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Article by DailyStocks_admin    (04-09-08 02:57 AM)

Filed with the SEC from Mar 27 to Apr 2
Captaris (CAPA)
Emancipation Capital wants Captaris to "expeditiously move forward" in signing an acquisition agreement with Vector Capital. Captaris confirmed that it had received an unsolicited offer from Vector to acquire it for $4.75 a share. Emancipation said that, by entering an agreement with Vector, the company's shareholders "are assured of a price premium, have a reasonable probability of yet a higher price and have eliminated the risk of a failed auction."
Emancipation encouraged Captaris to seek a higher price from Vector as a condition of entering an agreement. Emancipation holds 1,752,541 shares (6.65%).
BUSINESS OVERVIEW

Founded in 1982, Captaris, Inc., (“we”, “us”, “our”) is a provider of computer products that automate document-centric business processes. With a comprehensive suite of software, hardware and services, we help organizations gain control over many processes that include the need to integrate documents more securely and efficiently. Our solutions also provide interoperability between documents and business applications and technology platforms.

We develop products and services for document capture, intelligent document recognition and classification, routing, workflow, document management and document delivery. Our product lineup includes the brand names RightFax, FaxPress, Captaris Workflow, Alchemy, Single Click Entry, DOKuStar and RecoStar.

Our products are distributed and supported through a global network of technology partners. This distribution system consists of business partners from all levels of the information technology (“IT”) spectrum: value-added resellers, original equipment manufacturers (“OEMs”), system integrators, distributors, mass market resellers, online retailers, office equipment dealers, and independent software vendors (“ISVs”). We believe the use of multiple distribution channels increases the likelihood that our products will be sold to more customers.

We have a large installed base of customers that includes many Fortune 100 companies, the majority of the Global 2000 companies, and thousands of mid-sized enterprises. Our customers use our products to reduce costs, comply with regulations, increase the performance and productivity of critical business processes, and leverage their IT system investments.

In July 2007, we bolstered our product portfolio, customer base, and distribution capabilities by acquiring Castelle, a provider of “all-in-one” network fax appliance solutions for businesses and enterprises. Castelle FaxPress products are designed to be easily deployed and maintained and are generally intended for lower volume use at lower price points than our RightFax product offerings. FaxPress provides Captaris with a fax server product that can be positioned in the tier below RightFax for customers looking for basic fax services that are low cost and easily deployable. The FaxPress products are available through a worldwide network of distributors, resellers, and online retailers.

Castelle’s expertise in building “all-in-one” network appliance solutions facilitates our plan to broaden our offerings in the areas of document capture, routing and management. The network appliance design combines software and hardware into a “plug and play” device, and we believe this design is particularly well suited to support our focus on achieving synergies with multi-function product manufacturers and their dealer networks.

We further increased our product portfolio, customer base and distribution capabilities with the acquisition of Ocė Document Technologies GmbH (“ODT”) in January 2008. ODT is a provider of software and solutions for document capture, text recognition, and document classification. ODT, a wholly-owned subsidiary of the Ocė Group since 2000, has approximately 178 employees and maintains its global headquarters in Constance, Germany, and its North American office in Bethesda, Maryland. On an unaudited basis, ODT’s revenue was about €22.5 million for the 12 months ended November 30, 2007 and their gross margin was about 65%. ODT’s revenue includes software licenses, maintenance and support, hardware and professional services. In contrast to our business prior to acquisition, ODT’s revenue includes a higher percentage of professional services and a larger portion of their sales are made directly rather than through partners. As a result of these factors, and a smaller revenue and customer base, ODT has a lower gross margin and more revenue variability.

After our acquisition, we re-named ODT to Captaris Document Technologies (“CDT”). CDT develops intelligent document and character recognition technologies that can read and extract the important information from documents needed to drive business processes and decisions. CDT products include RecoStar, DOKuStar, Single Click Entry and ID-Star. CDT customers include some large ISVs and OEMs with capture offerings, as well as blue chip end-user accounts in Germany. CDT’s expertise in intelligent document recognition supports our vision of fully enabling document capture, collaboration and workflow. As we continue to merge our products, we anticipate leveraging CDT’s technology to enhance capture and routing in both the RightFax and Alchemy platforms. The ability to classify documents and extract critical meta-data will also enable deeper integrations with line of business applications and business process management.

Industry Background

Every organization looks to optimize and automate its internal processes to achieve several desirable outcomes: to comply with regulations; to improve customer service; to increase employee productivity; to improve and accelerate revenue flows; to decrease labor, system and program costs; and to more efficiently share, store and retrieve information. With increasing amounts of information to exchange and manage, we believe there is a growing need for organizations to intelligently and securely capture and manage business information and resources throughout the information lifecycle in a more timely and cost-effective manner.

Solutions to these business needs are found within the multi-billion dollar Enterprise Content Management (“ECM”) market. The ECM market is further categorized into several market segments:




Capture, which includes fax servers;




Business Process Management, which includes workflow;




Electronic Document Management Systems which includes document routing and multi-function product solutions;




Enterprise Search, and,




Electronic Records Management.

Captaris offers products that serve all of these market segments.

Strategy

We believe the ECM market presents growth opportunities for our products, particularly in the areas of distributed capture, routing, document and business process management. Further, we believe our product portfolio is appropriately targeted for opportunities being created by Microsoft’s development of SQL Server, SharePoint Server, the Windows Workflow Foundation, and enterprise search.

The rapid increase in document-based information, combined with the regulatory and legal pressure to control all of the content more closely than ever before, has further accentuated the need for organizations to purchase products and services that can solve their business challenges. With our comprehensive product portfolio, large and diverse distribution channels, and sizable installed base of customers, we believe we are poised to take advantage of these industry trends. The key components of our business strategy include:

Strengthening our leadership position in distributed document capture solutions. We believe organizations are moving away from centralized document capture operations designed to achieve economies of scale and moving towards capturing information closer to the point of origin within their enterprises. By capturing information at the point of origin, documents and associated data describing the context, content and structure of the data on the document are more easily integrated into business processes. Fax servers are by their very nature distributed capture solutions that import and route digital documents. Our intent is to add document classification and more robust data extraction technologies, acquired as part of the CDT acquisition, and evolve RightFax from a fax server into a broader distributed capture platform.

Leveraging our expanded product portfolio across our large channel . As we integrate the CDT technology into the RightFax and Alchemy platforms and leverage the appliance building capability of Castelle, we believe these technologies will reach a broader market through the larger customer base and distribution capabilities of Captaris. We intend to bring new or improved products to market in ways that fit each channel’s strengths.

Leveraging Captaris multi-function product (“MFP”) vendor relationships to enhance our distribution capabilities. Based on industry reports, we believe MFP vendors are selling over $1 billion in software licenses per year. Based on these reports, we believe the vast majority of these sales are in the areas of document capture, routing, and management. Over the past several years we have invested in building relationships with the MFP vendors and have established agreements with many large MFP distributors.

Selling more products into our large installed base of customers . We plan to grow our existing customer relationships by offering add-on modules, software upgrades and new products. We continually train our sales force and partners with the skills needed to cross-sell our entire product line into our existing customer base.

