ITEM 1. BUSINESS
BUSINESS
Omtool, Ltd. ("Omtool" or the "Company") designs, develops, markets and supports open, client/ server software, delivering solutions which automate and integrate communication throughout the enterprise. Omtool's product families, licensed typically on a shrink-wrap basis, provide users with an extensive, flexible feature set for transmitting and receiving documents and improve an organization's management of its communications processes by providing a suite of utility and control functions. Omtool's software products can be deployed on heterogeneous, multi-platform networks and can be integrated with both desktop and enterprise software applications as well as e-mail and groupware systems. To address the needs of large enterprises, Omtool's products are modular and scaleable, as servers, clients and fax lines can be implemented and added over time. To date, Omtool's products have addressed the facsimile and document communication needs of enterprises. Omtool's products are available on the Windows NT, AS/400, Sun Solaris, and VMS server operating systems, and Windows 95, Windows NT, Windows 3.1.x, AS/400, Macintosh, Java and ActiveX clients. Omtool has licensed its products to thousands of customers worldwide.
The Company was incorporated in New Hampshire in March 1991 and was reincorporated in Delaware in January 1996. The Company's principal executive offices are located at 8 Industrial Way, Salem, New Hampshire 03079 and its telephone number is (603) 898-8900.
INDUSTRY BACKGROUND
To be competitive in today's marketplace, companies must focus on improving electronic communications within their organizations and beyond the enterprise. Growth in electronic communication is being driven by productivity and efficiency demands on knowledge workers, the information sharing requirements of dispersed organizations, the emergence of the virtual enterprise to incorporate suppliers, customers and other business partners, and the general globalization of markets. Enterprises are responding to the need for improved communications through the use of a combination of telephony, facsimile, e-mail and groupware solutions. Facsimile transmission has been adopted as a worldwide standard for electronic communication because of its ease of use, real-time transmission of information, and consistent uniform protocol standards.
A number of technological developments have continued to emerge to create opportunities to automate, integrate and decrease the costs of fax and other corporate communications methods. These developments include the proliferation of personal computers in the corporate workplace, the growth of the client/server computing environment, the emergence of the fax modem and remote access technology, and the growth of wide area network ("WAN") infrastructure, including high speed T1/T3 public networks. Also, the further emergence and reliability of the Internet, T.37 standards for store-and-forward Internet faxing and corporate intranets have created additional opportunities to decrease and, in some cases, eliminate, the telecommunication costs of faxing. In addition, the rapid adoption of Windows NT as a cost-effective, technologically-advanced platform for enterprise computing is creating an environment whereby companies can realize significant improvements in corporate communications through the use of automation software.
Despite these technological improvements, only limited advances have been made to automate fax communication and to coordinate and integrate communication by fax with other communications methods. Traditional fax communication within and beyond the enterprise continues to be prone to errors and delays in transmission and reception due to manual copying, sending and routing processes. Additionally, business managers and information technology ("IT") professionals are often unable to effectively manage access and analyze and control usage costs across this critical corporate communications medium. Because the vast majority, the Company believes, of all faxed documents are created electronically, the lack of integration between traditional fax machines, fax servers and enterprise applications causes additional inefficiencies in the document communications and management process. Moreover, traditional fax communication via fax machines has failed to integrate with emerging communications methods that are complementary to fax transmission, such as e-mail and groupware, to create a coordinated communications process throughout the extended enterprise.
Historical approaches to improving facsimile communications such as desktop-based fax software and host-based fax applications have not provided a comprehensive solution for the requirements of the enterprise. Desktop fax applications are unable to support workgroups or divisions within an organization, are often limited to a single desktop operating system and do not provide complete management functions. In addition, desktop-based fax applications are limited in that they require significant investment by the organization in dedicated modem or fax boards in each user's PC and a telephone line connection for each modem or fax board. Host-based fax applications running on mainframes or minicomputers are typically expensive, difficult to maintain and relatively inflexible to meet the changing needs of the enterprise. In addition, host-based fax applications are difficult to integrate in a changing technological environment. Furthermore, these approaches have failed to integrate existing stand-alone fax machines and therefore use of these solutions requires individuals to change established practices of using fax machines to send facsimiles.
As corporate communications have become more critical and complex, a need has arisen for a solution to automate and integrate fax communications throughout the enterprise and address a broad range of faxing requirements from person-to-person to volume broadcast transmissions. Such a solution must provide users and managers with superior functionality, provide tight integration with applications and other communications methods such as e-mail and groupware, leverage existing network technology and be implemented on a scaleable, multi-platform client/server architecture to address the needs of the extended enterprise. Additionally, such a solution should also incorporate these features with more traditional methods of fax communication, such as stand-alone fax machines, so that companies have the flexibility to choose the most efficient method of faxing and eliminate the necessity of forcing individuals to change their established practices of faxing.
THE OMTOOL SOLUTION
Omtool provides an open, client/server software solution, licensed typically on a shrink-wrap basis, for automating and integrating facsimile communications throughout the enterprise. Omtool's solution provides the following key benefits:
COMPREHENSIVE FAX SOLUTION. Omtool's products provide users with an extensive, flexible feature set for transmitting, receiving and managing facsimiles. Omtool's products are designed to enhance an organization's management of its fax communications processes by providing a suite of utility and control functions for both IT staff and business managers.
TIGHT INTEGRATION WITH DESKTOP AND PRODUCTION APPLICATIONS. Omtool's products manage the transmission of documents originating from desktop applications as well as volume-based facsimiles generated by production applications, such as purchase orders, invoices and shipping notices. Omtool's products can be integrated with off-the-shelf software applications as well as in-house custom applications.
COMPLEMENTARY E-MAIL AND GROUPWARE FUNCTIONALITY. Omtool's products are designed to connect to and complement e-mail and groupware by enabling faxes to be sent and received through these applications. Omtool's products support multiple, complementary e-mail and groupware systems, including Microsoft Exchange, Lotus Notes, Microsoft Mail, Lotus cc:Mail and Simple Mail Transfer Protocol ("SMTP").
LEVERAGE EXISTING INFRASTRUCTURE INVESTMENTS. Omtool's products are designed to operate on heterogeneous networks and enable enterprises to leverage their existing IT server, desktop infrastructure and telecommunications investments. Omtool's products support multiple, simultaneous protocols and are generally available on the Windows NT, AS/400, Sun Solaris and VMS server operating systems, and Windows NT, Windows 95, Windows 3.1.x, AS/400, Macintosh, Java, and ActiveX clients. Omtool's products operate with existing public and leased telephone lines and enable users to take advantage of enhanced services offered by telecommunication carriers and specialized service providers.
INTEGRATION WITH FAX MACHINES. Additionally, a new suite of Internet fax products, planned for release in the second quarter of 1999, is designed to permit companies to send faxes via the Internet and will integrate existing, stand-alone fax machines with the enterprise's network fax servers. These products are intended to enable a company to integrate its entire faxing infrastructure. Furthermore, these offerings extend Fax Sr.'s management capability to archive, store, view and monitor the enterprise's fax machine inbound and outbound activity. This will enable telecommunications managers to identify fax trends and manage costs more effectively for all of their organization's inbound and outbound faxes.
ENTERPRISE-STRENGTH SOLUTION. Omtool's products are architected to be modular and scaleable to meet the needs of worldwide enterprises. Servers, clients, stand-alone fax machines and fax lines can be implemented and added over time in a deployment of Omtool's fax communication products.
STRATEGY
The Company's objective is to become the leading provider of client/server facsimile software solutions. The Company seeks to achieve this objective by implementing the following business strategy:
MAINTAIN TECHNOLOGY LEADERSHIP IN THE ENTERPRISE MARKET. The Company intends to continue to invest in research and development to ensure that its products remain robust and scaleable for the enterprise market. The Company strives to bring enhanced features to the market to respond to changing customer requirements and evolving technology. The Company believes that its core product, Fax Sr., was the first commercially available client/server facsimile solution to provide e-mail and Microsoft Exchange integration and to incorporate least cost and global routing.
CONTINUE LEADERSHIP IN THE WINDOWS NT ENVIRONMENT. The Company believes that Windows NT will become the dominant computing platform in the enterprise environment. The Company believes that its core product, Fax Sr., was the first commercially available client/server facsimile solution for the Windows NT platform, and the Company has built a leadership position in this market. The Company intends to continue to focus a portion of its near-term product development efforts on Windows NT-related functionality. See "Factors Affecting Future Performance."
ENTER VERTICAL MARKETS. With the acquisition of TRS Technologies, Inc. (now known as Omtool Legal Systems) in February 1998, the Company has begun to pursue opportunities in vertical industries. Omtool Legal Systems' primary product, LegalFax, was specifically designed to provide law firms with network faxing capabilities and to integrate with their cost recovery systems. The Company believes that significant opportunities exist to expand into other vertical industries and intends to pursue these opportunities by developing new products that leverage the specialized features already developed for LegalFax. See "Factors Affecting Future Performance."
ENTER LOW-END MARKETS. Historically, the Company has derived only a small percentage of its revenue from sales of its products to small businesses. The Company believes that there is potential to expand the use of its products into this market. The Company has recently introduced its Fax Sr. Express
product line that was designed for small businesses and for workgroups and remote offices within larger organizations. The Fax Sr. Express product line currently offers complete native integration with Microsoft Exchange and Outlook e-mail systems and is designed to meet the needs of workgroups consisting of up to 250 users. See "Factors Affecting Future Performance."
LEVERAGE EMERGING TECHNOLOGY. The Company believes that there are opportunities to expand the use of its products by leveraging emerging technology, such as the Internet, T.37 standards for store-and-forward Internet faxing and corporate intranets, to decrease and, in some cases, eliminate, the telecommunication costs of faxing. The Company intends to pursue these opportunities by introducing new products in the near-term. Accordingly, the Company intends to focus a significant portion of its near-term product development efforts on Internet related functionality. See "Factors Affecting Future Performance."
LEVERAGE INSTALLED BASE OF CUSTOMERS. The Company believes that significant opportunities exist to expand the use of its products across more users and applications at the Company's existing customer installations. The Company intends to pursue these opportunities by introducing new products and by providing comprehensive post-sale customer support. In addition, the Company believes that a highly-referenceable customer base is of critical importance in marketing its products to new customers.
PURSUE MULTIPLE DISTRIBUTION CHANNELS. The Company believes that multiple distribution channels are necessary to penetrate its target markets. The Company is currently expanding its distribution network, including expanding its indirect channels within the United States and internationally and continue to expand its existing dedicated sales force to focus on sales to large corporate accounts and post-sale relationship management.
EXPAND INTERNATIONAL SALES. The Company intends to expand its international presence (primarily in Europe and South America) in order to address its target markets outside of North America and to serve customers that operate on a multi-national basis. In 1996, 1997 and 1998, approximately 5%, 10% and 17%, respectively, of the Company's total revenues were derived from sales outside of North America (primarily in Europe). In 1999, the Company plans to continue to increase its investment in sales and marketing efforts directed toward international markets.
PURSUE STRATEGIC RELATIONSHIPS. The Company is seeking to form relationships with leading providers of products and services complementary to the Company's offerings. The Company believes that these relationships will provide both a valuable source of sales leads and an alternative source of implementation services. The Company also believes that these relationships will be beneficial in exposing its products to new markets and prospective customers. The Company has entered into strategic alliances with UNIFI Communications, Inc., Xpedite Systems, Inc., and Cable and Wireless, Inc., providers of enhanced fax carrier services, and with Active Voice Corporation and Lucent/Octel, providers of PC-based voice mail systems and computer-telephony integration solutions, and Hewlett Packard, a provider of network scanning/fax machines. Additionally, Omtool has recently entered into strategic alliances with NetCentric Corporation, a provider of carrier-class Internet fax systems, and System Software Associates (SSA), a global provider of enterprise resource planning software.
