our commonstock and could have an adverse effect on the market price of, and theefficiency of the trading market for, our common stock.  Furthermore, the delisting of our commonstock could significantly impair our ability to raise capital should we desireto do so in the future.

 

***The markets in which we sell our productsare characterized by intense and growing competition and our future success isdependent on our ability to distinguish our products from those of ourcompetitors and reach our target customers****.*  Inthe distributed document capture and delivery market where our AccuRoutesoftware competes, we are likely to see competitive products being

 

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offered by hardware vendorssuch as Xerox, Canon, Ricoh, Lexmark and others.  In some cases these products are the resultof partnerships with U.S.-based software companies.  We also expect competition in this marketfrom a number of independent software vendors whose business focus wasinitially the high volume production scanning segment such as Kofax and Captiva,or forms management and process routing companies such as Cardiff.  e-Copy, a former Omtool business partner, hasformed a relationship with Canon and has embedded their document capture androuting capabilities into the front panel of the Canon ImageRunnerMultifunction Printer (“MFP”)****device.  Other potential software competitors includeScanSoft, as well as document management vendors like Hummingbird andInterwoven/iManage who are seeking to develop, either through partnerships orinternal resources, scan-to-archive capabilities using standard e-mail as thetransport and a generic document profile as a means of entering the contentinto their repository.  We believe thatour ability to compete successfully in the distributed document capture and deliverymarket depends upon a number of factors both within and beyond our controlincluding product performance; reliability and features; ease of use; productscalability; quality of support services; price/performance; timeliness ofenhancements and new product releases by us and our competitors.  We expect this market to mature and becomeincreasingly competitive with success resulting from the formation of criticalpartnerships and alliances with both selected hardware and software partners.

 

The market for client/servercomputer-based facsimile solutions is also competitive and is more establishedand mature than the markets in which the AccuRoute and Genidocs productscompete.  We believe that our ability tocompete successfully in the fax market depends upon a number of factors bothwithin and beyond our control including product performance; reliability andfeatures; ease of use; product scalability; quality of support services;price/performance; timeliness of enhancements and new product releases by usand our competitors.  Given thesefactors, we believe that in order to be successful, we must continue our focuson delivering a core, modular and scalable product on one of the most prolificsystem platforms, Windows 2000/2003®, with features that appeal to the broadestsegment of the electronic document exchange market, which includes fax and allof the other document control and management features that we offer.

 

We compete directly with anumber of vendors of facsimile products, including providers of facsimilesoftware products for client/server networks such as Captaris/RightFax,Dicom/TopCall and Biscom.  We alsocompete with providers offering a range of alternative facsimile solutionsincluding outsourcing network facsimile solutions, such as Easylink Servicesand Xpedite; operating systems containing facsimile and document e-mailfeatures; low-end fax modem products; providers of desktop fax software; single-platformfacsimile software products; and customized proprietary softwaresolutions.  In addition, providers ofoperating systems or business software applications may bundle competitivefacsimile solutions as part of their broader product offerings.

 

In the intensely competitiveand rapidly changing business-to-business secure document exchange market, wecompete directly with Authentica, Sigaba, Tumbleweed, and Zixit and a number ofother providers.  There are also othercategories of technology solutions that overlap and compete in certain wayswith aspects of our products.  Theseinclude:

 

•                  Documentmanagement solutions from vendors such as EMC/Documentum, Hummingbird andInterwoven/iManage whose electronic collaboration solutions compete withcertain aspects of our solutions;

 

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

 

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

 

Weexpect the level of competition in the business-to-business secure documentexchange market to increase over time.

 

Many of our competitors andpotential competitors have longer operating histories and greater financial,technical, sales, marketing and other resources, as well as greater namerecognition and market acceptance of their products and technologies than wedo. In addition, there are relatively low barriers to entry in the markets inwhich we operate and intend to operate, and new competition may arise eitherfrom expansion by established companies or from new emerging companies or fromresellers of our products. There can be no assurance that our current orpotential competitors will not develop products comparable or superior — interms of price and performance features – to those developed by us.  Further, our competitors may adapt morequickly than we do to new or emerging technologies and changes in marketopportunities or customer requirements, establish alliances with industryleaders or take advantage of acquisition opportunities more readily than we canor do. In addition, no assurance can be given that we will not be required tomake substantial additional investments in connection with our research,development, engineering, marketing, sales and customer service efforts inorder to meet any competitive threat, or that those required investments willnot have a material adverse effect on our operating margins.  Changes in governing laws and regulations mayalso affect our ability to remain competitive. Increased competition may result in reduction in market share, pressurefor price reductions and related reductions in gross margins, any of whichcould materially adversely affect our ability to achieve our financial andbusiness goals. There can be no assurance that in the future we will be able tosuccessfully compete against current and future competitors.