Expanding our strategic technology partnerships worldwide . We have strategic partner relationships with large technology companies including Canon U.S.A., Inc., Cisco Systems, Inc., Hewlett Packard Company, Microsoft Corporation, Oracle Corporation and Xerox Corporation. We plan to pursue an expansion of similar agreements in the future through our business development efforts.

Pursuing global opportunities . We believe that the market for document-centric solutions outside the United States will experience consistent growth over the next few years. To pursue these opportunities, we localize our products into regional languages. We also actively recruit new international resellers, distributors and strategic partners to expand our market coverage and enhance technical expertise.

Grow through acquisitions . Growth through acquisitions of complementary technologies, products and distribution channels offers the potential for significant competitive advantages. In July 2007, we acquired Castelle, the maker of a network fax appliance, to expand our fax server offerings and acquire the skills necessary to develop other network appliances. In January 2008, we acquired CDT, a provider of document and character recognition technologies, to expand and strengthen our existing document solutions.

Products and Services

Our product suite addresses the key phases of the information lifecycle, from the capture, recognition and routing of documents to processing, management and delivery. Our products can be deployed alone or integrated together to solve challenging business problems and improve organizational efficiency.

Our products and services include the following categories:




Intelligent document capture, recognition, classification, and routing solutions that create “smart documents” and automatically deliver them to meet the collaboration and compliance needs of today’s business environment.




Business process management software that automates both functional and vertical business processes, helps organizations maintain accountability, supports compliance initiatives and increases productivity; and




Document management software products that target business needs for reducing paper by storing and accessing digital content throughout the information lifecycle and supporting compliance and collaboration within organizations.

Document Capture, Recognition, Classification, and Routing Products

Single Click Entry

Single Click Entry is designed to reduce human error and increase productivity for any application where data from scanned images is currently entered by hand. This application extracts data from an image and automatically transfers it to line of business applications for use within business processes. Powering this simple and easy to use application are a combination of high performance optical character recognition (“OCR”) and forms processing technologies from our CDT subsidiary.

DOKuStar

The DOKuStar product suite provides intelligent document recognition and classification, which are essential to reducing human error, improving compliance, and increasing productivity in any document-centric business process. DOKuStar is sold as a tool set to independent software vendors and system integrators for building vertical applications for document capture and forms processing.

RecoStar

RecoStar, an OCR product, is embedded into document management applications, providing fast processing speeds without sacrificing accuracy. Although OCR technology has been around for many years, we believe this technology is fundamental to new developments in the areas of information classification and enterprise search.

RightFax

RightFax is a solution for distributed capture and processing of business documents, delivering information within or without an organization in a secure and auditable way. The RightFax product suite includes a wide range of solutions: inbound document capture and routing, fax over Internet protocol (“FoIP”), desktop faxing over a network, and high-volume document delivery from back-office software applications such as those from Oracle or SAP. Although fax has been around for many years, we believe the market shift towards distributed capture provides new growth opportunities. When compared to other remote capture and delivery methods, our customers report that fax has advantages for digitizing documents remotely and routing them between users because of the widespread availability, proven security and reliable audit capabilities of faxing.

RightFax Connector for Microsoft SharePoint

The RightFax SharePoint Connector enables documents to be captured remotely and populated into SharePoint enabling collaboration and workflow. This integration routes the inbound document to a specific SharePoint repository, notifies the end-user of the documents arrival, and triggers the start of the business process.

FaxPress

FaxPress is an “all-in-one” network fax appliance for businesses and enterprises. FaxPress is designed to be easily deployed and maintained, and provides an economical solution for companies seeking basic fax services.

Business Process Automation Products

Captaris Workflow

Captaris Workflow is a workflow platform built on the Microsoft .NET (“.NET”) Framework, developed to take full advantage of the .NET environment. We designed Captaris Workflow to improve operational processes for midsize and large businesses that have standardized on Microsoft technologies. We believe Captaris Workflow offers significant advantages over past workflow automation approaches with a design that, we believe, facilitates rapid, understandable, affordable and robust solutions that are highly scalable.

We are currently developing new versions of Captaris Workflow that leverage and extend the Microsoft Windows Workflow (“WinWF”) foundation. We believe Captaris Workflow adds significant value on top of WinWF by providing higher-level objects interfaces and tools so that end-users, business analysts, and application developers can rapidly create and deploy applications to manage complex business processes, while supporting the users through the entire lifecycle of process-centric solutions.

Document Management Products

Alchemy

Alchemy provides organizations with a complete solution for document capture, indexing, document management, archiving, records management, search and retrieval. Alchemy is designed specifically for organizations with limited or constrained IT resources, and to be deployed quickly and efficiently by end-users. Alchemy specializes in the management of “fixed” content that organizations must retain for business, compliance and/or legal purposes.

Professional Services

Captaris provides strategic and architectural consulting, custom deployment, integration services to third-party technologies, training and other services. These services are frequently offered as an extension of the capabilities of our channel partners.

Distribution

We sell, promote and receive referrals for the use of our products primarily through an indirect channel of resellers and distributors, system integrators, strategic partnerships, OEMs and private label agreements, as well as through our enterprise sales team and national account managers that hold dedicated business relationships with assigned accounts on the Fortune 500 list. We believe the use of multiple distribution channels increases the likelihood that our products will be sold to more customers. No single customer represented more than 10% of our net revenue in 2007, 2006, or 2005.

Our revenue and long-lived assets are classified by geographic area in Note 15 to our Consolidated Financial Statements included herein.

Product Support

We sell a variety of customer support packages for all of our products. In addition, we typically bundle a first year maintenance program with our software licenses. Our maintenance and support agreements provide customers with telephone, web and on-location support and unspecified upgrades and updates, when and if available. We recognize revenue for maintenance and support agreements on a straight-line basis over the service contract term, generally ranging from one to five years. We provide worldwide support 24 hours per day, 7 days per week.

The Captaris Learning Center, our online training program, enables our customers to improve their skill levels around our products and solutions. Customers register for courses online, manage their curriculum, track their class history, receive training announcements on a regular basis, complete online surveys of classes taken and register and take web-based training from one location. We deliver some educational content as a subscription-based service and we recognize the revenue from these services on a straight-line basis over the term of the subscription.

Product Development

We have in-house expertise in the development of systems that capture, recognize, classify, index, route, process, render, store, retrieve and deliver documents and data. We also have expertise in integration with back-end office systems and databases. We believe that our expertise in these areas enables us to efficiently bring innovative software products to market.

In 2007 we contracted with multiple outsource companies for maintenance engineering efforts and selected new product development. In conjunction with our outsourcing program, we are in the late stages of completing a restructuring of our development organization. At the end of 2007, we have three primary product development centers: Bellevue, Washington; Morgan Hill, California; and Tucson, Arizona. With the acquisition of CDT, we added a product development center in Constance, Germany.

