Quarterly Report Period Of 09/30/2002
Table of Contents
 
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
FORM 10-Q
 
(Mark One)
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2002
 
or
 
x
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                        to                     .
Commission File Number 0-25186
 
 
CAPTARIS, INC.
(Name of Registrant as Specified in Its Charter)
 
Washington
   
91-1190085
(State of incorporation)
   
(I.R.S. Employer Identification Number)
 
11410 NE 122nd Way
Kirkland, WA 98034
(Address of principal executive offices)
 
Registrant’s telephone number, including area code: (425) 820-6000
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
 
The number of outstanding shares of the Registrant’s Common Stock as of October 25, 2002 was 31,888,465.
 

Table of Contents
 
As reported in Captaris Inc.’s (the “Company”) Quarterly report on Form 10-Q for the quarterly period ended June 30, 2002 filed on August 19, 2002, and as further discussed in Note 14 to the accompanying unaudited condensed consolidated financial statements, the Company has determined, after consultation with its new independent auditor, that it must restate (1) its consolidated financial statements for the year ended December 31, 2001 and (2) its unaudited condensed consolidated financial statements for the quarterly period ended March 31, 2002 and for each quarterly period during the year ended December 31, 2001. The restatement results from a deferred tax liability related to identified intangible assets associated with the acquisition of Infinite Technologies in January 2001.
 
As a result of the Company’s restatement of its consolidated financial statements for the year ended December 31, 2001, the Company has engaged its independent auditors to reaudit those financial statements. Upon completion of the audit, the Company expects to amend its Annual Report on Form 10-K for the year ended December 31, 2001, its Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2002 and any other Quarterly Report on Form 10-Q that the Company determines must be amended.
 

2

Table of Contents
 
CAPTARIS, INC.
 
FORM 10-Q
For the Quarter Ended September 30, 2002
 
Table of Contents
 
 
        
Page
PART I.
  
Financial information
     
      
4
      
14
      
25
   
Item 4.     Controls and Procedures
   
25
PART II.
  
Other Information
     
      
26
      
27

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Table of Contents
 
Part I.    FINANCIAL INFORMATION
 
Item 1.
  
FINANCIAL STATEMENTS
 
CAPTARIS, INC.
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
    
September 30, 2002
     
December 31,
2001
(as restated – see Note 14)
  
    
(in thousands)
  
ASSETS
              
Current assets:
                  
Cash and cash equivalents
   
$
8,540
 
   
$
12,726
 
Short-term investments, available for sale
   
 
61,105
 
   
 
64,446
 
Accounts receivable, net
   
 
15,967
 
   
 
14,597
 
Inventories
   
 
5,175
 
   
 
5,022
 
Deferred and prepaid income taxes
   
 
8,037
 
   
 
8,267
 
Prepaid expenses and other assets
   
 
1,591
 
   
 
1,304
 
    
  
Total current assets
   
 
100,415
 
   
 
106,362
 
Equipment and leasehold improvements, net
   
 
6,636
 
   
 
7,463
 
Goodwill, net
   
 
8,941
 
   
 
12,104
 
Intangibles and other assets, net
   
 
2,923
 
   
 
9,632
 
Deferred income taxes
   
 
2,705
 
   
 
2,769
 
Restricted cash
   
 
1,000
 
   
 
—
 
    
  
Total assets
   
$
122,620
 
   
$
138,330
 
    
  
LIABILITIES AND SHAREHOLDERS’ EQUITY
              
Current liabilities:
                  
Accounts payable
   
$
5,105
 
   
$
4,941
 
Accrued compensation and benefits
   
 
5,236
 
   
 
7,985
 
Deferred revenue
   
 
8,076
 
   
 
7,433
 
Other accrued liabilities
   
 
4,077
 
   
 
3,356
 
Current portion of note payable
   
 
—
 
   
 
527
 
    
  
Total current liabilities
   
 
22,494
 
   
 
24,242
 
    
  
Deferred income taxes
   
 
1,366
 
   
 
3,301
 
Note payable, net of current portion
   
 
—
 
   
 
882
 
    
  
Total liabilities
   
 
23,860
 
   
 
28,425
 
    
  
Shareholders’ equity:
                  
Preferred stock, par value $.01 per share, 2,000,000 authorized; none outstanding
   
 
—
 
   
 
—
 
Common stock, par value $.01 per share, 120,000,000 authorized; 31,884,465 and 31,746,067 shares outstanding, respectively, and additional paid-in capital
   
 
63,913
 
   
 
66,260
 
Retained earnings
   
 
35,351
 
   
 
44,173
 
Accumulated other comprehensive loss
   
 
(504
)
   
 
(528
)
    
  
Total shareholders’ equity
   
 
98,760
 
   
 
109,905
 
    
  
Total liabilities and shareholders’ equity
   
$
122,620
 
   
$
138,330
 
    
  
 
 
See accompanying notes to unaudited condensed consolidated financial statements.

4

Table of Contents
 
CAPTARIS, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
    
Quarter ended
September 30,
    
Nine months ended
September 30,
  
    
2002
     
2001
(as restated – see Note 14)
     
2002
     
2001
(as restated – see Note 14)
  
    
(in thousands, except per share data)
  
Net sales
   
$
23,087
 
   
$
23,737
 
   
$
67,378
 
   
$
67,714
 
Cost of sales
   
 
8,920
 
   
 
9,174
 
   
 
25,268
 
   
 
25,549
 
    
  
  
  
Gross profit
   
 
14,167
 
   
 
14,563
 
   
 
42,110
 
   
 
42,165
 
Operating expenses:
                                    
Research and development
   
 
3,088
 
   
 
3,408
 
   
 
8,535
 
   
 
10,911
 
Sales, general and administrative
   
 
11,659
 
   
 
14,898
 
   
 
37,112
 
   
 
45,330
 
Stock compensation
   
 
(633
)
   
 
—
 
   
 
(1,247
)
   
 
—
 
Impairment of intangible assets
   
 
—
 
   
 
—
 
   
 
5,529
 
   
 
—
 
Non-recurring charges
   
 
—
 
   
 
—
 
   
 
2,994
 
   
 
2,942
 
    
  
  
  
Total operating expenses
   
 
14,114
 
   
 
18,306
 
   
 
52,923
 
   
 
59,183
 
    
  
  
  
Operating income (loss)
   
 
53
 
   
 
(3,743
)
   
 
(10,813
)
   
 
(17,018
)
Other income, net
   
 
506
 
   
 
771
 
   
 
1,388
 
   
 
2,586
 
    
  
  
  
Income (loss) before income taxes and cumulative effect of change in accounting principle
   
 
559
 
   
 
(2,972
)
   
 
(9,425
)
   
 
(14,432
)
Income tax expense (benefit)
   
 
196
 
   
 
(891
)
   
 
(3,298
)
   
 
(4,902
)
    
  
  
  
Income (loss) before cumulative effect of change in accounting principal
   
 
363
 
   
 
(2,081
)
   
 
(6,127
)
   
 
(9,530
)
Cumulative effect of change in accounting principle
   
 
—
 
   
 
—
 
   
 
(2,695
)
   
 
—
 
    
  
  
  
Net income (loss)
   
$
363
 
   
$
(2,081
)
   
$
(8,822
)
   
$
(9,530
)
    
  
  
  
Net income (loss) per common share, basic and diluted:
                                    
Prior to cumulative effect of change in accounting principle
   
$
0.01
 
   
$
(0.06
)
   
$
(0.19
)
   
$
(0.30
)
Cumulative effect of change in accounting principle
   
 
—
 
   
 
—
 
   
 
(0.09
)
   
 
—
 
    
  
  
  
Net income (loss) per common share, basic and diluted
   
$
0.01
 
   
$
(0.06
)
   
$
(0.28
)
   
$
(0.30
)
    
  
  
  
Weighted average common shares outstanding, basic
   
 
31,914
 
   
 
32,075
 
   
 
31,876
 
   
 
32,137
 
Weighted average common shares outstanding, diluted
   
 
32,047
 
   
 
32,075
 
   
 
31,876
 
   
 
32,137
 
 
 
See accompanying notes to unaudited condensed consolidated financial statements.
 