PURSUE ACQUISITIONS. A key element of the Company's growth strategy is to augment its internal growth with the acquisitions of businesses, products and technologies that could complement or expand the Company's business. On December 5, 1997, the Company completed its acquisition of all of the outstanding share capital of CMA Ettworth Limited, a provider of fax solutions for the IBM AS/400 market, providing the Company with a European presence as well as extending the Company's enterprise solution capabilities into the IBM AS/400 platform. On February 19, 1998, the Company acquired all of the outstanding capital stock of Desktop Paging Software, Inc., a provider of wireless messaging software, and on February 27, 1998, the Company acquired all of the outstanding capital stock of TRS Technologies, Inc., a provider of LAN fax and cost recovery systems for law firms. See "Factors Affecting Future Performance."
PRODUCTS AND SERVICES
FAX SR.
Fax Sr. is a client/server software solution for automating and integrating fax communication throughout the enterprise. As an integrated component of an enterprise software system, Fax Sr. is designed to be deployed on heterogeneous, multi-platform networks and to integrate with desktop and enterprise software applications. Fax Sr. is licensed typically on a shrink-wrap basis, primarily on the Windows NT, Sun Solaris and VMS server operating systems. In 1998, approximately 69% of the Company's software license revenues were derived from Fax Sr. NT. Fax Sr. can be configured with a variety of networked clients, including Windows NT, Windows 95, Windows 3.1.x, Internet browsers, and Macintosh.
Fax Sr. NT was first released in March 1995 and the current version, 3.0, was released in December 1998. Fax Sr. Sun Solaris was first released in March 1998 and the current version, 5.2, was released in January 1999. Fax Sr. VMS was first released in 1993 and the current version, 4.1, was released in March 1997.
Fax Sr. is comprised of three main components: Fax Sr. Client, Fax Sr. Server and Fax Sr. Manager. The Fax Sr. Client allows users to send and receive faxes directly from the desktop or enterprise application. The Fax Sr. Server controls the function of prioritizing, queuing, and transmitting outbound faxes, while receiving and distributing inbound faxes. The Fax Sr. Manager allows for remote monitoring, control, and analysis of fax user activity from any Windows or Windows NT system that is connected to the network.
Fax Sr. offers a comprehensive feature set with functionality important to users, business managers and IT professionals. Fax Sr. users can fax documents, together with attachments, from any desktop application through the application's print function. Alternatively, faxes may be transmitted or received directly through e-mail. Users can create and revise shared, public and private phonebooks for fax transmissions. Fax Sr. offers a fax broadcast capability with immediate or delayed transmission to take advantage of off-peak telephone line utilization and charges. Inbound faxes can be directed to a printer, desktop personal computer or e-mail. Fax Sr. also offers remote access, including send and receive capability, for users who are away from the office.
Fax Sr. provides tools that allow business managers and IT professionals to effectively manage the fax communication process. Outbound faxes can be scheduled on the individual user level and enhanced management security and control capabilities are provided by furnishing password protection as well as user and location restrictions. Through global routing, Fax Sr. can least cost route fax transmissions between servers, over an organization's WAN or the Internet, allowing long distance fax transmissions to be made as local phone calls. Fax Sr. also offers sophisticated tools for facsimile usage analysis, including comprehensive recordkeeping of inbound and outbound faxes. The entire Fax Sr. environment can be managed, configured and controlled from one or more remote workstations.
Fax Sr. can be automatically linked to enterprise data processing applications on multiple platforms connected on an enterprise's network. Fax Sr. provides an integrated faxing environment across an organization's computer platforms, including both servers and desktops. Fax Sr. is scaleable as a business' need for faxing solutions expands.
Fax Sr. NT provides incremental functionality to the feature set available on all versions of the Fax Sr. product. Fax Sr. NT is fully integrated with Microsoft Exchange, Lotus Notes, and other e-mail systems. It enables business managers to pre-approve outbound faxes on an individual user level. Fax Sr. NT supports multiple e-mail systems and allows users to fax native file attachments via server side rasterization of multiple desktop application formats. Fax Sr. NT includes the capability of routing fax transmissions through third-party service providers, Internet browser client support (including JAVA and ActiveX content) and OCR (optical character recognition) for inbound routing.
The Company's Fax Sr. product is licensed to its customers on a per server basis. Pricing is based on the number of servers and facsimile telephone lines deployed. The software list price for a deployment of
one NT server, unlimited clients and four telephone lines is approximately $6,500. The software list price for a deployment of one NT server, unlimited clients and eight telephone lines is approximately $8,500. The software list price for a deployment with one NT server, unlimited clients and a T1 line, containing 24 telephone lines, is approximately $16,500.
FAX SR. EXPRESS
Fax Sr. Express, a new version of Fax Sr. introduced in February 1999, is designed for small businesses, workgroups and remote offices within larger organizations. Fax Sr. Express incorporates the most widely used features of Fax Sr. packaged in an easy-to-install, easy-to-manage, and easy-to-use product at a lower price.
Fax Sr. Express is licensed on a shrink-wrap basis and runs on the Windows NT version 4.0 operating system. Fax Sr. Express provides complete native integration with Microsoft Exchange and Outlook e-mail systems and a Windows 32-bit desktop fax client application so users can easily send and receive faxes from the desktop. Microsoft Management Console (MMC) based administration provides the ability to configure or reconfigure fax modems, monitor inbound and outbound fax queues, and add, delete or modify users and settings. Fax Sr. Express installs all NT platform and Fax Sr. Express application components in an easy-to-follow, step-by-step process and auto-detects and configures fax modems.
The Company's Fax Sr. Express product is licensed to its customers on a per server basis. Pricing is based on the number of servers, number of users, and number of facsimile telephone lines deployed. The software list price for a deployment of one NT server, 10 users, and two telephone lines is approximately $800. The software list price to add ten additional users is approximately $400 and to add two additional telephone lines is approximately $600.
LEGALFAX
LegalFax is a client/server software solution for law firms to automate and integrate fax communication and cost recovery systems. LegalFax is licensed typically on a shrink wrap basis, primarily on the Windows 95/98 and Windows NT operating systems. LegalFax supports Microsoft Mail, Microsoft Exchange, Novell GroupWise, Lotus cc:Mail, and Lotus Notes and allows users to fax using native transport protocol. Additionally, LegalFax is fully integrated with document management systems such as PC DOCS Open, iManage, and SoftSolutions, as well as with time and billing systems such as Equitrac, Elite and CMS Open.
LegalFax is comprised of four main components: LegalFax Client, LegalFax Server, LegalFax Accounting and LegalFax FaxCenter. The LegalFax Client allows users to send faxes directly from the desktop, automatically validating client matter data and integrates with document management systems. The LegalFax Server uses the Fax Sr. NT fax server as its fax engine and provides the messaging gateway for fax transmissions. The LegalFax Accounting component allows integration with cost recovery systems. The LegalFax FaxCenter allows fax administrators to instantly route incoming faxes directly to workstations, distribution lists, printers, or fax machines using existing e-mail networks.
LegalFax provides a comprehensive feature set with functionality important specifically to users, business managers, and IT professionals in law firms. LegalFax enables users to fax documents directly from document management systems and to retrieve and automatically validate client matter data from such systems before a fax is sent to the fax server. The LegalFax Accounting module automatically captures this client and cost information and produces a custom file which can be posted to most time and billing systems.
FAX/400
FAX/400 is a client/server software solution for automating and integrating fax communication for AS/400 and Windows NT users. FAX/400 incorporates the Fax Sr. NT Server and is a full-function fax system complete with built-in text editor for internal and external e-mail, directory and distribution list management. FAX/400 fully integrates with Microsoft Exchange, Lotus Notes, SMTP, Microsoft Mail, and
Lotus cc:Mail. FAX/400 can be configured with a variety of networked clients, including AS/400 terminals, Windows 95, Windows NT, Macintosh, ActiveX, Java, DOS and Office/Vision/400.
FAX/400 provides not only the feature set included in the Fax Sr. NT server but also a comprehensive feature set with functionality important specifically to users, business managers, and IT professionals of AS/400 systems. Fax/400 permits fax enabling of existing AS/400 line-of-business applications without programming, and its directories and distribution lists facilitate easy addressing of facsimiles. Additionally, FAX/400 provides a single point of sending and receiving faxes, while delivering portability between Windows NT and AS/400 mid-range systems.
FAX/400 allows faxes and e-mail to be sent in a variety of ways with or without automatic fax covers. These faxes and e-mail can be created from any terminal on the AS/400 system in the built-in text editor, Office/Vision/400 or any Windows, OS/2 or DOS application. Connection via TCP/IP, Client Access, Rumba, or Elite is supported in Windows 3.1, Windows 95, and OS/2 environments.
HARDWARE
The Company also resells certain hardware products, including intelligent fax boards and fax modems, to its customers. Hardware sales are undertaken as a convenience to the Company's customers, and hardware is neither bundled with the Company's software products nor required to be purchased from the Company. Omtool primarily resells intelligent fax boards from vendors such as Brooktrout Technology, Dialogic and Natural MicroSystems.
CUSTOMER SERVICE
To aid in the successful deployment of the Company's products by its customers, the Company's customer service organization provides technical support. For an additional fee at the time of the initial licensing of the Company's products, the Company provides support services to its customers for a period of 12 months, including telephone support, notification of product upgrades, minor product upgrades, functional releases and maintenance releases, technical bulletins and replacement of damaged media. Support services may be renewed by the customer on an annual basis. The Company currently provides annual support services based on a percentage of its product license fee. Although to date the Company has not provided consulting, configuration and installation services to any significant degree, the Company intends to offer these customer services in the future as warranted by customer demand. There can be no assurance, however, as to the time of introduction or level of market acceptance of, or revenue generated from, any such services. In the event that the Company devotes significant financial and other resources to the provision of such services and fails to achieve market acceptance and generate revenue, the Company's business, financial condition and results of operations could be materially adversely affected.
OTHER PRODUCTS
As a result of the Company's acquisition of Desktop Paging Software, Inc., the Company's product line has expanded to include both client/server and stand alone software that provide users with instant access to paging from within applications. U-Page Messenger is a client/server paging software solution for seamless integration of computer network and alphanumeric receiving devices. This product allows unlimited users anywhere on a corporate network, intranet, or internet to send messages to anyone carrying a message receiving device. U-Page Messenger is available on Windows NT and Windows 95 operating systems. U-Page Pro is a stand alone paging software solution for sending messages to alphanumeric receiving devices from a computer desktop. U-Page Pro is available in Windows 95, Windows NT, Windows 3.x and Macintosh versions. These new products are sold through the distribution channels presently used for sales of Fax Sr.
SALES AND MARKETING
The Company historically targeted large and mid-sized corporations, organizations and government entities as the primary market for its Fax Sr. product line. With the introduction of Fax Sr. Express in February 1999, the Company has begun to also target smaller businesses. To address the broad range of its sales opportunities, the Company relies on the coordinated efforts of its centralized telesales organization, its key executives and corporate account team, the Company's marketing department and its indirect channels, including resellers, distributors and systems integrators.
The telesales group qualifies and pursues sales leads generated by Omtool's marketing organization. The Company has historically conducted its telesales operation from its various offices in the US and Europe. Direct sales by the Company accounted for approximately 79%, 72% and 77%, respectively, of the Company's total revenues in 1996, 1997 and 1998.