We internally develop or acquire our defining core technologies, and we license from third parties primarily broad-based, generic or non-strategic components of our products, such as database software, imaging and network connection software. Whenever practical, we license and integrate such technology into our product offerings in order to decrease the cost of development and shorten the time to market for our products. We also believe that acquiring new technologies and new product offerings is consistent with our strategic initiatives, and we will pursue such opportunities as they become available.

For our product offerings to continue to achieve acceptance and remain competitive, we believe it is necessary to develop enhanced versions of our software applications. Our research and development expenditures were $16.2 million, $12.2 million, and $14.0 million in 2007, 2006, and 2005 respectively. Research and development expenses as a percentage of revenue were 17.0%, 13.3% and 16.2% in 2007, 2006, and 2005 respectively. Additional expenses in 2007 that we did not incur in 2006 or 2005 included making changes in our research and development organization’s structure to reduce the costs associated with sustaining and maintenance engineering for Alchemy and Captaris Workflow.

We also develop versions of our products for several foreign markets. This globalization effort includes converting client interfaces and documentation into foreign languages and includes the expansion of internal character sets to accommodate a broader set of potential foreign languages. We expect to continue to expend research and development resources on these efforts.

Proprietary Rights

We rely on a combination of patents, copyrights, trademarks and trade secret laws, nondisclosure and other agreements and technical measures to protect our proprietary technology. We own 12 U.S. patents, including six patents acquired in 2000 in the areas of number qualification, unified messaging and fax technology and two patents acquired in 2002 in the areas of speech compression and operating system installation/servicing. These issued patents will expire between 2014 and 2026. We also own 14 pending patent applications in the U.S. and eight internationally in a range of areas, including telephony, fax, unified messaging, workflow technology and mobility-related messaging. In addition, in connection with the acquisition of CDT in January 2008, we acquired approximately 10 patents and patent applications covering certain fields of use that we believe are relevant to CDT’s technology.

There can be no assurance that our efforts to protect our proprietary rights will be successful. In particular, there can be no assurance that our current or future patent applications will be granted or that our current or future issued patents will not be challenged, invalidated or circumvented, or that the rights granted under any such patents will provide competitive advantages to us.

We have periodically received letters and other communications from third parties asserting patent rights and requesting royalty payments. Some of these claims are unresolved and continue to be outstanding, even after several years of intermittent communication. Based upon our analysis, we do not believe it necessary, in most cases, to license any of the patent rights. In those cases in which we have determined a license of patent rights was necessary, we have entered into a license agreement.

We license certain portions of our technology from third parties under written agreements, some of which contain provisions for ongoing royalty payments. Our royalty expense as a percentage of net revenue was 1.3%, 0.9% and 1.0% for the years ended December 31, 2007, 2006 and 2005, respectively.

Competition

We compete in several software markets including document capture, fax servers, business process management, and document management software. These markets are quickly evolving, highly competitive and subject to rapid technological change. Moreover, we expect to face increasing competitive pressures from both current and future competitors in the markets we serve. In most cases, we face vendors that are focusing on one particular market. The principal competitive factors applicable to our products and services include:




breadth and quality of software alternatives;




the ability to integrate various products with customers’ existing business applications and networks;




the ability to respond to technological change;




the level of customer support and professional services;




relationships with distributors, strategic partners, value-added resellers and systems integrators;




an installed base of similar or related products;




end-user price; and




channel partner margins.

Our suite of products comprises versatile solutions for the mid-market and enterprise departments provided through a single vendor, which we believe is a competitive advantage of our products. With respect to individual offerings in our product line, our competitive position with respect to the factors above varies depending on the market addressed.

For our fax server and document delivery products, our principal competitors are Esker, Inc. S.A., Biscom, Inc., Kofax/TOPCALL, Fenestrae, GFI Software, Ltd. and SAGEM-Interstar. In the overall fax server market we believe we hold the leading market share, based on worldwide revenue. Our fax server products also compete with vendors offering a range of alternative fax solutions, including standalone fax machines, operating systems containing fax and document transmission features, low-end fax modem products, desktop fax software, single-platform fax software products, application service providers and hosted solutions including J2 Global Communications and PTEK Holdings, Inc., bundled fax software and hardware providers, and customized proprietary software solutions. We strive for competitive differentiation by offering complementary products from our extensive product portfolio.

Our capture products from the recent CDT acquisition face several competitors. In the RecoStar OCR market, we consider the main competitors to be Nuance’s Scansoft division, ABBYY and Iris. We expect increasing competition from emerging OCR companies specializing in Asian languages. In the DOKuStar intelligent document recognition (“IDR”) market, we compete against EMC/Captiva, Dicom/Kofax, and ReadSoft among others; these vendors provide packaged solutions. In comparison, we believe we have an advantage and defensible niche by providing an IDR platform that can be integrated within other applications.

For our business process automation products, we face several competitors offering similar products and using similar architecture designed for rapid deployment by knowledge workers. We believe the direct competitors of our business process automation products also utilize the .NET product architecture and would include K2.net (SourceCode Technology Holdings, Ltd.), Metastorm, and Ultimus, Inc. Overall, we believe our products are differentiated from our competitors’ products due to our deep integration with Microsoft technology and applications, as well as our ability to offer our own capture and document management products to round out solutions. We do not categorize Microsoft’s WinWF as a direct competitor but as a new and widely available platform on which to build our workflow and business process management products.

Our document management solutions compete primarily in the mid-market and MFP dealer channels based on functionality and price. Our main competitors are Hyland Software, Inc. (OnBase product), EMC Corporation / Documentum (ApplicationXtender product), Westbrook Technologies, Inc. (Fortis product) and Compulink Business Systems, Inc. (Laserfiche product). While these vendors offer products with similar functionality, we strive to differentiate by the simplicity of Alchemy, the respective price/value received, and by the inherent benefits of offering complementary products in the Captaris product suite: RightFax, FaxPress, Single Click Entry and Captaris Workflow.

Hardware

To augment RightFax sales, we currently purchase fax boards from Dialogic Corporation. Similarly, our FaxPress network appliance business is dependent upon our manufacturing partners and component suppliers. If these manufacturers terminate their relationships with us, are unable to fill orders on a timely basis, or experience quality performance issues, we may be unable to meet our customers’ demands which could delay or decrease our revenue or otherwise have an adverse impact on our operations. In 2007, we made strides in moving beyond our dependence on fax hardware by starting the transition to software-based FoIP which does not rely on fax hardware in many Internet protocol environments. We expect this shift from hardware to software to increase over the next several years.

Seasonality

Most of our software product revenue comes from current-quarter orders and sales, of which a substantial portion has, at times, occurred in the last month of the quarter. Our results of operations may fluctuate as a result of seasonal factors and they may cause our operating results to fall below the expectations of securities analysts and investors for a particular quarter. Specifically, due to typical year-end dealer sales patterns and end-user buyer patterns, revenue in our first quarter, without taking into account the effect of acquisitions, has historically declined from the fourth quarter of the previous year. Revenue builds gradually during the second and third quarters ending with the fourth quarter as our largest quarter for revenue. We anticipate this pattern will continue in 2008.

