SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[X] Annual Report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934
For the year ended December 31, 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
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g)of the Act:
Common Stock, par value $.001 per share
Indicate by check mark whether the registrant (1) has filed all reports required
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in the definitive proxy statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of such common stock held by non-affiliates of the
registrant, based on the closing price of such shares on the NASDAQ National
Market was approximately $25,072,838 as of June 30, 2003. Shares of common stock
held by each executive officer and director and each person known to us who
beneficially owns 5% or more of our outstanding common stock have been excluded
from this computation in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
The number of shares of registrant's common stock outstanding as of March 22,
2004 was 32,469,862.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement prepared in connection with its
2004 Annual Meeting of Stockholders, which is expected to be filed with the
Securities and Exchange Commission on or before April 30, 2004, are incorporated
by reference into Part III of this Annual Report on Form 10-K where indicated.
The table of Exhibits filed appears on page 84.
Axeda Systems Inc.
Form 10-K Annual Report
(Year Ended December 31, 2002)
Table of Contents
Part I
Page
Item 1 Business ........................................................3
Item 2 Properties .....................................................19
Item 3 Legal Proceedings ..............................................20
Item 4 Submission of Matters to a Vote of Security Holders ............21
Part II
Item 5 Market for Registrant's Common Equity and Related Stockholder
Matters .................................................... 22
Item 6 Selected Financial Data ........................................24
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations ....................................25
Item 7A Quantitative and Qualitative Disclosures About Market Risk .....43
Item 8 Financial Statements and Supplementary Data ....................44
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ....................................79
Item 9A Controls and Procedures.................... ....................79
Part III
Item 10 Directors and Executive Officers of the Registrant .............80
Item 11 Executive Compensation .........................................80
Item 12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters ..................80
Item 13 Certain Relationships and Related Transactions .................80
Item 14 Principal Accountant Fees and Services..........................80
Part IV
Item 15 Exhibits, Financial Statement Schedules, and Reports
on Form 8-K .................................................81
1
Cautionary Statement Concerning Forward-Looking Statements
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; our dependence on the cyclical software
industry; present and future competition; our ability to manage technological
change and respond to evolving industry standards; our ability to manage growth;
the long sales cycle for DRM solutions; our customers' ability to implement or
integrate our DRM solutions 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 "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.
2
PART I
ITEM 1. BUSINESS OF AXEDA
This Annual Report on Form 10-K includes certain registered trademarks and
tradenames of Axeda Systems Inc. Axeda, Axeda Systems, Axeda DRM, Axeda Device
Relationship Management System, Axeda Agent, Axeda Applications, Axeda
Enterprise, Axeda Software Management, Axeda Usage, Axeda Access, Axeda Service,
Axeda Device, Axeda Administration, Axeda Supervisor, Axeda Connector, Axeda
Gateway, Axeda Builder, Wizcon, Axeda @aGlance/IT, Axeda Web@aGlance, Axeda
FactorySoft OPC, Firewall-Friendly and Access. Insight. In Real Time. are
trademarks of Axeda Systems Inc. All other trademarks are property of their
respective owners, and are hereby acknowledged.
OVERVIEW
Axeda is a software and services company providing an emerging category of
business software known as Device Relationship Management, or DRM. Our flagship
product, the Axeda DRM System, is a distributed software solution designed to
enable businesses to remotely monitor, manage and service intelligent devices.
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.
Axeda customers include Global 2000 original equipment manufacturers, or OEMs,
in the Medical Instrument, Enterprise Technology, Printer and Copier and
Industrial and Building Automation industries.
COMPANY HISTORY
We were incorporated in Pennsylvania in April 1994 as Quadrant Sales
International, Inc. and changed our name to Quadrant International, Inc. in May
1994. In April 1999, we changed our name to Divicore Inc. and then
reincorporated in Delaware as RAVISENT Technologies Inc. in June 1999. We
changed our name to Axeda Systems Inc. in January 2002. 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. During 2002 our revenues were increasingly
generated from selling DRM products, and for 2003, substantially all of our
revenues were generated from selling DRM products. Our revenues in 2001 were
substantially generated from sales from our Internet Appliance, or IA, business,
our consumer electronics, or CE, business and our personal computer, or PC,
business.
Our IA business was involved in the development of products for the emerging
market in information appliances. This business sold IA hardware reference
designs and software technology through intellectual property licenses and
agreements with Internet service providers. This business provided us with a
number of Internet-related products, including an efficient web browser, and
several IA reference designs including a Web Pad design, Internet ready TV and
monitor designs and an Internet-ready screenphone. We sold the assets of our IA
business, excluding inventory, to Phoenix Technologies Ltd., or Phoenix, for $18
million in March of 2001.
Our CE business designed, developed, licensed and marketed software solutions
that enabled digital video and audio stream management in CE devices. This
business also provided supporting hardware designs to selected customers as well
as customization services and customer support. Our CE solutions enabled
decoding (playback) and encoding (recording) of multimedia formats such as
digital versatile disk or DVD; direct broadcast satellite or DBS and
high-definition television or HDTV on existing CE platforms. We sold the assets
of our CE business to STMicroelectronics, NV in March 2001 for approximately
$55.6 million.
We also generated revenue from our PC business until our exit from this business
in 2002. Our PC business designed, developed, licensed and marketed software
solutions that enabled digital video and audio stream management in PC systems.
Our PC solutions enabled decoding (playback) and encoding (recording) of
multimedia formats such as DVD, DBS and HDTV on existing personal computers. We
exited the PC business pursuant to an exclusive license with Sonic IP, Inc. in
May 2002 for a $2 million license fee.
3
Our DRM and Other products generated the following revenues for the last three
years:
Year Ended December 31,
--------------------------------------
2003 2002 2001
---- ---- ----
(In thousands)
Revenues:
DRM $12,622 $10,876 $ 1,614
Other 572 7,253 5,975
--- ----- -----
Total $ 13,194 $ 18,129 $ 7,589
======== ======== =======
A description of our segments is provided in note 17 to the consolidated
financial statements included at Item 8 herein. Asset and revenue information
about the geographic areas we operate in is included in notes 13 and 16 to the
consolidated financial statements, filed herewith at Item 8.
DRM INDUSTRY BACKGROUND
Computer-based control systems are increasingly the heart of new devices,
machines or systems made today. These intelligent systems consist of hardware
and software that is used to control the operation of the device as it is
running, perform diagnostics, and enable external systems or people to input or
query data that may be generated during operation. Depending on the cost and the
complexity of the device, all of this capability may be embedded within the
device itself or portions of it may reside on external computers that perform a
supervisory control function for one or more related devices.
Intelligent devices generate valuable information as they are operating.
Initially, this information was only made available locally through custom
control interfaces on the device itself. As embedded systems and PC technology
became pervasive and inexpensive, these devices moved to "soft" interfaces where
operators worked at computer screens to monitor and control devices. These soft
interfaces could be local to the device or more recently, could be remotely
accessible via computer networks. In many markets and for many devices, this
remains the state of the art today.
eMation, a company we acquired in December 2001, has built and marketed products
to address real-time device control and data management needs in the industrial
automation market since the late 1980s. These products include supervisory
control and data acquisition or SCADA systems for single or multiple devices.
They feature computer-based human-machine interface, or HMI, capability for
local monitoring, and offer sophisticated features for enabling remote control,
monitoring, HMI, and data management of device data via proprietary networks or
the Internet. Our communications technology enables multiple supervisory systems
or other real-time control and data management applications to be connected over
networks to remote operators or software systems.
eMation identified an opportunity in the late 1990s to develop a "DRM System" to
use the Internet to enable businesses to remotely monitor, manage and service
intelligent devices. The growth of the Internet provided a ubiquitous, open,
global network to tap into the data locked within intelligent devices. Devices
contain valuable information that could be used to control and monitor not only
their output, but also their health and operation. Business could work better if
these devices could communicate and if everyone in a business could tap directly
into the information within the devices they sell and service, or the systems
they use. For example, companies could benefit if they could tell when machines
are out of raw materials or about to fail, how many times they were used in a
week, how a facility was operating, or what features were most popular in
products in use by their customers. Based on this information, companies could
lower costs, operate more efficiently, and add new sources of revenue.
4
AXEDA DRM SOLUTIONS
The Axeda DRM System is a software solution that leverages the Internet to
provide real-time, continuous exchange of information between remote devices,
business systems and people. It allows timely, accurate and unbiased information
to be communicated automatically, via the Internet, between remote devices
deployed at customer facilities and external service personnel or enterprise
business systems. Patent-pending Axeda technology allows intelligent devices
hidden behind customer firewalls to have secure two-way Internet-based
communication with external sales and service personnel and their enterprise
applications. This enables companies to connect directly to their deployed
products rather than relying on feedback filtered through their users.
The Axeda DRM System can be used on a stand-alone basis where, for example,
personnel in a service department use the system on a day-to-day basis to
monitor and diagnose remote devices installed at customer sites. Further, Axeda
DRM solutions can be used to feed information to existing installed enterprise
software systems. These could include enterprise resource planning, customer
relationship management or CRM, and supply chain and asset management systems.
The Axeda DRM System is our major business focus. We complement our DRM products
with professional services, training, and support offerings. We leverage our mix
of experience in embedded systems, enterprise software, and the Internet to
solve difficult problems with practical solutions. We also continue to
separately sell the Axeda Supervisor, Axeda @aGlance/IT, Axeda Web@aGlance and
Axeda FactorySoft OPC to support our industrial automation business.
OUR STRATEGY
Our objective is to be the leading provider of DRM solutions and services in
targeted industries. Key elements of our strategy include:
o Reducing service costs in ready markets. We are focused on helping
device manufacturers in targeted industries provide better customer
service at lower cost. We intend to continue to expand our products
and services to ensure broad and successful adoption of the Axeda DRM
System in customer service operations within our target accounts.
o Reaching additional information stakeholders. Device data stored
within the Axeda DRM System is also available to additional
information stakeholders both inside and outside the company. We offer
applications that provide solutions to marketing, sales, operations
and product development departments. For example, our Axeda Usage
application enables marketing and sales departments to monitor how a
device is performing or how much consumable has been used during
operation, enabling proactive decisions about product development,
marketing programs, or automated upgrade or re-supply.
o DRM-enabling complementary products and solutions. We seek alliances
with complementary solution suppliers whose customers can benefit from
the availability of live device data within their businesses.
o Leverage our industrial automation experience. We are leveraging our
industrial automation products from a broad library of connectivity
software we have established to accelerate acceptance of the Axeda DRM
System within related markets. For example, Axeda Supervisor can be
used as part of a full Axeda DRM System or independently on a
stand-alone basis as per our industrial automation customers.
MARKETS
We market our DRM solutions to device OEMs and strategic large-scale end users
in a variety of industries. We target specific industries that have significant
service costs and uptime requirements as well as complex, intelligent systems.
Our current target industries are:
o Medical Instruments
o Office and Print Production Systems
o Enterprise Technology Equipment
o Industrial and Building Automation
We believe these industries have the greatest current need and most appropriate
systems for our DRM Solutions, because they utilize complex, computer
controlled, electro-mechanical devices that cannot afford downtime. They also
often use "consumables" in their operation that operators want to automatically
and remotely monitor and re-supply.
5
PRODUCTS AND SERVICES
The Axeda DRM System is a distributed software system that lets companies use
the Internet to remotely monitor, manage, and service intelligent devices
deployed at their customers' sites. It consists of a three tier architecture
with Axeda Agent software deployed in or near the remote device, an Axeda
Enterprise server that centrally receives and securely manages the information
flowing to and from remote devices, and Axeda Applications that let field
service or other enterprise personnel access, analyze, process and use the DRM
device information for business purposes. Axeda Agent software is configured to
monitor specific device data, process or filter it locally, and securely package
the information for sending to and from the device through customer firewalls.
Axeda Enterprise software manages the two way information communication with
devices, collects, stores and manages this information, and triggers actions per
specified business rules. Axeda Applications provide a family of web
browser-based software solutions that use device data and connectivity for a
variety of business processes including remote diagnostics and repair, usage
tracking, access and control, and software release management. Certain Axeda
Applications control the administration and configuration of the DRM System
itself.
Axeda Applications
Axeda Applications employ web-architected interfaces for remote device
administration, application sharing, usage tracking, software management,
diagnostics and data visualization. Whether remotely calibrating a product at a
customer site, administering a remote desktop, graphing real-time data for a
device, or updating profile information in hundreds of installed products, Axeda
DRM users access all information via their standard web browsers. No special
client-side software is required. Axeda Applications currently include:
o Axeda Service provides web-based access to global summaries and
statistics of all operating devices and enables field service and
technical support representatives to drill down for information from
an individual device to access the status for problem diagnosis and
resolution. Axeda Service provides interactive real-time and
historical data as well as automatic alarm notification and analysis
to enable fast reaction to potential problems.
o Axeda Access extends the remote monitoring and diagnostics capability
of the Axeda DRM System to include the remote administration of
software applications, databases, desktop computers, servers and
operating systems, increasing responsiveness to customer problems and
avoiding costly on-site service calls without compromising corporate
network security. It also allows support specialists to remotely
assist operators in the correct use of the device.
o Axeda Administration and Axeda Device let companies map the complex
relationships between users and devices with tools to configure device
business rules, define device information, and create and maintain
user information. They allow organizations to provide proactive
service worldwide while ensuring that only authorized personnel have
access to sensitive device information.
o Axeda Usage provides a window into device operation and customer
behavior, enabling companies to proactively identify usage trends.
Axeda Usage's flexible design lets it measure a wide variety of usage
types as appropriate to the targeted device. Its built-in intelligence
enables automatic interactions with existing enterprise applications.
For example, medical device manufacturers can measure the number of
tests performed by their instruments; service providers for printers
and copiers can track toner usage or predict remaining equipment life;
and enterprise technology makers can track system performance or disk
space utilization in data storage equipment.
o Axeda Software Management enables the efficient, secure, reliable and
cost-effective mass distribution of software modules such as
application and operating system updates, patches, documentation and
help files via Axeda patent-pending Firewall-Friendly Internet
communications technology. It also allows the rapid retrieval of key
files, such as log, data and configuration files from deployed
devices. Axeda Software Management enables users to automate complex,
remote installation and retrieval procedures by encapsulating
sequences of device and configuration instructions with the files.
6
Axeda Enterprise
- ----------------
Axeda Enterprise server software provides a secure, fault-tolerant
infrastructure for communicating and managing the information exchange between
remote devices and businesses. Axeda Enterprise software acts as a device data
center, storing and managing live and historical information in a secure
environment. Business rules drive automated device data analysis and
notification of people or initiate transactions with other enterprise business
systems such as billing, maintenance, help-desk, inventory, re-supply, ordering
and asset management. The Axeda Integrator for Siebel provides seamless
integration between Axeda Enterprise and the Siebel 7 Field Service application
from Siebel Systems Inc. The Axeda Integrator for SAP provides similar certified
integration with the mySAP.com e-business platform. The Axeda Enterprise SDK
adds the ability to customize Axeda Applications and create new custom
applications that leverage the power of the Axeda DRM System. Sophisticated
security features assure data is encrypted and authenticated as it moves between
devices and users. Access controls assure only the right people can access
designated devices. An integrated reporting engine enables data to be published
and analyzed.
Intelligent Agents
- ------------------
Axeda Agent products at the device allow distributed monitoring, communications
and control. These software products run on or are attached to devices, allowing
local data processing and two-way, Firewall-Friendly communications with the
enterprise. By putting intelligence on devices, Axeda DRM takes advantage of
distributed processing to enable large-scale deployment of proactive device
management.
Axeda Agents are fully portable across the most popular operating systems and
are easily integrated with existing designs or serve as the basis for entirely
new products. Intelligent Agent technology is offered in a variety of forms:
embedded within the chip or control processor, in an attached gateway, or as a
full supervisory system capable of managing multiple devices or a whole
facility.
Axeda Agents provide data acquisition, local decision-making, and web user
interface for intelligent devices and systems. Axeda Agents also pool the
information from multiple devices in a local area and sends it to the Axeda
Enterprise server, providing a single interface between multiple devices and the
enterprise. Axeda Agents include the functionality and extensible markup
language or XML processing needed to perform two-way Firewall-Friendly
communication between a group of local devices and the Axeda Enterprise server.
Axeda Builder provides a graphical development studio for creation, deployment
and remote administration of Axeda Agent applications. Axeda Policy Manager
gives authorized customer administrators the ability to establish and enforce
the privacy policy for all their devices.
Axeda Supervisor builds on this core agent capability and provides local control
for complex systems of devices such as building controls or plant floors,
sending system-wide data to the Axeda Enterprise server and enabling central
control and monitoring of geographically dispersed systems. Combining both
discrete and process control with the Internet, Axeda Supervisor supplies the
software tools businesses need to build a complete automation solution. Axeda
Supervisor can be used as part of a full Axeda DRM System, or independently on a
stand-alone basis, as per our industrial automation customers.
A comprehensive library of customizable drivers, industry standard protocols,
and sophisticated programs complete the connection between Axeda Agents and the
device. These can include custom device drivers, pre-built industry standard
interfaces, or multi-protocol toolkits developed by Axeda, including Axeda
@aGlance/IT, Axeda Web@aGlance and Axeda FactorySoft OPC.
DRM Professional Services
- -------------------------
Axeda delivers experienced project and system integration services designed to
provide clients with DRM solutions that meet their specific business needs in
the shortest time possible. Our software developers and application engineers
have a broad range of technical and commercial e-business experience. Our
methodology begins with a detailed evaluation of the business issues surrounding
the Internet enabling of the client's products, systems and services. Other
services include installation, application and device driver development,
deployment support, migration and tuning. Axeda also provides a range of
educational and support services to assure successful 24x7 ongoing operation.
7
STRATEGIC ALLIANCES
We have and will continue to enter into strategic alliances with experienced
technology, systems, consulting and distribution companies carefully selected
for their expertise in systems integration, hardware, software, enterprise
applications and other critical services. Our existing relationships include:
o Logicalis. In November 2003 we partnered with Logicalis, an
international provider of IT integration services and solutions, to
deliver DRM solutions for remote monitoring of mission critical
systems in complex IT environments.
o IBM-Life Sciences. In June 2003 IBM selected us as a Life Sciences
Partner. Together, we will bring the benefits of autonomic computing
to enable diagnostic device manufacturers with automated remote
monitoring, management, and service solutions.
o TietoEnator. In May 2003, TietoEnator, a provider of consulting and
system integration services in Scandinavia entered into an agreement
with us to jointly market the Axeda DRM System across Europe.
o Electronics For Imaging (EFI). In July 2002, we signed a multi-year,
exclusive agreement with EFI, a leader in software and hardware
imaging solutions for network printing, to develop and market
DRM-based products for the office and print production systems
marketplace.
o Toshiba IT-Solutions Corporation, a leading provider of information
technology (IT) systems integration and customer support solutions,
entered into a reseller agreement with us in December 2002 to offer
the Axeda DRM system as part of their Total Solutions offering.
