UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2002

 

OR

 

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

 

For the transition period from           to        

 

Commission File Number 0-22871

 

OMTOOL, LTD.

(Exact Name of Registrant as Specified in Its Charter)

 

 

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

 

Yes ý    No o

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).

 

Yes  o      No ý

 

There were 12,211,793 shares of the Company’s Common Stock, par value $0.01, outstanding on November 12, 2002.

 

 

OMTOOL, LTD. AND SUBSIDIARIES

 

FORM 10-Q

For the Quarter Ended September 30, 2002

CONTENTS

 

Item Number
PART I: FINANCIAL INFORMATION
Item 1.  Consolidated Financial Statements
	Consolidated Balance Sheets as of September 30, 2002 (Unaudited) and December 31, 2001
	Consolidated Statements of Operations for the three months and nine months ended September 30, 2002 and 2001 (Unaudited)
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001 (Unaudited)
	Notes to Consolidated Financial Statements
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.  Quantitative and Qualitative Disclosures About Market Risk
Item 4.  Controls and Procedures
PART II: OTHER INFORMATION
Item 6.  Exhibits and Reports on Form 8-K
Signatures
Certifications

 

2

 

PART I:  FINANCIAL INFORMATION

Item 1.  Financial Statements

 

OMTOOL, LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

		September 30, 2002			December 31, 2001
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	9,375,744		$	11,194,118
Short-term investments		—			1,296,750
Accounts receivable, less reserves of $720,000 at September 30, 2002 and $630,000 at December 31, 2001		1,406,652			1,867,332
Inventory – finished goods		150,733			168,039
Prepaid expenses and other current assets		468,973			613,662
Deferred tax asset		—			1,225,350
Total current assets		11,402,102			16,365,251
Property and equipment, net		699,858			836,366
Other assets		13,962			13,962
Total assets		$	12,115,922		$	17,215,579
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	549,115		$	733,290
Accrued liabilities		2,906,837			2,023,601
Deferred revenue		3,092,521			3,383,759
Total current liabilities		6,548,473			6,140,650
Stockholders’ equity:
Preferred Stock, $.01 par value — Authorized — 2,000,000 shares; Issued and outstanding — none		—			—
Common Stock, $.01 par value — Authorized — 35,000,000 shares; Issued — 13,009,372 shares		130,093			130,093
Additional paid-in capital		31,879,212			31,924,984
Accumulated deficit		(25,425,634		)	(20,152,079		)
Treasury Stock (797,579 shares at cost at September 30, 2002 and 320,305 shares at cost at December 31, 2001)		(924,570		)	(734,086		)
Cumulative translation adjustment		(91,652		)	(93,983		)
Total stockholders’ equity		5,567,449			11,074,929
Total liabilities and stockholders’ equity		$	12,115,922		$	17,215,579

 

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

 

3

 

OMTOOL, LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three months ended September 30,						Nine months ended September 30,
		2002			2001			2002			2001
Revenues:
Software license		$	899,656		$	1,078,336		$	3,041,068		$	3,649,610
Hardware		712,509			688,534			2,143,808			2,239,401
Service and other		1,925,714			1,769,944			5,607,134			5,362,857
Total revenues		3,537,879			3,536,814			10,792,010			11,251,868
Cost of revenues:
Software license		84,948			100,242			237,793			321,031
Hardware		437,355			480,588			1,398,172			1,471,175
Service and other		867,780			879,871			2,466,957			3,222,143
Total cost of revenues		1,390,083			1,460,701			4,102,922			5,014,349
Gross profit		2,147,796			2,076,113			6,689,088			6,237,519
Operating expenses:
Sales and marketing		1,332,134			1,602,744			4,854,374			4,680,122
Research and development		586,200			725,083			2,282,125			2,422,894
General and administrative		1,089,262			999,364			3,748,405			2,648,037
Total operating expenses		3,007,596			3,327,191			10,884,904			9,751,053
Loss from operations		(859,800		)	(1,251,078		)	(4,195,816		)	(3,513,534		)
Interest income		49,940			126,370			147,611			556,194
Loss before tax provision		(809,860		)	(1,124,708		)	(4,048,205		)	(2,957,340		)
Tax provision		—			—			1,225,350			—
Net loss		$	(809,860	)	$	(1,124,708	)	$	(5,273,555	)	$	(2,957,340	)
Net loss per share
Basic and Diluted		$	(0.06	)	$	(0.09	)	$	(0.42	)	$	(0.23	)
Weighted average number of common shares outstanding
Basic and Diluted		12,617,482			12,740,948			12,674,557			12,746,149

 

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

 

4

 

OMTOOL, LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Nine months ended September 30,
		2002			2001
Cash Flows from Operating Activities:
Net loss		$	(5,273,555	)	$	(2,957,340	)
Adjustments to reconcile net loss to net cash used in operating activities–
Depreciation and amortization		388,632			536,223
Deferred taxes		1,225,350			33,628
Changes in assets and liabilities–
Accounts receivable		480,915			513,348
Prepaid expenses and other current assets		138,332			(420,254		)
Inventory		18,435			89,711
Accounts payable		(194,847		)	(275,138		)
Accrued liabilities		873,540			(2,267,212		)
Deferred revenue		(323,219		)	87,431
Net cash used in operating activities		(2,666,417		)	(4,659,603		)
Cash Flows from Investing Activities:
Purchases of property and equipment		(247,309		)	(240,774		)
Proceeds from sale of short-term investments		1,296,750			3,283,113
Net cash provided by investing activities		1,049,441			3,042,339
Cash Flows from Financing Activities:
Net proceeds from issuance of common stock		19,083			63,573
Purchases of treasury stock		(255,339		)	(168,232		)
Net cash used in financing activities		(236,256		)	(104,659		)
Foreign exchange effect on cash		34,858			27,881
Net decrease in cash and cash equivalents		(1,818,374		)	(1,694,042		)
Cash and cash equivalents, beginning of period		11,194,118			14,599,350
Cash and cash equivalents, end of period		$	9,375,744		$	12,905,308

 

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

 

5

 

OMTOOL, LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

(1)               Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared by Omtool, Ltd. (the “Company” or “Omtool”) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2001 as filed with the SEC on March 22, 2002. The accompanying consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of results for the interim periods presented.  The results of operations for the three month and nine month periods ended September 30, 2002 are not necessarily indicative of the results to be expected for the full fiscal year.

 

The Company’s financial results for the first nine months of 2002 declined substantially from financial results for the first nine months of 2001 primarily due to the general economic softness in information technology spending as reflected in a decrease in demand for enterprise software solutions.  This decrease reflected the declining economic climate in the United States in the first nine months of 2002 as compared to that of 2001 causing customers and prospective customers to defer technology purchases. As a result of this decrease in demand, the Company’s revenues for the nine months ended September 30, 2002 decreased 4% from revenues for the nine months ended September 30, 2001, and the Company’s net loss increased from $2.9 million for the nine months ended September 30, 2001 to a net loss of $5.3 million for the nine months ended September 30, 2002.  The Company has experienced declining revenues and increasing operating losses over an extended period of time.  Based upon the current economic environment, general softness in information technology spending, products that may not achieve market acceptance, and short forecasting visibility, the Company cannot estimate that the financial and operating performance, financial position or cash flow will improve over the next twelve months.  As a result of the losses incurred and the anticipation of a continuing decline in the United States economy, the Company reduced its work force and office space in June 2002 to lower the overall cost of operations by approximately $750,000 annually.  Although the Company’s operating cash flow for the nine months ended September 30, 2002 resulted in a use of cash of $2.7 million, the Company’s cash and cash equivalents at September 30, 2002 were approximately $9.4 million. The Company anticipates that its balance of cash and cash equivalents will be approximately $8 million at the end of the fourth quarter of 2002. The Company believes that its existing cash and cash equivalents will be sufficient to meet the Company’s working capital and capital expenditures for at least the next twelve months.

