- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the Quarter Ended September 30, 2002
[_] 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 000-26287
Axeda Systems Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 23-2763854
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
257 Great Valley Parkway
Malvern, Pennsylvania 19355
---------------------------
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (800) 700-0362
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
---------------------------
On November 4, 2002, 27,218,417 shares of the Registrant's Common Stock, $.001
par value, were outstanding.
AXEDA SYSTEMS INC.
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2002
INDEX
Page
Part I Financial Information
Item 1 Financial Statements
Consolidated Balance Sheets at September 30, 2002 (unaudited) and December 31, 2001 2
Consolidated Statements of Operations for the three months ended September 30, 2002 and 3
2001 (unaudited).
Consolidated Statements of Operations for the nine months ended September 30, 2002 and 4
2001 (unaudited).
Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 5
2001 (unaudited).
Notes to Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 30
Item 3 Quantitative and Qualitative Disclosures About Market Risk 55
Item 4 Controls and Procedures XX
Part II Other Information
Item 1 Legal Proceedings 73
Item 2 Changes in Securities 74
Item 3 Defaults Upon Senior Securities 74
Item 4 Submission of Matters to a Vote of Security Holders 74
Item 5 Other Information 74
Item 6 Exhibits and Reports on Form 8-K 75
Certifications XX
1
AXEDA SYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
PART I
ITEM 1: FINANCIAL STATEMENTS
September 30, December 31,
2002 2001
---- ----
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents, including restricted cash of $650 in 2002 and
$2,549 in 2001 .......................................................... $ 23,138 $ 47,349
Accounts receivable, net of allowance for doubtful accounts of $158 in
2002 and $179 in 2001 ................................................... 3,326 4,623
Inventories, net ......................................................... -- 2,070
Prepaid expenses ......................................................... 558 934
Loans receivable - officers, net ......................................... -- 34
Other current assets ..................................................... 888 685
--- ---
Total current assets ................................................. 27,910 55,695
------ ------
Furniture and equipment, net ............................................. 3,486 2,567
Goodwill ................................................................. 20,618 20,819
Identified intangible assets, net of accumulated amortization of $1,969
in 2002 and $192 in 2001 ................................................ 7,776 9,553
Other assets ............................................................. 406 472
--- ---
Total assets ......................................................... $ 60,196 $ 89,106
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable ......................................... $ 293 $ 2,149
Accounts payable ......................................................... 4,035 5,047
Accrued expenses ......................................................... 7,857 8,928
Income taxes payable ..................................................... 407 1,075
Deferred revenue ......................................................... 1,691 926
----- ---
Total current liabilities ............................................ 14,283 18,125
------ ------
Non-current liabilities:
Notes payable, less current portion ...................................... 27 187
Other non-current liabilities ............................................ 945 1,428
Total liabilities ...................................................... 15,255 19,740
------ ------
Commitments and contingencies (note 13) ..................................... -- --
Stockholders' equity:
Preferred stock, $.001 par value; 5,000,000 shares authorized in 2002 and
2001, none issued or outstanding ........................................ -- --
Common stock, $.001 par value 50,000,000 authorized; 27,822,217 shares
issued in 2002 and 27,274,962 in 2001 ................................... 28 27
Additional paid-in capital ............................................... 143,856 143,454
Deferred stock compensation .............................................. (739) (1,842)
Accumulated deficit ...................................................... (96,849) (70,953)
Accumulated other comprehensive income ................................... 25 21
Treasury stock at cost, 603,800 shares in 2002 and 583,800 shares in 2001 (1,380) (1,341)
------ ------
Total stockholders' equity ........................................... 44,941 69,366
------ ------
Total liabilities and stockholders' equity ........................... $ 60,196 $ 89,106
========= =========
See accompanying notes to consolidated financial statements.
2
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
Three Months Ended September 30,
--------------------------------
2002 2001
(unaudited) (unaudited)
----------- -----------
Revenues:
License .................................................................... $ 3,421 $ 571
Services and maintenance ................................................... 795 --
Hardware ................................................................. 153 270
--- ---
Total revenues ................................................................. 4,369 841
----- ---
Cost of revenues:
License .................................................................... 579 207
Services and maintenance ................................................... 1,163 --
Hardware ................................................................... 29 303
Software amortization ...................................................... 525 --
----- -----
Total cost of revenues ......................................................... 2,296 510
----- -----
Gross profit ................................................................... 2,073 331
----- -----
Operating costs:
Research and development
Non-cash compensation ...................................................... 31 228
Other research and development expense ..................................... 1,655 1,084
Sales and marketing
Non-cash compensation ...................................................... 17 18
Other selling and marketing expense ........................................ 3,836 1,075
General and administrative
Non-cash compensation ...................................................... 103 275
Other general and administrative expense ................................... 2,401 2,620
Provision for doubtful accounts, net of recoveries of ($52) in 2002 ........ (27) --
Depreciation and amortization .................................................. 422 358
--- ---
Total operating costs .................................................. 8,438 5,658
----- -----
Operating loss ......................................................... (6,365) (5,327)
Loss on disposals of assets .................................................... 86 --
Interest (income) expense, net and other (income) expense, net ................. (140) (520)
---- ----
Loss before provision for income taxes (benefit) ............................... (6,311) (4,807)
Provision for income taxes (benefit) ...................................... -- (685)
----- -----
Net loss ....................................................................... $ (6,311) $ (4,122)
============= =============
Basic and diluted net loss per weighted average common share outstanding........ $ (0.23) $ (0.22)
============= =============
Weighted average number of common shares outstanding used in calculation
of basic and diluted net loss per common share ................................. 27,222,368 18,720,363
========== ==========
See accompanying notes to consolidated financial statements.
3
Nine Months Ended September 30,
2002 2001
------------ -------------
(unaudited) (unaudited)
Revenues:
License ................................................................... $ 9,039 $ 3,607
Services and maintenance .................................................. 2,012 407
Hardware .................................................................. 1,501 437
------------ ------------
Total revenues ................................................................ 12,552 4,451
------------ ------------
Cost of revenues:
License ................................................................... 2,396 1,162
Services and maintenance .................................................. 2,870 94
Hardware .................................................................. 1,281 444
Software amortization .................................................. 1,579 --
Inventory charges ........................................................ -- 13,420
------------ ------------
Total cost of revenues ........................................................ 8,126 15,120
------------ ------------
Gross profit .................................................................. 4,426 (10,669)
------------ ------------
Operating costs:
Research and development
Non-cash compensation ..................................................... 129 2,082
Other research and development expense .................................... 5,977 4,490
Sales and marketing
Non-cash compensation ..................................................... 55 87
Other selling and marketing expense ....................................... 13,628 5,409
General and administrative
Non-cash compensation ..................................................... 1,202 387
Other general and administrative expense .................................. 8,495 6,497
Provision for doubtful accounts, net of recoveries of ($142) in 2002
......................................................................... (49) 784
Depreciation and amortization ................................................. 1,062 2,413
Special charges ............................................................... 820 --
------------ ------------
Total operating costs ................................................. 31,319 22,149
------------ ------------
Operating loss ........................................................ (26,893) (32,818)
(Gain) loss on disposals and sales of assets .................................. 123 (52,037)
Interest (income) expense, net and other (income) expense, net ................ (450) (1,567)
------------ ------------
Income (loss) before provision for income taxes (benefit) ..................... (26,566) 20,786
Provision for income taxes (benefit) ..................................... (668) 1,123
------------ ------------
Net income (loss) ............................................................. $ (25,898) $ 19,663
============ ============
Basic net income (loss) per weighted average common share outstanding......... $ (0.96) $ 1.09
============ ============
Diluted net income (loss) per weighted average common share outstanding ....... $ (0.96) $ 1.01
============ ============
Weighted average number of common shares outstanding used in calculation of
basic net income (loss) per common share...................................... 27,000,897 17,982,817
============ ============
Weighted average number of common shares outstanding used in calculation
of diluted net income (loss) per common share................................ 27,000,897 19,450,774
============ ============
See accompanying notes to consolidated financial statements.
4
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended September 30,
2002 2001
-------- ----------
(unaudited) (unaudited)
Cash flows from operating activities:
Net income (loss) ............................................................ $(25,898) $ 19,663
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Depreciation and amortization .............................................. 2,641 2,413
(Gain) loss on disposals and sales of assets ............................... 457 (52,037)
Non-cash compensation and other expenses ................................... 1,371 2,129
Deferred income taxes ...................................................... -- 564
Provision for doubtful accounts ............................................ 92 (2,226)
Provision for inventory ................................................... -- 13,420
Changes in items affecting operations (excluding the effects of acquisitions
and divestitures):
Accounts receivable ........................................................ 1,205 7,221
Inventories ................................................................ 2,070 (615)
Loan receivable--officer ................................................... 34 (173)
Prepaid expenses and other current assets .................................. 173 (1,540)
Goodwill, other assets and intangible assets ............................... 107 (690)
Accounts payable ........................................................... (852) (8,579)
Accrued expenses and other non-current liabilities ......................... (1,508) 2,947
Income taxes payable ....................................................... (668) 1,075
Deferred acquisition costs ................................................. -- (2,233)
Deferred revenue ........................................................... 765 (1,104)
-------- --------
Net cash used in operating activities .......................................... (20,011) (19,765)
-------- --------
Cash flows from investing activities:
Capital expenditures ......................................................... (2,241) (392)
Net proceeds from sales of assets ............................................ -- 68,112
Note receivable .............................................................. -- (2,516)
-------- --------
Net cash provided by (used in) investing activities ............................ (2,241) 65,204
-------- --------
Cash flows from financing activities:
Repayments under capital lease obligations ................................... -- (30)
Net proceeds from exercise of stock options and warrants ..................... 53 1,523
Repurchase of common stock ................................................... -- (148)
Repayments of long-term debt ................................................. (2,016) --
-------- --------
Net cash provided by (used in) financing activities ............................ (1,963) 1,345
-------- --------
Effect of exchange rate changes on cash and cash equivalents ................... 4 6
-------- --------
Net increase (decrease) in cash and cash equivalents ........................... (24,211) 46,790
Cash and cash equivalents, including restricted cash of $650 in 2002 and $2,549
in 2001:
Beginning of period .......................................................... 47,349 9,615
-------- --------
End of period ................................................................ $ 23,138 $ 56,405
======== ========
Supplemental disclosure of non-cash investing and financing activities:
Settlement of pre-acquisition liability related to acquisition of eMation... $ 160 $-
======= ====
Fair value of 20,000 shares of Axeda common stock received in connection
with the settlement of a loan receivable.................................... 39 -
===== =====
Supplemental disclosure of cash flow information:
Interest paid.................................................................$107 $1
Income tax refund.............................................................(308 -
See accompanying notes to consolidated financial statements.
5
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Information with respect to September 30, 2002 and 2001 is unaudited)
1) Summary of Significant Accounting Policies
a) Description of Business (note 6, note 7 and note 8)
Axeda Systems Inc. ("we", "our", "us" or "Axeda"), which changed its
name from RAVISENT Technologies Inc. in January 2002, develops, markets
and sells software products and services used by multiple industries
and customers worldwide for Device Relationship Management ("DRM"), to
access and exploit hidden information within remote machines, devices
and facilities. We distribute our DRM products through direct sales to
original equipment manufacturers ("OEMs") and enterprise customers, as
well as through distributors and value-added resellers. We maintain
regional sales and support offices for DRM in the United States, Japan,
France, Israel and the Netherlands.
During the quarter ended September 30, 2002, our revenues were
substantially generated from selling DRM solutions, digital video
solutions to personal computer ("PC") OEMs and inventories. During 2001
our revenues were substantially generated from selling digital video
solutions and Internet appliance ("IA") devices to PC, consumer
electronics ("CE") and IA OEMs. In December 2001, we purchased all of
the outstanding capital stock of eMation, Ltd., a private company
organized under the laws of the State of Israel and headquartered near
Boston, Massachusetts, for the purpose of acquiring a company with
greater opportunity than our then existing product line. As a result of
the acquisition, we are now a provider of DRM solutions. See note
6-Acquisition for the description and accounting for the acquisition of
eMation.
Prior to June 2002, we also designed, developed, licensed and marketed
core-based modular software solutions that enabled digital video and
audio stream management in PC systems. Our PC solutions enabled
decoding (playback) and encoding (recording) of multimedia formats such
as digital versatile disk ("DVD"); direct broadcast satellite ("DBS")
and high-definition television ("HDTV") on existing personal computers.
Our digital video products customers consisted principally of PC and
computer graphics card OEMs. In May 2002 we entered into a Software
Distribution Agreement (the "Agreement") with Sonic IP, Inc. ("Sonic"),
a wholly-owned subsidiary of Sonic Solutions. As a result, we have
exited the digital media market (note 8).
In March 2001, we sold the assets of our CE and IA businesses (note 7).
We have sustained significant operating losses and negative cash flows
from operations since our inception. For the nine months ended
September 30, 2002 and 2001, our net losses excluding gains on sales of
assets, were $25.9 million and $32.4 million, respectively (note 7). We
plan to continue to invest in product development and sales and
marketing. There can be no assurances that we will be able to generate
sufficient revenues necessary to achieve or sustain profitability in
the short or long term. However, management believes that the current
cash and cash equivalent amount will be sufficient to sustain our
operations through at least 2003.
b) Basis of Presentation
Our interim consolidated financial statements for the three and nine
months ended September 30, 2002 and 2001, included herein, have been
prepared by us, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC"). Certain information and
footnote disclosures normally included in financial statements prepared
in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant to
such rules and regulations relating to interim financial statements. In
the opinion of management, the accompanying unaudited interim
consolidated financial statements reflect all adjustments consisting
only of normal recurring items necessary to present fairly our
financial position at September 30, 2002, the results of our operations
for the three and nine months ended September 30, 2002 and 2001 and our
cash flows for the nine months ended September 30, 2002 and 2001. The
unaudited consolidated financial statements included in this Form 10-Q
should be read in conjunction with the audited consolidated financial
statements and notes thereto included in our Form 10-K for the year
ended December 31, 2001. The interim results presented are not
necessarily indicative of results for any subsequent quarter or for the
year ending December 31, 2002.
6
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
c) Principles of Consolidation
The consolidated financial statements include the financial statements
of Axeda Systems Inc. and its wholly owned subsidiaries. All
significant intercompany balances and transactions have been eliminated
in consolidation.
d) Cash and Cash Equivalents
For purposes of the statement of cash flows, we consider all highly
liquid instruments purchased with an original maturity of three months
or less to be cash equivalents.
e) Revenue Recognition
In 2001, our primary revenue categories consisted of: software licenses
for PC and CE products, including DVD; IA products, including Internet
browser software and hardware reference designs; services for PC, CE
and IA products, including non-recurring engineering customization and
development services; and hardware for PC products, primarily DVD
boards and IA products, including Internet set-top boxes, and
integrated circuit boards (note 7 and note 8). Since December 2001, we
license our DRM system products to customers in the industrial,
building automation, technology, medical instrumentation and office and
semiconductor equipment industries (note 6).
We recognize software revenues in accordance with the American
Institute of Certified Public Accountants' ("AICPA") Statement of
Position 97-2, "Software Revenue Recognition" ("SOP 97-2"), as amended
by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition,
With Respect to Certain Transactions" ("SOP 98-9"). License revenues
are recognized in the period in which persuasive evidence of an
arrangement exists, the fee is fixed or determinable, delivery of the
technology has occurred requiring no significant production
modification or customization and collectibility is probable.
For software arrangements that include multiple elements, SOP 97-2
requires us to allocate the fee to the individual elements based on
vendor-specific objective evidence of fair value ("VSOE"), regardless
of the prices stated within the contract. VSOE is limited to the price
charged when the element is sold separately or, for an element that is
not yet sold separately, the price established by management having the
relevant authority. When there is VSOE for the undelivered elements in
multiple-element arrangements that are not accounted for using contract
accounting, we allocate revenue to the delivered elements of the
arrangement using the residual value method. Therefore, we defer
revenues from the arrangement fee equal to the fair value of the
undelivered elements and the difference between the total arrangement
fee and the amount deferred for the undelivered elements is recognized
as revenue related to the delivered elements. The fair value of
maintenance and postcontract customer support ("PCS") obligations are
based upon separate sales of renewals to other customers or upon
renewal rates quoted in the contracts. The fair value of services, such
as training or consulting, is based upon our separate sales of these
services to other customers.
When VSOE does not exist to allocate revenue to each of the various
elements of an arrangement and revenue cannot be allocated using the
residual value method, the entire fee from the arrangement is deferred
until the earlier of the establishment of VSOE or the delivery of all
the elements of the arrangement. In cases where a license grants a
customer unspecified upgrade rights, the license fee is deferred and
recognized ratably over the term of the arrangement. Billed amounts due
from the customers in excess of revenue recognized are recorded as
deferred revenue.
Our Axeda Supervisor, Axeda @aGlance/IT, Axeda Connector and Axeda
FactorySoft OPC products may be sold on a per-unit basis. In cases
where we sell such DRM products on a per-unit basis, revenues are
recognized when the product ships to an OEM, distributor or end user.
7
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Royalties representing software license fees paid on a per unit basis
are recognized when earned, which is generally based on receiving
notification from licensees stating the number of products sold which
incorporate the licensed technology from us and for which license fees,
based on a per unit basis, are due. The terms of the license agreements
generally require the licensees to notify us within 15 to 45 days of
the end of the quarter during which the sales of the licensees'
products take place. In a number of cases, we record the revenue in the
quarter following the sale of the licensee's products to our customers.
Hardware revenues are recognized upon shipment of products to
customers. For hardware transactions where no software is involved, we
apply the provisions of Staff Accounting Bulletin 101 "Revenue
Recognition" ("SAB 101") issued by the U.S. Securities and Exchange
Commission ("SEC").
We recognize revenue for maintenance services ratably over the contract
term. Our training and consulting services are billed based on hourly
or daily rates or fixed fees, and we generally recognize revenue as
these services are performed.
Revenues related to development contracts involving significant
modification or customization of hardware or software under development
arrangements are recognized in accordance with the provisions of AICPA
Statement of Position 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts" ("SOP 81-1"),
using the percentage-of-completion method, based on the
efforts-expended method or based on performance milestones specified in
the contract where such milestones fairly reflect progress toward
contract completion. For software license arrangements that include
services requiring significant modification or customization of the
licensed software, we apply the percentage-of-completion method of
contract accounting to the entire arrangement. For arrangements that
include services that, under SOP 97-2, qualify for separate accounting,
we follow the provisions of SOP 97-2 and allocate revenues to the
services element based on VSOE and recognize the revenues as the
services are performed. Revenues related to services are recognized
upon delivery of the service in the case of time and material
contracts. Losses on contracts are recognized for the entire
anticipated loss, if any, as soon as the loss becomes evident.
f) Use of Estimates
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.
On an ongoing basis, we evaluate our estimates, including those related
to revenue recognition, provision for doubtful accounts and returns,
fair value of acquired intangible assets and goodwill, useful lives of
intangible assets and property and equipment, income taxes, and
contingencies and litigation, among others. We base our estimates on
historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources.
Actual results could differ from the estimates made by management with
respect to these items and other items that require management's
estimates.
g) Foreign Currency Translation
Except for our subsidiary in Israel, we consider the functional
currency of our foreign subsidiaries to be the local currency, and
accordingly, the foreign currency is translated into U.S. dollars using
exchange rates in effect at period end for assets and liabilities and
average exchange rates during each reporting period for the results of
operations. The functional currency of our Israeli subsidiary is the
U.S. Dollar. Adjustments resulting from translation of foreign
subsidiary financial statements are reported in accumulated other
comprehensive income (loss). Gains or losses on foreign currency
transactions are recognized in current operations and have not been
significant to our operating results in any period presented.
h) Inventories
Inventories are valued at the lower of cost or market. Cost is
determined using the first-in, first-out method ("FIFO"). Inventories
are net of reserves of approximately $5.9 million and $21.3 million at
September 30, 2002 and December 31, 2001, respectively.
8
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
i) Computer Software Costs (Note 1m and Note 4)
Computer software costs consist of purchased software capitalized under
the provisions of Statement of Financial Accounting Standards No. 86,
"Computer Software to be Sold, Leased or Otherwise Marketed" ("SFAS
86"). Amortization of capitalized software costs is computed on a
straight-line basis over the estimated economic life of the product or
on a basis using the ratio of current revenue to the total of current
and anticipated future revenue, whichever is greater, and included in
cost of revenues in the accompanying statement of operations. To date,
no internally developed software costs have been capitalized. All other
research and development expenditures are charged to research and
development expense in the period incurred.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use,"
which provides guidance on accounting for such costs. SOP 98-1 requires
computer software costs that are incurred in the preliminary project
stage to be expensed as incurred. Once the capitalization criteria of
SOP 98-1 have been met, directly attributable development costs should
be capitalized. It also provides that upgrade and maintenance costs
should be expensed. The Company's treatment of such costs has
historically been consistent with SOP 98-1, with the costs capitalized
being amortized over the expected useful life of the software, ranging
from three to five years.
j) Computation of Net Income (Loss) Per Share
We compute earnings per share in accordance with SFAS No. 128,
"Computation of Earnings Per Share" ("SFAS 128"). In accordance with
SFAS 128, basic earnings per share is computed using the weighted
average number of common shares outstanding during the period. Diluted
earnings per share is computed using the weighted average number of
common and dilutive potential common shares outstanding during the
period. Potential common shares consist of the incremental common
shares issuable upon the exercise of stock options and warrants (using
the treasury stock method), and the incremental common shares issuable
upon the conversion of the convertible preferred stock (using the
if-converted method). Potential common shares are excluded from the
calculation if their effect is anti-dilutive.
The following is a reconciliation of the numerators and denominators of
the basic and diluted EPS computations for net income (in thousands,
except per share data):
i) Three Months Ended September 30, 2002
Options to purchase approximately 4.5 million shares of common
stock with a weighted-average exercise price of $2.19 were
outstanding during the three months ended September 30, 2002 but
were not included in the computation of diluted EPS because the
effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding options include 1.8
million options that are vested, with a weighted average exercise
price of $2.75, of which 0.7 million are vested and in the money,
with a weighted average exercise price of $0.01. The options have
various expiration dates during the next 10 years.
Warrants to purchase approximately 0.5 million shares of common
stock with a weighted-average exercise price of $3.28 were vested
and outstanding during the three months ended September 30, 2002,
but were not included in the calculation of diluted EPS because
the effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding warrants include 0.2
million warrants that are vested and in the money, with a weighted
average exercise price of $0.28. The warrants are fully vested and
have various expiration dates during the next 5 years.
9
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
ii) Nine months Ended September 30, 2002
Options to purchase approximately 4.5 million shares of common
stock with a weighted-average exercise price of $2.19 were
outstanding during the nine months ended September 30, 2002 but
were not included in the computation of diluted EPS because the
effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding options include 1.8
million options that are vested, with a weighted average exercise
price of $2.75, of which 0.8 million are vested and in the money,
with a weighted average exercise price of $0.19. The options have
various expiration dates during the next 10 years.
Warrants to purchase approximately 0.5 million shares of common
stock with a weighted-average exercise price of $3.28 were vested
and outstanding during the nine months ended September 30, 2002,
but were not included in the calculation of diluted EPS because
the effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding warrants include 0.2
million warrants that are vested and exercisable, with a weighted
average exercise price of $0.28. The warrants expire at various
dates during the next 5 years.
iii) Three Months Ended September 30, 2001
Options to purchase approximately 2.1 million shares of common
stock with a weighted-average exercise price of $3.24 were
outstanding during the three months ended September 30, 2001 but
were not included in the computation of diluted EPS because the
effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding options include 0.7
million options that were vested, with a weighted average exercise
price of $4.94, of which 0.1 million were vested and in the money,
with a weighted average exercise price of $0.01.