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Table of Contents
 
CAPTARIS, INC.
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
    
Nine months ended September 30,
  
    
2002
     
2001
(as restated – see Note 14)
  
    
(in thousands)
  
Cash flows from operating activities:
                  
Net loss
   
$
(8,822
)
   
$
(9,530
)
Adjustments to reconcile net income to net cash provided by operating activities:
                  
Depreciation and amortization
   
 
4,032
 
   
 
5,902
 
Loss on disposal of assets
   
 
353
 
   
 
—  
 
Deferred income taxes
   
 
(1,935
)
   
 
3,333
 
Stock compensation
   
 
(1,247
)
   
 
—  
 
Purchased in-process research and development, expensed
   
 
—  
 
   
 
1,900
 
Impairment of intangibles
   
 
5,529
 
   
 
—  
 
Cumulative effect of change in accounting principle
   
 
2,695
 
   
 
—  
 
Changes in assets and liabilities, net of amounts acquired:
                  
Accounts receivable
   
 
(1,370
)
   
 
1,420
 
Inventories
   
 
(127
)
   
 
458
 
Prepaid income taxes
   
 
294
 
   
 
(3,795
)
Prepaid expenses and other assets
   
 
(273
)
   
 
325
 
Accounts payable
   
 
121
 
   
 
(955
)
Accrued compensation and benefits
   
 
(2,749
)
   
 
2,781
 
Deferred revenue
   
 
538
 
   
 
1,501
 
Other accrued liabilities
   
 
721
 
   
 
(957
)
    
  
Net cash used by operating activities
   
 
(2,240
)
   
 
2,383
 
    
  
Cash flows from investing activities:
                  
Purchase of equipment and leasehold improvements
   
 
(2,480
)
   
 
(3,389
)
Short-term investments, net
   
 
3,341
 
   
 
(10,812
)
Cash deposited to secure lease
   
 
(1,000
)
   
 
—
 
Cash paid in acquisition, net
   
 
(456
)
   
 
(8,800
)
Intangibles and other assets
   
 
(301
)
   
 
(3,492
)
    
  
Net cash used by investing activities
   
 
(896
)
   
 
(26,493
)
    
  
Cash flows from financing activities:
                  
Repurchase of common stock
   
 
(84
)
   
 
(1,170
)
Settlement of note payable
   
 
(1,456
)
   
 
—  
 
Proceeds from exercise of stock options
   
 
466
 
   
 
5
 
    
  
Net cash provided by financing activities
   
 
(1,074
)
   
 
(1,165
)
    
  
Effects of foreign currency rates
   
 
24
 
   
 
47
 
    
  
Net decrease in cash and cash equivalents
   
 
(4,186
)
   
 
(25,228
)
Cash and cash equivalents at beginning of period
   
 
12,726
 
   
 
36,744
 
    
  
Cash and cash equivalents at end of period
   
$
8,540
 
   
$
11,516
 
    
  
Supplementary disclosures of cash flows:
                  
Income taxes refunded
   
$
1,447
 
   
$
1,138
 
Infinite Settlement (see Note 9)
                  
Goodwill
   
$
1,435
 
   
 
—  
 
Additional paid-in-capital
   
$
(1,435
)
   
 
—  
 
 
See accompanying notes to unaudited condensed consolidated financial statements.
 

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Table of Contents
 
CAPTARIS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1.    Interim Financial Statements
 
In the opinion of management, the accompanying unaudited condensed consolidated balance sheets and related interim consolidated statements of operations, and cash flows have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. All adjustments considered necessary for fair presentation have been included. Interim results are not necessarily indicative of results for a full year. These unaudited condensed consolidated financial statements include the impact of the restatement (see Note 14) and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 period. Actual amounts may differ from those estimates.
 
2.    Restricted Cash
 
In connection with a real property lease for the Company’s new headquarters in Bellevue, Washington, a certificate of deposit in the amount of $1 million dollars was issued as collateral against the lease.
 
3.    Business Acquired
 
In August 2002, the Company acquired the distribution activities, assets and fifteen employees of its long-time distributor in The Netherlands, OfficeCom B.V. The purchase price was approximately $575,000, which included $456,000 in cash. The purchase was primarily allocated to Goodwill.
 
4.    OEM Agreement
 
In January 2002, the Company entered into an original equipment manufacturing (OEM) agreement with Cisco Systems, Inc. The agreement and support term is approximately 40 months from the date of acceptance, which occurred in March 2002, and includes annual termination provisions at the option of Cisco. Revenue is generally recognized ratably over the term of the agreement and support period but not in excess of the amount of cash received. Deferred revenue associated with this contract was $392,000 as of September 30, 2002.

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Table of Contents
 
CAPTARIS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
5.    Cumulative Effect of Change in Accounting Principle
 
Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 142, “Goodwill and Other Intangibles Assets,” which eliminates the amortization of goodwill and indefinite-lived intangible assets, addresses the amortization of intangible assets with finite lives, and addresses impairment testing and recognition for goodwill and intangible assets. The company evaluated its other intangible assets, including core technology, customer lists, and other and determined that these assets have definite lives. These are classified on the company’s consolidated balance sheets as intangibles and other assets, net.
 
As of January 1, 2002 net intangible assets of $400,000 previously allocated to assembled workforce have been reclassified to goodwill in accordance with SFAS No. 142.
 
Management determined upon adoption of SFAS No. 142 that the Company had three reporting units: E-document services and two reportable units within the products segment (mobile delivery and the combination of fax and messaging products). After completion of an independent valuation, management determined that goodwill associated with the mobile delivery reporting unit was impaired. Accordingly, a non-cash charge of $2.7 million was recorded as a cumulative effect of change in accounting principle effective January 1, 2002.
 
The following table provides information about activity in goodwill, net by reporting unit for the period from December 31, 2001 to September 30, 2002 (in thousands):
 
    
Mobile Delivery
     
Fax and Messaging
     
E-document     Services    
   
Total
  
Goodwill, net, December 31, 2001
   
$
10,155
 
   
$
1,949
     
$
—  
   
$
12,104
 
Assembled workforce reclassification
   
 
400
 
   
 
—  
     
 
—  
   
 
400
 
Cumulative effect of adopting SFAS No. 142
   
 
(2,695
)
   
 
—  
     
 
—  
   
 
(2,695
)
    
  
    
  
Goodwill, net, January 1, 2002
   
 
7,860
 
   
 
1,949
     
 
—  
   
 
9,809
 
Settlement agreement (see Note 9)
   
 
(1,435
)
   
 
—  
     
 
—  
   
 
(1,435
)
OfficeCom acquisition
   
 
—  
 
   
 
567
     
 
—  
   
 
567
 
    
  
    
  
Goodwill, net, September 30, 2002
   
$
6,425
 
   
$
2,516
     
$
 —  
   
$
8,941
 
    
  
    
  
 
In accordance with SFAS No. 142, the cumulative effect of this accounting change is reflected as of January 1, 2002 and amortization of goodwill ceased beginning 2002. Supplemental comparative disclosures as if the cumulative change had been retroactively applied to the prior period are as follows:
 
      
Three months ended September 30, 2002
     
Three months ended September 30, 2001
       
Nine months ended September 30, 2002
       
Nine months ended September 30, 2001
  
      
(in thousands, except per share amounts)
  
Net loss
     
$
363
     
$
(2,081
)
     
$
(8,822
)
     
$
(9,530
)
Cumulative effect of change in accounting principle
     
 
—  
     
 
—  
 
     
 
2,695
 
     
 
—  
 
Plus: goodwill amortization
     
 
—  
     
 
423
 
     
 