Toshiba IT-Solutions sells and supports the Axeda DRM system and
provides related implementation, system integration, and managed
service offerings to their Japanese customers in a wide range of
markets including industrial equipment, medical and scientific
instruments, power systems, building automation, traffic control, and
computers and information equipment.
o Hitachi High-Technologies Corporation (HHT). In March 2002, HHT, a
high-tech trading company and equipment maker, selected us as its
partner for its new DRM managed services business. HHT initially
licensed the Axeda DRM System for its Japanese application service
provider (ASP) center. In September 2002, Hitachi High-Technologies -
Kasado Works, a major Japanese semiconductor tool manufacturer,
licensed the Axeda DRM System for use in Hitachi Series Plasma Etch
System including its M700 and U700 series for 300mm wafer application.
In November of 2003, HHT entered into a reseller agreement with us to
resell the Axeda DRM System to industrial companies in multiple
markets such as facilities management, various kinds of production
equipment, industrial automation and office equipment.
o Agrex, one of Japan's major information technology (IT) system
solution providers, entered into a reseller agreement with us in March
2003 to offer the Axeda DRM system as part of their comprehensive
solutions offering.
o Siebel Systems, Inc. We are a certified Siebel Software Partner.
Siebel is a leading e-business applications company, providing CRM
solutions to some of the world's largest companies. Our Axeda
Integrator for Siebel provides seamless integration with the Siebel
2000 and Siebel 7 Field Service application from Siebel Systems Inc.
allowing devices to automatically feed data to and start service
transactions with Siebel e-Business applications.
o SAP has certified the XML Communication Interface (CA-XML) for
integrating the Axeda DRM System with the mySAP.com(R) e-business
platform, thus extending the value of SAP(R) solutions with real-time
device information. Customers who leverage SAP's world leading
solutions will be able to benefit from automated access through Axeda
DRM to real-time information from remote devices.
o Nokia. We have developed solutions to bring together the Nokia M2M
Platform and the Axeda DRM System. Our objective is to jointly enable
businesses in multiple markets to offer automated monitoring,
management, service and re-supply of remote and mobile devices via
wireless communications and the Internet.
8
SALES AND MARKETING
Our sales and marketing strategy is focused on target account selling in
specific industries. The majority of our direct sales resources are targeted
toward direct sales of DRM to large OEMs in the United States, Europe and Japan.
We apply an integrated sales and marketing strategy with target account
marketing efforts focused on media and analyst relations, product marketing, web
sites, sales tools, targeted lead generation, executive events, direct marketing
promotions and trade shows in target industries. These direct resources are
leveraged in the industrial automation market through a network of OEMs,
distributors and systems integrators who sell our industrial automation products
to end users, some of which are smaller customers in remote markets, such as
those in South America, Eastern Europe, and China.
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 the Marketing Fund, totaling $1.2 million, and, through December
31, 2003, paid royalties of $0.6 million. We are obligated to pay royalties of
4.0% of revenues derived from sales of products developed using such grants, up
to a maximum of the total amount of the grants received.
CUSTOMERS
We target our DRM solutions to OEMs that build and support intelligent devices
in industries that have significant service costs and uptime requirements. We
currently serve Global 2000 companies in the medical instrument, enterprise
technology, office and print production systems and industrial and building
automation industries. Our customers include Bayer A.G., Fujifilm Medical
Systems, Agrex, Idexx Laboratories, Beckman Coulter, Fr. Sauter AG, Shinkawa
Electric Co., Ltd., CERN, Toshiba IT-Solutions Corporation, Varian Medical
Systems, Chiron Corporation, MAQUET, Procket Networks, Inc., Network Appliance,
Inc., Abbott Laboratories, Hitachi High-Technologies - Kasado Works, Applied
Biosystems Group, Xeikon International and Noritsu Koki Co., Ltd.
For the year ended December 31, 2003, five customers accounted for $2.9 million,
or 22%, of our total revenues.
RESEARCH AND DEVELOPMENT
We believe that our future success depends in large part on our ability to
enhance existing products, reduce product cost and develop new products that
maintain technological competitiveness. We believe that we must continually
enhance the performance and flexibility of our current products and successfully
introduce new products. Product development involves several functional groups
within our organization and is designed to provide a framework for defining and
addressing the activities required to bring product concepts and development
projects to market.
For the year ended December 31, 2003 our DRM business had research and
development expenditures, excluding non-cash compensation, totaling $5.0
million. For the years ended December 31, 2002 and 2001, eMation as a
stand-alone entity had research and development expenditures, excluding non-cash
compensation, totaling $5.6 million and $5.9 million, respectively.
The majority of our DRM product line is developed at our research and
development headquarters in Mansfield, Massachusetts.
Prior to being acquired by us in December 2001, eMation received grants in
Israel from the Office of the Chief Scientist or OCS in the aggregate amount of
$1.8 million to fund the development of our Axeda Supervisor product. 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, plus interest on any
unpaid outstanding balance, up to a maximum of the total amount of the grants
received. We have paid royalties to the OCS in the aggregate amount of $1.4
million. As of December 31, 2003, the remaining $0.4 million of principal
liability is accrued in other current liabilities. The terms of the OCS grants
require that we manufacture our products that were 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.
9
COMPETITION
Competition in the market for DRM solutions is emerging and expected to grow
stronger. The principal competitive factors that affect our performance in the
DRM market are :
o our ability to effectively market and sell our products;
o our customer service and support;
o our product reputation, quality and performance; and
o the price and features of our products such as adaptability,
scalability, the ability to integrate with other products,
functionality, and ease of use.
The Axeda DRM system faces competition from custom software development by
in-house developers within the machine and device manufacturers that are our
prime sales targets, or from system integrators doing custom product
development. These companies may choose to deploy their own information
technology personnel or utilize system integrators to write new code or rewrite
existing applications in an effort to develop their own information extraction
solutions. As a result, prospective clients may decide against purchasing and
implementing externally developed software and, instead, may develop their own
solutions similar to our DRM solutions.
A number of vertical market solution suppliers have also begun to market device
management infrastructures for use in specific industries. Today, companies such
as IBM Global Services/ILS and Brooks-PRI (semiconductor), Questra (medical and
office), Invensys (industrial), Imaging Portals (copiers), NextNine (telecom)
and Motive (enterprise technology, telecom), compete in specific market segments
that we operate in.
We also expect to see new or increased competition from several areas, including
device-networking companies, providers of industrial automation products, and
e-Business platforms such as the large CRM companies.
We expect competition to intensify as the DRM market matures. We expect that
competition will increase in the near term and that our primary long-term
competitors may not yet have entered the market. Our future competitors may have
significantly more personnel or greater financial, technical, marketing and
other resources than either our current competitors or we do. Furthermore, our
future competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements than we can. Also, future
competitors may have greater name recognition and more extensive customer bases
that they can leverage. Increased competition could result in price reductions,
fewer customer orders, reduced gross profit margins and loss of market share,
any of which could harm our business.
INTELLECTUAL PROPERTY
Our success is heavily dependent upon our proprietary technology. To protect our
proprietary rights, we rely on a combination of patent, copyright, trade secret
and trademark laws. We currently have twelve patent applications pending in the
United States and thirteen patent applications pending internationally with
respect to our DRM technology. We have registered the trademark "AXEDA" in the
U.S. Patent and Trademark Office, and have numerous corresponding trademark
registrations or applications filed for "AXEDA" in foreign jurisdictions. As a
part of our regular business processes, we generally enter into nondisclosure
agreements with employees, consultants, distributors and corporate partners, as
appropriate, and limit access to and distribution of our software, documentation
and other proprietary information. Further, our software licensing agreements
provide for protection of our intellectual property within our software.
EMPLOYEES
As of February 29, 2004, we employed 116 individuals. Our future performance
depends in significant part upon the continued services of our key technical,
sales and senior management personnel. The loss of the services of one or more
of our key employees could harm our business. None of our employees are
represented by a labor union. We have not experienced any work stoppages and
consider our relations with employees to be good.
10
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 $13.4 million for the year
ended December 31, 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 SYSTEM 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
industrial automation business.
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 our 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 us would be reduced.
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 does not maintain a minimum bid
price of one dollar for thirty consecutive days, we are subject to being
delisted from the Nasdaq National Market. If our stock is under $1.00 for thirty
consecutive business days, we will be able to maintain our listing if during the
next 90 day period, our stock maintains at least a minimum bid price of $1.00
for a ten consecutive day period. 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.
11
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.
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 license;
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.
12
IT MAY BE DIFFICULT, TIME-CONSUMING AND EXPENSIVE FOR OUR CUSTOMERS TO
INTEGRATE OUR DRM SOLUTIONS WITH THEIR PRODUCTS 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:
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.
13
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 twelve 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.
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.
14
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.
15
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.
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 year ended December 31, 2003, we derived
approximately 56% of our revenues from sales to foreign companies. We anticipate
that revenues from international operations will continue to represent a
significant portion of our revenues. As a result, we are subject to risks
associated with selling and operating in foreign countries. For example, some of
our contracts with foreign customers are denominated in foreign currencies. We
do not currently hedge against the risk of such transactions and as a result, we
face a risk of loss related to possible fluctuations in currency exchange rates.
Our geographic diversity requires significant management attention and financial
resources. 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.
16
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 December 31, 2003, the remaining
$0.4 million of principal liability is accrued in accrued expenses. 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, up to a maximum of the
total amount of the grants received. 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
December 31, 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, up to a maximum of the total
amount of the grants received.
BECAUSE OF THEIR SIGNIFICANT STOCK OWNERSHIP, OUR OFFICERS AND DIRECTORS CAN
EXERT SIGNIFICANT INFLUENCE OVER OUR FUTURE DIRECTION.
As of December 31, 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.
17
Our certificate of incorporation and by-laws include provisions that may have
the effect of deterring an unsolicited offer to purchase our stock. These
provisions, coupled with the provisions of the Delaware General Corporation Law,
may delay or impede a merger, tender offer or proxy contest involving us.
Furthermore, our board of directors is divided into three classes, only one of
which is elected each year. Directors are only capable of being removed by the
affirmative vote of 66 2/3% or greater of all classes of voting stock. These
factors may further delay or prevent a change of control.
WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY IN THE INTERNET-RELATED PRODUCTS AND
SERVICES MARKET.
Our DRM solutions communicate through public and private networks over the
Internet. The success of our products may depend, in part, on our ability to
continue developing products that are compatible with the Internet. 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.
18
Axeda Systems Inc.
ITEM 2. PROPERTIES
In May 2002, we entered into a sub-lease for approximately 35,000 square feet of
space in an office building in Mansfield, Massachusetts. This facility is leased
at an annual rental of approximately $310,000, plus operating expenses
(approximately $170,000 per year), utilities and taxes, and is used for research
and development, sales and support, services and administrative activities. The
sub-lease commenced in June 2002 and expires in July 2007.
In September 2002, we entered into a lease for approximately 4,500 square feet
of space in Malvern, Pennsylvania. This facility is leased at an annual rental
of approximately $42,000, plus operating expenses (approximately $19,000 per
year), utilities and taxes, and is used for administrative activities. The lease
commenced in December 2002 and expires in November 2005.
We currently lease 3 other international sales offices in France, Holland and
Japan with a total of approximately 4,169 square feet of space. The combined
annual rental for these offices is approximately $276,000 and $148,000 for 2004
and 2005, respectively, and approximately $138,000 for 2006 through 2010. The
leases have terms expiring from August 2004 through February 2011. The lease for
our primary office in France expires in 2011, but is cancelable without penalty
in 2008 upon 6 months written notice.
We believe our current facilities will be adequate to fulfill our needs for the
foreseeable future.
Prior to occupying our current offices in Mansfield, Massachusetts, we leased
approximately 12,000 square feet of space in an office building, located in the
same business park as our current offices, for our research and development,
sales and support and administrative activities. The lease for our former
offices expires in July 2004 and requires us to pay minimum future rental
payments totaling approximately $178,000, including operating expenses, as of
December 31, 2003.
19
Axeda Systems Inc.
ITEM 3. 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. We filed a motion to
dismiss the consolidated and amended class action complaint on July 3, 2000. 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., or 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., or 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 fraud,
and unspecified punitive damages and attorney's fees. On May 2, 2003, we moved
to dismiss all claims against RTIAG. 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 $2.7 million, plus
interest, fees and costs. IPM filed an answer to the amended complaint on July
22, 2003 denying the breach of contract claims. IPM filed a motion to amend
their complaint on February 19, 2004, which if granted would withdraw their
fraud complaint and modify their breach of contract claim to specify that the
defendants breached the contract by providing circuit boards which were
underpowered, and to an unacceptable extent, incapable of operating in IPM's
products. We filed a motion seeking summary judgment on March 9, 2004. 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.
20
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
21
Axeda Systems Inc.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
On January 14, 2002 we changed our name to Axeda Systems Inc. and effective as
of February 5, 2002, our common stock is quoted on the NASDAQ National Market
under the symbol XEDA. Prior to February 5, 2002 and since our initial public
offering in July 1999, our common stock was quoted on the NASDAQ National Market
under the symbol RVST. Prior to such time, there was no public market for our
common stock. On February 27, 2004, Axeda Systems Inc. had 32,469,862
outstanding shares of common stock held by 157 record holders, not including
stockholders who beneficially own common stock held in nominee or street name.
The following table sets forth, for the periods indicated, the high and low
sales prices per share of the common stock as reported on the NASDAQ National
Market.
2003 2002
-------------------- -------------------
High Low High Low
---- --- ---- ---
First Quarter $0.81 $0.32 $3.86 $2.15
Second Quarter $2.09 $0.30 $3.21 $1.11
Third Quarter $1.99 $1.19 $1.77 $0.38
Fourth Quarter $2.13 $1.27 $1.29 $0.25
22
UNREGISTERED ISSUANCE OF SECURITIES
None.
DIVIDEND POLICY
We have never declared or paid dividends on our capital stock and we do not
anticipate declaring or paying cash dividends in the foreseeable future. We
anticipate that we will retain all future earnings, if any, for use in our
operations and the expansion of our business. Payments of future dividends, if
any, will be at the discretion of our board of directors after taking into
account various factors, including our financial condition, operating results,
current and anticipated cash needs and plans for expansion. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
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 December 31, 2003:
(1) (2) (3)
Number of Securities
Weighted-Average Remaining Available for
Number of Securities Exercise Price of Future Issuance Under
to be Issued upon Outstanding Options, Equity Compensation
Exercise of Warrants, and Rights Plans (Excluding
Outstanding Options, (per share) Securities Reflected in
Plan Category Warrants, and Rights Column (1)
- ------------- -------------------- -------------------- ------------------------
Equity Compensation Plan
Approved by Shareholders ....... 5,720,641 $ 1.76 521,326
========= ======== =======
(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 3% of the shares of our common stock outstanding on
the last trading day of the immediately preceding calendar year, but
in no event shall such annual increase exceed 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 600,000 shares on the amount by which the
share reserve under the plan automatically increases at the beginning
of each year to 1,000,000 shares, and increasing the number of shares
authorized for issuance over the term of our 1999 Stock Incentive Plan
(prior to any automatic increase) by an additional 500,000 shares.
Purchases of Securities
None.
23
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data (presented in thousands,
except share and per share amounts) are derived from our consolidated financial
statements. This data should be read in conjunction with the consolidated
financial statements and notes thereto (Item 8), and with Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations.
Year Ended December 31,
-------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Revenues:
License ....................................................... $9,134 $12,772 $ 6,036 $ 12,328 $ 12,710
Services and maintenance ...................................... 3,737 3,124 442 1,898 968
Hardware ...................................................... 323 2,233 1,111 6,628 15,740
--- ----- ----- ----- ------
Total revenues..................... ............................... 13,194 18,129 7,589 20,854 29,418
------ ------ ----- ------ ------
Cost of revenues:
License......................... .............................. 1,292 2,849 1,629 3,374 1,874
Services and maintenance ...................................... 3,694 4,210 223 733 259
Hardware........................ .............................. 1 1,288 1,122 6,189 13,732
Software amortization ......................................... 634 1,943 171 - -
Inventory charges ............................................. - - 18,502 1,708 -
--- --- ------ ----- ---
Total cost of revenues.............. .............................. 5,621 10,290 21,647 12,004 15,865
----- ------ ------ ------ ------
Gross profit ...................................................... 7,573 7,839 (14,058) 8,850 13,553
Research and development (R&D)
Non-cash compensation ......................................... 102 163 2,100 801 200
Other R&D expense ........................ .................... 4,992 7,162 5,691 10,187 8,107
Sales and marketing (S&M)
Non-cash compensation and other expense ....................... 31 71 147 3,480 -
Other S&M expense .......................... .................. 8,421 16,642 7,670 10,863 5,296
General and administrative (G&A)
Non-cash compensation ......................................... 476 1,304 780 467 308
Other G&A expense ...................... ...................... 7,421 11,000 9,860 10,256 5,048
Provision for doubtful accounts (net of recoveries) ........... (15) (45) 929 4,965 31
Depreciation and amortization ..................................... 1,123 1,552 2,844 5,897 1,886
Special charges ................................................... - 820 - - -
Impairment charges ................................................ - 22,413 3,916 2,831 -
Acquired in-process research and development ...................... - - 3,112 1,373 1,888
--- --- ----- ----- -----
Operating loss ............................................(14,978) (53,243) (51,107) (42,270) (9,211)
Gains (losses) on disposals of assets ............................. 743 (138) 52,037 - -
Interest income (expense), net .................................... 19 441 1,753 1,792 1,192
Other income (expense), net ....................................... 806 554 (133) 51 -
--- --- ----- --- ---
Income (loss) before provision for income taxes (benefit) .........(13,410) (52,386) 2,550 (40,427) (8,019)
Provision for income taxes (benefit) ......................... 198 (459) 1,123 40 52
--- ----- ----- -- --
Net income (loss) .............................................. $ (13,608) $ (51,927) $1,427 $(40,467) $(8,071)
========== ========== ====== ========= ========
Accretion of discount on mandatory redeemable preferred stock .. - - - - 659
Net income (loss) attributable to common shareholders .......... $(13,608) $(51,927) $1,427 $(40,467) $(8,730)
========= ========= ====== ========= ========
Basic net income (loss) per weighted average common share
outstanding ................................................... $(0.48) $ (1.92) $ 0.08 $ (2.44) $ (1.02)
======= ======== ====== ========= ========
Diluted net income (loss) per weighted average common share
outstanding ................................................... $(0.48) $ (1.92) $ 0.07 $ (2.44) $ (1.02)
======= ======== ====== ========= ========
Weighted average number of common shares outstanding used in
calculation of basic net income (loss) per common share ....... 28,631,975 27,063,751 18,559,185 16,606,795 8,532,140
========== ========== ========== ========== =========
Weighted average number of common shares outstanding used in
calculation of diluted net income (loss) per common share ..... 28,631,975 27,063,751 20,194,713 16,606,795 8,532,140
========== ========== ========== ========== =========
Total assets ................................................... $20,886 $32,513 $89,106 $60,193 $89,748
======= ======= ======= ======= =======
24
Axeda Systems Inc.