Within North America, the Company also offers its product lines through indirect sales channels such as distributors, systems integrators and resellers of complementary hardware products. The Company plans to expand the number of resellers in North America selling its product lines and anticipates the revenues derived from indirect channels will therefore increase.
Outside of North America, the Company primarily utilizes independent distributors to promote, license and support its products. Omtool's distribution strategy is to engage large-volume distributors of software products to serve customers that operate on a multi-national basis. The Company expects to continue to market its products through independent distributors in strategic international markets including Europe and South America. In 1996, 1997 and 1998, sales outside of North America represented approximately 5%, 10% and 17%, respectively, of total revenues.
In support of its sales organization, the Company conducts comprehensive marketing programs intended to promote and create awareness of the Company's products and position the Company in the enterprise, client/server facsimile software market. These efforts include product advertising, public relations, trade show participation, educational seminars, direct mail and telemarketing campaigns and participation in industry programs and forums.
STRATEGIC RELATIONSHIPS
An element of the Company's strategy is the creation and development of strategic relationships with key industry participants, including leading providers of products and services complementary to the Company's offerings. The Company's goals in establishing these relationships are to create marketing alliances with entities that will endorse and promote the Company's products to a larger potential customer base and to assist the Company in developing a supply of aftermarket service providers, thereby leveraging the Company's resources and enhancing its reach.
The Company has entered into strategic alliances with UNIFI Communications, Inc., Xpedite Systems, Inc. and Cable and Wireless, Inc., providers of enhanced fax carrier services, and with Active Voice Corporation and Lucent/Octel, providers of PC-based voice mail systems and computer-telephony integration solutions. Additionally, Omtool has recently entered into strategic alliances with NetCentric Corporation, a provider of carrier-class Internet fax systems, and System Software Associates (SSA), a global provider of enterprise resource planning software. The agreements generally provide for reference sales, limited co-marketing activities and, in the case of UNIFI Communications, Inc. and Active Voice Corporation, resale of Fax Sr. These agreements are mutually non-exclusive.
CUSTOMERS
As of December 31, 1998, the Company had more than 2,500 customers worldwide. The Company's customer base reflects the cross-industry applicability of the Company's products and services.
No single customer accounted for 10% or more of total revenues in 1996, 1997 or 1998.
RESEARCH AND DEVELOPMENT
The Company has made substantial investments in research and development. The Company believes its future performance will depend in large part on its ability to develop new products, maintain technological competitiveness, enhance its current product line and meet an expanding range of customer requirements. Omtool deploys its development engineers in product teams which focus on the concurrent development of a range of product enhancements that leverage its products' modular product architecture. Omtool's product development efforts are focused on development of new products, the exploration of emerging technologies, continued enhancement of existing products, development of new features, and the integration of acquired products. The Company also continually reviews opportunities to form alliances with third-party vendors of complementary technologies and products in order to enhance the functionality of its product families. In the future, the Company may, based on timing and cost considerations, continue to explore opportunities to license or acquire technologies or products from third parties.
The Company is seeking and will continue to seek to hire additional skilled development engineers. Such engineers are likely to be in short supply, and the Company's business, financial condition and results of operations could be adversely affected if it encounters delays in hiring or fails to retain the required skilled engineers. The Company's research and development expense for 1996, 1997 and 1998 was approximately $2.2 million, $3.9 million and $5.1 million, respectively. Since its inception, the Company has not capitalized any research and development costs. The Company plans to continue to make significant investments in research and development, primarily through the hiring of additional skilled engineers and independent contractors.
COMPETITION
The client/server facsimile solution market is 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, including Internet enabled capabilities; ease of use; product scaleability; 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 products and standards; name recognition; the establishment of strategic alliances with industry leaders; and industry and general economic trends.
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 Inc. (a subsidiary of Applied Voice Technology, Inc.), Fenestrae BV, Optus Software Inc., TopCall International and Biscom, Inc. The Company also competes with providers offering a range of alternative facsimile solutions including 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 Omtool's 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 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 Omtool 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 the Company will be able to compete successfully in the future. Increased competition will result in reductions in market share, pressure for price reductions and related reductions in gross margins, any of which could materially and 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.
PROPRIETARY RIGHTS
The Company regards its software as a trade secret and attempts to protect it with a combination of copyright and trade secret laws, and employee nondisclosure and assignment of invention agreements. The Company has no patents or patents pending, and to date has not registered any copyrights or trademarks. The Company generally licenses its products under "shrink-wrap" licenses (i.e., licenses included as part of the product packaging). Shrink-wrap licenses are not negotiated with or signed by individual licensees, and purport to take effect upon the opening of the product package. Certain provisions of such licenses, including provisions protecting against unauthorized use, copying, transfer and disclosure of the licensed program, may be unenforceable under the laws of many jurisdictions. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy aspects of the Company's products or to obtain and use information that the Company regards as proprietary. Policing unauthorized use of the Company's products is difficult, and although the Company is unable to determine the extent to which piracy of its products exists, such piracy can be expected to be a persistent problem, particularly in international markets. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as the laws of the United States. There can be no assurance that these protections will be adequate or that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technologies.
There has been substantial litigation in the software industry involving intellectual property rights. There can be no assurance that claims of infringement of intellectual property rights will not be asserted against the Company and, if asserted, would not have a material adverse effect on the Company's business, financial condition and results of operations. In addition, inasmuch as the Company licenses certain components of its products from third parties, its exposure to copyright and other infringement actions may increase because the Company must rely on such third parties for information as to the origin and ownership of such licensed components. In the future, litigation may be necessary to enforce and protect trade secrets, copyrights and other intellectual property rights of the Company. The Company may also be subject to litigation to defend against claimed infringement of the rights of others or to determine the scope and validity of the intellectual property rights of others. Any such litigation could be costly and divert management's attention, either of which could have a material adverse effect on the Company's business, financial condition and results of operations. Adverse determinations in such litigation could result in the loss of the Company's proprietary rights, subject the Company to significant liabilities, require the Company to seek licenses from third parties or prevent the Company from selling its products, any one of which would have a material adverse effect on the Company's business, financial condition and results of operations.
EMPLOYEES
As of December 31, 1998, the Company employed 195 persons. The Company is not subject to any collective bargaining agreements, has never experienced a work stoppage and considers its relations with its employees to be good.
ITEM 2.
ITEM 2. PROPERTIES
The Company's executive offices are located in Salem, New Hampshire in a leased facility consisting of approximately 30,000 square feet. The lease expires on December 31, 2002, and the Company has an option to extend the lease for a period of three years thereafter. The Company believes that such facilities are adequate for its present operations. The Company, however, expects in the future to expand into additional facilities. The Company also leases additional facilities and offices for sales, customer service, development, and support in Florida, Oregon, Paris, France and London, England.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant from time to time in lawsuits incidental to its business. The Company is not a party to any material legal proceedings.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth quarter of 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been traded on The Nasdaq Stock Market under the symbol OMTL since August 8, 1997, the date of the Company's initial public offering of Common Stock. Prior to August 8, 1997, there was not a public market for the Company's Common Stock. The following table sets forth for the periods indicated the high and low bid prices for the Common Stock as reported by The Nasdaq Stock Market based on actual sales price.
On March 29, 1999, the closing price for the Common Stock was $13.00 per share. As of March 29, 1999, there were approximately 82 stockholders of record. The Company believes that shares of the Company's Common Stock held in bank, money management, institution and brokerage house "nominee" names may account for at least an estimated 1,566 additional beneficial holders.
The Company has not paid any cash dividends on its capital stock and does not anticipate paying cash dividends in the foreseeable future. The Company intends to retain any earnings or other cash resources to finance future growth of its business. Any future determinations to pay cash dividends will be at the discretion of the Company's Board of Directors and will be dependent upon the Company's results of operations, financial condition and other factors deemed relevant by the Board of Directors.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
The statements of consolidated operations data set forth below for each of the fiscal years ended December 31, 1996, 1997 and 1998 and the balance sheet data as of December 31, 1997 and 1998 have been derived from the Company's consolidated financial statements, which statements have been audited by Arthur Andersen LLP, independent public accountants, and are included herein. The statements of consolidated operations data for the fiscal years ended December 31, 1994 and 1995 and the balance sheet data as of December 31, 1994, 1995 and 1996 are derived from the Company's financial statements, which statements have been audited by Arthur Andersen LLP and are not included herein. The selected financial data set forth below should be read in conjunction with the consolidated financial statements and the notes thereto and with Management's Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in this Form 10-K.
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(1) Computed on the basis described in Note 2 of Notes to Consolidated Financial Statements.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Except for the historical information contained herein, this Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding, among other items, (i) the Company's growth strategies; (ii) anticipated trends in the Company's business; (iii) the Company's ability to expand its product and service offerings; (iv) the Company's ability to satisfy working capital requirements and (v) the Company's Year 2000 readiness. These forward-looking statements are based largely on the Company's expectations and are subject to a number of risks and uncertainties, certain of which are beyond the Company's control. Actual results could differ materially from these forward-looking statements as a result of a number of factors including, but not limited to, those factors described in "Certain Factors Affecting Future Operating Results."
OVERVIEW
Omtool designs, develops, markets and supports open, client/server software, delivering solutions that automate and integrate communication throughout the enterprise. The Company was incorporated in March 1991 and shipped its initial facsimile software products in 1991. Omtool's Fax Sr., LegalFax and FAX/400 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 majority of the Company's revenues are derived from licensing the rights to use its Fax Sr. software product directly to end-users and indirectly through resellers. The Company first achieved profitability for the year ended December 31, 1992 and has been profitable, excluding a one time charge for purchased, in-process research and development, for the last sixteen quarters.
Revenues from software licenses are recognized upon shipment of the software if there are no significant post-delivery obligations and collection of the resulting receivable is deemed probable. Payments received in advance for services or products are initially recorded as deferred revenue. The Company provides a 30-day money back guarantee for its Fax Sr. product and reserves for potential product returns and allowances at the time of shipment. Historically, the Company has adequately reserved for such potential returns and allowances
The Company is dependent on licenses of its Fax Sr. NT product, first licensed in March 1995, for a substantial portion of its revenues. In the years ended December 31, 1998, 1997 and 1996, approximately 69%, 83% and 66%, respectively, of the Company's software license revenues were derived from Fax Sr. NT. In addition, a substantial portion of the Company's hardware and service and other revenue is dependent on such licenses of Fax Sr. NT.
The Company also derives revenues from the sale of hardware products such as intelligent fax boards and fax modems. Hardware sales are undertaken as a convenience to the Company's customers and hardware is neither bundled with the Company's software products nor required to be purchased from the Company. Omtool primarily resells intelligent fax boards from vendors such as Brooktrout Technology, Dialogic and Natural MicroSystems. The Company purchases these hardware products as needed to ship to its customers and the Company maintains a minimal inventory of these hardware products. Revenue for hardware products is recognized upon shipment of the product.
Service and other revenues have consisted primarily of the sale of support contracts. Revenue from support contracts is recognized ratably over the term of the support contract period, which is typically one year. Although to date the Company has not provided a significant amount of consulting, configuration and installation services, the Company intends to offer these customer services in the future as warranted by customer demand.
The Company has historically derived substantially all of its total revenues from sales within North America. Sales outside of North America (primarily in Europe) represented approximately 17%, 10% and 5% of the Company's total revenues in 1998, 1997 and 1996, respectively. The Company's gross profit on these sales approximates the gross profit on sales within North America. The Company's strategy is to expand its international presence (primarily in Europe and South America) and to increase its investment in sales and marketing efforts directed toward international markets. See "Acquisitions". There can be no assurance that the Company will be able to maintain or increase international sales of its products, and the failure to do so may have a material adverse effect on the Company's business, financial condition and results of operations.
