OMTOOL LTD - 10-Q Quarterly Report

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 June 30, 2003

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)

Delaware		02-0447481
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)

8A Industrial Way, Salem, NH		03079
(Address of Principal Executive Offices)		(Zip Code)

(603) 898-8900
(Registrant’s Telephone Number Including Area Code)

Indicate by check mark whether the Registrant has: (1) filed all reports required to be filed by Section 13 or 15(d) of the 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 1,750,006 shares of the Company’s Common Stock, par value $0.01, outstanding on August 7, 2003.

OMTOOL, LTD. AND SUBSIDIARIES

FORM 10-Q

For the Quarter Ended June 30, 2003

CONTENTS

Item Number

PART I: FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Consolidated Balance Sheets as of June 30, 2003 (Unaudited) and December 31, 2002

Consolidated Statements of Operations for the three months and six months ended June 30, 2003 and 2002 (Unaudited)

Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002 (Unaudited)

Notes to Consolidated Financial Statements

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

PART II: OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

Item 6. Exhibits and Reports on Form 8-K

Signatures

PART I: FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

OMTOOL, LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	June 30, 2003			December 31, 2002
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	8,383,209		$	8,192,523
Short-term investments	—			1,597,155
Accounts receivable, less reserves of $472,000 at June 30, 2003 and $615,000 at December 31, 2002	1,369,693			1,664,849
Inventory – finished goods	164,493			187,918
Prepaid expenses and other current assets	228,021			420,083
Total current assets	10,145,416			12,062,528

Property and equipment, net	554,154			615,703
Other assets	13,962			13,962

Total assets	$	10,713,532		$	12,692,193

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	1,061,600		$	1,019,584
Accrued liabilities	1,591,383			1,665,046
Accrued state sales tax	976,272			1,275,735
Deferred revenue	3,173,117			3,397,568
Total current liabilities	6,802,372			7,357,933

Stockholders’ equity:
Preferred Stock, $.01 par value —
Authorized — 2,000,000 shares; Issued and outstanding — none	—			—
Common Stock, $.01 par value —
Authorized — 35,000,000 shares; Issued — 1,858,482 shares at June 30, 2003 and December 31, 2002, Outstanding — 1,746,113 and 1,744,542 shares at June 30, 2003 and December 31, 2002, respectively	18,585			18,585
Additional paid-in capital	31,980,616			31,990,720
Accumulated deficit	(27,095,729		)	(25,671,834		)
Treasury stock, at cost (112,369 shares at June 30, 2003 and 113,940 shares at December 31, 2002)	(911,826		)	(924,570		)
Accumulated other comprehensive loss	(80,486		)	(78,641		)
Total stockholders’ equity	3,911,160			5,334,260

Total liabilities and stockholders’ equity	$	10,713,532		$	12,692,193

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

OMTOOL, LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2002
Revenues:
Software license	$	1,110,787		$	862,591		$	1,988,278		$	2,141,412
Hardware	611,131			648,258			1,117,339			1,431,299
Service and other	1,609,867			1,780,658			3,208,323			3,681,420

Total revenues	3,331,785			3,291,507			6,313,940			7,254,131

Cost of revenues:
Software license	96,780			78,632			150,815			152,845
Hardware	451,330			443,701			799,520			960,817
Service and other	805,646			829,127			1,597,400			1,599,177

Total cost of revenues	1,353,756			1,351,460			2,547,735			2,712,839

Gross profit	1,978,029			1,940,047			3,766,205			4,541,292

Operating expenses:
Sales and marketing	1,336,674			1,875,410			2,668,522			3,522,240
Research and development	587,516			863,484			1,172,121			1,695,925
General and administrative	826,418			1,398,586			1,558,218			2,659,143

Total operating expenses	2,750,608			4,137,480			5,398,861			7,877,308

Loss from operations	(772,579		)	(2,197,433		)	(1,632,656		)	(3,336,016		)

Interest and other income, net	14,095			46,490			53,363			97,671

Loss before tax provision (benefit)	(758,484		)	(2,150,943		)	(1,579,293		)	(3,238,345		)

Tax provision (benefit)	—			1,225,350			(155,398		)	1,225,350

Net loss	$	(758,484	)	$	(3,376,293	)	$	(1,423,895	)	$	(4,463,695	)

Net loss per share
Basic and Diluted	$	(0.43	)	$	(1.86	)	$	(0.82	)	$	(2.46	)

Weighted average number of common shares outstanding
Basic and diluted	1,746,113			1,814,893			1,746,043			1,814,657