Warrants to purchase approximately 0.3 million shares of common
stock with a weighted-average exercise price of $1.38 were vested
and outstanding during the three months ended September 30, 2001,
but were not included in the calculation of diluted EPS because
the effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding warrants include 0.2
million warrants that are vested and in the money, with a weighted
average exercise price of $0.22. The warrants expire have at
various dates during the next 5 years.
iv) Nine months Ended September 30, 2001
For the Nine months Ended September 30, 2001
(in thousands, except per share data)
-------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
Net income available to common ........... $ 19,663
stockholders
Basic EPS
Net income available to common
stockholders ......................... 19,663 17,983 $ 1.09
========== ====== =======
Effect of Dilutive Securities
Warrants ................................. -- 218
Outstanding options ...................... -- 550
Contingently issuable shares ............. -- 700
--------- ------ ----------
Diluted EPS
Net income available to common
stockholders and assumed conversions . $ 19,663 19,451 $ 1.01
======== ====== ======
10
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Options to purchase approximately 1.1 million shares of common
stock at various exercise prices were outstanding during the nine
months ended September 30, 2001 but were not included in the
computation of diluted EPS because the corresponding exercise
prices of the options were greater than the average market price
of the common shares.
Warrants to purchase approximately 0.1 million shares of common
stock, issued at various exercise prices were outstanding during
the nine months ended September 30, 2001, but were not included in
the calculation of diluted EPS because the corresponding exercise
prices were greater than the average market price of the common
shares.
k) Stock Options
We account for our employee stock-based compensation plans using the
intrinsic value method. As such, deferred compensation is recorded on
the date of grant if the current market price of the underlying stock
exceeds the exercise price. We record and measure deferred compensation
for options granted to non-employees at their fair value. Deferred
compensation is expensed over the vesting period of the stock option.
l) Intangible Assets and Goodwill (Note 1m)
In July 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 141, "Business Combinations" ("SFAS 141)" and SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 requires
that the purchase method of accounting be used for all business
combinations. SFAS 141 also specifies criteria that intangible assets
acquired in a purchase method business combination must meet to be
recognized and reported apart from goodwill, noting that any purchase
price allocable to an assembled workforce must be recognized and
reported in goodwill. SFAS 142, which was effective January 1, 2002,
requires that intangible assets with indefinite useful lives should not
be amortized until their lives are determined to be finite and all
other intangible assets with finite lives must be amortized over their
useful lives to their estimated residual values. SFAS 142 also requires
that goodwill not be amortized, but instead be tested for impairment in
accordance with the provisions of SFAS 142 at least annually or between
annual tests upon the occurrence of certain events or upon certain
changes in circumstances. Intangible assets with finite useful lives
are reviewed for impairment in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). See "Impairment of Long-lived Assets," below.
We adopted SFAS 141 in 2001. Effective July 1, 2001, we adopted certain
provisions of SFAS 142, as required in the transition guidance
contained therein, and adopted the remaining provisions on January 1,
2002. There was not a cumulative transition adjustment upon adoption as
of July 1, 2001 or January 1, 2002. SFAS 141 and SFAS 142 required us
to perform the following as of January 1, 2002: (i) review goodwill and
intangible assets for possible reclassifications; (ii) reassess the
lives of intangible assets; and (iii) perform a transitional goodwill
impairment test. We reviewed the balances of goodwill and identifiable
intangibles and determined that we did not have any amounts that were
required to be reclassified from goodwill to identifiable intangible
assets, or vice versa. We also reviewed the useful lives of our
identifiable intangible assets and determined that the original
estimated useful lives remain appropriate. We completed the
transitional goodwill impairment test and determined that we did not
have a transitional impairment of goodwill.
As required by SFAS 142, we have not amortized goodwill associated with
acquisitions completed after June 30, 2001 for any period presented and
ceased amortization of goodwill associated with acquisitions completed
prior to July 1, 2001, effective January 1, 2002. Prior to January 1,
2002, we amortized goodwill associated with the pre-July 1, 2001
acquisitions over four years using the straight-line method.
Identifiable intangible assets (acquired technology, patent
applications and customer base) are currently amortized over two or
five years using the straight-line method.
11
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
We test goodwill for impairment in accordance with SFAS 142. SFAS 142
requires that goodwill be tested for impairment at the "reporting unit
level" ("Reporting Unit") at least annually and more frequently upon
the occurrence of certain events, as defined by SFAS 142. Goodwill is
tested for impairment annually, in the fourth quarter, in a two-step
process. First, we determine if the carrying amount of the Reporting
Unit exceeds the "fair value" of the Reporting Unit, which would
indicate that goodwill may be impaired. If we determine that goodwill
may be impaired, we compare the "implied fair value" of the goodwill,
as defined by SFAS 142, to its carrying amount to determine if there is
an impairment loss. If the carrying amount exceeds the implied fair
value, we will record an impairment charge for the excess, if any, but
not in an amount in excess of the carrying amount, in the period in
which the determination of impairment is made. Refer to notes 1m, 4 and
5 for further discussion of our intangible assets and goodwill.
m) Impairment of Long-Lived Assets
On January 1, 2002, we adopted SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which
supersedes certain provisions of APB Opinion No. 30 "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment
of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" ("APB 30"), and supersedes SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" ("SFAS 121"). There was no adjustment
required upon adoption of SFAS 144. In accordance with SFAS 144, we
evaluate long-lived assets, including intangible assets other than
goodwill, for impairment whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable
based on expected undiscounted cash flows attributable to that asset.
The amount of any impairment is measured as the difference between the
carrying value and the fair value of the impaired asset. SFAS 144
provides guidance on how a long-lived asset that is used as part of a
group should be evaluated for impairment, establishes criteria for when
a long-lived asset is held for sale, and prescribes the accounting for
a long-lived asset that will be disposed of other than by sale. SFAS
144 retains the basic provisions of APB 30 on how to present
discontinued operations in the income statement, but broadens that
presentation to include a component of an entity (rather than a segment
of a business).
We are in the process of completing the first step of the annual
goodwill impairment test under SFAS 142. With the assistance of an
independent, national valuation firm, we are performing a fair market
value analysis on our reporting unit in the fourth quarter of 2002 and
determined that the preliminary results of this first test indicate a
potential impairment of goodwill. In conjunction with the impairment
tests under SFAS 142, we are also in the process of testing our
identified intangible assets for impairment under SFAS 144. We are
required to perform a fair market value analysis of our identified
intangible assets under SFAS 144 and record an impairment charge and
writedown of such assets, if any, prior to recording an impairment
charge for goodwill. The SFAS 142 and SFAS 144 impairment tests are
currently in process, and we expect to record a non-cash charge in the
fourth quarter of 2002 to write-down a significant portion of our
goodwill and identified intangible assets.
n) Reclassifications
Certain prior year amounts have been reclassified to conform with the
current year presentation.
o) Recent Accounting Pronouncements
On October 1, 2002 the FASB issued SFAS No. 147, "Acquisitions of
Certain Financial Institutions" ("SFAS 147"). The standard amends SFAS
Nos. 72 and 144. We do not expect the adoption of SFAS 147 to have an
impact on our results of operations, financial position or cash flows.
At the October meeting of the Emerging Issues Task Force ("EITF") of
the Financial Accounting Standards Board (the "FASB"), the EITF reached
a consensus on Issue 1 of EITF Issue No. 02-17, "Recognition of
Customer Relationship Intangible Assets Acquired in a Business
Combination," ("EITF 02-17"). Issue 1 addresses when an entity
recognizes an intangible asset pursuant to paragraph 39 of SFAS 141,
whether the contractual-legal or separability criteria restrict the use
of certain assumptions, such as expectations of future contract
renewals and other benefits related to the intangible asset that would
be used in estimating the fair value of that intangible asset. The EITF
concluded that the contractual-legal and separability criteria do not
restrict the use of certain assumptions that would be used in
estimating the fair value of an intangible asset. Assumptions such as
expectations of future contract renewals and other benefits related to
the intangible asset must be considered in the estimates of fair value
regardless of whether they meet the contractual-legal or separability
criteria (note 1m).
12
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Also at the October meeting, the EITF reached a consensus on Issue 2 of
EITF Issue No. 02-17, "Recognition of Customer Relationship Intangible
Assets Acquired in a Business Combination," that the guidance in SFAS
141, paragraph A20, which states that a customer relationship meets the
contractual-legal criterion if an entity establishes relationships with
its customers through contracts, applies only if a contract is in
existence at the date of the acquisition. The EITF concluded that this
provision applies if an entity has a practice of establishing contracts
with its customers. Thus, an entity would recognize a customer
relationship at the date of the business combination even if there were
no contracts in existence at that date since the entity has a practice
of establishing contracts with its customers. The EITF also observed
that this consensus addresses only the recognition of customer
relationships and does not address the valuation of such customer
relationships. These consensuses should be applied on a prospective
basis for all business combinations consummated after October 25, 2002
and all Step 1 and Step 2 impairment tests performed after October 25,
2002 (note 1m).
In September 2002 the EITF reached a consensus in EITF Issue No. 02-13,
"Deferred Income Tax Considerations in Applying the Goodwill Impairment
Test in FASB Statement No. 142, Goodwill and Other Intangible Assets"
("EITF 02-13"). The EITF consensus requires that deferred income taxes,
if any, be included in the carrying amount of a reporting unit for the
purposes of the first step of the SFAS 142 goodwill impairment test. It
also provides guidance for determining whether to estimate the fair
value of a reporting unit by assuming that the unit could be bought or
sold in a non-taxable transaction versus a taxable transaction and the
income tax bases to use based on this determination. EITF 02-13 is
effective for goodwill impairment tests performed after September 12,
2002. We are currently analyzing the impact EITF 02-13 will have on our
consolidated financial statements (note 1m).
In July 2002 the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). The standard
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. Examples of costs covered by
the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. Previous
accounting guidance was provided by Emerging Issues Task Force Issue
No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring) ("EITF 94-3")." SFAS 146 replaces EITF
94-3. We do not expect the adoption of SFAS 146 to have a significant
impact on our results of operations, financial position or cash flows.
2) Comprehensive Income (Loss)
The components of comprehensive income (loss) are as follows (in
thousands):
Three Months Ended Nine months Ended
September 30, September 30,
2002 2001 2002 2001
------- ------- -------- --------
Net income (loss) ................................ $(6,311) $(4,122) $(25,898) $ 19,663
Foreign currency translation adjustment .......... (121) 26 4 6
Unrealized gain on available-for-sale
investment ...................................... -- -- -- (21)
------- ------- -------- --------
Comprehensive income (loss) ...................... $(6,432) $(4,096) $(25,894) $ 19,648
======= ======= ======== ========
3) Inventories
Inventories, net consist of the following (in thousands):
September 30, December 31,
2002 2001
-------------- -----------------
Raw materials.......... $ - $ 936
Products in progress... - -
Finished products...... - 1,134
---------- ----------------
Inventories, net $ - $ 2,070
========== ==============
13
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4) Intangible Assets (Note 1m)
Acquired intangible assets that are subject to amortization at September
30, 2002 and December 31, 2001, consist of the following (in thousands):
Gross Carrying Amount Accumulated Amortization
---------------- ----------------- ---------------- -----------------
September 30, December 31, September 30, December 31,
2002 2001 2002 2001
---------------- ----------------- ---------------- -----------------
Developed technology $ 1,378 $ 1,378 $574 $ 55
Core technology 7,055 7,055 1,176 116
Patent applications 990 990 165 16
Customer base 322 322 54 5
---------------- ----------------- ---------------- -----------------
Total $ 9,745 $ 9,745 $1,969 $ 192
================ ================= ================ =================
Aggregate amortization expense was approximately $591,000 and $1,776,000 for the
three and nine months ended September 30, 2002, respectively.
5) Goodwill (Note 1m)
The changes in the gross carrying amount of goodwill for the nine months
ended September 30, 2002 are as follows (in thousands):
DRM Solutions Balance as of December 31, 2001 $ 20,819
Goodwill adjustments during the period, net (201)
----
Balance as of September 30, 2002 $ 20,618
========
Goodwill adjustments primarily represent increases for additional
professional fees related to the purchase of eMation of approximately
$87,000 and adjustments to liabilities assumed on the date of acquisition
of approximately $288,000 that were settled at amounts less than the
present values estimated on the date of the acquisition.
Goodwill acquired in 2001 is not expected to be deductible for income tax
purposes.
Summarized below are the effects on net income (loss) and net income (loss)
per share data, if we had followed the amortization provisions of SFAS 142
for all periods presented (in thousands, except per share amounts):
For Three Months Ended September 30,
------------------------------------
2002 2001
---- ----
Reported net income (loss) $(6,311) $(4,122)
Add Back: Goodwill amortization - 248
------------- ----------------
Adjusted net income (loss) $(6,311) $(3,874)
============= ================
Basic earnings (loss) per share:
Reported net income (loss) $ (0.23) $ (0.22)
Goodwill amortization - 0.01
------------- ----------------
Adjusted net income (loss) $ (0.23) $ (0.21)
============= ================
Diluted earnings (loss) per share:
Reported net income (loss) $ (0.23) $ (0.22)
Goodwill amortization - 0.01
------------- ----------------
Adjusted net income (loss) $ (0.23) $ (0.21)
============= ================
14
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For Nine months Ended September 30,
-----------------------------------
2002 2001
---- ----
Reported net income (loss) $(25,898) $19,663
Add Back: Goodwill amortization - 1,978
------------ -------------
Adjusted net income (loss) $(25,898) $21,641
============ =============
Basic earnings (loss) per share:
Reported net income (loss) $ (0.96) $ 1.09
Goodwill amortization - 0.11
------------ -------------
Adjusted net income (loss) $ (0.96) $ 1.20
============ =============
Diluted earnings (loss) per share:
Reported net income (loss) $ (0.96) $ 1.01
Goodwill amortization - 0.10
------------ -------------
Adjusted net income (loss) $ (0.96) $ 1.11
============ =============
6) Acquisition
On December 7, 2001, we acquired all of the outstanding shares of eMation,
Ltd., a private company organized under the laws of the State of Israel and
headquartered near Boston, Massachusetts, a developer of Internet-based
solutions that extract and manage information from intelligent devices and
make that information available to people and business systems. We acquired
eMation to acquire a company with greater opportunity than our then
existing product line. As a result of the acquisition, we are a provider of
DRM solutions worldwide. The results of eMation's operations are included
in our consolidated financial statements since the date of acquisition.
We acquired eMation in consideration for: 8 million shares of Axeda common
stock, valued at approximately $17.4 million; the assumption of 1,428,710
shares of Axeda common stock reserved for issuance upon exercise of assumed
eMation stock options, 530,000 of which are exercisable for $0.01 per share
and the remaining 898,710 exercisable at $2.14 per share; options
exercisable for up to 113,600 shares of Axeda common stock issued at
closing pursuant to our 1999 Stock Incentive Plan exercisable at $2.14; and
warrants exercisable for up to 7,000 shares of Axeda common stock
exercisable at $2.14 issued to ex-employees of eMation in consideration for
cancellation of outstanding options to purchase shares of eMation. The
aggregate value of these issued and assumed options and warrants was
approximately $2.6 million. The total combined value of the securities
assumed and issued was approximately $20 million and we incurred
transaction costs of approximately $3.4 million related to the eMation
acquisition, for an aggregate purchase price of $23.4 million. We also
issued or assumed warrants at closing exercisable for up to 115,238 shares
of Axeda common stock with exercise prices ranging from $2.14 to $21.51 per
share to holders of warrants exercisable for shares of eMation. We also
assumed approximately $5 million of eMation net debt. The acquisition was
recorded under the purchase method of accounting.
Unaudited Pro Forma Financial Information
The following unaudited pro forma financial information presents the
results of our operations for the three and nine months ended September 30,
2001 as if the acquisition occurred on January 1, 2001. The unaudited pro
forma financial information for the three and nine months ended September
30, 2001 does not necessarily reflect the results of operations that would
have resulted had the acquisition occurred on January 1, 2001, nor is it
necessarily indicative of future results (in thousands except per share
data).
15
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Three Months Ended Nine months Ended
September 30, 2001 September 30, 2001
------------------- ------------------
Revenues ........................................... $ 3,943 $ 12,811
=================== =============
Net income (loss) .................................. $ (8,347) $ 7,153
=================== ==============
Basic net income (loss) per weighted average
common share outstanding .......................... $ (0.31) $ 0.28
=================== ==============
Diluted net income (loss) per weighted average
common share outstanding .......................... $ (0.31) $ 0.25
=================== ==============
7) Sales of Assets
a) Sale of Consumer Electronics Assets
On March 1, 2001, pursuant to an Asset Acquisition Agreement, we sold
certain assets related to our CE business to STMicroelectronics NV
("STMicroelectronics"), a Dutch corporation. The assets sold included
certain contracts, equipment, intangible assets, intellectual property,
prepaid expenses, accounts receivable and other assets primarily
related to the operations of the CE business. In connection with the
sale, we and STMicroelectronics entered into certain agreements
including an Assignment and Assumption of Lease with respect to our
former corporate headquarters office facility located in Malvern,
Pennsylvania. Certain employees of ours entered into employment
agreements with STMicroelectronics. Pursuant to the terms of the Asset
Acquisition Agreement, STMicroelectronics paid approximately $55.6
million. In connection with the asset sale, we and certain of our
subsidiaries granted to STMicroelectronics certain non-exclusive rights
to license and distribute certain of our technology used in our IA
products (note 7b) and PC products.
We recorded a gain on the sale of approximately $47.5 million during
the quarter ended March 31, 2001. The net gain was calculated as
follows (in thousands):
Sale price........................................... $ 55,602
Accounts receivable acquired........................ (261)
Accrued expenses assumed............................ 137
Net book value of deferred stock compensation........ (498)
Net book value of furniture and equipment sold...... (2,036)
Net book value of goodwill and intangible assets.... (968)
Other assets......................................... (18)
Employee transition and inducement costs............. (2,956)
Professional and legal fees.......................... (1,487)
----------
Gain on sale of CE assets........................ $ 47,515
==========
16
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
b) Sale of Internet Appliance Assets
On March 23, 2001, pursuant to an Asset Acquisition Agreement, we sold
certain assets related to our IA business to Phoenix Technologies Ltd.
("Phoenix"), a Delaware corporation. The assets sold included certain
contracts, equipment, intangible assets, intellectual property and
prepaid expenses primarily related to the operations of the IA
business, including those purchased from Teknema. Certain employees of
ours entered into employment agreements with Phoenix Technologies, Ltd.
Pursuant to the terms of the Asset Acquisition Agreement, Phoenix paid
$18 million, of which $1.8 million was being held by a third party in
escrow for indemnification purposes until March 2002. In March 2002, we
received $1.3 million, including interest of approximately $0.05
million, of the amount held in escrow. The remaining escrow balance of
approximately $0.55 million has been withheld pending the settlement of
a claim submitted by Phoenix and is included in restricted cash in the
consolidated balance sheet as of September 30, 2002. We are unable to
predict the resolution of this matter, or reasonably estimate any
amount of loss given the current status of this matter. Any escrow
amounts not returned to us will be recorded as a charge to the gain on
sale of assets in the period in which such determination is made. In
June 2002 we initiated an arbitration proceeding with the International
Chamber of Commerce (No. 12 203/JNK) seeking an order that the entire
$0.55 million be disbursed to Axeda. Phoenix filed an answer and
counterclaim in the arbitration, claiming entitlement to the entire
$550,000. We filed an answer to the counterclaim, denying the claim. A
hearing date has not yet been set.
We recorded a gain on the sale of approximately $4.5 million during the
quarter ended March 31, 2001. The net gain was calculated as follows
(in thousands):
Sale Price........................................ $18,000
Prepaid expenses.................................. (954)
Net book value of deferred stock compensation .... (121)
Net book value of furniture and equipment sold.... (466)
Net book value of goodwill and intangible assets.. (10,586)
License fee....................................... (250)
Employee transition and inducement costs.......... (763)
Professional and legal fees incurred.............. (338)
-----
Gain on sale of IA assets......................... $ 4,522
=======
c) Unaudited Pro Forma Financial Information
The following unaudited pro forma financial information presents our
results of operations for the nine months ended September 30, 2001, as
if the dispositions occurred on January 1, 2001, after giving effect to
certain adjustments, primarily revenues and personnel costs associated
with the disposed businesses, amortization of goodwill, the gains
recorded upon the dispositions and income taxes. The unaudited pro
forma financial information for the nine months ended September 30,
2001 does not necessarily reflect the results of operations that would
have occurred had the dispositions been completed on January 1, 2001
(in thousands except per share data).
Nine Months Ended
September 30, 2001
------------------
Revenues..................................... $ 4,004
=========
Net loss..................................... $ (26,038)
==========
Basic and diluted net loss per weighted
average common share outstanding.............. $ (1.45)
==========
17
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8) Transaction with Sonic Solutions
In May 2002 we entered into a Software Distribution Agreement (the
"Agreement") with Sonic IP, Inc. ("Sonic"), a wholly-owned subsidiary
of Sonic Solutions. As a result, we exited the digital media market
(see discussion of Services, below) and, as of June 30, 2002,
terminated or assigned to Sonic, substantially all of the customer
contracts of our PC business. Under the terms of the Agreement, Sonic
paid us $2 million for the exclusive and perpetual license to all of
the intellectual property ("IP") of our PC business, which was
delivered effective with the closing of the Agreement, and for certain
furniture and computer equipment (the "Equipment"). The Equipment,
which had a net book value totaling approximately $331,000, was used by
the employees of our PC business and was not essential to the
functionality of the licensed IP. Sonic also received certain
trademarks and World Wide Web domain names associated with the PC
business. In connection with the closing of the Agreement,
approximately 10 of our employees in the PC business accepted
employment offers from Sonic and we paid inducements to those employees
related to their acceptance totaling approximately $106,000. These
inducements were paid in June 2002 and are included in special charges
in the accompanying statements of operations for the nine months ended
September 30, 2002. In addition, the Axeda stock options held by
certain of these employees were modified to accelerate vesting upon
termination. In May 2002 we recorded a charge of approximately $24,000
related to the modifications, which is included in special charges in
the statements of operations for the nine months ending September 30,
2002. Under the terms of the Agreement we also agreed to designate our
remaining approximately 14 employees of the PC business to provide
unspecified services to Sonic to create improvements, R&D information,
and computer software (collectively, the "Services") through December
31, 2002. We provided the Services for May through August 2002 as part
of the base license agreement without additional charge to Sonic. If
Sonic wishes to maintain the Services agreement through December 31,
2002, then Sonic will pay Axeda $422,777, which approximates our cost,
for the Services provided from August to December 31, 2002, pro rated
to the date of termination of the Services. The Services fees are
recognized as services revenues as Sonic utilizes the Services, and are
payable semi-monthly in arrears on the 15th and 30th of each month
beginning August 2002. For the three and nine months ended September
30, 2002, we recognized approximately $115,000 of services revenues and
cost of revenues for the services provided in August and September
2002.