Employees

As of December 31, 2007, we had 450 full-time employees, 177 in sales and marketing, 118 in technical support and production, 84 in engineering and product development and 71 in finance, information technology and administration. Our employees enter into agreements containing confidentiality restrictions. We have never had a work stoppage and no employees, other than those with CDT, are represented by a labor organization. We consider our employee relations to be good.

Subsequent to year end, we acquired CDT. CDT has approximately 178 employees.

CEO BACKGROUND

R OBERT F. G ILB (age 61) has served as a director of Captaris since 1998. He has been the President of Robert F. Gilb Strategic & Business Consulting, L.L.C. since May 1997. From 1992 to 1997, Mr. Gilb held several positions at Microsoft Corporation, including General Manager, Financial Analysis; General Manager, Finance; and General Manager, Worldwide Business Operations. From 1979 to 1992, Mr. Gilb was an audit partner with Arthur Andersen L.L.P. in Seattle, Washington. In this capacity, he provided services to private and publicly owned companies in a variety of industries, including computer software, biotech, retail and distribution. His primary role was to audit and review financial statements for compliance with SEC reporting rules and generally accepted accounting principles. Mr. Gilb also provided services in connection with mergers and acquisitions and business process reengineering. Mr. Gilb is an Associate Trustee to the Pacific Science Center in Seattle. Mr. Gilb has a B.S. degree in accounting from California State University, Long Beach.

D ANIEL R. L YLE (age 61) has served as a director of Captaris since May 26, 2005. From 1982 to June 2003, Mr. Lyle served as a partner with PricewaterhouseCoopers LLP. During his tenure, he was Managing Partner for the National Retail Practice and Managing Partner for the West Region Retail and Consumer Product Practice. Mr. Lyle’s clients included many of PricewaterhouseCoopers’ largest retail and consumer products companies, and he was involved in numerous mergers, acquisitions and public financing transactions. Since July 2003, Mr. Lyle has served as a director for RedEnvelope, Inc., a specialty gift retailer, and is currently the Chairman of the Audit Committee. Mr. Lyle is also the Chairman of the Audit Committee for Gymboree, Inc., a clothing retailer. Mr. Lyle received a B.A. degree in economics from California State University, Northridge and an M.B.A. degree from the University of California at Los Angeles.

M ARK E. S IEFERTSON (age 47) has served as a director of Captaris since April 2005. Mr. Siefertson has accumulated over 20 years of technology architecture, systems design and consulting experience. In 1997, Mr. Siefertson co-founded Diamond Technology Partners, Inc., which was later merged with Cluster Consulting, a leading European consultancy, creating DiamondCluster International, Inc., a global management consulting firm. While with Diamond, Mr. Siefertson served in various positions, including Senior Vice President and Managing Director of the Marketplace Solutions Group, until his retirement from Diamond in June 2001. At Diamond, Mr. Siefertson’s specialty was digital strategy, technology strategy and technology architecture. His project experience included the design and implementation of complex scalable technologies across a broad range of industries. Prior to founding Diamond, Mr. Siefertson was employed in various positions with Technology Solutions Company, IBM and Electronic Data Systems Corp. After his retirement from Diamond, Mr. Siefertson founded Wild Eyed Technology, Inc., a strategy and technology consulting company, and he continues to serve as its President and sole employee.

B RUCE L. C ROCKETT (age 63) has served as a director of Captaris since September 2001 and was elected Chairperson of the Board of Directors in 2003. Mr. Crockett has accumulated 32 years of experience in finance and general management in the banking, aerospace and telecommunications industries. Mr. Crockett has served, since 1996, as Chairman of Crockett Technologies Associates, a strategic consulting firm that provides services to the information technology and communications industries. From 1992 to 1996, he served as President, Chief Executive Officer and a Director of COMSAT Corporation, an international satellite and wireless telecommunications company. Mr. Crockett currently serves as Chairperson of the Board of the mutual funds of the AIM Management Group Inc., an investment company, and as a director of ACE Limited, an insurance company. Mr. Crockett is also a Senior Trustee of the University of Rochester. Mr. Crockett holds an A.B. degree in geography and economics from the University of Rochester, an M.B.A. degree in finance from Columbia University, a B.S. degree in accounting from the University of Maryland and an Honorary J.D. degree from the University of Maryland.

R OBERT L. L OVELY (age 69) has served as a director of Captaris since 1983. He currently serves as President and a director of The Lovely Corporation, a business development and management firm. Mr. Lovely is also a director and treasurer of the Providence St. Peter Foundation. From 1994 to 2000, Mr. Lovely served as Executive Vice President and director of Travel Automation Systems Corporation, a software company. Prior to 1994, Mr. Lovely served as President, Chief Executive Officer and a director of Satellite Information Systems Co.; founder, general manager and director of US Intelco Networks, Inc. (now a part of VeriSign, Inc.); and founder, manager, Chief Executive Officer and director of Allied Data, a data processing services company. Over the years, Mr. Lovely has started or assisted in starting many privately held companies and has served as a director and officer on boards of a variety of civic and charitable organizations. He holds a B.A. degree in mathematics from Washington State University and an M.B.A. degree from Pacific Lutheran University. He has held a Certificate of Director Education from the NACD Corporate Directors Institute since 2005.

P ATRICK J. S WANICK (age 49) has served as a director of Captaris since November 2003. Mr. Swanick spent nearly 26 years in the financial services industry, holding various executive level positions in retail and commercial banking, operations, technology and e-commerce. Mr. Swanick currently serves as Chief Executive Officer of Gila Corporation, a privately held firm specializing in outsourced collections, payment processing and call center services for governmental entities and financial institutions nationwide. From June 1992 until January 2005, Mr. Swanick was employed by KeyCorp, a financial services company based in Cleveland, Ohio. At KeyCorp, he served as President of the Retail Bank, CEO of Key Electronic Services and Vice Chairman of KeyBank, N.A. In various other assignments, Mr. Swanick was KeyCorp’s executive in charge of all Call Centers, ATMs, Retail Operations, Consumer Product Management, Online Banking and Electronic Payments. Prior to his employment with KeyCorp, he was a senior executive with Fidelity Bank and First Fidelity Bancorporation in Philadelphia, Pennsylvania, both now part of Wachovia Corporation. He is a director of Tyfone, Inc., a privately held technology company focused on the mobile payments marketplace. Mr. Swanick also serves as a director of First Partners, Inc., the parent company of Gila Corporation. Mr. Swanick holds a B.S. degree in marketing, with a minor in Spanish, and an M.B.A. degree in management, from Saint Joseph’s University in Philadelphia, Pennsylvania.

D AVID P. A NASTASI (age 50) joined Captaris as President, Chief Executive Officer and a director in November 2000. From May to November 2000, Mr. Anastasi served as President and Chief Executive Officer of Conversational Computing Corporation, a speech recognition technologies company. Prior to that, he was a founder and President and Chief Executive Officer of the Global Chipcard Alliance, a SmartCard consortium, from 1999 to 2000. From 1994 to 1999, Mr. Anastasi served as Vice President and General Manager of the Public Access Solutions & Smart Card Division of U S WEST. Mr. Anastasi currently serves on the Board of Directors of the AeA (formerly known as the “American Electronics Association”). Mr. Anastasi holds a B.S. degree in marketing management from Bentley College and a master’s degree with an emphasis in international management from the University of San Francisco.