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with other
sections of this Annual Report on Form 10-K. including "Item 1: Business," "Item
6: Selected Financial Data," and "Item 8: Financial Statements and Supplementary
Data."
All assumptions, anticipations, expectations and forecasts contained herein are
forward-looking statements that involve risks and uncertainties. Our actual
results may differ materially from those projected in the forward-looking
statements as a result of various factors, including those described under "Risk
Factors" included under Item 1. Except to fulfill our obligations under the
federal securities laws, we undertake no obligation to update any
forward-looking statements to reflect events or circumstances after the date on
which it is made.
The preparation of the consolidated financial statements which are the basis of
the following discussion and analysis requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. We
evaluate our estimates, including those related to bad debts, inventories,
intangible assets, income taxes, warranty obligations, purchase commitments and
contingencies. The estimates are based upon historical experience and on various
other assumptions that are believed to be reasonable under the circumstances at
the time of the estimate, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
Overview
Axeda is a software and services company providing an emerging category of
business software known as Device Relationship Management, or DRM. Our flagship
product, the Axeda DRM System, is a distributed software solution designed to
enable businesses to remotely monitor, manage and service intelligent devices.
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.
In recent years we have undertaken several major steps to reposition our
business and capitalize on the emerging growth opportunities represented by the
DRM market. This market is also known as M2M (machine to machine), autonomic
computing, remote monitoring and management and several other descriptors in
different vertical markets.
On December 7, 2001, we acquired all of the outstanding shares of eMation, Ltd.
The acquisition gave us an entry into the DRM market. During 2002 our revenues
were increasingly generated from selling DRM products, and for 2003,
substantially all of our revenues were generated from selling DRM products. Our
revenues in 2001 were substantially generated from sales from our former
personal computer, or PC, business, our former Internet Appliance, or IA,
business, and our former consumer electronics, or CE, business. We sold the
assets of our IA business, excluding inventory, to Phoenix Technologies Ltd., or
Phoenix, for $18 million in March of 2001. We also sold the assets of our CE
business to STMicroelectronics, NV in March 2001 for approximately $55.6
million. We exited the PC business pursuant to an exclusive license with Sonic
IP, Inc., or Sonic, in May 2002 for a $2.0 million license fee.
In the second quarter of 2002 we foresaw that revenue would be short of our
expectations due to the macroeconomic climate impacting capital spending as well
as slower than expected development of the DRM market. As a result, 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. Due to the lower revenue and our lower market
capitalization, we determined that the fair value of our reporting unit could
not support the carrying value of its intangible assets and, accordingly,
recognized a goodwill and identified intangible asset impairment charge of
approximately $22.4 million in 2002. No such charge was recorded in 2003. In
2002 and 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. We will continue to evaluate our
cost structure and may undertake additional measures to reduce expenses in the
future.
25
We currently operate in 3 principal regions: the United States, Europe and
Japan. Overall revenues declined by $4.9 million in 2003 due to our exit from
the PC and IA hardware businesses. Despite the continued difficult capital
spending climate, our DRM revenues increased by $1.7 million in 2003 mainly due
to increases in the U.S. and Japan, while Europe was approximately unchanged.
These net increases were driven by an accelerated acquisition of new customer
accounts, as well as additional spending by our existing customers. While
recurring sales from existing customers and the timing of more widespread
adoption of our product remains difficult to predict, we believe overall
revenues will increase in 2004 due to further orders from our current customer
base, our sales pipeline and improvements in the marketplace.
For 2003 our operating expenses decreased by $38.5 million, or 63%, compared to
the prior year. This includes the goodwill and identified intangibles charge of
$22.4 million from 2002. We believe the cost reductions combined with an
increase in revenues will be sufficient to allow us to meet our cash needs
through the first quarter of 2005.
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 net proceeds
of $5.6 million. 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. At December 31, 2003, our cash
balance was $9.6 million compared with $19.1 million at year-end 2002. Operating
results and our liquidity position are discussed further below.
Geographic Areas
Information pertaining to revenues attributed to our country of domicile, the
United States of America, foreign sales in total and individual foreign
countries is included in note 16 of the notes to the consolidated financial
statements, filed herewith at Item 8-Financial Statements and Supplementary
Data. Revenues from individual countries are based upon information available to
us regarding our customers' country of domicile.
Information pertaining to long-lived assets is included in note 13 of the notes
to the consolidated financial statements, filed herewith at Item 8-Financial
Statements and Supplementary Data.
26
Results of Operations
The following table sets forth, for the periods indicated, the dollar amounts
and the dollar amounts expressed as a percentage of total revenues reflected in
our consolidated statements of operations:
Year Ended December 31,
-----------------------------------------------------------------------
2003 2002 2001
-------------------- ------------------ -------------------
$ `000's % $ `000's % $ `000's %
-------- ----- -------- ----- -------- -----
Revenues:
License .............................................. $ 9,134 69.2% $ 12,772 70.5% $ 6,036 79.6%
Services and maintenance ............................. 3,737 28.3 3,124 17.2 442 5.8
Hardware ............................................. 323 2.5 2,233 12.3 1,111 14.6
--- --- ----- ---- ----- ----
Total revenues ........................................... 13,194 100.0 18,129 100.0 7,589 100.0
------ ----- ------ ----- ----- -----
Cost of revenues:
License......................... ..................... 1,292 9.8 2,849 15.7 1,629 21.5
Services and maintenance ............................. 3,694 28.0 4,210 23.2 223 2.9
Hardware........................ ..................... 1 - 1,288 7.1 1,122 14.8
Software amortization ................................ 634 4.8 1,943 10.7 171 2.2
Inventory charges .................................... - - - - 18,502 243.8
---- --- --- --- ------ -----
Total cost of revenues ................................... 5,621 42.6 10,290 56.7 21,647 285.2
----- ---- ------ ---- ------ -----
Gross profit........................ ..................... 7,573 57.4 7,839 43.3 (14,058) (185.2)
----- ---- ----- ---- -------- -------
Research and development (R&D)
Non-cash compensation ................................ 102 0.8 163 0.9 2,100 27.7
Other R&D expense .................................... 4,992 37.8 7,162 39.5 5,691 75.0
Sales and marketing (S&M)
Non-cash compensation and other expense .............. 31 0.2 71 0.4 147 1.9
Other S&M expense .................................... 8,421 63.8 16,642 91.8 7,670 101.1
General and administrative (G&A)
Non-cash compensation ................................ 476 3.6 1,304 7.2 780 10.3
Other G&A expense .................................... 7,421 56.3 11,000 60.7 9,860 129.9
Provision for doubtful accounts (net of recoveries) . (15) (0.1) (45) (0.2) 929 12.2
Depreciation and amortization ............................ 1,123 8.5 1,552 8.6 2,844 37.5
Special charges .......................................... - - 820 4.5 - -
Impairment charges ....................................... - - 22,413 123.6 3,916 51.6
Acquired in-process research and development (IPR&D) ..... - - - - 3,112 41.0
------ ----- ------ ----- ------ -----
Total operating costs ............................ 22,551 170.9 61,082 336.9 37,049 488.2
------ ----- ------ ----- ------ -----
Operating loss ................................... (14,978) (113.5) (53,243) (293.7) (51,107) (673.4)
Gains (losses) on disposals of assets .................... 743 5.7 (138) (0.7) 52,037 685.7
Interest income (expense), net ........................... 19 0.1 441 2.4 1,753 23.1
Other income (expense), net .............................. 806 6.1 554 3.1 (133) (1.8)
--- --- --- --- ----- -----
Income (loss) before provision for income taxes (benefit) . (13,410) (101.6) (52,386) (288.9) 2,550 33.6
Provision for income taxes (benefit) ..................... 198 1.5 (459) (2.5) 1,123 14.8
--- --- ----- ----- ----- ----
Net income (loss) ........................................ $(13,608) (103.1)% $(51,927) (286.4)% $1,427 18.8%
========= ======= ========= ======= ====== ====
27
Revenues. Total revenues for the year ended December 31, 2003 decreased by $4.9
million, or 27%, to $13.2 million from $18.1 million in the previous year. For
the year ended December 31, 2003, sales of our DRM solutions increased $1.7
million, while sales of our IA inventories and PC license and services decreased
by $6.7 million compared to the prior year.
Currency movements in 2003 increased revenues by $1.0 million from the prior
year due to more favorable exchange rates. Increases in net revenues due to
currency movements are due primarily to the weakness versus prior year of the
U.S. dollar against the Euro, the British pound and the Japanese yen. Although
we cannot predict the future movements in currency rates, any strengthening of
the U.S. dollar against our foreign currencies will have an unfavorable impact
on our revenues in 2004. Currency effects on our revenues for 2002 and 2001 were
insignificant.
Total revenues for the year ended December 31, 2002 increased by $10.5 million,
or 139%, to $18.1 million, from $7.6 million in the previous year. For the year
ended December 31, 2002 our DRM solutions contributed $9.2 million to the
increase in revenues, due to the acquisition of eMation, while sales of our IA
inventories and PC services added $1.7 million to our total revenues. These
increases were partially offset by a decrease of $0.4 million in our CE business
over the prior year.
For the year ended December 31, 2003 revenues across our license, services and
maintenance and hardware streams decreased $3.6 million, increased $0.6 million
and decreased $1.9 million, respectively, from the prior year. For the year
ended December 31, 2002 revenues from license, services and maintenance and
hardware increased $6.7 million, $2.7 million and $1.1 million, respectively,
from the prior year.
License revenues for the year ended December 31, 2003 decreased by approximately
$3.6 million to $9.1 million, from $12.8 million in the previous year. The
decrease in license revenues was mainly attributable to the discontinuation of
our former PC business, which declined by $4.3 million and was partially offset
by an increase in DRM license revenues of approximately $0.6 million for the
year ended December 31, 2003. License revenues for the year ended December 31,
2002 increased by approximately $6.8 million to $12.8 million, from $6.0 million
in the previous year. The increase was attributable to sales of our DRM
products, which added $6.7 million to our revenues for the year ended December
31, 2002. Due to the complete shift from our legacy PC, CE and IA businesses to
our DRM product line, we do not expect any future license revenues from our
former businesses, and we expect DRM System license revenues to increase as our
DRM Systems are more widely adopted.
Hardware revenues for the year ended December 31, 2003 decreased by $1.9 million
compared to the prior year, to $0.3 million, due to decreased sales of
components for our former Internet appliances and Internet set-top boxes.
Conversely, hardware revenues for the year ended December 31, 2002 increased by
approximately $1.1 million compared to the prior year, to $2.2 million, due to
increased sales of components related to Internet appliances and Internet
set-top boxes. In the future we expect hardware sales to be minimal.
Services and maintenance revenues for year ended December 31, 2003 increased
$0.6 million from the prior year to $3.7 million, 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. Services and maintenance
revenues for the year ended December 31, 2002 increased $2.7 million compared to
the prior year to $3.1 million. The increase was attributable to services and
maintenance plans sold with our DRM system products, as well as PC-related
services provided to Sonic, which contributed $2.6 million and $0.5 million,
respectively, for the year ended December 31, 2002, offset by a decrease in
services of $0.4 million associated with our former CE business, which was sold
to STMicroelectronics in March 2001. We anticipate services and maintenance
revenues will vary, as opportunities in this area are subject to our customers'
requirements and approval process.
For year ended December 31, 2003, our top five customers accounted for $2.9
million, or 22% of our revenues. During 2002 a substantial portion of our
revenues were derived from a small number of customers. For the year ended
December 31, 2002, five customers accounted for $6.2 million, or 34%, of our
total revenues. Our revenues are becoming less concentrated as our business has
changed to the DRM market. 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 solutions primarily to companies in the industrial and building
automation, high technology devices, medical instrumentation and office
automation industries. For the year ended December 31, 2003 customers based in
North America accounted for 44% of our revenues. In the year ended December 31,
2002 companies based in North America accounted for 57% of our revenues. We
anticipate that revenues from international operations will continue to
represent a significant portion of our revenues.
28
Cost of Revenues. Cost of revenues for the year ended December 31, 2003
decreased $4.7 million from the prior year to $5.6 million. The decrease was due
to: a decrease in PC license and service expense of $1.5 million and $0.5
million, respectively, due to our exit from the PC business; a decrease in
hardware expense of $1.3 million, due to our exit from the IA business; a
decrease in software amortization of $1.3 million, due to the impairment of the
related intangible assets in 2002; and a decrease in other license fees of $0.2
million. Cost of revenues for the year ended December 31, 2002 decreased $11.4
million from the prior year to $10.3 million. The decrease was due to an $18.5
million inventory charge recorded during 2001 relating to our former IA
business, partially offset by increases relating to our DRM license and services
and maintenance, of approximately $1.2 million, $4.0 million, respectively,
hardware of approximately, $0.2 million, and DRM software amortization of
approximately $1.8 million.
Cost of revenues for license fees for the year ended December 31, 2003 decreased
by approximately $1.6 million, compared to the prior year, mainly due to a
decrease in costs associated with our former PC products, caused by our exit
from the PC business. For the year ended December 31, 2002, the $1.2 million
increase in cost of license revenues over the prior year was due to an
additional $1.0 million in costs associated with greater sales of our DRM
solutions and a net increase of $0.2 million for 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 for the year ended December 31, 2003
decreased by $1.3 million, compared to the prior year due to reduced hardware
sales, as well as the fully-reserved state of our inventories. The $0.2 million
increase in cost of revenues for hardware sales for the year ended December 31,
2002 from the prior year corresponds to the increase in our hardware sales. In
the future we expect hardware cost of sales to be minimal.
Cost of revenues for services and maintenance for the year ended December 31,
2003 decreased by $0.5 million from the prior year due to a decrease in PC
services expense, due to our exit from the PC business. The $4.0 million
increase in cost of services and maintenance for the year ended December 31,
2002 compared to the prior year is attributable to an approximate $3.6 million
increase from our DRM system services and maintenance plans, and a $0.5 million
increase in services related to our former PC business, offset by a $0.1 million
decrease in services related to our former CE business. 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.
Software amortization of our developed and core technologies for the year ended
December 31, 2003 decreased by $1.3 million, compared to the prior year, due to
the impairment of our identified intangible assets in the fourth quarter of 2002
that resulted in a decrease to the carrying amount of those assets, and
therefore a lower amortizable cost. Software amortization of our developed and
core technologies acquired in the eMation acquisition, added approximately $1.8
million to our cost of revenues for the year ended December 31, 2002. For the
year ended December 31, 2004 we expect non-cash amortization of acquired
technology to represent approximately $0.4 million of our cost of revenues.
Currency movements in 2003 increased expenses (operating costs and cost of
revenues) by $1.0 million from the prior year due to unfavorable exchange rates.
Increases in expenses due to currency movements are due primarily to the
weakness versus prior year of the U.S. dollar against the Euro, the British
pound and the Japanese yen. Although we cannot predict the future movements in
currency rates, any strengthening of the U.S. dollar against our foreign
currencies will have a favorable impact on our expenses in 2004. Currency
effects on our expenses for 2002 and 2001 were insignificant.
29
Gross Profit. Gross profit for the year ended December 31, 2003 decreased $0.3
million, or 3%, to $7.6 million, compared to the prior year. The decrease in
gross profit was due to a decrease in gross profit from sales of our former PC
and IA hardware products of $3.4 million, due to our exit from these businesses,
offset by increases in gross profit from our DRM license fees, DRM service and
maintenance revenues and reduced software amortization expenses, which totaled
$3.2 million.
Gross profit as a percentage of total revenues for the year ended December 31,
2003 increased to 57%, from 43% in the prior year, due to improved margins from
our DRM professional services and reduced software amortization expense.
Gross profit as a percentage of total revenues (excluding the charges recorded
for inventory and software amortization) for the year ended December 31, 2002
decreased to 54%, from 61% in the prior year, due to negative gross profit from
our services and maintenance products. The negative gross profit from our
services and maintenance products was attributable to the delivery of a large
number of non-billable proof of concepts, or POCs, delivered to prospective
customers during the year. In order to establish a stronger market presence and
earn a prospective customer's commitment, we performed various marketing
activities including delivering POCs to potential customers. These POCs provided
a business case to demonstrate that our product can successfully operate in our
customer's environment, perform according to published specifications as well as
deliver cost savings.
The gross profit margin on DRM license revenue was 88% for the year ended
December 31, 2003, compared to 86% for the prior year, and resulted from
reductions in product packaging costs. Services and maintenance gross profit
margin was 1% and negative 42% for the years ended December 31, 2003 and
December 31, 2002, respectively. The change reflects an improvement in the
billable utilization of professional services employees. 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.
Other Research and Development (R&D) Expense. Other R&D expense consists of
staff, staff-related, professional and other development-related support costs
associated with the development of new DRM products, quality assurance and
testing. Other R&D expense for the year ended December 31, 2003 decreased $2.2
million, or 30%, to $5.0 million, compared with the prior year. The
discontinuance of the PC development team during 2002, in connection with the
license to Sonic, contributed $1.6 million to the decrease, and a decrease in
staff related expense, consulting fees, and other expense, contributed the
remaining $0.6 million. Other R&D expenses as a percentage of total revenues
decreased from 40% in 2002 to 38% in 2003, due to the reduction in other R&D
expense, offset by the decrease in revenues. We expect other R&D expense to
continue to decrease in 2004 and also expect other R&D expense to decrease as a
percentage of revenues as we expect our future revenues to increase.
R&D expense for the year ended December 31, 2002 increased $1.5 million, or 26%,
to $7.2 million, compared with the prior year. The increase was attributable to
a full year of DRM expenses (up $5.1 million, from $0.5 million in 2001 to $5.6
million in 2002). This increase was partially offset by a decrease in R&D
expenses of $2.2 million in our former PC development team, and the elimination
of the CE and IA development teams in 2001, which contributed approximately $0.7
million and $0.8 million, respectively, to the decrease. As a percentage of
total revenues, other R&D expenses decreased from 75% to 40% of total revenues
due to the proportionally larger increase in total revenues from the prior year.
Non-cash Compensation R&D Expense. Non-cash R&D expense consists of compensation
related to stock options. Non-cash R&D expense decreased 92% from $2.1 million
for the year ended December 31, 2001, to $0.2 million for the year ended
December 31, 2002. Approximately $1.5 million of the decrease is partially due
to the immediate recognition of prepaid and deferred stock compensation relating
to reductions in staffing in connection with the closing of our Vancouver office
in March 2001. In addition, $0.5 million of the decrease resulted from
amortization of deferred compensation recorded in 2001 in connection with stock
options granted to employees in December 2000. No similar expenses were recorded
for the year ended December 31, 2002. This expense is offset by amortization of
$0.1 million for deferred compensation recorded in connection with stock options
granted to employees in December 2001 at less than fair market value for which
no similar expense was recorded in 2001.