Because we did not have vendor-specific evidence of fair value for each
of the elements of this license arrangement, and because we are
providing the Services to Sonic after the initial delivery of the
licensed IP, we are recognizing the $2 million license fee on a
straight-line basis over seven months, which is the period that we have
agreed to provide the Services. For the three and nine months ended
September 30, 2002 we have recognized approximately $857,000 and
$1,143,000, respectively, of license revenues under this arrangement.
Approximately $166,000 of the net book value of the Equipment was
charged to expense and is included in special charges in the
accompanying statements of operations for the nine months ending
September 30, 2002. The remaining net book value of the Equipment of
$165,000, which is attributed to Equipment that will continue to be
utilized by our employees who have not been offered and who have not
accepted employment offers from Sonic prior to December 31 2002, is
being amortized over the seven-month term of the Services.
Also as part of our strategy to exit the PC business, we vacated our
offices in San Jose, California in May 2002, and in July 2002 we
terminated our lease for this facility. The original term of the lease
ended in March 2005. In July 2002, we paid approximately $135,000,
including $64,000 held by the lessor as security from the inception of
the lease, to the lessor as an inducement to cancel the lease. We also
paid $210,000 in July 2002 and, for nominal consideration, sold
furniture, computer equipment and leasehold improvements to the new
lessee as incentives to the new lessee to enter into a lease for the
premises with the lessor. The total cash payments of $345,000,
including the foregone security deposit, and the net book value of the
assets sold of $168,000 are included in special charges in the
accompanying statements of operations for the nine months ending
September 30, 2002.
18
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
A summary of special charges recorded for the nine months ending
September 30, 2002, all in connection with our exit from the PC
business, is as follows:
Amount
Description ($-`000's)
Net book value of equipment................ $ 166
Employee termination expenses.............. 130
Inducements to other employees............. 11
Lease termination costs.................... 513
---
Total special charges....................... $ 820
=====
9) Notes Payable
a) Note Payable - Bank Leumi
In connection with the closing of the share purchase agreement to acquire
eMation on December 7, 2001, we acquired the balance of $1,650,000 of
eMation's amount outstanding under a $1,700,000 line of credit with Bank
Leumi in Israel. The line of credit was paid in full in January 2002,
including interest of approximately $21,000.
b) Equipment Line of Credit
As of September 30, 2002, we had approximately $238,000 outstanding on an
equipment line of credit with EVP with interest rates ranging from 12% to
13% and payments due monthly over a 36 month period. As of September 30,
2002, there is a financing fee due to EVP for approximately $54,000, which
was accrued and charged to interest expense for the three and nine months
ending September 30, 2002. The line of credit was available to finance
purchases of capital equipment through September 30, 2001. In connection
with the agreement, EVP has a senior security interest in substantially all
of eMation's capital equipment. In addition, the line of credit agreement
requires us to provide EVP with copies of quarterly financial statements
within 45 days of the end of each quarter and audited annual financial
statements within 90 days of the end of each year as well as other
information and notifications regarding eMation's financial and operating
results.
As of September 30, 2002, we were in compliance with all of our covenants
to EVP.
10) Accrued Expenses
Accrued expenses consist of the following:
September 30, December 31,
------------- ------------
2002 2001
---- ----
Legal and professional fees ................... 1,089 $2,708
Payroll and related costs ..................... 2,946 2,951
Severance ..................................... 145 899
Unutilized leased facility .................... 427 107
Royalties to Israeli government agencies ...... 755 620
Legal settlements ............................. 277 277
Accrued Dolby royalties ....................... 2 122
Sales, excise and other taxes ................. 427 192
Other ......................................... 1,789 1,052
------ ------
Total .................................... $7,857 $8,928
====== ======
11) Equity Transactions
a) Treasury Stock
In May 2002 we reached an agreement with a former officer to re-pay a
portion of the remaining balance of an original loan for $160,000 that
was originally extended to the officer in February 2000. The officer
previously paid $15,000 of the loan, leaving a balance of $145,000,
which was fully reserved during the fourth quarter of 2001. Under the
agreement, in June 2002, the former officer paid us $50,000 and
surrendered 20,000 shares of Axeda common stock held by the former
officer. On the day that we received the shares, the fair market value
of our common stock was $1.97 per share. As a result, during the
quarter ended June 30, 2002, we recorded treasury stock of $39,400 and
a reduction of $90,000 to the provision for doubtful accounts.
b) Exchangeable Preferred Stock
In May 2002 a former principal stockholder of Cinax Designs, Inc., a
company that we purchased in August 2000, exchanged 271,839 shares of
exchangeable preferred stock ("preferred stock") of our subsidiary,
Ravisent British Columbia Inc. ("Ravisent BC") issued in connection
with the acquisition (Note 1j). Shares of our common stock issued for
this transaction total 756,807 and 484,968 as of September 30, 2002 and
December 31, 2001, respectively, and are recorded as issued and
outstanding for financial reporting and earnings per share purposes,
including 271,839 shares and 311,826 shares of preferred stock which
were exchanged in 2002 and 2001, respectively. As the remaining
unexchanged shares of preferred stock totaling 14,692 shares are
exchanged by the preferred stockholders, such shares will be recognized
as issued and outstanding. The shares of preferred stock are
exchangeable, at the option of the holder at any time, on a one-for-one
basis, into shares of our common stock, have an automatic redemption
into shares of our common stock date on August 1, 2005, and contain
certain dividend restrictions, as defined.
19
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
c) Employee Stock Options Granted
In October 2002 we granted 634,000 stock options to employees,
including 100,000 to our current Chief Executive Officer ("CEO") and
75,000 to our President, with an exercise price per share equal to the
fair market value of our common stock and ranging from $0.43 to $0.47.
In August 2002 we granted 505,500 stock options to employees with an
exercise price per share equal to the fair market value of our common
stock and ranging from $0.89 to $1.15.
In April 2002 we granted 260,000 stock options to employees, including
65,000 to two of our directors, with an exercise price per share equal
to the fair market value of our common stock and ranging from $2.63 to
$2.67.
In February 2002 we granted 1,012,200 stock options to employees,
including 100,000 to our CEO, with an exercise price per share equal to
not less than the fair market value of our common stock on the date of
grant and ranging from $2.53 to $3.03.
In February 2002 we granted 20,000 stock options to employees with an
exercise price of $0.01 per share, which was less than the fair market
value of our common stock on the date of grant. We have recorded
approximately $50,000 of deferred stock compensation, which is being
amortized over the vesting term of 2 years.
d) Accelerated Vesting
Under the terms of the employment agreement with our CEO, 100,000
options with an exercise price of $0.01 per share, which were granted
to the CEO in August 2001, that, under the terms of the award would
have vested from February 2002 to August 2003, were to vest in February
2002 upon the continued employment of the CEO as of and after that
date. Upon the continued employment of the CEO as of and after February
2002, the respective options vested and were exercisable. For the nine
months ended September 30, 2002, we recorded a charge of approximately
$164,000 on the date of the acceleration, which is included in non-cash
compensation general and administrative expense in the accompanying
statement of operations, for deferred stock compensation that was
initially recorded in August 2001.
e) Amendment to 1999 Stock Incentive Plan
In June 2002 our stockholders approved the proposal to increase the
number of shares available for issuance under our 1999 Stock Incentive
Plan from 3,225,000 shares to 3,725,000 shares, excluding the annual
automatic increase shares.
12) Related Party Transactions
In January 2002, under the terms of the separation agreement with our
former CEO as director, we modified the terms our stock options awarded
during the term of employment with us to immediately vest all remaining
outstanding stock options awarded and to permit the continued exercise of
the options subsequent to termination until the earlier of the expiration
date for the respective options or January 9, 2005. We recorded a charge of
approximately $206,000 related to the accelerated vesting, primarily for
the remaining balance of deferred stock compensation that was initially
recorded in June 1999 and July 2001, and $223,000 related to the
modification for continued exercisability of the options, resulting
primarily from the incremental intrinsic value on the date of the
modification of options granted in July 1997 and July 2001. The total
charge of approximately $429,000 is included in non-cash compensation
general and administrative expense in the accompanying statement of
operations for the nine months ended September 30, 2002. In addition, we
forgave loans totaling approximately $414,000, including interest of
approximately $16,000. The loan forgiveness and related employment taxes,
totaling approximately $600,000 were accrued and charged to general and
administrative expense in December 2001.
20
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13) Commitments and Contingencies
On November 27, 2001, a putative shareholder class action was filed against
us, certain of our officers and directors, and several investment banks
that were underwriters of our initial public offering. The action was filed
in the United States District Court for the Southern District of New York,
purportedly on behalf of investors who purchased our stock between July 15,
1999 and December 6, 2000. The lawsuit alleges violations of Sections 11,
12(a)(2) and 15 of the Securities Exchange Act of 1933 and Section 10(b) of
the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder
against one or both of the Company and the individual defendants. The
claims are based on allegations that the underwriter defendants agreed to
allocate stock in the Company's July 15, 1999 initial public offering to
certain investors in exchange for excessive and undisclosed commissions and
agreements by those investors to make additional purchases in the
aftermarket at pre-determined prices. Plaintiffs allege that the Prospectus
for our initial public offering was false and misleading in violation of
the securities laws because it did not disclose these arrangements. This
lawsuit is part of the massive "IPO allocation" litigation involving the
conduct of underwriters in allocating shares of successful initial public
offerings. We believe that more than one hundred and eighty other companies
have been named in more than eight hundred identical lawsuits that have
been filed by some of the same plaintiffs' law firms. Certain of our
employees are members of the putative classes alleged in these actions and
therefore may have interests adverse to us with respect to the alleged
claims in these actions. We believe that such lawsuit and claims are
without merit and that we have meritorious defenses to the actions. On July
15, 2002, we filed a motion to dismiss all claims against us and our
officers and directors. The Court has not ruled on this motion. We plan to
vigorously defend the litigation. However, failure to successfully defend
this action could substantially harm our results of operations, liquidity
and financial condition.
Between February and April 2000, eleven class action lawsuits were filed
against us and certain of our officers and directors in the United States
District Court for the Eastern District of Pennsylvania. On May 25, 2000,
the cases were consolidated under Civil Action No. 00-CV-1014, and entitled
"In re RAVISENT Technologies Inc. Securities Litigation". Pursuant to the
court's consolidation order, a consolidated and amended class action
complaint was filed on June 14, 2000 with an alleged class period of July
15, 1999 through April 27, 2000. This complaint alleges violations of the
federal securities laws, specifically Sections 11 and 15 of the Securities
Exchange Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934, and Rule 10b-5 promulgated thereunder and seeks unspecified
damages on behalf of a purported class of purchasers of our stock during
the period stated above. On July 3, 2000, we filed a motion to dismiss the
consolidated and amended class action complaint. The motion is presently
fully briefed and the parties are awaiting a hearing date to be set for the
motion. In connection with our initial public offering, we purchased
directors and officers insurance that provides us with protection from
claims made against our officers, directors or us arising from claims
including but not limited to any written demand for damages and any civil,
criminal, administrative, or regulatory proceedings and appeals. Certain of
our employees and certain holders of 5% or more of our common stock are
members of the putative classes alleged in these actions and therefore may
have interests adverse to us with respect to the alleged claims in these
actions. We believe that such lawsuits or claims are without merit and that
we have meritorious defenses to the actions. We plan to vigorously defend
the litigation. However, failure to successfully defend these actions could
substantially harm our results of operations, liquidity and financial
condition.
Various third parties have notified us, as well as some of our former
digital media products customers, that our DVD products infringe patents
held by such third parties. We have received notices of up to an aggregate
of five million dollars asserting rights under the indemnification
provisions and warranty provisions of our license agreements from several
customers relating to such claims of infringement. We have not determined
whether and to what extent the patents held by such third parties are valid
and whether and to what extent our products may infringe such patents. We
are unable to predict the outcome of these matters, however, we are able to
reasonably estimate an amount of possible loss given the current status of
certain of these matters, and, during the quarter ended June 30, 2002,
accrued $375,000, which is included in other general and administrative
expense in the accompanying statements of operations for the nine months
ended September 30,2002.
21
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In May 2002, we entered into a sub-lease for approximately 35,000 square
feet of space in an office building in the same business park as our former
offices located in Mansfield, Massachusetts. This facility is leased at an
annual rental of approximately $310,000, plus operating expenses, utilities
and taxes, and will be used for research and development, sales and support
and administrative activities. The lease commenced in June 2002, expires in
July 2007, and provides for free rent through September 2002. We are
recording the net lease expense on a straight-line basis over the term of
the lease. Axeda obtained an irrevocable, cash-secured, standby letter of
credit (the "letter of credit") from a bank as security and for the benefit
of the lessor for $0.15 million. The letter of credit expires in August
2003 and provides for automatic one-year renewals, but not beyond August
2007. The letter of credit is secured by a certificate of deposit for $0.15
million from the same bank, and also expires in August 2003. This amount is
restricted for withdrawal and is included in other assets (non-current) in
our consolidated balance sheets. We completed our occupation of the new
offices in July 2002, and, in September 2002, we entered into a sublease
agreement with a tenant (the "Subtenant") for the balance of the term of
the lease for our former offices. The lease for our former offices expires
in July 2004 and required us to pay minimum future rental payments totaling
approximately $503,000 as of July 31, 2002. Under the terms of the sublease
agreement, we will receive minimum future rental payments totaling
approximately $322,000 from the Subtenant. For the three months ending
September 30, 2002, we recorded a charge of approximately $180,000, which
is included in other general and administrative expense, for the amount
representing the excess of the future minimum rental payments to be made
over the future minimum sublease payments to be received.
In June 2002 we entered into a Software License Agreement ("the Agreement")
with a vendor to provide server and client software that, beginning in
August 2002, is incorporated into our DRM Enterprise Server products.
License fees are due and payable at the rate of 2.5% of each billable sale,
as defined. Under the Agreement, we agreed to pay a minimum, non-refundable
prepaid license fee of $400,000 (the "minimum license fee"), which is
payable in installments. We paid $100,000 in July 2002, and are required to
pay $100,000 on June 30, 2003 and the remaining $200,000 on December 15,
2003. In addition to the license fees for billable sales, we owe the vendor
approximately $37,000 for a development software license fee (the
"development fee") for certain of the vendor's report products to be used
solely for development and test purposes. The license fee for the
development software will be credited against the minimum license fee. We
are also obligated to purchase annual maintenance from the vendor at a rate
of 18% of the cumulative license fee for billable sales and 18% of the
development fee. The annual maintenance fees are payable in advance and may
not be credited against the minimum license fee.
22
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14) Segment Information
We operate in a single industry segment, which is the development and
licensing of our technology.
We sell and license our technology to customers primarily in North America,
Europe and Asia. A majority of our revenues are derived from our North
American operations, and our total revenues were derived from the following
geographic regions:
Three Months Ended September 30,
-------------------------------------------------------------------
Country/ Geographic Region 2002 2001
- --------------------------
-------------------------------- ------------------------------
$ - `000's % of total $ - `000's % of total
---------- ---------- ---------- ----------
North America:
United States $ 2,192 50% $ 247 29%
Canada 378 9 276 33
---------------- ------------- ---------------- ------------
Total - North America 2,570 59 523 62
---------------- ------------- ---------------- ------------
Europe:
Germany 65 2 220 26
France 275 6 - -
Netherlands 134 3 - -
Switzerland 391 9 - -
United Kingdom 100 2 - -
Other 220 5 58 7
---------------- ------------- ---------------- ------------
Total - Europe 1,185 27 278 33
---------------- ------------- ---------------- ------------
Asia-Pacific:
Israel 105 3 - -
Japan 432 10 10 1
Taiwan - - 30 4
Other 58 1 - -
---------------- ------------- ---------------- ------------
Total - Asia-Pacific 595 14 40 5
---------------- ------------- ---------------- ------------
South America - Other 19 - - -
---------------- ------------- ---------------- ------------
Total $ 4,369 100% $ 841 100%
================ ============= ================ ============
23
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Nine months Ended September 30,
-------------------------------------------------------------------
Country/ Geographic Region 2002 2001
- --------------------------
------------------------------ -------------------------------
$ - `000's % of total $ - `000's % of total
---------- ---------- ---------- ----------
North America:
United States $ 5,465 44% $ 2,314 52%
Canada 1,634 13 1,366 31
---------------- ------------- ---------------- ------------
Total - North America 7,099 57 3,680 83
---------------- ------------- ---------------- ------------
Europe:
Germany 630 5 368 8
France 1,307 10 21 -
Netherlands 573 5 - -
Switzerland 615 5 - -
United Kingdom 339 3 - -
Turkey - - 6 -
Other 651 5 80 2
---------------- ------------- ---------------- ------------
Total - Europe 4,115 33 475 10
---------------- ------------- ---------------- ------------
Asia-Pacific:
Israel 274 2 - -
Japan 804 6 263 6
Taiwan - - 30 1
Other 180 1 2 -
---------------- ------------- ---------------- ------------
Total - Asia-Pacific 1,258 9 295 7
---------------- ------------- ---------------- ------------
South America - Other 80 1 1 -
---------------- ------------- ---------------- ------------
Total $12,552 100% $ 4,451 100%
================ ============= ================ ============
15) Segment Reporting
Segment information is presented in accordance with Statement of Financial
Accounting Standards No. 131 ("SFAS 131"), "Disclosures About Segments Of
An Enterprise And Related Information." This standard requires segmentation
based upon our internal organization and disclosure of revenue and
operating income based upon internal accounting methods. For the nine
months ended September 30, 2002 we had three reportable segments: device
relationship management ("DRM") solutions, personal computer ("PC") and
Internet appliance ("IA") (note 6, note 7 and note 8). For the nine months
ended September 30, 2001, we also had a consumer electronics ("CE")
segment.
DRM Solutions: Entered as a result of the acquisition of eMation in
December 2001 (note 6), this segment provides a distributed software
solution designed to enable businesses to remotely monitor, manage and
service intelligent devices. The Axeda DRMTM System enables the live
exchange of information via the Internet, between remotely deployed
"intelligent devices" (instruments, equipment, machines, facilities,
appliances, vehicles, sensors or systems incorporating computer-based
control technology) and the people that build, service and use them. The
Axeda DRMTM System enables our customers to use the Internet to establish
and manage continuous connections with devices deployed at their customers'
facilities, allowing them to stay in touch with their products throughout
their lifecycle, tapping the value of remote device information with new,
automated e-service, operations monitoring, and e-commerce offerings.
eMation historically derived its main source of revenue from its industrial
automation products, which are now components of our DRM system. While we
continue to sell the components of the DRM system, such as the Axeda
Supervisor, Axeda @aGlance/IT and Axeda FactorySoft OPC, to support our
traditional industrial automation business, we expect that sales of these
products will decrease in the future as we devote most of our resources to
the development and support of the Axeda DRMTM System.
24
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
PC: This segment designed, developed, licensed and marketed core-based
modular software solutions that enable digital video and audio stream
management in PC systems. The segment also provided supporting hardware
designs as well as customization services and customer support. The
segment's solutions enable decoding (playback) and encoding (recording) of
multimedia formats such as digital versatile disk ("DVD"); direct broadcast
satellite ("DBS") and high-definition television ("HDTV") on personal
computers (note 8).
CE: This segment designed, developed, licensed and marketed core-based
modular software solutions that enable digital video and audio stream
management in CE devices. The segment also provided supporting hardware
designs to selected customers as well as customization services and
customer support. The segments solutions enable decoding (playback) and
encoding (recording) of multimedia formats such as digital versatile disk
("DVD"); direct broadcast satellite ("DBS") and high-definition television
("HDTV") on existing CE platforms (note 7a).
IA: Our Internet technology segment was involved in the development of
products for the emerging market in information appliances. The segment
sold IA hardware reference designs and software technology through
intellectual property licenses and agreements with Internet service
providers. This segment provided us with a number of Internet-related
products, including an efficient web browser, and several IA reference
designs including a Web Pad design, Internet ready TV and monitor designs
and an Internet-ready screenphone (note 7b). Revenues from this segment are
the result of the sales of remaining inventories purchased for this
business.
We evaluate operating segment performance based on revenue and gross
profit. We have not historically evaluated segment performance based on
operating income nor allocated assets to individual operating segments.
Three Months Ended September 30,
----------------------------------------
2002 2001*
---------------- ----------------------
% Total % Total
($-`000's) revenues $-`000's)revenues
---------- -------- -------- -------
Revenue:
DRM Solutions ...................... $2,799 64% $-- -%
PC ................................. 1,426 33 605 72
IA ................................. 144 3 236 28
CE ................................. -- -- -- --
------ --- ---- ---
Total .................... $4,369 100% $841 100%
====== === ==== ====
Gross profit :
DRM Solutions (excluding software
amortization of $525 in 2002): ..... $1,436 32% $-- -%
PC ................................. 1,047 24 322 38
IA ................................. 115 3 9 1
CE ................................. -- -- -- --
------ --- ---- ---
Total (excludes software amortization of $2,598 59% $331 39%
$525 in 2002)........................... ======= === ==== ====
* - Does not include eMation, which was acquired in December 2001 (note 6).
25
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Nine months Ended September 30,
----------------------------------------
2002 2001*
--------------------- ------------------
% Total % Total
($-`000's) revenues ($-`000's) revenues
---------- -------- --------- --------
Revenue:
DRM Solutions ...................... $ 7,496 60% $ -- -%
PC ................................. 3,603 29 3,693 83
IA ................................. 1,453 11 337 8
CE ................................. -- -- 421 9
------- --- ------ ---
Total .................... $12,552 100% $4,451 100%
======= === ====== ===
Gross profit :
DRM Solutions (excluding software
amortization of $1,579 in 2002) .... $ 3,924 31% $ -- 0%
PC ................................. 1,908 15 2,400 54
IA (excludes inventory charges of
$13,420 in 2001)................... 173 2 24 1
CE ................................. -- -- 327 7
------- --- ----- ---
Total (excludes software amortization of
$1,579 in 2002 inventory charges of
$13,420 in 2001)...................... $ 6,005 48% $2,751 62%
======= === ====== ===
* - Does not include eMation, which was acquired in December 2001 (note 6).
26
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 2:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion of our financial condition and our results of
operations should be read in conjunction with the unaudited condensed
consolidated financial statements and notes thereto included elsewhere in this
report. The information herein contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995 that involve a
number of risks and uncertainties. Such statements are based on current
expectations of future events that involve a number of risks and uncertainties
that may cause the actual events of future results to differ from those
discussed herein. Such factors include, but are not limited to: the transition
in businesses we are currently undergoing; fluctuating quarterly operating
results; uncertainties in the market for DRM solutions and the potential for
growth in the DRM market; declining sales of our legacy products; the current
economic slowdown and our dependence on the cyclical software industry; present
and future competition; our ability to manage technological change and respond
to evolving industry standards; our ability to manage growth and attract and
retain additional personnel; the long sales cycle for DRM solutions; our
customers' ability to implement or integrate our DRM solutions successfully and
in a timely fashion, receive expected functionality and performance, or achieve
benefits attributable to our DRM solutions; limited distribution channels;
dependence on strategic partners; the difficulty of protecting proprietary
rights; the potential for defects in products; claims for damages asserted
against us; our ability to raise capital; the potential for NASDAQ delisting if
the trading price of our stock remains below $1.00; risks from international
operations; and others discussed in this section and in Item 3 under "Factors
That May Affect Future Results". In addition, such forward-looking statements
are necessarily dependent upon assumptions, estimates and dates that may be
incorrect or imprecise and involve known and unknown risks and other factors.