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

OMTOOL, LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six months ended June 30,
	2003			2002
Cash Flows from Operating Activities:
Net loss	$	(1,423,895	)	$	(4,463,695	)
Adjustments to reconcile net loss to net cash used in operating activities–
Depreciation and amortization	227,051			267,470
Deferred taxes	—			1,225,350
Accounts receivable reserve	(146,746		)	80,000
Changes in assets and liabilities–
Accounts receivable	450,142			434,457
Prepaid expenses and other current assets	193,607			170,575
Inventory	23,863			(123,911		)
Accounts payable	39,250			(161,332		)
Accrued liabilities	(80,498		)	257,102
Accrued state sales tax	(299,463		)	549,376
Deferred revenue	(236,111		)	(133,811		)

Net cash used in operating activities	(1,252,800		)	(1,898,419		)

Cash Flows from Investing Activities:
Purchases of property and equipment	(164,603		)	(186,509		)
Purchases of short-term investments	(1,999,449		)	—
Proceeds from sale of short-term investments	3,596,604			1,296,750

Net cash provided by investing activities	1,432,552			1,110,241

Cash Flows from Financing Activities:
Net proceeds from issuance of common stock	2,640			10,893
Purchases of treasury stock	—			(5,339		)

Net cash provided by financing activities	2,640			5,554

Foreign exchange effect on cash	8,294			18,137

Net increase (decrease) in cash and cash equivalents	190,686			(764,487		)

Cash and cash equivalents, beginning of period	8,192,523			11,194,118

Cash and cash equivalents, end of period	$	8,383,209		$	10,429,631

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

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, 2002 as filed with the SEC on March 11, 2003. 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 six month period ended June 30, 2003 are not necessarily indicative of the results to be expected for the full fiscal year.

The Company’s total revenues for the first six months of 2003 declined 13% from total revenues for the first six months of 2002 primarily due to the general decline in information technology spending and a decrease in demand for enterprise software solutions. This decrease reflected the overall sluggishness of the United States economy in the first six months of 2003 causing customers and prospective customers to defer technology purchases. However, the Company’s combined software and hardware revenues for the three months ended June 30, 2003 were higher than the combined software and hardware revenues for the three months ended June 30, 2002. The increased revenue was due primarily to the recognition of previously deferred revenue and an increase in sales bookings. The Company’s net loss improved from $4.5 million for the six months ended June 30, 2002 to $1.4 million for the six months ended June 30, 2003 due primarily to reduced operating expenses associated with a reduction in the Company’s workforce and a $1.2 million tax provision recognized in the second quarter of 2002. The Company has experienced declining revenues and 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 limited forecasting visibility, the Company cannot predict that the financial and operating performance, financial position or cash flow will improve over the next twelve months. The Company’s cash and cash equivalents at June 30, 2003 were $8.4 million. The Company anticipates that its balance of cash and cash equivalents will be approximately $7 million at the end of the third quarter of 2003. 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 months ended June 30, 2003 and June 30, 2002 exclude the potential common shares related to 375,580 and 344,145, respectively, outstanding stock options because to include them would have been antidilutive for the periods presented.

(3) Income Taxes

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 continued economic uncertainty, the Company has provided a full valuation allowance against all of its net deferred tax assets and will do so 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.

During the six months ended June 30, 2003, the Company recorded $155,398 of tax benefit due to a tax refund that its United Kingdom subsidiary received during the first quarter of 2003. This subsidiary had incurred a loss for the year ended

December 31, 1999 which resulted in an income tax benefit. The tax benefit was carried back to prior years’ taxes paid and resulted in a tax refund. Because the subsidiary was undergoing an Inland Revenue audit for tax year 1999, there existed doubt about the realizability of this refund and the Company did not record the benefit on its books until the audit was cleared and the cash was received, both of which occurred in the first quarter of 2003.

During the quarter ended June 30, 2002, the Company recorded an additional valuation allowance of $1.2 million against all of its net deferred tax assets. As a result of the downturn in the economy in the first half of 2002, the Company had incurred significant and previously unanticipated losses and the outlook indicated that significant uncertainty would continue for the remainder of that fiscal year and into the following fiscal year. These cumulative losses, together with the Company’s prior losses, resulted in management’s decision that it was more likely than not that all of its deferred tax assets would not be realized in the then foreseeable future. Accordingly, the remaining net deferred tax asset was written off in the second quarter of 2002.