30
Other Sales and Marketing (S&M) Expense. Other S&M expense consists of salaries,
travel expenses and costs associated with trade shows, advertising and other
sales and marketing efforts. Other S&M expense for the year ended December 31,
2003 decreased approximately $8.2 million to $8.4 million, or 49%, as compared
with the prior year. The elimination of our former business development
personnel focused on professional services in 2002, decreases in sales staff
headcount, the elimination of our former PC sales team and initial branding
expense contributed $2.8 million, $1.1 million and $0.6 million, respectively,
to the decrease in other S&M expense for the year ended December 31, 2003
compared to the prior year. In addition, reduced public relations, trade shows
and advertising expense equally contributed approximately $0.7 million for the
year ended December 31, 2003 over the prior year. Also, reductions in travel,
subcontractors and the closure of our Israeli office, each contributed $0.4
million to the decrease in 2003. Finally, reduced marketing and sales
collateral, severance and other expenses in 2003 contributed $0.3 million, $0.7
million and $0.7 million, respectively, compared to the same period in the prior
year. As a percentage of revenues, other S&M expenses decreased from 92% to 64%,
due to reduced S&M expense from the prior year, offset by the decrease in
revenues. In 2004 we expect other S&M expenses to continue to decrease and also
expect other S&M expenses to decrease as a percentage of revenues as we expect
our future revenues to increase.
Other S&M expense for the year ended December 31, 2002 increased $9.0 million,
or 117%, to $16.6 million, as compared with the prior year. The increase in
other S&M expense was attributable to the inclusion of the acquired eMation
sales, marketing and business development groups, which contributed $15.1
million. Partially offsetting this increase was the elimination of the sales and
marketing teams associated with our former CE and IA businesses, which resulted
in decreases of $0.4 million and $0.5 million, respectively. Decreases of
approximately $1.8 million, relating to the settlement of a South American
distribution rights agreement, and $2.8 million, from reduced staff in our
former PC sales and marketing teams, also partially offset the increase.
Branding expenses in 2001 associated with our name change also contributed
approximately $0.6 million to the decrease. As a percentage of total revenues,
other S&M expenses decreased from 101% to 92%, due to the proportionally larger
increase in total revenues from the prior year.
Other General and Administrative (G&A) Expense. Other G&A expense consists of
staff, staff related, and support costs for our finance, human resources, legal
and other management departments. Other G&A expense for the year ended December
31, 2003 decreased $3.6 million to $7.4 million, or 32%, as compared with the
prior year. Reduced staff related expense, expenses to support our former PC
business and estimated intellectual property expense contributed $1.0 million,
$0.5 million and $0.4 million, respectively, to the decrease. Cost reductions
associated with the closure of our Israeli office, reduced travel and other
expense contributed $0.3 million, $0.2 million and $0.4 million, respectively,
to the decrease. In addition, decreased use of consultants and reductions in
accruals for estimated liabilities and sales taxes contributed $1.0 million in
total to the decrease. The above decreases were partially offset by a $0.3
million increase in severance expense. Other G&A expense as a percentage of
total revenues decreased from 61% in 2002 to 56% in 2003 due to the reduction in
other G&A expense, offset by the decrease in revenues. In 2004 we expect other
G&A expense to continue to decrease based on cost reductions that occurred
throughout 2003, and we also expect other G&A expense to decrease as a
percentage of revenues as we expect our future revenues to increase.
Other G&A expense for the year ended December 31, 2002 increased $1.1 million,
or 12%, to $11.0 million, compared to the prior year. The increase was mainly
due to the addition of the acquired eMation G&A function, which contributed $3.1
million to the increase, partially offset by decreases in severance costs of
$1.1 million, staff retention expense of $0.4 million, executive recruiting
expense of approximately $0.3 million and rent and other expense of $0.2
million. Included in the $3.1 million increase is a net one-time lease charge of
$0.2 million representing the excess of the future minimum rental payments to be
made over the future minimum sublease payments to be received for a property
vacated during the third quarter of 2002. Other G&A expense as a percentage of
total revenues decreased from 130% to 61%, due to the proportionally larger
increase in total revenues.
31
Non-cash Compensation G&A Expense. Non-cash general and administrative expense
consists of compensation related to stock options. Non-cash general and
administrative expense decreased from $1.3 million for the year ended December
31, 2002 to $0.5 million for the year ended December 31, 2003. The decrease is
primarily attributable to the acceleration of vesting of $0.4 million and
modifications to certain outstanding stock options of $0.2 million in 2002, and
certain deferred stock compensation balances that were fully expensed by
December 31, 2002, resulting in $0.2 million less expense in 2003. There were no
accelerations or significant modifications that resulted in additional non-cash
compensation G&A expense in 2003.
Non-cash general and administrative expense increased from $0.8 million for the
year ended December 31, 2001 to $1.3 million for the year ended December 31,
2002. The increase is attributable to a $0.4 million expense incurred for the
acceleration of option vesting in accordance with certain employment agreements
offset by $0.1 million for the acceleration of option vesting in 2001. The
remaining portion of the increase is attributable to a one-time charge
recognized in 2002 of $0.2 million for the modification of stock options held by
a former employee.
Depreciation and Amortization. Depreciation and amortization decreased $0.4
million for the year ended December 31, 2003 to $1.1 million from $1.6 million
in 2002, and decreased $1.3 million for the year ended December 31, 2002 to $1.6
million from $2.8 million in the prior year. The $0.4 million decrease during
the year ended December 31, 2003 is due to the partial impairment in 2002 of the
identified intangible assets recorded in connection with our acquisition of
eMation, which contributed $0.2 million, as well as reduced depreciation
expense, which contributed $0.2 million. The $1.2 million decrease in expense
for the year ended December 31, 2002 is due to sales of the assets of our CE and
IA businesses, both of which were sold in March 2001, and contributed $1.2
million of the decrease, while the decrease in amortization expense relating to
our Cinax goodwill accounted for $1.0 million. Offsetting these decreases was an
increase of approximately $0.9 million attributable to depreciation of assets
and amortization of intangibles acquired in the purchase of eMation. In the
future we expect depreciation and amortization expense to approximate the
current year expense.
Special Charges. Special charges for the year ended December 31, 2002 consist of
items related to our exit from the PC business in May 2002. The charges include
$0.3 million for furniture and equipment and employee inducements, termination
expenses related to our license agreement with Sonic Solutions, lease
termination costs and inducements totaling approximately $0.5 million, including
$0.2 million for furniture and equipment, for our former San Jose facility.
Impairment Charges. During November 2002 we completed our annual impairment test
of goodwill in accordance with SFAS 142. Due to adverse market conditions, and a
slower than expected rate of adoption of our software technology in our
industry, we determined that the fair value of our reporting unit could not
support the carrying value of its intangible assets and, accordingly, recognized
a goodwill and identified intangible asset impairment charge of approximately
$22.4 million in 2002. No such charge was recorded in 2003. If our current
financial projections or related assumptions are modified in the future, we may
be required to record additional impairment charges.
Impairment charges for the year ended December 31, 2001 totaling $3.9 million
include a charge for an acquired Intel technology license, valued at $1.7
million, as well as charges for the identified intangible assets and goodwill
remaining from the Cinax acquisition totaling approximately $2.2 million. Both
the acquired technology rights and Cinax identified intangible assets and
goodwill were deemed to be impaired based upon various factors including the
projected cash flows expected from the use of the assets and their eventual
disposition, as well as our strategic shift to becoming a DRM software and
services company.
Gains on Disposals of Assets. For the year ended December 31, 2001 we recorded
gains of approximately $47.5 million and $4.5 million as a result of the sale of
the assets related to our CE and IA businesses, respectively, in March 2001. 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 connection with this
settlement agreement, we reversed accruals of approximately $0.7 million
recorded in March 2001 as part of the sale. During the year ended December 31,
2002 we recorded charges of $0.1 million for the disposal of certain assets that
were no longer utilized or needed for our continuing operations.
Interest Income (Expense), net. Net interest income decreased by $0.4 million or
96% for the year ended December 31, 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. Net interest income and expense decreased by $1.3
million, or 75%, for the year ended December 31, 2002 compared to the comparable
period in 2001. The decrease was the result of lower average cash balances and
lower bank interest rates in 2002.
32
Other Income and (Expense), net. We entered into a registration rights agreement
with the investors in the PIPE financing pursuant to which we were obligated to
file a registration statement 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, 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. 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 year ended December 31, 2003 was $0.8
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.
During the year ended December 31, 2002 we recorded, as other income, $0.5
million in connection with the settlement of a vendor disputeinvolving inventory
for which a portion of our total obligation was forgiven. There were no
equivalent charges recorded in the prior year.
Provision for Income Taxes (Benefit). The income tax expense recorded for the
year ended December 31, 2003 is attributable to the provision for certain
foreign income taxes. The income tax benefit recorded for the year ended
December 31, 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, and partially offset by a provision for certain foreign
income taxes.
Acquired In-Process Research and Development
In connection with the acquisition of eMation in December 2001, we expensed $3.1
million of the purchase price as IPR&D. The potential income streams were
discounted using a 15%-25% discount rate for risks, probabilities and
uncertainties, including the stage of development of the technology, viability
of target markets, and other factors.
As of the acquisition date, eMation was conducting ongoing research and
development into its next generation DRM product, as well as enhancing its
WizFactory and @aGlance industrial DRM products. Due to the significant
technological risks relating to the development of these products and the fact
that the products were not completed at the time of the acquisition, the work
effort estimated to bring these products to market was considered in-process
research and development. These development efforts were expected to include
product enhancements to enable the products to perform on an increased number of
platforms. In September 2002, we completed the next generation DRM product,
Axeda DRM 3. Release 3 expanded the diagnosis and repair, reporting,
performance, connectivity and security features of the Axeda DRM system. Also in
September 2002, we completed the new Windows XP version of our industrial
automation solution, Wizcon, version 8.2, supervisory control and data
acquisition, or SCADA, system. These products, along with any related services
and maintenance, are expected to generate revenues for the next several years.
33
Quarterly Results of Operations
The following table presents certain unaudited quarterly consolidated statements
of operations data for the eight quarters ended December 31, 2003. In the
opinion of management, this information has been presented on the same basis as
the audited consolidated financial statements appearing elsewhere in this Annual
Report, and all necessary adjustments have been included in the amounts stated
below to present fairly the unaudited quarterly results when read in conjunction
with our audited consolidated financial statements included at Item 8 herein.
Results of operations for any quarter are not necessarily indicative of the
results to be expected for the entire year or for any future period.
Mar. 31, Jun. 30, Sept. 30, Dec. 31, Mar. 31, Jun. 30, Sept. 30, Dec. 31,
2002 2002 2002 2002 2003 2003 2003 2003
---- ---- ---- ---- ---- ---- ---- ----
(In thousands, except share and per share data)
Revenues:
License ................................ $ 3,040 $ 2,578 $ 3,421 $ 3,733 $2,317 $2,158 $ 2,575 $2,084
Services and maintenance ............... 543 674 795 1,112 963 570 924 1,280
Hardware ............................... 1,057 291 153 732 137 46 104 36
----- --- --- --- --- -- --- --
Total revenues ............................. 4,640 3,543 4,369 5,577 3,417 2,774 3,603 3,400
----- ----- ----- ----- ----- ----- ----- -----
Cost of revenues:
License ................................ 1,035 782 579 453 511 314 151 316
Services and maintenance .............. 717 990 1,163 1,340 1,012 1,025 757 900
Hardware ............................... 1,009 243 29 7 - 1 - -
Software amortization .................. 529 525 525 364 157 159 159 159
--- --- --- --- --- --- --- ---
Total cost of revenues ..................... 3,290 2,540 2,296 2,164 1,680 1,499 1,067 1,375
----- ----- ----- ----- ----- ----- ----- -----
Gross profit ............................... 1,350 1,003 2,073 3,413 1,737 1,275 2,536 2,025
----- ----- ----- ----- ----- ----- ----- -----
Research and development (R&D)
Non-cash compensation .................. 64 34 31 34 28 28 28 18
Other R&D expense ...................... 2,232 2,090 1,655 1,185 1,714 1,407 969 902
Sales and marketing (S&M)
Non-cash compensation and other expense . 19 19 17 16 11 6 10 4
Other S&M expense ..................... 4,802 4,990 3,836 3,014 2,505 2,276 1,777 1,863
General and administrative (G&A)
Non-cash compensation ................. 860 239 103 102 103 170 108 95
Other G&A expense ..................... 3,018 3,076 2,401 2,505 2,570 1,943 1,763 1,145
Provision for doubtful accounts
(net of recoveries) .................. 45 (67) (27) 4 (9) 13 (16) (3)
Depreciation and amortization ............. 310 330 422 490 308 262 278 275
Impairment charges ........................ - - - 22,413 - - - -
Special charges ........................... - 820 - - - - - -
--- --- --- --- --- --- --- ---
Total operating costs ................... 11,350 11,531 8,438 29,763 7,230 6,105 4,917 4,299
------ ------ ----- ------ ----- ----- ----- -----
Operating loss .......................... (10,000) (10,528) (6,365) (26,350) (5,493) (4,830) (2,381) (2,274)
Gains (losses) on disposals of assets ..... - (37) (86) (15) 743 - - -
Interest income (expense), net ............ 220 93 93 35 31 22 (24) (10)
Other income (expense),net ................ - (3) 47 510 (18) - 639 185
--- --- --- --- ---- --- --- ---
Loss before provision for income taxes
(benefit) ................................ (9,780) (10,475) (6,311) (25,820) (4,737) (4,808) (1,766) (2,099)
Provision for income taxes (benefit) ...... (668) - - 209 50 45 45 58
----- --- --- --- --- --- --- ---
Net loss .................................. $ (9,112) $ (10,475) $ (6,311) $ (26,029) $ (4,787) $ (4,853) $ (1,811) $ (2,157)
========= ========== ========= ========== ========= ========= ========= =========
Basic and diluted net loss per weighted
average common share outstanding ......... $(0.34) $(0.39) $(0.23) $(0.96) $(0.18) $(0.18) $(0.07) $(0.07)
======= ======= ======= ======= ======= ======= ======= =======
Weighted average number of common shares
outstanding - basic and diluted .......... 26,789,174 26,986,387 27,222,368 27,250,263 27,179,237 27,245,700 27,741,394 32,314,920
========== ========== ========== ========== ========== ========== ========== ==========
34
Axeda Systems Inc.
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 December 31, 2003, we had approximately
$9.6 million in cash and cash equivalents.
Net cash used in operating activities for the year ended December 31, 2003 was
$15.2 million, compared to $23.9 million for the year ended December 31, 2002.
Cash used in operating activities for the year ended December 31, 2003 was
primarily the result of our net loss of approximately $13.6 million and other
changes in working capital of approximately $2.4 million, offset by
approximately $0.8 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%, by eliminating or not replacing 96
employees, engaged partners to provide us with variable staffing capabilities to
meet peak demand periods and have closely monitored our infrastructure costs. In
2002 we exited the PC business and focused our efforts on several key markets
for DRM Systems products. In 2002 and 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. As a result of these
actions, our cash and cash equivalents balance decreased by $11.3 million and
$3.7 million (excluding the $5.6 million received in September 2003) during the
first and second halves of 2003, respectively. 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 year ended December 31, 2003 was
$0.3 million, as compared to $2.3 million for the year ended December 31, 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 year ended
December 31, 2003 and consisted primarily 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
approximately $0.2 million. Net cash used in financing activities of $2.0
million for the year ended December 31, 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 $2.0 million or the borrowing base, as defined (limited to a percentage of
eligible accounts receivable). As of December 31, 2003, we had $0.4 million in
borrowings under the Line, which was repaid in January 2004. In addition, we
repaid the remaining balance under an equipment loan facility in December 2003.
As of December 31, 2003, we were in compliance with all of our covenants under
the Line.
35
In September 2003, we issued 4,918,100 shares of our common stock to certain
accredited investors in the PIPE financing. The shares were sold at a price of
$1.22 per share with proceeds of approximately $5.6 million, net of placement
and legal and accounting fees of approximately $0.4 million. In connection with
the PIPE financing, we also issued to the investors warrants exercisable through
September 23, 2008 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 December 31, 2003, we have $1.2 million of estimated accrued costs related
to facilities that we no longer occupy. We have made significant efforts to
terminate certain of 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 the first quarter of 2005. However, due to risks and
uncertainties, we cannot assure investors that our future operating cash flows
will be sufficient to meet our requirements. Additionally, financing may not be
available when needed and, if such financing is available, it may not be
available on terms favorable to us. In such event, our operations and liquidity
will be materially adversely affected.
36
Axeda Systems Inc.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to goodwill, intangible assets, income taxes, litigation and other
contingencies. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements. For a summary of all of our significant accounting
policies, including the critical accounting policies discussed below, see note 1
to the accompanying consolidated financial statements filed herewith at Item 8.
Revenue recognition. We derive our revenues from primarily two sources (i)
product revenues, which includes software license, royalties and hardware
revenues, and (ii) services and support revenues, which includes professional
services, software license maintenance, training and consulting revenues. As
described below, significant management judgments and estimates must be made and
used in connection with the revenue recognized in any accounting period.
Material differences may result in the amount and timing of our revenue for any
period if our management made different judgments or utilized different
estimates.
We generally license our software products on a perpetual basis. Some of our
licenses include maintenance and support, which typically are for renewable
periods of one year.
We apply the provisions of Statement of Position 97-2, "Software Revenue
Recognition," or SOP 97-2, as amended by Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions," or SOP 98-9, to all transactions involving the sale of software
products.
We recognize revenue from the sale of software licenses when persuasive evidence
of an arrangement exists, the product has been delivered, the fee is fixed or
determinable and collection of the resulting receivable is probable. Delivery
generally occurs when product is delivered to a common carrier. If a significant
portion of a fee is due after our normal payment terms, we account for the fee
as not being fixed or determinable. In these cases, we recognize revenue as the
fees become due and payable.
We assess collection based on a number of factors, including the transaction
history and the credit-worthiness of the customer. If we determine that
collection of a fee is not probable, we defer the fee and recognize revenue at
the time collection becomes probable, which is generally upon receipt of cash.
For all sales we use either a signed agreement or a binding purchase order as
evidence of an arrangement. Sales through our distributors are evidenced by a
master agreement governing the relationship together with binding purchase
orders on a transaction-by-transaction basis.
For multiple-element arrangements that are not accounted for using contract
accounting (for example, undelivered maintenance and support), we allocate
revenue to the delivered elements of the arrangement using the residual value
method when there is vendor-specific objective evidence of fair value, or VSOE,
for each of the undelivered elements. We defer revenue from the arrangement fee
equivalent to the fair value of the undelivered elements, and the difference
between the total arrangement fee and the amount deferred for the undelivered
elements is recognized as revenue related to the delivered elements. The fair
value of DRM maintenance and postcontract customer support, or PCS, obligations
is based upon separate sales of renewals to other customers or upon renewal
rates quoted in the contracts. The fair value of DRM services, such as training
or consulting, is based upon separate sales by us of these services to other
customers.
Our arrangements do not generally include acceptance clauses. However, if an
arrangement includes an acceptance provision, acceptance occurs upon the earlier
of receipt of a written customer acceptance or expiration of the acceptance
period.