Accordingly, any forward-looking statements included herein do not purport to be
predictions of future events or circumstances and may not be realized.
Forward-looking statements can be identified by, among other things, the use of
forward-looking terminology such as "believes," "expects," "may," "will,"
"should," "seeks," "pro forma," "anticipates," "plans," "estimates," or
"intends," or the negative of any thereof, or other variations thereon or
comparable terminology, or by discussions of strategy or intentions. Given these
uncertainties, prospective investors are cautioned not to place undue reliance
on such forward-looking statements. All forward-looking statements and reasons
why results may differ included in this report are made as of the date of this
report, and except as required by law, we disclaim any obligations to update any
such factors or to publicly announce the results of any revisions to any of the
forward-looking statements contained herein or reasons why results might differ
to reflect future events or developments. References herein to "Axeda", "we,"
"our," and "us" collectively refer to Axeda Systems Inc., a Delaware
corporation, and all of its direct and indirect U.S., Israeli, Japanese,
European and Canadian subsidiaries.
The following is a summary of the topics of Management's Discussion And Analysis
of Financial Condition and Results of Operations and where they can be found in
this section:
Description Page(s)
- --------------------------------------------------------------------------------------- --------------------
Overview and Recent Events 28 - 30
- --------------------------------------------------------------------------------------- --------------------
DRM 31
- --------------------------------------------------------------------------------------- --------------------
Results of Operations Data - Three and Nine Months Ended September 30, 2002 and 2001 36 - 40
- --------------------------------------------------------------------------------------- --------------------
Results of Operations - Nine Months Ended September 30, 2002 and 2001 41 - 46
- --------------------------------------------------------------------------------------- --------------------
Results of Operations - Nine Months Ended September 30, 2002 and 2001 41 - 46
- --------------------------------------------------------------------------------------- --------------------
Acquired In-process Research and Development 47
- --------------------------------------------------------------------------------------- --------------------
Liquidity and Capital Resources 48 - 50
- --------------------------------------------------------------------------------------- --------------------
Critical Accounting Policies 51 - 54
- --------------------------------------------------------------------------------------- --------------------
Recent Accounting Pronouncements 54
- --------------------------------------------------------------------------------------- --------------------
27
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Overview and Recent Events
The quarter ending September 30, 2002 marks the third period for which we are
reporting a full quarter of activity of Axeda Systems, Ltd. (formerly eMation,
Ltd. ("eMation"), a private company organized under the laws of the State of
Israel, which we acquired on December 7, 2001. The acquisition gave us an
immediate entry into the enterprise software and services market, and provided
us with a new category of software products called Device Relationship
Management ("DRM"), which enable companies to access and exploit hidden
information within remote machines, devices and facilities.
We believe that you should not rely on the results for any previous period as an
indication of our future performance because our business model has changed
significantly since the sales of our consumer electronics ("CE") and Internet
appliance ("IA") assets in the first quarter of 2001, the license of our
personal computer ("PC") technology to Sonic in May 2002, and the acquisition of
eMation in December 2001, which are each described below.
We expect our future license and services and maintenance revenues to be
increasingly driven by our DRM solutions. For the three months ended September
30, 2002 revenues from our DRM Solutions were approximately $2.8 million or 64%
of our total revenues for the quarter. Excluding non-cash software amortization,
gross profit for the DRM Solutions was approximately $1.4 million or 50% of our
total DRM revenues for the three months ended September 30, 2002.
eMation historically derived its main source of revenue from its industrial
automation products, which are now components of our DRM system. While we
continue to sell the components of the DRM system, such as the Axeda Supervisor,
Axeda @aGlance/IT and Axeda FactorySoft OPC, to support our traditional
industrial automation business, we expect that sales of these products will
decrease in the future as we devote most of our resources to the development and
support of our DRM system.
In May 2002 we entered into a Software Distribution Agreement (the "Agreement")
with Sonic IP, Inc. ("Sonic"), a wholly-owned subsidiary of Sonic Solutions. As
a result, we exited the digital media market (see discussion of Services, below)
and, as of June 30, 2002, terminated or assigned to Sonic, substantially all of
the customer contracts of our PC business. Under the terms of the Agreement, in
May 2002, Sonic paid us $2 million for the exclusive and perpetual license to
all of the intellectual property ("IP") of our PC business, which was delivered
effective with the closing of the Agreement, and for certain furniture and
computer equipment (the "Equipment"). The Equipment, which had a net book value
totaling approximately $331,000, was used by the employees of our PC business
and was not essential to the functionality of the licensed IP. Sonic also
received certain trademarks and World Wide Web domain names associated with the
PC business. In connection with the closing of the Agreement, approximately 10
of our employees in the PC business accepted employment offers from Sonic and we
paid inducements to those employees related to their acceptance totaling
approximately $106,000. These inducements were paid in June 2002 and are
included in special charges in the accompanying statements of operations for the
nine months ended September 30, 2002. In addition, the Axeda stock options held
by certain of these employees were modified to accelerate vesting upon
termination. In May 2002 we recorded a charge of approximately $24,000 related
to the modifications, which is included in special charges in the statements of
operations for the nine months ending September 30, 2002. Under the terms of the
Agreement we also agreed to designate our remaining approximately 14 employees
of the PC business to provide unspecified services to Sonic to create
improvements, R&D information, and computer software (collectively, the
"Services") through December 31, 2002. We provided the Services for May through
August 2002 as part of the base license agreement without additional charge to
Sonic. If Sonic wishes to maintain the Services agreement through December 31,
2002, then Sonic will pay Axeda $422,777, which approximates our cost, for the
Services provided from August to December 31, 2002, pro rated to the date of
termination of the Services. The Services fees are recognized as services
revenues as Sonic utilizes the Services, and are payable semi-monthly in arrears
on the 15th and 30th of each month beginning August 2002. For the three and nine
months ended September 30, 2002, we recognized approximately $115,000 of
services revenues and cost of revenues for the services provided in August and
September 2002.
28
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Because we did not have vendor-specific evidence of fair value for each of the
elements of this license arrangement, and because we are providing the Services
to Sonic after the initial delivery of the licensed IP, we are recognizing the
$2 million license fee on a straight-line basis over seven months, which is the
period that we have agreed to provide the Services. For the three and nine
months ended September 30, 2002 we have recognized approximately $857,000 and
$1,143,000, respectively, of license revenues under this arrangement.
Approximately $166,000 of the net book value of the Equipment was charged to
expense and is included in special charges in the accompanying statements of
operations for the nine months ending September 30, 2002. The remaining net book
value of the Equipment of $165,000, which is attributed to Equipment that will
continue to be utilized by our employees who have not been offered and who have
not accepted employment offers from Sonic prior to December 31 2002, is being
amortized over the seven-month term of the Services.
Also as part of our strategy to exit the PC business, we vacated our offices in
San Jose, California in May 2002, and in July 2002 we terminated our lease for
this facility. The original term of the lease ended in March 2005. In July 2002,
we paid approximately $135,000, including $64,000 held by the lessor as security
from the inception of the lease, to the lessor as an inducement to cancel the
lease. We also paid $210,000 in July 2002 and, for nominal consideration, sold
furniture, computer equipment and leasehold improvements to the new lessee as
incentives to the new lessee to enter into a lease for the premises with the
lessor. The total cash payments of $345,000, including the foregone security
deposit, and the net book value of the assets sold of $168,000 are included in
special charges in the accompanying statements of operations for the nine months
ending September 30, 2002.
During the course of 2001 we completed several transactions transforming our
product offerings and shifting the markets in which we compete. Prior to March
2001, we designed, developed, licensed and marketed innovative modular software
solutions that enabled digital video and audio stream management in PC systems,
CE devices and Internet appliances. We also licensed supporting hardware designs
to select customers, provided customization services and customer support. In
addition, we also sold Internet appliances and components to telecommunications
companies, Internet service providers and others.
On December 7, 2001, we acquired all of the outstanding shares of eMation, Ltd.
("eMation"), pursuant to a share purchase agreement amended and restated as of
October 5, 2001, in consideration for: 8 million shares of our common stock;
options exercisable for up to 1,428,710 shares of our common stock in connection
with assumed eMation stock options, 530,000 of which are exercisable for $0.01
per share and the remaining 898,710 exercisable at $2.14 per share; options
exercisable at $2.14 for up to 113,600 shares of our common stock issued at
closing pursuant to our 1999 Stock Incentive Plan; and warrants exercisable for
up to 7,000 shares of our common stock exercisable at $2.14 issued to
ex-employees of eMation in consideration for cancellation of outstanding options
to purchase shares of eMation. We also issued warrants at closing exercisable
for up to 108,238 shares of our common stock with exercise prices ranging from
$4.88 to $21.51 per share to holders of warrants exercisable for shares of
eMation. The total combined value of the securities assumed and issued was
approximately $20 million. Pursuant to the lock-up agreement executed by each
selling eMation shareholder, each shareholder agreed not to directly or
indirectly transfer any shares or rights relating to the shares of Axeda common
stock received pursuant to the share purchase agreement until the one year
anniversary of the closing, subject to certain exceptions. Axeda common stock
issued and to be issued to the selling eMation shareholders will not be
registered at the time of issuance.
The acquisition was recorded under the purchase method of accounting. We
incurred transaction costs of approximately $3.4 million related to the eMation
acquisition and assumed approximately $5 million of eMation net debt. Prior to
the acquisition, we loaned a total of $4.3 million to eMation for working
capital purposes. We also paid sign-on bonuses of $0.3 million to three of
eMation's executives. In connection with the acquisition, we expensed $3.1
million of the purchase price as acquired in-process research and development
("IPR&D") and recorded identifiable intangible assets and goodwill of
approximately $9.7 million and $20.8 million, respectively. In accordance with
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"), certain provisions of which were adopted
in 2001 and the remaining provisions on January 1, 2002, we no longer amortize
goodwill, but instead test it for impairment at least annually and at the same
time every year. See Impairment Analysis, below.
29
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
An aggregate of 1.6 million shares of our common stock issued in the eMation
acquisition has been deposited with a third party escrow agent to be held in
escrow to compensate us for certain losses and taxes that may arise as a result
of the eMation acquisition. The shareholders' agent appointed pursuant to the
share purchase agreement agreed to us submitting a claim on the escrow fund for
the return of 23,843 shares of our common stock in consideration for our
issuance of certain warrants at the closing. This escrow arrangement will expire
on December 7, 2002 and any shares remaining in escrow will be returned to
former eMation shareholders. Any shares returned to us will reduce the balance
of goodwill recorded in the acquisition.
During the first quarter of 2001 we sold substantially all of the assets of our
CE and IA businesses and in the process raised approximately $73.6 million,
enabling us to pursue other strategic alternatives. Effective as of March 1,
2001, pursuant to an asset acquisition agreement dated as of January 18, 2001,
along with our subsidiaries, Ravisent I.P., Inc., Ravisent Operating Company,
Inc. and VIONA Development Hard and Software Engineering GmbH & Co. KG, we sold
and licensed substantially all of our assets related to our CE business to
STMicroelectronics, NV, a Dutch corporation, STMicroelectronics, Inc., a
Delaware corporation, and STMicroelectronics GmbH (collectively,
STMicroelectronics). The assets sold and licensed included contracts, equipment,
intangible assets, intellectual property, prepaid expenses, accounts receivable
and other assets primarily related to the operation of the CE business. In
addition, approximately 76 of our employees, most of whom were associated with
our CE business, accepted employment with STMicroelectronics in connection with
the asset sale. Pursuant to the terms of the asset acquisition agreement,
STMicroelectronics paid approximately $55.6 million. In connection with the
asset sale, we granted to STMicroelectronics certain non-exclusive rights to
license and distribute certain of our technology used in our IA products and our
PC products. In addition, we agreed not to compete in significant aspects of the
CE market until March 1, 2006. Revenues and gross margin for the CE business
totaled approximately $0.4 million, or 9% of total revenues, and $0.3 million,
or 12% of total gross profit, respectively, for the nine months ended September
30, 2001. These amounts are not necessarily indicative of the results that would
have been obtained for any future period.
Effective as of March 23, 2001, pursuant to an asset acquisition agreement dated
as of March 21, 2001, along with certain of our subsidiaries, we sold
substantially all of the assets, excluding inventory, related to our IA business
to Phoenix Technologies Ltd., a Delaware corporation, for $18 million, of which
$1.8 million was being held in escrow by a third party for indemnification
purposes until March 2002. In March 2002 we received $1.3 million, including
interest of approximately $0.05 million. The remaining balance of approximately
$0.55 million has been withheld pending the settlement of a claim submitted by
Phoenix. In June 2002 we initiated an arbitration proceeding with the
International Chamber of Commerce (No. 12 203/JNK) seeking an order that the
entire $550,000 be disbursed to Axeda. Phoenix filed an answer and counterclaim
in the arbitration, claiming entitlement to the entire $550,000. We filed an
answer to the counterclaim, denying the claim. A hearing date has not yet been
set. We are unable to predict the resolution of this matter, or reasonably
estimate a range of possible loss given the current status of this matter. Any
escrow amounts not returned to us will be recorded as a charge to the gain on
sale of assets in the period in which such determination is made. The assets
sold included certain of the contracts, equipment, intangible assets,
intellectual property, prepaid expenses and other assets primarily related to
the operation of the IA business. Under the asset acquisition agreement, Phoenix
Technologies purchased our e-Surfer embedded software Internet browser and
related hardware designs for the IA market. In addition, in connection with this
asset sale, 13 of our employees associated with the IA business accepted
employment with Phoenix Technologies. Sales for the IA business totaled
approximately $0.2 million, or 28% of total revenues and were made at amounts
approximating our carrying value resulting in nominal gross margin for the
quarter ended September 30, 2001. These amounts are not necessarily indicative
of the results that would have been obtained for any future period if we had not
sold our IA business. Revenues and gross profit associated with our remaining IA
hardware assets totaled approximately $1.5 million, or 11% of total revenues,
and $0.2 million, or 3% of total gross profit excluding software amortization
for the nine months ended September 30, 2002. As of September 30, 2002 our
inventories, which relate primarily to our former IA business, are completely
reserved, thus, future sales of our inventories, if any, will result in
substantial gross margins because there would be no cost of revenues.
30
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
DRM Solutions
Since December 7, 2001, our main strategic focus has been on our DRM solutions .
We have not yet licensed certain DRM solutions individually and therefore do not
have vendor-specific objective evidence of fair value ("VSOE") for this element.
However, when offered with our DRM maintenance and/or services, we apply the
provisions of Statement of Position 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, With Respect to Certain Transactions." SOP 97-2 requires us
to allocate the fee to the individual elements based on VSOE, regardless of the
prices stated within the contract. VSOE is limited to the price charged when the
element is sold separately or, for an element that is not yet sold separately,
the price established by management having the relevant authority. When there is
VSOE for the undelivered elements in multiple-element arrangements that are not
accounted for using contract accounting, we allocate revenue to the delivered
elements of the arrangement using the residual value method. Therefore, we defer
revenues from the arrangement fee equal to the fair value of the undelivered
elements and the difference between the total arrangement fee and the amount
deferred for the undelivered elements is recognized as revenue related to the
delivered elements. The fair value of maintenance and postcontract customer
support ("PCS") obligations are based upon separate sales of renewals to other
customers or upon renewal rates quoted in the contracts. The fair value of
services, such as training, configuration and installation, is based upon our
separate sales of these services to other customers.
When VSOE does not exist to allocate revenue to each of the various elements of
an arrangement and revenue cannot be allocated using the residual value method,
the entire fee from the arrangement is deferred until the earlier of the
establishment of VSOE or the delivery of all the elements of the arrangement. In
cases where a license grants a customer unspecified upgrade rights, the license
fee is deferred and recognized ratably over the term of the arrangement. Billed
amounts due from the customers in excess of revenue recognized are recorded as
deferred revenue.
We recognize services revenues in accordance with the provisions of AICPA
Statement of Position 81-1, "Accounting for Performance of Construction-Type and
Certain Production-Type Contracts" ("SOP 81-1"). Revenues related to services
are recognized upon delivery of the service in the case of time and material
contracts. Revenues related to development contracts involving significant
modification or customization of hardware or software under development
arrangements are recognized using the percentage-of-completion method, based on
the efforts-expended method or based on performance milestones specified in the
contract where such milestones fairly reflect progress toward contract
completion. For software license arrangements that include services requiring
significant modification or customization of the licensed software, we apply the
percentage-of-completion method of contract accounting to the entire
arrangement. Losses on contracts are recognized for the entire anticipated loss,
if any, as soon as the loss becomes evident.
Our Axeda Supervisor, Axeda @aGlance/IT, Axeda Connector and Axeda FactorySoft
OPC products are sold on a per-unit basis. In cases where we sell such DRM
products on a per-unit basis, revenues are recognized when the product ships to
an OEM or distributor.
Prepaid maintenance and PCS fees are initially deferred and recognized on a
ratable basis over the one-year maintenance period. Services revenues are
recognized on a time and material basis.
31
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Results of Operations
Three and Nine Months Ended September 30, 2002 Compared to Three and Nine Months
Ended September 30, 2001.
The following table sets forth, for the periods indicated, the amount and
percentage of total revenues represented by certain items reflected in our
consolidated statements of operations:
Axeda Systems Inc.
Unaudited Consolidated Statements of Operations Data
(Amounts in thousands)
Three Months Ended September 30, Nine Months Ending September 30,
----------------------------------------- ---------------------------------------------------
2002 2001 2002 2001
-------------------- ------------------- --------------------- --------------------------
Percentage Percentage Percentage Percentage
Amount of Revenues Amount of Revenues Amount of Revenues Amount of Revenues
------ ----------- ------ ----------- ------ ----------- ------ -----------
Revenues:
License ......................... $ 3,421 78.3% $ 571 67.9% $ 9,039 72.0% $ 3,607 81.1%
Services and maintenance ........ 795 18.2 -- -- 2,012 16.0 407 9.1
Hardware ........................ 153 3.5 270 32.1 1,501 12.0 437 9.8
------- ----- -------------- -------- --------- -------- --------
Total revenues ................ 4,369 100.0 841 100.0 12,552 100.0 4,451 100.0
------- ----- -------------- -------- --------- -------- --------
Cost of revenues:
License ......................... 579 13.2 207 24.6 2,396 19.1 1,162 26.1
Services and maintenance ........ 1,163 26.6 -- -- 2,870 22.8 94 2.1
Hardware ........................ 29 0.7 303 36.0 1,281 10.2 444 10.0
Software amortization ........... 525 12.0 -- -- 1,579 12.6 -- --
Inventory charges ............... -- -- -- -- -- -- 13,420 301.5
------- ----- -------------- -------- --------- -------- --------
Total cost of revenues ........ 2,296 52.5 510 60.6 8,126 64.7 15,120 339.7
------- ----- -------------- -------- --------- -------- --------
Gross profit ....................... 2,073 47.5 331 39.4 4,426 35.3 (10,669) (239.7)
------- ----- -------------- -------- --------- -------- --------
Research and development
Non-cash compensation .......... 31 0.7 228 27.1 129 1.0 2,082 46.8
Other research and development
expense .......................... 1,655 37.9 1,084 128.9 5,977 47.6 4,490 100.9
Sales and marketing
Non-cash compensation .......... 17 0.4 18 2.1 55 0.4 87 1.9
Other selling and marketing expense. 3,836 87.8 1,075 127.8 13,628 108.6 5,409 121.5
General and administrative
Non-cash compensation .......... 103 2.3 275 32.7 1,202 9.6 387 8.7
Other general and
administrative expense ............. 2,401 55.0 2,620 311.5 8,495 67.7 6,497 146.0
Provision for doubtful accounts..... (27) (0.6) -- (49) (0.4) 784 17.6
Depreciation and amortization ...... 422 9.7 358 42.6 1,062 8.5 2,413 54.2
Special charges .................... -- -- -- -- 820 6.5 -- --
------- ----- ------- ------- -------- --------- -------- --------
Total Operating Costs .............. 8,438 193.0 5,658 673.0 31,319 250.0 22,149 498.0
----- ----- ----- ----- ------ -------- ------- -----
Operating loss ..................... (6,365) (145.7) (5,327) (633.3) (26,893) (214.2) (32,818) (737.3)
(Gain) loss on disposals of assets.. 86 2.0 -- -- 123 1.0 (52,037) (1,169.1)
Interest (income) expense, net and
other (income) expense, net ........ (140) (3.2) (520) (61.8) (450) (3.6) (1,567) (35.2)
------- ----- ------ -------- -------- --------- -------- --------
Loss before income tax benefit ..... (6,311) (144.5) (4,807) (571.5) ( 26,566) (211.6) 20,786 (467.0)
Provision for income taxes (benefit) -- -- (685) (81.4) (668) (5.3) 1,123 (25.2)
------- ----- ------- ------ -------- --------- -------- --------
Net income (loss) .................. $(6,311) (144.5)% $(4,122) (490.1)% (25,898) (206.3) 19,663 (441.8)%
======= ====== ======= ====== ======= ====== ====== ======
32
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Three Months Ended September 30, 2002 Compared to Three Months Ended
September 30, 2001.
Revenues. Total revenues increased by 420%, or $3.5 million, from $0.8 million
in the quarter ending September 30, 2001 to $4.4 million during the quarter
ending September 30, 2002. The overall increase in revenues was mainly due to
the addition of our DRM solutions, resulting from our acquisition of eMation in
December 2001, which added $2.8 million. Sales from our PC licenses added
approximately $0.8 million to our total revenues, while sales of IA products
decreased by $0.1 million in the quarter ended September 30, 2002. Revenues from
license, services and maintenance and hardware increased/(decreased)
approximately $2.8 million, $0.8 million, and $(0.1) million, respectively, from
the prior year.
License Revenues. License revenues increased by approximately $2.9 million,
from $0.6 million for the quarter ended September 30, 2001 to $3.4 million for
the quarter ended September 30, 2002. The increase was mainly attributable to
the addition of sales of DRM products of $2.2 million as well as increased PC
license revenues of $0.7 million. The increase in PC revenues resulted from
revenues associated with the Agreement with Sonic of $0.9 million offset by
decreases associated with customer contracts cancelled or assigned as part of
the Agreement with Sonic in May 2002. In the future we expect license revenues
to increase as software solutions related to our DRM system products contribute
to this revenue stream.Except for the amortization of the remaining $0.9 million
license and license fees associated with the remaining customer contract
described in "Results of Operations - License revenues" for the nine months
ended September 30, 2002, below, we do not expect to record material license
revenues related to our PC business subsequent to September 30, 2002.
Hardware Revenues. Hardware revenues decreased by approximately $0.1 million for
the quarter ended September 30, 2002 from $0.3 million for the quarter ended
September 30, 2001 due to decreased sales of our Internet set-top boxes. As of
September 30, 2002 our inventories, which relate primarily to our former IA
business, are completely reserved, thus, future sales of our inventories, if
any, will result in substantial gross margins, because there would be no cost of
revenues.
Services and maintenance revenues. Services and maintenance revenues increased
to $0.8 million for the quarter ended September 30, 2002 and was attributable to
contractual services and maintenance plans, consisting of post contract support,
sold with our DRM system products, and services associated with our contract
with Sonic Solutions, which contributed $0.6 million and $0.2 million,
respectively, during the quarter ended September 30, 2002.
Concentration. During 2001 the majority of our revenues were derived from a
small number of customers. In the quarter ending September 30, 2002, five
customers accounted for $2.3 million or 53% of our total revenues and 70% of our
total gross profit excluding software amortization. In the quarter ended
September 30, 2001, three customers accounted for 60% of our total revenues. In
the future, we expect our revenues to be less concentrated as sales of our
enterprise software and services span a wider customer base with our DRM System
solutions.
