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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period Ended September 30, 2003
[_] 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)
21 Oxford Road
Mansfield, Massachusetts 02048
---------------------------
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (508) 337-9200
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[ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes[ ] No[X]
---------------------------
On November 13, 2003, 32,312,557 shares of the Registrant's Common Stock, $.001
par value, were outstanding.
AXEDA SYSTEMS INC.
FORM 10-Q
INDEX
Page
Part I Financial Information
Item 1 Financial Statements
Consolidated Balance Sheets as of September 30, 2003 (unaudited) and December 31, 2002 ......2
Consolidated Statements of Operations for the three months ended September 30, 2003 and
2002 (unaudited). ...........................................................................3
Consolidated Statements of Operations for the nine months ended September 30, 2003 and
2002 (unaudited). ...........................................................................4
Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and
2002 (unaudited). ...........................................................................5
Notes to the Consolidated Financial Statements ...............................................6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations ........18
Item 3 Quantitative and Qualitative Disclosures About Market Risk ...................................37
Item 4 Controls and Procedures ......................................................................37
Part II Other Information
Item 1 Legal Proceedings ...........................................................................38
Item 2 Changes in Securities .......................................................................39
Item 3 Defaults Upon Senior Securities .............................................................39
Item 4 Submission of Matters to a Vote of Security Holders .........................................39
Item 5 Other Information ...........................................................................39
Item 6 Exhibits and Reports on Form 8-K ............................................................39
Signatures ...................................................................................40
Exhibit Index ................................................................................41
Exhibit 10.4
Exhibit 10.5
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
AXEDA SYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
PART I FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
September 30, December 31,
2003 2002
---- ----
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents, including restricted cash of $100 in 2003
and $650 in 2002 ....................................................... $ 11,355 $ 19,065
Accounts receivable, net ................................................ 3,475 3,305
Prepaid expenses and other current assets ............................... 741 973
--------- ---------
Total current assets .................................................. 15,571 23,343
Furniture and equipment, net ............................................ 2,433 3,111
Goodwill ................................................................ 3,575 3,651
Identified intangible assets, net ....................................... 1,589 2,087
Other assets ............................................................ 319 321
--------- ---------
Total assets .......................................................... $ 23,487 $ 32,513
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank line of credit ..................................................... $ 448 $ --
Current portion of notes payable ........................................ 55 238
Accounts payable ........................................................ 1,184 2,448
Accrued expenses ........................................................ 5,417 8,015
Income taxes payable .................................................... 763 616
Deferred revenue ........................................................ 1,244 1,078
--------- ---------
Total current liabilities ............................................. 9,111 12,395
Non-current liabilities:
Other non-current liabilities ........................................... 876 1,046
Financing-related liability ............................................. 2,765 --
--------- ---------
Total liabilities ..................................................... 12,752 13,441
--------- ---------
Commitments and contingencies (note 7)
Stockholders' equity:
Preferred stock, $.001 par value; 5,000,000 shares authorized in 2003 and
2002, none issued or outstanding ...................................... -- --
Common stock, $.001 par value 50,000,000 authorized; 32,912,766 shares
issued in 2003 and 27,822,217 in 2002 .................................. 33 28
Additional paid-in capital .............................................. 146,445 143,847
Deferred stock compensation ............................................. (175) (578)
Accumulated deficit ..................................................... (134,329) (122,880)
Accumulated other comprehensive income .................................. 141 35
Treasury stock at cost, 603,800 shares in 2003 and 2002 ................. (1,380) (1,380)
--------- ---------
Total stockholders' equity ............................................ 10,735 19,072
--------- ---------
Total liabilities and stockholders' equity ............................ $ 23,487 $ 32,513
========= =========
See accompanying notes to the consolidated financial statements .....
2
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
Three Months Ended September 30,
2003 2002
---- ----
Revenues:
License .......................................... $ 2,575 $ 3,421
Services and maintenance ......................... 924 795
Hardware ......................................... 104 153
------------ ------------
Total revenues ................................. 3,603 4,369
------------ ------------
Cost of revenues:
License .......................................... 151 579
Services and maintenance ......................... 757 1,163
Hardware ......................................... -- 29
Software amortization ............................ 159 525
------------ ------------
Total cost of revenues ......................... 1,067 2,296
------------ ------------
Gross profit ................................... 2,536 2,073
------------ ------------
Research and development
Non-cash compensation ............................ 28 31
Other research and development expense ........... 969 1,655
Sales and marketing
Non-cash compensation ............................ 10 17
Other selling and marketing expense .............. 1,777 3,836
General and administrative
Non-cash compensation ............................ 108 103
Other general and administrative expense ......... 1,747 2,374
Depreciation and amortization .................... 278 422
------------ ------------
Total operating expenses ....................... 4,917 8,438
------------ ------------
Operating loss ................................. (2,381) (6,365)
Loss on disposals of assets ........................ -- (86)
Interest income (expense), net ..................... (24) 93
Other income (expense), net ........................ 639 47
------------ ------------
Loss before provision for income taxes ............. (1,766) (6,311)
Provision for income taxes .................... 45 --
------------ ------------
Net loss ........................................... $ (1,811) $ (6,311)
============ ============
Basic and diluted net loss per weighted average
common share outstanding .......................... $ (0.07) $ (0.23)
============ ============
Weighted average number of common shares outstanding
used in calculation of basic and diluted net loss
per common share .................................. 27,741,394 27,222,368
============ ============
See accompanying notes to the consolidated financial statements.
3
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
Nine Months Ended September 30,
-------------------------------
2003 2002
---- ----
Revenues:
License .......................................... $ 7,050 $ 9,039
Services and maintenance ......................... 2,457 2,012
Hardware ......................................... 287 1,501
------------ ------------
Total revenues ................................. 9,794 12,552
------------ ------------
Cost of revenues:
License .......................................... 976 2,396
Services and maintenance ......................... 2,794 2,870
Hardware ......................................... 1 1,281
Software amortization ............................ 475 1,579
------------ ------------
Total cost of revenues ......................... 4,246 8,126
------------ ------------
Gross profit ................................... 5,548 4,426
------------ ------------
Research and development
Non-cash compensation ............................ 84 129
Other research and development expense ........... 4,090 5,977
Sales and marketing
Non-cash compensation ............................ 27 55
Other selling and marketing expense .............. 6,558 13,628
General and administrative
Non-cash compensation ............................ 381 1,202
Other general and administrative expense ......... 6,264 8,446
Depreciation and amortization .................... 848 1,062
Special charges ................................. -- 820
------------ ------------
Total operating expenses ....................... 18,252 31,319
------------ ------------
Operating loss ................................. (12,704) (26,893)
Gain (loss) on disposals of assets ................. 743 (123)
Interest income (expense), net ..................... 29 406
Other income (expense), net ........................ 621 44
------------ ------------
Loss before provision for income taxes (benefit) ... (11,311) (26,566)
Provision for income taxes (benefit) .......... 140 (668)
------------ ------------
Net loss ........................................... $ (11,451) $ (25,898)
============ ============
Basic and diluted net loss per weighted average
common share outstanding .......................... $ (0.42) $ (0.96)
============ ============
Weighted average number of common shares outstanding
used in calculation of basic and diluted net loss
per common share .................................. 27,390,836 27,000,897
============ ============
See accompanying notes to the consolidated financial statements.
4
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30,
-------------------------------
2003 2002
---- ----
Cash flows from operating activities:
Net loss ................................................. $(11,451) $(25,898)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization ............................ 1,323 2,641
Net (gains) and losses on disposal of assets ............. (729) 457
Unrealized gain on finacing-related liability ............ (645) --
Non-cash compensation and other expenses ................. 492 1,371
Provision for doubtful accounts .......................... (59) 92
Changes in items affecting operations:
Accounts receivable ...................................... (111) 1,205
Inventories .............................................. -- 2,070
Loan receivable--officer ................................. -- 34
Prepaid expenses and other current assets ................ 276 173
Goodwill, intangible assets and other assets ............. 78 107
Accounts payable ......................................... (1,264) (852)
Accrued expenses and other non-current liabilities ....... (1,708) (1,508)
Income taxes payable ..................................... 147 (668)
Deferred revenue ......................................... 166 765
-------- --------
Net cash used in operating activities .................. (13,485) (20,011)
-------- --------
Cash flows from investing activities:
Capital expenditures ..................................... (111) (2,241)
-------- --------
Net cash used in investing activities .................. (111) (2,241)
-------- --------
Cash flows from financing activities:
Borrowing under bank line of credit ...................... 448 --
Net proceeds from issuance of common stock ............... 5,597 --
Repayments of long-term debt and other
non-current liabilities ............................ (226) (2,016)
Net proceeds from exercise of stock options ............. 8 53
-------- --------
Net cash provided by (used in) financing activities .... 5,827 (1,963)
-------- --------
Effect of exchange rate changes on cash and cash equivalents 59 4
-------- --------
Net decrease in cash and cash equivalents .................. (7,710) (24,211)
Cash and cash equivalents:
Beginning of period ...................................... 19,065 47,349
-------- --------
End of period, including restricted cash of $100 in 2003
and $650 in 2002 ........................................ $ 11,355 $ 23,138
======== ========
See accompanying notes to the consolidated financial statements.
5
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Information with respect to September 30, 2003 and 2002 is unaudited)
All amounts are in thousands, except share and per share amounts, unless noted
otherwise.
1) Summary of Significant Accounting Policies
a) Description of Business and Liquidity
Axeda Systems Inc. ("we", "our", "us" or "Axeda") develops, markets and sells
enterprise software products and services used by multiple industries and
customers worldwide for Device Relationship Management ("DRM"), to access and
exploit information hidden 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 and France.
In December 2001 we purchased all of the outstanding capital stock of eMation,
Ltd., or eMation, a private company organized under the laws of the State of
Israel and headquartered near Boston, Massachusetts. In 2003 our revenues have
been substantially generated from selling DRM products. During 2002 our revenues
were increasingly generated from selling DRM products.
We have sustained significant net losses and negative cash flows from operations
since our inception. For the nine months ended September 30, 2003 and 2002, our
net losses were $11,451 and $25,898, respectively, and negative cash flows from
operations were $13,888 and $20,011, respectively. There can be no assurances
that we will be able to generate sufficient revenues or positive cash flows from
operations necessary to achieve or sustain profitability in the short or long
term. Management believes that the current cash and cash equivalent amounts will
be sufficient to sustain our operations through at least 2004. However, due to
risks and uncertainties, there can be no assurances that our future operating
cash flows will be sufficient to meet our requirements. In such event, our
operations and liquidity will be materially adversely affected. Additional
financing may not be available when needed and, if such financing is available,
it may not be available on terms favorable to us.