(4) Comprehensive Loss

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

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2003
Net loss	$	(758,484	)	$	(3,376,293	)	$	(1,423,895	)	$	(4,463,695	)
Foreign currency translation adjustments	32,015			(7,575		)	(1,845		)	(1,645		)
Comprehensive loss	$	(726,469	)	$	(3,383,868	)	$	(1,425,740	)	$	(4,465,340	)

(5) Stock Based Compensation

The Company accounts for stock-based compensation for employees under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

	Three months Ended June 30,						Six months Ended June 30,
	2003			2002			2003			2002

Net loss, as reported	$	(758,484	)	$	(3,376,293	)	$	(1,423,895	)	$	(4,463,695	)
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards	(174,188		)	(259,237		)	(440,182		)	(509,857		)
Pro forma net loss	$	(932,672	)	$	(3,635,530	)	$	(1,864,077	)	$	(4,973,552	)

Net loss per share:
Basic and diluted, as reported	$	(0.43	)	$	(1.86	)	$	(0.82	)	$	(2.46	)
Basic and diluted, pro forma	$	(0.53	)	$	(2.00	)	$	(1.07	)	$	(2.74	)

(6) 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 $717,000 and $1.2 million for the three months and six months ended June 30, 2003 and $509,000 and $1.3 million for the three months and six months ended June 30, 2002, 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 June 30,				Six months ended June 30,
Total revenues (1)	2003		2002		2003		2002
United States	$	2,615,274	$	2,782,918	$	5,156,653	$	5,988,679
Europe	533,711		345,748		884,208		838,187
Rest of World	182,800		162,841		273,079		427,265
	$	3,331,785	$	3,291,507	$	6,313,940	$	7,254,131

Long-lived assets (2)	June 30, 2003		December 31, 2002
United States	$	547,439	$	600,116
United Kingdom	20,677		29,549
	$	568,116	$	629,665

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

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

(7) Guarantees

In November 2002, the FASB issued FASB Interpretation 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”). FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, and of the obligations it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor’s obligations does not apply to product warranties or to guarantees accounted for as derivatives. The disclosure requirements are effective for financial statements issued after December 15, 2002 and the recognition/measurement requirements are effective on a prospective basis for guarantees issued or modified after December 31, 2002. The following is a summary of the Company’s agreements that it has determined are within the scope of FIN 45.

As permitted under Delaware law, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was serving, at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a Director and Officer insurance policy that limits its exposure and enables it to recover a portion of any future amounts paid. As a result of its insurance policy coverage, the Company believes that the estimated fair value of these indemnification agreements is minimal.

The Company enters into standard indemnification agreements in its ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally its resellers or certain customers, in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to its products. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes that the estimated fair value of these agreements is minimal.

The Company warrants that its software products will perform in all material respects in accordance with its standard published specifications in effect at the time of delivery of the licensed products to certain of its customers for the life of the product. If necessary, the Company would provide for the estimated cost of product warranty based on specific warranty claims and claim history, however, the Company has never incurred significant expense under its product warranty. As a result, the Company believes that the estimated fair value on these agreements is minimal.

(8) Recently Issued Accounting Standards

In November 2002, the FASB Emerging Issues Task Force released Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. EITF 00-21 establishes three principles: (a) revenue arrangements with multiple deliverables should be divided into separate units of accounting; (b) arrangement consideration should be allocated among the separate units of accounting based on their relative fair values; and (c) revenue recognition criteria should be considered separately for separate units of accounting. EITF 00-21 is effective for all arrangements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. The Company is currently reviewing and evaluating the scope of EITF 00-21, but does not expect the adoption of EITF 00-21 will have a material impact on the Company’s financial statements.

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 11, 2003.

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 AccuRoute™ software enables users to deliver a hardcopy document from certain digital scanning and multifunctional devices to multiple recipients, via multiple channels, simultaneously using a method that is as simple as using a photocopier. The multiple channels consist of fax, e-mail, or a document management system. 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 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 for the foreseeable future, 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, 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.

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, revenue 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 15% and 13% of the Company’s total revenues for the six months ended June 30, 2003 and 2002, 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. 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 represented 23% and 20% of the Company’s total revenues for the six months ended June 30, 2003 and 2002, respectively.

Critical Accounting Policies and Estimates

The Company has identified the policies and estimates 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 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 does not have a favorable report or the Company does not have enough credit information to determine 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. Management’s calculation of the estimated return reserve is based upon (1) an account specific review of potential returns, where a return probability is known, and (2) a general estimate based upon past historical returns as a percentage of revenue. 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 receivable. 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. Management’s calculation of the estimated accounts receivable reserve is based upon (1) an account specific review of potential uncollectible accounts, where a bad debt probability is known and (2) a general estimate based upon past historical bad debts as a percentage of accounts receivable.