The Company's United Kingdom subsidiary transacts business primarily in its local currency. The Company manages its foreign exchange exposure by monitoring its net monetary position using natural hedges of its assets and liabilities denominated in local currencies. There can be no assurance that this policy will eliminate all currency exposure. Foreign currency exposure has not been material to the Company's financial position or results of operations to date. If the Company's business denominated in foreign currencies increases, the Company may be required to use derivatives to hedge foreign currency exposure.
Historically, the Company has marketed and sold its products principally through its direct telesales force. However, the Company continues to actively recruit VARs, systems integrators, resellers and distributors to expand its indirect distribution channel. Sales through the Company's indirect distribution channels represent approximately 23%, 28% and 21% of the Company's total revenues for the years ended December 31, 1998, 1997 and 1996, respectively.
ACQUISITIONS
On December 5, 1997, the Company acquired all of the outstanding shares of capital stock of CMA Ettworth Limited ("CMA Ettworth"). CMA Ettworth (now known as Omtool Europe) is headquartered in London, England, with offices in Paris, France and Melbourne, Florida, and designs, markets and supports fax solutions for the IBM AS/400 market. As a result of the CMA Ettworth acquisition, the Company acquired the CMA Ettworth Telex/Fax/400 software products for the IBM AS/400 market including related know-how and goodwill. The purchase price was paid with a combination of 363,637 newly issued shares of common stock, $.01 par value, of the Company and $4 million in cash. The cash used by the Company to fund the acquisition was derived primarily from the proceeds of the Company's initial public offering, which became effective on August 7, 1997. The acquisition was accounted for as a purchase, in accordance with Accounting Principles Board (APB) Opinion No. 16, BUSINESS COMBINATIONS. Based on an independent appraisal, a substantial portion of the purchase price was allocated to purchased in-process research and development (IPR&D) for which the Company incurred a one time charge against earnings of approximately $3.1 million (as restated) in the quarter ended December 31, 1997. See "Discussion of Acquired Technologies".
On February 19, 1998, the Company acquired all of the outstanding capital stock of Desktop Paging Software, Inc. (DPSI) in exchange for 294,840 shares of Omtool common stock. DPSI develops, markets and supports wireless messaging software. This transaction was accounted for as a pooling of interests and, accordingly, the Company's consolidated financial statements were restated to include the accounts and operations of DPSI for all periods presented prior to the acquisition.
On February 27, 1998, the Company acquired all of the outstanding capital stock of TRS Technologies, Inc. (TRS) in exchange for 384,430 shares of Omtool common stock. TRS develops, markets and supports LAN fax and cost recovery systems for law firms. This transaction was accounted for as a pooling of interests and, accordingly, the Company's consolidated financial statements were restated to include the accounts and operations of TRS for all periods presented prior to the acquisition.
Regarding Omtool's acquisition of CMA, the transaction was structured as a purchase of the assets and the business of CMA. Subsequent to the acquisition, it was appropriate to immediately expense the purchased in-process technology that had not yet reached technological feasibility without any alternative use. The value was determined by estimating the costs to develop the purchased in-process technology into commercially viable products, estimating the resulting net cash flows from such projects, and discounting the net cash flows back to their present value. The discount rate included a factor that took into account the uncertainty surrounding the successful development of the purchased in-process technology. In the Company's 1997 Form 10-K, the amount of the CMA purchase price that was allocated to purchased in-process technology was determined to be $6.7 million. This was based on accepted appraisal methodologies used at the time of the allocation. Since that time, the Securities and Exchange Commission (SEC) provided new guidance with respect to the valuation of intangible assets in purchase business combinations, including IPR&D. In response to this new guidance and comments received by the Company from the SEC Staff, the Company obtained a revised independent appraisal incorporating this new guidance, resulting in a change to the allocation of the purchase price. The amount allocated to IPR&D has been revised to an allocation of $3.1 million incorporating the new guidelines. The accompanying 1997 financial statements have been restated to reflect the above revised purchase price allocation. The effect of the restatement was as follows:
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods indicated as a percentage of total revenues:
FISCAL YEARS ENDED DECEMBER 31, 1998 AND 1997
REVENUES
TOTAL REVENUES. The Company's revenues are currently derived primarily from licensing fees of the Company's software products and, to a lesser extent, from related sales of hardware and services. The Company's total revenues were $31.1 million and $21.6 million for the years ended December 31, 1998 and 1997, respectively, representing an increase of 44%.
SOFTWARE LICENSE. The Company's software license revenues are derived primarily from the licensing of the Company's Fax Sr. product. Software license revenues were $18.5 million for the year ended December 31, 1998 and $14.2 million for the year ended December 31, 1997, representing an increase of 30%. Software license revenues accounted for 60% and 66% of total revenues for each respective period. The increase in dollar amount was primarily due to increased market acceptance of the Company's
facsimile software products for various operating systems as well as the expansion into new markets as a result of recent acquisitions. Approximately $2.0 million of the increase in software license revenue is attributable to the Company's acquisition of CMA-Ettworth Limited in December 1997. The decrease in software license revenue as a percentage of total revenues is primarily attributable to the increase in service and other revenue due to the Company's larger installed customer base.
HARDWARE. Hardware revenues are derived from the resale of third-party hardware products sold to the Company's customers in conjunction with the licensing of the Company's software. Hardware revenues were $6.5 million for the year ended December 31, 1998 and $4.3 million for the year ended December 31, 1997, representing an increase of 50%. Hardware revenues accounted for 21% and 20% of total revenues for each respective period. The increase in hardware revenues was due primarily to the increase of hardware unit sales accompanying the Company's products and a change in the sales mix of third-party hardware products from less expensive modem products to high-end multi-channel modem boards.
SERVICE AND OTHER. Service and other revenues are primarily comprised of fees from maintenance contracts. Service and other revenues were $6.1 million and $3.0 million for 1998 and 1997, respectively, representing an increase of 101%. Service and other revenues accounted for 20% and 14% of total revenues for each respective period. The increase in dollar amount was due primarily to an increase in maintenance revenues as a result of a larger installed customer base. The Company anticipates that service revenue will continue to increase as the Company's installed base grows.
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 $1.3 million and $1.0 million in 1998 and 1997, respectively, representing 7% of software license revenues for each respective period. The increase in dollar amount was primarily due to the higher volume of products shipped during the fiscal year 1998 compared to the same period in 1997. Software license gross margin percentages remained constant at 93% for the years ended December 31, 1998 and 1997.
HARDWARE. Cost of hardware revenues consists primarily of the costs of third-party hardware products. Cost of hardware revenues was $3.9 million and $2.9 million in 1998 and 1997, respectively, representing 61% and 67% of hardware revenues for each respective period. The increase in dollar amount for the cost of hardware revenues for the fiscal year ended December 31, 1998 was due primarily to the increase of hardware unit sales accompanying the Company's products and a change in the sales mix of third-party hardware products from less expensive modem products to high-end multi-channel modem boards. The gross margin percentage for hardware sales increased to 39% for 1998 from 33% in 1997 due to the change in the hardware sales mix.
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 $3.0 million and $1.4 million in 1998 and 1997, respectively, representing 48% of service and other revenues for each respective period. The increase in dollar amount of cost of service and other revenues during the period was due primarily to the hiring of incremental personnel to support growth in the customer base. The gross margin percentage for service and other revenues remained constant at 52% for the years ended December 31, 1998 and 1997.
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 direct mailings, public relations, trade shows, seminars, and related communication costs. Sales and marketing expenses were $12.3 million and $7.9 million in 1998 and 1997, respectively, or 40% and 37% of total revenues for each respective period. The increase in dollar amount and the increase in sales and marketing expenses as
a percentage of total revenues was primarily due to the Company's effort to expand its direct telesales force and marketing organization, higher sales commissions associated with increased revenues, and planned increases in marketing program activities. The Company expects that sales and marketing expenses will remain relatively consistent with the current sales and marketing expenses in absolute terms.
RESEARCH AND DEVELOPMENT. Research and development expenses include expenses associated with the development of new products, enhancements of existing products and quality assurance activities, and consist primarily of employee salaries, benefits, and associated overhead costs as well as consulting expenses and the cost of software development tools. Research and development expenses were $5.1 million and $4.0 million in 1998 and 1997, respectively, or 16% and 18% of total revenues for each respective period. The increase in dollar amount was primarily attributable to the employment of additional staff to develop and enhance the Company's products and provide quality assurance as well as the additional personnel added as a result of recent acquisitions. The Company expects research and development expenses will remain relatively consistent with current research and development expenses in absolute terms.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist primarily of employee salaries and benefits for administrative, executive and finance personnel and associated overhead costs, as well as consulting, accounting and legal expenses. General and administrative expenses were $4.8 million and $2.1 million in 1998 and 1997, respectively, or 15% and 10% of total revenues for each respective period. The increase in dollar amount and as a percentage of revenues was primarily attributable to an increase in personnel and the overhead costs allocated to support such personnel as well as additional administrative expenses and amortization expense incurred as a result of recent acquisitions. The Company expects general and administrative expenses are likely to continue to increase in absolute terms.
WRITE-OFF OF PURCHASED, IN-PROCESS RESEARCH AND DEVELOPMENT. In connection with the acquisition of CMA Ettworth, the Company expensed $3.1 million of in-process research and development costs that did not have a future alternative use during the quarter ended December 31, 1997. See Note 4 of Notes to Consolidated Financial Statements.
INTEREST INCOME, NET. Interest income, net consists principally of interest earned on cash, cash equivalents, and short-term investments, offset by interest expense associated with equipment financing and borrowings. Interest income, net represented income of $754,000 for the fiscal year ended December 31, 1998 and $392,000 for the fiscal year ended December 31, 1997, due primarily to interest income earned on excess cash from the proceeds of the Company's initial public offering which was completed in August 1997.
PROVISION FOR INCOME TAXES. The provision for income taxes was $406,000 and $993,000 for fiscal years ended December 31, 1998 and 1997, respectively. The effective income tax rate in 1998 was approximately 27% which is lower than the combined federal and state statutory rates primarily as a result of tax credits and tax-exempt interest. The effective income tax rate was approximately 38% in 1997, calculated based on pre-tax income before a non-deductible charge for purchased, in-process research and development of $3.1 million, which approximates the Company's respective federal and state statutory rates. See Note 8 of Notes to Consolidated Financial Statements.
FISCAL YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUES
TOTAL REVENUES. The Company's total revenues were $21.6 million and $10.3 million in 1997 and 1996, respectively, representing an increase of 109%.
SOFTWARE LICENSE. Software license revenues were $14.2 million in 1997 and $6.6 million in 1996, representing an increase of 114%. Software license revenues accounted for 66% and 64% of total revenues
for each respective period. The increase in dollar amount was primarily due to increased market acceptance of the Company's Fax Sr. product for the Windows NT operating system, as well as expansion of the Company's direct telesales force and indirect sales channels.
HARDWARE. Hardware revenues were $4.3 million in 1997 and $1.8 million in 1996, representing an increase of 135%. Hardware revenues accounted for 20% and 18% of total revenues for each respective period. The increase in hardware revenues was due primarily to the increase of hardware unit sales accompanying increased licenses of Fax Sr. and a change in the sales mix of third-party hardware products from lower priced modem products to high-end multi-channel modem boards.
SERVICE AND OTHER. Service and other revenues were $3.0 million in 1997 and $1.9 million in 1996, representing an increase of 61%. Service and other revenues accounted for 14% and 18% of total revenues for each respective period. The increase in dollar amount was due primarily to the increase in maintenance revenues as a result of a larger installed customer base.