Beginning in the second quarter of 2002, we initiated a series of steps designed
to consolidate and streamline our operations and decrease our losses and
corresponding use of cash. We have halved the number of global offices, reduced
staffing levels by approximately 46%, and have closely monitored our
infrastructure costs. We exited the personal computer, or PC, business and
focused our efforts on several key markets for DRM Systems products. In 2002 and
through the third quarter of 2003, we recorded approximately $1,900 and $1,400,
respectively, in restructuring charges to reduce staffing levels, terminate
certain leases and consolidate our operations. Combined with our expected
continued year over year growth in DRM Systems revenues, we believe that future
operating losses will continue to be lower than in previous quarters. We will
continue to evaluate our cost structure and may undertake additional measures to
reduce expenses in the future.
b) Basis of Presentation
The interim consolidated financial statements of Axeda for the three and nine
months ended September 30, 2003 and 2002 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 of
normal recurring items, necessary to present fairly the financial position of
Axeda at September 30, 2003, the results of our operations for the three and
nine months ended September 30, 2003 and 2002 and our cash flows for the nine
months ended September 30, 2003 and 2002. 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, 2002. The interim results presented
are not necessarily indicative of results for any subsequent quarter or for the
year ending December 31, 2003.
c) Principles of Consolidation
The consolidated financial statements include our financial statements and the
financial statements of our wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
6
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
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 Web@aGlance, 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.
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 contracts involving significant modification or
customization of 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.
Royalties representing software license fees paid on a per unit basis are
recognized when earned, which is 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 by
the end of the quarter during which the sales of the licensees' products take
place.
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").
7
f) Financial Instruments
Our financial instruments principally consist of cash and cash equivalents,
accounts receivable, accounts payable and notes payable that are carried at
cost, which approximates fair value. The financing-related liability financial
instrument is recorded at fair value (note 6).
g) Stock-based Compensation
SFAS No. 123, "Accounting for Stock-based Compensation" ("SFAS 123"), provides
companies the alternative to adopt the fair value method for expense recognition
of employee stock options and stock-based awards or to continue to account for
such items using the intrinsic value method as outlined under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25") with pro forma disclosures of results of operations as if the fair
value method had been applied.
At September 30, 2003 we have two stock-based employee compensation plans. We
account for those plans under the recognition and measurement principles of APB
25 and related interpretations. The following table illustrates the effect on
net loss and net loss per share if we had applied the fair value recognition
provisions of SFAS 123 to stock-based compensation:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ---------------------
2003 2002 2003 2002
---- ---- ---- ----
Net loss, as reported .................... $ (1,811) $ (6,311) $(11,451) $(25,898)
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards ........ (742) (1,215) (2,054) (3,645)
-------- ----------- -------- --------
Pro forma net loss ....................... $ (2,553) $ (7,526) $(13,505) $(29,543)
======== =========== ======== ========
Net loss per common share --
basic and diluted:
As reported ............................. $ (0.07) $ (0.23) $ (0.42) $ (0.96)
======== =========== ======== ========
Pro forma ................................ $ (0.09) $ (0.28) $ (0.49) $ (1.09)
======== =========== ======== ========
We used the following range of assumptions to determine the fair value of stock
options granted using the Black-Scholes option-price model:
September 30,
-------------
2003 2002
------------- -------------
Dividend yield ................................ 0% 0%
Expected volatility ........................... 0% - 192% 0% - 192%
Average expected option life .................. 4 years 4 years
Risk-free interest rate ....................... 1.02% - 5.73% 1.41% - 5.73%
h) 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. The more significant areas involving the use of
estimates in these financial statements include allowances for uncollectible
accounts receivable, goodwill and intangible assets, valuation allowances for
deferred tax assets and deferred tax liabilities, foreign income taxes,
valuation of the financing-related liability and percentage of completion for
certain sales agreements accounted for under contract accounting. Actual results
could differ from those estimates.
8
i) Computation of Earnings Per Share
We compute earnings per share in accordance with SFAS No. 128, "Computation of
Earnings Per Share," or 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 common equivalent shares
outstanding during the period. Common equivalent 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). Common equivalent shares are excluded from the calculation
if their effect is anti-dilutive.
The following potential shares of common stock have been excluded from
the computation of diluted net loss per share for all periods presented because
the effect would have been anti-dilutive:
i) Three Months Ended September 30, 2003
Options to purchase approximately 5.7 million shares of common stock with a
weighted-average exercise price of $1.76 were outstanding during the three
months ended September 30, 2003 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 2.7 million options
that are vested, with a weighted average exercise price of $2.21, of which 1.1
million are vested and in the money, with a weighted average exercise price of
$0.12. The options have various expiration dates during the next 10 years.
Warrants to purchase approximately 2.7 million shares of common stock with a
weighted-average exercise price of $2.03 were vested and outstanding, including
2.5 million warrants which were not exercisable as of September 30, 2003, during
the three months ended September 30, 2003, 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 less
than 0.1 million warrants that are vested and in the money, with a weighted
average exercise price of $1.39. The warrants have various expiration dates
during the next 5 years.
ii) Nine Months Ended September 30, 2003
Options to purchase approximately 5.7 million shares of common stock with a
weighted-average exercise price of $1.76 were outstanding during the nine months
ended September 30, 2003 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 2.7 million options
that are vested, with a weighted average exercise price of $2.21, of which 1.0
million are vested and in the money, with a weighted average exercise price of
$0.09. The options have various expiration dates during the next 10 years.
Warrants to purchase approximately 2.7 million shares of common stock with a
weighted-average exercise price of $2.03 were vested and outstanding, including
2.5 million warrants which were not exercisable as of September 30, 2003, during
the nine months ended September 30, 2003, 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. No outstanding warrants are vested
and in the money. The warrants have various expiration dates during the next 5
years.
iii) 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 were exercisable, with a weighted average exercise price of $2.75, of which
0.7 million were vested and exercisable, with a weighted average exercise price
of $0.01.
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 were vested and in the money, with a weighted average exercise
price of $0.28.
iv) 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 were exercisable, with a weighted average exercise price of $2.75, of which
0.8 million were vested and exercisable, with a weighted average exercise price
of $0.19.
9
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 were vested and in the money, with a weighted average exercise
price of $0.28.
j) Recent Accounting Pronouncements
In May 2003, the Financial Accounting Standards Board, ("FASB"), issued SFAS No.
150, "Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity" ("SFAS 150"). SFAS 150 changes the accounting for
certain financial instruments that under previous guidance issuers could account
for as equity. It requires that those instruments be classified as liabilities
in balance sheets. The guidance in SFAS 150 is generally effective for all
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective on July 1, 2003. In October 2003, the FASB decided to defer
indefinitely the provisions of SFAS 150 related to mandatorily redeemable
noncontrolling interests. Early adoption of the deferred provisions is not
permitted. We do not expect the adoption of SFAS 150 to have a material impact
on our financial position, cash flows or results of operations.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149") which amends SFAS
133 for certain decisions made by the FASB Derivatives Implementation Group. In
particular, SFAS 149: (1) clarifies under what circumstances a contract with an
initial net investment meets the characteristic of a derivative, (2) clarifies
when a derivative contains a financing component, (3) amends the definition of
an underlying to conform it to language used in FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others," and (4) amends certain other
existing pronouncements. SFAS 149 is effective for contracts entered into or
modified after June 30, 2003, and for hedging relationships designated after
June 30, 2003. In addition, most provisions of SFAS 149 are to be applied
prospectively. We do not expect the adoption of SFAS 149 to have a material
impact on our financial position, cash flows or results of operations.
In March 2003 the FASB added a project to its agenda that will seek to improve
the accounting and disclosures relating to stock-based compensation, with a view
to issuing an Exposure Draft later this year that could become effective in
2004. The project will address whether compensation paid in the form of equity
instruments should be recognized in the financial statements and how that
compensation should be measured. In April 2003 the FASB decided that goods or
services received in exchange for compensation result in a cost that is
recognized in the income statement as an expense when the goods or services are
consumed by an enterprise, that the economic event being measured is the
exchange of goods or services received for stock-based compensation, that the
measurement focus of that exchange is the value of the goods or services
received, that the exchange should be measured at the grant date and that the
measurement attribute for the exchange is the fair value. The FASB believes
there is a need for one consistent approach to recognize the costs associated
with employee stock options, and is examining whether there are ways to improve
the precision and consistency of measuring the cost of employee stock options,
as well as whether to require additional informative disclosures. The FASB plans
to continue deliberations on this project through the fourth quarter of 2003,
and to issue an Exposure Draft in the first quarter of 2004. The FASB has set a
goal of completing its redeliberations and issuing a final statement in the
third quarter of 2004. The effective date of the proposed standard would be for
all equity-based compensation awards granted, modified or settled in years
beginning after December 15, 2004, with early adoption permitted.
In March and May 2003, respectively, the United States Congress introduced
proposed legislation titled the Broad-Based Stock Option Plan Transparency Act
(H.R. 1372 and S. 979, respectively), or the Bill, that calls for a three-year
moratorium on mandatory expensing of stock-based compensation and directs the
Securities and Exchange Commission to call for improved disclosure on employee
stock option plans. H.R. 1372 directs the Securities and Exchange Commission, or
SEC, to require, by rule, enhanced reporting disclosures of all employee stock
options given by publicly-traded companies. Additionally, the SEC would not be
permitted to recognize any new accounting standard related to stock options
until they have submitted a report to Congress on the effectiveness of the new
disclosures, following a three year period of study. The Bill would also require
that the Secretary of Commerce spend one year studying the impact of broad-based
employee stock option plans in expanding corporate ownership, recruiting skilled
workers, stimulating research and innovation and growing the U.S. economy.
Committees and subcommittees of the House and Senate are reviewing the Bills.
k) Guarantees
Our software license agreements typically provide for indemnification of
customers for intellectual property infringement claims. We also warrant to
customers, when requested, that our software products operate substantially in
accordance with standard specifications for a limited period of time. We have
not incurred significant obligations under customer indemnification or warranty
provisions historically, and do not expect to incur significant obligations in
the future. Accordingly, we do not maintain accruals for potential customer
indemnification or warranty-related obligations.
10
We have agreements in place with our directors and officers whereby we indemnify
them for certain events or occurrences while the officer or director is, or was,
serving at our request in such capacity. The maximum potential amount of future
payments we could be required to make under these indemnification agreements is
unlimited; however, we have a director and officer insurance policy that may
enable us to recover a portion of any future amounts paid.
l) Reclassifications
Certain prior year amounts have been reclassified to conform to the
current year presentation.
2) Supplemental Disclosure of Balance Sheet Information
Provision for Doubtful Accounts
Accounts receivable are net of provisions for doubtful accounts of $25
and $84 as of September 30, 2003 and December 31, 2002, respectively.
Acquired Intangible Assets
Accumulated amortization at September 30, 2003 and December 31, 2002 was
$571 and $73, respectively.
3) Notes Payable
As of September 30, 2003, we had approximately $55 outstanding on an equipment
line of credit with interest rates ranging from 12% to 13% and payments due
monthly over a 36 month period ending in December 2003. As of September 30,
2003, we are in compliance with all of the covenants under the equipment line of
credit.