The Company’s combined accounts receivable and returns reserve was $472,000 and $716,000 as of June 30, 2003 and 2002, respectively. Both components of calculating the estimated reserve, specific identification and historic ratio, are material judgments. These judgments are based on historic trends, taking into consideration current business and economic

conditions, which could change materially, thus changing the required reserve level materially. The potential change could be positive, in the event the reserve estimate proves unnecessary, or negative, if the reserve proves inadequate.

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

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 software development costs to operations in the period incurred.

Taxes. The Company is required to estimate its income and state sales taxes. This process involves estimating the Company’s actual current tax obligations together with assessing differences resulting from the different treatment of items for tax and accounting purposes which result in deferred income tax assets and liabilities and accrued state sales tax liabilities. The Company has deferred income tax assets and liabilities and accrued state sales tax 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.

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.

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

Results of Operations

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

	Three months ended June 30,				Six months ended June 30,
	2003		2002		2003		2002
Revenues:
Software license	33.3	%	26.2	%	31.5	%	29.5	%
Hardware	18.3		19.7		17.7		19.7
Service and other	48.4		54.1		50.8		50.8
Total revenues	100.0		100.0		100.0		100.0
Cost of revenues:
Software license	2.9		2.4		2.4		2.1
Hardware	13.5		13.5		12.7		13.2
Service and other	24.2		25.2		25.3		22.1
Total cost of revenues	40.6		41.1		40.4		37.4
Gross profit	59.4		58.9		59.6		62.6
Operating expenses:
Sales and marketing	40.2		57.0		42.2		48.5
Research and development	17.6		26.2		18.6		23.4
General and administrative	24.8		42.5		24.7		36.7
Total operating expenses	82.6		125.7		85.5		108.6
Loss from operations	(23.2	)	(66.8	)	(25.9	)	(46.0	)
Interest and other income, net	0.4		1.4		0.8		1.3
Tax benefit (provision)	—		(37.2	)	2.5		(16.9	)

Net loss	(22.8	)%	(102.6	)%	(22.6	)%	(61.5	)%

Gross profit:
Software license	91.3	%	90.9	%	92.4	%	92.9	%
Hardware	26.1		31.6		28.4		32.9
Service and other	50.0		53.4		50.2		56.6

Three Months Ended June 30, 2003 and 2002

Revenues

Total Revenues. The Company’s total revenues were $3.3 million for each of the three months ended June 30, 2003 and 2002.

Software License. Software license revenues for the three months ended June 30, 2003 are comprised of the following: 95% from the Company’s fax related product lines and 5% from its non-fax related product lines. Revenues for the three months ended June 30, 2002 are comprised of the following: 91% from the Company’s fax related product lines and 9% from its non-fax related product lines. Software license revenues were $1.1 million for the three months ended June 30, 2003 and $863,000 for the three months ended June 30, 2002, representing an increase of 29%. Software license revenues accounted for 33% and 26% of total revenues for each respective period. The increase in software license revenue in dollars and as a percentage of total revenues is primarily the result of recognizing previously deferred revenue and an increase in sales bookings.

Hardware. Hardware revenues were $611,000 for the three months ended June 30, 2003 and $648,000 for the three months ended June 30, 2002, representing a decrease of 6%. Hardware revenues accounted for 18% and 20% of total revenues for each respective period. The decrease in hardware revenues was due primarily to a change in the particular mix of products sold in the three month period ended June 30, 2003 resulting in a decrease in accompanying hardware sales. The decrease in hardware revenue as a percentage of total revenues is a result of higher relative software revenues in the second quarter of 2003 compared to the second quarter of 2002.

Service and Other. Service and other revenues were $1.6 million for the three months ended June 30, 2003 and $1.8 million for the three months ended June 30, 2002, representing a decrease of 10%. Service and other revenues accounted for 48% and 54% of total revenues for each respective period. The decrease in service and other revenues is due primarily to continuing decreases in software maintenance and support revenues. The decrease in service and other revenues as a percent of total revenues is due primarily to the increase in software license revenue, resulting in a decreased percentage in service revenue to total revenue.

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 $97,000 and $79,000 for the three months ended June 30, 2003 and 2002, respectively, representing an increase of 23%. The increase is due to the increase in software sales as software license gross margin percentages were 91% for each respective period.