 

(2)               Net Loss per Common Share

 

The Company reports earnings per share in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128, Earnings per Share.  Diluted weighted average shares outstanding for the three and nine months ended September 30, 2002 and September 30, 2001 exclude the potential common shares related to 2,702,263 and 2,341,638, respectively, outstanding stock options because to include them would have been antidilutive for the periods presented.

 

(3)               Income Taxes

 

During the quarter ended June 30, 2002, the Company recorded an additional valuation allowance of approximately $1.2 million against all of its net deferred tax assets. SFAS No. 109, Accounting for Income Taxes requires a valuation allowance to be recorded against deferred tax assets when it is more likely than not that some or all of the deferred tax assets will not be realized. As a result of the downturn in the economy, the Company incurred significant and previously unanticipated losses in the first half of the current fiscal year, and the current outlook indicates that significant uncertainty will continue for the remainder of this fiscal year and into the next fiscal year. These cumulative losses, together with the Company’s prior losses, resulted in management’s decision that it is more likely than not that all of its deferred tax assets will

 

6

 

not be realized in the foreseeable future.  Accordingly, the remaining net deferred tax asset was written off in the second quarter of 2002.

 

The Company will continue to provide a valuation allowance against all of its net deferred tax assets until it returns to an appropriate level of taxable income. The ultimate realization of these deferred tax assets depends upon the Company’s ability to generate sufficient future taxable income. If the Company is successful in generating sufficient future taxable income, the Company will reduce the valuation allowance through a reduction in income tax expense in the future.

 

(4)               Comprehensive Loss

 

The components of the Company’s comprehensive loss are as follows:

 

		Three months ended September 30,						Nine months ended September 30,
		2002			2001			2002			2001
Net loss		$	(809,860	)	$	(1,124,708	)	$	(5,273,555	)	$	(2,957,340	)
Foreign currency translation adjustments		3,976			(1,697		)	2,331			1,383
Comprehensive loss		$	(805,884	)	$	(1,126,405	)	$	(5,271,224	)	$	(2,955,957	)

 

(5)               Segment and Geographic Information

 

To date, the Company has viewed its operations and manages its business as principally one segment, software sales and associated services. As a result, the financial information disclosed herein, represents all of the material financial information related to the Company’s principal operating segment in accordance with SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information.

 

Total revenues from international sources were approximately $711,000 and $2.0 million for the three months and nine months ended September 30, 2002, respectively, and $515,000 and $1.7 million for the three months and nine months ended September 30, 2001, respectively. The Company’s revenues from international sources were primarily generated from customers located in Europe. The following table represents amounts relating to geographic locations:

 

		Three months ended September 30,						Nine months ended September 30,
Total revenues (1)		2002			2001			2002			2001
United States		$	2,826,718		$	3,022,232		$	8,815,399		$	9,537,014
United Kingdom		239,405			218,380			929,477			726,704
Other North America		249,384			211,118			580,064			667,975
Other Europe		97,564			73,591			245,679			232,898
Latin America / Pacific Rim		124,808			135			171,499			20,162
Middle East / Far East / Australia		—			11,358			49,894			67,115
		$	3,537,879		$	3,536,814		$	10,792,012		$	11,251,868

 

Long-lived assets (2)		September 30, 2002			December  31, 2001
North America		$	674,685		$	789,915
Europe		39,135			60,413
		$	713,820		$	850,328

 

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

(2)  Long-lived assets include all long-term assets except those specifically excluded under SFAS No. 131 such as deferred income taxes andfinancial instruments.

 

7

 

(6)               Recently Issued Accounting Pronouncements

 

In July 2002, the Financial Accounting Standards Board issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities.  SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).  SFAS No. 146 requires that a liability be recognized when it is incurred and should initially be measured and recorded at fair value.  This statement is effective for exit or disposal activities that are initiated after December 31, 2002 and the adoption is not expected to have a material impact on the consolidated financial statements of the Company.

 

8

 

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying consolidated financial statements for the periods specified and the associated notes.  Further reference should be made to the Company’s Annual Report on Form 10-K as filed with the Securities Exchange Commission on March 22, 2002.

 

Overview

 

Omtool, Ltd. is a leading provider of e-mail and fax-based messaging software that enables secure, confirmed document exchange between businesses. The Company was incorporated in March 1991 and shipped its initial facsimile software products in 1991. Omtool’s Genidocs™ product family enables users throughout an enterprise to deliver confidential and secure e-mail over the Internet.  Omtool’s Fax Sr.™, LegalFax™ and Genifax™ product families provide users with an extensive, flexible feature set for transmitting and receiving faxes and improve an organization’s management of its fax communications process by providing a suite of utility and control functions. A significant portion of the Company’s revenues is derived from licensing rights to use its Genifax and Fax Sr. software products directly to end-users and indirectly through resellers.

 

The Company’s financial results for the first nine months of 2002 declined substantially from financial results for the first nine months of 2001, due primarily to the general economic softness in information technology spending as reflected in a decrease in demand for enterprise software solutions.  This decrease reflected the declining economic climate in the United States in the first nine months of 2002 as compared to that of 2001 causing customers and prospective customers to defer technology purchases. As a result of this decrease in demand, the Company’s revenues for the nine months ended September 30, 2002 decreased 4% from revenues for the nine months ended September 30, 2001, and the Company’s net loss increased from $2.9 million for the nine months ended September 30, 2001 to a net loss of $5.3 million for the nine months ended September 30, 2002.  The Company has experienced declining revenues and increasing operating losses over an extended period of time.  Based upon the current economic environment, general softness in information technology spending, products that may not achieve market acceptance, and short forecasting visibility, the Company cannot estimate that the financial and operating performance, financial position or cash flow will improve over the next twelve months.  As a result of the losses incurred and the anticipation of a continuing decline in the United States economy, the Company reduced its work force and office space in June 2002 to lower the overall cost of operations by approximately $750,000 annually. Although the Company’s operating cash flow for the nine months ended September 30, 2002 resulted in a use of cash of $2.7 million, the Company’s cash and cash equivalents at September 30, 2002 were approximately $9.4 million.  The Company anticipates that its balance of cash and cash equivalents will be approximately $8 million at the end of the fourth quarter of 2002. The Company believes that its existing cash and cash equivalents will be sufficient to meet the Company’s working capital and capital expenditures for at least the next twelve months.

 

The Company cannot predict when the market for enterprise software solutions will improve. When the market does improve, the Company cannot predict whether, and to what extent, the demand for its products will increase.  The Company believes that the current lack of demand for enterprise software solutions will continue during the remainder of 2002, and that its operations and financial results will continue to be negatively affected during that period. Any continued decline in the Company’s revenues will have a significant impact on the Company’s financial results, particularly because a significant portion of the Company’s operating costs (such as personnel, rent and depreciation) are fixed in advance of a particular quarter. As a result, despite cost savings realized from the Company’s June 2002 restructuring, the Company’s costs for sales and marketing, research and development and general and administrative could continue to increase as a percentage of revenues, thereby affecting the Company’s operating results.