International. We sell our DRM system solutions to Global 2000 companies in the
industrial and building automation, high technology devices, medical
instrumentation, semiconductor equipment, and office automation industries. In
the three and nine months ended September 30, 2002 companies based in North
America accounted for 59% and 57%, respectively, of our total revenues. In the
future we expect the majority of our revenues to be derived from companies based
in North America.
Cost of Revenues. Cost of revenues increased $1.8 million, or 350%, from $0.5
million for the quarter ended September 30, 2001 to $2.3 million for the quarter
ended September 30, 2002. The increase was a result of an increase to our cost
of licenses fees of approximately $0.4 million and services and maintenance cost
of revenues of approximately $1.2 million. Partially offsetting these increases
were decreases in our cost of hardware of $0.3 million. In addition, we are
amortizing developed and core technologies, acquired in the eMation acquisition,
which added $0.5 million to our cost of revenues for the quarter ended September
30, 2002.
33
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
The $0.4 million increase in cost of license revenues over the prior year is due
to an additional $0.3 million in costs associated with our DRM solution and a
net $0.1 million increase in our PC cost of licenses. The decrease of $0.3
million in cost of hardware revenues corresponds directly to the decrease in our
hardware sales. The $1.2 million increase in cost of services and maintenance is
attributable to the $1.1 million increase from our DRM system services and
maintenance plans for the quarter ended September 30, 2002 and $0.1 million
relating to our PC business. We expect our cost of revenues related to licenses
as a percentage of license revenues to decrease in the future as our license
revenues shift more to our DRM products. The addition of non-cash amortization
of acquired technology will partially offset this future decrease in cost of
revenues as a percentage of total revenues, and will represent approximately
$2.1 million of our cost of revenues for the year ending December 31, 2002.
Gross Profit. Excluding the $0.5 million software amortization expense recorded
in the quarter ended September 30, 2002, gross profit increased by approximately
$2.3 million, or 685%, from $0.3 million for the quarter ended September 30,
2001 to $2.6 million for the quarter ended September 30, 2002. The increase is
attributable to increases in license revenues associated with our DRM Systems
sales and license revenues associated with our sale to Sonic Solutions, which
contributed approximately $1.4 million and $0.8 million, respectively, to the
gross margin increase.
For the quarter ended September 30, 2002, 78% of our total revenues were derived
from licenses, and 18% from services and maintenance, in comparison to 68% and
0%, respectively, in 2001. Historically the gross profit percentage from license
revenues and services revenues is higher than that from hardware sales. As a
percentage of total revenues, gross profit, excluding software amortization,
increased from 39% for the quarter ended September 30, 2001 to 59% for the
quarter ended September 30, 2002, due to a more favorable product mix. Gross
profit from our DRM products and services, excluding non-cash software
amortization, for the quarter ending September 30, 2002 was 50%. Our services
and maintenance gross profit is negative $0.4 million and is the direct result
of the delivery of a high volume of proof of concept projects ("POC's")
delivered as presales services during the quarter. In order to establish a
stronger market presence and earn a prospective customer's commitment, we
perform various marketing activities including delivering POC's to potential
customers. These POC's provide a business case to demonstrate that our product
can successfully operate in our customer's environment, perform according to
published specifications and deliver cost savings. As we continue to expand into
other markets and win additional customers, we expect to deliver additional
proofs of concepts resulting in continued negative service margins.
Research and Development Expense. Other research and development expenses
consist of staff, staff-related, professional and other development related
support costs associated with the development of new products, customization of
existing products for customers, quality assurance and testing. Research and
development expenses increased 53%, from $1.1 million for the quarter ended
September 30, 2001 to $1.7 million for the quarter ended September 30, 2002.
The increase in research and development expenses was due to the addition of
staff expenses related to the DRM development team of approximately $1.4
million, and includes $0.1 million of severance incurred during the quarter,
partially offset by $0.8 million in reductions in the PC development team and
related professional fees. As a percentage of total revenues, other research and
development expenses decreased from 129% to 38%. The decrease in research and
development expenses as a percentage of total revenues resulted from higher
revenues. We expect research and development expenses to increase in 2002,
compared to 2001, as we continue to invest in product development for our
enterprise software and services offerings.
Non-cash Compensation Research and Development Expense. Non-cash research and
development expense consists of compensation related to stock options. Non-cash
research and development expense decreased $0.2 million from the quarter ended
September 30, 2001 to the quarter ended September 30, 2002. The decrease from
the prior year is mainly due to the reductions in staffing in connection with
the closing of our Vancouver office in March 2001. No similar expense was
recorded in the third quarter of 2002.
34
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Sales and Marketing Expense. Other selling and marketing expenses consist of
salaries, travel expenses and costs associated with trade shows, advertising and
other marketing efforts, as well as technical support costs. Sales and marketing
expenses increased approximately $2.8 million or 257% from $1.1 million for the
quarter ended September 30, 2001 to $3.8 million for the quarter ended September
30, 2002.
The increase in sales and marketing expense is attributable to the inclusion of
the eMation sales and marketing team, which contributed $3.3 million. In
addition severance and other reorganization costs added $0.6 million to the
increase for the quarter ended September 30, 2002. Partially offsetting this
increase was a $1.1 million reduction in expense relating to the PC sales and
marketing teams. As a percentage of total revenues, sales and marketing expenses
decreased from 128% for 2001 to 88% for 2002. We expect sales and marketing
expenses to increase in 2002, compared to 2001, as we continue to invest in our
sales force for our enterprise software and services offerings.
Other General and Administrative Expense. Other general and administrative
expenses consist of staff, staff related, and support costs for our finance,
human resources, information systems and other management departments. Other
general and administrative expenses decreased $0.2 million or 8% from $2.6
million for the quarter ended September 30, 2001 to $2.4 million for the quarter
ended September 30, 2002. As a percentage of total revenues, other general and
administrative expenses decreased from 312% for 2001 to 55% for 2002 of total
revenues due to the proportionally larger increase in total revenues.
The decrease in other general and administrative expenses was due to a decrease
in executive recruiting, severance, and staff retention expense totaling $0.2
million, $0.6 million and $0.3 million, respectively, offset by an increase of
$0.9 million relating to the addition of the eMation general and administrative
functions. Included in the $0.9 million increase is a one time lease charge of
$0.2 million representing the excess of the future minimum rental payments to be
made over the future minimum sublease payments to be received in a property
vacated this quarter. We expect total annual general and administrative expenses
for 2002 to approximate the total annual 2001 amount, as we focus on our
infrastructure needs and reduce unnecessary overhead expenses.
Non-cash Compensation General and Administrative Expense. Non-cash general and
administrative expense consists of amortization of compensation related to stock
options. Non-cash general and administrative expense decreased from $0.3 million
for the quarter ended September 30, 2001 to $0.1 million for the quarter ended
September 30, 2002. The $0.2 million decrease is attributable to amortization of
deferred compensation recorded in connection with stock options granted to
employees in July 2001 at less than fair market value. No similar expense was
incurred in 2002.
Depreciation and Amortization. We recorded depreciation and amortization of $0.4
million for the quarter ended September 30, 2002 and for the quarter ended
September 30, 2001. Reduced amortization expense of $0.2 million resulting from
the impairment of our Cinax goodwill in December 2001 was partially offset by
additional depreciation expense of $0.2 million resulting from the eMation
acquisition. On a quarterly basis, we expect depreciation and amortization
expense to be approximately the same for the balance of the year ended December
31, 2002.
Impairment Analysis Under SFAS No. 142, goodwill acquired in a business
combination after June 30, 2001 is no longer amortized. The provisions of SFAS
No. 142 require that goodwill be tested for impairment on an annual basis at the
same time every year. Accordingly, we have not recorded amortization expense in
2002 for goodwill of approximately $20.8 million acquired in our purchase of
eMation in December 2001. Intangible assets acquired in a business combination
and recognized as an asset apart from goodwill must arise from contractual or
other legal rights or otherwise are separable. Under SFAS No. 142, recognized
intangible assets with finite useful lives are amortized over the period which
the assets are expected to contribute directly or indirectly to the our future
cash flows. We recorded identified intangible assets totaling approximately $9.7
million in connection with our purchase of eMation, comprised of developed and
core technologies of approximately $1.4 million and $7.0 million, respectively,
patent applications of approximately $1.0 million and customer base of
approximately $0.3 million. The developed and core technologies are being
amortized over their estimated useful lives of 2 and 5 years, respectively, and
are recorded as cost of revenues, which totaled $0.5 million for the quarter
ended September 30, 2002. The patent applications and customer base are being
amortized over their estimated useful lives of 5 years and are included with
operating expenses, which totaled approximately $0.1 million for the quarter
ended September 30, 2002.
35
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
We are in the process of completing the first step of the annual impairment test
under SFAS 142 concerning the accounting for goodwill. With the assistance of an
independent, national valuation firm, we are performing a fair market value
analysis on our reporting unit in the fourth quarter of 2002, and determined
that the preliminary results of this first test indicate a potential impairment
of goodwill. In conjunction with the impairment tests under SFAS 142, we are
also in the process of testing our identified intangible assets for impairment
under SFAS 144 concerning the accounting for long-lived assets. We are required
to perform a fair market value analysis of our identified intangible assets
under SFAS 144 and record an impairment charge and writedown of such assets, if
any, prior to recording an impairment charge for goodwill. The SFAS 142 and the
SFAS 144 impairment tests are currently in process, and we expect to record a
non-cash charge in the fourth quarter of 2002 to write-down a significant
portion of the value of our goodwill and identified intangible assets.
Loss on disposals of assets. During the quarter ended September 30, 2002 we
recorded a one time charge of $0.1 million for the disposal of certain assets
that were no longer utilized or needed for our continuing operations. There were
not equivalent charges recorded in the prior year.
Interest (Income) and Expense, net and Other (Income) and Expense, net. Net
interest income decreased by $0.4 million, or 73%, for the quarter ended
September 30, 2002 compared to the comparable period in 2001. The decrease is
the result of lower bank interest rates and lower average cash balances in 2002.
36
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Results of Operations
Nine months Ended September 30, 2002 Compared to Nine months Ended
September 30, 2001.
Revenues. Total revenues increased by 182%, or $8.1 million, from $4.5 million
in the nine months ended ending September 30, 2001 to $12.6 million during the
nine months ending September 30, 2002. Sales from our DRM systems contributed
$7.5 million to the increase in revenues while sales of our Internet appliance
inventories added $1.1 million to our total revenues in the nine months ended
September 30, 2002 and were partially offset by decreases of $0.4 million and
$0.1 million in our CE and PC businesses, respectively, over the prior year.
Revenues across our license, services and maintenance and hardware streams
increased $5.4 million, $1.6 million, and $1.1 million, respectively, from the
prior year.
License revenues. License revenues increased by approximately $5.4 million from
$3.6 million for the nine months ended September 30, 2001 to $9.0 million for
the nine months ended September 30, 2002. The increase was mainly attributable
to the addition of sales of DRM products of $5.7 million offset by a decrease in
PC revenues of $0.3 million. The $0.3 million net decrease in PC revenues was
mainly attributable to the loss of a significant licensing customer from the
prior year offset by increases in our former web-based sales of PC products.
Additionally, revenue decreases in several OEMs have been offset by an increase
in revenues to a PC graphics component manufacturer. We have licensed our
CineMaster DVD product ("CineMaster") to such PC graphics component manufacturer
on a per-unit basis since October 1, 2001 (see "Critical Accounting Policies").
The per-unit sales price of CineMaster to the customer now includes the cost of
Dolby technologies licensed by us from Dolby. The new agreement provided for a
royalty-free license for CineMaster, but not Dolby, for the quarter ended
December 31, 2001. Under the agreement with the customer, the amount due from
the customer for the Dolby royalties is equal to our cost. Since we are
obligated to collect and remit royalties to Dolby for sales of our products
incorporating Dolby technologies, our revenues attributable to this customer now
include the total sales price for the DVD product sold to the customer,
including the amount attributable to technologies licensed by us from Dolby. The
related cost of revenues includes the cost of the Dolby royalties. As a result,
there is no margin on the Dolby invoicing under this arrangement, which
terminates on December 31, 2002, for the nine months ended September 30, 2002.
Such amounts included in license revenues and cost of license revenues totaled
approximately $1.3 million for the nine months ended September 30, 2002.
Following the expiration of the agreement on December 31, 2002 and receipt of
the final royalty reports, we will no longer record any revenue or cost of
revenue associated with Dolby fees in our results. In the future we expect
license revenues to increase as software solutions related to our DRM system
products contribute to this revenue stream.
Except for the amortization of the remaining $0.9 million license and
license fees associated with the remaining customer contract described above, we
do not expect to record material license revenues related to our PC business
subsequent to September 30, 2002.
Hardware revenues. Hardware revenues increased by approximately $1.1 million for
the nine months ended September 30, 2002 from $0.4 million for the nine months
ended September 30, 2001 due to increased sales of components related to
Internet appliances, and, to a lesser extent, Internet set-top boxes. As of
September 30, 2002 our inventories, which relate primarily to our former IA
business, are completely reserved, thus, future sales of our inventories, if
any, will result in substantial gross margins, because there would be no cost of
revenues.
Services and maintenance revenues. Services and maintenance revenues
increased 394% from $0.4 million for the nine months ended September 30, 2001 to
$2.0 million for the nine months ended September 30, 2002. The increase was
attributable to services and maintenance plans sold with our DRM system products
as well as services provided to Sonic Solutions, which contributed $1.8 million
and $0.2 million, respectively, during the nine months ended September 30, 2002,
offset by a decrease in services of $0.4 million associated with our former CE
business, which was sold to STMicroelectronics in March 2001.
37
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Concentration. During 2001 the majority of our revenues were derived from a
small number of customers. For the nine months ended September 30, 2002, our top
five customers accounted for $4.5 million or 36% of our total revenues and 36%
of our total gross profit excluding software amortization. In the nine months
ended September 30, 2001, three customers accounted for 59% of our total
revenues. In the future, we expect our revenues to be less concentrated as sales
of our enterprise software and services span a wider customer base and we expect
customers of our DRM solutions to increase our revenues.
International. We sell our DRM system solutions to Global 2000 companies in the
industrial and building automation, high technology devices, medical
instrumentation, semiconductor equipment, and office automation industries. In
the nine months ended September 30, 2002 companies based in North America
accounted for 57% of our revenues. In the future we expect a greater portion of
our revenues to be derived outside of North America.
Cost of Revenues. Cost of revenues decreased $7.0 million or 46% from $15.1
million for the nine months ended September 30, 2001 to $8.1 million for the
nine months ended September 30, 2002. The decrease was a result of a $13.4
million inventory charge recorded during the quarter ended September 30, 2001,
partially offset by increases relating to our license, services and maintenance
and hardware of approximately $1.2 million, $2.8 million, and $0.8 million,
respectively, from the prior year. In addition, we are amortizing developed and
core technologies, acquired in the eMation acquisition, which added $1.6 million
to our cost of revenues for the nine months ended September 30, 2002.
The $1.2 million increase in cost of license revenues over the prior year is due
to an additional $0.9 million in costs associated with our DRM solution and a
net increase of $0.3 million for our PC products. The net increase in our PC
cost of license revenues was due to the new license arrangement we have with a
PC graphics component manufacturer, as previously described (see "Revenues,"
above), and increases in Dolby royalty rates due to reduced sales of products
incorporating Dolby, offset by decreases in Dolby fees in total, attributable to
lower sales of our PC products. The increase of $0.8 million in cost of hardware
revenues corresponds directly to the increase in our hardware sales. The $2.8
million increase in cost of services and maintenance is attributable to an
approximate $2.7 million increase from our DRM system services and maintenance
plans and a $0.2 increase in services related to our PC business offset by a
$0.1 million decrease in services related to our former CE business. We expect
our cost of revenues related to licenses as a percentage of license revenues to
decrease in the future as our license revenues shift more to our DRM products.
The addition of non-cash amortization of acquired technology will partially
offset this future decrease in cost of revenues as a percentage of total
revenues, and will represent approximately $2.1 million of our cost of revenues
for the year ending December 31, 2002.
Gross Profit. Excluding the $13.4 million charge for inventory recorded in the
nine months ending September 30, 2001 and the $1.6 million software amortization
expense recorded in the nine months ended September 30, 2002, gross profit
increased by $3.3 million, or 118%, from 2.8 million for the nine months ended
September 30, 2001 to $6.0 million for the nine months ended September 30, 2002.
The increase is attributable to increases in license revenues associated with
our DRM Systems sales.
For the nine months ended September 30, 2002, 72% of our total revenues were
derived from licenses, and 16% from services and maintenance, in comparison to
81% and 9%, respectively, in 2001. Historically the gross profit percentage from
license revenues and services revenues is higher than that from hardware sales.
As a percentage of total revenues, gross profit, excluding the charges recorded
for inventory and software amortization, decreased from 62% for the nine months
ended September 30, 2001 to 48% for the nine months ended September 30, 2002,
due to negative gross profit from our services and maintenance operations. The
negative gross profit from our services and maintenance operations is
attributable to the delivery of a large number of non-billable POC services
delivered to prospective customers during the year. In order to establish a
stronger market presence and earn a prospective customer's commitment, we
perform various marketing activities including delivering proofs of concepts
("POC's) to potential customers. These POC's provide a business case to
demonstrate that our product can successfully operate in our customer's
environment, perform according to published specifications and deliver cost
savings. As we continue to expand into other markets and win additional
customers we expect to deliver additional proofs of concepts resulting in
continued negative service margins. Additionally, the negative gross profit from
our services and maintenance was due to the sale of the assets of our CE
business in March 2001 and a less favorable mix of licensing products in our PC
business. Excluding the significant PC customer from the prior year and
inventory charges, gross profit for the nine months ended September 30, 2001
would have been 47%.
38
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Research and Development Expense. Other research and development expenses
consist of staff, staff-related, professional and other development related
support costs associated with the development of new products, customization of
existing products for customers, quality assurance and testing. Research and
development expenses increased 33%, from $4.5 million for the nine months ended
September 30, 2001 to $6.0 million for the nine months ended September 30, 2002.
The increase in research and development expenses was due to the addition of
staff expenses related to the DRM development team of approximately $4.5 million
partially offset by $1.5 million from the PC development team and related
professional fees. In addition decreases due to the elimination of the CE and IA
development teams in the first quarter of 2001, contributed approximately $0.7
million and $0.8 million to the decrease as well. As a percentage of total
revenues, other research and development expenses decreased from 101% to 48%.
The decrease in research and development expenses as a percentage of total
revenues resulted from higher revenues. We expect research and development
expenses to increase in 2002, compared to 2001, as we continue to invest in
product development for our enterprise software and services offerings.
Non-cash Compensation Research and Development Expense. Non-cash research and
development expense consists of compensation related to stock options. Non-cash
research and development expense decreased 94% from $2.1 million for the nine
months ended September 30, 2001 to $0.1 million for the nine months ended
September 30, 2002. $1.4 million of the decrease is due to the immediate
recognition in March 2001 of prepaid and deferred stock compensation, that would
have continued to vest through September 2003, related to reductions in staffing
in connection with the closing of our Vancouver office in March 2001. The
remaining $0.6 million is the result of amortization of deferred compensation
recorded in 2001 in connection with stock options granted to employees in
September 2000. No similar expenses were recorded for the nine months ended
September 30, 2002.
Sales and Marketing Expense. Other selling and marketing expenses consist of
salaries, travel expenses and costs associated with trade shows, advertising and
other marketing efforts, as well as technical support costs. Selling and
marketing expenses increased $8.2 million or 152% from $5.4 million for the nine
months ended September 30, 2001 to $13.6 million for the nine months ended
September 30, 2002.
The increase in sales and marketing expense is attributable to the inclusion of
the eMation sales and marketing team and the addition of our new professional
services group, which contributed $10.2 and $2.8 million, respectively, to the
increase for the nine months ended September 30, 2002. Partially offsetting this
increase was the elimination of the sales and marketing teams associated with
our CE and IA businesses, which resulted in decreases $0.4 million and $1.0
million, respectively, for the quarter ending September 30, 2002. Decreases of
approximately $1.8 million relating to the settlement of a South American
distribution rights agreement and $1.6 million from reduced staff in the PC
sales teams also partially offset the increase. As a percentage of total
revenues, sales and marketing expenses decreased from 121% to 109%. We expect
sales and marketing expenses to increase in 2002, compared to 2001, as we
continue to invest in our sales force for our enterprise software and services
offerings.
Other General and Administrative Expense. Other general and administrative
expenses consist of staff, staff related, and support costs for our finance,
human resources, information systems and other management departments. Other
general and administrative expenses increased $2.0 million or 31% from $6.5
million for the nine months ended September 30, 2001 to $8.5 million for the
nine months ended September 30, 2002. As a percentage of total revenues, other
general and administrative expenses decreased from 146% to 68% of total revenues
due to the proportionally larger increase in total revenues. The increase in
other general and administrative expenses was mainly due to the addition of the
eMation general and administrative function, which contributed $2.7 million to
the increase, partially offset by decreases executive recruiting and staff
retention expense of approximately $0.3 and $0.4 million respectively. Included
in the $2.7 million increase is a one time lease charge of $0.2 million
representing the excess of the future minimum rental payments to be made over
the future minimum sublease payments to be received in a property vacated this
quarter. We expect total general and administrative expenses for 2002 to
approximate the total 2001 amount, as we focus on our infrastructure needs and
reduce unnecessary overhead expenses.
39
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Non-cash Compensation General and Administrative Expense. Non-cash general and
administrative expense consists of amortization of compensation related to stock
options. Non-cash general and administrative expense increased from $0.4 million
for the nine months ended September 30, 2001 to $1.2 million for the nine months
ended September 30, 2002. The increase is attributable to a $0.4 million expense
incurred for the acceleration of option vesting in accordance with certain
employment agreements. In addition, $0.2 million of the increase is the result
of amortization of deferred compensation recorded in connection with stock
options granted to employees at less than fair market value granted between July
and December 2001. The remaining portion of the increase is attributable to a
one-time charge of $0.2 million for the modification of stock options held by a
former employee.
Provision for Doubtful Accounts. The provision for doubtful accounts represents
management's best estimate of the doubtful accounts for each period. During the
nine months ended September 30, 2002 we had net recoveries of less than $0.1
million from previously reserved accounts resulting in a reversal of this
expense. In the future we expect this expense to vary slightly as a result of
improved credit and collection efforts and increased revenues.
Depreciation and Amortization. We recorded depreciation and amortization of $1.1
million for the nine months ended September 30, 2002, compared to $2.4 million
for the nine months ended September 30, 2001. The sales of the assets of our CE
and IA businesses, both of which were sold in March 2001, contributed $1.2
million of the decrease, while the impairment of our Cinax goodwill in December
2001 accounted for $0.8 million of the decrease. Offsetting these decreases was
an increase of approximately $0.6 million attributable to depreciation of assets
and amortization of intangibles acquired in the purchase of eMation. We expect
depreciation and amortization expense to be approximately the same for the
balance of the year ending December 31, 2002.