37
We recognize revenues for maintenance services ratably over the contract term.
Our training and professional services are billed based on daily rates, and we
generally recognize revenues as these services are performed. However, if our
services are bundled with a license component and the arrangement requires us to
perform significant work, such as altering the underlying software or building
additional, complex interfaces so that the software conforms to the customer's
requirements, we recognize the entire fee using the percentage of completion
method. We estimate the percentage of completion based on the costs incurred to
date as a percentage of the estimated total costs to complete the project. For
arrangements that include services that, under SOP 97-2, qualify for separate
accounting, we follow the provisions of SOP 97-2 and allocate revenues to the
services element based on VSOE and recognize the revenues as the services are
performed. During our analysis, if the work effort to complete a project exceeds
our revenue projections, a loss on the project is immediately recognized.
Provision for doubtful accounts. Management must make estimates of the
collectibility of our accounts receivable. Management specifically analyzes
accounts receivable and analyzes historical bad debts, customer concentrations,
customer creditworthiness, current economic trends and changes in our customer
payment terms when evaluating the adequacy of the allowance for doubtful
accounts. Our accounts receivable balance was $3.2 million, net of allowance for
doubtful accounts of less than $0.1 million as of December 31, 2003.
Valuation of long-lived assets and intangible assets with finite lives, and
goodwill. We evaluate long-lived assets, including intangible assets other than
goodwill, for impairment under SFAS No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets," or SFAS 144. In accordance with SFAS 144, we
evaluate long-lived assets, including intangible assets other than goodwill, for
impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable based on expected undiscounted
cash flows attributable to that asset. The amount of any impairment is measured
as the difference between the carrying value and the fair value of the impaired
asset. As of December 31, 2003, the carrying amount of our identified intangible
assets was $1.4 million.
Factors we consider important which could trigger an impairment review include
the following:
o significant underperformance relative to expected historical or
projected future operating results;
o significant changes in the manner of our use of the acquired assets or
the strategy for our overall business;
o significant negative industry or economic trends; and
o significant decline in our stock price for a sustained period; and our
market capitalization relative to net book value.
We evaluate goodwill on a quarterly basis for indications of impairment based on
our fair value as determined by our market capitalization in accordance with
Statement of Financial Standards No. 142, or SFAS 142, "Goodwill and Other
Intangible Assets." If this evaluation indicates that the value of the goodwill
may be impaired, we make an assessment of the impairment of the goodwill using
the two-step method prescribed by SFAS 142. Any such impairment charge could be
significant and could have a material adverse effect on our reported financial
statements. During the fourth quarter of 2003, we performed the annual goodwill
impairment test, which indicated that goodwill was not impaired. We did not
record any impairment charges on our goodwill during 2003. As of December 31,
2003, the carrying amount of our goodwill was $3.6 million.
Contingencies. Management's current estimated range of liability related to our
pending legal claims is based on claims for which management can estimate the
amount or range of loss. We have accrued for estimated losses in the
accompanying consolidated financial statements for those matters where we
believe the likelihood of an adverse outcome is probable and the amount of the
loss is reasonably estimable. Because of the uncertainties related to both the
amount and range of loss on the remaining pending legal claims, management is
unable to make a reasonable estimate of the liability that could result from an
unfavorable outcome. As additional information becomes available, we will assess
the potential liability related to our pending legal claims and revise our
estimates. Such revisions in our estimates of the potential liability could
materially impact our results of operations, financial position and cash flows.
Income Taxes. The relative proportions of our domestic and foreign revenue and
income directly affect our effective tax rate. We are also subject to changing
tax laws in the multiple jurisdictions in which we operate. We have recorded a
valuation allowance for our entire deferred tax asset balance due to
uncertainties related to our ability to utilize our deferred tax assets,
primarily consisting of certain net operating losses carried forward, before
they expire. The valuation allowance is based on our estimates of taxable income
by jurisdiction in which we operate and the period over which our deferred tax
assets will be recoverable.
38
CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations as of December 31,
2003 (in thousands):
Payments Due By Period
------------------------------------------------------------------------
Less than 1 More than 5
Contractual obligation Total year 1-3 years 3-5 years years
- ---------------------------- ----- ---- --------- --------- -----
Long-term debt obligation $ 14 $ 14 $ -- $ -- $ --
Operating lease obligations 3,925 1,230 1,411 819 465
Purchase obligations 1,404 1,191 213 - -
----- ----- --- --- ---
Total $5,343 $2,435 $1,624 819 465
====== ====== ====== === ===
A purchase obligation is defined as an agreement to purchase goods or services
that is enforceable and legally binding on the registrant and that specifies all
significant terms, including: fixed or minimum quantities to be purchased;
fixed, minimum or variable price provisions; and the approximate timing of the
transaction.
39
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 2004 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 years
ended December 31, 2003 and 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."
2003 2002
---- ----
Net grants during the period as % of outstanding shares (#) ...............4.11% 9.17%
Grants to Named Executive Officers during the period as % of
total options granted (%) ................................................11.66% 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 (%) ..................................................34.98% 40.90%
40
General Option Information
The following table sets forth the summary of activity under the Plans for the
years ended December 31, 2003 and 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 (1,329,000) 1,329,000 1.47
Exercises - (85,645) 0.17
Cancellations* 486,902 (601,533) 2.88
Additional shares reserved 1,100,000 N/A
--------- ---
December 31, 2003 521,326 5,720,641 $1.76
======= =========
* The "Number of Shares Available for Options" does not include options under
assumed plans exercisable for 114,631 and 103,319 shares that were cancelled
during 2003 and 2002, respectively, as no options will be granted in the future
pursuant to these assumed plans.
The following table sets forth a comparison, as of December 31, 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 December 31, 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 Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
In-the-money 1,424,805 $ 0.17 941,007 $ 0.54 2,365,812 $ 0.32
Out-of-the-money (1) 1,783,796 $ 3.48 1,571,033 $ 1.99 3,354,829 $2.78
Total options outstanding 3,208,601 $ 2.01 2,512,040 $ 1.45 5,720,641 $ 1.76
(1) Out-of-the-money options are those options with an exercise price equal to
or above the closing price of $1.36 as of December 31, 2003, as reported by the
NASDAQ National Market.
41
Executive Options
The following table sets forth information regarding stock options granted
in 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.
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 7.52% $ 0.01 4/28/2013 $66,703 $111,272
John C. Roberts 55,000 4.14% $ 1.45 9/24/2013 $40,450 $67,476
*Based on a total of 1,329,000 shares subject to options granted to employees
under our option plans during 2003.
Stock Option Exercises and Option Holdings
The following table shows stock options exercised by the Named Executive
Officers for the year ended December 31, 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 December 31, 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 December 31, 2003 of our common stock.
Number of
Shares
Named Executive Acquired on Value Number of Securities Underlying Values of Unexercised
Officer Exercise Realized Unexercised Options In-the-Money Options*
- ------------------- -------- -------- ----------------------------------- -------------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
Robert M. Russell - $ - 513,663 367,337 $364,252 $ 221,908
Dale E. Calder - - 521,874 53,126 437,749 72,251
Thomas J. Fogarty - - 343,538 86,462 335,749 72,251
John C. Roberts - - 29,790 85,210 20,966 19,834
* Option values based on stock price of $1.36 on December 31, 2003.
42
Recent Accounting Pronouncements
Information regarding recent accounting pronouncements is provided in note 1q to
the consolidated financial statements included at Item 8 herein.
ITEM 7A. 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.
43
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated Financial Statements
Axeda Systems Inc.
Independent Auditors' Report ...................................................... .........................45
Consolidated Balance Sheets, December 31, 2003 and 2002 ........................... .........................46
Consolidated Statements of Operations, Years ended December 31, 2003, 2002, and 2001 ........................47
Consolidated Statements of Changes in Stockholders' Equity, Years ended December 31, 2003, 2002, and 2001 ...48
Consolidated Statements of Cash Flows, Years ended December 31, 2003, 2002, and 2001 ........................50
Notes to the Consolidated Financial Statements ..................................... ........................51
44
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Axeda Systems Inc.:
We have audited the accompanying consolidated balance sheets of Axeda Systems
Inc. and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of operations, changes in stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 2003.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Axeda Systems Inc.
and subsidiaries as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.
As discussed in Note 1e to the consolidated financial statements, Axeda Systems
Inc. adopted Statement of Financial Accounting Standard No. 142, "Goodwill and
Other Intangible Assets," effective January 1, 2002.
/s/KPMG LLP
Philadelphia, Pennsylvania
February 2, 2004
45
AXEDA SYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
December 31,
----------------------
2003 2002
---- ----
ASSETS
Current assets:
Cash and cash equivalents, including restricted cash of $650 in 2002 ......... 9,617 19,065
Accounts receivable, net of provision for doubtful accounts of $68 in 2003 and
$84 in 2002 .................................................................. 3,200 3,305
Prepaid expenses .............................................................. 307 546
Other current assets .......................................................... 121 427
--------- ---------
Total current assets ...................................................... 13,245 23,343
Furniture and equipment, net .................................................. 2,229 3,111
Goodwill ...................................................................... 3,640 3,651
Identified intangible assets, net ............................................. 1,423 2,087
Other assets .................................................................. 349 321
--------- ---------
Total assets .............................................................. $ 20,886 $ 32,513
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable .............................................. $ 417 $ 238
Accounts payable .............................................................. 1,253 2,448
Accrued expenses .............................................................. 4,866 8,015
Income taxes payable .......................................................... 733 616
Deferred revenue .............................................................. 1,422 1,078
--------- ---------
Total current liabilities ................................................. 8,691 12,395
Non-current liabilities:
Other non-current liabilities ................................................. 862 1,046
Financing-related liability .................................................. 2,608 --
--------- ---------
Total liabilities ........................................................... 12,161 13,441
--------- ---------
Commitments and contingencies (note 12)
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 shares authorized; 32,913,211 shares
issued in 2003 and 27,822,217 shares issued in 2002 .......................... 33 28
Additional paid-in capital .................................................... 146,644 143,847
Deferred stock compensation ................................................... (310) (578)
Accumulated deficit ........................................................... (136,488) (122,880)
Accumulated other comprehensive income ........................................ 226 35
Treasury stock at cost, 603,800 shares in 2003 and 2002 ....................... (1,380) (1,380)
--------- ---------
Total stockholders' equity ................................................ 8,725 19,072
--------- ---------
Total liabilities and stockholders' equity ................................ $ 20,886 $ 32,513
========= =========
See accompanying notes to the consolidated financial statements.
46
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
Year Ended December 31,
--------------------------------------------
2003 2002 2001
------------ ------------ ------------
Revenues:
License ................................................................. $ 9,134 $ 12,772 $ 6,036
Services and maintenance ................................................ 3,737 3,124 442
Hardware ................................................................ 323 2,233 1,111
------------ ------------ ------------
Total revenues ............................................................ 13,194 18,129 7,589
------------ ------------ ------------
Cost of revenues:
License ................................................................. 1,292 2,849 1,629
Services and maintenance ................................................ 3,694 4,210 223
Hardware ................................................................ 1 1,288 1,122
Software amortization ................................................... 634 1,943 171
Inventory charges ....................................................... -- -- 18,502
------------ ------------ ------------
Total cost of revenues .................................................... 5,621 10,290 21,647
------------ ------------ ------------
Gross profit ................................................................ 7,573 7,839 (14,058)
------------ ------------ ------------
Research and development
Non-cash compensation ................................................... 102 163 2,100
Other research and development expense .................................. 4,992 7,162 5,691
Sales and marketing
Non-cash compensation and other expense ................................. 31 71 147
Other selling and marketing expense ..................................... 8,421 16,642 7,670
General and administrative
Non-cash compensation ................................................... 476 1,304 780
Other general and administrative expense ................................ 7,421 11,000 9,860
Provision for doubtful accounts (net of recoveries) ..................... (15) (45) 929
Depreciation and amortization ............................................... 1,123 1,552 2,844
Special charges ............................................................. -- 820 --
Impairment charges .......................................................... -- 22,413 3,916
Acquired in-process research and development ................................ -- -- 3,112
------------ ------------ ------------
Total operating costs ....................................................... 22,551 61,082 37,049
------------ ------------ ------------
Operating loss ............................................................ (14,978) (53,243) (51,107)
Gains (losses) on disposals of assets ....................................... 743 (138) 52,037
Interest income (expense), net .............................................. 19 441 1,753
Other income (expense), net ................................................. 806 554 (133)
------------ ------------ ------------
Income (loss) before provision for income taxes (benefit) ................... (13,410) (52,386) 2,550
Provision for income taxes (benefit) ................................... 198 (459) 1,123
------------ ------------ ------------
Net income (loss) ........................................................... $ (13,608) $ (51,927) $ 1,427
============ ============ ============
Basic net income (loss) per weighted average common share outstanding ....... $ (0.48) $ (1.92) $ 0.08
============ ============ ============
Diluted net income (loss) per weighted average common share
outstanding ................................................................. $ (0.48) $ (1.92) $ 0.07
============ ============ ============
Weighted average number of common shares outstanding used in calculation
of basic net income (loss) per common share ................................. 28,631,975 27,063,751 18,559,185
============ ============ ============
Weighted average number of common shares outstanding used in calculation
of diluted net income (loss) per common share ............................... 28,631,975 27,063,751 20,194,713
============ ============ ============
See accompanying notes to the consolidated financial statements.
47
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands, except share and per share data)
Additional Deferred
Common stock paid-in stock Accumulated
Shares Amount capital compensation deficit
------ ------ ------------ ------- -------------
Balances as of December 31, 2000 ................. 17,594,429 $17 $ 121,330 $(3,241) $ (72,380)
---------- --- --------- ------- ---------
Issuance of common stock upon exercise of
options ......................................... 1,167,132 1 1,570 -- --
Issuance of common stock upon exercise of
warrants ........................................ -- -- 4 -- --
Issuance of common stock for employee stock
purchase plan ................................... 38,735 -- 86 -- --
Issuance of equity securities related to Cinax ... 474,666 1 14 344 --
Issuance of common stock to acquire eMation,
Ltd ............................................. 8,000,000 8 19,752 (847) --
Compensation related to stock options and warrants -- -- 698 549 --
Amortization of deferred stock
compensation .................................... -- -- -- 1,353 --
Repurchases of common stock ...................... -- -- -- -- --
Foreign currency translation
adjustment ...................................... -- -- -- -- --
Reclassification adjustment for available-for-sale
investment sold ................................. -- -- -- -- --
Net income ....................................... -- -- -- -- 1,427
---------- --- --------- ------- ---------
Balances as of December 31, 2001 ................. 27,274,962 $27 $ 143,454 $(1,842) $ (70,953)
---------- --- --------- ------- ---------
Issuance of common stock upon exercise of
options ......................................... 207,331 -- 53 -- --
Issuance of common stock for employee stock
purchase plan ................................... 68,085 -- 65 -- --
Issuance of equity securities related to Cinax.... 271,839 1 (1) -- --
Compensation related to stock options and warrants -- -- 276 45 --
Amortization of deferred stock
compensation .................................... -- -- -- 1,219 --
Common stock received as repayment of officer loan
receivable ...................................... -- -- -- -- --
Foreign currency translation
adjustment ...................................... -- -- -- -- --
Net loss ......................................... -- -- -- -- (51,927)
---------- --- --------- ------- ---------
Balances as of December 31, 2002 ................. 27,822,217 $28 $ 143,847 $ (578) $(122,880)
---------- --- --------- ------- ---------
Issuance of common stock in private placement
transaction, net 4,918,100 5 2,165 -- --
Escrow shares returned from acquisition of eMation, Ltd. (98,127) -- 182 -- --
Issuance of common stock upon exercise of options
and warrants....... 147,238 -- 15 -- --
Issuance of common stock for employee stock
purchase plan............ 123,783 -- 50 -- --
Compensation related to stock options and warrants -- -- 385 (279) --
Amortization of deferred stock compensation .... -- -- -- 547 --
Foreign currency translation adjustement..... -- -- -- -- --
Net loss........................................ -- -- -- -- (13,608)
---------- --- --------- ------- ---------
Balances as of December 31, 2003 32,913,211 $33 $ 146,644 $(310) $(136,488)
========= === ========= ======= =========
See accompanying notes to the consolidated financial statements.
48
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands, except share and per share data)
Accumulated Total
other stockholders' Comprehensive
comprehensive Treasury equity income
income (loss) stock (deficiency) (loss)
-------------- ------------ -------------- ---------------
Balances as of December 31, 2000 ................. $(178) $ (720) $ 44,828 $(40,565)
---------- --- ------- ---------
Issuance of common stock upon exercise of
options ......................................... -- -- 1,571 --
Issuance of common stock upon exercise of
warrants ........................................ -- -- 4 --
Issuance of common stock for employee stock
purchase plan ................................... -- -- 86 --
Issuance of equity securities related to Cinax ... -- -- 359 --
Issuance of common stock to acquire eMation,
Ltd ............................................. -- -- 18,913 --
Compensation related to stock options and warrants -- -- 1,247 --
Amortization of deferred stock
compensation .................................... -- -- 1,353 --
Repurchases of common stock ...................... -- (621) (621) --
Foreign currency translation
adjustment ...................................... 112 -- 112 112
Reclassification adjustment for available-for-sale
investment sold ................................. 87 -- 87 87
Net income ....................................... -- -- 1,427 1,427
--------- ------- -------- --------
Balances as of December 31, 2001 ................. $ 21 $(1,341) $ 69,366 $ 1,626
---------- -------- ------- ---------
Issuance of common stock upon exercise of
options ......................................... -- -- 53 --
Issuance of common stock for employee stock
purchase plan ................................... -- -- 65 --
Issuance of equity securities related to Cinax
.. ................................................ -- -- -- --
Compensation related to stock options and warrants -- -- 321 --
Amortization of deferred stock
compensation .................................... -- -- 1,219 --
Common stock received as repayment of officer loan
receivable ...................................... -- (39) (39) --
Foreign currency translation
adjustment ...................................... 14 -- 14 14
Net loss ......................................... -- -- (51,927) (51,927)
----- ------- -------- --------
Balances as of December 31, 2002 ................. $ 35 $(1,380) $ 19,072 $(51,913)
----- ------- -------- --------
Issuance of common stock in private placement
transaction, net -- -- 2,170 --
Escrow shares returned from acquisition of
eMation, Ltd. -- -- 182 --
Issuance of common stock upon exercise of options
and warrants....... -- -- 15 --
Issuance of common stock for employee stock
purchase plan............ -- -- 50 --
Compensation related to stock options and warrants -- -- 106 --
Amortization of deferred stock compensation -- -- 547 --
Foreign currency translation adjustment 191 -- 191 191
Net loss...................................... -- -- (13,608) (13,608)
------- ------- ------- -------
Balances as of December 31, 2003 $226 $(1,380) $8,725 $(13,417)
===== ======== ====== =========
See accompanying notes to the consolidated financial statements.