COST OF REVENUES
SOFTWARE LICENSE. Cost of software license revenues were $1.0 million and $588,000 in 1997 and 1996, respectively, representing 7% and 9% of software license revenues for each respective period. The increase in dollar amount was primarily due to the higher volume of products shipped during fiscal year 1997 compared to the same period in 1996. Software license gross margin percentages remained relatively constant at 93% in 1997 compared to 91% in 1996.
HARDWARE. Cost of hardware revenues were $2.9 million and $1.3 million in 1997 and 1996, respectively, representing 67% and 71% of hardware revenues for each respective year. The increase in dollar amount was due primarily to increased unit sales of hardware products accompanying licenses of Fax Sr. and a change in the sales mix of third-party hardware products from less expensive modem products to high-end multi-channel modem boards. The gross margin percentage for hardware sales increased to 33% in 1997 from 29% in 1998 due to the change in the hardware sales mix.
SERVICE AND OTHER. Cost of service and other revenues were $1.4 million and $993,000 in 1997 and 1996, respectively, representing 48% and 53% of service and other revenues for each respective year. The increase in dollar amount was due primarily to the higher volume of products shipped during the year ended December 31, 1997 and the hiring of incremental personnel to support such growth. The gross margin percentage for service and other revenues increased to 52% from 47% for the fiscal year ended 1997 as compared to 1996.
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing expenses were $7.9 million and $3.3 million in 1997 and 1996, respectively, or 37% and 32% of total revenues for each respective period. The increase in dollar amount and the increase in sales and marketing expenses as a percentage of total revenues was primarily due to the Company's effort to expand its direct telesales force and marketing organization, higher sales commissions associated with increased revenues and increased marketing program activities.
RESEARCH AND DEVELOPMENT. Research and development expenses were $4.0 million and $2.2 in 1997 and 1996, respectively, or 18% and 21% of total revenues for each respective period. The increase in dollar amount was primarily attributable to the employment of additional staff and independent contractors to develop and enhance the Company's products and provide quality assurance.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were $2.1 million and $1.1 million in 1997 and 1996, respectively, or 10% and 11% of total revenues for each respective period. The increase in dollar amount was primarily attributable to an increase in personnel and the overhead costs allocated to support such personnel.
INTEREST INCOME, NET. Interest income, net represented income of $392,000 for the fiscal year ended December 31, 1997, due primarily to interest income earned on excess cash from the proceeds of the Company's initial public offering which was completed in August 1997.
PROVISION FOR INCOME TAXES. The provision for income taxes was $993,000 and $244,000 for fiscal years ended December 31, 1997 and 1996, respectively. The effective income tax rate in 1997 was approximately 38% calculated based on pre-tax income before non-deductible charge for purchased in-process research and development of $3.1 million, which approximates the Company's federal and state statutory rates. The effective income tax rate was 31% in 1996. Income taxes in 1996 were provided at the Company's respective federal and state statutory rates, reduced primarily for income tax credits. See Note 8 of Notes to Consolidated Financial Statements.
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 December 31, 1998, the Company had cash and cash equivalents of $2.7 million, short-term investments of $18.0 million and working capital of $23.6 million.
The Company's operating activities provided cash of $1.1 million and $1.2 million for the years ended December 31, 1998 and 1997, respectively. Net cash provided during the year ended December 31, 1998 consisted primarily of net income from operations, depreciation and amortization, and increases in deferred revenue and accounts payable, offset by increased accounts receivable and income taxes payable. Net cash provided during the year ended December 31, 1997 consisted primarily of a net loss, increased accounts receivable and prepaid expenses and other current assets, offset by the write-off of purchased, in-process research and development, depreciation and amortization, and increases in accrued expenses and deferred revenue.
Investing activities provided cash of $560,000 during the year ended December 31, 1998 and used cash of $25.1 million during the year ended December 31, 1997. During the year ended December 31, 1998, the principal uses were purchases of short-term investments, increases in other assets and purchases of property and equipment, offset by proceeds from the sale of short-term investments. During the year ended December 31, 1997, the principal uses were purchases of short-term investments, cash paid for the acquisition of CMA Ettworth, and purchases of property and equipment, offset by the proceeds from the sale of short-term investments.
Financing activities used cash of $1.3 million during the year ended December 31, 1998 due primarily to the purchases of treasury stock. Financing activities generated cash of $24.1 million for the year ended December 31, 1997 due primarily to net proceeds from the issuance of 3,000,000 shares of Common Stock in an initial public offering which was completed in August 1997.
At December 31, 1998, the Company did not have any material commitments for capital expenditures.
Subject to the factors discussed below, the Company believes that the existing cash balances, short-term investments and cash generated from operations will be sufficient to finance the Company's operations for the next twelve months. Although operating activities may provide cash in certain periods, to the extent the Company grows in the future, its operating and investing activities may use cash. There can be no assurance that any necessary additional financing will be available to the Company on commercially reasonable terms, or at all.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This statement requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives
would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS No. 133 will be effective for all fiscal quarters beginning within the Company's fiscal year ending December 31, 2000. The Company believes that this statement will not have a significant impact on the Company.
In March 1998, the AICPA issued SOP 98-4, DEFERRAL OF THE EFFECTIVE DATE OF A PROVISION OF SOP 97-2, SOFTWARE REVENUE RECOGNITION, which amends certain provisions of SOP 97-2. The Company believes it is in compliance with the provisions of SOP 97-2 as amended by SOP 98-4. However, detailed implementation guidelines for this standard have not yet been issued. Once issued, such guidance could lead to unanticipated changes in the Company's current revenue recognition practices, and such changes could be material to the Company's results of operations. In December 1998, the AICPA issued SOP 98-9, MODIFICATION OF SOP 97-2, SOFTWARE REVENUE RECOGNITION, WITH RESPECT TO CERTAIN TRANSACTIONS, which amends certain provisions of SOP 97-2 and extends the deferral of the application of certain passages of SOP 97-2 provided by SOP 98-4 until the beginning of the Company's fiscal year 2000. The Company is currently evaluating the impact of SOP 98-9 on its consolidated financial statements and related disclosures.
In March 1998, the Accounting Standards Executive Committee issued SOP 98-1, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE. This standard requires companies to capitalize qualifying computer software costs, which are incurred during the application development stage, and amortize them over the software's estimated useful life. The Company is required to adopt this standard in fiscal 1999 and is currently evaluating the impact that its adoption will have on the consolidated financial position and results of operations of the Company.
DISCUSSION OF ACQUIRED TECHNOLOGIES
CMA-Ettworth (now known as "Omtool Europe") was acquired in the quarter ended December 31, 1997. The Company acquired in-process research and development related to a strategic fax gateway solution called IMPS (Integrated Message Processing Server), which was to provide integrated fax, voice, e-mail, Internet connectivity and EDI on a single platform product application. Omtool Europe is located in Kingston-upon-Thames, just outside of London, England, and has two wholly owned subsidiaries, one in Paris, France and the other in Melbourne, Florida.
At the time of the acquisition, Omtool Europe's in-process research and development value was comprised of several ongoing projects which included (1) development of a Windows NT 4.0-based server; (2) development of a 32-bit Windows 95 client; (3) development of an email-to-fax capability; (4) development of workload balancing functions; (5) development of least-cost routing systems using a corporate WAN or the Internet; and (6) development of in-bound fax routing techniques. These projects had not yet reached technological feasibility at the time of the acquisition.
Development of the acquired in-process technology into commercially viable products and services required efforts principally related to the completion of all planning, designing, coding, prototyping, scalability verification, and testing activities necessary to establish that the proposed technologies would meet their design specifications, including functional, technical, and economic performance requirements. The Company has successfully developed certain acquired in-process research and development and is currently benefiting from the technology through sales of the enhanced Omtool Fax Sr. applications.
Omtool's acquisition of Omtool Europe was structured as a purchase of the assets and the business of Omtool Europe. Subsequent to the acquisition, it was appropriate to immediately expense the purchased in-process technology that had not yet reached technological feasibility without any alternative use. The value was determined by estimating the costs to develop the purchased in-process technology into commercially viable products, estimating the resulting net cash flows from such projects, and discounting the net cash flows back to their present value. The discount rate included a factor that took into account the uncertainty surrounding the successful development of the purchased in-process technology. In the December 31, 1997 Form 10-K, the amount of the Omtool Europe purchase price that was allocated to
purchased in-process technology was determined to be $6.7 million. This was based on accepted appraisal methodologies used at the time of the allocation. Since the date of the September 30, 1998 filing, the allocation for in-process technology has been revised to $3.1 million, incorporating new guidelines.
The acquired in-process research and development was valued at $3.1 million based on an analysis of forecasted income. The developmental projects at the time of the acquisition were not technologically feasible and had no alternative future use. This conclusion was attributable to the fact that Omtool Europe had not completed a working model that had been tested and proven to work at performance levels which were expected to be commercially viable, and that the technologies constituting the projects had no alternative use other than as an enterprise fax software application. The value is attributable solely to the development efforts completed as of the acquisition date.
The valuation included, but was not limited to, an analysis of (1) the market for Omtool Europe products; (2) the completion costs for the projects; (3) the expected cash flows attributable to the in-process research and development projects; and (4) the risks associated with achieving such cash flows. The assumptions underlying the cash flow projections were derived from investment banking reports, independent analyst reports, Omtool and Omtool Europe company records, and discussions with the management of both companies. Primary assumptions such as revenue growth and profitability were compared to indications of similar companies as well as to indications from industry analyst reports, to determine the extent to which these assumptions were supportable. The Company did not assume in its model any material change in its profit margins as a result of the acquisition and did not assume any material increases in selling, general and administrative expenses as a result of the acquisition. The Company did not anticipate any expense reductions or other synergies as a result of the acquisition. The basis of the acquisition was an attempt to enhance the Company's competitive position by offering a broader product line, including support for AS/400 systems and the implementation of advanced technologies such as least-cost routing, load balancing, in-bound fax routing and fax-to-email connectivity.
In the analysis, revenues attributable to the Omtool Europe in-process technologies were estimated to total approximately $70 million over five years assuming the successful completion and market acceptance of the new Omtool Europe technology in conjunction with Omtool products, in particular the Fax Sr. product line. Revenues were expected to peak in 2001 and then decline as other new products and technologies are expected to enter into the market. The Company does not break down revenues attributable specifically to Omtool Europe-derived products; since products are offered both as a suite and as individual applications, Omtool license fees are not necessarily application-specific. However, the Company believes that revenues generated to date concur with the assumptions used in the valuation analysis.
Because the Company does not account for expenses by product, it is not possible to determine the actual expenses associated with the technology acquired from Omtool Europe. The Company currently believes that expenses associated with completing the purchased in-process research and development and integrating the technology with the Company's existing products are approximately consistent with the Company's estimates used in the analysis and that completion dates for the Omtool Europe development projects discussed above concur with projections used at the time of the acquisition. Research and development spending with respect to these offerings is expected to continue at a rate that is consistent with the Company's overall research and development spending. The Company does not believe that the acquisition resulted in any material changes in its profit margins or in selling, general and administrative expenses. The Company does not believe that it achieved any material expense reductions or synergies as a result of the acquisition.
The rates utilized to discount the net cash flows to their present value were consistent with the nature of the forecast and the risks associated with the projected growth, profitability and developmental projects. A discount rate of 24% was deemed appropriate for the business enterprise and for the in-process research and development. These discount rates were consistent with Omtool Europe's stage of development; the
uncertainties in the economic estimates described above; the inherent uncertainty at the time of the acquisition surrounding the successful development of the purchased in-process technology; the useful life of such technology; the profitability levels of such technology; and the inherent uncertainties of the technological advances that were indeterminable at the time of the acquisition.