Impairment Analysis. Under SFAS No. 142, goodwill acquired in a business
combination after June 30, 2001 is no longer amortized. The provisions of SFAS
No. 142 require that goodwill be tested for impairment on an annual basis at the
same time every year. Accordingly, we have not recorded amortization expense in
2002 for goodwill of approximately $20.8 million acquired in our purchase of
eMation in December 2001. Intangible assets acquired in a business combination
and recognized as an asset apart from goodwill must arise from contractual or
other legal rights or otherwise are separable. Under SFAS No. 142, recognized
intangible assets with finite useful lives are amortized over the period which
the assets are expected to contribute directly or indirectly to the our future
cash flows. We recorded identified intangible assets totaling approximately $9.7
million in connection with our purchase of eMation, comprised of developed and
core technologies of approximately $1.4 million and $7.0 million, respectively,
patent applications of approximately $1.0 million and customer base of
approximately $0.3 million. The developed and core technologies are being
amortized over their estimated useful lives of 2 and 5 years, respectively, and
are recorded as cost of revenues, which totaled $1.6 million for the nine months
ended September 30, 2002. The patent applications and customer base are being
amortized over their estimated useful lives of 5 years and are included with
operating expenses, which totaled approximately $0.2 million for the nine months
ended September 30, 2002.
We are in the process of completing the first step of the annual impairment test
under SFAS 142 concerning the accounting for goodwill. With the assistance of an
independent, national valuation firm, we are performing a fair market value
analysis on our reporting unit in the fourth quarter of 2002, and determined
that the preliminary results of this first test indicate a potential impairment
of goodwill. In conjunction with the impairment tests under SFAS 142, we are
also in the process of testing our identified intangible assets for impairment
under SFAS 144 concerning the accounting for long-lived assets. We are required
to perform a fair market value analysis of our identified intangible assets
under SFAS 144 and record an impairment charge and writedown of such assets, if
any, prior to recording an impairment charge for goodwill. The SFAS 142 and the
SFAS 144 impairment tests are currently in process, and we expect to record a
non-cash charge in the fourth quarter of 2002 to write-down a significant
portion of the value of our goodwill and identified intangible assets.
40
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Special Charges. Special charges for the nine months ended September 30, 2002
consist of items related to our exit from the PC business in May 2002. The
charges include $0.3 million for furniture and equipment and employee
inducements related to our license agreement with Sonic Solutions and lease
termination costs and inducements totaling approximately $0.5 million, including
$0.2 million for furniture and equipment, for our San Jose facility.
Loss on disposals of assets. During the nine months ended September 30, 2002 we
recorded charges of $0.1 million for the disposal of certain assets that were no
longer utilized or needed for our continuing operations. There were not
equivalent charges recorded in the prior year.
Interest (Income) and Expense, net and Other, net. Net interest income decreased
by $1.1 million, or 71%, for the nine months ended September 30, 2002 compared
to the comparable period in 2001. The decrease is the result of lower average
cash balances and lower bank interest rates in 2002.
Provision for Income Taxes (Benefit). The income tax benefit recorded for the
nine months ended September 30, 2002 is attributable to the reversal of certain
prior year U.S. income tax accruals no longer necessary as a result of newly
enacted tax legislation in 2002.
41
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Acquired In-Process Research and Development
In connection with the acquisition of eMation, we expensed $3.1 million of the
purchase price as IPR&D. The potential income streams were discounted using a
15%-25% discount rate for risks, probabilities and uncertainties, including the
stage of development of the technology, viability of target markets, and other
factors.
As of the acquisition date, eMation was conducting ongoing research and
development into its next generation DRM product, as well as enhancing its
WizFactory and @aGlance industrial DRM products. Due to the significant
technological risks relating to the development of these products and the fact
that the products were not completed at the time of the acquisition, the work
effort estimated to bring these products to market was considered in-process
research and development. These development efforts are expected to include
product enhancements and enable the products to perform on an increased number
of platforms. In September 2002, we completed the next generation DRM product,
Axeda DRM 3. Release 3 expands the diagnosis and repair, reporting, performance,
connectivity and security features of the Axeda DRM system. Also in September
2002, we completed the new Windows XP version of our industrial automation
solution, Wizcon, version 8.2, supervisory control and data acquisition (SCADA)
system. These products, along with any related services and maintenance, are
expected to generate revenues through at least 2004.
42
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
LIQUIDITY AND CAPITAL RESOURCES
We financed our operations up until 2001 primarily through the issuance and sale
of debt and equity securities to investors including our initial public offering
completed on July 16, 1999. Since March 2001, our operations have also been
financed through the sales of the assets of our CE and IA businesses. As of
September 30, 2002, we had approximately $23.1 million in cash and cash
equivalents, including $0.55 million of the proceeds from the sales of the
assets of our IA businesses in March 2001 which are currently held in escrow by
third parties pending the settlement of a claim submitted by Phoenix. We are
unable to predict the resolution of this matter, or reasonably estimate any
amount of possible loss given the current status of this matter. Any escrow
amounts not returned to us will be recorded as a charge to the gain on sale of
assets in the period in which such determination is made. In June 2002 we
initiated an arbitration proceeding with the International Chamber of Commerce
(No. 12 203/JNK) seeking an order that the entire $0.55 million be disbursed to
Axeda. Phoenix filed an answer and counterclaim in the arbitration, claiming
entitlement to the entire $550,000. We filed an answer to the counterclaim,
denying the claim. A hearing date has not yet been set.
Net cash used in operating activities for the nine months ending September 30,
2002 was $20 million. Cash used in operating activities for this period was
primarily the result of our net loss of approximately $(25.9) million, adjusted
for other non-cash charges, including non-cash compensation and depreciation and
amortization totaling approximately $4.0 million, losses on disposals of assets
totaling approximately $0.5 million and other changes in working capital of
approximately $1.4 million. Net cash used in operating activities for the nine
months ended September 30, 2001 was $19.8 million. Cash used in operating
activities for this period was primarily the result of net income, adjusted for
non-recurring gains of approximately $52.0 million and non-cash compensation
expense and depreciation and amortization totaling approximately $4.5 million.
Net cash used in investing activities for the nine months ending September 30,
2002 was $2.2 million, and consisted of purchases of leasehold improvements,
furniture and equipment. Net cash provided by investing activities for the nine
months ended September 30, 2001 was approximately $65.2 million and consisted
primarily of the net proceeds from the sales of assets of our CE and IA
businesses of approximately $68.1 million, offset by purchases of furniture and
equipment of approximately $0.4 million.
In March 2001, we completed the sale of the assets of our CE business to
STMicroelectronics and received approximately $55.6 million, of which $0.7
million that was previously held in escrow was released in September 2002.
In March 2001, we sold the assets of our IA business, excluding inventory, to
Phoenix Technologies for $18 million, of which $0.55 million remains withheld by
a third party pending the settlement of a claim submitted by Phoenix.
Net cash used in financing activities was $2.0 million for the nine months
ending September 30, 2002 and consisted of the repayment of the balance of $1.65
million under the line of credit acquired in the acquisition of eMation and
principal payments of the equipment line of credit to EVP of approximately $0.4
million. Net cash provided by financing activities for the nine months ended
September 30, 2001 was $1.3 million and consisted of proceeds from the exercise
of stock options and warrants.
As of September 30, 2002, we had approximately $0.3 million outstanding on an
equipment line of credit with European Venture Partners ("EVP") with interest
rates ranging from 12% to 13% and payments due monthly over a 36 month period.
The line of credit was available to finance purchases of capital equipment until
September 30, 2001. In connection with the agreement, EVP has a senior security
interest in substantially all of eMation's capital equipment. In addition, the
line of credit agreement requires us to provide EVP with copies of quarterly
financial statements within 45 days of the end of each quarter and audited
annual financial statements within 90 days of the end of each year as well as
other information and notifications regarding eMation's financial and operating
results. As of September 30, 2002, we were in compliance with all of our
covenants to EVP.
43
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
A portion of our liability for severance pay is calculated pursuant to Israeli
severance pay law based on the most recent salary of the employees multiplied by
the number of years of employment, as of the balance sheet date. Employees who
are employed in Israel are entitled to one month's salary for each year of
employment or a portion thereof. The liability for all of our Israeli employees
is fully provided by monthly deposits with insurance policies and by an accrual,
totaling approximately $0.5 million. The aggregate value of these policies is
approximately $0.3 million. The deposited funds may be withdrawn only upon the
fulfillment of the obligation pursuant to Israeli severance pay law or labor
agreements. The value of the deposited funds is based upon the cash surrender
value of these policies.
In May 2002, we entered into a lease for approximately 35,000 square feet of
space in an office building in the same business park as our current offices
located in Mansfield, Massachusetts. This facility is leased at an annual rental
of approximately $310,000, plus operating expenses, utilities and taxes, and is
used for research and development, sales and support and administrative
activities. The lease commenced in June 2002, expires in July 2007, and provides
for free rent through September 2002. We will record the net lease expense on a
straight-line basis over the term of the lease. Axeda obtained an irrevocable,
cash-secured, standby letter of credit (the "letter of credit") from a bank as
security and for the benefit of the lessor for $0.15 million. The letter of
credit expires in August 2003 and provides for automatic one-year renewals, but
not beyond August 2007. The letter of credit is secured by a certificate of
deposit for $0.15 million from the same bank, and also expires in August 2003.
This amount is restricted for withdrawal and is included in other assets
(non-current) in our consolidated balance sheets. We completed our occupation of
the new offices in July 2002 and, in September 2002, we entered into a sublease
with a subtenant (the "Subtenant") for the balance of the term of the lease for
our former offices. The lease for our former offices expires in July 2004 and
requires us to pay minimum future rental payments totaling approximately $0.5
million as of July 31, 2002. Under the terms of the sublease agreement, we will
receive minimum future rental payments totaling approximately $0.3 million from
the Subtenant. For the three months ending September 30, 2002, we recorded a
charge of approximately $0.2 million, which is included in other general and
administrative expense, for the amount representing the excess of the future
minimum rental payments to be made over the future minimum sublease payments to
be received.
As part of our occupancy of this new site in Mansfield, we contracted for
improvements, primarily construction of offices and other improvements, which
were substantially completed in July 2002. The cost of the improvements is $1.3
million, and we are considering our alternatives for these costs, which include
obtaining third party financing of this amount.
In June 2002 we entered into a Software License Agreement ("the Agreement") with
a vendor to provide server and client software that, beginning in August 2002,
is incorporated into our DRM Enterprise Server products. License fees are due
and payable at the rate of 2.5% of each billable sale, as defined. Under the
Agreement, we agreed to pay a minimum, non-refundable prepaid license fee of
$400,000 (the "minimum license fee"), which is payable in installments. We paid
$100,000 in July 2002, and are required to pay $100,000 on June 30, 2003 and the
remaining $200,000 on December 15, 2003.
We maintain approximately 9,000 square feet of office space in Marlborough,
Massachusetts under an operating lease, which is no longer used for operating
purposes. The lease requires annual rental payments totaling approximately $0.2
million and expires in February 2009. The present value of the future lease
payments, discounted at 5%, of approximately $1.1 million was accrued by eMation
as of the date of acquisition and the balance as of September 30, 2002 is
approximately $1.0 million.
During the second quarter we initiated cost reduction actions, which we believe
will reduce our cash operating expenses by approximately one third of our second
quarterrate, with a goal to reduce our ongoing quarterly cash burn rate to $3.0
million by the fourth quarter of 2002. These reductions have centered on selling
and marketing and general and administrative expenses, and in areas not core to
the DRM solutions growth. We have also reduced the number of global offices and
closely monitored our infrastructure costs. We began to reduce our cost
structure in the second quarter of 2002, and we incurred $1 million in charges
during the third quarter of 2002 to reduce staffing levels and to terminate
certain leases. We expect to incur up to $1 million in charges during fourth
quarter of 2002, and we expect that the ongoing cost savings will continue to
increase throughout the fourth quarter of 2002.
44
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Except for the improvements to our new offices in Mansfield, Massachusetts
described above, we have no other material commitments for capital expenditures,
and we anticipate minimal increases in our capital expenditures as our needs in
operations, infrastructure and personnel arise.
In September 2001, our Board of Directors authorized a stock repurchase program
to acquire up to $10 million worth of shares of our common stock for a one year
period, which expired in September 2002. The shares may be purchased from time
to time at prevailing market prices through open market or unsolicited
negotiated transactions, depending upon market conditions. From September 2001
to December 2001, we repurchased 383,800 shares for an aggregate cost of
approximately $0.6 million including commissions, at an average market price per
share of approximately $1.58. No shares were repurchased under the program in
the nine months ending September 30, 2002.
We believe that our current cash and cash equivalents balance will be adequate
to meet our cash needs through at least 2003.
45
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Critical Accounting Policies
In December 2001 the SEC issued Financial Reporting Release No. 60, "Cautionary
Advice Regarding Disclosure About Critical Accounting Policies" ("FRR 60"),
suggesting companies provide additional disclosure and commentary on those
accounting policies considered most critical. FRR 60 considers an accounting
policy to be critical if it is important to our financial condition and results,
and requires significant judgment and estimates on the part of management in its
application. We believe the following represent our critical accounting policies
as contemplated by FRR 60. For a summary of all of our significant accounting
policies, including the critical accounting policies discussed below, see note 1
to the accompanying consolidated financial statements.
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Revenue recognition. We derive our revenues from primarily two sources (i)
product revenues, which includes software license, royalties and hardware
revenues, and (ii) services and support revenues, which includes software
license maintenance, training, and consulting revenues. As described below,
significant management judgments and estimates must be made and used in
connection with the revenue recognized in any accounting period. Material
differences may result in the amount and timing of our revenue for any period if
our management made different judgments or utilized different estimates.
We license our software products generally on a perpetual basis. Some of our
licenses include maintenance and support, which typically are for periods of one
year.
We apply the provisions of Statement of Position 97-2, "Software Revenue
Recognition," ("SOP 97-2") as amended by Statement of Position 98-9
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions" ("SOP 98-9") to all transactions involving the sale of software
products. For hardware transactions where no software is involved, we apply the
provisions of Staff Accounting Bulletin 101 "Revenue Recognition" ("SAB 101").
We recognize revenue from the sale of software licenses when persuasive evidence
of an arrangement exists, the product has been delivered, the fee is fixed and
determinable and collection of the resulting receivable is reasonably assured.
Delivery generally occurs when product is delivered to a common carrier. If a
significant portion of a fee is due after our normal payment terms, we account
for the fee as not being fixed and determinable. In these cases, we recognize
revenue as the fees become due.
We assess collection based on a number of factors, including the transaction
history and the credit-worthiness of the customer. If we determine that
collection of a fee is not reasonably assured, we defer the fee and recognize
revenue at the time collection becomes reasonably assured, which is generally
upon receipt of cash.
For all sales, except those completed over the Internet, we use either a binding
purchase order or a signed agreement as evidence of an arrangement. For sales
over the Internet, we utilize a third party distributor to process our
transactions. Sales through our distributors are evidenced by a master agreement
governing the relationship together with binding purchase orders on a
transaction-by-transaction basis.
For multiple-element arrangements that are not accounted for using long-term
contract accounting (for example, undelivered maintenance and support), we
allocate revenue to the delivered elements of the arrangement using the residual
value method when there is VSOE for each of the undelivered elements. We defer
revenue from the arrangement fee equivalent to the fair value of the undelivered
elements and the difference between the total arrangement fee and the amount
deferred for the undelivered elements is recognized as revenue related to the
delivered elements. The fair value of DRM maintenance and postcontract customer
support ("PCS") obligations is based upon separate sales of renewals to other
customers or upon renewal rates quoted in the contracts. The fair value of DRM
services, such as training or consulting, is based upon separate sales by us of
these services to other customers.
46
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Our arrangements do not generally include acceptance clauses. However, if an
arrangement includes an acceptance provision, acceptance occurs upon the earlier
of receipt of a written customer acceptance or expiration of the acceptance
period.
In cases where we engage a third party warehouse or distributor to sell any of
our inventory on consignment, and collectibility is not probable, revenue is not
recognized and inventory is not reduced until cash from the sale is received. In
certain consignment arrangements with distributors, if the period under which a
right to return has expired with no physical return of the inventory, the
inventory is considered sold, assuming all other criteria in SAB 101 are met.
We recognize revenues for maintenance services ratably over the contract term.
Our training and consulting services are billed based on hourly or daily rates,
and we generally recognize revenues as these services are performed. However, if
our services are bundled with a license component and the arrangement requires
us to perform significant work, such as altering the underlying software or
building additional, complex interfaces so that the software conforms to the
customer's requirements, we recognize the entire fee using the percentage of
completion method. We estimate the percentage of completion based on the costs
incurred to date as a percentage of the estimated total costs to complete the
project. For arrangements that include services that, under SOP 97-2, qualify
for separate accounting, we follow the provisions of SOP 97-2 and allocate
revenues to the services element based on VSOE and recognize the revenues as the
services are performed. During our analysis if the work effort to complete a
project exceeds our revenue projections, a loss on the project is immediately
recognized.
Provision for doubtful accounts. Management must make estimates of the
collectibility of our accounts receivables. Management specifically analyzes
accounts receivable and analyzes historical bad debts, customer concentrations,
customer creditworthiness, current economic trends and changes in our customer
payment terms when evaluating the adequacy of the allowance for doubtful
accounts. Our accounts receivable balance was $3.3 million, net of allowance for
doubtful accounts of $0.2 million as of September 30, 2002.
Valuation of inventories. We previously assessed the value of our inventories on
a periodic basis based upon numerous factors including expected product or
material demand, current market conditions, technological obsolescence, current
cost and net realizable value. In cases where any of these factors adversely
affected our ability to realize the carrying value of our inventories, an
inventory reserve was recorded. Because the timing and magnitude of these
changes to inventories were difficult to predict, changes to our inventories'
value could have occurred unexpectedly. However, as of September 30, 2002, our
inventories, which relate primarily to our former IA business, are fully
reserved.
Valuation of long-lived assets and intangible assets with finite lives, and
goodwill. On January 1, 2002, we adopted SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which supersedes
certain provisions of APB Opinion No. 30 "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions" ("APB 30"), and
supersedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" ("SFAS 121"). There was no adjustment
required upon adoption of SFAS 144. In accordance with SFAS 144, we evaluate
long-lived assets, including intangible assets other than goodwill, for
impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable based on expected undiscounted
cash flows attributable to that asset. The amount of any impairment is measured
as the difference between the carrying value and the fair value of the impaired
asset.
Factors we consider important which could trigger an impairment review include
the following:
o significant underperformance relative to expected historical or projected
future operating results;
o significant changes in the manner of our use of the acquired assets or
the strategy for our overall business;
o significant negative industry or economic trends;
o significant decline in our stock price for a sustained period; and our
market capitalization relative to net book value.
47
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
When we determine that the carrying value of identified intangible assets or
long-lived assets may not be recoverable based upon the existence of one or more
of the above indicators of impairment, we measure any impairment based on a
projected discounted cash flow method using a discount rate determined by our
management to be commensurate with the risk inherent in our current business
model. Net identified intangible assets with finite lives and long-lived assets
amounted to $10.8 million as of September 30, 2002 and $12.1 million as of
December 31, 2001.
SFAS No. 142, which was effective January 1, 2002, requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with finite useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, beginning in 2002 and annually thereafter. As a
result, we are not amortizing approximately $20.8 million of goodwill recorded
in 2001. We adopted certain provisions of SFAS No. 142, as required in the
transition guidance contained therein, in 2001 and adopted the remaining
provisions on January 1, 2002. The application of the transition guidance did
not result in an impairment of goodwill as of January 1, 2002. Goodwill amounted
to approximately $20.6 million as of September 30, 2002 and $20.8 million as of
December 31, 2001. We have not recorded any amounts for intangible assets with
indefinite useful lives as of September 30, 2002 or December 31, 2001.
We are in the process of completing the first step of the annual impairment test
under SFAS 142 concerning the accounting for goodwill. With the assistance of an
independent, national valuation firm, we are performing a fair market value
analysis on our reporting unit in the fourth quarter of 2002, and determined
that the preliminary results of this first test indicate a potential impairment
of goodwill. In conjunction with the impairment tests under SFAS 142, we are
also in the process of testing our identified intangible assets for impairment
under SFAS 144 concerning the accounting for long-lived assets. We are required
to perform a fair market value analysis of our identified intangible assets
under SFAS 144 and record an impairment charge and writedown of such assets, if
any, prior to recording an impairment charge for goodwill. The SFAS 142 and the
SFAS 144 impairment tests are currently in process, and we expect to record a
non-cash charge in the fourth quarter of 2002 to write-down a significant
portion of the value of our goodwill and identified intangible assets.
Contingencies. Management's current estimated range of liability related to its
pending legal claims is based on claims for which our management can estimate
the amount or range of loss. We have accrued for estimated losses in the
accompanying financial statements for those matters where we believe the
likelihood of an adverse outcome is probable and the amount of the loss is
reasonably estimable. Because of the uncertainties related to both the amount
and range of loss on the remaining pending legal claims, management is unable to
make a reasonable estimate of the liability that could result from an
unfavorable outcome. As additional information becomes available, we will assess
the potential liability related to our pending legal claims and revise our
estimates. Such revisions in our estimates of the potential liability could
materially impact our results of operations, financial position and cash flows.
48
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Recent Accounting Pronouncements
On October 1, 2002 the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions" ("SFAS 147"). The standard amends SFAS Nos. 72 and 144.
We do not expect the adoption of SFAS 147 to have an impact on our results of
operations, financial position or cash flows.
At the October meeting of the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board (the "FASB"), the EITF reached a consensus
on Issue 1 of EITF Issue No. 02-17, "Recognition of Customer Relationship
Intangible Assets Acquired in a Business Combination," ("EITF 02-17"). Issue 1
addresses when an entity recognizes an intangible asset pursuant to paragraph 39
of SFAS 141, whether the contractual-legal or separability criteria restrict the
use of certain assumptions, such as expectations of future contract renewals and
other benefits related to the intangible asset that would be used in estimating
the fair value of that intangible asset. The EITF concluded that the
contractual-legal and separability criteria do not restrict the use of certain
assumptions that would be used in estimating the fair value of an intangible
asset. Assumptions such as expectations of future contract renewals and other
benefits related to the intangible asset must be considered in the estimates of
fair value regardless of whether they meet the contractual-legal or separability
criteria.
Also at the October meeting, the EITF reached a consensus on Issue 2 of EITF
Issue No. 02-17, "Recognition of Customer Relationship Intangible Assets
Acquired in a Business Combination," that the guidance in SFAS 141, paragraph
A20, which states that a customer relationship meets the contractual-legal
criterion if an entity establishes relationships with its customers through
contracts, applies only if a contract is in existence at the date of the
acquisition. The EITF concluded that this provision applies if an entity has a
practice of establishing contracts with its customers. Thus, an entity would
recognize a customer relationship at the date of the business combination even
if there were no contracts in existence at that date since the entity has a
practice of establishing contracts with its customers. The EITF also observed
that this consensus addresses only the recognition of customer relationships and
does not address the valuation of such customer relationships. These consensuses
should be applied on a prospective basis for all business combinations
consummated after October 25, 2002 and all Step 1 and Step 2 impairment tests
performed after October 25, 2002.
In September 2002 the EITF reached a consensus in EITF Issue No. 02-13,
"Deferred Income Tax Considerations in Applying the Goodwill Impairment Test in
FASB Statement No. 142, Goodwill and Other Intangible Assets" ("EITF 02-13").