—  
 
     
 
1,269
 
      
    
    
    
Adjusted net loss
     
$
363
     
$
(1,658
)
     
$
(6,127
)
     
$
(8,261
)
      
    
    
    
Basic and diluted net loss per share before cumulative effect
     
$
0.01
     
$
(0.06
)
     
$
(0.28
)
     
$
(0.30
)
Cumulative effect of change in accounting principle
     
 
—  
     
 
—  
 
     
 
0.09
 
     
 
—  
 
Goodwill amortization
     
 
—  
     
 
0.01
 
     
 
—  
 
     
 
0.04
 
      
    
    
    
Adjusted basic and diluted net loss per share
     
$
0.01
     
$
(0.05
)
     
$
(0.19
)
     
$
(0.26
)
      
    
    
    

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Table of Contents
 
CAPTARIS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
6.    Intangible Assets
 
As a result of the goodwill impairment discussed in Note 5, the Company also engaged its independent appraisers to evaluate potential impairment of identified intangible assets in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which the company adopted effective January 1, 2002. The Company’s appraisers completed an impairment assessment and determined that certain intangible assets acquired from the Infinite Technologies purchase in January 2001 were impaired and accordingly recorded a charge of $5.5 million. Following is a summary of the Company’s intangible assets:
 
    
September 30, 2002
  
December 31, 2001
    
Gross Carrying amount
   
Accumulated amortization
     
Impairment charges
     
Other intangible assets, net
   
Gross carrying amount
   
Accumulated Amortization
     
Other intangible assets, net
    
(in thousands)
Core Technology
   
$
3,500
   
$
(764
)
   
$
(2,440
)
   
$
296
   
$
3,500
   
$
(500
)
   
$
3,000
Trade name/domain name
   
 
2,400
   
 
(685
)
   
 
(849
)
   
 
866
   
 
2,400
   
 
(414
)
   
 
1,986
Customer base and marketing channel
   
 
3,200
   
 
(960
)
   
 
(2,240
)
   
 
—
   
 
3,200
   
 
(640
)
   
 
2,560
Assembled workforce
   
 
—
   
 
—
 
   
 
—
 
   
 
—
   
 
800
   
 
(400
)
   
 
400
Other
   
 
4,901
   
 
(3,464
)
   
 
—
 
   
 
1,438
   
 
4,118
   
 
(3,254
)
   
 
864
    
  
  
  
  
  
  
Total
   
$
14,001
   
$
(5,873
)
   
$
(5,529
)
   
$
2,600
   
$
14,018
   
$
(5,208
)
   
$
8,810
    
  
  
  
  
  
  
 
Intangible assets are scheduled to be amortized over future periods, with corresponding amortization expense estimated to be $138,000, $461,000, $458,000, $451,000, $451,000 and $375,000 for the remainder of fiscal 2002, fiscal years 2003, 2004, 2005, 2006 and 2007, respectively.
 
7.    Net Income/(Loss) Per Share
 
Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income available to common shareholders by the weighted average number of common and potentially dilutive common shares outstanding during the period, which includes the additional dilution related to conversion of stock options as computed under the treasury stock method.
 
At September 30, 2002, and for the nine months then ended, potentially dilutive common shares of 394,128 were excluded from the calculation of diluted shares outstanding for the year to date, as they were antidilutive.
 
At September 30, 2001, potentially dilutive common shares of 42,580 and 1,180,505 were excluded from the calculation of diluted shares outstanding for the quarter and year to date, respectively, as they were antidilutive.

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Table of Contents
 
CAPTARIS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
8.    Segment Reporting
 
The segment information provided reflects the two distinct business models of the Company’s organizational structure: software products and e-document delivery services. Interest and other debt expense, provision for income taxes, interest income and gains and losses on the disposition of marketable securities are centrally managed at the corporate level and, accordingly, such items are not presented by segment since they are excluded from the measure of segment profitability reviewed by the Company’s management. Reconciling items include corporate expense items and amortization charges, which are not allocated to operating segments. Certain amounts have been reclassified from reconciling amounts to software products to reflect the way management currently evaluates the segments. The Company’s assets continue to be managed on a company-wide basis versus by segment; accordingly, asset information is not reported.
 
    
Software
Products
     
E-document     Services    
   
Reconciling
Amounts
     
Total
  
    
(in thousands)
  
Quarter ended September 30, 2002
                                  
Net sales
   
$
17,065
 
   
$
6,022
   
$
—  
 
   
$
23,087
 
Operating income (loss)
   
 
(634
)
   
 
850
   
 
(163
)
   
 
53
 
Quarter ended September 30, 2001
                                  
Net sales
   
$
18,148
 
   
$
5,589
   
$
—  
 
   
$
23,737
 
Operating income (loss)
   
 
(2,419
)
   
 
263
   
 
(1,587
)
   
 
(3,743
)
Nine months ended September 30, 2002
                                  
Net sales
   
$
49,632
 
   
$
17,746
   
$
—  
 
   
$
67,378
 
Operating income (loss)
   
 
(11,952
)
   
 
2,589
   
 
(1,450
)
   
 
(10,813
)
Nine months ended September 30, 2001
                                  
Net sales
   
$
50,600
 
   
$
17,114
   
$
—  
 
   
$
67,714
 
Operating income (loss)
   
 
(13,332
)
   
 
1,042
   
 
(4,728
)
   
 
(17,018
)
 
The Company’s sales by country were as follows:
 
    
Quarter ended
September 30,
  
Nine months ended September 30,
    
2002
   
2001
   
2002
   
2001
    
(in thousands)
United States
   
$
19,038
   
$
19,291
   
$
55,445
   
$
53,854
Canada
   
 
550
   
 
542
   
 
1,283
   
 
1,975
United Kingdom
   
 
806
   
 
1,452
   
 
2,713
   
 
4,206
Other
   
 
2,693
   
 
2,452
   
 
7,937
   
 
7,679
    
  
  
  
    
$
23,087
   
$
23,737
   
$
67,378
   
$
67,714
    
  
  
  
 

10

Table of Contents
 
CAPTARIS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
9.    Settlement Agreement
 
In April 2002, Brett Warthen, the Company’s Senior Vice President—Wireless Strategy and Technology and the former majority owner of Infinite Technologies, Inc., which was acquired in January of 2001, resigned. In connection with his departure, the Company and Mr. Warthen agreed to restructure the outstanding payments due under the acquisition agreement. The original terms of the agreement provided that the Company would pay approximately $2.9 million in a combination of cash and common stock over three years from the date of closing, and up to an additional $3.9 million in a combination of cash and common stock under a performance incentive arrangement over the same three-year period, that if paid, would have been expensed as compensation. Pursuant to the April 2002 separation agreement, the Company paid approximately $1.5 million in cash in full satisfaction of all outstanding payments due under the agreement. The Company recorded the cash payment to Mr. Warthen as full satisfaction of the debt of approximately the same amount. The remainder of the $2.9 million, $1.4 million of which was originally to be paid in stock, was recorded as a reduction of goodwill in the second quarter of 2002. In the second quarter of 2002 the Company also recorded the reversal of a prior year accrual associated with the performance incentive arrangement of approximately $700,000, which is included in research and development expenses.
 
10.    Non-recurring Charges
 
In April of 2002, in connection with the settlement of a patent infringement suit filed by AudioFax, the Company recorded a one-time charge of $875,000.
 
