FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Quarterly Report Under Section 13 or 15 (d)
of the Securities Exchange Act of 1934

Commission File Number 0-13898

     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 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 requirement for the past 90 days.

YES x   NO o

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

YES o  NO x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of July 31, 2004

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INDEX

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PART I - FINANCIAL INFORMATION

VERAMARK TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

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

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VERAMARK TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

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

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VERAMARK TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

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

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VERAMARK TECHNOLOGIES, INC.

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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) GENERAL

     The accompanying unaudited consolidated financial statements include all adjustments of a normal and recurring nature which, in the opinion of Company’s management, are necessary to present fairly the Company’s financial position as of June 30, 2004 and the results of its operations and cash flows for the three and six months ended June 30, 2004 and 2003.

     Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s annual report on Form 10-K to the Securities and Exchange Commission for the year ended December 31, 2003.

     The results of operations and cash flows for the three and six months ended June 30, 2004 are not necessarily indicative of the results to be expected for the full year’s operation.

(2) PROPERTY AND EQUIPMENT

     The major classifications of property and equipment at June 30, 2004, and December 31, 2003 were:

For the three and six months ended June 30, 2004, the Company recorded depreciation expense of $72,615 and $141,312, respectively.

(3) STOCK-BASED COMPENSATION

In 2002, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” This standard provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. Additionally, the standard also requires prominent disclosures in

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			the Company’s financial statements about the method of accounting used for stock-based employee compensation, and the effect of the method used when reporting financial results.
			The Company accounts for stock-based compensation in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation.” As permitted by SFAS No. 123, the Company continues to measure compensation for such plans using the intrinsic value based method of accounting, prescribed by Accounting Principles Board (APB), Opinion No. 25, “Accounting for Stock Issued to Employees.” Had compensation cost for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates for awards consistent with the method of SFAS No. 123, the Company’s net loss and net loss per common share would have been adjusted to the pro forma amounts indicated below:

For purposes of the disclosure above, the fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2004 and 2003. There were no stock options issued in the second quarter of 2004.

(4) TOTAL COMPREHENSIVE INCOME (LOSS)

Total comprehensive income (loss) for the three and six months ended June 30, 2004 and 2003 was as follows:

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(5) NET INCOME (LOSS) PER SHARE (EPS)

SFAS 128 “Earnings Per Share” requires the Company to calculate net income (loss) per share based on basic and diluted net income (loss) per share, as defined. Basic EPS excludes dilution and is computed by dividing net income (loss) by the weighted average number of shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The dilutive effect of outstanding options issued by the Company are reflected in diluted EPS using the treasury stock method. Under the treasury stock method, options will only have a dilutive effect when the average market price of common stock during the period exceeds the exercise price of the options.

Calculations of Earnings (Loss) Per Share

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(6) INDEMNIFICATION OF CUSTOMERS

Our agreements with customers generally require us to indemnify the customer against claims that our software infringes third party patent, copyright, trademark or other proprietary rights. Such indemnification obligations are generally limited in a variety of industry-standard respects, including our right to replace an infringing product. As of June 30, 2004 we had not experienced any material losses related to these indemnification obligations and no material claims with respect thereto were outstanding. We do not expect significant claims related to these indemnification obligations, and consequently, we have not established any related reserves.

(7) BENEFIT PLANS

			The Company sponsors an employee incentive savings plan under Section 401(k) for all eligible employees. The Company’s contributions to the plan are discretionary. There were no contributions to the plan for the three and six months ended June 30, 2004 and 2003.
			The Company also sponsors an unfunded Supplemental Executive Retirement Program (“SERP”), which is a non-qualified plan that provides certain key employees defined pension benefits. Periodic pension expense for the three and six months ended June 30, 2004 and 2003 consists of the following:

			The Company paid pension obligations of $83,067 and $79,567 for the six months ended June 30, 2004 and 2003, respectively.
			The discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 6% and 3% respectively, for the three and six months ended June 30, 2004 and 7% and 3%, respectively, for the three and six months ended June 30, 2003.
			The Company maintains life insurance covering certain key employees under its Supplemental Executive Retirement Program with the Company named as beneficiary. The Company intends to use the death benefits of these policies, as well as loans against the accumulating cash surrender value of the policies, to fund the pension obligation. The total death benefit associated with these policies is $10.2 million, with an associated accumulated cash surrender value of approximately $1,930,000 at June 30, 2004. The accumulated cash surrender values of these policies at December 31, 2003 was approximately $1,858,000.

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

Results of Operations

     Management’s Discussion and Analysis contains statements that are forward-looking. Such statements are identified by the use of words like “plans,” “expects,” “intends,” “believes,” “will,” “anticipates,” “estimates” and other words of similar meaning in conjunction with, among other things, discussions of future operations, financial performance, the Company’s strategy for growth, product development, regulatory approvals, market position and expenditures. Forward-looking statements are based on management’s expectations as of the date of this report. The Company cannot guarantee that any forward-looking statement will be accurate, although the Company believes that it has been reasonable in its expectations and assumptions. Forward-looking statements are subject to the risks identified in “Issues and Risks” and elsewhere in this report. Readers are cautioned not to place undue reliance on forward-looking statements and are advised to review the risks identified in “Issues and Risks” and elsewhere in this report. The Company has no obligation to update forward-looking statements.