4) Line of Credit
In June 2003 we executed a loan and security agreement with Silicon Valley Bank,
or the Bank, that provides us with a line of credit, or the Line, in the amount
of the lesser of $2,000 or the borrowing base, as defined (limited to a
percentage of eligible accounts receivable). The Line also provides for a
maximum of $1,000 in the form of letters of credit or other services from the
bank that reduces the amount of available borrowings under the Line. The Line
matures in June 2004, bears interest at the prime rate plus 1% (6.25% at
September 30, 2003), with a minimum rate of 5.25%, and is collateralized by
substantially all of our assets. We are required to comply with a tangible net
worth covenant, as defined in the loan and security agreement, and a minimum
available cash (including amounts available but undrawn under the Line)
covenant. At September 30, 2003, we were in compliance with our covenants and
approximately $448 was available and outstanding under the terms of the Line.
In connection with obtaining the Line, we issued a warrant to the Bank to
acquire 43,042 shares of our common stock at an exercise price of $1.39 per
share and which expires in June 2008. The estimated fair value of the warrant
issued was $44 and was recorded as debt issuance costs. We also incurred legal
and professional fees of approximately $38 in obtaining the Line. These amounts,
totaling $82, will be amortized over the one-year term of the Line and included
in interest expense.
At September 30, 2003 there were no letters of credit or other amounts for bank
services outstanding under the Line.
5) Accrued Expenses
Accrued expenses consist of the following:
September 30, December 31,
------------- ------------
2003 2002
---- ----
Legal and professional fees .................... $ 977 $1,202
Payroll and related costs ...................... 1,168 2,778
Severance ...................................... 59 355
Unutilized leased facilities ................... 714 566
Royalties to Israeli government agencies ....... 700 828
Legal settlements .............................. -- 277
Sales, excise and other taxes .................. 577 689
Other .......................................... 1,222 1,320
------ ------
$5,417 $8,015
====== ======
6) Private Placement
On September 23, 2003, we issued 4,918,100 shares of our common stock to certain
accredited investors in a private investment in public equity, or PIPE,
financing. The shares were sold at a price of $1.22 per share with gross
proceeds of $6,000. Subsequent to September 30, 2003, we paid placement and
legal and accounting fees of approximately $400 in connection with the
financing.
11
In connection with the PIPE financing, we also issued to the investors warrants
exercisable for the purchase of up to an aggregate of 2,459,050 shares of our
common stock at an initial exercise price of $1.71 per share. The number of
shares issuable upon exercise of the warrants and the exercise price thereof are
subject to adjustment for stock splits and similar transactions. In addition,
the number of shares issuable upon exercise of the warrants and the exercise
price are subject to adjustment on a weighted average basis in the event of
certain dilutive financings, subject to customary exceptions. The warrants are
exercisable any time beginning March 23, 2004 through September 23, 2008,
provided that, subject to certain limitations, any unexercised warrants will
expire upon 30 days notice if the closing bid price of a share of common stock
on NASDAQ equals or exceeds $3.42 (appropriately adjusted for any stock split,
recapitalization or similar event) for twenty consecutive trading days after
September 23, 2005.
The number of shares of common stock that may be acquired upon any exercise of
any of the warrants is limited to the extent necessary to insure that, following
such exercise, the total number of shares of common stock then beneficially
owned by such exercising holder and its affiliates does not exceed 19.999% of
the total number of issued and outstanding shares of common stock.
We also entered into a registration rights agreement with the investors in the
PIPE financing pursuant to which we were obligated to file a registration
statement on Form S-3 for the resale of the shares sold in the transaction and
the shares issuable upon exercise of the warrants with the SEC. The SEC declared
the registration statement effective on October 23, 2003. In the event that
sales cannot be made because we have not updated the registration statement to
keep it effective and to comply with securities law requirements, we will be
required to pay liquidated damages to each PIPE investor equal to 1.5% of the
purchase price paid by such investor for each thirty-day period or pro rata for
any portion thereof after the deadline that passes before the registration
statement is updated and declared effective by the SEC.
The FASB's Emerging Issues Task Force ("EITF") Issue No. 00-19, "Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock" ("EITF 00-19"), addresses accounting for equity derivative
contracts indexed to, and potentially settled in, a company's own stock ("equity
derivatives") by providing guidance for distinguishing between permanent equity,
temporary equity and assets and liabilities. EITF 00-19 addresses and clarifies
whether specific contract provisions or other circumstances cause a net-share or
physical settlement alternative to be within or outside the control of the
issuer. Under EITF 00-19, to qualify as permanent equity all the following
criteria must be met: the equity derivative contract must permit the company to
settle in unregistered shares, the company must have sufficient authorized but
unissued shares available to settle the contract, the contract must contain an
explicit limit on the number of shares to be delivered in a share settlement,
there can be no requirement in the contract to post collateral, there can be no
"make whole" provisions in the contract, there can be no provisions that could
require a net cash settlement to the holder of the contract and there can be no
provisions in the contract that indicate the counterparty has rights that rank
higher than those of a common shareholder. Equity derivative contracts accounted
for as permanent equity are recorded at their initial fair value and subsequent
changes in fair value are not recognized unless a change in the contracts
classification occurs. Equity derivative contracts not qualifying for permanent
equity accounting are recorded at fair value as an asset or liability with
subsequent changes in fair value recognized through the statement of operations.
EITF 00-19 provides that the ability to keep SEC filings current is beyond the
control of a registrant. Therefore, the potential liquidated damages we may be
required to pay pursuant to the registration rights agreement if we fail to keep
our registration statement effective is a potential net cash settlement pursuant
to EITF 00-19. While we view this liquidated damages contingency as neither
probable nor reasonably estimable, , we recorded the estimated fair value of the
warrant as of September 23, 2003 of $3,410 as a financing-related liability in
the consolidated balance sheet in accordance with EITF 00-19. The registration
rights agreement described above contains certain liquidated damages provisions
which could require us to pay the holders of the warrants cash under certain
unusual and unexpected circumstances. The fair value of the financing-related
liability is adjusted at each balance sheet date, with the non-cash change in
fair value reported in the consolidated statement of operations as other income
or expense. Upon the earlier of the exercise of the warrants or the expiration
of the period for which liquidated damages may be assessed against us, the fair
value of the financing-related liability will be reclassified to additional
paid-in capital.
12
The estimated fair value of the financing-related liability as of September 30,
2003 was $2,765. The $645 net change in the fair value from September 23, 2003
was recorded as other income in the consolidated statement of operations.
The estimated fair value of the warrant was calculated using the Black-Scholes
model and using the following assumptions:
September 30, September 23,
2003 2003
-------- --------
Current market price/share ................. $ 1.41 $ 1.70
Exercise price/share ....................... $ 1.71 $ 1.71
Dividend yield ............................. 0% 0%
Expected volatility ........................ 115% 115%
Expected life .............................. 5 years 5 years
Risk-free interest rate .................... 3.13% 3.13%
7) 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 and 15 of the Securities
Act of 1933 and Section 10(b) and 20(a) of the Securities Exchange Act of 1934
and Rule 10b-5 promulgated thereunder against one or both of us and the
individual defendants. The claims are based on allegations that the underwriter
defendants agreed to allocate stock in 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. Similar "IPO allocation" actions
have been filed against over 300 other issuers that have had initial public
offerings since 1998 and all are included in a single coordinated proceeding in
the Southern District of New York. Certain of our employees were members of the
putative classes alleged in these actions (the "Individual Defendants"). On July
15, 2002, we moved to dismiss all claims against the Individual Defendants and
us. On October 9, 2002, the Court dismissed the Individual Defendants from the
case without prejudice.
A proposal was made in July 2003 for the settlement and release of claims
against the issuer defendants, including us. The settlement is subject to a
number of conditions, including approval of the proposed settling parties and
the court. We believe the terms of the settlement will not have a material
impact on our results of operations, liquidity, and financial condition. If the
settlement does not occur, and litigation against us continues, we believe we
have meritorious defenses and intend to defend the case vigorously. However,
failure to successfully defend this action could substantially harm our results
of operations, liquidity and financial condition.
On March 20, 2003, Industria Politecnica Meridionale Spa., or IPM, filed a
complaint against us in the United States District Court for the Northern
District of California. The lawsuit alleges breach of the Ravisent Technologies
Internet Appliance Group, Inc., or RTIAG, agreement with IPM and fraud in
connection with the delivery of circuit boards to IPM that were not in
compliance with the agreement, and claims damages of $15,000 for breach of
contract, and $15,000 for fraud and punitive or exemplary damages. On May 2,
2003 we moved to dismiss all claims. On or about June 23, 2003, IPM filed an
amended complaint adding RTIAG as a party in the action and providing further
specificity on the fraud allegation. We withdrew our motion to dismiss shortly
thereafter. We filed an answer to the amended complaint on July 3, 2003 denying
the breach of contract and fraud claims. RTIAG filed a counterclaim on July 3,
2003 for breach of contract against IPM, seeking damages of $2,733 in addition
to interest, fees and costs. IPM filed an answer to the amended complaint on
July 22, 2003 denying the breach of contract claims. 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. We are unable to predict the
outcome of these matters or reasonably estimate an amount of loss given the
current status of this matter.
13
Various third parties have notified us, as well as some of our former customers
for our former digital media products, that our former DVD products infringe
patents held by such third parties. We have received notices of up to an
aggregate of $6,500 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 former products may have infringed 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, in 2002, accrued $375.
In March 2003 we entered into a confidential settlement agreement with Phoenix
Technologies and the remaining $550 of the purchase price for the sale of the
assets of our former Internet Appliance ("IA") business held in escrow by a
third party for indemnification purposes (included in restricted cash at
December 31, 2002), was paid to us and is no longer restricted. In connection
with this settlement agreement, we reversed accruals of approximately $743
initially recorded in March 2001 as part of the sale of our former IA business.
From time to time we are involved in lawsuits, claims, investigations or
proceedings, in addition to those identified above, consisting of intellectual
property, commercial, employment and other matters, which arise in the ordinary
course of business. In accordance with SFAS No. 5, we make a provision for a
liability when it is both probable that a liability has been incurred, and the
amount of the loss can be reasonably estimated. These provisions are reviewed at
least quarterly and adjusted to reflect the impacts of negotiations,
settlements, rulings, advice of legal counsel and other information and events
pertaining to a particular case. It is possible that our cash flows or results
of operations could be affected in any particular period by the resolution of
one or more of these contingencies.