The forecast used in valuing the in-process research and development were based upon assumptions the Company believed to be reasonable but which were inherently uncertain and unpredictable. For these reasons, actual results may vary from projected results. The Company continues to develop all of its products with the acquired technologies. The Company maintains a research and development group with facilities in the United Kingdom.
YEAR 2000 READINESS DISCLOSURE STATEMENT
Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21(st) century dates from 20(th) century dates. As a result, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. Significant uncertainty exists in the software industry concerning the potential effects associated with such compliance.
The Company is in the process of evaluating the Year 2000 readiness of the software products sold by the Company ("Products"). The Company performs on-going assessments of the current versions of its most significant Products and believes they are generally Year 2000 compliant. Even so, the assessment of whether a complete system or device in which a Product is embedded will operate correctly for an end-user depends in large part on the Year 2000 compliance of the system's other components, most of which are supplied by parties other than the Company. The cost to evaluate the Company's Year 2000 compliance has not been material to date and the Company does not expect future expenditures to be material. To the extent that the Company's Products are sold through system integrators or other third parties, there can be no assurance that the users of the Company's Products will not experience Year 2000 problems as a result of the integration of the Company's software with noncompliant Year 2000 products of such third party suppliers. In addition, in certain circumstances, the Company has warranted that the use or occurrence of dates on or after January 1, 2000 will not adversely affect the performance of the Company's Products with respect to four digit date dependent data or the ability to create, store, process and output information related to such data. If any of the Company's licensees experience Year 2000 problems, such licensees could assert claims for damages against the Company.
The Company has certain key relationships with suppliers of third-party hardware products sold to the Company's customers in conjunction with the licensing of the Company's software. If these suppliers fail to adequately address the Year 2000 issue for the hardware products they provide to the Company, and as a result, any of the Company's hardware customers experience Year 2000 problems such customers could discontinue use of the Company's Products resulting in a material adverse impact on the Company's operations and financial results. The Company is still addressing the effect the Year 2000 issue will have on its suppliers and at this time, cannot determine the impact it will have.
The Year 2000 issue also affects the Company's internal systems, including information technology (IT) systems, such as management information systems and financial accounting packages, and non-IT systems, such as building security, voice mail and other systems. Omtool is assessing the readiness of its systems for handling the Year 2000. Although the assessment is still underway, management currently believes that all material internal systems will be compliant by the Year 2000 and that the cost to address any issues will not be material.
To date, the Company has not identified a complete and separate budget for investigating and remedying issues related to Year 2000 compliance, whether involving the Company's own software products or the software of systems used in its internal operations. Additionally, the Company has currently not developed a contingency plan related to Year 2000. The Company expects to evaluate the
costs versus the benefits of developing such a plan in fiscal year 1999. There can be no assurance that the Company's resources spent on the investigating and remedying Year 2000 compliance issues will not have a material adverse effect on the Company's business, financial condition and results of operations. Moreover, customer purchasing patterns may be affected by Year 2000 issues as customers delay purchases in anticipation of the future release of Year 2000 compliant products or releases, and as customers expend significant resources to upgrade their current software systems and applications for Year 2000 compliance. These expenditures may result in reduced funds available to purchase software products such as those offered by the Company.
CERTAIN FACTORS AFFECTING FUTURE OPERATING RESULTS
The Company operates in a rapidly changing environment that involves a number of risks, some of which are beyond the Company's control. The discussion highlights some of the risks which may affect future operating results.
DEPENDENCE ON FAX SR. NT AND THE WINDOWS NT ENVIRONMENT. The Company currently derives a substantial portion of its revenues from licenses of Fax Sr. NT and related services and resale of related hardware. Broad market acceptance of Fax Sr. NT is critical to the Company's future success. As a result, any decline in demand for or failure to achieve broad market acceptance of Fax Sr. NT 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 the successful development, introduction and customer acceptance of new and enhanced versions of Fax Sr. NT. The Company is devoting a significant portion of its near-term product development efforts on Internet related functionality. There can be no assurance that the Company will continue to be successful in marketing Fax Sr. NT or any new or enhanced versions of Fax Sr. NT. 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, 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, or 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.
INTENSE COMPETITION. The enterprise, client/server facsimile solution market is 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, including Internet related capabilities;
ease of use; product scaleability; 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 products and standards; name recognition; the establishment of strategic alliances with industry leaders; and industry and general economic trends.
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 Inc. (a subsidiary of Applied Voice Technology, Inc.), Fenestrae BV, Optus Software Inc., TopCall International and Biscom, Inc. The Company also competes with vendors offering a range of alternative facsimile solutions including operating systems containing facsimile and document transmission features; low-end fax modem products; 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 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 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. Increased competition will 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.
NEW PRODUCTS AND TECHNOLOGICAL CHANGE. The market for the Company's products is relatively new and is 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, including the planned Internet enabled products, 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 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 and products currently under development 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 currently planned or other new product offerings by the Company or its competitors will not cause customers to defer or forego the licensing of the Company's existing products and have a material adverse effect on the Company's business, financial condition and results of operations.
RISKS ASSOCIATED WITH ACQUISITIONS. A key element of the Company's growth strategy is to 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 intergrating 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 may 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 result in dilution to the Company's existing stockholders.
LIMITED OPERATING HISTORY. The Company was incorporated in March 1991 and shipped its initial facsimile software products in 1991. The Company has significantly increased its operating expenses in recent periods as it has continued to expand its organization to support sales growth and product development. Although the Company has experienced significant growth during the past three years, the Company does not believe that prior growth rates are sustainable or indicative of future operating results. There can be no assurance that the Company will be able to increase its level of revenues or maintain profitability in the future. Increases in operating expenses are expected to continue and, together with pricing pressures, may result in a decrease in operating income and operating margin percentage. The Company's limited operating history makes the prediction of future operating results difficult or impossible. Future operating results will depend on many factors, including, without limitation, the degree and rate of growth of the markets in which the Company competes and the accompanying demand for the Company's products, the level of acceptance of the Windows NT operating system, 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 telesales force and indirect distribution channels both domestically and internationally, and the ability of the Company to attract and retain key personnel.
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 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. In addition, the sale of the Company's products often involves delays because customers have tended to implement the products on a large scale and customers 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 effort yet receive no revenues. It may be difficult to accurately predict the sales cycle of any large order. If one or more large orders fails 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.
The Company's business has experienced and is expected to continue to experience seasonality. The Company has historically had and expects to continue to have weaker sales in the months of July and August which may have an adverse affect on third quarter sales. The Company believes that these fluctuations are caused primarily by customer budgeting and purchasing patterns.
In general, revenues are difficult to forecast because the market for enterprise, client/server facsimile software has developed and 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.
ABILITY TO MANAGE GROWTH. The Company has rapidly and significantly expanded its operations and anticipates that significant expansion will continue to be required in order to address potential market opportunities. The Company anticipates that it will continue to significantly increase the size of its sales and marketing, research and development, customer support and administrative operations. There can be no assurance that such expansion will be successfully completed or that it will 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.
EXPANSION OF INDIRECT CHANNELS; POTENTIAL FOR CHANNEL CONFLICT. The Company markets its products and services directly through telesales and indirectly through marketing channels such as value-added resellers ("VARs"), systems integrators and distributors. Although the Company has historically focused its efforts on marketing through its telesales 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 and distributors to market successfully the Company's products. In addition, there can be no assurance that the Company's resellers will not develop, acquire or market computer-based facsimile products competitive with the Company's products. The failure to retain its VARs, systems integrators and distributors 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. Such relationships may be terminated by either party, 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. The inability to retain certain VARs, systems integrators or distributors, or the development or marketing by VARs, systems integrators
or distributors 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 INTERNATIONAL EXPANSION. A key element of the Company's strategy is to continue to increase its international sales. The Company expects to face competition from local facsimile product providers in their native countries. To successfully expand international sales, the Company will need to recruit and retain additional international resellers and distributors. In order to penetrate the international market more fully, the Company has translated its products into several foreign languages. There can be no assurance that the completion of such translation will allow the Company to capitalize on the international market opportunity. There can be no assurance that the Company will be able to maintain or increase 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. With the acquisition of CMA Ettworth, based in London, England, in December 1997, the Company obtained its first sales offices 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, none of whom is bound by an employment agreement and only certain of whom are bound by noncompetition agreements. 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. The Company currently carries a key man life insurance policy in the amount of $1 million on each of Robert L. Voelk and Martin A. Schultz, with the proceeds payable to the Company.
ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DERIVATIVE FINANCIAL INSTRUMENTS, OTHER FINANCIAL INSTRUMENTS, AND DERIVATIVE COMMODITY INSTRUMENTS
As of December 31, 1998, 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. All of the Company's investments consist of money market funds and municipal bonds that are carried on the Company's books at amortized cost, which approximates fair market value. Accordingly, the Company has no quantitative information concerning the market risk of participating in such investments.
PRIMARY MARKET RISK EXPOSURES
The Company's primary market risk exposures are in the areas of interest rate risk and foreign currency exchange rate risk. The Company's investment portfolio of cash equivalent and short-term investments is subject to interest rate fluctuations, but the Company believes this risk is immaterial due to the short-term nature of these investments. The Company's exposure to currency exchange rate fluctuations has been and is expected to continue to be modest due to the fact that the operations of its United Kingdom subsidiary are almost exclusively conducted in its local currency. The United Kingdom subsidiary operating results are translated into U.S. dollars and consolidated for reporting purposes. The impact of currency exchange rate movements on intercompany transactions was immaterial for the year ended December 31, 1998. Currently the Company does not engage in foreign currency hedging activities.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's Consolidated Financial Statements, together with the auditors' reports thereon, appear at pages through, respectively, of this Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The information concerning directors of the Company required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's fiscal year ended December 31, 1998.
EXECUTIVE OFFICERS
The information concerning officers of the Company required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's fiscal year ended December 31, 1998.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION AND OTHER INFORMATION
The information required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's fiscal year ended December 31, 1998.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission not later than 120 days after the close of the Company's fiscal year ended December 31, 1998.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this item is incorporated herein by reference to the Company's definitive proxy statement pursuant to Regulation 14A, to be filed with the Commission within 120 days after the close of the Company's fiscal year ended December 31, 1998.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(a) List of documents filed as part of this report
(1) Financial Statements Listed under Part II, Item 8 and included herein by reference.
(2) Financial Statement Schedules
All schedules are not submitted because they are not applicable, not required or because the information is included in the Financial Statements as Notes to Financial Statements.
(3) Exhibits
(b) Reports on Form 8-K.
The Company did not file any current report on Form 8-K during the fourth quarter of the fiscal year ended December 31, 1998.
(c) Exhibits.
The exhibits required by this Item are listed under Item 14(a)(3).
(d) Financial Statement Schedules.
The financial statement schedules required by this Item are listed under Item 14(a)(2).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Salem, State of New Hampshire, on the 30th day of March 1999.