     Sales for the quarter ended June 30, 2004 of $2,567,599, were 13% lower than sales of $2,952,514 for the quarter ended June 30, 2003. For the six months ended June 30, 2004, sales of $5,241,297 were 8% lower than the sales of $5,702,535 recognized for the first six months of 2003.

     Veramark incurred a net loss of $521,386, or $0.06 per share for the quarter ended June 30, 2004, which compared with a net loss of $75,451, or $0.01 per share for the quarter ended June 30, 2003. For the six months ended June 30, 2004, the company has incurred a net loss of $495,848, or $0.06 per share. For the same six month period of 2003, Veramark reported a net loss of $280,529, or $0.03 per share.

     We continue to see customer order rates fluctuate significantly on a week-to-week basis, with no sustainable trend emerging. Though orders received for the second quarter of 2004 increased 15% over the first quarter of 2004, overall, orders remain below expectations. The increase in second quarter orders, does however, allow us to begin the third quarter of 2004 with a higher sales backlog than we had entering the second quarter.

     During the first and second quarters of 2004, Veramark has realized a net cash outflow of approximately $600,000. This outflow is the result of the lower sales volumes, coupled with higher gross operating expenses for the first six months of 2004 as compared with the first six months of 2003. The Company had anticipated a reduction in its total cash position through the first six months of 2004 as a result of the increased operating expenses associated with the launch of the VeraSMART 2.0 product, but the decline has been greater than expected as a result of the lower sales. Management believes that with the increased sales expected from VeraSMART 2.0 in the third and fourth quarters of 2004, as well as with careful monitoring of operating expenses, the Company will be cash flow positive for the second half of the year.

     The lower sales for both the three and six months ended June 30, 2004 are attributable to two major factors. The first was the 2003 acquisition of one of our largest distributors, Expanets, by Avaya Inc. Prior to the acquisition, both Expanets and Avaya served as separate channels of distribution for the Company’s core call accounting products. The integration of these formerly separate channels has progressed slowly, resulting in a 40% decrease in sales to the combined channel for the first six months of 2004, as compared to the first six months of 2003, when Avaya and Expanets were separate channels.

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     Though we have experienced increased sales through other channels of distribution for call accounting and telemanagement products and services, overall Veramark realized a decrease of 4% in sales of call accounting and telemanagement products and services for both the three and six months ended June 30, 2004 as compared with the same three and six months ended June 30, 2003.

     The second factor affecting sales for the three and six months ended June 30, 2004 was the phase-out of sales of the Quantum Series® of enterprise-level products, in anticipation of the planned second quarter release of VeraSMART 2.0®. Development of VeraSMART 2.0, a critical component of the next generation replacement of the Quantum Series, in terms of significant new technology and functionality, was completed ahead of schedule, late in the second quarter and is now available for sale. Initial interest from customers has been very encouraging, and within the first month of availability, the Company has received several significant orders for VeraSMART 2.0 including one from Avaya for the Commonwealth of Massachusetts, and a direct sale to Cal State University. Revenue from these orders will be recognized during the third and fourth quarters of 2004.

     Primarily, as a result of the phase-out of Quantum Series products, sales of enterprise-level products decreased 30% and 15%, respectively, for the three and six months ended June 30, 2004, as compared with the same three and six months periods of 2003. The Company expects to realize an increase in sales of enterprise-level products over the second half of 2004 with the release of VeraSMART 2.0.

     Revenues generated from the Veramark’s Service Bureau operation, a provider of outsourced solutions, increased 26% and 16%, respectively for the three and six months ended June 30, 2004, as compared to prior year results. The increase in Service Bureau revenues includes initial revenues from a division of Lockheed Martin, a new customer added during the first quarter of 2004, plus a significant order from Travelers Insurance, expanding their Service Bureau offering to include an additional 57 sites. Additionally, at the same time, Travelers extended their service contract for an extra year.

     Gross profit margins, determined by subtracting cost of sales from total sales were 81% and 84% for the three and six months ended June 30, 2004. For the three and six months ended June 30, 2003, gross profit margins were 85% and 84%, respectively. The decrease in the gross profit margin for the three months ended June 30, 2004 versus the prior year is attributable to an increase in amortization expense charged to cost of sales as we initiate the amortization of the previously capitalized development costs of VeraSMART 2.0.

     Net expenses for engineering and software development expenses, after the effects of software capitalization were $573,653 for the three months ended June 30, 2004, and $811,701 for the six months ended June 30, 2004. This compares with net engineering and software development expenses of $630,659 and $1,250,657 for the same three and six month periods of 2003. However, gross spending for engineering and development efforts increased 12% for both the three and six months ended June 30, 2004 as compared to the prior year.

     The table below encapsulates the gross expense for engineering and software development, costs capitalized, net engineering and software development expenses, amounts amortized, and the overall impact on the Company’s Statements of Operations for the three and six months ended June 30, 2004 and 2003:

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     Engineering and development efforts for the first six months of 2004 were primarily focused on the successful completion of the VeraSMART 2.0 development. The expanded VeraSMAR