14
8) Segment Information
We sell and license our technology to customers primarily in North America,
Europe and Asia. A significant portion 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 2003 2002
- -------------------------- ----------------- ----------------
% of % of
Total Total
----- -----
North America:
United States ............ $1,700 47% $2,192 50%
Canada ................... -- -- 378 9
------ ------ ------ ------
Total - North America 1,700 47 2,570 59
------ ------ ------ ------
Europe:
Germany .................. 141 4 65 2
France ................... 275 8 275 6
Netherlands .............. 111 3 134 3
Switzerland .............. 492 14 391 9
United Kingdom ........... 268 7 100 2
Other .................... 412 12 220 5
------ ------ ------ ------
Total - Europe ...... 1,699 48 1,185 27
------ ------ ------ ------
Asia-Pacific:
Israel ................... 49 1 105 3
Japan .................... 110 3 432 10
Other .................... 11 -- 58 1
------ ------ ------ ------
Total - Asia-Pacific 170 4 595 14
------ ------ ------ ------
Other ......................... 34 1 19 1
------ ------ ------ ------
Total ................ $3,603 100% $4,369 100%
====== === ====== ===
Nine Months Ended September 30,
--------------------------------
Country/ Geographic Region 2003 2002
- -------------------------- ----------------- ----------------
% of % of
Total Total
----- -----
North America:
United States ............ $ 3,882 39% $ 5,465 44%
Canada ................... 260 3 1,634 13
------- ------- ------- -------
Total - North America 4,142 42 7,099 57
------- ------- ------- -------
Europe:
Germany .................. 413 4 630 5
France ................... 1,073 11 1,307 10
Netherlands .............. 341 3 573 5
Switzerland .............. 908 9 615 5
United Kingdom ........... 365 4 339 3
Other .................... 904 10 651 5
------- ------- ------- -------
Total - Europe ...... 4,004 41 4,115 33
------- ------- ------- -------
Asia-Pacific:
Israel ................... 214 2 274 2
Japan .................... 1,237 13 804 6
Other .................... 95 1 180 1
------- ------- ------- -------
Total - Asia-Pacific 1,546 16 1,258 9
------- ------- ------- -------
Other ......................... 102 1 80 1
------- ------- ------- -------
Total ................ $ 9,794 100% $12,552 100%
======= === ======= ===
15
9) Segment Reporting
Segment information is presented in accordance with Statement of Financial
Account 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 2003, DRM is our reportable segment.
The DRM segment was created as a result of the acquisition of eMation in
December 2001. The Axeda DRM System is a distributed software solution designed
to enable businesses to remotely monitor, manage and service intelligent
devices. DRM enables the live exchange of information via the Internet, between
remotely deployed "intelligent devices" (instruments, equipment, machines,
facilities, appliances, sensors or systems incorporating computer-based control
technology) and the people that build, service and use them. The Axeda DRM
System enables manufacturers and service providers 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. The
product offerings enable customers to gain business insight and benefits from
live information sources by helping them capitalize on the wealth of previously
unavailable device performance and usage data. eMation historically derived its
main source of revenues from its industrial automation products, which are now
also offered as Axeda Agent components of our DRM System. We also continue to
separately sell such industrial automation products, such as the Axeda
Supervisor, Axeda @aGlance/IT, Axeda Web@aGlance and Axeda FactorySoft OPC, to
support our traditional industrial automation business.
We evaluate operating segment performance based on revenue and gross profit. We
have not historically evaluated segment performance based on operating income or
allocated assets to our individual operating segments.
Three Months Ended September 30,
--------------------------------
2003 2002
------ ------
Revenues:
DRM ............................. $3,499 $2,799
Other ........................... 104 1,570
------ ------
Total ................... $3,603 $4,369
====== ======
Gross profit:
DRM ........................ $2,432 $ 911
Other ...................... 104 1,162
------ ------
Total ................... $2,536 $2,073
====== ======
Nine Months Ended September 30,
-------------------------------
2003 2002
------- -------
Revenues:
DRM ....................... $ 9,258 $ 7,496
Other ..................... 536 5,056
------- -------
Total ............. $ 9,794 $12,552
======= =======
Gross profit:
DRM .................. $ 5,262 $ 2,345
Other ................ 286 2,081
------- -------
Total ......... $ 5,548 $ 4,426
======= =======
16
10) Consolidated Statements of Cash Flows
Supplemental disclosure of cash flow information:
Nine Months Ended September 30,
-------------------------------
2003 2002
----- -------
Cash paid during the period for:
Interest .................................................................... $ 32 $ 107
Income taxes (refund) ....................................................... 33 (308)
===== =======
Non-cash investing and financing activities:
Amortization of deferred stock compensation ................................. 441 1,147
===== =======
Common stock financing-related liability .................................... 3,410 --
===== =======
Issuance of warrants in connection with common stock financing .............. 76 --
===== =======
Issuance of warrants in connection with bank line of credit ................. 44 --
===== =======
Issuance of stock options in connection with grants below fair value ........ 38 50
===== =======
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
===== =======
11) Comprehensive Income (Loss)
The components of comprehensive loss are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net loss .................................... $ (1,811) $ (6,311) $(11,451) $(25,898)
Foreign currency translation adjustment ..... 53 (121) 59 4
-------- -------- -------- --------
Comprehensive loss .......................... $ (1,758) $ (6,432) $(11,392) $(25,894)
======== ======== ======== ========
17
ITEM 2:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This report 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 to differ from those discussed herein. Such factors include, but
are not limited to: our ability to become profitable; future expenses; future
results of operations; uncertainties in the market for DRM solutions and the
potential for growth in the DRM market; our ability to raise capital; the
potential for NASDAQ delisting; declining sales of our legacy products; our
dependence on the cyclical software industry; present and future competition;
our ability to manage technological change and respond to evolving industry
standards; the long sales cycle for DRM solutions; our customers' ability to
integrate our DRM solutions into and deploy their products successfully and in a
timely fashion; 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; risks from international
operations; and others discussed under "Factors that may Affect Future Results -
Risk Factors" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations." 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 that are 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.
Overview and Recent Events
On September 23, 2003, we issued 4,918,100 shares of our common stock to certain
accredited investors in a private investment in public equity, or PIPE,
financing. The shares were sold at a price of $1.22 per share with gross
proceeds of $6 million. The gross proceeds from the financing will be reduced by
placement fees and legal and accounting fees of approximately $0.4 million. In
connection with the PIPE financing, we also issued to the investors warrants
exercisable for the purchase of up to an aggregate of 2,459,050 shares of our
common stock at an initial exercise price of $1.71 per share.
Beginning in the second quarter of 2002, we initiated a series of steps designed
to consolidate and streamline our operations, and decrease our operating losses
and corresponding use of cash. We have halved the number of global offices,
reduced staffing levels by approximately 46%, and have closely monitored our
infrastructure costs. We exited the PC business and focused our efforts on
several key markets for DRM Systems products. In 2002 and through the third
quarter of 2003, we recorded approximately $1.9 million and $1.4 million in
restructuring charges, respectively, to reduce staffing levels, to terminate
certain leases and consolidate our operations. Combined with our expected
continued year over year growth in DRM Systems revenues, we believe that future
operating losses will continue to be lower than in previous quarters. We will
continue to evaluate our cost structure and may undertake additional measures to
reduce expenses in the future.
In May 2002 we entered into a Software Distribution Agreement with Sonic IP,
Inc. ("Sonic"), a wholly-owned subsidiary of Sonic Solutions. As a result, we
exited the personal computer, or PC, business and terminated or assigned to
Sonic substantially all of the customer contracts of our PC business. As a
result, a comparison of our results in 2003 with 2002 may not provide a
meaningful indication of our future performance.
On December 7, 2001, we acquired all of the outstanding shares of eMation, Ltd.,
or eMation, a private company organized under the laws of the State of Israel.
The acquisition gave us an entry into the DRM market and changed our strategic
focus to the enterprise software and services market. eMation historically
derived its main source of revenues from its industrial automation products,
which are now offered as Axeda Agent components of our DRM System. While we
continue to sell the components of the DRM System, such as the Axeda Supervisor,
Axeda @aGlance/IT, Axeda Web@aGlance 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 enterprise component of the Axeda DRM System. For
the nine months ending September 30, 2003, substantially all of our license and
services revenues were from sales of our DRM solutions.
18
Results of Operations
Three and Nine Months Ended September 30, 2003 Compared to Three and Nine Months
Ended September 30, 2002.
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
(In thousands)
Three Months Ended September 30, Nine Months Ending September 30,
---------------------------------------------- ------------------------------------------
2003 2002 2003 2002
----------------------- --------------------- -------------------- ---------------------
Percent of Percent of Percent of Percent of
Amount Revenues Amount Revenues Amount Revenues Amount Revenues
------ -------- ------ -------- ------ -------- ------ --------
Revenues:
License ............................ $ 2,575 71.5% $ 3,421 78.3% $ 7,050 72.0% $ 9,039 72.0%
Services and maintenance ........... 924 25.6 795 18.2 2,457 25.1 2,012 16.0
Hardware ........................... 104 2.9 153 3.5 287 2.9 1,501 12.0
-------- -------- -------- ------ -------- ------ -------- ------
Total revenues ................... 3,603 100.0 4,369 100.0 9,794 100.0 12,552 100.0
-------- -------- -------- ------ -------- ------ -------- ------
Cost of revenues:
License ............................ 151 4.2 579 13.2 976 10.0 2,396 19.1
Services and maintenance ........... 757 21.0 1,163 26.6 2,794 28.5 2,870 22.8
Hardware ........................... -- -- 29 0.7 1 -- 1,281 10.2
Software amortization .............. 159 4.4 525 12.0 475 4.8 1,579 12.6
-------- -------- -------- ------ -------- ------ -------- ------
Total cost of revenues ........... 1,067 29.6 2,296 52.5 4,246 43.3 8,126 64.7
-------- -------- -------- ------ -------- ------ -------- ------
Gross profit .......................... 2,536 70.4 2,073 47.5 5,548 56.7 4,426 35.3
-------- -------- -------- ------ -------- ------ -------- ------
Research and development
Non-cash compensation ............. 28 0.8 31 0.7 84 0.9 129 1.0
Other research and development
expense .......................... 969 26.9 1,655 37.9 4,090 41.8 5,977 47.6
Sales and marketing
Non-cash compensation ............. 10 0.3 17 0.4 27 0.3 55 0.4
Other selling and marketing
expense .......................... 1,777 49.3 3,836 87.8 6,558 66.9 13,628 108.6
General and administrative
Non-cash compensation ............. 108 3.0 103 2.3 381 3.9 1,202 9.6
Other general and administrative
expense .......................... 1,747 48.5 2,401 55.0 6,267 64.0 8,495 67.7
Provision for doubtful accounts ... -- -- (27) (0.6) (3) -- (49) (0.4)
Depreciation and amortization ......... 278 7.7 422 9.7 848 8.6 1,062 8.5
Special charges ....................... -- -- -- -- -- -- 820 6.5
-------- -------- -------- ------ -------- ------ -------- ------
Total Operating Costs ................. 4,917 136.5 8,438 193.0 18,252 186.4 31,319 250.0
-------- -------- -------- ------ -------- ------ -------- ------
Operating loss ........................ (2,381) (66.1) (6,365) (145.7) (12,704) (129.7) (26,893) (214.2)
Gain (loss) on sales of assets ........ -- -- (86) (2.0) 743 7.6 (123) (1.0)
Interest income (expense), net and
other income (expense), net ........... 615 17.1 140 3.2 650 6.9 450 3.6
-------- -------- -------- ------ -------- ------ -------- ------
Loss before income tax (benefit) ...... (1,766) (49.0) (6,311) (144.5) (11,311) (115.2) (26,566) (211.6)
Income tax expense (benefit) .......... 45 1.2 -- -- 140 1.4 (668) (5.3)
-------- -------- -------- ------ -------- ------ -------- ------
Net loss .............................. $ (1,811) (50.2)% $(6,311 (144.5)% $(11,451) (116.6) (25,898) (206.3)%
======== ===== ======= ====== ======== ====== ======= ======
19
AXEDA SYSTEMS INC.