 

9

 

The Company’s future revenues and operating results may fluctuate from quarter to quarter based on the number and size of sales transactions the Company enters into with customers, the adequacy of provisions for losses, general economic conditions and other factors. In addition, revenues from a large order may constitute a significant portion of the Company’s total revenues in a particular quarter.

 

The Company has historically derived a substantial portion of its total revenues from sales within North America. Sales outside of North America (primarily in Europe) represented approximately 13% and 9% of the Company’s total revenues for the nine months ended September 30, 2002 and 2001, respectively.

 

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

 

The Company continues to actively recruit value-added resellers (“VARs”), systems integrators, resellers and distributors to expand its indirect distribution channel. The Company is pursuing sales opportunities via its solution/reseller channel as well as focusing sales efforts on specific market segments in order to facilitate product acceptance.  Sales through the Company’s indirect distribution channels represent approximately 20% and 22% of the Company’s total revenues for the nine months ended September 30, 2002 and 2001, respectively.

 

10

 

Results of Operations

 

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

 

		Three months ended September 30,				Nine months ended September 30,
		2002		2001		2002		2001
Revenues:
Software license		25.4	%	30.5	%	28.1	%	32.4	%
Hardware		20.2		19.5		19.9		19.9
Service and other		54.4		50.0		52.0		47.7
Total revenues		100.0		100.0		100.0		100.0
Cost of revenues:
Software license		2.4		2.8		2.2		2.9
Hardware		12.4		13.6		13.0		13.1
Service and other		24.5		24.9		22.9		28.6
Total cost of revenues		39.3		41.3		38.1		44.6
Gross profit		60.7		58.7		61.9		55.4
Operating expenses:
Sales and marketing		37.7		45.3		45.0		41.6
Research and development		16.6		20.5		21.1		21.5
General and administrative		30.8		28.3		34.7		23.5
Total operating expenses		85.1		94.1		100.8		86.6
Loss from operations		(24.4	)	(35.4	)	(38.9	)	(31.2	)
Interest income		1.4		3.6		1.4		4.9
Tax provision		—		—		(11.4	)	—
Net loss		(23.0	)%	(31.8	)%	(48.9	)%	(26.3	)%
Gross profit:
Software license		90.6	%	90.7	%	92.2	%	91.2	%
Hardware		38.6		30.2		34.8		34.3
Service and other		54.9		50.3		56.0		39.9

 

Three Months Ended September 30, 2002 and 2001

 

Revenues

 

Total Revenues.  The Company’s revenues are currently derived from licensing fees of the Company’s software products and from sales of related hardware and services. The Company’s total revenues were $3.5 million for each of the three months ended September 30, 2002 and 2001.

 

Software License.  The Company’s software license revenues are derived primarily from the licensing of the Company’s Fax Sr. and Genifax products.  Software license revenues were $900,000 for the three months ended September 30, 2002 and $1.1 million for the three months ended September 30, 2001, representing a decrease of 17%.  Software license revenues accounted for 25% and 31% of total revenues for each respective period.  The decline in software license revenues can be attributed to a number of factors that include the general softness in information technology spending which is reflected in a decrease in demand for enterprise software solutions and a decline in the growth rate of the overall United States economy causing customers and prospective customers to defer technology purchases.  The decrease in software license revenue as a percentage of total revenues is primarily attributable to the decrease in software revenues combined with the relative stability of the level of service and other revenues.  The Company did not recognize a significant amount of revenue from its Genidocs products.

 

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Hardware.  Hardware revenues are derived from the resale of third-party hardware products sold to the Company’s customers in conjunction with the licensing of the Company’s software. Hardware revenues were $713,000 for the three months ended September 30, 2002 and $689,000 for the three months ended September 30, 2001, representing an increase of 4%. Hardware revenues accounted for 20% and 19% of total revenues for each respective period.  The increase in hardware revenues was due primarily to a change in the particular mix of software sales made in the third quarter of 2002 resulting in a corresponding increase in accompanying hardware sales.

 

Service and Other.  Service and other revenues are primarily comprised of fees from software maintenance contracts. Service and other revenues were $1.9 million for the three months ended September 30, 2002 and $1.8 million for the three months ended September 30, 2001, representing an increase of 9%. Service and other revenues accounted for 54% and 50% of total revenues for each respective period.  The increase in dollar amount and in service and other revenue as a percentage of total revenues is due to the support renewals from the Company’s increased installed customer base.

 

Cost of Revenues

 

Software License.  Cost of software license revenues consists primarily of the costs of sublicensing third–party software products, product media, and product duplication.  Cost of software license revenues was $85,000 and $100,000 for the three months ended September 30, 2002 and 2001, respectively, representing 9% of software license revenues for each respective period.  Software license gross margin percentages remained constant at 91% for the three months ended September 30, 2002 and for the three months ended September 30, 2001.

 

Hardware.  Cost of hardware revenues consists primarily of the costs of third–party hardware products. Cost of hardware revenues was $437,000 and $481,000 for the three months ended September 30, 2002 and 2001, respectively, representing 61% and 70% of hardware revenues for each respective period. The gross margin percentage for hardware sales was 39% and 30% for the three months ended September 30, 2002 and 2001, respectively. The decrease in dollar amount for the cost of hardware revenues and the increase in gross margin is due mainly to a change in the mix of the particular hardware products sold as well as the level of discounts at which the products are sold.

 

Service and Other.  Cost of service and other revenues consists primarily of the costs incurred in providing technical support as well as other miscellaneous customer service–related expenses.  Cost of service and other revenues was $868,000 and $880,000 for the three months ended September 30, 2002 and 2001, respectively, representing 45% and 50% of service and other revenues for each respective period.  The gross margin percentage for service and other revenues was 55% and 50% for the three months ended September 30, 2002 and 2001, respectively. The improved gross margin and the decrease in dollar amount and as a percentage of service and other revenues was due primarily to the reduction of overhead costs associated with the elimination of several positions within the department that occurred during fiscal 2001.

 

Operating Expenses

 

Sales and Marketing.  Sales and marketing expenses consist primarily of employee salaries, benefits, commissions, and associated overhead costs, the cost of marketing programs such as advertisements, direct mailings, public relations, trade shows, seminars and related communication costs.  Sales and marketing expenses were $1.3 million and $1.6 million for the three months ended September 30, 2002 and 2001, respectively, or 38% and 45% of total revenues for each respective period.  The decrease in dollar amount and as a percentage of total revenues was due to an decrease in overhead costs associated with a decreased number of employees in the sales and marketing departments as a result of a corporate restructuring which took place at the end of the second quarter of 2002.

 

Research and Development. Research and development expenses include expenses associated with the development of new products, enhancements of existing products and quality assurance activities and consist primarily of employee salaries, benefits, and associated overhead costs as well as consulting expenses and the cost of software development tools. Research and development expenses were $586,000 and $725,000 for the respective three month periods ended September 30, 2002 and September 30, 2001, representing 17% and 21% of total revenues for each respective period.  In conjunction with a corporate restructuring, several positions were eliminated during the quarter ended June 30, 2002. The decrease in dollar amount and as a percentage of total revenue is primarily attributable to the decrease in overhead costs of supporting a decreased number of employees in the research and development department.