Hardware. Cost of hardware revenues consists primarily of the costs of third-party hardware products. Cost of hardware revenues was $451,000 and $444,000 for the three months ended June 30, 2003 and 2002, respectively, representing 74% and 68% of hardware revenues for each respective period. The increase in dollar amount for the cost of hardware revenues was due primarily to the increase of hardware unit sales accompanying the Company’s products as well as a $20,000 reserve for potentially obsolete inventory. The gross margin percentage for hardware sales was 26% and 32% for each of the three month periods ended June 30, 2003 and 2002 due to a change in the mix of hardware products sold.

Service and Other. Cost of service and other revenues consists primarily of the costs incurred in providing telephone support as well as other miscellaneous customer service-related expenses. Cost of service and other revenues was $806,000 and $829,000 for the three months ended June 30, 2003 and 2002, respectively, representing 50% and 47% of service and other revenues for each respective period. The gross margin percentage for service and other revenues decreased to 50% for the three months ended June 30, 2003, compared to 53% in the same period in 2002. The decrease in gross margin is due to decreased support revenues while the infrastructure cost remained consistent. The decrease in the cost of service and other revenues was due primarily to a decrease in travel related expenses in the installation services area.

Operating Expenses

Sales and Marketing. Sales and marketing expenses consist primarily of employee salaries, benefits, commissions, and associated overhead costs, and 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 $1.9 million for the three months ended June 30, 2003 and 2002, respectively, or 40% and 57% of total revenues for each respective period. The decrease in dollar amount was due to a decrease in the number of sales personnel and their associated costs, a decrease in advertising expenses during the quarter and the absence of severance related expenses incurred in 2002. The Company expects sales and marketing expenses to remain consistent in absolute dollars.

Research and Development. Research and development expenses include expenses associated with the development of new products, enhancements of existing products and quality assurance activities. These expenses consist primarily of employee salaries, benefits, associated overhead costs, consulting expenses and the cost of software development tools. Research and development expenses were $588,000 for the three months ended June 30, 2003 and $863,000 for the three months ended June 30, 2002, representing 18% and 26% of total revenues for each respective period. The decrease in the expense and in the expense as a percent of total revenues was due to a fewer number of employees in the research and development department as well as the absence of severance related expenses incurred in 2002. The Company expects research and development expenses to remain consistent in absolute dollars.

General and Administrative. General and administrative expenses consist primarily of employee salaries, benefits for administrative, executive and finance personnel and associated corporate general and administrative expenses. General and administrative expenses were $826,000 and $1.4 million for the three months ended June 30, 2003 and 2002, respectively, or 25% and 43% of total revenues for each period. The decrease in dollar amount and percent of total revenues is due to the reduction in the number of general and administrative personnel and overhead costs associated with supporting such personnel, a decrease in management consulting expenses and a decrease in state sales tax accruals during the quarter. The Company expects general and administrative expenses to remain consistent in absolute dollars.

Interest and other Income, net. Interest and other income, net consists principally of interest income, net earned on cash balances. Interest and other income, net was $14,000 for the three months ended June 30, 2003 and $46,000 for the three months ended June 30, 2002. The decrease in interest and other income, net is due to changes in principal balances of the Company’s investments combined with a currency exchange loss that was recognized during the quarter.

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

Six Months Ended June 30, 2003 and 2002

Revenues

Total Revenues. The Company’s total revenues were $6.3 million for the six months ended June 30, 2003 and $7.3 million for the six months ended June 30, 2002.

Software License. Software license revenues for the six months ended June 30, 2003 are comprised of the following: 95% from its fax related product lines and 5% from its non-fax related product lines. Revenues for the six months ended June 30, 2002 are comprised of the following: 91% from its fax related product lines and 9% from its non-fax related product lines. Software license revenues were $2.0 million for the six months ended June 30, 2003 and $2.1 million for the six months ended June 30, 2002, representing a decrease of 7%. The decline in software license revenue can be attributed to a number of factors that had an impact on first quarter results such as a general decline in information technology spending, a decrease in demand for enterprise software solutions and continued sluggishness of the United States economy causing customers and prospective customers to defer technology purchases. However, this decline was partially offset by increased sales bookings in the second quarter of 2003 compared to the second quarter of 2002. Software license revenues accounted for 32% and 30% of total revenues for each respective six month period. The increase in software license revenue as a percentage of total revenues is a result of lower relative service and other revenues in the first two quarters of 2003 compared to the first two quarters of 2002.