49
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
----------------------------------
2003 2002 2001
---- ---- ----
Cash flows from operating activities:
Net income (loss) .......................................................... $(13,608) $(51,927) $ 1,427
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Depreciation and amortization ............................................ 1,757 3,495 3,015
Impairment charges ....................................................... -- 22,413 3,916
(Gains) losses on disposals of assets .................................... (729) 472 (52,037)
Unrealized gain on financing-related liability ........................... (802) -- --
Non-cash compensation and other expenses ................................. 610 1,523 2,599
Provision for doubtful accounts (recoveries) ............................. (65) (97) 929
Provision for inventory .................................................. -- -- 18,783
Acquired in-process research and development ............................ -- -- 3,112
Changes in items affecting operations (excluding the effects of acquisitions
and divestitures):
Accounts receivable ...................................................... 121 1,415 2,252
Inventories .............................................................. -- 2,070 (895)
Loan receivable--officer ................................................. -- -- 494
Prepaid expenses and other current assets ................................ 589 680 (1,590)
Other assets and intangible assets ....................................... (17) 35 572
Accounts payable ......................................................... (1,195) (2,439) (15,623)
Accrued expenses and other current and non-current liabilities ........... (2,316) (1,266) 2,257
Income taxes payable ..................................................... 117 (459) 1,075
Deferred revenue ......................................................... 344 152 (765)
-------- -------- --------
Net cash used in operating activities ........................................ (15,194) (23,933) (30,479)
-------- -------- --------
Cash flows from investing activities:
Capital expenditures ....................................................... (293) (2,334) (505)
Net proceeds from sales of assets .......................................... -- -- 68,112
Acquisition, net of cash acquired .......................................... -- -- 497
-------- -------- --------
Net cash provided by (used in) investing activities .......................... (293) (2,334) 68,104
-------- -------- --------
Cash flows from financing activities:
Net proceeds from issuance of common stock ................................. 5,597 -- --
Net borrowings under bank line of credit ................................... 417 -- --
Net proceeds from exercise of stock options and warrants ................... 10 53 1,538
Repayments of long-term debt ............................................... (238) (2,084) --
Repurchases of common stock ................................................ -- -- (621)
Repayments under other liabilities ......................................... -- -- (132)
Repayment of shareholder bridge loan ....................................... -- -- (750)
Repayments under capital lease obligations ................................. -- -- (38)
-------- -------- --------
Net cash provided by (used in) financing activities .......................... 5,786 (2,031) (3)
Effect of exchange rate changes on cash and cash equivalents ................. 253 14 112
-------- -------- --------
Net increase (decrease) in cash and cash equivalents ......................... (9,448) (28,284) 37,734
Cash and cash equivalents:
Beginning of period ........................................................ 19,065 47,349 9,615
-------- -------- --------
End of period, including restricted cash of $650 in 2002 and $2,549 in 2001 $ 9,617 $ 19,065 $ 47,349
======== ======== ========
See accompanying notes to the consolidated financial statements.
50
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
All amounts are in thousands, except share and per share amounts, unless noted
otherwise.
1) Summary of Significant Accounting Policies
a) Description of Business
Axeda Systems Inc., or we, our, us or Axeda, develops, markets and sells
software products and services used by multiple industries and customers
worldwide for Device Relationship Management, or 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, or 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 (note 4).
In 2003 our revenues have been substantially generated from selling DRM
products.
We have sustained significant net losses and negative cash flows from
operations since our inception. For the years ended December 31, 2003, 2002
and 2001, our net losses, excluding gains and losses on disposals of
assets, were $14,351, $51,789, and $50,610, 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 the
first quarter of 2005. 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 2003, we recorded approximately $1,900 and $1,400,
respectively, in restructuring charges to reduce staffing levels, terminate
certain leases and consolidate our operations. As a result of these actions
our cash and cash equivalents balance decreased by $11,305 and $3,740
(after taking into consideration the net $5,597 raised in September 2003 -
note 10), during the first and second halves of 2003, respectively.
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 years. We will continue to evaluate our cost structure and
may undertake additional measures to reduce expenses in the future.
b) 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.
c) Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, we consider all
highly liquid instruments purchased with an original maturity of three
months or less to be cash equivalents.
51
d) Furniture and Equipment
Furniture and equipment is stated at cost. Equipment under capital leases
is stated at the lower of the present value of the minimum lease payments
or the fair value of the equipment. Depreciation and amortization on
furniture and equipment is calculated on the straight-line method over the
estimated useful lives of the assets. Equipment under capital leases is
amortized straight-line over the lease term or the estimated useful lives
of the assets. The estimated useful lives of the assets are as follows:
Purchased software ........... .. 3-5 years
Computer and other equipment . .. 3-5 years
Furniture and equipment ...... .. 7 years
e) Goodwill and Intangible Assets (Note 1f)
In July 2001, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 141, "Business
Combinations," or SFAS 141, and SFAS No. 142, "Goodwill and Other
Intangible Assets," or SFAS 142. SFAS 141 requires that the purchase method
of accounting be used for all business combinations. SFAS 141 also
specifies criteria that intangible assets acquired in a purchase method
business combination must meet to be recognized and reported apart from
goodwill. SFAS 142, which was effective January 1, 2002, requires that
intangible assets with indefinite useful lives should not be amortized
until their lives are determined to be finite and all other intangible
assets with finite lives must be amortized over their useful lives to their
estimated residual values. SFAS 142 also requires that goodwill not be
amortized, but instead be tested for impairment in accordance with the
provisions of SFAS 142 at least annually or between annual tests upon the
occurrence of certain events or upon certain changes in circumstances.
Intangible assets with finite useful lives are reviewed for impairment in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," or SFAS 144. See "Impairment of Goodwill and Long-lived
Assets," below.
We adopted SFAS 141 in 2001. Effective July 1, 2001, we adopted certain
provisions of SFAS 142, as required in the transition guidance contained
therein, and adopted the remaining provisions on January 1, 2002. There was
not a cumulative transition adjustment upon adoption as of July 1, 2001 or
January 1, 2002. SFAS 141 and SFAS 142 required us to perform the following
as of January 1, 2002: (i) review goodwill and intangible assets for
possible reclassifications; (ii) reassess the lives of intangible assets;
and (iii) perform a transitional goodwill impairment test. We reviewed the
balances of goodwill and identifiable intangible assets and determined that
we did not have any amounts that were required to be reclassified from
goodwill to identifiable intangible assets, or vice versa. We also reviewed
the useful lives of our identifiable intangible assets and determined that
the original estimated useful lives remain appropriate. We completed the
transitional goodwill impairment test and determined that we did not have a
transitional impairment of goodwill.
As required by SFAS 142, we have not amortized goodwill associated with
acquisitions completed after June 30, 2001 for any period presented and
ceased amortization of goodwill associated with acquisitions completed
prior to July 1, 2001, effective January 1, 2002. Prior to January 1, 2002,
we amortized goodwill associated with the pre-July 1, 2001 acquisitions
over four years using the straight-line method. Identifiable intangible
assets (acquired technology, patent applications and customer base) are
currently amortized over two or five years using the straight-line method.
We test goodwill for impairment in accordance with SFAS 142. SFAS 142
requires that goodwill be tested for impairment at the "reporting unit
level," or Reporting Unit, at least annually, and more frequently upon the
occurrence of certain events, as defined by SFAS 142. Goodwill is tested
for impairment annually, in the fourth quarter, in a two-step process.
First, we determine if the carrying amount of the Reporting Unit exceeds
the "fair value" of the Reporting Unit, which would indicate that goodwill
may be impaired. If we determine that goodwill may be impaired, we compare
the "implied fair value" of the goodwill, as defined by SFAS 142, to its
carrying amount to determine if there is an impairment loss. If the
carrying amount exceeds the implied fair value, we will record an
impairment charge for the excess, if any, but not in an amount in excess of
the carrying amount, in the period in which the determination of impairment
is made. Refer to notes 1f, 4 and 7 for further discussion of acquisitions,
intangible assets and goodwill.
52
Goodwill represents the excess of cost over fair value of assets of
businesses acquired. In accordance with SFAS 142, $3,640 of goodwill
acquired subsequent to June 30, 2001, in connection with the acquisition of
eMation. (notes 1e, 1f and 4), is not being amortized. Also under SFAS 142,
through December 31, 2001, all other goodwill was amortized on a
straight-line basis over the expected period to be benefited, estimated at
four years. Other identified intangible assets, consisting of developed and
core technology and customer base, are being amortized on a straight-line
basis over periods from two to five years. Amortization expense was $664,
$2,177 and $2,418 in 2003, 2002 and 2001, respectively. See notes 1f, 4, 6
and 7 for further discussion of acquisitions, acquired intangible assets
and goodwill.
f) Impairment of Goodwill and Long-Lived Assets
We evaluate long-lived assets, including intangible assets other than
goodwill, for impairment under SFAS 144 whenever events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable based on expected undiscounted cash flows attributable to that
asset. The amount of any impairment is measured as the difference between
the carrying value and the fair value of the impaired asset.
During the fourth quarter of 2003, we performed the annual goodwill
impairment test (note 1e), which indicated that goodwill was not impaired.
During the fourth quarter of 2002, with the assistance of an independent,
national valuation firm, we completed our annual goodwill impairment test
under SFAS 142, and also tested our identified intangible assets for
impairment under SFAS 144. Due to the severity and the length of the
industry downturn, including the decrease in the fair market value of our
common stock during 2002, and uncertainty of the timing of improvement in
industry conditions, we revised our earnings forecasts for the DRM
reporting unit. As a result, we recognized impairment charges of $17,124 to
reduce goodwill and $5,290 to reduce the identified intangible assets in
the DRM reporting unit. The impairment charges pertain to the core and
developed technologies, customer list and patent applications acquired
from, and goodwill related to the acquisition of eMation. The weighted fair
value of the DRM reporting unit was estimated using the Market Approach
(70%) and the Income Approach (30%). The market approach weighted the fair
values determined by valuing the market value of our common stock (the
Quoted Price Methodology - 35%), transactions of minority interests in
publicly-traded companies engaged in a similar business to ours (the
Exchange Method - 30%) and the median value-to-revenue multiple of recent
transactions in the software industry, adjusted for term debt (the
Acquisition Method - 5%). The income approach weighted the fair value
determined by the expected present value of future cash flows (the
Discounted Cash Flow Methodology - 30%). The fair value of the identified
intangible assets was determined using the expected present value of future
cash flows. The aggregate charges of $22,414 recorded in 2002 are included
in impairment charges in the accompanying consolidated statement of
operations.
In 2001, we recognized an impairment charge of $2,199 to reduce the amount
of goodwill and intangible assets associated with a prior acquisition to
their estimated fair value of zero. The impairment charge was attributable
to certain technology acquired from, and goodwill related to the
acquisition of Cinax Designs Inc. in 2000. During the fourth quarter of
2001, we determined that we would not allocate future resources to assist
in the market growth of this technology and we did not anticipate material
future sales of the products. Also in 2001, we recognized an impairment
charge of $1,716 to reduce the amount of acquired technology rights
associated with a prior equity financing to its estimated fair value of
zero. This impairment charge was attributable to certain technology
acquired from Intel in connection with the sale of our Series C preferred
stock in 1999. During the fourth quarter of 2001, we determined that we
would not allocate future resources to assist in the market growth of this
technology and we did not anticipate any material future sales of products
incorporating this technology. The aggregate amount of impaired long-lived
assets of $3,915 recorded in 2001 is included in impairment charges in the
accompanying consolidated statement of operations.
53
g) Revenue Recognition
Since December 2001, we license our DRM system products to customers in the
industrial, building automation, technology, medical instrumentation and
office and semiconductor equipment industries (note 4). Prior to December
2001, our primary revenue categories consisted of: software licenses for PC
and consumer electronics, or CE, products, including Digital Versatile
Disc, or DVD (note 5); Internet Appliance, or IA, products, including
Internet browser software and hardware reference designs; services for PC,
CE and IA products, including non-recurring engineering customization and
development services; and hardware for PC products, primarily DVD boards
and IA products, including Internet set-top boxes, and integrated circuit
boards.
We recognize software revenues in accordance with the American Institute of
Certified Public Accountants' , or AICPA, Statement of Position 97-2,
"Software Revenue Recognition," or SOP 97-2, as amended by SOP 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to
Certain Transactions," or 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, or VSOE, regardless of the prices stated
within the contract. VSOE is generally 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, or 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 development contracts involving significant
modification or customization of hardware or software under development
arrangements are recognized in accordance with the provisions of AICPA
Statement of Position 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts," or 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.
54
h) Computer Software Costs
Computer software costs consist of purchased software capitalized under the
provisions of Statement of Financial Accounting Standards No. 86, "Computer
Software to be Sold, Leased or Otherwise Marketed." Amortization of
capitalized software costs is computed on a straight-line basis over the
estimated economic life of the product (notes 4 and 6) or on a basis using
the ratio of current revenue to the total of current and anticipated future
revenue, whichever is greater, and included in cost of revenues in the
accompanying consolidated statements of operations. To date, no internally
developed software costs have been capitalized. All other research and
development expenditures are charged to research and development expense in
the period incurred.
Software developed for internal use is recognized in accordance with SOP
98-1, "Accounting For The Cost Of Computer Software Developed Or Obtained
For Internal Use," or SOP 98-1. SOP 98-1 requires all costs related to the
development of internal use software other than those incurred during the
application development stage to be expensed as incurred. It also provides
guidance on the capitalization of costs incurred during the application
development stage for computer software developed or obtained for internal
use. SOP 98-1 has not had a material impact on our operating results or
financial position.
i) Advertising Costs
Advertising costs are expensed as incurred. Advertising expense was $311,
$1,125 and $1,908 for the years ended December 31, 2003, 2002 and 2001,
respectively.
j) Income Taxes
Income taxes are accounted for in accordance with SFAS No. 109, "Accounting
for Income Taxes," or SFAS 109. Under the asset and liability method of
SFAS 109, deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carry forwards.
k) 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 10).
l) Stock-based Compensation
SFAS No. 123, "Accounting for Stock-based Compensation," or 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," or APB 25, with pro forma disclosures of
results of operations as if the fair value method had been applied.
55
At December 31, 2003 we have two stock-based employee compensation plans,
which are described more fully in note 11. 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 income
(loss) and net income (loss) per share if we had applied the fair value
recognition provisions of SFAS 123 to stock-based compensation:
Year Ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
Net income (loss), as reported......................... $ (13,608) $ (51,927) $ 1,427
Add: Stock-based employee compensation included in
reported net income, net of related tax effects .............. 609 1,538 3,027
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards,
net of related tax effects ................................... (2,560) (4,860) (4,369)
---------- ---------- ---------
Pro forma
$ (15,559) $ (55,249) $ 85
========== ========== =========
Net income (loss) per common share - basic:
As reported ................................................... $ (0.48) $ (1.92) $ 0.08
========== ========== =========
Pro forma ..................................................... $ (0.54) $ (2.04) $ 0.00
========== =========== =========
Net income (loss) per common share - diluted:
As reported ................................................... $ (0.48) $ (1.92) $ 0.07
========== ========== =========
Pro forma ..................................................... $ (0.54) $ (2.04) $ 0.00
========== ========== =========
We used the following range of assumptions to determine the fair value of
stock options granted using the Black-Scholes option-price model:
2003 2002 2001
---- ---- ----
Dividend yield..................... 0% 0% 0%
Expected volatility................ 116% 145% 192%
Average expected option life....... 4 years 4 years 4 years
Risk-free interest rate............ 1.28% 1.41% 2.28%
m) 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. Significant
items subject to estimates in these financial statements include goodwill
and intangible assets, valuation allowances for accounts receivable,
deferred tax assets and deferred tax liabilities and foreign income taxes.
Actual results could differ from those estimates.
n) Foreign Currency Translation
Except for our subsidiary in Israel, we consider the functional currency of
our foreign subsidiaries to be the local currency, and accordingly, the
foreign currency is translated into U.S. dollars using exchange rates in
effect at period end for assets and liabilities and average exchange rates
during each reporting period for the results of operations. The functional
currency of our Israeli subsidiary is the U.S. dollar. Adjustments
resulting from translation of foreign subsidiary financial statements are
reported in accumulated other comprehensive income (loss). Gains or losses
on foreign currency transactions are recognized in current operations and
historically have not been significant to our operating results in any
period presented. For the year ended December 31, 2002, we recorded net
foreign currency gains of $67, primarily from our operations in Israel.
56
o) Computation of Net Income (Loss) Per Share
We compute earnings per share in accordance with SFAS No. 128, "Computation
of Earnings Per Share," or SFAS No. 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 is a reconciliation of the numerators and denominators of the
basic and diluted EPS computations for net income (loss):
i) Year Ended December 31, 2003
Options to purchase 5,720,641 shares of common stock with a
weighted-average exercise price of $1.76 were outstanding during
the year ended December 31, 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 3,208,601 options that are vested,
with a weighted average exercise price of $2.01, of which
1,389,083 are vested and in the money, with a weighted average
exercise price of $0.15. The options have various expiration dates
during the next 10 years.
Warrants to purchase 1,019,625 shares of common stock with a
weighted-average exercise price of $2.37 were vested and
outstanding, including 673,712 warrants with a weighted average
exercise price of $1.71 that were not exercisable as of December
31, 2003, during the year ended December 31, 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 163,345 warrants that are
in the money, with a weighted average exercise price of $0.51. The
warrants have various expiration dates during the next 5 years.
ii) Year Ended December 31, 2002
Options to purchase 5,078,819 of common stock with a weighted-average
exercise price of $1.95 were outstanding during the year ended
December 31, 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
2,115,396 options that are vested, with a weighted average exercise
price of $2.69, of which 738,640 are vested and in the money, with a
weighted average exercise price of $0.01. The options have various
expiration dates during the next 10 years.
Warrants to purchase 464,191 shares of common stock with a
weighted-average exercise price of $3.28 were vested and outstanding
during the year ended December 31, 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 243,919 warrants that are vested and in the money,
with a weighted average exercise price of $0.28. The warrants are
fully vested and have various expiration dates during the next 5
years.
57
iii) Year Ended December 31, 2001
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
Net income available to common stockholders ............ $ 1,427 18,559,185 $ 0.08
-------------- ---------- -------
Effect of Dilutive Securities
Warrants .............................................. -- 218,258
Outstanding options ................................... -- 658,879
Contingently issuable shares .......................... -- 758,391
------ ----------
Diluted EPS
Net income available to common stockholders and
assumed conversions .................................. $ 1,427 20,194,713 $ 0.07
============== ========== =======
Options to purchase 2,001,263 shares of common stock with a
weighted-average exercise price of $4.15 were outstanding during the
year ended December 31, 2001 but were not included in the computation
of diluted EPS because the effects of assumed conversion or exercise
would have had an anti-dilutive effect on EPS. The outstanding options
included 1,226,192 options that were vested, with a weighted average
exercise price of $3.45, of which 383,214 were vested and in the
money, with a weighted average exercise price of $0.01. The options
had various expiration dates during the next 10 years.