The EITF consensus requires that deferred income taxes, if any, be included in
the carrying amount of a reporting unit for the purposes of the first step of
the SFAS 142 goodwill impairment test. It also provides guidance for determining
whether to estimate the fair value of a reporting unit by assuming that the unit
could be bought or sold in a non-taxable transaction versus a taxable
transaction and the income tax bases to use based on this determination. EITF
02-13 is effective for goodwill impairment tests performed after September 12,
2002. We are currently analyzing the impact EITF 02-13 will have on our
consolidated financial statements.
In July 2002 the FASB issued Statement No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). The standard requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the standard include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity.
Previous accounting guidance was provided by Emerging Issues Task Force Issue
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring) ("EITF 94-3")." Statement 146 replaces EITF 94-3. We do not
expect the adoption of SFAS 146 to have a significant impact on our results of
operations, financial position or cash flows.
49
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 3:
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop products in the United States and in Israel and sell such products in
North America and various countries in Europe, Asia and Latin America. We
collect a portion of our revenues and pay a portion of our operating expenses in
foreign currencies. As a result, our financial results could be affected by
factors such as changes in foreign currency exchange rates or weak economic
conditions in foreign markets. Currently, we do not use derivative instruments
to hedge our foreign exchange risk, although we may do so in the future. Our
interest income is sensitive to changes in the general level of U.S. interest
rates, particularly since the majority of our investments are in short-term
instruments. Due to the nature of our short-term investments, we have concluded
that there is no material market risk exposure. Therefore, no quantitative
tabular disclosures are required.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Our business and the value of our shares are subject to numerous risks. Some of
these risks are described above and certain additional risks are described
below. You should carefully consider the risks described below, in addition to
the other information contained in this Report and in our other filings with the
SEC. The risks and uncertainties described below are not the only ones we face.
Additional risks and uncertainties not presently known to us or that we
currently deem immaterial may also affect our business operations. If any of
these risks actually occur, our business, financial condition or results of
operations could be seriously harmed. In that event, the market price for our
common stock could decline and you may lose part or all of your investment.
We have never been profitable and may never achieve profitability in the future
We had a net loss from operations of approximately $26.9 million for the nine
months ended September 30, 2002. To date, we have not achieved operating
profitability on an annual basis.
We have invested and continue to invest significant resources in product
development, selling and marketing, services, professional services and support
and administrative expenses. To achieve profitability, we will need to increase
revenues significantly. We cannot assure you that our revenues will grow or that
we will achieve or maintain profitability in the future.
We are currently undergoing a business transition that may adversely affect
our Company
We sold the assets of our CE business and our IA business in March 2001. As part
of these sales, approximately 89 of our employees accepted employment with
either STMicroelectronics or Phoenix Technologies. These employees were
dedicated primarily to research and development activities in the digital media
market. The reduction in our research and development workforce has adversely
affected our ability to offer new products in the digital media market. The
reduction in our sales force adversely affected our ability to sell our digital
media products. Pursuant to the terms of our agreement with STMicroelectronics,
we may not participate in significant aspects of the CE market prior to March
2006. These sales negatively impacted relationships with our partners,
distributors and customers in the digital media market and left us with a
limited digital media offering of products that could be used only in personal
computers. In May 2002 we entered into an exclusive Software Distribution
Agreement with Sonic Solutions, who will license the intellectual property of
our PC and digital media business. As a result, we have exited the digital media
market. In December 2001, we announced the completion of the eMation
acquisition. Our focus on the DRM business will present challenges different
from those presented by the digital media business. We cannot assure you that
our management team will be successful in managing this new business. If we are
unable to successfully operate the DRM business, our business and operating
results will be adversely affected.
Our future success depends upon the acceptance of our DRM solution
We expect our future growth to be driven by our DRM products and services. We
have limited experience in this market. We acquired eMation in December 2001.
eMation was founded in 1988 and historically derived its main source of revenue
from its industrial automation products.
50
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We offer complete DRM solutions and we also continue to separately sell
components of the system, such as the Axeda Supervisor, Axeda @aGlance/IT and
Axeda FactorySoft OPC, to support our traditional industrial automation
business.
Factors adversely affecting the pricing of or demand for our DRM solutions, such
as competition and technological change, could have a material adverse effect on
our business, financial position and results of operations. If our DRM solutions
do not achieve market acceptance or if competitors release new products that
achieve greater market acceptance, have more advanced features, offer better
performance or are more price-competitive, revenues from our DRM solutions may
not grow as expected.
Our complete DRM solutions will involve significant capital expenditures by our
customers. We have a limited history of selling DRM solutions and will have to
devote substantial resources to educate prospective customers about the benefits
of our DRM solutions. Even if our DRM solutions are effective in reducing our
customers' costs or in providing our customers with new revenue sources, our
target customers may not choose them for technical, cost, support or other
reasons. If the market for our products fails to grow or grows more slowly than
we anticipate, our business will suffer.
Net revenues from our legacy products, which include Axeda Supervisor, Axeda
@aGlance/IT and Axeda FactorySoft OPC, have decreased and we expect that net
revenues from these lines of products will continue to decline in the future as
we focus our efforts on the development of complete DRM solutions
Net revenues from eMation's legacy products, which include Axeda Supervisor,
Axeda @aGlance/IT and Axeda FactorySoft OPC, have accounted for a significant
portion of its historical net revenues but have declined recently. We anticipate
that net revenues from our legacy products will continue to decline in the
future as we plan to continue to focus on the development of our complete DRM
solutions. We do not know if this transition in product development will be
successful. If the expected decline in net revenues attributable to our legacy
products is not offset by increases in net revenues from our complete DRM
solutions, our business could be harmed.
Economic conditions could adversely affect our revenue growth and ability
to forecast revenue
The revenue growth of our business depends on the overall demand for DRM
software and services. Because our sales targets are primarily major corporate
customers in the industrial and building automation, high technology, medical
instrumentation, semiconductor equipment, and office automation industries, our
business depends on the overall economic conditions and the economic and
business conditions within these industries. Predictions regarding economic
conditions have a low degree of certainty, and further predicting the effects of
the changing economy is even more difficult. Customers may defer or reconsider
purchasing products if they continue to experience a lack of growth in their
business or if the general economy fails to significantly improve. A softening
of demand for computer software caused by a continued weakening of the economy,
domestically or internationally, may result in a decrease in revenues and growth
rates. In addition, the financial, political, economic and other uncertainties
following the terrorist attacks upon the United States in September 2001 have
led to a further weakening of the global economy. Subsequent terrorist acts
and/or the threat of future outbreak or continued escalation of hostilities
involving the United States or other countries could adversely affect the growth
rate of our software license and services revenue and have an adverse effect on
our business, financial condition or results of operations.
Our historical financial information is of limited value in projecting our
future operating results or evaluating our operating history
We believe that you should not rely on the results for any previous period as an
indication of our future performance because our business model has changed
significantly since inception and has further changed with the acquisition of
eMation.
You should expect our quarterly operating results to fluctuate in future periods
and they may fail to meet the expectations of investors, which could cause our
stock price to decline
Our operating results have varied widely in the past, and we expect that they
will continue to vary significantly as we establish our products in the DRM
market and complete our transition to focus on the DRM market. Furthermore, our
revenues and operating results will vary significantly from quarter-to-quarter
due to a number of additional factors, including:
51
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
o variations in demand for our products and services, which are relatively
few in number;
o customers' decisions to defer or accelerate orders for our products or
services;
o increased economic uncertainty and political instability world-wide
following the terrorist attacks which began in the United States on
September 11, 2001;
o capital budgeting and purchasing cycles of current and prospective
customers may cause our sales to be seasonal; it is difficult for us to
evaluate the degree to which this seasonality may affect our business;
o the timing of large contracts that materially affect our operating results
in a given quarter;
o delays in introducing new products and services;
o changes in our pricing policies or the pricing policies of our competitors;
o the costs of litigation and intellectual property protection;
o our ability to develop and attain market acceptance of enhancements to our
products;
o new product introductions by competitors;
o the mix of license and services revenues;
o unanticipated customer demands which impact our ability to deliver our
products and ultimately recognize revenues;
o the mix of domestic and international sales;
o our ability to attract, integrate, train, retain and motivate sales and
marketing, research and development, administrative and product management
personnel;
o our ability to expand our operations; and
o global economic conditions as well as those specific to the industries our
customers operate in.
We determine our operating expenses largely on the basis of anticipated revenue
trends and a high percentage of our expenses are fixed in the short term and are
significant. As a result, any delay in generating or recognizing revenues could
cause significant variations in our operating results from quarter-to-quarter
and could result in substantial operating losses.
Due to the foregoing factors, we believe that quarter-to-quarter comparisons of
our operating results may not be a good indication of our future performance. In
future quarters, our operating results may be below the expectations of
investors. In this event, the price of our common stock may fall significantly.
52
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We may not be able to compete effectively
Competition in the market for DRM solutions is emerging and expected to grow
stronger. If we are unable to compete effectively, the demand for, or the prices
of, our products may be reduced. To maintain and improve our competitive
position, we must continue to develop and introduce, on a timely and
cost-effective basis, new products, features and services that keep pace with
the evolving needs of our customers. The principal competitive factors that
affect our performance in the DRM market are the following:
o our ability to effectively market and sell our products;
o our customer service and support;
o our product reputation, quality, performance; and
o the price and features of our products such as adaptability,
scalability, the ability to integrate with other products,
functionality, and ease of use.
We compete in a market with companies that may utilize varying approaches to
enable the remote management of information from intelligent devices. One
competitive approach to the Axeda DRM(TM) system today is from custom software
development from in-house developers within the machine and device manufacturers
that are our prime sales targets, or from system integrators doing custom
product development. These companies may choose to deploy their own information
technology personnel or utilize system integrators to write new code or rewrite
existing applications in an effort to develop their own information extraction
solutions. As a result, prospective clients may decide against purchasing and
implementing externally developed software and, instead, may develop their own
solutions similar to our DRM solutions. However, we are also developing working
relationships with system integrators who may choose to leverage the Axeda DRM
system in their engagements, generating sales for Axeda and additional services
opportunities for them.
A number of vertical market solution suppliers have also begun to market device
management infrastructures for use in specific industries. Today, companies such
as IBM Global Services, ILS and Brooks-PRI (semiconductor), Questra (medical and
office), Invensys (industrial), Imaging Portals (copiers), NextNine (telecom)
and Motive (technology), compete in specific industries that we operate in.
We expect competition to intensify as the DRM market matures. We expect that
competition will increase in the near term and that our primary long-term
competitors may not yet have entered the market. Our future competitors may have
significantly more personnel or greater financial, technical, marketing and
other resources than either our current competitors or we do. Furthermore, our
future competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements than we can. Also, future
competitors may have greater name recognition and more extensive customer bases
that they can leverage. Increased competition could result in price reductions,
fewer customer orders, reduced gross profit margins and loss of market share,
any of which could harm our business.
We expect to see new or increased competition from several areas, including:
Device Networking - The embedded networking companies are perhaps the most
visible infrastructure companies in this emerging market. We do not develop
networking protocols and our technology generally can work with any open or
proprietary communications protocols. We therefore today see device-networking
companies like emWare, e-Device, Lantronix, Opto22, domainLogix, and Echelon as
current or potential partners. Opto22 has entered into an alliance with us to
promote remote monitoring, service, and management solutions for devices and
equipment across a variety of industries. We believe that the current focus of
these embedded networking companies is primarily on Internet-enabling devices,
which complements our focus on managing device data remotely via distributed,
enterprise-class solutions. However, in the future these companies may choose to
directly compete with us.
Industrial Automation Products - There are a number of automation products
available worldwide from vendors large and small that are used to monitor and
control buildings, factories, machines and devices. Some of these PC-based
HMI/SCADA software companies have focused on extending their business upward to
Internet-based access and enterprise application integration typically to
support e-manufacturing. Today, these companies compete directly with our Axeda
Supervisor, Axeda @aGlance/IT and Axeda FactorySoft OPC products. Over time we
could see these companies as competitors in the full DRM market. These companies
include WonderWare, Intellution, Indusoft, Afcon, Iconics, IndX, Rockwell
Automation, Siemens, GE Fanuc and Honeywell.
e-Business Platforms - We see the large CRM companies, network management
vendors and e-business technology platform providers such as Siebel Systems,
Oracle, IBM, SAP, BEA, PeopleSoft, Sun Microsystems, Hewlett Packard, BMC,
MicroMuse, and Computer Associates as both potential competitors and partners.
These companies have an interest in device networking and pervasive computing
technologies and could choose to extend their offering into DRM. Building on
well-understood and widely available standard infrastructure components, such as
J2EE(R) application servers and relational databases, enables us to interoperate
with and to take advantage of partnering opportunities with these suppliers as
well as their application and systems integration partners. Axeda is a Siebel
Software Partner and our Axeda Integrator(TM) for Siebel provides seamless
integration with the Siebel 7 Field Service application from Siebel Systems Inc.
We have also integrated the Axeda DRM(TM) System with the mySAP.com(R)
e-business platform, extending the value of SAP(R) solutions with real-time
device information. However, in the future, these companies may choose to
compete directly with us.
53
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We may not be able to keep pace with technological advances
The process of remotely extracting information from intelligent devices will
likely be characterized by rapid technological change, frequent new product
introductions and emerging industry standards. We also expect that the rapid
evolution of Internet-based applications and standards, as well as general
technology trends such as changes in or introductions of operating systems, will
require us to adapt our products to remain competitive. Our products could
become obsolete and unmarketable if we are unable to quickly adapt to new
technologies or standards.
To be successful, we will need to develop and introduce new products and product
enhancements that respond to technological changes, evolving industry standards
and other market changes and developments in a timely manner and on a
cost-effective basis. Although we plan to continue to spend substantial amounts
on research and development in the future, we cannot assure you that we will
develop new products and product enhancements successfully or that our products
will achieve broad market acceptance. Our failure to respond in a timely and
cost-effective manner to new and evolving technologies and other market changes
and developments could adversely impact our business.
Our sales cycle for DRM products is long and may be seasonal and we may rely on
large contracts from relatively few DRM customers, which may cause our operating
results to fluctuate
Our sales cycle is lengthy and may be subject to seasonality. Our sales
typically involve significant capital investment decisions by prospective
customers, as well as a significant amount of time to educate them as to the
benefits of our products. As a result, before purchasing our products, companies
spend a substantial amount of time performing internal reviews and obtaining
capital expenditure approvals. It may take up to six to nine months or more from
the time we first contact a prospective customer before receiving an initial
order. The length of our sales cycle may also depend on a number of additional
factors, including the following:
o the complexities of the problems our solutions address;
o the breadth of the solution required by the customer, including the
technical, organizational and geographic scope of the license; o the
sales channel through which the solution is sold; o the economic conditions in
the United States and abroad; o increased economic uncertainty and political
instability world-wide
following the terrorist attacks which began in the United States on
September 11, 2001; and
o any other delays arising from factors beyond our control.
Furthermore, our software license revenues may result from a relatively small
number of sales, some of which generate disproportionately large revenues.
Variations in the length of our sales cycles could cause our revenue to
fluctuate widely from period to period. Because we typically recognize a
substantial portion of our software revenue in the last month of a quarter, any
delay in the license of our products could cause significant variations in our
revenue from quarter to quarter. These fluctuations could cause our operating
results to suffer in some future periods because our operating expenses are
relatively fixed over the short term and we devote significant time and
resources to prospective clients.
54
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A variation in the conversion of our revenue pipeline to contracts could
adversely affect our revenues and ability to forecast operations.
Our revenue pipeline estimates may not consistently correlate to actual revenues
in a particular quarter or over a longer period of time. A slowdown in the
economy, domestically and internationally, has caused and may continue to cause
customer purchasing decisions to be delayed, reduced in amount or canceled, all
of which have reduced and could continue to reduce the rate of conversion of the
pipeline into contracts. A variation in the pipeline or in the conversion of the
pipeline into contracts could cause us to plan or budget inaccurately and
thereby could adversely affect our business, financial condition or results of
operations.
Implementation of our products can be difficult, time-consuming and expensive
and customers may be unable to implement our products successfully or otherwise
achieve the benefits attributable to our products.
Our customers often desire to integrate our DRM solutions with their existing
computer systems and software programs. This can be complex, time-consuming and
expensive, and may cause delays in the deployment of our products. As a result,
some customers may have difficulty or be unable to implement our products
successfully or otherwise achieve the benefits attributable to our products.
Delayed or ineffective implementation of our software and services may limit our
ability to expand our revenues and may result in customer dissatisfaction, harm
to our reputation and cause issues relating to the collection of accounts
receivable.
We are dependent upon our key management for our future success, and few of
our key personnel are obligated to stay with us
Our success depends on the efforts and abilities of our senior management and
certain other key personnel. Many of our key employees are employed at will. Our
business could be harmed if any of these or other key employees left or was
seriously injured and unable to work and we were unable to find a qualified
replacement. We have recently hired new managers and may hire key management
personnel as needed. We may not be able to successfully assimilate our recently
hired managers or to hire qualified key management personnel to replace them.
Our future growth will be limited if we are unable to expand our indirect
distribution sales channels
We currently have relationships with only a limited number of these indirect
distribution channels, consisting of relationships with independent software
vendors, software distributors and system integrators. Nevertheless, we have
derived, and we anticipate that we will continue to derive, a significant
portion of our revenues from these relationships.
Our future growth will be limited if:
o we fail to work effectively with indirect distribution channels;
o we fail to increase the number of indirect distribution channels with which
we have relationships;
o the business of one or more of our indirect distribution channels fails; or
o there is a decrease in the willingness and ability of our indirect
distribution channels to devote sufficient resources and efforts to
marketing and supporting our products.
If any of these circumstances occurs, we will have to devote substantially more
resources to the sales, marketing, distribution, implementation and support of
our products than we otherwise would, and our own efforts may not be as
effective as those of our indirect distribution channels.
55
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Increased sales through indirect channels may adversely affect our operating
performance.
Even if our marketing efforts through indirect channels are successful and
result in increased sales, our average selling prices and operating margins
could be adversely affected because of the lower unit prices that we receive
when selling through indirect channels.
We depend on our strategic partners and other third parties for sales and
implementation of our products. if we fail to derive benefits from our existing
and future strategic relationships, our business will suffer.
From time to time, we have collaborated with other companies in areas such as
marketing, distribution or implementation. Maintaining these and other
relationships is a meaningful part of our business strategy. However, some of
our current and potential strategic partners are either actual or potential
competitors, which may impair the viability of these relationships. In addition,
some of our relationships have failed to meet expectations and may fail to meet
expectations in the future. A failure by us to maintain existing strategic
relationships or enter into successful new strategic relationships in the future
could seriously harm our business, operating results and financial condition.
We rely upon technology licensed from third parties, and if we do not maintain
these license arrangements, we may experience delays until replacement
technology is licensed and integrated
We license technology that is used in our products from third parties under
agreements and we may not be able to maintain these license arrangements. This
technology may not continue to be available on commercially reasonable terms, if
at all, and would be difficult to replace. The loss of any of these technology
licenses could result in delays until replacement technology is licensed and
integrated. In addition, any defects in this licensed technology could prevent
the implementation or impair the functionality of our products, delay new
product introductions or injure our reputation. If we are required to enter into
license agreements with third parties for replacement technology, we could be
subject to higher royalty payments.
Our business model depends upon licensing our intellectual property, and if we
fail to protect our proprietary rights, our business could be harmed
Our ability to compete depends substantially upon our internally developed
technology. We have a program for securing and protecting rights in patentable
inventions, trademarks, trade secrets and copyrightable materials. However,
there can be no assurance that we have taken or will take all necessary steps to
protect our intellectual property rights. If we are not successful in protecting
our intellectual property, our business could be substantially harmed.
Our pending patents may never be issued, and even if issued, may provide us
with little protection
We regard the protection of patentable inventions as important to our
business. We currently have ten U. S. patent applications pending relating to
our DRM business and three patent applications pending internationally. It is
possible that:
o our pending patent applications may not result in the issuance of patents;
o our patents may not be broad enough to protect our proprietary rights;
o any issued patent could be successfully challenged by one or more third
parties, which could result in our loss of the right to prevent others from
exploiting the inventions claimed in those patents;
o current and future competitors may independently develop similar
technology, duplicate our products or design around any of our patents; and
o effective patent protection, if any, may not be available in every country
in which we do business.
56
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We rely upon trademarks, copyrights and trade secrets to protect our proprietary
rights, which are only of limited value
We rely on a combination of laws, such as copyright, trademark and trade secret
laws, and contractual restrictions, such as confidentiality agreements and
licenses, to establish and protect our proprietary rights. Despite any
precautions which we have taken:
o laws and contractual restrictions may not be sufficient to prevent
misappropriation of our technology or deter others from developing similar
technologies;
o other companies may claim common law or other trademark rights based upon
state or foreign law which precede our registration or use of such marks;
o Current federal laws that prohibit software copying provide only limited
protection from software pirates, and effective trademark, copyright and
trade secret protection may be unavailable or limited in certain foreign
countries;
o companies we acquire may not have taken similar precautions to protect
their proprietary rights;
o policing unauthorized use of our products and trademarks is difficult,
expensive and time-consuming and we are unable to determine the extent to
which piracy of our products and trademarks may occur, particularly
overseas;
o certain of our products are licensed under shrink-wrap license agreements
that are not signed by licensees and therefore may not be binding under the
laws of certain jurisdictions; and
o tamper-resistant copy protection codes and dongles may not be successful in
preventing unauthorized use of our software.
The laws of other countries in which we market our products might offer little
or no effective protection of our proprietary technology. Reverse engineering,
unauthorized copying or other misappropriation of our proprietary technology
could enable third parties to benefit from our technology without paying us for
it, which could significantly harm our business.
Any failure to adequately protect our proprietary rights could result in our
competitors offering similar products, potentially resulting in the loss of some
of our competitive advantage and a decrease in our revenue. Infringement claims
and lawsuits would likely be expensive to resolve and would require management's
time and resources and, therefore, could harm our business.
We may be subject to product returns, product liability claims and reduced sales
because of defects in our products
Our products are very complex and may contain undetected errors that could harm
our reputation, result in product liability or decrease market acceptance of our
products. The likelihood of errors is higher when a new product is introduced or
when new versions or enhancements are released. Our products are integrated with
our customers' networks and software applications. Errors may also arise as a
result of defects in the products and systems into which our products are
incorporated. We are unable to test our products in each of the applications in
which they are designed to work. It is possible that defects could cause our
customers to experience network or application failures. We have an extensive
quality assurance process in place and procedures to handle customer complaints
and deliver bug fixes. Despite our quality assurance process and that of our
customers, defects and errors may be found in new products or in new versions or
enhancements of existing products after commercial shipment has begun. We may be
required to devote significant financial resources and personnel to correct any
defects. Known or unknown errors or defects that affect the operation of our
products could result in the following, any of which could harm our business:
57
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
o delay or loss of revenues;
o although we have not lost a customer due to defects, it is foreseeable that
a customer could cancel a contract due to defects;
o diversion of development resources;
o increased product development costs;
o damage to our reputation;
o delay or diminish market acceptance of our products;
o increased service and warranty costs; and
o litigation costs.
Although some of our licenses with customers contain provisions designed to
limit our exposure to potential product liability claims, these contractual
limitations on liability may not be enforceable. In addition, our product
liability insurance may not be adequate to cover our losses in the event of a
product liability claim resulting from defects in our products and may not be
available to us in the future.
Substantial litigation regarding intellectual property rights exists in our
industry. There is a risk that third-parties, including current and potential
competitors and current developers of our intellectual property, will claim that
our products, or our customers' products, infringe on their intellectual
property rights or that we have misappropriated their intellectual property.