 

General and Administrative.  General and administrative expenses consist primarily of employee salaries and benefits for administrative, executive and finance personnel and associated overhead costs, as well as consulting, accounting and legal

 

12

 

expenses. General and administrative expenses were $1.1 million and $999,000 for the three months ended September 30, 2002 and 2001, respectively, or 31% and 28% of total revenues for each respective period. The increase in dollar amount and the expenses as a percentage of total revenues is due mainly to an increase in state sales tax accruals offset by a decrease in other miscellaneous general and administrative expenses.

 

Interest Income.  Interest income consists principally of interest income earned on cash balances.  Interest income was $50,000 for the three months ended September 30, 2002 and $126,000 for the three months ended September 30, 2001.  The decrease is due to a reduction in cash balances and an approximate 51% reduction in interest rates the Company was earning on its investments.

 

Nine Months Ended September 30, 2002 and 2001

 

Revenues

 

Total Revenues.  The Company’s total revenues were $10.8 million and $11.3 million for the nine months ended September 30, 2002 and 2001, respectively, representing a decrease of 4%.

 

Software License.  Software license revenues were $3.0 million for the nine months ended September 30, 2002 and $3.6 million for the nine months ended September 30, 2001, representing a decrease of 17%.  Software license revenues accounted for 28% and 32% of total revenues for each respective period. The decline in software license revenue can be attributed to a number of factors that include the general softness in information technology spending which is reflected in a decrease in demand for enterprise software solutions and a decline in the growth rate of the overall U.S. economy causing customers and prospective customers to defer technology purchases. The decrease in software license revenue as a percent of total revenue is primarily attributable to the decrease in software revenues.

 

Hardware.  Hardware revenues were $2.1 million for the nine months ended September 30, 2002 and $2.2 million for the nine months ended September 30, 2001, representing a decrease of 4%.  Hardware revenues accounted for 20% of total revenues for each respective period.  The decrease in hardware revenues was due primarily to the decrease in the number of software sales made in the nine months ended September 30, 2002 resulting in a decrease in accompanying hardware sales.

 

Service and Other.  Service and other revenues were $5.6 million for the nine months ended September 30, 2002 and $5.4 million for the nine months ended September 30, 2001, representing an increase of 5%.  Service and other revenues accounted for 52% and 48% of total revenues for each respective period.  The increase in support revenue as a percentage of total revenues is due to the decrease in software and hardware sales combined with an increase in customer installation revenue during the first nine months of 2002.

 

Cost of Revenues

 

Software License.  Cost of software license revenues was $238,000 and $321,000 for the nine months ended September 30, 2002 and 2001, respectively, representing 8% and 9% of software license revenues for each respective period, resulting in respective gross margins of 92% and 91%. The decrease in dollar amount and the improvement in gross margin are attributable to decreased product duplication costs and decreased royalty payments due to lower sales volume of products with associated royalty payments.

 

Hardware.  Cost of hardware revenues was $1.4 million and $1.5 million for the nine months ended September 30, 2002 and 2001, respectively, representing 65% and 66% of hardware revenues for each respective period.  The decrease in dollar amount for the cost of hardware revenues for the nine months ended September 30, 2002 was due primarily to the decrease of hardware unit sales accompanying the Company’s software products.  The gross margin percentage for hardware sales was 35% for the nine months ended September 30, 2002 compared to 34% in the same period in 2001.  The increase in gross margin percentage is due mainly to the overall decrease in hardware costs.

 

Service and Other.  Cost of service and other revenue was $2.5 million and $3.2 million for the nine months ended September 30, 2002 and 2001, respectively, representing 44% of service and other revenues versus 60% for the same period last year. The gross margin percentage for service and other revenues improved from 40% to 56% for the nine month-periods ended September 30, 2001 and 2002, respectively.  The decrease in dollar amount of cost of services and the improvement in gross

 

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margin during the period are due primarily to the fewer number of support personnel within the department and the associated overhead costs of supporting such personnel.

 

Operating Expenses

 

Sales and Marketing.  Sales and marketing expenses were $4.9 million and $4.7 million for the nine months ended September 30, 2002 and 2001, respectively, or 45% and 42% of total revenues for each respective period. The increase in dollar amount and as a percentage of total revenues was due to an increase in the number of employees in the sales and marketing departments offset by a decrease in advertising expenses for the nine months ended September 30, 2002. However, in conjunction with a corporate restructuring, several positions were eliminated during the quarter ended June 30, 2002. The severance paid to those employees of approximately $128,000 also contributed to the increase in expenses during that same period.

 

Research and Development.  Research and development expenses were $2.3 million and $2.4 million for the nine months ended September 30, 2002 and 2001, respectively, or 21% and 22% of total revenues for each respective period.  The decrease in dollar amount and as a percentage of total revenue is due primarily to the fewer number of employees in the research and development department and the reduction in associated overhead costs.

 

General and Administrative.  General and administrative expenses were $3.7 million and $2.6 million for the nine months ended September 30, 2002 and 2001, respectively, or 35% and 24% of total revenues for each respective period.  The increase in dollar amount was primarily attributable to an increase in management consulting expenses and an increase in state sales tax accruals.

 

Interest Income. Interest income consists principally of interest income earned on cash balances. Interest income was $148,000 for the nine months ended September 30, 2002 and $556,000 for the nine months ended September 30, 2001.  The decrease is due to a reduction in cash balances and an approximate 59% reduction in interest rates the Company was earning on its investments.

 

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

 

Liquidity and Capital Resources

 

Since 1996, the Company has financed its operations primarily through cash flow from operations, the private sales of preferred stock and the Company’s initial public offering of Common Stock completed in August 1997. At September 30, 2002, the Company had cash and cash equivalents of $9.4 million and working capital of $4.9 million.

 

The Company’s operating activities used cash of $2.7 million and $4.7 million for the nine months ended September 30, 2002 and 2001, respectively. Net cash used during the nine months ended September 30, 2002 consisted primarily of a net loss from operations and a decrease in deferred revenues and accounts payable offset by depreciation and amortization, a decrease in accounts receivable and an increase in accrued liabilities.   Net cash used during the nine months ended September 30, 2001 resulted from a net loss from operations and a decrease in accrued liabilities offset by depreciation and amortization and a decrease to accounts receivable.  Due to the anticipation of continuing economic softness, the Company anticipates that it will use approximately $1.1 million of cash per quarter for at least the next four quarters.

 

Investing activities provided cash of $1.0 million and $3.0 million during the nine months ended September 30, 2002 and 2001, respectively.  During the nine months ended September 30, 2002 and 2001, the principal uses were purchases of property and equipment, offset by proceeds from the sale of short-term investments.

 

Financing activities used cash of $236,000 and $105,000 for the nine months ended September 30, 2002 and 2001, respectively, due primarily to the purchases of treasury stock.

 

At September 30, 2002, the Company did not have any material commitments for capital expenditures.

 

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The Company has experienced declining revenues and increasing operating losses over an extended period of time.  Based upon the current economic environment, general softness in information technology spending, the release of new and emerging products that may not achieve market acceptance, and shortened forecasting visibility, the Company cannot estimate that the financial and operating performance, financial position or cash flow will improve over the next twelve months.  Subject to the factors contained herein, the Company believes that it has sufficient liquidity and cash available to meet the operating needs of the company for at least the next twelve months.  There can be no assurance that any necessary additional financing will be available to the Company on commercially reasonable terms, or at all.