Warrants to purchase 815,907 shares of common stock with a
weighted-average exercise price of $4.86 were vested and outstanding
during the year ended December 31, 2001, but were not included in the
calculation of diluted EPS because the effects of assumed conversion
or exercise would have been anti-dilutive. The outstanding warrants
include 243,919 warrants that were vested and in the money, with a
weighted average exercise price of $0.22. The warrants were fully
vested and had various expiration dates during the next 5 years.
p) 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.
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.
q) Recent Accounting Pronouncements
On December 17, 2003, the Staff of the Securities and Exchange Commission,
or SEC, issued Staff Accounting Bulletin No. 104, or SAB 104, "Revenue
Recognition," which supersedes SAB 101, "Revenue Recognition in Financial
Statements." SAB 104's primary purpose is to rescind the accounting
guidance contained in SAB 101 related to multiple-element revenue
arrangements that was superseded as a result of the issuance of EITF 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables," or EITF
00-21. Additionally, SAB 104 rescinds the SEC's related "Revenue
Recognition in Financial Statements Frequently Asked Questions and Answers"
issued with SAB 101 that had been codified in SEC Topic 13, "Revenue
Recognition." While the wording of SAB 104 has changed to reflect the
issuance of EITF 00-21, the revenue recognition principles of SAB 101
remain largely unchanged by the issuance of SAB 104, which was effective
upon issuance. The adoption of SAB 104 did not have an effect on our
financial position or results of operations.
58
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others - an Interpretation of FASB Statements
No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34," or FIN 45.
FIN 45 requires that a guarantor recognize, at the inception of certain
guarantees, a liability for the fair value of the obligation undertaken in
issuing such guarantee. FIN 45 also requires additional disclosure
requirements about a guarantor's obligations under certain guarantees that
it has issued. The initial recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued
or modified after December 31, 2002 and the disclosure requirements are
effective for financial statement periods ending after December 15, 2002.
We added certain disclosures in our consolidated financial statements to
reflect the guidance proscribed in FIN 45; however, the adoption of FIN 45
did not have a significant impact on our results of operations, financial
position or cash flows.
In November 2002, the EITF reached a consensus on issue No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables," on a
model to be used to determine when a revenue arrangement with multiple
deliverables should be divided into separate units of accounting and, if
separation is appropriate, how the arrangement consideration should be
allocated to the identified accounting units. The EITF also reached a
consensus that this guidance should be effective for all revenue
arrangements entered into in fiscal periods beginning after June 15, 2003.
The adoption of EITF 00-21 did not have an effect on our results of
operations or financial position.
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, The FASB continued its deliberations on this project through
the fourth quarter of 2003, and plans 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, 2005, 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 Transparency 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
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 Transparency 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
Transparency Bill.
In November 2003 the United States Congress introduced proposed legislation
titled the Stock Option Accounting Reform Act (H.R. 3574 and S. 1890,
respectively), or the Reform Bill, that would require mandatory expensing
of stock options granted to executive officers. The Reform Bill provides
for limited exemptions to the expensing requirement, but also prohibits the
SEC from recognizing any accounting principle as generally accepted unless
and until the Secretary of Commerce and Secretary of Labor complete a joint
study on the impact of the mandatory expensing of all employee stock
options. Committees or subcommittees of the House and Senate are reviewing
the Reform Bill and conducting hearings.
In May 2002 the FASB added a project to its technical agenda to develop a
comprehensive Statement of Financial Accounting Standards on revenue
recognition. The FASB plans to issue Exposure Drafts for the Statement in
the latter part of 2004, and to finalize them in 2005.
r) Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
59
2) Furniture and Equipment
Furniture and equipment consist of the following at December 31, 2003 and 2002:
2003 2002
---- ----
Furniture and fixtures............................... $ 647 $ 793
Leasehold improvements.............................. 1,117 1,145
Computer and other equipment 1,627 1,670
Purchased software 1,003 851
----- ---
4,394 4,691
Less: accumulated depreciation and amortization 2,165 1,579
----- -----
Furniture and equipment, net $ 2,229 $ 3,111
======= =======
Depreciation expense was $1,093, $1,319 and $597 for the years ended
December 31, 2003, 2002 and 2001, respectively.
3) Restricted Cash
Restricted cash consisted of a portion of the sales price, held by a third party
in escrow for indemnification purposes, related to the 2001 sale of the assets
of our IA business totaling $550. The remaining escrow balance had been withheld
pending the settlement of a claim submitted by Phoenix and was included in
restricted cash in the consolidated balance sheet as of December 31, 2002. In
March 2003 we entered into a confidential settlement agreement with Phoenix
Technologies and the remaining $550 of the purchase price was paid to us and is
no longer restricted.
4) Acquisition
On December 7, 2001, we acquired all of the outstanding shares of eMation, Ltd.,
a private company organized under the laws of the State of Israel and
headquartered near Boston, Massachusetts, a developer of Internet-based
solutions that extract and manage information from intelligent devices and make
that information available to people and business systems. As a result of the
acquisition, we are a provider of DRM solutions worldwide. The results of
eMation's operations are included in our consolidated financial statements since
the date of acquisition.
We acquired eMation in consideration for: 8,000,000 shares of Axeda common
stock, valued at $17,440; the assumption of 1,428,710 shares of Axeda common
stock reserved for issuance upon exercise of assumed eMation stock options,
530,000 of which are exercisable for $0.01 per share and the remaining 898,710
exercisable at $2.14 per share; options exercisable for up to 113,600 shares of
Axeda common stock issued at closing pursuant to our 1999 Stock Incentive Plan;
and warrants exercisable for up to 7,000 shares of Axeda common stock
exercisable at $2.14 issued to ex-employees of eMation in consideration for
cancellation of outstanding options to purchase shares of eMation. The aggregate
value of these issued and assumed options and warrants was $2,570. The total
combined value of the securities assumed and issued was $20,010 and we incurred
transaction costs of $3,415 related to the acquisition, for an aggregate
purchase price of $23,425. We also assumed approximately $5,000 of eMation net
debt.
The value of the common stock issued was determined based on the average market
price of our common stock a few days before and after the terms of the
acquisition were agreed to and announced. The value of the assumed and issued
options was estimated using the Black-Scholes option-pricing model with the
following assumptions: risk-free interest rate of 3.15%, volatility factor of
125%, no dividend factor and a remaining life of 2 years.
The acquisition was recorded under the purchase method of accounting. We
expensed $3,112 of the purchase price as in-process research and development, or
IPR&D, in connection with the eMation acquisition.
We also issued or assumed warrants at closing exercisable for up to 108,240
shares of Axeda common stock with exercise prices ranging from $4.88 to $21.51
per share to holders of warrants exercisable for shares of eMation. Prior to the
acquisition, we loaned eMation $4,300, with an interest rate of 3-month LIBOR
plus 2.5%, for working capital purposes. On the date of the closing of the
transaction, we paid certain employees of eMation for joining us sign-on bonuses
totaling $300.
60
An aggregate of 1,600,000 shares of our common stock issued in the eMation
acquisition was deposited with a third party escrow agent to be held in escrow
to compensate us for certain losses and taxes that may have arisen as a result
of the eMation acquisition. This escrow arrangement expired February 21, 2003.
In February 2003 98,127 shares were returned to us from escrow.
The following table summarizes the estimated fair value of the assets
acquired and the liabilities assumed as of the date of acquisition:
Current assets ................................................ $ 3,856
Property and equipment ........................................ 1,168
Identified intangible assets .................................. 9,745
IPR&D ......................................................... 3,112
Goodwill ...................................................... 20,819
--------
Total assets acquired .................................... 38,700
--------
Current liabilities ........................................... 12,358
Long-term debt ................................................ 2,336
Other non-current liabilities ................................. 1,428
--------
Total liabilities assumed ................................ 16,122
--------
Unvested stock options allocated to deferred stock compensation (847)
--------
Net assets acquired ...................................... $ 23,425
========
The acquired identifiable intangible assets that are subject to
amortization consist of the following:
December 31, 2003 December 31, 2002
----------------- -----------------
Weighted Weighted
Average Average
Estimated Estimated
Useful Life Useful Life
Amount (Years) Amount (Years)
Developed Technology $ 210 -* $ 210 1
Core Technology .... 1,840 3 1,840 4
Customer Base ...... 110 3 110 4
------ ------ ------ ------
Total .............. $2,160 3 $2,160 4
====== ====== ====== ======
* - fully amortized as of December 31, 2003
The amount allocated to IPR&D was determined by independent appraisal. The
projects in progress, the next generation DRM product and industrial
automation products, required resolution of high-risk testing and
development issues in order to be completed. At acquisition, those projects
had not reached technological feasibility and had no alternative future
uses. In accordance with SFAS No. 2, "Accounting for Research and
Development Costs," and FASB Interpretation No. 4, "Applicability of SFAS
No. 2 to Business Combinations Accounted for by the Purchase Method,"
amounts assigned to IPR&D technology meeting the above stated criteria must
be charged to expense as part of the allocation of purchase price of a
business combination. The IPR&D technology was valued using the income
approach, a cash flow model under which projected income and expenses
attributable to the purchased technology were identified, and potential
income streams were discounted using a 25% discount rate for risks,
probabilities and uncertainties, including the stage of development of the
technology, viability of target markets and other factors.
61
The amount allocated to deferred stock compensation was determined in
accordance with Financial Accounting Standards Board Interpretation No. 44,
"Accounting for Certain Transactions involving Stock Compensation-an
interpretation of APB Opinion No. 25," or FIN 44. Under FIN 44, to the
extent that service is required subsequent to the consummation date of the
acquisition in order to vest in the assumed options, a portion of the
intrinsic value (if any) of the unvested awards shall be allocated to
unearned compensation and recognized as compensation cost over the
remaining future vesting (service) period. The amount allocated to unearned
compensation cost shall be based on the portion of the intrinsic value at
the consummation date related to the future vesting (service) period.
Accordingly, the intrinsic value, which corresponded to 530,000 of the
total 1,550,000 stock options and warrants assumed and issued, of $847 was
deducted from the fair value of the awards for purposes of the allocation
of the purchase price and allocated to deferred stock compensation. We
amortized this amount over the respective vesting periods of 6 to 24 months
and recorded approximately $359, $439 and $40 of non-cash compensation
expense in 2003, 2002 and 2001, respectively, related to these awards.
The following unaudited pro forma information is presented as if the
acquisition of eMation occurred as of the beginning of 2001. The pro forma
information, however, is not necessarily indicative of the results that
would have resulted had the acquisition occurred at the beginning of the
period presented, nor is it necessarily indicative of future results.
Revenues........................................ $ 18,148
========
Net loss....................................... $ (17,718)
=========
Basic and diluted net loss per weighted
average common share outstanding ............. $ (0.68)
=======
5) Transaction With Sonic Solutions
In May 2002 we entered into a Software Distribution Agreement, or the
Agreement, with Sonic IP, Inc., or Sonic, a wholly-owned subsidiary of
Sonic Solutions. As a result, we exited the digital media market (see
discussion of Services, below) and, as of June 30, 2002, terminated or
assigned to Sonic, substantially all of the customer contracts of our PC
business. Under the terms of the Agreement, Sonic paid us $2,000 for the
exclusive and perpetual license to all of the intellectual property, or IP
of our PC business, which was delivered effective with the closing of the
Agreement, and for certain furniture and computer equipment, or the
Equipment. The Equipment, which had a net book value totaling $331, was
used by the employees of our PC business and was not essential to the
functionality of the licensed IP. Sonic also received certain trademarks
and World Wide Web domain names associated with the PC business. In
connection with the closing of the Agreement, approximately 10 of our
employees in the PC business accepted employment offers from Sonic and we
paid inducements to those employees related to their acceptance totaling
$107. These inducements were paid in June 2002 and are included in special
charges in the accompanying consolidated statement of operations for the
year ended December 31, 2002. In addition, the Axeda stock options held by
certain of these employees were modified to accelerate vesting upon
termination. In May 2002 we recorded a charge of $24 related to the
modifications, which is included in special charges in the consolidated
statement of operations for the year ended December 31, 2002. Under the
terms of the Agreement we also agreed to designate our remaining
approximately 14 employees of the PC business to provide unspecified
services to Sonic to create improvements, R&D information, and computer
software (collectively, the "Services") through December 31, 2002. We
provided the Services for May through August 2002 as part of the base
license agreement without additional charge to Sonic. Sonic maintained the
Services agreement through December 31, 2002, and paid Axeda $423, which
approximated our cost, for the Services provided from August to December
31, 2002. The Services fees were recognized as services revenues ratably
over the period. For the year ended December 31, 2002, we recognized $423
of services revenues and cost of revenues related to these services.
Because we did not have vendor-specific evidence of fair value for each of
the elements of this license arrangement, and because we provided the
Services to Sonic after the initial delivery of the licensed IP, we
recognized the $2,000 license fee on a straight-line basis over the seven
months ended December 31, 2002, which was the period that we agreed to
provide the Services. Approximately $166 of the net book value of the
Equipment was charged to expense and was included in special charges in the
accompanying consolidated statement of operations for the year ended
December 31, 2002. The remaining net book value of the Equipment of $165,
which was attributed to the Equipment that was utilized by our employees
who provided the services to Sonic through December 31, 2002, was amortized
over the seven-month term of the Services.
62
Also as part of our strategy to exit the PC business, we vacated our
offices in San Jose, California in May 2002, and, in July 2002, we
terminated our lease for this facility. The original term of the lease
ended in March 2005. In July 2002, we paid $135, including $64 held by the
lessor as security from the inception of the lease, to the lessor as an
inducement to cancel the lease. We also paid $210 in July 2002 and, for
nominal consideration, sold furniture, computer equipment and leasehold
improvements to the new lessee as incentives to the new lessee to enter
into a lease for the premises with the lessor. The total cash payments of
$345, including the foregone security deposit, and the net book value of
the assets sold of $168 are included in special charges in the accompanying
consolidated statement of operations for the year ended December 31, 2002.
A summary of special charges recorded for the year ended December 31, 2002,
all in connection with our exit from the PC business, is as follows:
Net book value of equipment....... $ 166
Employee termination expenses..... 130
Inducements to other employees.... 11
Lease termination costs........... 513
---
Total special charges $ 820
=====
6) Acquired Intangible Assets (note 1e and 1f)
Acquired intangible assets that are subject to amortization at December 31, 2003
and 2002, consist of the following:
Gross Carrying Amount Accumulated Amortization
--------------------- ------------------------
2003 2002 2003 2002
---- ---- ---- ----
Developed Technology ...... $ 210 $ 210 $210 $ 21
Core Technology ........... 1,840 1,840 497 50
Customer Base ............. 110 110 30 2
--- --- -- --
Total ................ $ 2,160 $ 2,160 $737 $ 73
======= ======= ==== =====
Aggregate amortization expense was $664, $2,200 and $2,400 for the years ended
December 31, 2003, 2002 and 2001, respectively. Estimated aggregate expense for
each of the next 3 years is as follows:
Charged to:
Cost of Operating
Year ending December 31, Total revenues expense
- ------------------------ ----- -------- -------
2004.................... $ 474 $ 447 $ 27
2005.................... 474 447 27
2006.................... 474 447 27
Thereafter.............. - - -
63
7) Goodwill (note 1e and 1f)
The changes in the gross carrying amount of goodwill, all attributable to our
DRM segment, for the years ended December 31, 2003 and 2002, are as follows:
Balance as of December 31, 2001 .......... $ 20,819
========
Impairment charges....... ................ (17,168)
========
Balance as of December 31, 2002... ....... $ 3,651
=======
Other .................................... (11)
====
Balance as of December 31, 2003 .......... $3,640
======
Goodwill acquired in 2001 is not deductible for income tax purposes.
Summarized below are the effects on net income and net income per share
data, if we had followed the amortization provisions of SFAS 142 for 2001:
Reported net income .......................... $1,427
Add Back: Goodwill amortization ............. 2,246
-----
Adjusted net income .......................... 3,673
=====
Basic earnings per share:
Reported net income ................. $0.08
Goodwill amortization ............... 0.12
----
Adjusted net income ................. $0.20
=====
Diluted earnings per share:
Reported net income ................. $0.07
Goodwill amortization ............... 0.11
----
Adjusted net income ................. $0.18
=====
8) 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% (5.25% at December 31, 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 December 31, 2003 there
were no letters of credit or other amounts for bank services outstanding
under the Line. At December 31, 2003, we were in compliance with our
covenants and approximately $567 was available and $417 was outstanding
under the terms of the Line at December 31, 2003.
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 $82, are being amortized over the one-year
term of the Line and included in interest expense.
64
9) Accrued Expenses
Accrued expenses consist of the following:
December 31,
2003 2002
------ ------
Legal and professional fees ....................$ 558 $1,202
Payroll and related costs ...................... 1,477 2,778
Severance ...................................... 88 355
Unutilized leased facilities ................... 547 566
Royalties to Israeli government agencies ....... 759 828
Legal settlements .............................. -- 277
Sales, excise and other taxes .................. 266 689
Other .......................................... 1,171 1,320
------ ------
$4,866 $8,015
====== ======
10) Equity Transactions and Capital Stock
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 $1.22 per share with net proceeds of $5,597.
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", or EITF 00-19, addresses accounting for equity derivative
contracts indexed to, and potentially settled in, a company's own stock, or
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.
65
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 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.
The estimated fair value of the financing-related liability as of December 31,
2003 was $2,608. The $802 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:
December 31, 2003 September 23, 2003
----------------- ------------------
Current market price/share ............ $ 1.36 $ 1.70
Exercise price/share .................. $ 1.71 $ 1.71
Dividend yield ........................ 0% 0%
Expected volatility ................... 115% 115%
Expected life ......................... 4.7 years 5 years
Risk-free interest rate ............... 3.13% 3.13%
Other Equity Transactions
In May 2002 we reached an agreement with a former officer to re-pay a
portion of the remaining balance of a loan for $160 that was originally extended
to the officer in February 2000. The officer previously paid $15 of the loan,
leaving a balance of $145. Under the agreement, in June 2002, the former officer
paid us $50 and surrendered 20,000 shares of Axeda common stock held by the
former officer. On the day that we received the shares, the fair market value of
our common stock was $1.97 per share. As a result, during the quarter ended June
30, 2002, we recorded treasury stock of $39. The aggregate amount of $89 was
recorded as a recovery of bad debt expense in the consolidated statement of
operations for the year ended December 31, 2002.
11) Stock Options, Stock Purchases and Warrants
a) Stock Options
We adopted the 1995 Stock Option Plan, or 1995 Plan, in May 1995. The 1995
Plan provided for the grant of incentive stock options and non-qualified
stock options to employees, consultants, our advisors, and members of the
board of directors to purchase shares of common stock. Prior to the
adoption of the 1995 Plan, 43,258 options were granted to employees. Under
the terms of the 1995 Plan, authorized options were granted at estimated
fair value. The options generally vest over a period ranging from 2 to 5
years and expire 5 to 10 years from the grant date. In 1998 the board of
directors approved an amendment to our 1995 Plan in which the total number
of options available for grant was increased to 8,500,000. In April 1999,
we, with the approval of the board of directors, adopted the 1999 Stock
Incentive Plan, or 1999 Plan, as a successor to the 1995 Plan. The 1999
Plan has reserved 6,105,361, 4,505,361 and 3,905,361 shares as of December
31, 2003, 2002 and 2001, respectively. The 1999 Plan has three separate
programs which included: 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.