On January 10, 2002, the Company announced an 18% reduction of its workforce, which resulted in the recognition of a one-time charge of $2.1 million related to severance, impairment of certain assets and non-cancelable lease obligations. Amounts paid and accrued at September 30, 2002 were as follows:
 
    
Accrued as of March 31, 2002
   
Payments
       
Accrued
as of September 30, 2002
    
(in thousands)
Severance
   
$
363
   
$
(363
)
     
$
—  
Non-cancelable leases for real property
   
 
247
   
 
(247
)
     
 
—  
Other non-cancelable contracts
   
 
66
   
 
(27
)
     
 
39
    
  
    
    
$
676
   
$
(637
)
     
$
39
    
  
    
 
On March 15, 2001, the Company announced the consolidation of its two primary product groups, Computer Telephony Software Group and Document Exchange Software Group, resulting in a 14% reduction of its workforce and a one-time charge of approximately $1.0 million, which consisted of mainly severance and other employee benefits and consulting services, all of which was paid by December 31, 2001.
 
In January 2001, the Company acquired all of the outstanding common stock of Infinite Technologies, Inc. The acquisition was accounted for as a purchase. In connection with the acquisition, the Company recorded a one-time charge of $1.9 million related to the write-off of its purchased in-process research and development.

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Table of Contents
 
CAPTARIS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
11.    Changes in Shareholders’ Equity
 
    
Common Stock
     
Retained Earnings
     
Acccum. Other Compre-hensive Loss
     
Total
  
Beginning balance at December 31, 2001, as restated
   
$
66,260
 
   
$
44,173
 
   
$
(528
)
   
$
109,905
 
Net loss
            
 
(8,822
)
            
 
(8,822
)
Stock-based compensation
   
 
(1,247
)
                     
 
(1,247
)
Reduction of additional paid-in-capital upon Infinite settlement (see Note 9)
   
 
(1,482
)
                     
 
(1,482
)
Effects of foreign currency
                     
 
24
 
   
 
24
 
Stock buy-back
   
 
(84
)
                     
 
(84
)
Exercise of stock options
   
 
466
 
                     
 
466
 
    
  
  
  
Ending balance at September 30, 2002
   
$
63,913
 
   
$
35,351
 
   
$
(504
)
   
$
98,760
 
    
  
  
  
 
12.    Legal Proceedings
 
On April 10, 2002, the Company entered into a nonexclusive license agreement with AudioFAX IP LLC, settling a patent infringement suit filed by AudioFAX on November 30, 2001. As reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001, the lawsuit was filed against the Company in the United States District Court for the Northern District of Georgia. The Company paid a one-time fee to license the technology until the patents expire in 2008 and 2011. In the first quarter of 2002, the Company recorded a charge of $875,000, (included in non-recurring charges), reflecting management’s assessment of the fair value of the portion of the license fee that relates to prior years. The balance of the license fee, the amount of which is confidential, was capitalized and is being amortized over the remaining life of the licensor’s patents. The related amortization is not expected to be material to the Company’s future results of operations.
 
13.    Stock Based Compensation
 
During the second quarter of 2001, the Company offered a limited non-compulsory exchange of employee stock options on a less than one-for-one basis. The exchange (which closed on July 10, 2001) resulted in the voluntary cancellation of employee stock options to purchase 3,125,620 shares of our common stock with varying exercise prices greater than $10.00 per share in exchange for 1,298,284 employee stock options with an exercise price of $2.11. The Company had 1,400,811 shares subject to variable accounting as of September 30, 2002. Variable accounting will continue until all options subject to variable accounting treatment are exercised, cancelled or expired. Variable accounting treatment will result in charges or credits, recorded to “Stock compensation expense,” dependent on unpredictable fluctuations in quoted prices for the Company’s common stock. The impact of variable accounting resulted in credits of $633,000 and $1,247,000 to stock compensation expense for the quarter and nine months ended September 30, 2002, respectively.

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CAPTARIS, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
 
14.    Restatement
 
During July 2002, the Company determined that a deferred tax liability associated with identified intangibles of the Infinite Technologies acquisition in January 2001 should have been established. Establishment of such liability would have increased goodwill and the related amortization thereof. Accordingly, the accompanying unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2001 and the financial statements for the year ended December 31, 2001 have been restated to give effect to the changes as of January 2001, the date of acquisition, and recognize additional goodwill amortization from that date. A summary of the significant effects of the restatement are as follows:
 
 
    
December 31, 2001
    
As previously reported
   
As restated
Balance Sheet:
              
Goodwill
   
$
9,134
   
$
12,104
Deferred Tax Liability
   
 
—
   
 
3,301
Retained earnings
   
 
44,504
   
 
44,173
 
    
Year ended
December 31, 2001
    
Quarter ended
September 30, 2001
    
Nine months ended
September 30, 2001
  
    
As previously reported
     
As restated
     
As previously reported
     
As restated
     
As previously reported
     
As restated
  
Statement of Operations:
                                                      
Sales, general and administrative
   
$
60,367
 
   
$
60,862
 
   
$
14,774
 
   
$
14,898
 
   
$
44,959
 
   
$
45,330
 
Total operating expenses
   
 
78,586
 
   
 
79,081
 
   
 
18,182
 
   
 
18,306
 
   
 
58,812
 
   
 
59,183
 
Operating loss
   
 
(21,296
)
   
 
(21,791
)
   
 
(3,619
)
   
 
(3,743
)
   
 
(16,647
)
   
 
(17,018
)
Loss before income tax expense
   
 
(17,949
)
   
 
(18,444
)
   
 
(2,848
)
   
 
(2,972
)
   
 
(14,061
)
   
 
(14,432
)
Income tax benefit
   
 
(5,945
)
   
 
(6,109
)
   
 
(854
)
   
 
(891
)
   
 
(4,779
)
   
 
(4,902
)
Net loss
   
$
(12,004
)
   
$
(12,335
)
   
$
(1,994
)
   
 
(2,081
)
   
$
(9,282
)
   
$
(9,530
)
Basic and diluted net loss per common share
   
$
(0.37
)
   
$
(0.38
)
   
$
(0.06
)
   
 
(0.06
)
   
$
(0.29
)
   
$
(0.30
)
 
As a result of the Company’s restatement of its consolidated financial statements for the year ended December 31, 2001, the Company has engaged its independent auditors to audit those financial statements. Upon completion of that audit, the Company expects to amend its Annual Report on Form 10-K for that year. The Company also expects to amend its Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 and any other Quarterly Report the Company determines must be amended.
 
15.    Subsequent Event
 
On October 31, 2002, the Company began a voluntary layoff program designed to eliminate approximately 40 positions, which represents less than ten percent of its total workforce, from the Kirkland, Washington offices by the end of 2002. The Company expects to incur additional operating expenses during the fourth quarter of 2002 of approximately $1 million resulting from this program.

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Item 2.
   
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This discussion and analysis reflects certain restatements to our previously reported results of operations, see Note 14 to the unaudited condensed consolidated financial statements for a discussion of this matter.
 
This discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and accompanying notes included in this document and the 2001 audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K, (except as set forth in Note 14 of the condensed consolidated financial statements included in this filing), which was filed with the Securities and Exchange Commission on March 27, 2002.
 
The following discussion of our financial condition and results of operations contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Words such as “believes,” “expects,” “anticipates,” “intends,” “plans” and similar expressions are intended to identify forward-looking statements. Captaris’ actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the factors described below and under the caption “Additional Factors that May Affect Our Business, Future Operating Results and Financial Condition” set forth at the end of this Item 2. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Form 10-Q.
 
The Company is a leading provider of unified communications solutions and a provider of mobile business solutions for medium and large-sized enterprises, which the Company considers to be primarily enterprises with 250 to 5,000 employees. The Company provides flexible, cost-effective products for unified communications and mobile business solutions. These products, which comprise the Company’s software products segment, address the fax server, production fax, document delivery, unified messaging, voice messaging, and mobile wireless markets and are distributed primarily through independent distributors and value-added resellers. The Company’s products run on off-the-shelf hardware, are certified for operation with Windows NT, Windows 2000, and Exchange 2000, and interface with a wide variety of telephony and computer equipment. The Company’s services segment offers an e-document delivery service, including both broadcast fax and permission-based e-mail. This service is offered to customers primarily through a direct sales force.
 