Results of Operations
Revenues. Overall revenues decreased by $0.8 million or 18% and $2.8 million or
22%, to $3.6 million and $9.8 million, during the three and nine months ending
September 30, 2003, respectively, compared to the same periods in 2002. Sales of
our DRM solutions increased $0.7 million and $1.8 million, while PC and hardware
sales decreased $1.5 million and $4.5 million during the three and nine months
ending September 30, 2003, respectively.
License revenues for the three and nine months ending September 30, 2003
decreased by approximately $0.8 million and $2.0 million, respectively, compared
to the same periods in 2002. The decrease in license revenues was mainly
attributable to the discontinuation of our former PC business, which declined by
$1.2 million and $3.1 million during the three and nine months ending September
30, 2003, respectively, from the year earlier periods. Partially offsetting
these decreases were increases in DRM license revenues of approximately $0.4
million and $1.1 million during the three and nine months ending September 30,
2003, respectively. We do not expect any future license revenues from our former
PC business, and expect DRM System license revenues to increase as our DRM
Systems are more widely adopted.
Hardware revenues remained flat and decreased by $1.2 million for the three and
nine months ending September 30, 2003, respectively, compared to the same
periods in 2002, due to decreased sales of components for our former Internet
appliances and Internet set-top boxes. We expect future hardware revenues and
related gross profit to be minimal.
Services and maintenance revenues increased $0.1 million and $0.4 for the three
and nine months ending September 30, 2003, respectively, compared to the same
periods in 2002. The increase over the three and nine-month periods in
comparison to the same period in 2002 is due to a greater demand for
professional services in connection with existing DRM installations, as well as
additional maintenance plans sold with our DRM Systems. We anticipate services
and maintenance revenues will vary, as opportunities in this area is subject to
our customers' requirements and approval process.
Historically, the majority of our revenues have been derived from a small number
of customers. However, as our model has shifted to the enterprise software
market, our revenues are becoming less concentrated. For the three and nine
month periods ending September 30, 2003, our top five customers accounted for
$1.7 million, or 46%, and $2.5 million, or 26%, of our total revenues,
respectively. For the three and nine month period ending September 30, 2002, our
top five customers accounted for $2.3 million, or 53%, and $4.5 million, or 36%,
of our total revenues, respectively. In the future, we expect our revenues to be
less concentrated as sales of our enterprise software and services span a wider
customer base. There has also been a shift in industry-wide buying patterns for
enterprise software, from large up-front purchases to smaller, more frequent
purchases over time.
We sell our DRM System solutions primarily to companies in the industrial and
building automation, high technology devices, medical instrumentation, and
office automation industries. In the quarter ending September 30, 2003 customers
based in North America accounted for 46% of our revenues. We anticipate that
revenues from international operations will continue to represent a significant
portion of our revenues.
Cost of Revenues. Cost of revenues decreased by $1.2 million and $3.9 million,
or 54% and 48%, respectively, to $1.1 million and $4.2 million for the three and
nine months ending September 30, 2003 compared to the same periods in 2002.
Cost of revenues for license fees for the three and nine months ending September
30, 2003 decreased by approximately $0.4 million and $1.4 million, respectively,
compared to the same periods in 2002, due to a decrease in costs associated with
our former PC products. We expect our cost of license fees as a percentage of
license revenues to decline, as our license revenues are now comprised entirely
of our DRM products.
Cost of revenues for hardware sales remained flat and decreased by $1.3 million
for the three and nine months ending September 30, 2003, respectively, compared
to the same periods in 2002. The decrease in cost of hardware revenues for the
three months ended is due our inventories having been substantially fully
reserved since June 30, 2002. The decrease in cost of hardware revenues for the
nine months ended corresponds directly to the decrease in our hardware sales, as
well as the fully-reserved state of our inventories.
Cost of revenues for services and maintenance decreased by $0.4 and $0.1 for the
three and nine months ending September 30, 2003, respectively, compared to the
same periods in 2002. The $0.4 million decrease in cost of services and
maintenance for the three months ending September 30, 2003 is attributable to a
$0.3 million and $0.1 million decrease in DRM professional staff expense and PC
service expense. We expect our cost of services and maintenance as a percentage
of services and maintenance revenues to remain approximately the same, as our
service and maintenance costs are adjusted to meet the requirements of our
customers.
20
Software amortization of our developed and core technologies for the three and
nine months ending September 30, 2003 decreased by $0.4 and $1.1 million,
respectively, compared to the same periods in 2002, due to an impairment of our
identified intangibles in the fourth quarter of 2002. Non-cash amortization of
acquired technology will represent approximately $0.6 million of our cost of
revenues for the year ending December 31, 2003.
Gross Profit. Gross profit increased $0.5 million and $1.1 million, or 22% and
25%, to $2.5 million and $5.5 million for the three and nine months ending
September 30, 2003, respectively, compared to the same periods in 2002. The
increase in gross profit is largely attributable to an increase in revenues from
our DRM license fees and the higher gross profit associated with such revenues,
increased DRM service and maintenance revenues, and reduced software
amortization expense. Offsetting these increases were corresponding decreases in
revenue and gross profit from our former PC products.
For the three and nine months ending September 30, 2003, 71% and 72% of our
total revenues were derived from license fees in comparison to 78% and 72%
during the same periods in the prior year. As a percentage of total revenues,
gross profit increased from 47% to 70% for the three months ending September 30,
2003 and 35% to 57% for the nine months ending September 30, 2003, compared to
the same periods in 2002. The increase in gross profit margin was largely due to
increased revenues and associated gross profit from our DRM licenses fees and
reduced software amortization expense.
DRM license gross profit margin was 94% and 86% for the three and nine months
ending September 30, 2003, respectively, and 86% and 84% for the three and nine
months ending September 30, 2002, respectively. Services and maintenance plans
gross profit margin was 18% and negative 14% for the three and nine months
ending September 30, 2003, respectively, reflecting an improvement in the
billable utilization of professional services employees. For the three and nine
months ending September 30, 2002 services and maintenance plans gross profit
margin was negative 46% and negative 43%, respectively. The variability in our
services and maintenance gross profit margin reflects the variability in our
services revenues, and cost savings from our recent restructuring efforts.
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, quality assurance
and testing. Research and development expenses decreased $0.7 million and $1.9
million, or 41% and 32%, to $1.0 million and $4.1 million for the three and nine
months ending September 30, 2003, respectively, compared to the same periods in
2002.
The $0.7 million decrease in the three months ending September 30, 2003 was
attributable to the discontinuance of the PC development team during 2002, which
contributed $0.3 million as well as a decrease in staff related and other costs,
which totaled $0.4 million. The $1.9 million decrease in the nine months ending
September 30, 2003 was due to the discontinuance of the PC development team,
which contributed $1.5 million as well as a decrease in staff related and other
costs, which totaled $0.4 million. As a percentage of revenues, research and
development expenses decreased from 38% to 27%, and 48% to 42% for the three and
nine months ending September 30, 2003, compared to the same periods in 2002. We
expect research and development expenses to remain at approximately the same
level from the quarter ending September 30, 2003 for the remainder of 2003.
Additionally, we expect research and development expenses to decrease as a
percentage of revenues as our future revenues increase.
Sales and Marketing Expense. Other sales and marketing expenses consist of
salaries, travel expenses and costs associated with trade shows, advertising and
other sales and marketing efforts, as well as technical support costs. Sales and
marketing expenses decreased approximately $2.1 million and $7.1 million, or 54%
and 52%, to $1.8 million and $6.6 million for the three and nine months ending
September 30, 2003, respectively, compared to the same periods in 2002.
Decreases in sales staff headcount, severance and the elimination of our former
business development personnel focused on professional services in 2002
contributed $0.7 million, $0.2 million and $0.2 million to the decrease in sales
and marketing expense for the three months ending September 30, 2003 compared to
the same periods in the prior year. In addition, reduced public relations, trade
shows and advertising expense equally contributed approximately $0.3 million for
the three month period ending September 30, 2003 over the prior year. Finally,
reductions in travel, subcontractors, the closure of our Israeli office, and
other expenses contributed $0.2, $0.1, $0.1 and $0.3 million, respectively, to
the decrease for the three months ending September 30, 2003, compared to the
same period in the prior year.
21
The elimination of our former business development personnel focused on
professional services in 2002, decreases in sales staff headcount, and the
elimination of our former PC sales team and initial branding expense contributed
$2.8 million, $0.8 million and $0.6 million to the decrease in sales and
marketing expense for the nine months ending September 30, 2003 compared to the
same periods in the prior year. In addition, reduced public relations, trade
shows and advertising, expense equally contributed approximately $0.6 million
for the nine month period ending September 30, 2003 over the prior year. Also,
reductions in travel, subcontractors, the closure of our Israeli office,
contributed $0.4, $0.5, and $0.4 million. Finally, reduced collateral, severance
and other expenses contributed $0.2 million, $0.2 million and $0.5 million,
compared to the same period in the prior year.
As a percentage of revenues, sales and marketing expenses decreased from 88% to
49%, and 109% to 67%, respectively, for the three and nine months ending
September 30, 2003, compared to the same periods in 2002. We expect sales and
marketing expenses to remain at approximately the same level from the quarter
ending September 30, 2003 for the remainder of 2003. Additionally, we expect
sales and marketing expenses to decrease as a percentage of revenue as our
future revenues increase.
Other General and Administrative Expense. Other general and administrative
expenses consist of staff, staff related, and support costs for our finance,
human resources, legal and other management departments. Other general and
administrative expenses decreased $0.7 million and $2.2 million, or 27% and 26%,
to $1.7 million and $6.3 million for the three and nine months ending September
30, 2003, respectively, compared to the same periods in 2002. As a percentage of
total revenues, other general and administrative expenses decreased from 55% to
48%, and 68% to 64% of total revenues for the three and nine months ending
September 30, 2003, respectively, compared to the same periods in 2002.
Rent and other expense to support our former PC business and staff related
expense contributed $0.3 million and $0.2 million to the decrease in general and
administrative expense for the three months ending September 30, 2003 compared
to the same periods in the prior year. In addition, insurance and the closure of
our Israeli office each contributed $0.1 million to the decrease in general and
administrative expense for the three months ending September 30, 2003 compared
to the prior year.
Reduced staffing, expenses to support our former PC business and estimated
intellectual property expense contributed $0.7 million, $0.4 million, and $0.4
million, respectively, to the decrease for the nine months ending September 30,
2003 compared to the same period in the prior year. In addition, cost reductions
associated with the closure of our Israeli office, reduced travel and other
expense contributed $0.3 million, $0.1 million and $0.3 million to the decrease
in general and administrative expense for the nine months ending September 30,
2003 compared to the same periods in the prior year. Finally, decreases in third
party consultants were offset by an increase in severance expense for the nine
months ending September 30, 2003, compared to the same periods in 2002. We
expect general and administrative expense to remain at approximately the same
level from the quarter ending September 30, 2003 for the remainder of 2003.