Hardware. Hardware revenues were $1.1 million for the six months ended June 30, 2003 and $1.4 million for the six months ended June 30, 2002, representing a decrease of 22%. Hardware revenues accounted for 18% and 20% of total revenues for each respective period. The decrease in hardware revenues was due primarily to the decrease in the number of software license transactions in the six month period ended June 30, 2003 resulting in a decrease in accompanying hardware sales. The decrease in hardware revenue as a percentage of total revenues is a result of lower hardware revenues in the first two quarters of 2003 compared to the first two quarters of 2002, as well as the increase in software license revenue.

Service and Other. Service and other revenues were $3.2 million for the six months ended June 30, 2003 and $3.7 million for the six months ended June 30, 2002, representing a decrease of 13%. Service and other revenues accounted for 51% of total revenues for each respective period. The decrease in service and other revenues is due primarily to decreases in software maintenance, support revenues and consulting service revenues. Service and other revenues did not change as a percent of total revenues due to the fact that service and other revenue declined in the same percentage as total revenue in the first two quarters of 2003 compared to the first two quarters of 2002.

Cost of Revenues

Software License. Cost of software license revenues was $151,000 and $153,000 for the six months ended June 30, 2003 and 2002, respectively, representing a decrease of 1%. The decrease in the cost of software license revenue is due to decreased production expenses. Cost of software license revenues as a percentage of software license revenue was 8% and 7% for each respective period. Software license gross margin percentages were 92% and 93% for the six month periods ended June 30, 2003 and June 30, 2002.

Hardware. Cost of hardware revenues was $800,000 and $961,000 for the six months ended June 30, 2003 and 2002, respectively, representing 72% and 67% of hardware revenues for each respective period. The decrease in dollar amount for the cost of hardware revenues was due primarily to the decrease of hardware unit sales accompanying the Company’s products. The gross margin percentage for hardware sales was 28% and 33% for each of the six month periods ended June 30, 2003 and 2002 which represents a change in the mix of hardware products sold and a $20,000 reserve for potentially obsolete inventory in the second quarter of 2003.

Service and Other. Cost of service and other revenues was $1.6 million for each of the six month periods ended June 30, 2003 and 2002, respectively, representing 50% and 43% of service and other revenues for each respective period. The gross margin percentage for service and other revenues decreased to 50% for the six months ended June 30, 2003, compared to 57% in the same period in 2002. The decrease in gross margin percentage was due primarily to the decrease in service and other revenue while the infrastructure cost remained relatively flat in the first six months of 2003 as compared to the first six months of 2002.

Operating Expenses

Sales and Marketing. Sales and marketing expenses were $2.7 million and $3.5 million for the six months ended June 30, 2003 and 2002, respectively, or 42% and 49% of total revenues for each respective period. The decrease in dollar amount was due to a decrease in the number of sales personnel and their associated costs, the absence of severance related expenses incurred in 2002 and a decrease in advertising expenses during the first two quarters of 2003. The Company expects sales and marketing expenses to remain consistent in absolute dollars.

Research and Development. Research and development expenses were $1.2 million for the six months ended June 30, 2003 and $1.7 million for the six months ended June 30, 2002, representing 19% and 23% of total revenues for each respective period. The decrease in the expense and in the expense as a percent of total revenues was due to a decrease in the number of research and development personnel, the absence of severance related expenses incurred in 2002 and a decrease in consulting expenses. The Company expects research and development expenses to remain consistent in absolute dollars.

General and Administrative. General and administrative expenses were $1.6 million and $2.7 million for the six months ended June 30, 2003 and 2002, respectively, or 25% and 37% of total revenues for each period. The decrease in dollar amount and as a percent of total revenues is due a decrease in the number of general and administrative personnel and overhead costs associated with supporting such personnel, a decrease in management consulting expenses and a decrease in state sales tax accruals. The Company expects general and administrative expenses to remain consistent in absolute dollars.

Interest and other Income, net. Interest and other income, net consists principally of interest income earned on cash balances. Interest and other income, net was $53,000 for the six months ended June 30, 2003 and $98,000 for the six months ended June 30, 2002. The decrease is due to changes in principal balances of the Company’s investments combined with a currency exchange loss that was recognized during the second quarter of 2003.

Tax Provision. During the six months ended June 30, 2003, the Company recorded a $155,398 tax benefit which resulted from a tax refund that its United Kingdom subsidiary received during the first quarter of 2003. This subsidiary had incurred a loss for the fiscal year ended December 31, 1999 which resulted in an income tax benefit. The tax benefit was carried back to prior years’ taxes paid and resulted in a tax refund. Because the subsidiary was undergoing an Inland Revenue audit for tax year 1999, the realizability of this refund was not certain and therefore the Company did not record the benefit on its books until the audit was cleared and the cash was received, both of which occurred in the first quarter of 2003.