T HOMAS M. M URNANE (age 60) has served as a director of Captaris since July 2003. From July 1988 until September 2002, Mr. Murnane was a partner with PricewaterhouseCoopers LLP where he served as Director of the firm’s Retail Strategy Consulting Practice and later as Global Director of Marketing and Brand Management for PwC Consulting. Since retiring as a Partner from PricewaterhouseCoopers in October 2002, Mr. Murnane has served on the Boards of Directors and Audit Committees of each of Pacific Sunwear of California, Inc., a specialty apparel retailer, Finlay Enterprises, Inc., a specialty jewelry retailer, and The Pantry, Inc., a convenience store chain, where he is Lead Director. Mr. Murnane serves as the Chairperson of the Governance Committee at Finlay Enterprises, Inc. and The Pantry, Inc. and is on the Executive Committee of the Board of Directors of The Pantry, Inc. In addition, he is a founder and principal of ARC Business Advisors, a consulting firm that advises on merger and acquisition transactions involving retail and apparel companies, and provides research and strategic consulting services to retailers and their suppliers. As a strategy consultant at PricewaterhouseCoopers from 1980 until 1998, Mr. Murnane worked with several well-known retail and consumer products companies, led the development of the business strategy for PwC Consulting and later oversaw the development of the new brand for PwC Consulting, in connection with its intended initial public offering. Mr. Murnane also served on PwC Consulting’s Executive Committee from July 1998 until July 2001. Mr. Murnane holds a B.S.B.A. degree and an M.B.A. degree from The Ohio State University.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

Founded in 1982, Captaris, Inc., (“we”, “us”, “our”) is a provider of computer products that automate document-centric business processes. With a comprehensive suite of software, hardware and services, we help organizations gain control over many processes that include the need to integrate documents more securely and efficiently. Our solutions also provide interoperability between documents and business applications and technology platforms.

We develop products and services for document capture, intelligent document recognition and classification, routing, workflow, document management and document delivery. Our product lineup includes the brand names RightFax, FaxPress, Captaris Workflow, Alchemy, Single Click Entry, DOKuStar and RecoStar.

Our products are distributed and supported through a global network of technology partners. This distribution system consists of business partners from all levels of the information technology (“IT”) spectrum: value-added resellers, original equipment manufacturers (“OEMs”), system integrators, distributors, mass market resellers, online retailers, office equipment dealers, and independent software vendors (“ISVs”). We believe the use of multiple distribution channels increases the likelihood that our products will be sold to more customers.

We have a large installed base of customers that includes, as of the date of this report, the entire Fortune 100, the majority of the Global 2000 companies, and thousands of mid-sized enterprises. Our customers use our products to reduce costs, comply with regulations, increase the performance and productivity of critical business processes, and leverage their IT system investments.

In July 2007, we bolstered our product portfolio, customer base, and distribution capabilities by acquiring Castelle, a provider of “all-in-one” network fax appliance solutions for businesses and enterprises. Castelle FaxPress products are designed to be easily deployed and maintained and are generally intended for lower volume use at lower price points than our RightFax product offerings. FaxPress provides Captaris with a fax server product that can be positioned in the tier below RightFax for customers looking for basic fax services that are low cost and easily deployable. The FaxPress products are available through a worldwide network of distributors, resellers, and online retailers.

Included in our single business segment, Castelle’s expertise in building “all-in-one” network appliance solutions facilitates our plan to broaden our offerings in the areas of document capture, routing and management. The network appliance design combines software and hardware into a “plug and play” device, and we believe this design is particularly well suited to support our focus on achieving synergies with multi-function product manufacturers and their dealer networks.

We further increased our product portfolio, customer base and distribution capabilities with the acquisition of Ocė Document Technologies GmbH (“ODT”) in January 2008. ODT is a provider of software and solutions for document capture, text recognition, and document classification. ODT, a wholly-owned subsidiary of the Ocė Group since 2000, has approximately 178 employees and maintains its global headquarters in Constance, Germany, and its North American office in Bethesda, Maryland. On an unaudited basis, ODT’s revenue was about €22.5 million for the 12 months ended November 30, 2007 and their gross margin was about 65%. ODT’s revenue includes software licenses, maintenance and support, hardware and professional services. In contrast to our business prior to acquisition, ODT’s revenue includes a higher percentage of professional services and a larger portion of their sales are made directly rather than through partners. As a result of these factors, and a smaller revenue and customer base, ODT has a lower gross margin and more revenue variability.

After our acquisition, we re-named ODT to Captaris Document Technologies GmbH (“CDT”). CDT develops intelligent document and character recognition technologies that can read and extract the important information from documents needed to drive business processes and decisions. CDT products include RecoStar, DOKuStar, Single Click Entry and ID-Star. CDT customers include some large ISVs and OEMs with capture offerings, as well as blue chip end-user accounts in Germany. CDT’s expertise in intelligent document recognition supports our vision of fully enabling document capture, collaboration and workflow. As we continue to merge our products, we anticipate leveraging CDT’s technology to enhance capture and routing in both the RightFax and Alchemy platforms. The ability to classify documents and extract critical meta-data will also enable deeper integrations with line of business applications and business process management.

Executive Summary

We derive net revenue primarily from licensing software as well as follow-on sales of add-on software modules, incremental capacity and the sale of maintenance, support and service agreements, professional services, appliances and the resale of fax boards.

We work with resellers and distributors located throughout the world. These resellers and distributors sell and install our products and they receive discounts based on the volume of sales. Within our selling and marketing groups, we dedicate significant resources to monitor our resellers and distributors and to generate demand and provide market positioning and support.

Utilizing an indirect channel approach provides several advantages, including minimizing our investment in office facilities and personnel in field locations and applying greater resources to sales and implementation efforts. However, with a channel sales model, we have more difficultly tracking the number and location of all end-users utilizing our products. This also limits our ability to capture information around product usage, system integration characteristics, and deployment satisfaction directly from our customers’ perspective in order to enhance or build new products, solutions and services.

We have extensive service offerings that are sold in conjunction with our products, including: maintenance, support, professional services and solutions. All of these offerings are designed to help customers protect and extend their software investment.

Our $2.8 million revenue growth over the prior year was primarily attributable to the inclusion of Castelle in our results of operations from July 10, 2007 through December 31, 2007, and the continuing growth of our traditional maintenance, support and service revenue. In comparison to 2007, we expect 2008 revenue increases from software, appliances, and services. This expectation is based on including in our 2008 results of operations revenue from both Castelle for the entire year and, as discussed in the Acquisitions and Divestitures section below, CDT, as well as increased customer demand from increased investment in our sales organization. In comparison to 2007, we expect 2008 hardware revenue to decrease as a percentage of overall revenue due to market shifts to software-based fax over Internet protocol, which does not rely on fax hardware in many Internet protocol environments. No single customer represented more than 10% of our net revenue for each of the years ended December 31, 2007, 2006 or 2005.