Additionally, we expect general and administrative expense to decrease as a
percentage of revenue as our future revenues increase.
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 $1.2 million
for the nine months ending September 30, 2002 to $0.4 million for the nine
months ending September 31, 2003. The decrease is attributable to modifications
to certain outstanding stock options and deferred stock compensation expense
incurred in 2002. No similar expense was incurred during in the first nine
months of 2003. For the nine months ending September 30, 2002, a $0.4 million
expense was incurred for the acceleration of option vesting in accordance with
the termination of certain employment agreements. In addition, $0.2 million was
the result of amortization of deferred stock 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 2002 non-cash
compensation general and administrative expense was attributable to a one-time
charge of $0.2 million for the modification of stock options held by a former
employee.
Depreciation and Amortization. We recorded depreciation and amortization of $0.3
million and $0.4 million and $0.8 million and $1.1 million for the three and
nine months ending September 30, 2003, respectively compared to the same periods
in 2002. The decrease in amortization expense is due to the partial impairment
of identified intangible assets recorded in connection with our acquisition of
eMation in December 2001.
Special Charges. Special charges for the nine months ending September 30, 2002
consisted of items related to our exit from the PC business in May 2002. The
charges included $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. No special
charges were recorded for the nine months ending September 30, 2003.
22
Gains on Disposals of Assets. We signed a confidential settlement agreement in
March 2003 for the escrow relating to the sale of the assets of our former IA
business in March 2001. In connection with this settlement agreement, we
reversed accruals of approximately $0.7 million recorded in March 2001 as part
of the sale. No corresponding gains were recorded for the nine months ending
September 30, 2002.
Interest Income and (Expense), net. Net interest income decreased by $0.4
million or 93% for the nine months ending September 30, 2003 compared to the
same period in 2002. The decrease is the result of lower average cash balances
and lower bank interest rates in 2003.
Other income and (expense), net. While we view the liquidated damages
contingency related to the financing-related liability as neither probable nor
reasonably estimable, we recorded the estimated fair value of the warrant as of
September 23, 2003 as a financing-related liability in the consolidated balance
sheet in accordance with EITF 00-19. The fair value of the financing-related
liability is adjusted at each balance sheet date, with the non-cash change in
fair value reported in the consolidated statement of operations as other income
or expense. The related mark-to-market non-cash gain for the quarter ending
September 30, 2003 was $0.6 million. Due to the uncertainty surrounding the
variables required by the valuation model for the financing-related liability
and corresponding gain or loss adjustment, it is difficult to estimate the
future income or expense resulting from the periodic valuations of the
liability.
Provision for Income Taxes (Benefit). The income tax benefit recorded for the
nine months ending 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.
23
LIQUIDITY AND CAPITAL RESOURCES
Since March 2001, our operations have largely been financed through the sales of
the assets of our Consumer Electronics and Internet Appliance businesses and the
September 2003 PIPE financing. As of September 30, 2003, we had approximately
$11.4 million in cash and cash equivalents.
Net cash used in operating activities for the nine months ending September 30,
2003 was $13.4 million, compared to $20.0 million for the nine months ending
September 30, 2002. Cash used in operating activities for the nine months ending
September 30, 2003 was primarily the result of our net loss of approximately
$11.4 million and other changes in working capital of approximately $2.4
million, offset by approximately $0.4 million for the net non-cash expenses,
gains on asset disposals and financing-related gain. The reduction in net cash
used in operations is primarily the result of the lower net loss.
Beginning in the second quarter of 2002, we initiated a series of steps designed
to consolidate and streamline our operations, and decrease our operating losses
and corresponding use of cash. We have halved the number of global offices,
reduced staffing levels by approximately 46%, and have closely monitored our
infrastructure costs. We exited the PC business and focused our efforts on
several key markets for DRM Systems products. In 2002 and through the third
quarter of 2003, we recorded $1.9 million and $1.4 million in restructuring
charges, respectively, to reduce staffing levels, to terminate certain leases
and consolidate our operations. We will continue to evaluate our cost structure
and may undertake additional measures to reduce expenses in the future.
Net cash used in investing activities for the nine months ending September 30,
2003 was $0.1 million, as compared to $2.2 million for the nine months ending
September 30, 2002, and consisted of purchases of furniture and equipment in
both periods. We have no material commitments for capital expenditures, and we
anticipate minimal spending on capital expenditures as our needs in operations,
infrastructure and personnel arise.
Net cash provided by financing activities was $5.8 million for the nine months
ending September 30, 2003 and consisted of net proceeds from the issuance of
common stock of $5.6 million and borrowings under a bank line of credit of $0.4
million, offset by principal payments reducing other indebtedness of $0.2
million. Net cash used in financing activities of $2.0 million for the nine
months ending September 30, 2002 consisted of principal payments reducing other
indebtedness.
In June 2003, we executed a loan and security agreement with Silicon Valley Bank
that provides us with a line of credit, or the Line, in the amount of the lesser
of $2 million or the borrowing base, as defined (limited to a percentage of
eligible accounts receivable). As of September 30, 2003, we had $0.4 million in
borrowings under the Line, which was repaid in October 2003. In addition, we had
approximately $0.1 million outstanding on an equipment loan facility, or the
Loan, with payments due monthly over a 36 month period ending in December 2003.
As of September 30, 2003, we were in compliance with all of our covenants under
the Line and the Loan.
In September 2003, we issued 4,918,100 shares of our common stock to certain
accredited investors in a private investment in public equity, or PIPE,
financing. The shares were sold at a price of $1.22 per share with gross
proceeds of approximately $6.0 million. Subsequent to September 30, 2003, we
paid placement and legal and accounting fees of approximately $0.4 million in
connection with the financing. In connection with the PIPE financing, we also
issued to the investors warrants exercisable for the purchase of up to an
aggregate of 2,459,050 shares of our common stock at an initial exercise price
of $1.71 per share.
As of September 30, 2003, we have $1.4 million of estimated accrued costs
related to facilities that we no longer occupy. We have made significant efforts
to terminate these occupancy arrangements, but if these arrangements cannot be
terminated, we may be required to make these payments.
We maintain an irrevocable, cash-secured, standby letter of credit, or the
letter of credit, from a bank for $0.15 million as security for our corporate
headquarters lease. The letter of credit expires on August 31, 2004 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 on August 31, 2004. This amount is restricted for
withdrawal and is included in other assets (non-current) in our consolidated
balance sheets.
Based on our cash resources, our expected continued year over year growth in DRM
Systems revenues and the continued realization of savings from our already
implemented expense reductions, we expect to have sufficient cash resources to
meet our cash needs through at least 2004. However, due to risks and
uncertainties, we cannot assure investors that our future operating cash flows
will be sufficient to meet our requirements. In such event, our operations and
liquidity will be materially adversely affected.
Additional financing may not be available when needed and, if such financing is
available, it may not be available on terms favorable to us.
24
Employee and Director Stock Options
Option Program Description
Our stock option program is a broad-based, long-term retention program that is
intended to attract, retain and provide performance incentives for talented
employees, officers and directors, and to align stockholder and employee
interests. Currently, we grant options from the 1999 Stock Incentive Plan, as
amended (the "1999 Plan"). The 1999 Plan has three separate programs which
include: the discretionary option grant program, under which employees may be
granted options to purchase shares of common stock; the stock issuance program,
under which eligible employees may be granted shares of common stock; and the
automatic grant program, whereby eligible non-employee board members are granted
options to purchase shares of common stock. To date, we have not issued any
shares under the stock issuance program. In addition, our stock option program
includes the 1995 Stock Option Plan (the "1995 Plan"), from which we no longer
grant options. In connection with the eMation acquisition, we assumed options
issued under eMation, Ltd.'s 2001 Stock Option Plan that became exercisable for
up to 1,428,710 shares of our common stock, 530,000 of which are exercisable for
$0.01 per share and the remaining 898,710 exercisable at $2.14 per share. No
options have been or will be granted under the eMation, Ltd. 2001 Stock Option
Plan subsequent to our acquisition of eMation, Ltd. The plans listed above are
collectively referred to in the following discussion as "the Plans." We consider
our option programs critical to our operation and productivity; essentially all
of our employees participate. Option vesting periods are generally 1 to 4 years
and expire 10 years from the grant date for the 1999 Plan. Option vesting
periods are generally 2 to 5 years and expire 5 to 10 years from the grant date
for the 1995 Plan.
All stock option grants to executive officers are made after a review by and
with the approval of the Compensation Committee of the Board of Directors. All
members of the Compensation Committee are independent directors, as defined in
the current and proposed rules applicable to issuers traded on the NASDAQ Stock
Market. See the "Compensation Committee Report in Executive Compensation"
appearing in our 2003 Proxy Statement for further information concerning our
policies and procedures, including those of the Compensation Committee,
regarding the use of stock options.
Distribution and Dilutive Effect of Options
The table below provides information about stock options granted for the
nine months ended September 30, 2003 and for the year ended December 31, 2002 to
our Chief Executive Officer and our three other executive officers, Dale E.
Calder, Thomas J. Fogarty and John C. Roberts. This group is referred to as the
"Named Executive Officers."
Options granted to Named Executive Officers for the nine months ended
September 30, 2003 and the year ended December 31, 2002 are summarized as
follows:
Nine Months Ended Year Ended
September 30, December 31,
2003 2002
------- -------
Net grants during the period as % of outstanding shares (#) ......... 4.04% 9.17%
Grants to Named Executive Officers during the period as % of
total options granted (%) ........................................... 11.87% 13.82%
Grants to Named Executive Officers during the period as % of
outstanding shares granted (%) ...................................... 0.48% 1.27%
Cumulative options held by Named Executive Officers as % of total
options outstanding (%) ............................................. 34.93% 40.90%
25
General Option Information
The following table sets forth the summary of activity under the Plans
for the nine months ended September 30, 2003 and the year ended December 31,
2002:
Options Outstanding
----------------------------------------
Number of Shares Number of Shares Weighted Average
Available for Issuable on Exercise Exercise Price
Options of Options (per share)
------- ---------- -----------
December 31, 2001 771,301 3,781,592 $2.43
------- --------- -----
Grants (2,533,700) 2,533,700 1.63
Exercises - (207,331) 0.26
Cancellations* 925,823 (1,029,142) 3.27
Additional shares reserved 1,100,000 N/A
--------- ---
December 31, 2002 263,424 5,078,819 $1.95
======= =========
Grants (1,306,000) 1,306,000 1.46
Exercises - (74,437) 0.12
Cancellations* 469,610 (581,471) 2.89
Additional shares reserved 1,100,000 N/A
--------- ---
September 30, 2003 527,034 5,728,911 $1.76
======= ========= =====
* The "Number of Shares Available for Options" does not include options under
assumed plans exercisable for 103,319 and 111,861 shares that were cancelled
during 2002 and the first nine months of 2003, respectively, as no options will
be granted in the future pursuant to these assumed plans.