 

***Our business is subject toseasonality and fluctuations on a quarterly and annual basis due to the longsales cycle for our***

 

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***products and numerous other factors and,therefore, our results may vary from quarter-to-quarter and year-to-year****.*Our quarterly revenues and results ofoperations have fluctuated significantly in the past and will likely continueto fluctuate significantly in the future. Causes of these fluctuations haveincluded and may include, among others, the demand for our products andservices; the size and timing of orders; the number, timing and significance ofnew product announcements by us and our competitors; our ability to develop,introduce, market and ship new and enhanced versions of our current and plannedproducts on a timely basis; the level of product and price competition; changesin operating expenses; changes in average selling prices and mix of ourproducts; changes in our sales incentive strategy; the mix of direct andindirect sales; and general economic factors, including factors affecting theoverall U.S. economy and the demand for enterprise information technologysolutions. In addition, the sale of our products often involves delays becausecustomers tend to implement the products on a large scale, requiring them firstto establish certain minimum hardware capabilities. Our products thereforeoften have a lengthy sales cycle while potential customers evaluate and receiveapprovals for the purchase of our products. During these sales cycles, we mayexpend substantial funds and management efforts, yet receive no revenues. It isdifficult to accurately predict the sales cycle of any large order. If one ormore large orders fail to close as forecasted in a fiscal quarter, our revenuesand operating results for that quarter could be materially adversely affected.Any one or more of these or other factors could have a material adverse effecton our business, financial condition and results of operations. The potentialoccurrence of any one or more of these factors makes the prediction of revenuesand results of operations on a quarterly basis difficult and performanceforecasts derived from these predictions unreliable.

 

In addition, we may investin research and development and marketing expenses in order to promote furtherour products within current or new vertical markets, including our current planto incur additional sales and marketing expenses as we target the finance andhealthcare markets with our AccuRoute product. These investments would be required in advance of related marketacceptance and revenue and, accordingly, any failure of our products to achieveplanned levels of acceptance would have a material adverse effect on ourbusiness, financial condition and results of operations on a quarter-to-quarterbasis and overall.

 

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

 

                A substantial portion of ouroperating expense is related to personnel, facilities, equipment and marketingprograms. The level of spending for these expenses cannot be adjusted quicklyand is therefore fixed in the short term. Our expense levels for personnel,facilities, equipment and marketing programs are based, in significant part, onour expectations of future revenues on a quarterly basis. If actual revenuelevels on a quarterly basis are below management’s expectations, results ofoperations are likely to be adversely affected by a similar amount because arelatively small amount of our expense varies with our revenue in the shortterm.

 

                Due to all of the foregoingfactors, it is likely that in some future periods our results of operationswill be below the expectations of securities analysts and investors. In suchevent, the price of our common stock would likely be materially adverselyaffected.

 

***In addition to direct sales, weutilize indirect sales and distribution channels and strategic alliances withcompatible partners in order to broaden sales of our products and any failureon our part to form and leverage relationships with these indirect sales anddistribution channel partners could have a material adverse affect on ourbusiness and results of operations****.*  Wemarket our products and services directly through telesales and indirectlythrough marketing channels such as value added resellers (“VARs”), systemsintegrators, distributors and strategic business partners. Although we havehistorically focused our efforts on marketing through our sales force, wecontinue to utilize resources to develop and expand indirect marketingchannels. There can be no assurance that we will be able to attract and retaina sufficient number of qualified VARs, systems integrators, distributors andstrategic business partners, or that those third parties will successfullymarket our products. In addition, there can be no assurance that our resellersand strategic business partners will not develop, acquire or market computer-basedelectronic document exchange, document routing and distribution and facsimileproducts that are competitive with our products. The failure to retain ourVARs, systems integrators, distributors and strategic partners could have amaterial adverse effect on our business, financial condition and results ofoperations.

 

                The distributor agreementsgoverning our relationships generally provide that either party may terminatethe agreement without cause upon 30 days written notice to the otherparty.  We also resell our products on apurchase order basis through other VARs, systems integrators anddistributors.  Generally, in thosesituations, either party may terminate the relationship at any time, andtherefore there can be no assurance that any VAR, systems integrator ordistributor will continue to represent and sell our products.  Furthermore, our strategic alliancesgenerally may be terminated by either party, at any time; there can thereforebe no assurances that these strategic alliances will continue.  The inability to retain certain VARs, systemsintegrators, distributors or strategic business

 

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partners,or the development or marketing by VARs, systems integrators, distributors orstrategic business partners of competitive offerings, could have a materialadverse effect on our business, financial condition and results of operations.