The Company sells its products primarily through an indirect channel of resellers and distributors, as well as through direct sales, OEM and private label agreements. The Company’s data-oriented enhanced fax products include: RightFax and RightFax Enterprise, the Company’s LAN-based fax server lines for Windows NT / Windows 2000, and the RightFax Production System, a high-volume production-oriented server that enables fax and other forms of electronic transmission for electronic commerce applications. The Company’s telephony-oriented products include: CallXpress and CallXpress Enterprise, a multi-application, high capacity unified messaging platform, and PhoneXpress, a full-featured advanced messaging system for small to medium-sized enterprises. The Company’s mobile delivery products primarily include Infinite Mobile Delivery and the Infinite WAP Gateway. The Company’s e-document delivery services, branded under the name MediaLinq, offer high-volume, simultaneous delivery of fax and e-mail documents via the Web, from desktop software or a fax machine.
 
Results of Operations
 
Net sales.    Net sales decreased 2.7% to $23,087,000 in the quarter ended September 30, 2002, from $23,737,000 in the comparable 2001 quarter. Software product sales decreased 6.0% over the same quarter of the preceding year primarily from a decline in fax product sales that the Company believes is representative of the overall softness in technology spending and the economy in general. E document services increased 7.7% over the same quarter of the preceding year and were primarily driven by an increase in mortgage industry related sales. Software product sales for the quarter ended September 30, 2002 included approximately $600,000 from the Company’s OEM agreement with Cisco Systems. International sales for the quarter decreased 8.9% compared to the third quarter of 2001, and represented 17.5% of total net sales.
 
For the nine months ended September 30, 2002, net sales were $67,378,000, nearly matching the net sales of $67,714,000 recorded in the same period of 2001. For the nine months ended September 30, 2002, software product sales decreased 1.9% while E-documents services increased 3.7% over the same period of the prior year. For the nine months ended September 30, 2002, software product sales included approximately $1,300,000 from the Company’s OEM agreement with Cisco Systems. International sales decreased 13.7% over the prior year and represented 17.7% of net sales.
 
Decreases in net sales in the software products group for the nine months ended September 30, 2002, over the same period of the prior year, are reflective of decreased sales of messaging and fax products, which management believes is a result of continued softness in telecommunications and information technology spending. The notable increase in e-document services net sales over the prior-year period continues to be a result of increased volume and relatively stable pricing. Although pricing pressure in the services segment appears to have stabilized, there can be no assurance that this trend will continue.

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Table of Contents
 
Gross profit.    Gross profit as a percentage of net sales was 61.4% in the quarters ended September 30, 2002 and 2001. In the nine-month period ended September 30, 2002, gross margin was 62.5% as compared to 62.3% in the comparable prior year period. The gross margin percentage in 2002 includes the effect of inventory write-downs due to product version upgrades as well as normal product mix variances.
 
Research and development.    For the three months ended September 30, 2002, research and development expenses were $3,088,000, constituting 13.4% of net sales as compared to $3,408,000 or 14.4% in the prior-year period. For the nine months ended September 30, 2002, research and development expenses were $8,535,000 or 12.7% of sales, compared with $10,911,000 or 16.1% of sales in the same period of the prior year, and includes the effect of recording a reversal of a performance incentive arrangement of approximately $700,000, as more fully discussed in Note 9. The decrease for the quarter also reflects the effect of continued cost containment measures.
 
Sales, general and administrative.    Sales, general and administrative expenses decreased to $11,659,000 in the quarter ended September 30, 2002, from $14,898,000 in the comparable prior-year quarter. The prior year quarter and nine-month expenses included costs associated with the launch of the Company’s mobile delivery product, amortization of goodwill and the impact of the expenditures in 2001 for corporate branding and the company’s name change. The current year quarter and nine-month period continues to benefit from the Company’s cost reduction initiatives. Sales, general and administrative costs for the current quarter represented 50.5% of net sales, a decrease from 62.8% in the comparable prior-year quarter.
 
For the nine months ended September 30, 2002, sales, general and administrative expenses were $37,112,000 or 55.1% of sales compared to $45,330,000 or 66.9% of sales in the same period of the prior year. This represented a decrease of 18.1% over the prior year.
 
Stock-Based Compensation.    During the second quarter of 2001, the Company offered a limited non-compulsory exchange of employee stock options on a less than one-for-one basis. The exchange (which closed on July 10, 2001) resulted in the voluntary cancellation of employee stock options to purchase 3,125,620 shares of our common stock with varying exercise prices greater than $10.00 per share in exchange for 1,298,284 employee stock options with an exercise price of $2.11. The Company had 1,400,811 shares subject to variable accounting as of September 30, 2002. Variable accounting will continue until all options subject to variable accounting treatment are exercised, cancelled or expire. Variable accounting treatment will result in charges or credits, recorded to “Stock compensation expense,” and such charges or credits are dependent on unpredictable fluctuations in quoted prices for the Company’s common stock. The impact of variable accounting resulted in credits of $633,000 and $1,247,000 to stock compensation expense for the quarter and nine months ended September 30, 2002, respectively.
 
Impairment of intangible assets.    In the second quarter of 2002, the Company recorded a $5.5 million impairment charge related to the SFAS No. 144 review of intangible assets of its Mobile Delivery group as described in Note 6 of the Financial Statements.
 
Non-recurring charges.    On January 10, 2002, the Company announced a reduction in workforce, which resulted in an 18% reduction of its workforce and recorded a one-time charge of $2.1 million. Additionally, the Company recorded $875,000 in the first quarter related to the settlement of a patent infringement lawsuit.
 
In the first quarter of 2001, non-recurring charges of $1,042,000 were incurred related primarily to the consolidation of the operations of the Tucson and Kirkland product groups and consisted of mainly severance and other employee benefits and consulting services. Additionally, $1,900,000 of acquired in-process research and development related to the acquisition of Infinite Technologies was expensed during the first quarter of 2001.
 
Operating income (loss).    Operating income for the quarter ended September 30, 2002 was $53,000 compared to an operating loss of $3,743,000 in the comparable prior-year quarter. For the nine-month period ending September 30, 2002, operating loss was $10,813,000 compared to $17,018,000 in the same period of 2001.
 
Other income, net.    Net other income was $506,000 for the quarter ended September 30, 2002, as compared to $771,000 in the comparable prior-year quarter. For the nine months ended September 30, 2002, net other income was $1,388,000 compared to $2,586,000 in the same period of the prior year. The decrease in other income is primarily reflective of lower interest rates and reduced investment balances.
 
Income tax.    The effective tax expense and benefit rate for the three and nine-month period ended September 30, 2002 was 35%, respectively, compared with an effective tax benefit rate of 30.0% and 34%, respectively, for the same periods in the prior year.

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Table of Contents
 
Cumulative Effect of Change in Accounting Principle
 
Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 142, “Goodwill and Other Intangibles Assets,” which eliminates the amortization of goodwill and indefinite-lived intangible assets, addresses the amortization of intangible assets with finite lives, and addresses impairment testing and recognition for goodwill and intangible assets. The company evaluated its other intangible assets, including core technology, customer lists, and other and determined that these assets have definite lives. These are classified on the company’s consolidated balance sheets as intangibles and other assets, net.
 
As of January 1, 2002 net intangible assets of $400,000 previously allocated to assembled workforce have been reclassified to goodwill in accordance with SFAS No. 142.
 
Management determined upon adoption of SFAS No. 142 that the Company had three reporting units: E-document services and two reportable units within the products segment (mobile delivery and the combination of fax and messaging products). After completion of an independent valuation, management determined that goodwill associated with the mobile delivery reporting unit was impaired. Accordingly, a non-cash charge of $2.7 million was recorded as a cumulative effect of change in accounting principle effective January 1, 2002.
 