POWER OF ATTORNEY
We, the undersigned officers and directors of Omtool, Ltd., hereby severally constitute and appoint Robert L. Voelk and Darioush Mardan, and each of them singly, our true and lawful attorneys-in-fact and agents with full power of substitution and resubstitution in each of them, to sign for us and in our names in the capacities indicated below, and generally to do all such things in our names and on our behalf in our capacities as officers and directors to enable Omtool, Ltd. to comply with the provisions of the Securities Exchange Act of 1934, as amended, and all requirements of the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorneys, or any of them.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
OMTOOL, LTD. AND SUBSIDIARIES
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Omtool, Ltd.:
We have audited the accompanying consolidated balance sheets of Omtool, Ltd. (a Delaware corporation) and subsidiaries as of December 31, 1998 and 1997 (as restated--see Note 4), and the related consolidated statements of operations, convertible redeemable preferred stock and stockholders' equity (deficit) and cash flows for the years ended December 31, 1998, 1997 (as restated--see Note 4) and 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Omtool, Ltd. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts January 22, 1999
OMTOOL, LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
OMTOOL, LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these consolidated financial statements.
OMTOOL, LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CONVERTIBLE REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
The accompanying notes are an integral part of these consolidated financial statements.
OMTOOL, LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
OMTOOL, LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
The accompanying notes are an integral part of these consolidated financial statements.
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) OPERATIONS
Omtool, Ltd. and subsidiaries (Omtool or the Company) design, develop, market and support open, client/server software, delivering solutions that automate and integrate communication throughout the enterprise. Omtool's Fax Sr., LegalFax and FAX/400 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 processes by providing a suite of utility and control functions. The Company predominantly does business in markets located within North America and Europe.
The Company is subject to a number of risks associated with emerging, technology-oriented companies with a limited operating history, including continued market acceptance of the Company's products, competition from substitute products and larger companies, and the continued ability to manage and finance the Company's anticipated future growth.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements reflect the application of certain accounting policies as described in this note and elsewhere in the notes to consolidated financial statements.
(A) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany transactions have been eliminated in consolidation.
(B) REVENUE RECOGNITION
The Company generates revenue from licensing the rights to use its software products directly to end users and indirectly through resellers. The Company also generates revenue from sales of support contracts and consulting services to customers who license its products and from resale of related hardware products.
Revenues from software license agreements are recognized upon shipment of the software, if there are no significant post-delivery obligations and if payment is due within one year. Revenues are recorded net of an allowance for estimated future returns. If an acceptance period is required, revenues are recognized upon the earlier of the customer's acceptance or the expiration of the acceptance period.
Revenues from support contracts are recognized ratably over the term of the support period, which is generally one year. Service and other revenue is primarily related to implementation services performed on a time-and-material basis under separate service agreements related to the installation of the Company's software products.
Service and other revenues are recognized as services are performed. If a transaction includes both license and service elements, license fee revenues are recognized upon shipment of the software, provided services do not include significant customization or modification of the base product and the payment terms for licenses are not subject to acceptance criteria. In cases where license fee payment is contingent upon the acceptance of services, revenues from both the license and the service elements are deferred until the acceptance criteria are met.
Cost of license revenues consists of the cost of media on which the product is delivered and any related royalties. Cost of service revenues consists primarily of salaries and benefits related to consulting personnel and the customer support group.
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (C) RESEARCH AND DEVELOPMENT AND SOFTWARE DEVELOPMENT COSTS
Software development costs are considered for capitalization when technological feasibility is established in accordance with Statement of Financial Accounting Standards (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 could be capitalized are not material to the Company's consolidated financial position or results of operations. Therefore, the Company charges all research and development expenses to operations in the period incurred.
(D) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents. Cash equivalents consist primarily of investments in money market funds. In accordance with SFAS No. 115, ACCOUNTING FOR INVESTMENTS IN CERTAIN DEBT AND EQUITY SECURITIES, the Company's cash equivalents are classified as held-to-maturity securities. Held-to-maturity securities are carried at amortized cost, which approximates market value.
(E) SHORT-TERM INVESTMENTS
As of December 31, 1998 and 1997, the Company had $18,039,250 and $21,179,766, respectively, invested in securities consisting of municipal bonds. In accordance with SFAS No. 115, the Company has classified its short-term investments as available-for-sale. These securities have been recorded at cost, which approximates market value at December 31, 1998 and 1997.
(F) DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company does not have any derivative or other financial instruments as defined by SFAS No. 119, DISCLOSURE ABOUT DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS.
SFAS No. 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS, requires disclosure of an estimate of the fair value of certain financial instruments. The Company's financial instruments consist of cash equivalents, short-term investments, accounts receivable, accounts payable and debt. The estimated fair value of these financial instruments approximates their carrying value at December 31, 1998 and 1997 due to the short-term nature of these instruments.
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (G) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation is calculated using accelerated and straight-line methods over the following useful lives:
The Company capitalizes expenditures that materially increase asset lives and charges ordinary repairs and maintenance to operations as incurred.
(H) USE OF ESTIMATES IN THE PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
(I) CONCENTRATION OF CREDIT RISK
SFAS No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK, requires disclosure of any significant off-balance sheet and credit risk concentrations. As of December 31, 1998, the Company has no significant off-balance sheet or credit risk concentrations, such as foreign currency exchange contracts or other hedging instruments. Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments and trade accounts receivable. The Company places its temporary cash investments in financial institutions. The Company has not experienced significant losses related to receivables from individual customers or groups of customers in any specific industry or by geographic area. Due to these factors, no additional credit risk beyond amounts provided for collection losses is believed by management to be inherent in the Company's accounts receivable.
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The following schedule summarizes the activity of the Company's accounts receivable reserve for the three years ended December 31, 1998:
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(1) Amount represents additional reserves resulting from the purchase of all of the outstanding common stock of CMA Ettworth Limited in December 1997.
For the years ended December 31, 1998, 1997 and 1996, no single customer accounted for greater than 10% of the Company's revenues.
(J) RECLASSIFICATIONS
The Company has reclassified certain prior year information to conform with the current year's presentation.
(K) FOREIGN CURRENCY TRANSLATION
The Company translates the financial statements of its foreign subsidiaries in accordance with SFAS No. 52, FOREIGN CURRENCY TRANSLATION. Accordingly, assets and liabilities are translated at exchange rates in effect at the end of the year, and revenues and expenses are translated at the average exchange rates during the year. All cumulative translation gains or losses from the translation into the Company's reporting currency are included as a separate component of stockholders' equity (deficit) in the accompanying consolidated balance sheets.
(L) NET INCOME (LOSS) PER SHARE
The Company reports earnings per share in accordance with SFAS No. 128. In accordance with SEC Staff Accounting Bulletin (SAB) No. 98, the Company has determined that there were no nominal issuances of common stock or potential common stock in the period prior to the Company's initial public offering (IPO). The dilutive effect of potential common shares in 1998, consisting of outstanding stock options, is determined using the treasury stock method, in accordance with SFAS No. 128. The dilutive effect of potential common shares in 1996, consisting of outstanding stock options and redeemable convertible preferred stock, is determined using the treasury stock method and the if-converted method, respectively, in accordance with SFAS No. 128. Diluted weighted average shares outstanding for 1997 exclude the potential common shares from stock options and redeemable convertible preferred stock
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) outstanding because to include them would have been antidilutive for the year presented. A reconciliation of basic and diluted common shares outstanding is as follows:
For the year ended December 31, 1998, the calculation above excludes the potential common shares related to 1,500 outstanding stock options which have an anti-dilutive effect. For the year ended December 31, 1997, the calculation above excludes the potential common shares related to 971,285 outstanding stock options and 1,822,339 shares of redeemable convertible preferred stock which have an anti-dilutive effect.
(M) RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This statement requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS No. 133 will be effective for all fiscal quarters beginning within the Company's fiscal year ending December 31, 2000. The Company believes that this statement will not have a significant impact on the Company.
In March 1998, the AICPA issued SOP 98-4, DEFERRAL OF THE EFFECTIVE DATE OF A PROVISION OF SOP 97-2, SOFTWARE REVENUE RECOGNITION, which amends certain provisions of SOP 97-2. The Company believes it is in compliance with the provisions of SOP 97-2 as amended by SOP 98-4. However, detailed implementation guidelines for this standard have not yet been issued. Once issued, such guidance could lead to unanticipated changes in the Company's current revenue recognition practices, and such changes could be material to the Company's results of operations. In December 1998, the AICPA issued SOP 98-9, MODIFICATION OF SOP 97-2, SOFTWARE REVENUE RECOGNITION, WITH RESPECT TO CERTAIN TRANSACTIONS, which amends certain provisions of SOP 97-2 and extends the deferral of the application of certain passages of SOP 97-2 provided by SOP 98-4 until the beginning of the Company's fiscal year 2000. The Company is currently evaluating the impact of SOP 98-9 on its financial statements and related disclosures.
In March 1998, the Accounting Standards Executive Committee issued SOP 98-1, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE. This standard requires companies to capitalize qualifying computer software costs, which are incurred during the application development stage
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) and amortize them over the software's estimated useful life. The Company is required to adopt this standard in fiscal 1999 and is currently evaluating the impact that its adoption will have on the consolidated financial position and results of operations of the Company.
(3) COMPREHENSIVE INCOME (LOSS)
The Company adopted SFAS No. 130, REPORTING COMPREHENSIVE INCOME, effective January 1, 1998. SFAS No. 130 establishes standards for reporting and display of comprehensive income (loss) and its components in financial statements. The components of the Company's comprehensive income (loss) are as follows:
(4) ACQUISITIONS
(A) CMA ETTWORTH--RESTATEMENT OF FINANCIAL STATEMENTS
On December 5, 1997 the Company acquired all of the outstanding common stock of CMA Ettworth Limited (CMA). The purchase price was paid in a combination of 363,637 shares of common stock valued at approximately $3.0 million and $4.0 million in cash. The Company also incurred approximately $500,000 in acquisition related costs resulting in a total purchase price of approximately $7.5 million. The acquisition was accounted for as a purchase in accordance with Accounting Principle Board (APB) Opinion No. 16, BUSINESS COMBINATIONS, and accordingly, CMA's operating results since December 5, 1997 are included in the accompanying consolidated financial statements. For tax purposes, the Company has recorded the transaction at CMA's carryover basis of assets and liabilities.
In accordance with APB Opinion No. 16, the Company allocated the purchase price based on the fair value of assets acquired and liabilities assumed. A significant portion of the purchase price, was identified in an independent appraisal as intangible assets using proven valuation procedures and techniques, including approximately $6,680,000 of in-process research and development projects (IPR&D) that had not reached technological feasibility without any alternative future use. Accordingly, the portion allocated to IPR&D was expensed immediately. Acquired intangibles include developed technology and assembled workforce. These intangibles are being amortized over their estimated useful lives of 4 to 7 years. Due to a difference in the bases of certain assets for financial statement and income tax purposes, deferred income taxes of $236,000 were provided as part of the purchase price allocation in accordance with SFAS No. 109, ACCOUNTING FOR INCOME TAXES.
The value allocated to IPR&D was determined by estimating the costs to develop the purchased in-process technology into commercially viable products, estimating the resulting net cash flows from such projects and discounting the net cash flows back to their present value. The discount rate included a factor that took into account the uncertainty surrounding the successful development of the purchased in-process technology. This valuation was based on accepted appraisal methodologies used at the time of the
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) ACQUISITIONS (CONTINUED) allocation. Since that time, the Securities and Exchange Commission (SEC) has provided new guidance with respect to the valuation of intangible assets in purchase business combinations, including IPR&D. In response to this new guidance and comments received by the Company from the SEC Staff, the Company obtained a revised independent appraisal incorporating this new guidance, resulting in a change to the allocation of the purchase price, as follows:
The accompanying 1997 financial statements have been restated to reflect the above revised purchase price allocation. The effect of the restatement was a reduction in net loss and diluted net loss per share of $3,504,084 and $0.41, respectively for the year ended December 31, 1997.