 

Selling through indirectchannels may limit our contacts with our customers.  As a result, our ability to accuratelyforecast sales, evaluate customer satisfaction and recognize emerging customerrequirements may be hindered. Our strategy of marketing our products directlyto end-users and indirectly through VARs, systems integrators and distributorsmay result in distribution channel conflicts. Our direct sales efforts maycompete with those of our indirect channels and, to the extent differentresellers target the same customers, resellers may also come into conflict witheach other. As we strive to expand our indirect distribution channels, therecan be no assurance that emerging channel conflicts will not materiallyadversely affect our relationships with existing VARs, systems integrators ordistributors or adversely affect our ability to attract new VARs, systemsintegrators and distributors.

 

***The success of our business is dependent onour ability to expand our sales internationally, which will subject us toregulatory, exchange rate and other risks that might hinder our ability to meetour targets for international sales and might impair our results of operation****.*  Anelement of our strategy is to increase our international sales.  We expect to face competition from securebusiness-to-business electronic document exchange solutions and local facsimileproduct providers in their native countries. To successfully maintain international sales, we need to recruit andretain additional international resellers and distributors.  There can be no assurance that we will beable to maintain international sales of our products or that our internationaldistribution channels will be able to adequately market, service and supportour products.  International operationsgenerally are subject to certain risks, including dependence on independentresellers, fluctuations in foreign currency exchange rates, compliance withforeign regulatory and market requirements, variability of foreign economicconditions and changing restrictions imposed by United States export laws.  Additional risks inherent in our internationalbusiness activities generally include unexpected changes in regulatoryrequirements, tariffs and other trade barriers, costs of localizing productsfor foreign countries, lack of acceptance of localized products in foreigncountries, longer accounts receivable payment cycles, difficulties in managinginternational operations, difficulties in enforcing intellectual propertyrights and the burdens of complying with a wide variety of foreign laws.

 

We currently have a salesoffice outside of the United States.  Ournon-United States presence subjects us to certain additional risks includingdifficulties in staffing and managing these foreign operations and potentiallyadverse tax consequences including restrictions on the repatriation ofearnings.  There can be no assurance thatthese factors will not have a material adverse effect on our futureinternational sales and, consequently, our business, financial condition andresults of operations.  To date, a majorityof our sales have been made in United States dollars and we have not engaged inany hedging transactions through the purchase of derivative securities orotherwise.  Our United Kingdom subsidiarytransacts business primarily in its local currency.  Our United Kingdom subsidiary operating resultsare translated into U.S. dollars and consolidated for reporting purposes.  Significant currency exchange ratefluctuations could have a material impact on our results of operations.

 

***Given the nature of our business, wemay not be able to obtain sufficient or attractive financing should that becomenecessary****.** ***We expect that our current cash, cash equivalents and investments willmeet our normal working capital and capital expenditure needs for at least thenext twelve months.  We may, however,need to raise additional funding at that time or earlier if we decide toundertake more rapid expansion, including acquisitions of complementaryproducts or technologies, or if we increase our marketing and/or research anddevelopment efforts in order to respond to competitive pressures.  We cannot be certain that we will be able toobtain additional financing on favorable terms, if at all.  We may obtain additional financing by issuingshares of our common stock, which could dilute our existing stockholders.  If we cannot raise needed funds on acceptableterms, or at all, we may not be able to develop or enhance our products orrespond appropriately to competitive pressures, which would seriously harm ourbusiness.

 

***We may not successfully completeacquisitions or integrate acquisitions we do make, which could impair ourability to compete and could harm our operating results.***  Wemay augment our internal growth with acquisitions of businesses, products andtechnologies that could complement or expand our business.  Certain of these businesses may be marginallyprofitable or unprofitable.  In order toachieve anticipated benefits from these acquisitions, we must successfullyintegrate the acquired businesses with our existing operations and no assurancecan be given that we will be successful in this regard.  We have limited experience in integratingacquired companies into our operations, in expanding the scope of operations ofrequired businesses, in managing geographically dispersed operations and inoperating internationally.  In the past,we have incurred one-time costs and expenses in connection with acquisitionsand it is likely that we could incur similar one-time costs and expenses inconnection with future acquisitions.  Inaddition, we may be required to amortize significant intangible assets inconnection with future acquisitions, which could adversely affect our operatingresults.  Further, attractiveacquisitions are difficult to identify and complete for a number of reasons,including competition among prospective buyers and the possible need to obtainregulatory approval.  There can be noassurance that we will be able to complete future acquisitions.  In order to finance such acquisitions, we mayneed to raise additional funds either through public or private financings,including bank borrowings.  Anyfinancing, if available at all, may be on terms that are not favorable tous.  We may also issue shares of ourcommon stock to acquire attractive businesses, which may dilute our existingstockholders.