Net income (loss).    The Company recognized net income of $363,000 or $0.01 per common share for the quarter ended September 30, 2002, as compared to a net loss of $2,081,000 or $0.06 per common share for the comparable prior-year quarter. For the nine months ended September 30, 2002 the net loss was $8,822,000 or $0.28 per share compared to a net loss of $9,530,000 or $0.30 per share for the same period of 2001.
 
The results for the nine months ended September 30, 2002 reflect a $2,695,000 charge in connection with goodwill impairment that was identified in the second quarter and recorded as the cumulative effect of change in accounting principle as of the date of adoption, which was January 1, 2002, in accordance with SFAS No. 142.
 
Liquidity and Capital Resources
 
Cash used by operating activities in the nine months ended September 30, 2002 was $2,240,000. Days sales outstanding (DSO) was approximately 62 days at September 30, 2002 compared to 60 days in the comparable prior-year period. The Company faces credit risks with customers and partners in its distribution model and therefore maintains appropriate accruals for such exposures, while continuing to closely monitor reserves. Accounts receivable increased from $14.6 million at December 31, 2001 to $16.0 million at September 30, 2002.
 
In August 2000, the Board of Directors authorized the Company to repurchase up to $15 million worth of its common stock. At September 30, 2002, $13.5 million remains available for the repurchase program. Repurchases of 37,700 shares were made during the nine months ended September 30, 2002. The Company may repurchase shares in the future subject to overall market conditions, stock prices, and the Company’s cash position and requirements going forward.
 
The Company expects that its current cash, short-term investments, and available bank line of credit will provide sufficient working capital for operations for the foreseeable future.

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Table of Contents
 
Commercial Commitments and Contractual Obligations
 
The following table summarizes the Company’s contractual obligations as of September 30, 2002 and the effect such obligations are expected to have on liquidity in future periods:
 
    
Payments Due by Period
Contractual Obligations
   
Total
   
Less than 1 year
   
1-3 years
   
4-5 years
   
After 5 years
Operating Leases
   
$
7,201,160
   
$
2,138,026
   
$
2,674,258
   
$
2,014,746
   
$
374,130
 
During the quarter the company entered into a 5-year lease agreement for office space in Bellevue, Washington. This facility will serve as the Company’s new headquarters beginning February 2003. The lease commitment is for approximately 61,500 sq. feet of office space and will replace approximately 70,000 sq. feet currently leased.
 
The Company maintains a $4.0 million unsecured revolving line of credit, none of which is outstanding. The Company’s line of credit expires in August 2004, and contains certain financial covenants and restrictions as to various matters. The Company is currently in compliance with all such covenants and restrictions. Borrowings under the line of credit bear interest at the bank’s prime rate or its interbank offering rate plus 1.50%, at the Company’s option.
 
OEM Agreement
 
In January of 2002, the Company entered into an original equipment manufacturing (OEM) agreement with Cisco Systems, Inc. The agreement and support term is approximately 40 months from the date of acceptance, which occurred in March 2002, and includes annual termination provisions at the option of Cisco. Revenue is generally recognized ratably over the term of the agreement and support period but not in excess of the amount of cash received. Deferred revenue associated with this contract was $392,000 as of September 30, 2002.
 
Stock Options
 
On July 23, 2002, the Company issued its annual stock option awards to non-senior management employees. Options were granted to purchase approximately 800,000 shares with a strike price of $2.72.
 
Settlement Agreement
 
In April 2002, Brett Warthen, the Company’s Senior Vice President – Wireless Strategy and Technology and the former majority owner of Infinite Technologies, Inc., which was acquired in January of 2001, resigned. In connection with his departure, the Company and Mr. Warthen agreed to restructure the outstanding payments due under the acquisition agreement. The original terms of the agreement provided that the Company would pay approximately $2.9 million in a combination of cash and common stock over three years from the date of closing, and up to an additional $3.9 million in a combination of cash and common stock under a performance incentive arrangement over the same three-year period, that if paid, would have been expensed as compensation. Pursuant to the April 2002 separation agreement, the Company paid approximately $1.5 million in cash in full satisfaction of all outstanding payments due under the agreement. The Company recorded the cash payment to Mr. Warthen as full satisfaction of the debt of approximately the same amount. The remainder of the $2.9 million, $1.4 million of which was originally to be paid in stock, was recorded as a reduction of goodwill in the second quarter of 2002. In the second quarter of 2002 the Company also recorded the reversal of a prior year accrual associated with the performance incentive arrangement of approximately $700,000, which is included in research and development expenses.

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Table of Contents
 
Intangible Assets
 
As a result of the goodwill impairment discussed in Note 5, the Company also engaged its independent appraisers to evaluate potential impairment of identified intangible assets in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which the Company adopted effective January 1, 2002. The Company’s appraisers completed an impairment assessment and determined that certain intangible assets acquired from the Infinite Technologies purchase in January 2001 were impaired and accordingly recorded a charge of $5.5 million.
 
Subsequent Event
 
On October 31, 2002, the Company began a voluntary layoff program designed to eliminate approximately 40 positions, which represents less than ten percent of its total workforce, from the Kirkland, Washington offices by the end of 2002. The Company expects to incur additional operating expenses during the fourth quarter of 2002 of approximately $1 million resulting from this program.

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Table of Contents
 
Additional Factors that May Affect our Business, Future Operating Results and Financial Condition
 
The following factors may materially adversely affect our business, financial condition or results of operations. In that event, the trading price of our shares could decline and you may lose part or all of your investment, therefore, you should carefully consider the risks described below before making an investment decision.
 
Our recently expanded business strategy to focus on the mobile business solutions market, which is a new and unproven market, may not be successful.
 
In March 2001, we announced that we were expanding our business strategy to focus on the mobile business solutions market, which we believed to be a potential higher-growth opportunity. We continue to believe that this market is likely to develop over time, but it has been slower to develop than we anticipated. Certain early entrants to this market have not achieved their publicly forecasted financial results. While we will continue to invest in this strategy, we intend to slow our investment rate until the market develops. There can be no assurance that we will realize a return on our past or future investment in this unproven mobile business solutions market.
 
In the future, in order to implement this strategy, we must continue to design, develop and introduce competitive new wireless products, improve our marketing of such products, and build credibility among customers that we are capable of delivering advanced mobile business solutions. Execution of this strategy may involve a substantial increase in costs and, as a result, our expenses could increase disproportionately to revenue in the future. Moreover, future focus on this strategy may disrupt our other operations and distract management, which could have a material adverse effect on our operating results. We cannot guarantee that the demand for mobile business solutions will develop in the future, that new technologies will not cause the market to evolve in a manner different from what we expect or that we will be able to obtain a leadership position if this market opportunity develops.
 
We are moving our corporate headquarters and order fulfillment facilities, which could disrupt our operations and negatively impact our results.
 
The lease for our corporate headquarters and order fulfillment facilities in Kirkland, Washington, expires in January 2003. We have entered into a lease for new facilities in Bellevue, Washington and are scheduled to move in February 2003. A move of this magnitude can be challenging and, as a result, we may experience disruptions in our business that could negatively impact our results of operations.
 
Our operating results fluctuate from quarter to quarter, which could cause our operating results to fall below expectations of securities analysts and investors.
 
We expect our operating results to fluctuate significantly from quarter to quarter in the future. Because of these fluctuations, our operating results for a particular quarter may fall below the expectations of securities analysts and investors. If this occurs, the trading price of our stock may decline. Such fluctuations could cause period-to-period comparisons to be less than meaningful. Numerous factors contribute to the unpredictability of our operating results, including
 
 
•
 
the timing of customer orders;
 
 
•
 
changes in our mix of products and distribution channels;
 
 
•
 
the announcement or introduction of new products by us or our competitors;
 
 
•
 
pricing pressures; and
 
 
•
 
general economic conditions.
 