 

In August and September 2002, the Nasdaq National Market (“Nasdaq”) informed the Company that it was not in compliance with Nadsaq’s minimum bid price and market value listing requirements, respectively. The Company has determined that its ability to comply with the listing requirements is unlikely. As such, on October 29, 2002, the Company applied to transfer from the Nasdaq National Market to the SmallCap Market. As of the date of this filing, Nasdaq has not made a determination on the application.  The Company cannot predict the impact, if any, of a change in listing to the SmallCap Market. If the application is not accepted and the stock is delisted, the Company’s common stock will be traded on the Over-The-Counter market. The delisting of the Company’s common stock could significantly impair the Company’s ability to raise capital in the future.

 

Critical Accounting Policies

 

The Company has identified the policies below as critical to its business operations and the understanding of its results of operations. The impact and any associated risks related to these policies on the Company’s business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect the Company’s reported and expected financial results. Note that the Company’s preparation of this Form 10-Q requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the Company’s financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates.

 

Revenue Recognition and Accounts Receivable Reserves.  The Company derives its revenue from primarily two sources (i) product revenue, which includes software license and hardware revenue and (ii) services and support revenue, which includes software maintenance and support, installation, training and consulting revenue. The Company licenses its software products on a perpetual basis.  The Company generates revenue from licensing the rights to use its software products and sales of hardware directly to end-users and indirectly through resellers.  The Company’s resellers order products from the Company based on purchase orders received from end-users and do not order stock.  The Company’s products are sold to resellers and directly to end-users without any specifically stated rights of return. Occasionally however, the Company, in its sole discretion, will accept a product return if the end-user finds that the product does not fit its needs. The Company also sells hardware products, which are provided by a third-party, on a pass through basis, plus an additional mark-up, to end-users and indirectly through resellers. To support its software products, the Company sells software maintenance and support, installation, training and consulting services to end-users and indirectly through resellers.

 

The Company applies the provisions of Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions, to all transactions involving the sale of multiple elements including software, hardware and service revenue.  In December 1999, the SEC issued Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements. This bulletin establishes guidelines for revenue recognition. The Company’s revenue recognition policy complies with this pronouncement as well.  The Company applies the provisions of SFAS No. 48, Revenue Recognition When Right of Return Exists, with respect to providing for potential future product returns.   As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period.  Material differences may result in the amount and timing of the Company’s revenue if management made different judgments or utilized different estimates.

 

The Company recognizes revenue from the sale of software products and hardware to both end-users and resellers when persuasive evidence of an arrangement exists, the products have been delivered, the fee is fixed or determinable, collection of the resulting receivable is reasonably assured and there are no customer acceptance provisions. The Company maintains a reserve for potential product returns. Software maintenance and support revenue is recognized ratably over the term of the related maintenance period, typically one-year.  Other services revenue is recognized as the services are performed. If an arrangement includes an acceptance provision, the Company will defer all revenue until the customer accepts the

 

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products.  Acceptance generally occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period.

 

The Company’s transactions frequently involve the sales of software, hardware and related services under multiple element arrangements.   Revenue under multiple element arrangements is allocated to each element under the residual method, in accordance with SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. Under this method, revenue is allocated first to all undelivered elements, such as services, based on the fair value of those elements, which is the price charged when these elements are sold separately and unaccompanied by other elements.  The Company’s services are not essential to the functionality of the software as these services do not alter the capabilities of the software and do not carry a significant degree of risk to perform. The amount allocated to the delivered elements, such as software license and hardware revenue, is the difference between the total arrangement value and the amount allocated to the undelivered elements. If the delivered elements include both software and hardware, the amount allocated to hardware revenue is based on the price charged to the Company by the third party vendor plus an additional mark up, with the remainder allocated to software revenue. To the extent that a discount is offered in the arrangement, the entire discount is allocated to the delivered element or elements. If the delivered elements include hardware and software, the discount is allocated to the hardware and software based on their respective list prices.

 

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

 

At the time of the transaction, the Company assesses whether the fee associated with the transaction is fixed or determinable and whether or not collection is reasonably assured.  If a significant portion of a fee is due beyond the Company’s normal payment terms, which are thirty to sixty days from invoice date, the Company accounts for the fee as not being fixed or determinable.  In these cases, the Company recognizes revenue as the fees become due. The Company assesses collection based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer.  The Company reviews D&B credit reports for all of its resellers and adjusts its credit limits with those resellers accordingly.  If the reseller should not have a favorable report or the Company does not have enough credit information to distinguish if the reseller is credit-worthy then the Company predominantly sells to such resellers on C.O.D. terms.  The Company does not request collateral from its customers.  If the Company determines that collection of a fee is not reasonably assured, the fee is deferred and revenue is recognized at the time collection becomes reasonably assured, which is generally upon receipt of payment.

 

The Company reserves for potential product returns and makes adjustments to the reserve as needed, based on historical product return rates, and considers the impact of new product introductions, changes in customer demand and acceptance of the Company’s products.  Significant management judgments and estimates must be made and used in connection with establishing the sales returns reserve in any accounting period.  Material differences may result in the amount and timing of revenue for any period if management made different judgments or utilized different estimates.  Similarly, management must make estimates of the uncollectability of the Company’s accounts receivables.  Management specifically analyzes accounts receivable and historical bad debts, customer credit-worthiness, current economic trends and changes in customer payment patterns when evaluating the adequacy of the allowance for doubtful accounts.

 

The Company’s deferred revenue is comprised mainly of revenue that is deferred for software maintenance and support contracts.  The other components of deferred revenue are the amounts from transactions that were deferred because they did not meet all of the provisions of the Company’s revenue recognition policy.

 

Research and Development and Software Development Costs.  Software development costs are considered for capitalization when technological feasibility is established in accordance with SFAS No. 86, Accounting for the Costs of Computer Software To Be Sold, Leased or Otherwise Marketed. The Company sells software in a market that is subject to rapid technological change, new product introductions and changing customer needs. Accordingly, the Company has determined that it cannot determine technological feasibility until the development state of the product is nearly complete. The time period during which cost could be capitalized from the point of reaching technological feasibility until the time of general product release is very short and, consequently, the amounts that might be capitalized are not material to the Company’s consolidated financial position or results of operations. Therefore, the Company charges all research and development expenses to operations in the period incurred.

 

Income Taxes.  The Company is required to estimate its income taxes. This process involves estimating the Company’s actual

 

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current tax obligations together with assessing differences resulting from the different treatment of items for tax and accounting purposes which result in deferred tax assets and liabilities. The Company has deferred tax assets and liabilities included within its balance sheet. The Company’s deferred tax assets are assessed for each reporting period as to whether it is more likely than not that they will be recovered from future taxable income, including assumptions regarding on-going tax planning strategies. To the extent the Company believes that recovery is uncertain, the Company must establish a valuation allowance for assets not expected to be recovered. Changes to the valuation allowance are included as an expense or benefit within the tax provision in the statement of operations. In the event that actual results differ from these estimates, the Company’s provision for income taxes could be materially impacted.

 

Recent Accounting Pronouncements

 

In July 2002, the Financial Accounting Standards Board issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities.  SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).  SFAS No. 146 requires that a liability be recognized when it is incurred and should initially be measured and recorded at fair value.  This statement is effective for exit or disposal activities that are initiated after December 31, 2002 and the adoption is not expected to have a material impact on the consolidated financial statements of the Company.