Our gross profit is the selling price of our products, net of estimated returns, less cost of revenue. Our cost of revenue includes manufacturing and distribution costs, royalties for licensed products, amortization of acquired technology, product warranty costs, operation costs related to product support and costs associated with the delivery of professional services.

Our $1.8 million gross profit increase over the prior year was primarily attributable to the inclusion of Castelle in our results of operations from July 10, 2007 through December 31, 2007, and the continuing growth of our traditional maintenance, support and service revenue. We expect our gross profit will increase in 2008 due to anticipated increases in revenue mentioned above. We expect gross profit as a percentage of revenue will decline in 2008 for two reasons. First, CDT has traditionally recorded lower gross margins than Captaris primarily because of a higher portion of professional services; therefore including CDT in our results of operations will have the effect of reducing our overall gross profit as a percentage of revenue. Secondly, we anticipate recording a portion of the amortization expense related to the technology acquired from CDT in cost of revenue.

Our operating expenses were $69.9 million, $60.4 million and $67.7 million for the years ended December 31, 2007, 2006 and 2005, respectively. The $9.5 million increase from 2006 to 2007 was due primarily to increases in the overall number of employees and occupancy costs of $3.8 million, Castelle operating expenses of $2.7 million and research and development spending of $1.9 million for outsourced engineering. The $7.3 million decrease from 2005 to 2006 was due primarily to a $2.3 million reduction in compensation cost due to the minimum incentive plan obligation for certain Teamplate founders, which was discontinued in late 2005, and a $1.3 million reduction in advertising expenses.

Our income from continuing operations for the year ended December 31, 2007 was $228,000, compared to income of $4.0 million for the year ended December 31, 2006 and a loss from continuing operations of $4.0 million for the year ended December 31, 2005. The decrease in income from continuing operations from 2006 to 2007 was primarily attributable to an overall increase in operating expenses in 2007. The increase in income from continuing operations from 2005 to 2006 was primarily attributable to revenue growth and an overall reduction in operating expenses in 2006. In addition, 2005 operating expenses included corporate reorganizations charges as well as non-cash impairment charges. We did not incur these charges in 2006.

We recorded an income tax benefit of $1.5 million and $3.3 million, respectively, on losses from continuing operations for the years ended December 31, 2007 and December 31, 2005. For the year ended December 31, 2006, we recorded an income tax provision of $1.8 million on income from continuing operations. Our income tax benefit in 2007 included the reversal of tax liabilities of $403,000 which we determined were no longer probable based on updated information surrounding the related tax return, a research and development tax credit of $173,000, and the tax benefit for tax-exempt interest income of $566,000. Our income tax provision in 2006 included adjustments of $72,000 primarily associated with correcting deferred tax asset balances as of December 31, 2005. The income tax benefits in 2005 included the reversal of tax liabilities of $523,000 which we determined were no longer probable based on updated information surrounding the related tax return. In 2006, we received income tax refunds of $1.9 million that primarily resulted from the carry-back of our 2005 net operating loss to 2003.

Prior to December 31, 2007, our principal sources of liquidity were cash and cash equivalents. In anticipation of our acquisition of CDT in January 2008, we liquidated our investments in cash and cash equivalents ($46.2 million) and entered into a $10.0 million line of credit agreement as described below. As of December 31, 2006, our portfolio consisted primarily of money market funds, adjustable rate mortgage-backed securities, and municipal and United States government agency-backed securities. The balance of cash, cash equivalents and short and long-term investments at December 31, 2006 totaled $59.4 million.

The decrease in cash, cash equivalents and short and long-term investments from 2006 to 2007 was primarily due to the Castelle acquisition of $12.0 million, repurchase of our common stock of $9.5 million and capital purchases of $5.2 million. These decreases were partially offset by increases from our net cash flow provided by operations of $10.6 million and proceeds of $2.2 million from the exercise of stock options. Capital expenditures during the year ended December 31, 2007, consisted primarily of an enterprise resource management system to support the growth of our core business activities. In the first quarter of 2008, we paid $680,000 for management incentive bonuses we accrued in 2007.

On January 1, 2006, we adopted the provisions of FASB Statement of Financial Accounting Standard (“SFAS”) Statement No. 123(R), Share-Based Payment , (“SFAS No. 123R”), which, among other things, requires us to measure and recognize compensation expense for all share-based payment awards made to employees and directors including stock options and stock units. Under the provisions of SFAS No. 123R, we recorded $1.4 million and $677,000, respectively, in 2007 and 2006 as stock-based compensation expense relating to stock options and stock units. Prior to 2006, we had only disclosed in the footnotes to our consolidated financial statements, as permitted by SFAS No. 123, pro forma financial results including the effects of share-based compensation expense. For the year ended December 31, 2005, the pro forma stock-based compensation expense was $3.9 million. The decrease in stock-based compensation expense in 2006, compared to our pro forma stock-based compensation expense in 2005, can be attributed to accelerating the vesting of underwater stock options in 2005, the reduction in number of shares granted in 2006 compared to 2005 and differences between accounting for stock options and stock units under SFAS No. 123R in 2006 and SFAS No. 123 in 2005.

Acquisitions

2008

On January 4, 2008, our wholly-owned subsidiary, Captaris Verwaltungs GmbH, a German limited liability company (“CV GmbH”), acquired Océ Document Technologies GmbH (“ODT”), pursuant to a Sale and Purchase Agreement (the “SPA”) by and between CV GmbH and Océ Deutschland Holding GmbH & Co. KG, a German limited partnership (the “Seller”), dated December 20, 2007. Under the terms of the SPA, CV GmbH acquired all of the outstanding equity of ODT from the Seller, and ODT became a wholly-owned subsidiary of CV GmbH and an indirect wholly-owned subsidiary of Captaris.

Under the terms of the acquisition agreement, CV GmbH acquired ODT for approximately €10.4 million ($15.4 million), net of ODT’s cash balance as of the closing of approximately €21.6 million ($31.8 million). CV GmbH also assumed ODT’s operating and financial liabilities, including approximately €12.1 million ($17.9 million) in future retirement obligations. At the closing, €2.0 million ($3.0 million) of the purchase price was deposited in a third-party escrow account for 12 months as security for any post-closing purchase price adjustment and, subject to certain limitations, for indemnification claims against the Seller; however, in connection with the resolution of a post-closing dispute with the Seller, we expect to release the full amount of the escrow to the Seller during the first quarter of 2008.

After our acquisition, we re-named ODT to Captaris Document Technologies GmbH (“CDT”). CDT is a provider of software and solutions for document capture, text recognition and document classification. CDT has approximately 178 employees and maintains its global headquarters in Constance, Germany, and its North American office in Bethesda, Maryland.

Years ended December 31, 2007 and 2006. Net revenue for the year ended December 31, 2007 increased by $2.8 million compared to the year ended December 31, 2006. The net revenue increase was due primarily to including Castelle appliance and maintenance, support and services revenue, for the period of July 10, 2007 through December 31, 2007, in our 2007 operating results. Additionally, as a result of an increase in the number of underlying agreements, our traditional maintenance, support and services revenue also increased. These increases were partially offset by decreases in revenue from software and hardware.