Unaudited pro forma operating results for the Company, assuming the acquisition of CMA occurred as of the beginning of the years presented:
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(1) For the purposes of these pro forma operating results, the in-process research and development was assumed to have been written off prior to January 1, 1997, so that the operating results presented include only recurring costs.
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) ACQUISITIONS (CONTINUED) (2) For the purposes of these pro forma weighted average number of common shares outstanding, the 363,637 shares issued in connection with the CMA Ettworth acquisition have been included as outstanding for the entire period presented.
Fiscal 1997 represents the results of Omtool for the year ended December 31, 1997 combined with CMA's results from January 1, 1997 through the date of acquisition.
(B) OTHER ACQUISITIONS
On February 19, 1998, the Company acquired all of the outstanding capital stock of Desktop Paging Software, Inc. (DPSI) in exchange for 294,840 shares of Omtool common stock. DPSI develops, markets and supports wireless messaging software. This transaction has been accounted for as a pooling of interests and, accordingly, the Company's consolidated financial statements have been restated to include the accounts and operations of DPSI for all periods presented prior to the acquisition.
On February 27, 1998, the Company acquired all of the outstanding capital stock of TRS Technologies, Inc. (TRS) in exchange for 384,430 shares of Omtool common stock. TRS develops, markets and supports LAN fax and cost recovery systems for law firms. This transaction has been accounted for as a pooling of interests and, accordingly, the Company's consolidated financial statements have been restated to include the accounts and operations of TRS for all periods presented prior to the acquisition.
Separate total revenues and net income (loss) amounts of the acquired entities are presented in the following table.
(5) INTANGIBLE ASSETS
The Company assesses the realizability of intangible assets in accordance with SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. Under SFAS No. 121, the Company is required to assess the valuation of its long-lived assets, including intangible assets, based on the estimated cash flows to be generated by such assets. Based on its most recent analysis, the Company believes that no material impairment of intangible assets exists as of December 31, 1998.
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) INTANGIBLE ASSETS (CONTINUED) Intangible assets are included in "Other Assets" on the face of the balance sheet and are amortized on a straight-line basis, based on their estimated lives, as follows:
(6) ACCRUED LIABILITIES
Accrued liabilities consist of the following:
(7) LINE OF CREDIT
The Company had a line of credit that allowed the Company to borrow the lesser of $250,000 or 75% of eligible accounts receivable, as defined. This line of credit had an interest rate equal to the bank's prime rate (8.5% at December 31, 1997) plus 1.75%. This line of credit was collateralized by certain accounts receivable, inventory, equipment and general intangibles of the Company, required the Company to maintain certain financial ratios, and was guaranteed by certain of the Company's shareholders. This line of credit expired on November 1, 1998. At December 31, 1997, approximately $245,000 was outstanding under this line of credit.
(8) INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109, the objective of which is to recognize the amount of current and deferred income taxes at the date of the consolidated financial statements as a result of all differences in the tax basis and financial statement carrying amount of assets and liabilities as measured by enacted tax laws.
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) INCOME TAXES (CONTINUED) The components of the deferred tax assets and the deferred tax liabilities are as follows:
Under SFAS No. 109, the Company recognizes a deferred tax asset for the future benefit of its temporary differences if it concludes that it is more likely than not that the deferred tax asset will be realized. The Company has recorded a valuation allowance relating to a portion of its net operating loss and tax credit carryforwards for which realization is uncertain.
A reconciliation of the federal statutory rate to the Company's effective tax rate is as follows:
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(1) Calculated based on pre-tax income, before non-deductible charge for purchased, in-process research and development of $3.1 million for 1997.
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) INCOME TAXES (CONTINUED) The provision for income taxes in the accompanying consolidated statements of operations consists of the following:
The components of domestic and foreign income (loss) before taxes are as follows:
(9) SERIES B CONVERTIBLE REDEEMABLE PREFERRED STOCK
In July 1996, the Company issued 1,356,116 shares of Series B Convertible Redeemable Preferred Stock (Series B Preferred Stock) at $3.69 per share, less offering costs of approximately $76,000, for net proceeds of approximately $4,924,000. Upon the closing of the Company's initial public offering, the Series B Preferred Stock automatically converted into an aggregate of 2,712,232 shares of Common Stock.
(10) STOCKHOLDERS' EQUITY
(A) INITIAL PUBLIC OFFERING
In August 1997, the Company completed its initial public offering (IPO) of 3,000,000 shares of Common Stock at $9.00 per share resulting in net proceeds to the Company of approximately $24.0 million, net of issuance costs. The Series A Convertible Preferred Stock and Series B Convertible Redeemable Preferred Stock automatically converted into 325,000 shares and 2,712,232 shares, respectively, of Common Stock upon the closing of the IPO.
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) STOCKHOLDERS' EQUITY (CONTINUED) (B) RECAPITALIZATION
On January 23, 1997, the Company's Board of Directors approved a two-for-one stock split of the Company's Common Stock effected in the form of a stock dividend. The accompanying consolidated financial statements and notes have been retroactively restated for all periods presented to reflect this stock split.
(C) SERIES A CONVERTIBLE PREFERRED STOCK
Pursuant to subscription agreements entered into in February 1996, in July 1996, certain directors of the Company purchased 162,500 shares of Series A Preferred Stock for an aggregate of $325,000. Upon the closing of the Company's IPO, the Series A Preferred Stock automatically converted into an aggregate of 325,000 shares of Common Stock.
(D) REPURCHASE OF COMMON STOCK
Concurrent with the issuance of the Series B Preferred Stock, as approved by the stockholders and the Board of Directors, the Company purchased and retired 1,084,992 shares of Common Stock from two of its principal stockholders for $2,000,183.
(E) TREASURY STOCK
In October 1998, the Company's Board of Directors authorized the repurchase of up to 1.0 million shares of the Company's Common Stock. Subject to price and market considerations and applicable securities laws, such purchases will be made from time to time on the open market. No time limit was placed on the duration of the repurchase program. The Company may use the repurchased shares to offset shares issued in connection with various Company employee stock plans. As of December 31, 1998, the Company has repurchased 660,780 shares.
(F) RESERVED COMMON STOCK
As of December 31, 1998, 2,673,326 shares of Common Stock were reserved for issuance pursuant to stock option plans and the employee stock purchase plan.
(11) STOCK PLANS
(A) STOCK OPTION PLANS
On January 2, 1996, the Board of Directors adopted the 1996 Stock Option Plan (the 1996 Plan). The 1996 Plan provides for the granting of options covering 1,500,000 shares of Common Stock. The 1996 Plan is administered by the Board of Directors and allows for the granting of "incentive stock options" within the meaning of the Internal Revenue Code of 1986, as amended, and non-qualified stock options. Incentive stock options under the 1996 Plan are granted at not less than the fair market value per share of common stock on the date of grant or 110% of fair market value for any stockholder who holds more than 10% of the total combined voting power of all classes of stock of the Company. Under the terms of the 1996 Plan, options vest and become exercisable as determined by the Board of Directors and expire 10 years after the date of grant. In April 1997, The Company's Board of Directors voted that, effective upon the closing of the initial public offering, no further options may be granted or issued under the 1996 Plan.
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) STOCK PLANS (CONTINUED) The Company's 1997 Stock Plan (the 1997 Plan) was adopted by the Board of Directors in April 1997 and approved by the Company's stockholders in June 1997. The 1997 Plan took effect upon the closing of the Company's initial public offering. The 1997 Plan provides for the issuance of Common Stock pursuant to the grant to employees of "incentive stock options" within the meaning of the Internal Revenue Code of 1986, as amended, and the grant of non-qualified stock options, stock awards or opportunities to make direct purchases of stock in the Company to employees, consultants, directors and officers of the Company. The aggregate number of shares of Common Stock which may be issued pursuant to the 1997 Plan is 1,800,000.
The following is a summary of all stock option activity:
At December 31, 1998, options to purchase 1,102,350 shares of Common Stock were available for future grants under the 1997 Plan.
The range of exercise prices for options outstanding and options exercisable at December 31, 1998 is as follows:
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) STOCK PLANS (CONTINUED) On August 13, 1998, the Company's Board of Directors authorized a repricing of certain employee stock options. A total of 761,550 options with exercise prices ranging from $5.50 to $12.13 were affected by the repricing. These options were repriced to $4.875, the closing market price of the Company's Common Stock on that date. Substantially all other terms and conditions of the options remain the same. For employees that opted to participate in the repricing, the original options were amended to reflect the terms of the repricing. These amended options are not reflected as canceled and granted in the option rollforward above.
(B) 1997 EMPLOYEE STOCK PURCHASE PLAN
The 1997 Employee Stock Purchase Plan (the 1997 Purchase Plan) was adopted by the Board of Directors in April 1997 and approved by the Company's stockholders in June 1997. The 1997 Purchase Plan took effect in January 1998. The 1997 Purchase Plan provides for the issuance of a maximum of 200,000 shares of Common Stock pursuant to the exercise of nontransferable options granted to participating employees. The exercise price for the option for each six-month purchase period is 85% of the lesser of the market price of the Common Stock on the first or last business day of the six-month purchase period. As of December 31, 1998, 3,678 shares had been issued under the plan.
(C) STOCK BASED COMPENSATION
The Company accounts for stock-based compensation for employees under Accounting Principles Board Opinion No. 25 and elects the disclosure-only alternative under SFAS No. 123 for options granted in 1998, 1997 and 1996 using the Black-Scholes option pricing model prescribed by SFAS No. 123. Based on the use of the Black-Scholes option pricing model, options granted in 1998, 1997 and 1996 had a weighted average fair value of $3.52, $3.31 and $0.22, respectively. The weighted average assumptions are as follows:
The pro forma effect on the Company of applying SFAS No. 123 for all options to purchase common stock would be as follows:
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) 401(K) AND PROFIT-SHARING PLAN
On December 1, 1995, the Company adopted a 401(k) and profit-sharing plan (the Profit-Sharing Plan) to cover all eligible employees. The Profit-Sharing Plan allows for voluntary contributions by eligible employees. The Company matches 50% of eligible employee contributions up to a specified amount. The Company contributed approximately $169,000, $124,000 and $69,000 to the Profit-Sharing Plan for the years ended December 31, 1998, 1997 and 1996, respectively. Additional profit-sharing contributions to the Profit-Sharing Plan are at the discretion of the Company's management. During 1998, 1997 and 1996, the Company made no additional discretionary contributions.
(13) LEASE COMMITMENTS
The Company leases certain equipment and its office facility under operating leases that expire at various times through December 2002.
Future minimum lease payments under these leases at December 31, 1998 are as follows:
Rent expense included in the accompanying statements of operations was approximately $623,000, $472,000 and $377,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
(14) SEGMENT AND GEOGRAPHIC INFORMATION
The Company has adopted SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, in the fiscal year ended December 31, 1998. SFAS No. 131 establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information for those segments to be presented in interim financial reports issued to stockholders. SFAS No. 131 also establishes standards for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision making group, in making decisions how to allocate resources and assess performance. The Company's chief decision-maker, as defined under SFAS No. 131, is the Chief Executive Officer. 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.
Total revenues from international sources were approximately $5.4 million, $2.1 million and $560,000 in 1998, 1997 and 1996, respectively. The Company's revenues from international sources were primarily
OMTOOL, LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(14) SEGMENT AND GEOGRAPHIC INFORMATION (CONTINUED) generated from customers located in Europe. The following table represents amounts relating to geographic locations for the years ended December 31, 1998, 1997 and 1996:
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(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.
(15) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table presents a condensed summary of quarterly results of operations for the years ended December 31, 1998 and 1997.