 

Certain Factors Affecting Future Operating Results

 

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

 

Information provided by the Company from time to time including statements in this Form 10-Q which are not historical facts are so-called “forward-looking statements” that involve risks and uncertainties, made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  In particular, statements contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations and Notes to Consolidated Financial Statements which are not historical facts (including, but not limited to, statements concerning:  the plans and objectives of management; expectations for sales and marketing, research and development and general and administrative expenses; developments relating to the Company’s product and service offerings, markets and acquisitions; anticipated trends in the Company’s future operating results; the Company’s strategic alliances; changes in the regulatory environment; and the Company’s expected liquidity and capital resources) may constitute forward-looking statements. These forward-looking statements are neither promises nor guarantees, but are subject to risk and uncertainties that could cause actual results to differ materially from the expectations set forth in the forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors contained herein, and the other risks discussed from time to time in the Company’s other filings with the Securities and Exchange Commission.

 

Future Operating Results Uncertain.  The Company incorporated and shipped its initial facsimile software products in 1991.  In the years ending December 31, 1999, 2000 and 2001 the Company had operating losses and decreasing revenues and in the nine months ended September 30, 2002, the Company had operating losses. There can be no assurance that the Company will be able to increase its level of revenues or return to profitability in the future; as the Company’s operating history makes the prediction of future operating results difficult or impossible.  Increases in operating expenses may continue and, together with pricing pressures and a continued decline in the growth rate of the overall U.S. economy, may result in a continued decrease in operating income and operating margin percentage.  The Company’s ability to improve its operating results will depend upon, among other things, its ability to increase sales of the Company’s secure business-to-business electronic document exchange solutions and client/server facsimile solutions to new customers as well as increased product penetration into existing customers.  The Company commenced its strategic expansion into secure business-to-business electronic document exchange solutions market in the fourth quarter of 2000, and has limited financial and operating data and a limited operating history relevant to these solutions. Accordingly, it is difficult to evaluate the prospects for the level of acceptance of the Company’s secure business-to-business electronic document exchange solutions. Future operating results will depend on many other factors, including, without limitation, the degree and rate of growth of the markets in which the Company competes, the level of acceptance of the Windows NT, Windows 2000 and Windows XP operating systems, the level of product and price competition, the ability of the Company to establish strategic relationships and develop and market new and enhanced products and to control costs, the ability of the Company to expand its direct sales force and indirect distribution channels both domestically and internationally and the ability of the Company to attract and retain key personnel. As a result, it is possible

 

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that in the future the Company’s operating results will be below the expectations of public market analysts and investors.  In such event, the price of the Company’s common stock would likely be materially adversely affected.

 

Product Concentration.  To date, much of the Company’s revenues have been attributable to licenses of the Company’s facsimile-based enterprise solutions and related products and services. The Company expects such products and related services to continue to account for much of the Company’s future revenues. However, recently the amount of revenues attributable to the licenses of such products has declined and there can be no assurances that such decline will not continue. Furthermore, in September 2000, the Company changed its strategic focus to the development of secure business-to-business electronic document exchange solutions. The Company introduced its secure business-to-business electronic document exchange products, Genidocs and Genifax, to the market in the fourth quarter of 2000.  To date, the Company has not recognized a significant amount of revenues from its Genidocs product. The Company expects that its Genidocs product may account for an increasing portion of future revenues. However, there can be no assurances that the Genidocs product will be financially successful or result in any significant revenues. Factors adversely affecting the pricing of or demand for such products, such as competition or technological change, could have a material adverse effect on the Company’s business, financial condition and results of operations. The Company’s prospects must be considered in light of the risks and difficulties frequently encountered by companies dependent upon operating revenues from a new product line in an emerging and rapidly evolving market.

 

New Products and Technological Change.  The markets for the Company’s products are relatively new and are characterized by rapid technological change, evolving industry standards, changes in end-user requirements and frequent new product introductions and enhancements. The Company’s future success will depend upon its ability to enhance its current products and to develop and introduce new products that keep pace with technological developments and respond to evolving end-user requirements. There can be no assurance that the Company will be successful in developing and marketing new products or product enhancements on a timely basis, or that new products or product enhancements developed by the Company, such as the Genidocs and Genifax products will achieve market acceptance. The introduction of products embodying new technologies and the emergence of new industry standards could render the Company’s existing products obsolete and unmarketable. From time to time, the Company and its competitors may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycle of the Company’s existing product offerings. There can be no assurance that announcements of new product offerings by the Company or its competitors will not cause customers to defer or forego the licensing of the Company’s existing or planned products and have a material adverse effect on the Company’s business, financial condition and results of operations.

 

The Market Risks for Secure Business-to-Business Electronic Document Exchange Solutions.  The market for Genidocs, the Company’s secure business-to-business electronic document exchange solution is new and evolving rapidly. The Company’s success will depend upon the adoption and use by current and potential customers of secure business-to-business electronic document exchange solutions. The Company’s success will also depend upon acceptance of its technology as the standard for providing these solutions. The adoption and use of the Company’s secure business-to-business electronic document exchange solution will involve changes in the manner in which businesses have traditionally exchanged information. The Company’s ability to influence usage of its secure business-to-business electronic document exchange solution by customers is limited. The Company intends to spend considerable resources educating potential customers about the value of secure business-to-business electronic document exchange solutions. It is difficult to assess, or to predict with any assurance, the present and future size of the potential market for the Company’s secure business-to-business electronic document exchange solution, or its growth rate, if any. Moreover, the Company cannot predict whether the Company’s secure business-to-business electronic document exchange solution will achieve any market acceptance. Any future products or future product enhancements that are not favorably received by customers may not be profitable and, furthermore, could damage the Company’s reputation or brand name.

 

Dependence on Fax Sr. NT and Genifax Product Lines and the Windows NT/2000 Environment.  The Company currently derives a significant portion of its revenues from licenses of the Fax Sr. NT and Genifax products and related services and resale of related hardware. Continued market acceptance of the Fax Sr. NT and Genifax products are critical to the Company’s future success. As a result, any decline in demand for or failure to maintain broad market acceptance of the Fax Sr. NT and Genifax product lines as a result of competition, technological change or otherwise, would have a material adverse effect on the Company’s business, financial condition and results of operations. The Company’s future financial performance will depend in large part on customer acceptance of the Fax Sr. NT product and new and enhanced versions of the Genifax product.  There can be no assurance that the Company will continue to be successful in marketing the Fax Sr. NT and Genifax products or any new or enhanced versions of the Genifax product. In addition, there can be no assurance that the Windows NT operating system will not be replaced by a new or enhanced operating system. There can be no assurance that the Company

 

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will be successful in developing products for new or enhanced operating systems such as Windows 2000 or Windows XP, or that such systems will not obviate the need for the Company’s products. If any new or enhanced operating system gains widespread use and the Company fails to develop and provide its products for this operating system on a timely basis, the Company’s business, financial condition and results of operations would be materially adversely affected.