Software revenue decreased $1.3 million primarily due to a non-recurring $1.8 million strategic licensing arrangement with Xpedite recorded in our 2006 results which we discuss in further detail below.

Hardware revenue decreased in 2007 in comparison to 2006 due to several large sales to large customers in 2006 and fewer comparably large individual software license sales in 2007. Variations in hardware revenue generally trends directly with software revenue as we resell fax boards with a significant number of our RightFax software products. Also, the volume and associated revenue varies from period to period depending upon the mix of software sold and the requirements of each customer.

We believe our net revenue will increase in 2008 primarily due to the addition of CDT revenue from the date of acquisition, a full year of revenue from Castelle, product growth from our existing product lines, and revenue from new product releases. A significant portion of CDT revenue is in Europe, is sold direct and includes a relatively higher portion of professional services.

MANAGEMENT DISCUSSION FOR LATEST QUARTER
Results of Operations

Net Revenue

Net revenue is calculated as the selling price of our products less an estimate for returns. We derive net revenue primarily from licensing software as well as follow on sales of add-on software modules, incremental capacity and the sale of maintenance, support and service agreements, professional services, appliances and the resale of fax boards.

The quarter over quarter overall revenue decrease reflects a $1.0 million non-recurring strategic license arrangement realized in 2006, lower than expected performance from channel partners in North America, and a reduction in sales to the financial services sector. Additionally, the year over year decrease includes an additional $750,000 in non-recurring strategic license arrangement sale. The decline in revenue was offset by the inclusion of Castelle revenue for July 10 to September 30, 2007 in our operating results.

Software revenue decreased in the quarter ended September 30, 2007 compared to the quarter ended September 30, 2006 primarily due to a non-recurring $1.0 million strategic license arrangement recorded in the third quarter of 2006 and another large non-recurring transaction in 2006. The year over year comparative decrease in software revenue was primarily due to a non-recurring $1.8 strategic license arrangement recorded in the first nine months of 2006, lower sales by our channel partners and a reduction in sales to the financial services sector.

Maintenance, support and services revenue increased for both the quarter and nine months ended in comparison to the prior year primarily from the inclusion of Castelle’s revenue in our operating results.

We resell fax boards with a significant number of our Rightfax software products. The volume and associated revenue will vary from period to period depending upon the mix of software sold and customer requirements. As a result, hardware revenue for the quarter and nine months ended September 30, 2007 decreased in comparison to the same periods in 2006, due to several large sales to large customers in 2006 and lower software sales in 2007.

We anticipate revenue will increase in the fourth quarter of 2007 compared to the third quarter due to the seasonality of our revenue which typically increases over the course of the year. We also anticipate revenue will increase in the next three quarters compared to the corresponding quarters of the prior year due to the inclusion of revenue from the Castelle product line beginning in the third quarter of 2007.

Gross Profit

Gross profit is calculated as the difference between net revenue and the cost of revenue. Cost of revenue includes manufacturing and distribution costs for products and programs sold, royalties for licensed products, amortization of acquired technology, product warranty costs, operation costs related to product technical support and costs associated with the delivery of professional services. Gross margin is calculated by dividing gross profit by total revenue.

In comparison to the prior year, gross profit decreased slightly for the quarter and nine months ended September 30, 2007. The decrease for the nine months ended was primarily due to $1.8 million of non-recurring strategic license revenue recorded in 2006. This transaction had no associated cost of revenue. The gross profit margin increase for the quarter ended September 30, 2007, in comparison to the prior year, was primarily due to a lower mix of hardware revenue compared to software revenue, partially offset by $1.0 million of non-recurring strategic license revenue recorded in 2006. This transaction had no associated cost of revenue.

Research and Development

Research and development expenses consist of the salaries and related benefits for our product development personnel, prototype materials and expenses related to the development of new and improved products, facilities and depreciation expenses.

For the quarter ended September 30, 2007, research and development expenses increased $1.4 million compared to the quarter ended September 30, 2006, primarily due to an increase in outsourced engineering efforts ($714,000) and increased staffing costs, including organizational transition costs and Castelle staffing cost ($707,000). These increases were partially offset by a decrease in depreciation costs ($65,000) as certain assets became fully depreciated.

For the nine months ended September 30, 2007, research and development expenses increased $1.9 million compared to the nine months ended September 30, 2006, primarily due to increased staffing, including organizational transition costs and Castelle staffing cost ($1.1 million) and an increase in outsourced engineering services ($1.0 million), partially offset by a decrease in depreciation costs ($216,000) as certain assets became fully depreciated.

We expect overall research and development expenses to increase in the fourth quarter of 2007 compared to the first three quarters of 2007 as we continue to maintain our investments in research and development and record additional research and development expenses as a result of the third quarter 2007 Castelle acquisition and subsequent consolidation of our joint operating results.

Selling and Marketing

Selling and marketing expenses consist primarily of salaries and benefits, sales commissions, travel expenses and related facilities costs for our sales, business development, marketing and order management personnel. Selling expenses also include professional fees associated with partner development, as well as costs of programs aimed at increasing revenue, such as advertising, trade shows, public relations and other market development programs.

The increase of $646,000 in selling and marketing expenses for the quarter ended September 30, 2007, compared to the quarter ended September 30, 2006, was due primarily to increases in staffing costs ($1.1 million) due to hiring additional personnel in our sales organization and the inclusion of Castelle selling and marketing personnel. These increases were partially offset by a decrease for marketing programs ($217,000), other expenses ($108,000) and commissions on lower sales ($90,000).

The increase of $1.9 million in selling and marketing expenses for the nine months ended September 30, 2007, compared to the nine months ended September 30, 2006, was due primarily to increases in staffing cost due to hiring additional personnel in our sales organization and the inclusion of Castelle selling and marketing personnel ($1.9 million), travel and entertainment associated with an increased investment in our sales organization and partner conferences ($399,000) and commissions on higher compensation plans ($293,000). These increases were partially offset by a decrease in marketing programs ($375,000), a decrease in consulting fees ($324,000) and a reduction in other expenses ($34,000).

We expect selling and marketing expenses in the fourth quarter of 2007 will be higher than the corresponding quarter of 2006 due to increased commissions on increased sales. We also expect to record additional selling and marketing expenses as a result of the third quarter 2007 Castelle acquisition and subsequent consolidation of our joint operating results. We expect selling and marketing expenses to increase in comparison to prior quarters of 2007 as a result of revenue seasonality as well as the expenses from investing in our sales organization and the inclusion of Castelle’s operating results in our financial results. We expect selling and marketing expenses will remain relatively consistent or slightly down as a percentage of revenue.

General and Administrative

General and administrative expenses consist of the salaries, benefits and related costs of our executive, finance, information technology, human resource and legal personnel, third-party professional service fees, bad debt charges, facilities, and depreciation expenses.