Most of our software product revenue comes from current-quarter orders and sales, of which a substantial portion, and sometimes a majority, occurs in the last month of each quarter. We do not maintain a large backlog of orders, and most of our distributors maintain little or no inventory. Order fulfillment cycles are typically short, and often as short as one to two days. Accordingly, the timing of customer orders can cause significant variations in quarterly results of operations. Because we sell our products to end-customers through various third parties such as telephone system manufacturers, value-added resellers, telephone interconnect resellers, and others, we are unable to project with certainty the actual orders, sales, and revenues these third parties will generate in a given quarter. The combination of these factors impairs and delays our ability to know when revenues and earnings will be higher or lower than expected. We base product development and other operating expenses on our expected revenues. Because our expenses are relatively fixed in the short term, we may be unable to adjust our spending in time to compensate for any unexpected shortfall in quarterly revenues.
 
Revenue recognition on the Company’s OEM agreement with Cisco Systems is impacted by the timing of payments received. Certain variables exist within the contract that allow Cisco to influence such timing. Additionally the ultimate realizability of the contract amount is subject to cancellation provisions under Cisco’s control.

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Table of Contents
 
Our operating results may vary by season, which could cause our operating results to fall below expectations of securities analysts and investors.
 
Our results of operations may fluctuate as a result of seasonal factors, and this may cause our operating results to fall below expectations of securities analysts and investors for a particular quarter. Specifically, due to typical year-end dealer sales patterns and end-user buying patterns, net sales in our first quarter, without taking into account the effect of acquisitions, have in the past declined from the fourth quarter of the previous year.
 
We rely heavily on telephone system manufacturers, independent equipment resellers and value-added resellers.
 
A substantial majority of our net sales depends on a network of independent telephone equipment resellers and computer-oriented value-added resellers. There is intense competition for the attention of these independent resellers from our competitors and from providers of other products distributed through these channels. Many of these resellers do not have the financial resources to withstand a downturn in their businesses. We may not be able to maintain or expand our network of resellers in the future. Moreover, our resellers may not maintain or expand their present level of efforts to sell our products. If we lose a major dealer or reseller, or if our dealers and resellers lose interest in selling our products, our business, results of operations and financial condition may suffer.
 
Failure to establish and maintain strategic relationships could limit our ability to maintain or increase sales.
 
Creation and maintenance of strategic relationships is important to our success because these relationships enable us to market and distribute our products to a larger customer base than we could otherwise reach through our direct marketing efforts. We currently have strategic relationships with Ericsson, NEC Corporation, Fujitsu Limited, Lotus Development Corporation, Xerox Corporation and others. However, we may not be successful in creating new strategic relationships on acceptable terms, if at all. Moreover, although we view our strategic relationships as an important factor in the successful commercialization of our products and services, our current strategic partners may not view their relationships with us as significant for their own businesses and any one of them could reassess their commitment to us in the future. Further, our relationships are generally non-exclusive, which means our strategic partners may develop relationships with some of our competitors. Failure of one or more of our strategic partners to successfully develop and sustain a market for our services, or the termination of one or more of our strategic relationships could adversely affect our ability to increase sales.
 
Additionally, our partners from time to time require us to customize our products and / or develop further enhancements or capabilities. If we are unable to meet these requests in a timely manner, our relationships with our partners and operating results could be negatively impacted.
 
The integration of recent and any future acquisitions may be difficult and disruptive.
 
We frequently evaluate potential acquisitions of products, technologies and businesses. Since January 1997, we have made five strategic acquisitions, including the January 2001 acquisition of Infinite Technologies. Our recent and any future acquisitions may direct management’s attention away from the day-to-day operations of our business and may pose numerous other risks. For instance, we may not be able to successfully integrate any technologies, products, personnel or operations of companies that we may acquire.
 
In making acquisitions, we may need to make dilutive issuances of our equity securities, incur debt, write off purchased, in-process research and development, and amortize expenses related to goodwill and other intangible assets.

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Technology and customer needs change rapidly in our industry.
 
In our industry, technology and customer demands change rapidly, and we and our competitors frequently introduce new products and features. To succeed, we must identify, develop and market new products, features and services that achieve broad market acceptance by satisfying those changing customer needs and keeping pace with those technological developments. To do this, we must spend substantial funds on product development. We regularly devote significant resources to technologies that we anticipate will be widely adopted. In addition, in the future, we intend to pursue new revenue streams by leveraging our expertise in voice and data communication to integrate these capabilities in unified messaging and mobile wireless delivery, among other possible areas. The market for unified messaging software and mobile wireless delivery is relatively new and, as yet, unproven. To be successful, we must, among other things, develop and market products and services that achieve broad market acceptance. We may not be able to develop new products or product enhancements on a timely basis. Even if we do, the market may not accept the new products or product enhancements that we develop.
 
Our market is highly competitive.
 
The computer-telephony market is highly competitive. Moreover, we believe the competitive pressures we face are likely to intensify, particularly as our competitors make new offerings based on the Windows operating system. We may not have the financial resources, marketing, distribution and service capability, depth of key personnel or technological knowledge to continue to compete successfully in each of our markets.
 
We believe the main competitive factors affecting our business are breadth and quality of application software, product integration, ability to respond to technological change, quality of a Company’s sales force, price, size of the installed base, level of customer support and professional services.
 
In the telephony-oriented market for messaging systems, our principal competitors are independent suppliers such as Avaya, Inc., Mitel Corporation, Active Voice, Inc. (now a division of NEC America, Inc.), Cisco Systems, Inc., and Callware Technologies, Inc.
 
In addition to independent suppliers of computer-telephony solutions, we also compete with private branch exchange and key telephone systems manufacturers. Those manufacturers offer integrated voice messaging systems, unified messaging systems and automatic call distribution systems of their own design or under various OEM agreements. Competitors in this category include Lucent Technologies, Inc., Nortel Networks Corporation, Siemens Business Communication Systems, Inc., Mitel Corporation and NEC America, Inc.
 
In the market for LAN-based facsimile systems, our principal competitors are Omtool, Ltd., Optus Software, Inc., Esker, S.A., and Computer Associates International, Inc. Our fax server products also compete 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 the market for production facsimile systems, our principal competitors are Biscom, Inc., Esker, S.A. and Topcall International AG. In the market for document distribution products, our principal competitors include the Xpedite division of PTEK Holdings, Inc. and other telecommunications providers such as Cable & Wireless, Inc. Competitors to our mobility offerings include companies such as Openwave Systems, Inc., Aether Systems, Inc. and 724 Solutions, Inc.
 
Further acceptance of open systems architectures and the development of industry standards in the call processing market may eliminate some of the technical barriers to entry, allowing additional competitors to enter the market. Many of our existing competitors have larger customer and installed bases and substantially greater technical, financial and marketing resources than we do. In addition, some of our competitors have a marketing advantage because they can sell their call processing equipment or facsimile solutions as part of their broader product offerings. Recently, we believe our business has been, and may continue to be, adversely affected by the introduction of next-generation IP PBX switches as potential customers delay purchasing decisions as they evaluate these new product offerings. We expect our competitors will continue to offer improved product technologies and capabilities. The availability of these products could cause sales of our existing products to decline. For these reasons, we may be unable to compete successfully against our current and future competitors.

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Our average sales prices have declined for some of our products.
 
The average sales prices in our basic voice messaging products have declined due to competitive pressures. In the future, prices may decline in some of our other product lines. If the average sales prices of our more significant product lines fall, our overall gross margins will likely fall. To offset and forestall declining average sales prices, we must continue to develop product enhancements and new products with advanced features that are likely to generate higher-margin incremental revenue. If we are unable to do so in a timely manner, or if our products do not achieve significant customer acceptance, our business, results of operations and financial condition may suffer. Additionally, we have experienced, as have others in our broadcast fax and document delivery markets, pricing pressures for our services.
 
We may be unable to adequately protect our proprietary rights.
 