The following table sets forth a comparison, as of September 30, 2003, of the
number of shares subject to our options whose exercise prices were at or below
the closing price of our common stock on September 30, 2003 ("In-the-Money"
options) to the number of shares subject to options whose exercise prices were
greater than the closing price of our common stock on such date
("Out-of-the-Money" options):
Exercisable Unexercisable Total
----------- ------------- -----
Weighted Weighted
Average Average
Number of Exercise Number of Exercise Number of Weighted Average
Shares Price Shares Price Shares Exercise Price
In-the-money 1,061,044 $ 0.11 1,310,976 $ 0.49 2,372,020 $ 0.32
Out-of-the-money (1) 1,664,903 $ 3.54 1,691,988 $ 2.03 3,356,891 $ 2.78
Total options outstanding 2,725,947 $ 2.21 3,002,964 $ 1.36 5,728,911 $ 1.76
(1) Out-of-the-money options are those options with an exercise price equal to
or above the closing price of $1.41 as of September 30, 2003, as reported by the
NASDAQ National Market.
Executive Options
The following table sets forth information regarding stock options granted
in nine months ended September 30, 2003, to our Named Executive Officers,
each under our 1999 Plan. Options were granted with an exercise price equal
to or less than the closing price of our common stock on the date of grant.
Potential realizable values are net of exercise price, but before taxes
associated with exercise. These amounts represent hypothetical gains that
could be achieved for the options if exercised at the end of the option
term of ten (10) years. The assumed 5% and 10% rates of stock price
appreciation are provided for purposes of illustration only and do not
represent our estimate or projection of the future price of our common
stock.
26
Individual Grants
Number of Potential Realizable Value
Securities Percentage of Total Exercise at Assumed Annual Rates of
Underlying Option Options Granted to Price (Per Expiration Stock Price Appreciation for
Name Per Grant Employees * Share) Date Option Terms
- ---- --------- ----------- ------ ---- ------------
5% 10%
-- ---
Robert M. Russell, Jr - - N/A N/A N/A N/A
Dale E. Calder ....... - - N/A N/A N/A N/A
Thomas J. Fogarty .... 100,000 7.66% $ 0.01 4/28/2013 $ 66,703 $111,272
John C. Roberts ...... 55,000 4.21% $ 1.45 9/24/2013 $ 40,450 $ 67,476
*Based on a total of 1,306,000 shares subject to options granted to employees
under our option plans during the nine months ended September 30, 2003.
Stock Option Exercises and Option Holdings
The following table shows stock options exercised by the Named Executive
Officers for the nine months ended September 30, 2003, if any, including the
total value of gains on the date of exercise based on actual sale prices or on
the closing price that day if the shares were not sold that day, in each case
less the exercise price of the stock options. In addition, the number of shares
covered by both exercisable and non-exercisable stock options, as of September
30, 2003, is shown. Also reported are the values for "In-the-Money" options. The
dollar amounts shown in the "In-the-Money" column represent the positive spread
between the exercise price of any such existing stock options and the closing
price as of September 30, 2003 of our common stock.
Number of
Shares
Acquired on Value Number of Securities Underlying Values of Unexercised In-the-Money
Exercise Realized Unexercised Options Options*
-------- -------- ------------------- --------
Named Executive
Officer Exercisable Unexercisable Exercisable Unexercisable
------- ----------- ------------- ----------- -------------
Robert M. Russell - $ - 486,496 394,504 $351,089 $ 256,621
Dale E. Calder - - 503,125 71,875 436,219 92,531
Thomas J. Fogarty - - 327,706 102,294 331,937 91,063
John C. Roberts - - 26,874 88,126 19,388 22,913
* Option values based on stock price of $1.41 on September 30, 2003.
Equity Compensation Plan Information
The following table gives information about our common stock that may be issued
upon the exercise of options under all of our Plans as of September 30, 2003:
(1) (2) (3)
Number of Securities
Number of Securities Weighted-Average Remaining Available for
to be Issued upon Exercise Price of Future Issuance Under Equity
Exercise of Outstanding Options, Compensation Plans (Excluding
Outstanding Options, Warrants, and Rights Securities Reflected in
Plan Category Warrants, and Rights (per share) Column (1) )
- ------------- -------------------- ----------- ------------
Equity Compensation Plan Approved by
Shareholders (A) (B) 4,525,381 $1.90 527,034
========= ===== =======
27
(A) 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, pursuant to a share purchase agreement amended and restated
as of October 5, 2001. In connection with such acquisition, we assumed
options issued under eMation, Ltd.'s 2001 Stock Option Plan that
became exercisable for up to 1,428,710 shares of our common stock,
530,000 of which are exercisable for $0.01 per share and the remaining
898,710 exercisable at $2.14 per share. No options have been or will
be granted under the eMation, Ltd. 2001 Stock Option Plan subsequent
to our acquisition of eMation, Ltd.
(B) The number of shares reserved for issuance under our 1999 Stock
Incentive Plan is automatically increased on January 1 of each year by
an amount equal to three percent (3%) of the shares of Common Stock
outstanding on the last trading day of the immediately preceding
calendar year, but in no event shall such annual increase exceed one
million (1,000,000) shares. On January 1, 2003, 600,000 additional
shares were reserved for issuance. At our 2003 annual stockholders
meeting, proposals were approved increasing the limit of six hundred
thousand (600,000) shares on the amount by which the share reserve
under the plan automatically increases at the beginning of each year
will to one million (1,000,000) shares, and increasing the number of
shares authorized for issuance over the term of the Plan (prior to any
automatic increase) by an additional 500,000 shares.
Recent Accounting Pronouncements
Information regarding recent accounting pronouncements is provided in note 1j to
the consolidated financial statements included at Part I, Item 1 herein.
28
Axeda Systems Inc.
FACTORS THAT MAY AFFECT FUTURE RESULTS
RISK FACTORS
Our business is subject to a number of risks. 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 loss before income taxes of approximately $11.3 million for the nine
months ended September 30, 2003. 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
and support and administrative expenses. To achieve profitability, we will need
to increase revenues and/or reduce expenses significantly. We cannot assure you
that our revenues will grow or that we will achieve or maintain profitability in
the future.
Our future success depends upon the acceptance of our DRM solutions.
Our future growth will be driven by sales of Axeda DRM Systems and related
services. We acquired eMation, Ltd., or eMation, a private Israeli company, in
December 2001. eMation was founded in 1988 and historically derived its main
source of revenues from its industrial automation products. We offer the Axeda
DRM System and also continue to separately sell the Axeda Supervisor, Axeda
@aGlance/IT, Axeda Web @aGlance and Axeda FactorySoft OPC to support our
traditional industrial automation business.
Revenues from our legacy products, which include Axeda Supervisor, Axeda
@aGlance/IT, Axeda Web@aGlance and Axeda FactorySoft OPC, have decreased and we
expect that revenues from these products will continue to decline in the future
as we focus our efforts on the development of the Axeda DRM System.
Revenues from eMation's legacy products, which include Axeda Supervisor, Axeda
@aGlance/IT, Axeda Web@aGlance and Axeda FactorySoft OPC, accounted for a
significant portion of its historical revenues but have declined recently. We
anticipate that revenues from our legacy products will continue to decline in
the future as we plan to continue to focus on the Axeda DRM System.
It may be difficult to raise needed capital in the future, which could
significantly harm our business.
We may require additional capital to finance our future growth and fund our
ongoing research and development activities. Our capital requirements will
depend on many factors, including but not limited to the following:
o acceptance of and demand for our DRM products;
o our ability to continue year over year growth in DRM Systems revenues;
o the costs of developing new products; o the extent to which we invest in
new technology and research and development projects;
o competing technological and market developments; and
o the expansion of strategic alliances for the sales, marketing,
manufacturing and distribution of our products.
To the extent that the currently available funds and revenues are insufficient
to meet current or planned operating requirements, we will be required to seek
additional funds through equity or debt financing, strategic alliances with
corporate partners and others, or through other sources. There can be no
assurance that the financial sources described above will be available when
needed or on terms commercially acceptable to us. If adequate funds are not
available, we may be required to delay, further scale back or eliminate certain
aspects of our operations or attempt to obtain funds through arrangements with
collaborative partners or others that may require us to relinquish rights to
certain of our technologies, products or potential markets. If adequate funds
are not available, our business, financial condition and results of operations
will be materially and adversely affected. If we issue additional stock to raise
capital, your percentage ownership in Axeda would be reduced.
29
Failure to comply with NASDAQ's listing standards could result in our delisting
by NASDAQ from the NASDAQ National Market and severely limit the ability to sell
any of our common stock.
Our common stock is currently traded on the NASDAQ National Market. There can be
no assurance that our common stock will remain eligible for trading on the
NASDAQ National Market. 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 on the over-the-counter market. This may have a negative impact on the
liquidity and price of our common stock.
Economic and political 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 medical instruments, enterprise technology, industrial and
building automation equipment, and office equipment and print production
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. The
September 11, 2001 terrorist attacks, consequences of the war in Iraq, and the
possibility of war or hostilities relating to other countries, and changes in
international political conditions as a result of these events, may continue to
affect the United States and the global economy, and could materially and
adversely affect the growth rate of our software license and services revenues
and have a material 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 period prior to the
eMation acquisition as an indication of our future performance because our
business model has changed significantly since the sales of the assets of our
consumer electronics, or CE, and Internet appliance, or IA, businesses in the
first quarter of 2001, the license of our personal computer, or PC, technology
to Sonic in May 2002 and the acquisition of eMation in December 2001.
We may not be able to compete effectively.
Competition in the market for DRM solutions is emerging and expected to grow
stronger. 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 have a material adverse effect on
our business.
We may not be able to keep pace with technological advances.
The process of remotely extracting and managing 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 have a material
adverse effect on our business.
30
Our sales cycle for DRM Systems 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 DRM Systems
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 nine to twelve months or more
from the time we first contact a prospective customer before receiving an
initial order. The length of our DRM Systems sales cycle may also depend on a
number of additional factors, including but not limited to 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 icense;
o the sales channel through which the solution is sold; o the economic
conditions in the United States and abroad; 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 may 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 have typically recognized 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.
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. There has been a shift
in industry-wide buying patterns for enterprise software, from large up-front
purchases to smaller, more frequent purchases over time. A variation in the
revenue pipeline or in the conversion of the revenue pipeline into contracts
could cause us to plan or budget inaccurately and thereby could adversely affect
our business, financial condition or results of operations.
Our customers' ability to integrate our DRM solutions with their products can be
difficult, time-consuming and expensive and they may be unable to deploy their
products successfully or otherwise achieve the benefits attributable to our DRM
solutions.
Our customers often desire to integrate our DRM solutions with their existing
products, computer systems and software programs. This can be complex,
time-consuming and expensive, and may cause delays in the deployment of our
customers' products. As a result, some customers may have difficulty or be
unable to integrate our products successfully or otherwise achieve the benefits
attributable to our products. Delayed or ineffective integration of our DRM
solutions may limit our ability to expand our revenues, and may result in
customer dissatisfaction, causing harm to our reputation.