The $423,000 increase in general and administrative expenses in the quarter ended September 30, 2007 compared to the same period last year was due primarily to increases in staffing cost for increased headcount, including Castelle employees ($373,000) and stock compensation expense on additional grants ($120,000). These increases were partially offset by a reduction in depreciation as certain assets became fully depreciated ($70,000).

The $1.0 million increase in general and administrative expenses in the nine months ended September 30, 2007 compared to the same period last year was due primarily to increases in salaries related to organizational changes including severance costs associated with the departure of our Chief Operating Officer and increased headcount for Castelle employees ($1.1 million), stock compensation ($352,000) and consulting costs related to our ERP system implementation ($165,000). These increases were partially offset by a reduction in depreciation as certain assets became fully depreciated ($268,000), a decrease in other expenses ($150,000) and a decrease in professional fees including legal and audit ($134,000).

In the fourth quarter we expect general and administrative costs to increase in comparison to the same quarter in the prior year as a result of the third quarter 2007 Castelle acquisition and subsequent consolidation of our joint operating results.

Amortization of Intangible Assets

Amortization of intangible assets is a result of the acquisitions of Castelle, IMR, Teamplate and Infinite Technologies, in addition to amortization expense associated with two nonexclusive license agreements with Syntellect and AudioFax. Amortization expense for acquired core technology and license agreements is recorded in cost of revenue and was $874,000 and $2.1 million for the quarter and nine months ended September 30, 2007, respectively, and $481,000 and $1.4 million for the quarter and nine months ended September 30, 2006, respectively. Amortization expense recorded in operating expenses related to the acquisitions was $384,000 and $665,000 for the quarter and nine months ended September 30, 2007, respectively, and $354,000 and $1.1 million for the quarter and nine months ended September 30, 2006, respectively. The increase in amortization expense in the quarter ended 2007 compared to 2006 are due to the amortization of Castelle intangibles acquired in July 2007. The decrease in amortization expense for the nine months ended September 30, 2007 compared to 2006 was due to certain intangibles becoming fully amortized. We expect amortization expense for 2007 to increase for the remainder of 2007, in comparison to 2006, due to the amortization of the Castelle intangibles.

Sale of CallXpress Product Line

In September of 2003, we sold our CallXpress product line to Applied Voice and Speech Technologies, Inc. (“AVST”). Concurrent with the transaction, we entered into an earn-out agreement with AVST which entitled us to receive additional payments of up to $1.0 million per year for each of the three years following the sale, depending on AVST’s success in achieving certain revenue targets. In March 2007 and 2006, we received cash payments of $1.0 million, confirming achievement of the revenue target for 2006 and 2005. These cash receipts were classified on our income statement in operating expenses in the first quarters of 2007 and 2006. The payment received in March 2007 was the final payment to be received under this agreement.

Other Income, Net

Other income, net, consists primarily of investment income and foreign currency transaction gains and losses. For the quarter and nine months ended September 30, 2007, net other income was $420,000 and $1.8 million, respectively compared to $335,000 and $1.2 million, respectively, for the same periods last year. The increase in other income for the quarter ended September 30, 2007 was due primarily to a lower foreign currency loss of $26,000 in the quarter ended September 30, 2007 compared to a foreign currency loss of $146,000 for the quarter ended September 30, 2006. The increase in other income for the nine months ended September 30, 2007 was due primarily to increased interest income and a foreign currency gain of $227,000. Assuming interest rates and currency exchange rates remain constant, we expect other income, net to decrease slightly in the next quarter due to a reduction in cash used to purchase Castelle.

Income Tax Expense (Benefit)

We are subject to income taxes in both the United States and numerous foreign jurisdictions. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. We establish accruals for tax-related uncertainties based on estimates of whether, and to the extent which, additional taxes and interest will be due. These accruals are established when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are likely to be challenged and may not be sustained on review by tax authorities. We adjust these accruals in light of changing facts and circumstances, such as the closing of a tax audit or the expiration of statutes of limitations. The provision for income taxes includes the impact of potential tax claims and changes to accruals that we consider appropriate, as well as the related penalties and interest.

Our effective tax rates differ from the statutory rate primarily due to state income taxes, foreign income taxes, tax exempt interest income and accruals for certain tax exposures discussed above. We recorded an income tax benefit of $1.6 million and an income tax provision of $693,000 in the quarters ended September 30, 2007 and 2006, respectively, on income (loss) from continuing operations. In accordance with SFAS No. 109, we estimate our effective tax rate for interim reporting periods based on our projected taxable income for the full fiscal year. Our estimated effective tax rate for the quarter and nine months ended September 30, 2007 increased significantly from the first six months of 2007 due to a change in estimate of our earnings for fiscal 2007 from a taxable income position to a taxable loss position. This change in estimate occurred during the third quarter of 2007. Because we are now estimating that our earnings for fiscal 2007 will result in a taxable loss position, pursuant to FIN No. 18 guidance, we are now estimating our effective tax rate for fiscal 2007 as if our taxable loss for fiscal 2007 will be equal to our loss from continuing operations for the nine months ended September 30, 2007 plus adjustments to exclude annualized estimated tax exempt interest income plus the tax benefit of our annualized research and development credits. The ratio of our annualized tax exempt interest income to our loss from continuing operations is high and this in conjunction with the tax benefit of our research and development credits significantly influences the fluctuation of our effective tax rate for interim periods. As such, our effective tax rate increased significantly for the quarter and nine months ended September 30, 2007 compared to the six months ended June 30, 2007. In addition, we recorded an income tax benefit of $1.6 million and an income tax provision of $989,000, respectively, on income (loss) from continuing operations for the nine months ended September 30, 2007 and 2006. Included in the income tax benefit for the nine months ended September 30, 2007 and for the quarter ended September 30, 2007 were income tax benefits of $385,000 and $448,000, respectively, which consisted primarily of relieving a FIN No. 48 tax contingency due to the expiration of a statute of limitations. Included in the income tax provision for the nine months ending September 30, 2006 were income tax expenses of $172,000 primarily related to additional federal income tax expense on state net operating loss carry forwards and a change in estimate of our blended effective state tax rate. Included in the income tax provision for the quarter ending September 30, 2006 were income tax benefits of $15,000 related to a true-up of the 2005 income tax returns.

At September 30, 2007, we have available unused net operating losses that may be applied against future taxable income. These net operating losses consist of international losses of $2.6 million that do not expire, federal losses of $8.7 million that expire from 2019 to 2027, and state losses of $13.8 million which expire from 2007 to 2027. We believe that there is sufficient positive evidence to support our conclusion not to record a valuation allowance against these net operating losses. We believe that we will utilize the loss carry forwards in the future because we have had a history of pre-tax income. In addition, we project that the Internal Revenue Code (“IRC”) Section 382 limitation for the acquired net operating losses will not prohibit our utilization of these losses in the future. At September 30, 2007, our Canadian subsidiary had unused tax credits of $2.2 million which primarily consist of investment tax credits. Due to the uncertainty of utilizing these tax credits within the statute of limitations, we have recorded a full valuation allowance on them at September 30, 2007.


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