The Company recorded a provision of $1.2 million against the valuation of its net deferred tax asset in the six months ended June 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 June 30, 2003, the Company had cash and cash equivalents of $8.4 million and working capital of $3.3 million.

The Company’s operating activities used cash of $1.3 million and $1.9 million for the six months ended June 30, 2003 and 2002, respectively. Net cash used during the six months ended June 30, 2003 consisted primarily of a net loss from operations and decreases in deferred revenue; accrued sales tax and accounts receivable reserve offset by depreciation and amortization; and a decrease to accounts receivable, prepaids and other current assets. The decrease in deferred revenue is due primarily to the recognition of previously deferred revenue during the first six months of 2003. The decrease to accrued sales tax is due to payments made to various states in the first two quarters of 2003 for sales taxes due. The decrease to the accounts receivable reserve is due primarily to the collection of certain accounts for which management had previously specifically reserved. The decline in the accounts receivable balance is a function of decreased sales activities as well as continued efforts by management to continue to improve its working capital by expediting the collection of accounts receivable. Net cash used

during the six months ended June 30, 2002 resulted from a net loss from operations and a decrease in deferred revenues and accounts payable offset by the deferred tax change, depreciation and amortization, a decrease in accounts receivable and an increase in accrued liabilities. In anticipation of continuing economic softness, the Company anticipates that it may use approximately $2 million of cash and cash equivalents during the remainder of 2003.

Investing activities provided cash of $1.4 million and $1.1 million during the six months ended June 30, 2003 and 2002, respectively. During the six months ended June 30, 2003, the principal uses were purchases of property and equipment and short-term investments, offset by proceeds from the sale of short-term investments. The Company’s investments are professionally managed and the Company has instructed its broker to earn the highest interest rate possible for very low-risk securities. The Company’s broker primarily purchases cash equivalent securities but may, on occasion, purchase short-term investments. Property and equipment purchases were predominately of computer related software and hardware products.

Financing activities provided cash of $2,600 and $5,500 for the six months ended June 30, 2003 and 2002, respectively, largely from the issuance of common stock pursuant to the Company’s employee stock purchase program.

The Company has experienced declining revenues and 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.

The following table represents the approximate amounts of payments due under specified contractual obligations as of June 30, 2003:

	Less than one year		One to three years		Three to five years	More than Five years

Operating lease obligations	$	215,000	$	624,000	—	—
Total obligations	$	215,000	$	624,000	—	—

Operating lease requirements consist mainly of lease payments for the Company’s offices in Salem, NH and London, England. As of June 30, 2003, the Company did not have any long-term debt obligations, material commitments for capital expenditures, capital lease obligations, or other long-term liabilities for which payments are required.

Recently Issued Accounting Standards

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 which 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 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 business; the Company’s strategic alliances; changes in the regulatory environment; the Company’s expected liquidity and capital resources and the Company’s critical accounting policies) 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 discussed below, and the other risk 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, 2000, 2001, 2002 and the six months ending June 30, 2003, the Company had operating losses and decreasing revenues. 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 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 and it introduced its proprietary document and routing software, Accuroute, in the second quarter of 2002. To date, the Company has not recognized a significant amount of revenues from its Genidocs and Accuroute products. The Company expects that its Genidocs and Accuroute products may account for an increasing portion of future revenues however, there can be no assurances that these products 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, Genifax and Accuroute 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 Genifax and Fax Sr. NT Product Lines and the Windows NT/2000 Environment. The Company currently derives a significant portion of its revenues from licenses of the Genifax and Fax Sr. NT products and related services and