Software, business processes and other property rights in our industry might be
increasingly subject to third-party infringement claims as the number of
competitors grows and the functionality of products in different industry
segments overlaps. Other parties might currently have, or might eventually be
issued, patents that infringe on the proprietary rights we use. Any of these
third parties might make a claim of infringement against us.
We have received notices of claims related to our PC products, and may receive
additional notices of claims in the future, regarding the alleged infringement
of third parties' intellectual property rights that may result in restrictions
or prohibitions on the sale of our PC products, if any, and cause us to pay
license fees and damages.
Some third parties claim to hold patents covering various aspects of DTV, HDTV
and DVD technology incorporated into our and our customers' digital media
products and have claimed that various aspects of DTV, HDTV and DVD technology
incorporated into our and our customers' digital media products infringe upon
patents held by them, including the following:
o Our digital video stream management solutions comply with industry DVD
specifications, which incorporate technology known as MPEG-2 that governs
the process of storing a video input in digital form. In 1998 and/or 1999
we received notice from two of our largest customers that a third party
with a history of litigating its proprietary rights and which has
substantial financial resources has alleged that aspects of MPEG-2
technology infringe upon patents held by the third party. In July 2002, one
of these customers notified us that this third party has sued such customer
for patent infringement, and the customer is seeking indemnification from
us. The other customer may in the future seek compensation or
indemnification from us arising out of the third party claims. We may be
required to agree to indemnify either or both of these customers to secure
future business or otherwise.
o A group of companies has formed a consortium known as MPEG-LA to enforce
the proprietary rights of other holders of patents covering essential
aspects of MPEG-2 technology that are incorporated into our products.
MPEG-LA has notified us, as well as a number of PC manufacturers, including
our customers, that the distribution of products that incorporate the
MPEG-2 technology infringes patents owned by members of the consortium.
MPEG-LA has requested that these PC manufacturers pay license fees for the
use of the technology covered by MPEG-LA patents.
58
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
o Another group of companies has formed a consortium known as DVD6C (formerly
DVD Patent License Program) to enforce the proprietary rights of other
holders of patents covering essential aspects of DVD technology that are
incorporated into our products. DVD6C has notified us, as well as a number
of PC manufacturers and other companies manufacturing or licensing
DVD-related products, including our customers, that products that
incorporate the DVD technology infringe patents owned by members of the
consortium. DVD6C has requested that we as well as these PC manufacturers
pay license fees for using the DVD6C patents.
o A third party has notified us, as well as two of our customers, that
parental control features of our CineMaster products infringe patents held
by the third party.
o Another consortium of companies, commonly known as 3C, notified a number of
DVD product manufacturers that the members of the consortium hold patents
that are essential to DVD technology, and have requested that such
companies pay license royalties for the use of the technology covered by
the 3C patents.
o A letter dated September 12, 2000 from a third party to one of our
customers who distributes our product claims infringement of a Japanese
utility model patent regarding Internet terminals which can be coupled to a
television set. This third party is seeking a license agreement as a
resolution. We have requested more time to respond and are accumulating
prior art to invalidate the utility model patent.
o A third party has asserted that some of our products infringe one or more
of such third party's patents in the field of all format decoders. The
third party has stated that it was prepared to license the relevant patents
to us on favorable terms. We have been in discussions with such third
party. The third party may seek compensation from us related to this
matter. We do not know if this party has contacted any of our customers
regarding this matter. If so, our customers may in the future seek
compensation or indemnification from us arising out of the third party's
claims. No claim for such payments has been made to date. We have not
determined whether and to what extent that the patents held by the third
party are valid and whether and to what extent our products are covered by
their patents.
We may be liable to some of our customers for damages that they incur in
connection with intellectual property claims. Some of our license agreements,
including many of the agreements we have entered into with our large PC OEM
customers, contain warranties of non-infringement and/or commitments to
indemnify our customers against liability arising from infringement of
third-party intellectual property, which may include third-party intellectual
property such as the patents held by members of MPEG LA, DVD6C, and others.
These commitments may require us to indemnify or pay damages to our customers
for all or a portion of any license fees or other damages, including attorneys'
fees, they are required to pay or agree to pay these or other third parties. We
have received notices of up to an aggregate of five million dollars asserting
rights under the indemnification provisions and warranty provisions of our
license agreements from several former digital media products customers. We may
be required to pay substantial damages with respect to such indemnification
assertions.
We may be required to pay substantial damages and may be restricted or
prohibited from selling our products if it is proven that we violate the
intellectual property rights of others. If MPEG LA, DVD6C, 3C, or any other
third party proves that our digital media technology infringes its proprietary
rights, we may be required to pay substantial damages for past infringement.
In addition to the claims described above, we may receive notices of claims of
infringement of other parties' proprietary rights. The defense of infringement
claims and lawsuits, regardless of their outcome, would likely be expensive to
resolve and could require a significant portion of management's time. We cannot
assume that we will prevail in intellectual property disputes regarding
infringement, misappropriation or other disputes. Litigation in which we are
accused of infringement or misappropriation might cause a delay in the
introduction of new products, require us to develop non-infringing technology,
require us to enter into royalty or license agreements, which might not be
available on acceptable terms, or at all, or require us to pay substantial
damages, including triple damages if we are held to have willfully infringed a
third party's intellectual property. If a successful claim of infringement was
made against us and we could not develop non-infringing technology or license
the infringed or similar technology on a timely and cost-effective basis, our
business could be significantly harmed.
In addition, rather than litigating an infringement matter, we may determine
that it is in our best interests to settle the matter. The terms of a settlement
may include the payment of damages and our agreement to license technology in
exchange for a license fee and ongoing royalties. These fees may be substantial.
If we are forced to take any of the actions described above, defend against any
claims from third parties or pay any license fees or damages, our business could
be harmed.
59
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
It may be difficult to raise needed capital in the future, which could
significantly harm our business
We may require substantial additional capital to finance our future growth and
fund our ongoing research and development activities beyond 2003. Our capital
requirements will depend on many factors, including:
o acceptance of and demand for our products;
o the number and timing of acquisitions and the cost of such acquisitions;
o the costs of developing new products;
o the costs associated with our expansion; and
o the extent to which we invest in new technology and research and
development projects.
Although our current business plan does not foresee the need for further
financing to fund our operations for the next year, due to risks and
uncertainties in the market place as well as a potential of pursuing further
acquisitions, we may need to raise additional capital. Additionally, to the
extent that the proceeds from the dispositions of our CE, IA, and PC businesses
are exhausted, and if our existing sources of cash and cash flow from
operations, if any, are insufficient to fund our activities, we may need to
raise additional funds. If we issue additional stock to raise capital, your
percentage ownership in Axeda would be reduced. Additional financing may not be
available when needed and, if such financing is available, it may not be
available on terms favorable to us.
We received a letter from NASDAQ stating that if we are unable to comply with
the minimum bid price of $1.00, our common stock will be delisted
We received a letter dated September 13, 2002, from the staff of the NASDAQ
Stock Market, or NASDAQ, which notified us that the bid price for our common
stock had been below $1.00 per share for a period of thirty consecutive days.
NASDAQ advised us that we would be given a period of ninety days within which to
comply with the minimum bid price requirement in order to maintain the listing
of our common stock on the NASDAQ National Market. If we are unable to
demonstrate compliance with the minimum bid requirement for ten consecutive days
on or before December 12, 2002, NASDAQ will provide us with written notification
that our common stock will be delisted. At that time we may appeal the staff's
decision to a NASDAQ Listing Qualification Panel. In the alternative, we may
apply to transfer our securities to the NASDAQ SmallCap Market. If we submit a
transfer application and pay the applicable listing fees by December 12, 20002,
initiation of de-listing proceedings will be stayed pending NASDAQ's review of
our transfer application. If the transfer application is approved, we will have
a 180 day grace period ending on March 12, 2003 from meeting the NASDAQ SmallCap
listing requirements and will be eligible for an additional 180 day grace period
if we meet the initial listing requirements for the NASDAQ SmallCap Market. We
intend to pursue all available options to meet the NASDAQ listing requirements.
If our common stock is delisted from the NASDAQ National Market, sales of our
common stock would likely be conducted on the SmallCap Market or in the
over-the-counter market. This may have a negative impact on the liquidity and
price of our common stock and investors may find it more difficult to purchase
or dispose of, or to obtain accurate quotations as to the market value of, our
common stock.
Stock-based compensation will negatively affect our operating results
We have recorded deferred compensation in connection with the grant of stock
options to employees where the option exercise price is less than the estimated
fair value of the underlying shares of common stock as determined for financial
reporting purposes. We have recorded deferred compensation, net of forfeitures,
within stockholders' equity of $2.3 million at September 30, 2002, which is
being amortized over the vesting period of the related stock options, ranging
from one to four years. A balance of $0.7 million remains at September 30, 2002
and will be amortized as follows: $0.1 million in 2002; $0.5 million in 2003;
and $0.1 million in 2004.
The amount of stock-based compensation in future periods will increase if we
grant stock options where the exercise price is less than the quoted market
price of the underlying shares or if we modify the terms of existing stock
options. The amount of stock-based compensation amortization in future periods
could decrease if options for which accrued, but unvested deferred compensation
has been recorded, are forfeited.
60
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our business is subject to risks from international operations such as legal
uncertainty, tariffs and trade barriers and political and economic instability
We conduct business in a number of different countries. We sell products in
several countries outside the United States, including Israel, France, Germany,
Holland, the United Kingdom and countries in Asia and Latin America. Our
operations outside the United States include facilities located in Israel,
France, Holland, and Japan. For the nine months ended September 30, 2002, we
derived approximately 56% of our revenues from sales to foreign companies. We
anticipate that revenues from international operations will continue to
represent a significant portion of our revenues. As a result, we are subject to
risks associated with selling and operating in foreign countries. For example,
some of our contracts with foreign customers are denominated in foreign
currencies. We do not currently hedge against the risk of such transactions and
as a result, we face a risk of loss related to possible fluctuations in currency
exchange rates.
Our geographic diversity requires significant management attention and financial
resources. We intend to expand certain of our international operations in the
future. Significant management attention and financial resources are needed to
develop our international sales, support and distribution channels. We may not
be able to maintain international market demand for our products. Our business
could be adversely impacted if we are unable to successfully launch our DRM
products into our international operations.
Additional risks related to selling and operating in foreign countries include,
among others:
o legal uncertainty regarding liability;
o language barriers in business discussions;
o cultural differences in the negotiation of contracts and conflict
resolution;
o time zone differences;
o reduced protection for intellectual property rights in some countries;
o differing labor regulations;
o tariffs, trade barriers and other regulatory barriers;
o problems in collecting accounts receivable;
o political and economic instability;
o changes in diplomatic and trade relationships;
o seasonal reductions in business activity;
o potentially adverse tax consequences;
o changes in a country's or region's political or economic conditions;
o complexity and unexpected changes in local laws and regulations;
o greater difficulty in staffing and managing foreign operations; and
o increased financial accounting and reporting burdens and complexities.
61
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to risks associated with doing business in the State of Israel
Conditions in Israel may affect our operations. Our subsidiary Axeda Systems,
Ltd. (formerly eMation, Ltd.) is incorporated in Israel. We have an office and
approximately 14 employees in Israel and approximately 3% and 2% of our sales
were made to customers in Israel for the three and nine months ended September
30, 2002, respectively. Our Axeda Supervisor products (formerly known as
WizFactory), are developed in Israel.
We are directly influenced by the political, economic, and military conditions
affecting Israel and the Middle East. Therefore, any major hostilities involving
Israel or the interruption or curtailment of trade between Israel and its
present trading partners could have an adverse effect on our operations.
We are subject to conditions attached to governmental grants we have received
In the past, eMation was the beneficiary of certain governmental grants from
government agencies in Israel to encourage development and marketing of its
legacy technology under certain conditions. We do not expect to apply for
additional grants of this nature in the future. Prior to being acquired by us in
December 2001, eMation received grants from the Office of the Chief Scientist
("OCS") in the aggregate amount of $1.8 million and paid royalties to the OCS in
the aggregate amount of $1.4 million. As of September 30, 2002, $0.1 million of
the remaining potential $0.4 million of principal liability is accrued in other
current liabilities. We are obligated to pay royalties of 3.0% to 3.5% of
revenues derived from sales of products funded through grants received from the
Office of the Chief Scientist. The terms of the Office of the Chief Scientist
grants require that we manufacture our products that are developed with such
grants in Israel. In addition, we may not transfer the technology developed
pursuant to the terms of these grants to third parties without the prior
approval of a governmental committee.
Additionally, prior to being acquired by us in December 2001, eMation received
grants from the Israeli Government through the Fund for the Encouragement of
Marketing Activities in the aggregate amount of $1.2 million and royalties in
the aggregate amount of $0.5 million have been repaid. As of September 30, 2002,
$0.6 million of the remaining potential $0.9 million of principal liability is
accrued in other current liabilities. We are obligated to pay royalties of 4.0%
of revenues derived from sales of products that result from grants received
through the Fund for the Encouragement of Marketing Activities.
We face risks from the uncertainties of any future governmental regulation
Many of the industries in which our products are used are subject to U.S. and
foreign governmental regulation. We are not currently subject to direct
regulation by any domestic or foreign governmental agency (excluding regulation
by governmental agencies in Israel that have provided grants to us), other than
regulations applicable to businesses generally. However, it is possible that
future laws and regulations may be adopted that regulate our products and the
industries in which they are sold. Our business could be harmed by any new
legislation or regulation, the application of laws and regulations from
jurisdictions whose laws do not currently apply to our business, or the
application of existing laws and regulations to our products and the industries
in which they are sold.
Because of their significant stock ownership, our officers and directors can
exert significant control over our future direction
As of September 30, 2002, our executive officers, directors and entities
affiliated with them, in the aggregate, beneficially owned approximately 6.8
million shares, or approximately 25% of our outstanding common stock. These
stockholders, if acting together, would be able to significantly influence all
matters requiring approval by our stockholders, including the election of
directors, the approval of mergers or other business combination transactions or
a sale of all or substantially all of our assets.
62
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Certain provisions of our certificate of incorporation and by-laws make changes
of control difficult even if they would be beneficial to our stockholders
The board of directors has the authority without any further vote or action on
the part of our stockholders to issue up to 5,000,000 shares of preferred stock
and to determine the price, rights, preferences, privileges and restrictions of
the preferred stock. This preferred stock, if it is ever issued, may have
preference over and harm the rights of the holders of our common stock. Although
the issuance of this preferred stock will provide us with flexibility in
connection with possible acquisitions and other corporate purposes, this
issuance may make it more difficult for a third party to acquire a majority of
our outstanding voting stock. We currently have no plans to issue preferred
stock.
Our certificate of incorporation and by-laws include provisions that may have
the effect of deterring an unsolicited offer to purchase our stock. These
provisions, coupled with the provisions of the Delaware General Corporation Law,
may delay or impede a merger, tender offer or proxy contest involving us.
Furthermore, our board of directors is divided into three classes, only one of
which is elected each year. Directors are only capable of being removed by the
affirmative vote of 66 2/3% or greater of all classes of voting stock. These
factors may further delay or prevent a change of control.
We may not be able to compete effectively in the Internet-related products and
services market.
Our DRM solutions communicate through public and private networks over the
Internet. The success of our products may depend, in part, on our ability to
continue developing products that are compatible with the Internet. We cannot
predict with any assurance whether the demand for Internet-related products and
services will increase or decrease in the future. The increased commercial use
of the Internet could require substantial modification and customization of our
products and the introduction of new products.
Critical issues concerning the commercial use of the Internet, including
security, privacy, demand, reliability, cost, ease of use, accessibility,
quality of service and potential tax or other government regulation, remain
unresolved and may affect the use of the Internet as a medium to support the
functionality of our products. If these critical issues are not favorably
resolved, our business, financial condition or results of operations could be
adversely affected.
Our business is subject to changes in financial accounting standards, which may
affect our reported revenue, or the way we conduct business
We prepare our financial statements in conformity with accounting principles
generally accepted in the United States of America ("GAAP"). GAAP are subject to
interpretation by the Financial Accounting Standards Board, the American
Institute of Certified Public Accountants ("AICPA"), the SEC and various bodies
appointed by these organizations to interpret existing rules and create new
accounting policies. In particular, a task force of the Accounting Standards
Executive Committee, a subgroup of the AICPA, meets on a quarterly basis to
review various issues arising under the existing software revenue recognition
rules, and interpretations of these rules. Additional interpretations issued by
the task force may have an adverse effect on how we report revenue or on the way
we conduct our business in the future.
63
AXEDA SYSTEMS INC.
CONTROLS AND PROCEDURES
ITEM 4. CONTROLS AND PROCEDURES
a) Evaluation of Disclosure Controls and Procedures
Based on their evaluation of our disclosure controls and procedures
conducted within 90 days of the date of filing this report on Form
10-Q, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) promulgated under the Securities Exchange
Act of 1934) are effective.
b) Changes in Internal Controls
There were no significant changes in our internal controls or in other
factors that could significantly affect these controls subsequent to
the date of their evaluation.
64
AXEDA SYSTEMS INC.
LEGAL PROCEEDINGS
PART II: OTHER INFORMATION
Item 1: LEGAL PROCEEDINGS
Between February and April 2000, eleven class action lawsuits were filed against
certain of our current and former officers and directors and us in the United
States District Court for the Eastern District of Pennsylvania. On May 25, 2000,
the cases were consolidated under Civil Action No. 00-CV-1014, and entitled "In
re RAVISENT Technologies Inc. Securities Litigation." Pursuant to the court's
consolidation order, a consolidated and amended class action complaint was filed
on June 14, 2000 with an alleged class period of July 15, 1999 through April 27,
2000. This complaint alleges violations of the federal securities laws,
specifically Sections 11 and 15 of the Securities Exchange Act of 1933, Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5
promulgated thereunder and seeks unspecified damages on behalf of a purported
class of purchasers of our stock during the period stated above. On July 3,
2000, we filed a motion to dismiss the consolidated and amended class action
complaint. The motion is presently fully briefed and the parties are waiting for
a hearing date to be set for the motion. Certain of our employees and certain
holders of 5% or more of Axeda common stock are members of the putative classes
alleged in these actions and therefore may have interests adverse to us with
respect to the alleged claims in these actions. We believe that such lawsuits or
claims are without merit and that we have meritorious defenses to the actions.
On July 15, 2002, we filed a motion to dismiss all claims against us and our
officers and directors. The Court has not ruled on this motion. We plan to
vigorously defend the litigation. However, failure to successfully defend these
actions could substantially harm our results of operations, liquidity and
financial condition.
On November 27, 2001, a putative shareholder class action was filed against us,
certain of our officers and directors, and several investment banks that were
underwriters of our initial public offering. The action was filed in the United
States District Court for the Southern District of New York, purportedly on
behalf of investors who purchased our stock between July 15, 1999 and December
6, 2000. The lawsuit alleges violations of Sections 11, 12(a)(2) and 15 of the
Securities Exchange Act of 1933 and Section 10(b) of the Securities Exchange Act
of 1934 and Rule 10b-5 promulgated thereunder against one or both of the Company
and the individual defendants. The claims are based on allegations that the
underwriter defendants agreed to allocate stock in the our July 15, 1999 initial
public offering to certain investors in exchange for excessive and undisclosed
commissions and agreements by those investors to make additional purchases in
the aftermarket at pre-determined prices. Plaintiffs allege that the Prospectus
for our initial public offering was false and misleading in violation of the
securities laws because it did not disclose these arrangements. This lawsuit is
part of the massive "IPO allocation" litigation involving the conduct of
underwriters in allocating shares of successful initial public offerings. We
believe that more than one hundred and eighty other companies have been named in
more than eight hundred identical lawsuits that have been filed by some of the
same plaintiffs' law firms. Certain of our employees are members of the putative
classes alleged in these actions and therefore may have interests adverse to us
with respect to the alleged claims in these actions. We believe that such
lawsuit and claims are without merit and that we have meritorious defenses to
the actions. We plan to vigorously defend the litigation. However, failure to
successfully defend this action could substantially harm our results of
operations, liquidity and financial condition.
From time to time, we have received, and expect to continue to receive, notices
of claims of infringement of other parties' proprietary rights and other claims
in the ordinary course of our business. See "FACTORS THAT MIGHT AFFECT FUTURE
RESULTS - We have received notices of claims and might become involved in
litigation over proprietary rights, which could be costly and time consuming."
We have accrued for estimated losses in the accompanying financial statements
for those matters where we believe the likelihood of an adverse outcome is
probable and the amount of the loss is reasonably estimable. The adverse
resolution of any one or more of these matters could have a material
adverseeffect on our business, financial condition or results of operations.
65
AXEDA SYSTEMS INC.
PART II: ITEM 2 - ITEM 5
Item 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) CHANGES IN SECURITIES: NONE
(b) DIVIDENDS:
We have never declared or paid any dividends on our common stock. We do not
anticipate paying any cash dividends in the foreseeable future. We currently
intend to retain future earnings, if any, to finance operations and the
expansion of our business. Any future determination to pay cash dividends will
be at the discretion of the board of directors and will be dependent upon our
financial condition, operating results, capital requirements and such other
factors as the board of directors deems relevant. Moreover, pursuant to
agreements with our lender, we are prohibited from declaring or paying dividends
without the prior written consent of the lender. See "Management's Discussion
and Analysis of Financial Condition and Results the of Operations-Liquidity and
Capital Resources."
(c) USE OF PROCEEDS:
Not applicable.
Item 3: DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Item 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Item 5: OTHER INFORMATION
None.
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AXEDA SYSTEMS INC.
EXHIBITS AND REPORTS ON FORM 8-K
Item 6:
(a) Exhibits
Exhibit Number Description and Method of Filing
10.45* License and Distribution Agreement, dated July 26, 2002, by and between Electronics for
Imaging, Inc. and Axeda Systems Operating Company Inc.
* Filed herewith
(b) The following reports were filed on Form 8-K during this period:
On August 14, 2002, Axeda Systems Inc. submitted the certification
required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 in
connection with its Form 10-Q for the quarterly period ended June 30,
2002.
67
AXEDA SYSTEMS INC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act
of 1934, as amended, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the city of
Malvern, Commonwealth of Pennsylvania on this 7th day of November 2002.
November 7, 2002
Axeda Systems Inc.
/s/ Thomas J. Fogarty
- ---------------------
Thomas J. Fogarty,
Executive Vice President and Chief Financial Officer
68
AXEDA SYSTEMS INC.
CERTIFICATIONS
I, Robert M. Russell Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Axeda Systems
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 registrants 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 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 registrants 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 registrants other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants auditors and
the audit committee of registrants 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 registrants ability to
record, process, summarize and report financial data and have
identified for the registrants 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 registrants
internal controls; and
6. The registrants 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.
Date: November 7, 2002 /s/ Robert M. Russell Jr.
Robert M. Russell Jr.
Chief Executive Officer
69
AXEDA SYSTEMS INC.
CERTIFICATIONS
I, Thomas J. Fogarty, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Axeda Systems
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 registrants 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 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 registrants 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 registrants other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants auditors and
the audit committee of registrants 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 registrants ability to
record, process, summarize and report financial data and have
identified for the registrants 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 registrants
internal controls; and
6. The registrants 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.
Date: November 7, 2002 /s/ Thomas J. Fogarty
Thomas J. Fogarty
Executive Vice President and
Chief Financial Officer
70