 

***Our future success depends on ourability to manage the growth and expansion of our business.***  Wemay expand our operations as we anticipate that expansion may be required inorder to address potential market opportunities.  We may also increase

 

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the size of our sales andmarketing and research and development expenditures as necessary.  There can be no assurance that we will beable to complete this expansion successfully or that the expansion wouldgenerate sufficient revenues to cover our expenses.  We will need to continue to attract andretain highly qualified technical, sales and managerial personnel.  There can be no assurance that we will beable to retain or continue to hire this kind of personnel in the future.  Our inability to effectively expandoperations and manage growth, if any, could have a material adverse effect onour business, financial condition and results of operations.

 

***The effectiveness of our disclosurecontrols and procedures and internal controls over financial reporting may belimited.***  Pursuant to the requirements of theSarbanes-Oxley Act of 2002, we must maintain and enhance our internal controlsover financial reporting.  Presently, weare not an “accelerated filer” as that term is defined in the SecuritiesAct.  If we were to become an acceleratedfiler for the fiscal year ending on December 31, 2005, then commencing with ourannual report on Form 10-K for the fiscal year ending December 31, 2005, ourmanagement would be required to deliver a report regarding its determination ofthe effectiveness of our internal controls over financial reporting. Further,under Section 404 of Sarbanes-Oxley, our independent registered publicaccounting firm would be required to deliver an attestation report regardingmanagement’s assessment of the effectiveness of our internal controls overfinancial reporting.  If we are not anaccelerated filer as of the end of fiscal year ending on December 31, 2005,then our management and our independent registered public accounting firm willhave to comply with these requirements commencing with our annual report onForm 10-K for the fiscal year ending December 31, 2006.  As a result, during the fiscal years endingDecember 31, 2005 and 2006, our management will expend considerable time,attention and resources to determining the strength and effectiveness of ourinternal controls over financial reporting and, where appropriate, makingimprovements.

 

Ourdisclosure controls and procedures and internal controls over financialreporting may not prevent all errors and intentional misrepresentations.  Any system of internal controls can onlyprovide reasonable assurance that all control objectives have been and willcontinue to be met.  Some of thepotential risks involved could include, without limitation, managementjudgments, simple errors or mistakes, willful misconduct regarding controls ormisinterpretation.  Though we believethat our disclosure controls and procedures and internal controls overfinancial reporting are effective, there can be no guarantee that existingcontrols and procedures will prevent or detect all material issues, errors orintentional misrepresentations.  Further,our existing controls may not be effective in future situations.  Any failure of our disclosure controls andprocedures or internal controls over financial reporting could have a materialimpact on our financial condition and results of operation.  Our assessment of our internal controls overfinancial reporting may identify weaknesses in our internal controls overfinancial reporting that we need to remedy or may raise other issues of concernfor our investors.  Should we determinethat a material weakness exists in our internal controls over financialreporting, the price of our common stock might decline.

 

***Our reliance on a sole hardware suppliercould adversely impact our business****. *Wecurrently purchase hardware products for sale to our customers from a singlethird-party supplier.  We do not have along-term, fixed-price or minimum volume contract with this supplier.  Instead, we order hardware equipment throughpurchase orders from time to time. We do not carry significant inventories ofthese hardware products and do not have a guaranteed supply arrangement withthis supplier.  Although we believe thatwe could secure these hardware products from alternative suppliers, in theevent of a disruption of supply from this sole supplier, we might not be ableto develop an alternative source in a timely manner or at favorable prices.  Even if we were able to purchase thesehardware components from alternative sources, we would have little control overthe costs of these products.  Were weforced to pay significantly higher prices for these hardware products, it mightlimit the mark-up over the price paid by us that we can reasonably charge ourcustomers.  Were we unable to providethis hardware to our customers, forcing our customers to buy this hardwaredirectly from third parties, or were we forced to decrease the size of our mark-up,our hardware and total revenues would be negatively impacted.