resale of related hardware. Continued market acceptance of the Genifax and Fax Sr. NT 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 Genifax and Fax Sr. NT 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 new and enhanced versions of the Genifax product and customer acceptance of the Fax Sr. NT product. There can be no assurance that the Company will continue to be successful in marketing the Genifax and Fax Sr. NT 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 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 Listing on the Nasdaq SmallCap 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 did not regain compliance and on October 29, 2002, the Company applied to transfer from the Nasdaq National Market to the Nasdaq SmallCap Market. On November 26, 2002, the Company transferred to the Nasdaq SmallCap Market and it was afforded the remainder of this market’s 180 calendar day grace period, or until February 3, 2003, to regain compliance with the minimum bid price per share requirement. On January 14, 2003, Omtool’s Board of Directors voted a one-for-seven stock split of the Company’s Common Stock effective January 15, 2003 pursuant to a special meeting of stockholders that was held on the same day approving an amendment to the Company’s Amended and Restated Certificate of Incorporation of the Company to effect a reverse stock split. On February 5, 2003, the Company was notified by Nasdaq that it had regained compliance. The Company cannot predict the impact, if any, of a change in listing to the SmallCap Market. In addition, the Company cannot predict the continuance of its listing status in the future including the possibility of delisting from the Nasdaq SmallCap 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. In the intensely competitive and rapidly changing business-to-business secure document exchange market, the Company competes directly with Authentica, Sigaba, Tumbleweed, and Zixit and a number of other providers. There are also

other categories of technology solution that overlap and compete in certain ways with aspects of the Company’s products. These include:

• Document management solutions from vendors such as Documentum, Hummingbird and iManage whose electronic collaboration solutions compete with certain aspects of the Company’s solutions;

• Electronic forms and electronic signature solutions from vendors such as Adobe, PureEdge, CreateForm and Silanis that offer the creation of electronic documents with electronic signatures; and

• Security infrastructure solutions from vendors such as Verisign and Entrust whose solutions can be used to build applications that enable secure document communications.

The Company expects the competition in the business-to-business secure document exchange market to increase over time.

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 providers offering a range of alternative facsimile solutions including outsourcing network facsimile solutions, such as Easylink Services; operating systems containing facsimile and document e-mail features; low-end fax modem products; providers of desktop fax software; single-platform facsimile software products; and customized proprietary software solutions. In addition, providers of operating systems or business software applications may 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, enterprise client/server facsimile solutions software and routing and distribution 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.

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 the Use of Arthur Andersen as Independent Auditors. Arthur Andersen LLP (“Andersen”), the Company’s former independent public accountants that audited the Company’s financial statements until June 28, 2002, was found guilty by a jury on June 15, 2002 of federal obstruction of justice in connection with the government’s investigation of Enron Corporation. Andersen ceased practicing before the SEC effective August 31, 2002. Although the Company has no reason to believe that those financial statements are incorrect, it is possible that events arising out of the indictment may adversely affect Andersen’s ability to satisfy any claims arising from its provision of auditing and other services to the Company, including claims that may arise out of Andersen’s audit of the Company’s financial statements. The SEC has indicated that it will continue accepting financial statements audited or reviewed by Andersen provided that the Company comply with the applicable rules and orders issued by the SEC in March 2002 for such purpose.

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 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 who 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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

As of June 30, 2003, 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 commercial paper 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 equivalents 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 June 30, 2003. Currently the Company does not engage in foreign currency hedging activities.

Item 4. Controls and Procedures

As of the end of the fiscal quarter (the “Evaluation Date”), the Company, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b) and 15d-15(b) 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.

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

PART II: OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

The annual meeting of security-holders of the Company was held on April 21, 2003. The following nominees were re-elected as Class III Directors of the Company each to serve for a three-year term or until his successor is elected and qualified.

Nominee	Total Votes for Nominee	Total Votes Withheld for Nominee
Robert L. Voelk	1,581,476	10,363

Martin A. Schultz	1,581,476	10,363

The term of office for the following directors continued after the meeting: Richard D. Cramer (Class I), Andrew E. Lietz (Class I), Arnold E. Ditri (Class II) and William C. Styslinger, III (Class II).

At the same annual meeting, the Stockholders ratified the appointment of PricewaterhouseCoopers LLP as the Company’s independent auditors for the fiscal year ending December 31, 2003 by the following vote:

For		Against		Abstention		Broker Non-Votes
1,590,878		469		492		0

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

31.1	Rule 13a-14(a)/15d-14(a) Certification

31.2	Rule 13a-14(a)/15d-14(a) Certification

32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K

The Company did not file any reports on Form 8-K during the second quarter of 2003; however, the Company furnished a Report on Form 8-K, dated April 21, 2003, pursuant to Item 9 thereof furnishing the results of its operations for the quarter ended March 31, 2003.

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.


August 8, 2003	By:	/s/ Timothy P. Losik
		Timothy P. Losik
		Vice President, Chief Financial Officer, Chief Operating Officer, Secretary and Treasurer

Exhibit Index

31.1		Rule 13a-14(a)/15d-14(a) Certification

31.2		Rule 13a-14(a)/15d-14(a) Certification

32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.