To succeed, we must adequately protect our proprietary technology. 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, but those measures may be insufficient. We have one patent in the area of unified messaging, but our competitors may challenge or circumvent the claims in that patent. Our current patent, or any future patents, may never provide us with any competitive advantages. Other measures that we take to protect our proprietary technology may not prevent or deter misappropriation of our technology or the development of technologies with similar characteristics. Moreover, our use of open systems architecture in the design of our products may make it easier for competitors to misappropriate or replicate our designs and developments.
 
Other companies may claim that we infringe their intellectual property or proprietary rights, which could cause us to incur significant expenses or be prevented from selling our products.
 
Our success depends on our ability to operate without infringing the patents and proprietary rights of third parties. Product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies. Historically, competitors in the computer-telephony software industry have filed numerous allegations of patent infringement, resulting in considerable litigation. We have received claims of patent infringement from several parties and will probably receive additional claims in the future. Any litigation, regardless of our success, would probably be costly and require significant time and attention of our key management and technical personnel. Litigation could also force us to
 
 
•
 
stop or delay selling, or using, products that use the challenged intellectual property;
 
 
•
 
pay damages for infringement;
 
 
•
 
obtain licenses, which may be unavailable on acceptable terms; or
 
 
•
 
redesign products or services that use the infringing technology.
 
We face risks from expansion of our international operations.
 
Maintaining or growing our revenue depends, in part, on continued expansion of our international sales. We have spent significant management attention and financial resources on our international operations. A significant portion of our revenues are subject to the risks associated with international sales, which include
 
 
•
 
difficulty adapting products to local languages and telephone system technology;
 
 
•
 
inability to respond to changes in regulatory requirements;
 
 
•
 
inability to meet special standards requirements;
 
 
•
 
exposure to exchange rate fluctuations;
 
 
•
 
tariffs and other trade barriers;
 
 
•
 
difficulties in staffing and managing international operations;
 
 
•
 
potentially adverse tax consequences; and

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•
 
uncertainties arising from local business practices and cultural considerations.
 
In addition, the laws of some foreign countries are uncertain or do not protect intellectual property rights to the same extent as the United States. Moreover, we could be sued for patent infringement or other intellectual property violations in a foreign country where it could be very costly to defend such a lawsuit.
 
Currently, substantially all of our international sales are denominated in U.S. dollars. Increases in the value of the dollar against local currency could cause our products to become relatively more expensive to customers in a particular country, leading to reduced sales or profitability in that country. As we continue to expand our international operations, we expect our non-dollar-denominated sales and our exposure to gains and losses on international currency transactions to increase. We do not currently engage in transactions to hedge against the risk of currency fluctuations, but we may do so in the future.
 
We may not be able to hire and retain highly skilled employees, which could affect our ability to compete effectively.
 
To succeed, we must attract and retain key personnel in engineering, research and development, marketing, sales, finance and administration. We also depend to a significant degree on the efforts of our senior management team. If we fail to recruit such personnel or lose the services of existing key persons in any functional area, our current operations and new product development efforts could be adversely affected. Competition for skilled personnel is intense. When our stock price is lower than our employees’ stock option price, it is particularly difficult to retain skilled personnel. Past reductions in force and any additional reductions in force we undertake may adversely impact employee morale and impair our ability to attract and retain highly qualified personnel. We do not maintain material key person life insurance.
 
We may experience difficulties in managing our growth.
 
Growth in our business has placed, and will continue to place, significant demands on our management and operations. To succeed, our officers and key employees must manage growth successfully. We must continue to implement and improve our operational, financial and management information systems. In addition, we must expand, train and manage our employee base. We may be unable to successfully accomplish these tasks in a timely manner.

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We depend on third parties for certain key components of our products.
 
We use standard computer hardware for our products. Most of the components we use are readily available. However, only three domestic suppliers can provide voice-processing circuit boards in the quantities we need. In addition, only two domestic suppliers can provide our facsimile processing circuit boards in the quantity we require. Historically, we have relied almost exclusively on Dialogic Corporation (now a part of Intel Corporation) for our voice cards, and on Dialogic and Brooktrout, Inc. for our fax cards. We rely on those suppliers primarily because of volume price discounts and the cost and effort required to develop software for an alternate voice or fax card. Significant delays, interruptions or reductions in our supply of voice or fax cards, or unfavorable changes to price and delivery terms could adversely affect our business.
 
Our stock price may be highly volatile.
 
The market price of our common stock has been, and may continue to be, highly volatile. The future price of the common stock will fluctuate in response to factors such as
 
 
•
 
new product announcements or changes in product pricing policies by us or our competitors;
 
 
•
 
quarterly fluctuations in our operating results;
 
 
•
 
announcements of technical innovations;
 
 
•
 
announcements relating to strategic relationships or acquisitions;
 
 
•
 
changes in earnings estimates by securities analysts; and
 
 
•
 
general conditions in the computer-telephony market.
 
In addition, the market prices of securities issued by many companies, particularly in high-technology industries, are volatile for reasons unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock.

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Item 3.
   
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
The Company is exposed to market risk related to changes in interest rates and foreign currency exchange rates, each of which could adversely affect the value of the Company’s investments. The Company does not currently use derivative financial instruments.
 
The Company maintains a short-term investment portfolio consisting of interest bearing securities with an average maturity of less than one year. These securities are classified as “available for sale” securities. The interest bearing securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from levels at September 30, 2002, the fair value of the portfolio would decline by an immaterial amount. Because the Company has the current ability to hold its fixed income investments until maturity, it does not expect its operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates on its securities portfolio.
 
The Company has assets and liabilities denominated in certain foreign currencies related to the Company’s international sales operations. The Company has not hedged its translation risk on these currencies as the Company has the current ability to hold its foreign-currency denominated assets indefinitely and does not expect that a sudden or significant change in foreign exchange rates would have a material impact on future net income or cash flows.
 
Item 4.
   
Controls and Procedures
 
(a)    Evaluation of disclosure controls and procedures.  Under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of its disclosure controls and procedures (as defined in Rule 13a-14(c) and Rule 15d-14 under the Securities Exchange Act of 1934) within 90 days prior to the filing date of this quarterly report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that these disclosure controls and procedures are effective.
 
(b)    Changes in internal controls.  Subsequent to the date of our evaluation, the Company’s internal controls or in other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

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Part II.    OTHER INFORMATION
 
Item 6.     Exhibits and Reports on Form 8-K
 
(a)  Exhibits
 
   
10.1
   
Lease Agreement dated August 15, 2002 between BTC Seattle LLC and Captaris, Inc.
   
99.1
   
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   
99.2
   
Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
(b)  Reports on Form 8-K
 
The Company filed a Current Report on Form 8-K (Item 4) on July 22, 2002 relating to the appointment of the Company’s new independent auditor.
 
The Company filed a Current Report on Form 8-K (Item 5) on July 26, 2002 relating to its preliminary financial results for the second quarter of 2002.
 
The Company filed a Current Report on Form 8-K (Item 5) on August 15, 2002 relating to the filing of a Notification of Late Filing on Form 12b-25.

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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
       
CAPTARIS, INC.
         
Date:  November 14, 2002
      
By:
  
/s/    JEFFREY B. DECILLIA      
               
Jeffrey B. deCillia
               
Senior Vice President and
               
Chief Financial Officer
               
Signing on behalf of registrant and
               
principal financial officer

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Certification
 
I, David P. Anastasi, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q of Captaris, Inc.;
 
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
 
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
 
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
 
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
 
6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
 
November 14, 2002
 
/s/    DAVID P. ANASTASI        
Chief Executive Officer
 

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Certification
 
I, Jeffrey B. deCillia, certify that:
 
1. I have reviewed this quarterly report on Form 10-Q of Captaris, Inc.;
 
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
 
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
 
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):
 
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
 
6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
 
November 14, 2002
 
/s/    JEFFREY B. DECILLIA        
Chief Financial Officer