 

***We may face additional expenses anddisruption due to the upcoming expiration of the lease on our headquartersspace, especially if we elect to relocate.***  We lease office space, used as ourheadquarters and primary business location, at 8A Industrial Way in Salem, NewHampshire.  Our current lease terminateson December 31, 2005.  As a result, wehave engaged a real estate agent to assist us in considering our options.  At this time, we have not determined whetherwe will be able to renew our lease at our present location on sufficientlyfavorable terms or whether we will instead lease a new facility andrelocate.  The process of evaluatingoptions and negotiating a new or renewed lease will require time and attentionfrom members of our management.  Further,if we elect to relocate our operations to a new location, we will incur relatedexpenses and will encounter disruption of operations related to the move, allof which could have a material adverse effect on our financial condition andresults of operation.

 

***We are dependent on our keypersonnel and any inability to retain or hire key personnel could impact ourbusiness and results of operations****.*  Ourfuture performance depends, in significant part, upon the continued service ofour key technical, sales and senior management personnel, most of whom are notbound by employment agreements or noncompetition agreements.  The loss of the services of one or more ofour executive officers or other key employees could have a material adverseeffect on our business, financial condition and results of operations.  Our future success also depends on ourcontinuing ability to attract and retain highly qualified technical, sales andmanagerial personnel, particularly in light of our expanded AccuRoute sales andmarketing strategy.

 

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Competition for this highlyqualified personnel is intense and we have historically experienced difficultyin recruiting qualified technical personnel. There can be no assurance that we will be able to retain or continue tohire key technical, sales and managerial personnel in the future.

 

**Item 3. Quantitative and Qualitative Disclosures About MarketRisk**

 

*Derivative Financial Instruments, Other FinancialInstruments, and Derivative Commodity Instruments.*** ** As of March 31, 2005, the Company did notparticipate in any derivative financial instruments or other financial andcommodity instruments for which fair value disclosure would be required underSFAS No. 107,*Disclosures about FairValue of Financial Instruments*. All of the Company’s investmentsconsist of money market funds and commercial paper that are carried on theCompany’s books at amortized cost, which approximates fair market value.Accordingly, the Company  has noquantitative information concerning the market risk of participating in suchinvestments.

 

*Primary Market Risk Exposure*s.* *The Company’s primary market risk exposures are in the areas of interest raterisk and foreign currency exchange rate risk. The Company’s investmentportfolio of cash equivalents is subject to interest rate fluctuations, but theCompany believes this risk is immaterial due to the short-term nature of theseinvestments. The Company’s exposure to currency exchange rate fluctuations hasbeen and is expected to continue to be modest due to the fact that theoperations of its United Kingdom subsidiary are almost exclusively conducted inits local currency. The United Kingdom subsidiary’s operating results aretranslated into U.S. dollars and consolidated for reporting purposes. Theimpact of currency exchange rate movements on intercompany transactions wasimmaterial for the quarter ended March 31, 2005. The Company manages itsforeign currency exchange risk by monitoring its net monetary position usingnatural hedges of its assets and liabilities denominated in localcurrencies.  There can be no assurancethat this approach will eliminate all foreign currency exchange rate exposure.Currently, the Company does not engage in foreign currency hedging activities.

 

**Item 4.Controls and Procedures**

 

Asof the end of the fiscal quarter (the “Evaluation Date”), the Company, underthe supervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, evaluatedthe effectiveness of the Company’s disclosure controls and procedures pursuantto Rule 13a-15(b) and 15d-15(b) promulgated under the Securities Exchange Actof 1934, as amended (the “Exchange Act”).  Based upon that evaluation, theCompany’s Chief Executive Officer and Chief Financial Officer concluded that,as of the Evaluation Date, the Company’s disclosure controls and procedures areeffective in ensuring that information relating to the Company (including itsconsolidated subsidiaries) required to be disclosed by the Company in thereports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms, including ensuring that such information is accumulated andcommunicated to the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure.

 

Therewas no change in the Company’s internal control over financial reporting duringthe Company’s last fiscal quarter that has materially affected, or isreasonably likely to materially affect, the Company’s internal control over financialreporting.

 

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**PART II: OTHER INFORMATION**

 

**Item5.    Other Information**

 

Therehave been no changes to the procedures by which security holders may recommendnominees to the Company’s Board of Directors during the time period covered bythis Quarterly Report on Form 10-Q.

 

**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

 

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|               | OMTOOL,  LTD. |
|--------------------|---------------|
|               |          |   |
|               |          |   |
| May 12,  2005 | By:           | /s/  Daniel A. Coccoluto |   |
|               |          | Daniel  A. Coccoluto |
|               |          | Chief  Financial Officer, Secretary and Treasurer |
|               |          | (Duly  authorized officer and principal financial officer) |

 

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**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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