 

Dependence on Client/Server Environment.  The Company’s enterprise, client/server facsimile software products are intended to help organizations efficiently manage their facsimile communications, utilizing a client/server computing environment. The client/server market is relatively new and there can be no assurance that organizations will move away from the use of stand–alone fax machines or continue to adopt client/server environments, or that customers of the Company that have begun the migration to a client/server environment will broadly implement this model of computing. The Company’s future financial performance will depend in large part on continued growth in the market for client/server applications, which in turn will depend in part on the growth in the number of organizations implementing client/server computing environments. There can be no assurance that these markets will continue to grow or that the Company will be able to respond effectively to the evolving requirements of these markets. If the market for client/server application products and services does not grow in the future, grows more slowly than the Company anticipates, or if the Company fails to respond effectively to evolving requirements of this market, the Company’s business, financial condition and results of operations would be materially adversely affected.

 

Risks Associated with Delisting From the Nasdaq National Market.  In August 2002, the Nasdaq National Market (“Nasdaq”) informed the Company that its common stock had traded for 30 consecutive trading days below the minimum bid price and that the Company had until November 4, 2002, to demonstrate compliance with Nasdaq’s listing requirements by maintaining a bid price for its common stock of at least $1.00 for a minimum of ten consecutive trading days. The Company has not regained compliance and on October 29, 2002, the Company applied to transfer from the Nasdaq National Market to the SmallCap Market.  As of the date of this Report, Nasdaq has not made a determination on the application. The Company cannot predict the impact, if any, of a change in listing to the SmallCap Market.  If the application is not accepted and the stock is delisted,  the Company’s common stock will be traded on the Over-The-Counter market.  The delisting of the Company’s common stock from Nasdaq may materially impair the stockholder’s ability to buy and sell shares of the Company’s common stock and could have an adverse effect on the market price of, and the efficiency of the trading market for, the Company’s common stock.  Furthermore, the delisting of the Company’s common stock could significantly impair the Company’s ability to raise capital should it desire to do so in the future.

 

Intense Competition.  The secure business-to-business electronic document exchange solution and enterprise, client/server facsimile solution markets are intensely competitive and rapidly changing and the Company expects competition to continue to increase. The Company believes its ability to compete successfully depends upon a number of factors both within and beyond its control, including product performance; reliability and features; product adoption; ease of use; product scalability; quality of support services; price/performance; timeliness of enhancements and new product releases by the Company and its competitors; the emergence of new computer–based facsimile and secure business-to-business electronic document exchange solutions and standards; name recognition; the establishment of strategic alliances with industry leaders and industry and general economic trends.

 

The Company may not be able to compete successfully against current and future competitors in the secure business-to-business electronic document exchange solutions market, and the competitive pressures the Company faces could harm its business and prospects. The Company’s solutions provide an alternative to traditional mail and courier document delivery services, such as those offered, among others, by Federal Express, United Parcel Service or the U.S. Postal Service. The Company’s solution is also an alternative to general-purpose e-mail applications and services. In the area of secure online document exchange, the Company’s competition comes from secure online document exchange services providers. Some of these providers have products that are intended to compete with the Company’s products. Examples of these companies include Pitney Bowes, Sigaba, Tumbleweed, the U.S. Postal Service and Zixit.  In addition, many companies with which the Company does not presently compete may become competitors in the future. This could occur either through the expansion of the Company’s products or through other companies’ product development in the area of secure online communication. These companies could include Documentum, Hummingbird and iManage.  Additionally, companies such as JetForm, PureEdge and Silanis may develop and deliver competitive digital signature products in the future.

 

The Company competes directly with a large number of vendors of facsimile products, including providers of facsimile software products for client/server networks such as RightFAX (a subsidiary of Captaris), Fenestrae, TopCall International and Biscom. The Company also competes with vendors offering a range of alternative facsimile solutions including outsourcing network facsimile solutions, such as Mail.com; operating systems containing facsimile and document transmission features; low-end fax modem products; desktop fax software; single-platform facsimile software products; and

 

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customized proprietary software solutions. In addition, providers of operating systems or business software applications may decide to bundle competitive facsimile solutions as part of their broader product offerings.

 

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

 

Fluctuations in Quarterly Results of Operations; Seasonality.  The Company’s quarterly revenues and results of operations have fluctuated significantly in the past and will likely fluctuate significantly in the future. Causes of such fluctuations have included and may include, among others, the demand for the Company’s products and services; the size and timing of orders; the number, timing and significance of new product announcements by the Company and its competitors; the ability of the Company to develop, introduce, market and ship new and enhanced versions of the Company’s current and planned products on a timely basis; the level of product and price competition; changes in operating expenses; changes in average selling prices and mix of the Company’s products; changes in the Company’s sales incentive strategy; the mix of direct and indirect sales, and general economic factors, including a continued decline in the growth rate of the overall U.S. economy. In addition, the sale of the Company’s products often involves delays because customers tend to implement the products on a large scale and they also must establish certain minimum hardware capabilities. The Company’s products therefore often have a lengthy sales cycle while the customer evaluates and receives approvals for the purchase of the Company’s products. During such sales cycles, the Company may expend substantial funds and management efforts yet receive no revenues. It is difficult to accurately predict the sales cycle of any large order. If one or more large orders fail to close as forecasted in a fiscal quarter, the Company’s revenues and operating results for such quarter could be materially adversely affected. Any one or more of these or other factors could have a material adverse effect on the Company’s business, financial condition and results of operations. The potential occurrence of any one or more of these factors makes the prediction of revenues and results of operations on a quarterly basis difficult and performance forecasts derived from such predictions unreliable.

 

In general, revenues are difficult to forecast because the market for secure business-to-business electronic document exchange and enterprise client/server facsimile solutions software is evolving rapidly and the Company’s sales cycle—from the customer’s initial evaluation through purchase of licenses and the related support services—varies substantially from customer to customer. License fee revenues in any quarter depend on orders received and shipped in that quarter with an increasing percentage of orders in any quarter being received in the last weeks of the quarter.  License fee revenues from quarter to quarter are difficult to forecast, as no significant order backlog exists at the end of any quarter because the Company’s products typically are shipped upon receipt of customers’ orders.

 

A substantial portion of the Company’s operating expense is related to personnel, facilities, equipment and marketing programs. The level of spending for such expense cannot be adjusted quickly and is therefore fixed in the short term. The Company’s expense levels for personnel, facilities, equipment and marketing programs are based, in significant part, on the Company’s expectations of future revenues on a quarterly basis. If actual revenue levels on a quarterly basis are below management’s expectations, results of operations are likely to be adversely affected by a similar amount because a relatively small amount of the Company’s expense varies with its revenue in the short term.

 

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

 

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

 

The distributor agreements generally provide that either party may terminate the agreement without cause upon 30 days written notice to the other party.  The Company also resells its products on a purchase order basis through other VARs, systems integrators and distributors.  Either party may terminate such relationships, at any time, and therefore there can be no assurance that any VAR, systems integrator or distributor will continue to represent the Company’s products.  Furthermore, the Company’s strategic alliances may be terminated by either party, at any time; there can be no assurances that such strategic alliances will continue.  The inability to retain certain VARs, systems integrators, distributors or strategic business partners, or the development or marketing by VARs, systems integrators, distributors or strategic business partners of competitive offerings, could have a material adverse effect on the Company’s business, financial condition and results of operations.