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.
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 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:
31
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.
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 may 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.
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. We regard
the protection of patentable inventions as important to our business. We
currently have eleven United States patent applications pending relating to our
DRM business and thirteen patent applications pending internationally. It is
possible that our pending patent applications may not result in the issuance of
patents or that our patents may not be broad enough to protect our proprietary
rights.
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 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 security buttons may not be
successful in preventing unauthorized use of our software.
32
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 revenues. 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 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 device 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:
o delay or loss of revenues;
o 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 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. 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.
33
We have received notices of claims related to our former PC products (or digital
media products) regarding the alleged infringement of third parties'
intellectual property rights that may cause us to pay damages.
Some third parties claim to hold patents covering various aspects of digital
television, or DTV, high-definition television, or HDTV, and digital versatile
disk, or DVD technology incorporated into our former and our former PC
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:
A group of companies 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 were incorporated into our former PC products.
Another group of companies 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 were incorporated into
our former PC products.
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.
If MPEG LA, DVD6C, 3C, or any other third party proves that our former digital
media products infringe their proprietary rights, we may be required to pay
substantial damages for such past infringement.
We may also be liable to some of our former customers for damages that they
incur in connection with intellectual property claims. Some of our license
agreements with former customers contain warranties of non-infringement and/or
commitments to indemnify our former 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, 3C
and others. These commitments may require us to indemnify or pay damages to our
former 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 $6.5
million asserting rights under the indemnification provisions and warranty
provisions of our license agreements from several of our former digital media
products customers. We may be required to pay substantial damages with respect
to such indemnification assertions, which could have a material adverse effect
on our business, financial condition or results of operations.
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 had a balance of $0.2 million of unamortized deferred
stock compensation as at September 30, 2003 that will be amortized as follows:
$0.1 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.
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 France, Germany, the
Netherlands, Japan, the United Kingdom, Israel and other countries in Asia and
Latin America. Our operations outside the United States include facilities
located in France and Japan. For the nine months ended September 30, 2003, we
derived approximately 61% 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. 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.
34
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 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.
We are subject to conditions attached to governmental grants we have received in
Israel.
Prior to being acquired by us in December 2001, eMation received grants in
Israel from the Office of the Chief Scientist of Israel's Ministry of Industry
and Trade, or OCS, in the aggregate amount of $1.8 million to fund the
development of our Axeda Supervisor product. We have paid royalties to the OCS
in the aggregate amount of $1.4 million. As of September 30, 2003, $0.3 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
OCS. The terms of the OCS 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, or Marketing Fund, in the aggregate amount of $1.2 million
and royalties in the aggregate amount of $0.6 million have been repaid. As of
September 30, 2003, $0.4 million of the remaining potential $0.6 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 Marketing Fund.
Because of their significant stock ownership, our officers and directors can
exert significant influence over our future direction.
As of September 30, 2003, our executive officers, directors and entities
affiliated with them, in the aggregate, beneficially owned approximately 4.0
million shares, or approximately 13%, 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.
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 million 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.
35
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.
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, or GAAP. GAAP are subject to
interpretation by the Financial Accounting Standards Board, the American
Institute of Certified Public Accountants, or AICPA, the Securities and Exchange
Commission, or 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.
36
ITEM 3:
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop products in the United States and sell such products in North
America, Asia and various countries in Europe. 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.
ITEM 4. CONTROLS AND PROCEDURES
Based on their evaluation of our disclosure controls and procedures as required
by Rules 13a-15(b) and 15d-15(b), our Chief Executive Officer and Chief
Financial Officer have concluded that as of September 30, 2003 our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated
under the Securities Exchange Act of 1934) are effective.
37
AXEDA SYSTEMS INC.
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 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. 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 and 15 of the Securities
Act of 1933 and Section 10(b) and 20(a) of the Securities Exchange Act of 1934
and Rule 10b-5 promulgated thereunder against one or both of us and the
individual defendants. The claims are based on allegations that the underwriter
defendants agreed to allocate stock in 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. Similar "IPO allocation" actions
have been filed against over 300 other issuers that have had initial public
offerings since 1998 and all are included in a single coordinated proceeding in
the Southern District of New York. Certain of our employees were members of the
putative classes alleged in these actions (the "Individual Defendants"). On July
15, 2002, we moved to dismiss all claims against the Individual Defendants and
us. On October 9, 2002, the Court dismissed the Individual Defendants from the
case without prejudice.
A proposal has been made for the settlement and release of claims against the
issuer defendants, including us. The settlement is subject to a number of
conditions, including approval of the proposed settling parties and the court.
We believe the terms of the settlement will not have a material impact on our
results of operations, liquidity, and financial condition. If the settlement
does not occur, and litigation against us continues, we believe we have
meritorious defenses and intend to defend the case vigorously. However, failure
to successfully defend this action could substantially harm our results of
operations, liquidity and financial condition.
On March 20, 2003, Industria Politecnica Meridionale Spa. ("IPM"), an Italian
corporation, filed a complaint against us in the United States District Court
for the Northern District of California. The lawsuit alleges breach of an
agreement between IPM and our wholly owned subsidiary Ravisent Technologies
Internet Appliance Group, Inc. ("RTIAG") and fraud in connection with the
delivery of circuit boards to IPM that were not in compliance with the
agreement, and claims damages of $15 million for breach of contract, and $15
million for fraud and punitive or exemplary damages. On May 2, 2003, we moved to
dismiss all claims against it. On or about June 23, 2003, IPM filed an amended
complaint adding RTIAG as a party in the action and providing further
specificity on the fraud allegation. The Company withdrew its motion to dismiss
shortly thereafter. Axeda and RTIAG filed an answer to the amended complaint on
July 3, 2003 denying the breach of contract and fraud claims. RTIAG filed a
counterclaim on July 3, 2003 for breach of contract against IPM, seeking damages
of $2.7 million, plus interest, fees and costs. IPM filed an answer to the
amended complaint on July 22, 2003 denying the breach of contract claims. 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.
38
From time to time, we have received notices of claims of infringement of other
parties' proprietary rights and other claims in the ordinary course of our
business. See "Factors that may Affect Future Results - Risk Factors - We have
received notices of claims related to our PC products regarding the alleged
infringement of third parties' intellectual property rights that may cause us to
pay damages." 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
adverse effect on our business, financial condition or results of operations.
Item 2: CHANGES IN SECURITIES
RECENT SALES OF UNREGISTERED SECURITIES
On September 23, 2003, we issued 4,918,100 shares of our common stock to certain
accredited investors in a private investment in public equity, or PIPE,
financing. In connection with the PIPE financing, we also issued to the
investors warrants exercisable for the purchase of up to an aggregate of
2,459,050 shares of our common stock at an initial exercise price of $1.71 per
share. The shares and warrants were issued in a private placement exempt from
registration under the Securities Act of 1933 pursuant to Section 4(2) of the
Act.
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.
Item 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The exhibits listed on the Exhibit Index (following the Signatures section of
this report) are included, or incorporated by reference, in this quarterly
report.
(b) The following reports were filed on Form 8-K during this period:
On September 23, 2003 the Registrant filed a Form 8-K to announce that it had
completed a private placement of its common stock and warrants to certain
accredited investors.
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities 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 Mansfield,
Commonwealth of Massachusetts on this 14th day of November 2003.
November 14, 2003
Axeda Systems Inc.
/s/ Thomas J. Fogarty
-----------------
Thomas J. Fogarty
Executive Vice President and Chief Financial Officer
40
EXHIBIT INDEX
Pursuant to Item 601(a)(2) of Regulation S-K, this Exhibit
Index immediately precedes the exhibits.
The following exhibits are included, or incorporated by reference, in this
Quarterly Report on Form 10-Q (and are numbered in accordance with Item 601 of
Regulation S-K):
EXHIBITS
Exhibit Number Exhibit Title
- -------------- -------------
2.1 Asset Acquisition Agreement dated as of January 18, 2001 among STMicroelectronics, Inc.,
STMicroelectronics, NV and RAVISENT Technologies Inc., RAVISENT I.P., Inc. and RAVISENT Operating
Company, Inc. (3)
2.2 Asset Acquisition Agreement dated as of March 21, 2001 among Phoenix Technologies Ltd. and RAVISENT
Internet Appliance Group, Ravisent I.P., Inc. and RAVISENT Operating Company, Inc. (4)
2.3 Amended and Restated Share Purchase Agreement dated as of October 5, 2001 by and among RAVISENT
Technologies Inc., a Delaware corporation, eMation, Ltd., a private company organized under the laws of
the State of Israel and certain of the shareholders of eMation, Ltd. (5)
3.1 Amended and Restated Certificate of Incorporation. (1)
3.2 Bylaws of Axeda Systems Inc., as amended by the Board of Directors on February 22, 2002. (2)
3.3 Certificate of Ownership and Merger of Axeda Systems Inc., a Delaware corporation with and into Ravisent
Technologies Inc., a Delaware corporation, dated as of January 10, 2002. (6)
4.1 Form of registrant's Specimen Common Stock Certificate. (1)
10.1 Purchase Agreement, dated September 22, 2003, by and among Axeda Systems Inc. and the investors named on
the signature pages thereto. (7)
10.2 Registration Rights Agreement, dated September 23, 2003, by and among Axeda Systems Inc. and the investors
named on the signature pages thereto. (7)
10.3 Form of Common Stock Warrant. (7)
10.4 * + Employment Agreement dated September 25, 2003 by and between Axeda Systems Inc. and John C. Roberts
10.5 * Amendment #1 to License and Distribution Agreement effective August 15, 2003
31.1 * Certification of the Chief Executive Officer of Axeda Systems Inc. required pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 * Certification of the Chief Financial Officer of Axeda Systems Inc. required pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 * Certification of the Chief Executive Officer and Chief Financial Officer of Axeda Systems Inc. required
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
FOOTNOTES:
(1) Incorporated by reference to The registrant's registration statement on Form S-1 declared effective
with Securities and Exchange Commission on July 15,1999 (File No. 333-77269).
(2) Incorporated by reference to the registrant's current report on Form 8-K dated February 25, 2002 as filed
with the Securities and Exchange Commission on February 27, 2002.
(3) Incorporated by reference the registrant's current report on Form 8-K dated March 1, 2001, as filed with
the Securities and Exchange Commission on March 16, 2001.
(4) Incorporated by reference to the registrant's current report on Form 8-K dated March 23, 2001, as filed
with the Securities and Exchange Commission on April 9, 2001.
(5) Incorporated by reference to the registrant's Definitive Proxy Statement on Form 14A dated November 9,
2001, as filed with the Securities and Exchange Commission on November 19, 2001.
(6) Incorporated by reference to the registrant's quarterly report on Form 10-Q for the quarterly period
ended March 31, 2002.
(7) Incorporated by reference to the registrant's current report on Form 8-K dated September 23, 2003 as filed
with the Securities and Exchange Commission on September 23, 2003.
* Filed herewith.
+ Compensation plans and arrangements for executives and others
41