 

Selling through indirect channels may limit the Company’s contacts with its customers.  As a result, the Company’s ability to accurately forecast sales, evaluate customer satisfaction and recognize emerging customer requirements may be hindered. The Company’s strategy of marketing its products directly to end-users and indirectly through VARs, systems integrators and distributors may result in distribution channel conflicts. The Company’s direct sales efforts may compete with those of its indirect channels and, to the extent different resellers target the same customers, resellers may also come into conflict with each other. As the Company strives to expand its indirect distribution channels, there can be no assurance that emerging channel conflicts will not materially adversely affect its relationships with existing VARs, systems integrators or distributors or adversely affect its ability to attract new VARs, systems integrators and distributors.

 

Risks Associated with Acquisitions.  The Company may augment its internal growth with acquisitions of businesses, products and technologies that could complement or expand the Company’s business. Certain of these businesses may be marginally profitable or unprofitable. In order to achieve anticipated benefits from these acquisitions, the Company must successfully integrate the acquired businesses with its existing operations and no assurance can be given that the Company will be successful in this regard. The Company has limited experience in integrating acquired companies into its operations, in expanding the scope of operations of required businesses, in managing geographically dispersed operations and in operating internationally. In the past the Company has incurred one-time costs and expenses in connection with acquisitions and it is likely that similar one-time costs and expenses would be incurred in connection with future acquisitions.  In addition, attractive acquisitions are difficult to identify and complete for a number of reasons, including competition among prospective buyers and the possible need to obtain regulatory approval. There can be no assurance that the Company will be able to complete future acquisitions. In order to finance such acquisitions, it may be necessary for the Company to raise additional funds either through public or private financings, including bank borrowings.  Any financing, if available at all, may be on terms which are not favorable to the Company.  The Company may also issue shares of its common stock to acquire such businesses, which may dilute the Company’s existing stockholders.

 

Ability to Manage Growth.  The Company may expand its operations and anticipates that expansion may be required in order to address potential market opportunities. The Company may increase the size of its sales and marketing and research and development expenditures as necessary. There can be no assurance that such expansion would be completed successfully or that it would generate sufficient revenues to cover the Company’s expenses. The Company will need to continue to attract and retain highly qualified technical, sales and managerial personnel. There can be no assurance that the Company will be able to retain or continue to hire such personnel in the future. The inability of the Company to effectively expand operations and manage growth, if any, could have a material adverse effect on the Company’s business, financial condition and results of operations.

 

Risks Associated with International Expansion.  An element of the Company’s strategy is to continue to maintain its international sales. The Company expects to face competition from secure business-to-business electronic document exchange solutions and local facsimile product providers in their native countries. To successfully maintain international sales, the

 

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Company needs to recruit and retain additional international resellers and distributors. There can be no assurance that the Company will be able to maintain international sales of its products or that the Company’s international distribution channels will be able to adequately market, service and support the Company’s products. International operations generally are subject to certain risks, including dependence on independent resellers, fluctuations in foreign currency exchange rates, compliance with foreign regulatory and market requirements, variability of foreign economic conditions and changing restrictions imposed by United States export laws. Additional risks inherent in the Company’s international business activities generally include unexpected changes in regulatory requirements, tariffs and other trade barriers, costs of localizing products for foreign countries, lack of acceptance of localized products in foreign countries, longer accounts receivable payment cycles, difficulties in managing international operations, difficulties in enforcing intellectual property rights and the burdens of complying with a wide variety of foreign laws.  The Company has a sales office outside of the United States, such operations are subject to certain additional risks, including difficulties in staffing and managing such operations and potentially adverse tax consequences including restrictions on the repatriation of earnings. There can be no assurance that such factors will not have a material adverse effect on the Company’s future international sales and, consequently, the Company’s business, financial condition and results of operations. To date, a majority of the Company’s sales have been made in United States dollars and the Company has not engaged in any hedging transactions through the purchase of derivative securities or otherwise.

 

Dependence on Key Personnel.  The Company’s future performance depends, in significant part, upon the continued service of its key technical, sales and senior management personnel, most of whom are not bound by an employment agreement or by a noncompetition agreement. The loss of the services of one or more of the Company’s executive officers or other key employees could have a material adverse effect on the Company’s business, financial condition and results of operations. The Company’s future success also depends on its continuing ability to attract and retain highly qualified technical, sales and managerial personnel. Competition for such personnel is intense, and the Company has experienced difficulty in recruiting qualified technical personnel. There can be no assurance that the Company will be able to retain or continue to hire key technical, sales and managerial personnel in the future.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

 

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

 

As of September 30, 2002, the Company did not participate in any derivative financial instruments or other financial and commodity instruments for which fair value disclosure would be required under SFAS No. 107, Disclosures about Fair Value of Financial Instruments. All of the Company’s investments consist of money market funds and municipal bonds that are carried on the Company’s books at amortized cost, which approximates fair market value. Accordingly, the Company has no quantitative information concerning the market risk of participating in such investments.

 

Primary Market Risk Exposures

 

The Company’s primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk. The Company’s investment portfolio of cash equivalent and short-term investments is subject to interest rate fluctuations, but the Company believes this risk is immaterial due to the short-term nature of these investments. The Company’s exposure to currency exchange rate fluctuations has been and is expected to continue to be modest due to the fact that the operations of its United Kingdom subsidiary are almost exclusively conducted in its local currency. The United Kingdom subsidiary operating results are translated into U.S. dollars and consolidated for reporting purposes. The impact of currency exchange rate movements on intercompany transactions was immaterial for the quarter ended September 30, 2002. Currently the Company does not engage in foreign currency hedging activities.

 

Item 4. Controls and Procedures

 

(a) Evaluation of disclosure controls and procedures.

 

As of a date (the “Evaluation Date”) within ninety days prior to the filing date of this Quarterly Report on Form 10-Q, the Company, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures are effective in ensuring that information relating to the Company (including its consolidated subsidiaries) required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, including ensuring that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

(b) Changes in internal controls

There were no significant changes in the Company’s internal controls or in other factors that could significantly affect the Company’s internal controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

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PART II:  OTHER INFORMATION

 

Item 6.                         Exhibits and Reports on Form 8-K

 

(a)                      Exhibits

10.11	Offer Letter with Michael Sheehy
10.12	Severence Eligibility Letter with Michael Sheehy
99.1	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.
99.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)                     Reports on Form 8-K

 

None

 

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OMTOOL, LTD.

 

Signatures

 

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

 

	OMTOOL, LTD.
November 13, 2002	By:	/s/ Timothy P. Losik
		Timothy P. Losik
		Vice President, Chief Financial Officer, Chief Operating Officer, Secretary and Treasurer

 

 

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CERTIFICATIONS

 

I, Robert L. Voelk, certify that:

 

1.                                       I have reviewed this quarterly report on Form 10-Q of Omtool, Ltd.;

 

2.                                       Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.                                       Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.                                       The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b)                                     Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)                                      Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors:

 

a)                                      All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weakness in internal controls; and

 

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b)                                     Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.                                       The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date: November 13, 2002
	By:	/s/ Robert L. Voelk
		Robert L. Voelk
		Chief Executive Officer

 

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I, Timothy P. Losik, certify that:

 

1.                                       I have reviewed this quarterly report on Form 10-Q of Omtool, Ltd.;

 

2.                                       Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

3.                                       Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

4.                                       The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

b)                                     Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)                                      Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

5.                                       The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors:

 

a)                                All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weakness in internal controls; and

 

b)                                     Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

6.                                       The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Date: November 13, 2002
	By:	/s/ Timothy P. Losik
		Timothy P. Losik
		Chief Financial Officer

 

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