In December 2001 and in connection with the acquisition of eMation (note
4), we assumed 530,000 unvested stock options held by certain officers and
employees of eMation exercisable at a price of $0.01, which was less than
the fair market value of our common stock of $2.14 on the date of the
acquisition. We recorded deferred stock compensation of $847 that was
amortized on a pro rata basis over the vesting periods of 6 to 24 months.
Also in connection with the acquisition of eMation, we assumed 883,710
unvested and 15,000 fully vested stock options held by certain officers and
employees of eMation and issued 113,600 unvested stock options to an
officer and certain employees of eMation exercisable at a price of $2.14,
which was equal to the fair market value of our common stock on the date of
the acquisition.
66
In August 2001, the board of directors granted an aggregate of 331,000
stock options to an officer-employee with an exercise price of $0.01 per
share. We recorded deferred stock compensation of $543 that is being
amortized over the vesting period of three years. In connection with the
closing of the acquisition of eMation (note 4), in February 2002, options
for 100,000 shares became immediately vested and exercisable. As a result
we recorded additional non-cash compensation expense of $132 attributable
to the accelerated vesting of this option. Also in August 2001, the board
of directors granted 300,000 stock options to the officer-employee with an
exercise price equal to the fair market value on the date of grant, or
$1.65. These options vest 25% upon completion of one year of service from
the date of grant, with the balance vesting equally over a 36-month period
measured from the first anniversary of the vesting commencement date.
A summary of stock option activity follows:
2003 2002 2001
------------------------ ---------------------- --------------------------
Weighted Weighted Weighted
average average average
Number of exercise Number of exercis Number of exercise
Options price Options price Options price
------- ----- ------- ----- ------- -----
Balance as of beginning of year 5,078,819 $ 1.95 3,781,592 $ 2.43 3,055,318 $ 5.69
Options granted ............... 1,329,000 $ 1.47 2,533,700 $ 1.63 1,600,300 $ 1.07
Options assumed ............... -- $ -- -- $ -- 1,428,710 $ 1.35
Options (forfeited) ........... (601,533) $ 2.88 (1,029,142) $ 3.27 (1,135,604) $ 9.53
Options (exercised) ........... (85,645) $ 0.17 (207,331) $ 0.26 (1,167,132) $ 1.35
------- -------- -------- -------- ---------- --------
Balance at end of year ....... 5,720,641 $ 1.76 5,078,819 $ 1.95 3,781,592 $ 2.43
========= ======== ========= ======== ========= ========
At December 31, 2003, 3,208,601 options with a weighted-average exercise
price of $2.01 were fully vested and exercisable. At December 31, 2002,
2,115,396 options with a weighted-average exercise price of $2.69 were
fully vested and exercisable. At December 31, 2001, 1,226,317 options with
a weighted-average exercise price of $3.45 were fully vested and
exercisable.
The weighted-average exercise prices and weighted average grant-date fair
value of options granted during 2003, 2002 and 2001 are as follows:
2003 2002 2001
---- ---- ----
Weighted Weighted Weighted
average Weighted average Weighted average Weighted
exercise average exercise average fair exercise average fair
price fair value price value price value
----- ---------- ----- ----- ----- -----
Exercise price equals fair market
value .............................. $1.59 $1.36 $1.62 $1.39 $1.96 $1.85
Exercise price exceeds fair
market value ....................... N/A N/A $1.96 $1.36 N/A N/A
Exercise price is less than fair
market value ....................... $0.01 $0.39 $0.01 $2.52 $0.01 $1.96
Weighted average - all options
granted ............................ $1.47 $1.28 $1.63 $1.39 $1.07 $1.90
67
The following summarizes information about our stock options outstanding at
December 31, 2003:
Options outstanding Options exercisable
----------------------------------------------- --------------------------
Weighted average Weighted Weighted
remaining average average
Number contractual life exercise Number exercise
Range of exercise prices outstanding (years) price outstanding price
- ------------------------ ----------- ------- ----- ----------- -----
$ 0.01- 3.88 .............. 5,382,575 8.1 $ 1.29 2,880,131 $ 1.18
$ 3.89- 7.75 .............. 127,050 5.8 $ 6.58 118,002 $ 6.58
$ 7.76-11.63 .............. 200,316 0.6 $ 10.01 199,797 $ 10.01
$ 15.51-19.38 ............. 5,850 1.6 $ 15.94 5,821 $ 15.94
$ 19.39-38.75 ............. 4,850 6.0 $ 38.75 4,850 $ 38.75
----- --- --------- ----- ---------
Totals . ............ 5,720,641 7.8 $ 1.76 3,208,601 $ 2.01
========= === ========= ========= =========
b) Employee Stock Purchase Plan
In April 1999, we, with the approval of the board of directors, adopted an
Employee Stock Purchase Plan and reserved 500,000 shares of common stock
for issuance thereunder. The purchase plan permits eligible employees to
acquire shares of our common stock through periodic payroll deductions of
up to 15% of total compensation. Each offering period will have a maximum
duration of twenty-four months. The price at which the common stock may be
purchased is 85% of the lesser of the fair market value of our common stock
on the first day of the applicable offering period or on the last day of
the respective purchase interval. The initial offering period commenced on
the effectiveness of our initial public offering in July 1999.
A summary of the shares purchased is as follows:
Number of
Purchase Date Shares Purchased Purchase Cost
------------- --------------- -------------
January 31, 2000 ........... 27,513 $ 281
July 31, 2000 .............. 48,378 190
January 31, 2001 ........... 27,330 71
July 31, 2001 .............. 11,405 15
February 1, 2002 ........... 9,627 14
July 31, 2002 .............. 58,458 60
January 31, 2003 ........... 70,652 28
July 31, 2003 .............. 53,131 22
------ --
Total............. ........ 306,494 $ 681
======= =====
On the January 31, 2004 purchase date, 50,390 shares were purchased at an
aggregate cost of $21.
68
c) Warrants
The warrants that we issue generally contain customary provisions requiring
proportionate adjustment of the exercise price in the event of a stock
split or stock dividend.
A summary of warrant activity follows:
Common stock
------------
Number of Weighted Average
Warrants exercise price
-------- --------------
Balance as of December 31, 2000 ............... 1,835,633 $ 5.96
========== ========
Warrants granted ......................... 48,077 12.84
Warrants assumed ......................... 74,661 5.52
Warrants canceled......................... (1,500,000) 7.00
Warrants exercised ...................... -- --
---------- --------
Balance as of December 31, 2001 ............... 458,371 $ 3.19
---------- --------
Warrants granted ......................... 3,750 6.64
Warrants assumed (note 4) ................ 2,068 18.03
Warrants canceled........................ -- --
Warrants exercised ...................... -- --
---------- --------
Balance as of December 31, 2002................ 464,189 $ 3.28
========== ========
Warrants granted ......................... 2,652,092 1.66
Warrants canceled......................... (326,904) 1.59
Warrants exercised........................ (100,000) $ 0.59
---------- --------
Balance as of December 31, 2003................ 2,689,377 $ 1.99
========== ========
In December 2001 and in connection with the acquisition of eMation (note
4), we issued or assumed 115,238 fully-vested stock warrants at exercise
prices ranging from $2.14 to $21.51.
12) Commitments and Contingencies
a) Leases
We lease our office facilities and various equipment under operating leases
that expire at various dates through 2011. We also lease automobiles with
combined annual rentals of approximately $83, $44 and $28 for the years
ending December 31, 2004, 2005 and 2006, respectively. The automobile lease
terms expire at various dates through November 2006. The following is a
schedule by year of future minimum lease payments relating to noncancelable
operating leases as of December 31, 2003:
Year ending December 31, Amount
-----
2004.......................................$ 1,233
2005....................................... 750
2006....................................... 666
2007....................................... 502
2008....................................... 319
Thereafter................................. 465
===
Total minimum lease payments............ $ 3,935
=======
69
The following table shows the composition of total rent expense for
operating leases, except those with terms of one month or less that were
not renewed:
Year Ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
Minimum rentals ** ......... $ 1,132 $ 1,915 $ 1,023
Less: Sublease rentals ** .. 92 441 92
--- --- --
$ 1,040 $ 1,474 $ 931
======= ======= =====
** In 2002 minimum rentals and minimum sublease rentals include
$545 and $344, respectively, for amounts accrued for an
unutilized leased facility, which we subleased to an unrelated
third party. Minimum rentals for 2003 include $199 for the
reversal of a portion of the sublease accrued in 2002.
In September 2002, we entered into a lease for approximately 4,500 square
feet of space in an office building in Malvern, Pennsylvania. This facility
is leased at an annual rental of $42, plus operating expenses ($17 per
year), utilities and taxes, and is used for administrative activities. The
lease commenced in December 2002 and expires in November 2005.
In May 2002, we entered into a sub-lease for approximately 35,000 square
feet of space in an office building in Mansfield, Massachusetts. This
facility is leased at an annual rental of $310, plus operating expenses
($170 per year), utilities and taxes, and is used for research and
development, sales and support and administrative activities. The lease
commenced in June 2002 and expires in July 2007.
Prior to occupying our current offices in Mansfield, Massachusetts, we
leased approximately 12,000 square feet of space in an office building,
located in the same business park as our current offices, for our research
and development, sales and support and administrative activities. We
completed our occupation of the current offices in July 2002 and, in
September 2002, we entered into a sublease with a subtenant, or Subtenant,
for the balance of the term of this lease for our former offices. The lease
for our former offices expires in July 2004 and required us to pay minimum
future rental payments, including operating expenses, totaling $545 as of
December 31, 2002. Under the terms of the sublease agreement, we were to
receive minimum future rental payments, including operating expenses,
totaling $344 from the Subtenant. For the year ended December 31, 2002, we
recorded a charge of approximately $201, which is included in other general
and administrative expense, for the amount representing the excess of the
future minimum rental payments to be made over the future minimum sublease
payments to be received. The Subtenant had made rental payments totaling
$92 through and including June 30, 2003, and in August 2003, filed for
bankruptcy protection. We have not found an alternate Subtenant and have
reversed and expensed in 2003 the remaining subrental accrual of $199,
which is included in other general and administrative expense. We are
required to pay minimum future rental payments totaling $131, including
operating expenses, as of December 31, 2003.
We currently lease 3 other international sales offices in France, Japan and
Holland, with a total of 4,169 square feet of space. The combined annual
rental for these offices is $276 and $148 for 2004 and 2005, respectively,
and $138 for 2006 through 2010. The leases have terms expiring from April
2003 through February 2011. The lease for our office in France expires in
2011, but is cancelable without penalty in 2008 upon 6 months written
notice.
We are associated with approximately 9,000 square feet of office space in
Marlborough, Massachusetts, which is no longer used for operating purposes.
The lease requires annual rental payments totaling $181 and expires in
February 2009. The present value of the future lease payments, discounted
at 5%, of $1,200 was accrued by eMation as of the date of acquisition.
b) Royalties
Under various licensing agreements, we are required to pay royalties,
generally on per unit basis, on the sales of certain products that
incorporate licensed technology. Royalty expense under such agreements was
$1,275, $2,688 and $1,324 for the years ended December 31, 2003, 2002 and
2001, respectively, and is included in cost of revenues in the consolidated
statements of operations.
70
Royalty Commitments to the Chief Scientist:
Prior to 2001, eMation had received grants from the Chief Scientist of
Israel's Ministry of Industry and Trade to finance the research and
development of certain products. We are obligated to pay royalties at a
rate of 3.0 - 3.5% resulting from sales of the products developed within
the framework of the aforementioned grants, and the services related to the
products, up to an amount equal to 100% of the grants received, linked to
the U.S. dollar. Grants received in respect of approvals obtained after
December 31, 1998 bear interest at an annual rate equal to 12-month LIBOR
(1.4582% at December 31, 2003). As of December 31, 2003, we accrued
royalties of $372.
Royalties to the Fund for the Encouragement of Marketing Activities:
Prior to 2001, the Israeli Government, through the Fund for the
Encouragement of Marketing Activities, awarded eMation grants for
participation in foreign marketing expenses. We are required to pay
royalties at the rate of 4% of the increase in export sales, up to an
amount equal to 100% of the grants received, linked to the U.S. dollar.
Grants received after January 1, 1998 bear interest at an annual rate equal
to 6-month LIBOR (1.2192% at December 31, 2003). As of December 31, 2003,
we accrued royalties of $387.
DRM License Fees:
In June 2002 we entered into a Software License Agreement, or the
Agreement, with a vendor to provide server and client software that,
beginning in August 2002, is incorporated into our DRM Enterprise Server
products. License fees are due and payable at the rate of 2.5% of each
billable sale, as defined. Under the Agreement, we agreed to pay a minimum,
non-refundable prepaid license fee of $400, which was payable in
installments. We paid $100 in July 2002, $100 in June 2003 and the
remaining $200 in January 2004.
c) 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 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.
71
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. We filed a motion
to dismiss the consolidated and amended class action complaint on July 3,
2000. 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 March 20, 2003, Industria Politecnica Meridionale Spa., or 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., or 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 $15,000 for breach of
contract and fraud, and unspecified punitive damages and attorney's fees.
On May 2, 2003, we moved to dismiss all claims against RTIAG. 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. 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 $2,733, plus interest,
fees and costs. IPM filed an answer to the amended complaint on July 22,
2003 denying the breach of contract claims. IPM filed a motion to amend
their complaint on February 19, 2004, which if granted would withdraw their
fraud complaint and modify their breach of contract claim to specify that
the defendants breached the contract by providing circuit boards which were
underpowered, and to an unacceptable extent, incapable of operating in
IPM's products. We filed a motion seeking summary judgment on March 9,
2004. 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.
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 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 $743 initially recorded
in March 2001 as part of the sale of the assets of our former IA business.
72
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 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.
d) Employment Agreements
We have entered into employment agreements with certain of our officers and
employees. The agreements are generally for two to three-year periods,
generally provide for annual salaries and bonuses, guaranteed bonuses,
incentive and nonqualified stock options, as determined by the board of
directors and covenants not-to-compete during the employment term and for
one year thereafter. The employment agreements also generally provide for
severance benefits of six month's to one year's salary and health insurance
coverage in the event the individual is terminated under the terms of the
agreements. The aggregate amount payable for salaries in the event of
employee severance totals approximately $2,931 as of December 31, 2003.
13) Business Risks and Credit Concentration
Axeda markets its DRM solutions worldwide to the service operation of
device original equipment manufacturers (OEMs) and strategic large-scale
end users in a variety of industries including the industrial and building
automation, high-technology devices, medical instrumentation, office
automation and semiconductor equipment industries.
We perform ongoing credit evaluations of our customers' financial condition
and generally no collateral is required. We had three customers
representing, in the aggregate, 28%, 19% and 26% of accounts receivable at
December 31, 2003, 2002 and 2001, respectively.
Geographic Areas
Long-lived assets, at cost, consisting principally of furniture and
equipment, were located in the following countries, including our country
of domicile, the United States, for the following years noted:
December 31,
------------
Country 2003 2002 2001
- ------- ---- ---- ----
United States .............. $3,714 $3,919 $2,994
France ..................... 540 369 113
Germany .................... 11 10 --
Japan ...................... 90 89 64
Holland .................... 39 109 79
Israel ..................... -- 195 240
United Kingdom ............. -- -- 5
------ ------
Total ...................... $4,394 $4,691 $3,495
====== ====== ======
73
14) Income Taxes
The provision for income taxes (benefit) is as follows:
Years ended December 31,
------------------------
2003 2002 2001
------ ------ ------
Federal ................ $ -- $ (668) $ 668
State .................. -- -- 55
Foreign ................ 198 209 400
------ ------ ------
Total .................. $ 198 $ (459) $1,123
====== ====== ======
The table below reconciles the U.S. federal statutory income taxes to the
recorded provision for income taxes (benefit):
December 31,
------------
2003 2002 2001
-------- -------- --------
Federal income tax expense (benefit) at U.S. federal statutory rate ..... $ (4,559) $(17,811) $ 864
State income tax benefit, net of federal income tax expense
(benefit) .............................................................. (183) (1,539) (656)
In-process research and development expenses and goodwill ............... -- 6,702 6,560
Foreign income taxes .................................................... 114 209 400
Warrant and option expense .............................................. -- 419 1,162
Non-deductible acquisition costs ........................................ -- -- 630
Change in valuation allowance ........................................... 2,111 20,835 (3,045)
Benefit related to change in tax legislation ............................ -- (668) --
Acquired deferred tax assets, including provision to return
adjustments ............................................................ 3,160 (8,518) (4,526)
Other ................................................................... (445) (88) (266)
-------- -------- --------
$ 198 $ (459) $ 1,123
======== ======== ========
The components of the net deferred tax assets (liabilities) consist of:
December 31,
------------
2003 2002
---- ----
Deferred tax assets:
Net operating losses $44,571 $40,234
Reserves and accruals not currently deductible 1,228 727
Depreciation and amortization (729) (476)
Deferred compensation and other....................... 2,573 5,048
----- -----
47,643 45,533
Valuation allowance (47,643) (45,533)
------- --------
Net deferred tax assets $ -- $ --
====== ======
Deferred income taxes reflect the net tax effects of temporary
differences between carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes. In assessing the realizability of deferred tax assets,
management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The
ultimate realization of deferred tax assets is dependent upon the
generation of future taxable income during the periods in which
temporary differences representing net future deductible amounts
become deductible. Due to the uncertainty of our ability to realize
the benefit of the deferred tax assets, the deferred tax assets are
fully offset by a valuation allowance at December 31, 2003 and 2002.
74
As of December 31, 2003, we have approximately $111,359 of U.S.
federal and $81,592 of state net operating loss carryforwards
available to offset future taxable income. The federal carryforwards
will begin expiring in 2011 and the state carryforwards will begin
expiring in 2006, respectively, if not utilized. Approximately $50,697
of the state net operating loss carryforwards is subject to a $2,000
annual limitation. In addition, we have approximately $4,210 of
foreign net operating loss carryforwards of which approximately $1,700
begins to expire in 2006 with the remaining amounts carried forward
indefinitely.
Under the Tax Reform Act of 1986, the utilization of a corporation's
net operating loss carryforward is limited following a greater than
50% change in ownership. Due to our prior and recent transactions, our
net operating loss carry forwards are subject to an annual limitation.
Any unused annual limitation may be carried forward to future years
for the balance of the net operating loss carryforward period. We have
not yet determined the limitation as defined by the Act. Additionally,
because U.S. tax laws limit the time during which these carryforwards
may be applied against future taxes, we may not be able to take full
advantage of these attributes for Federal income tax purposes.
Additionally, approximately $5,063 of the gross deferred tax assets
will reduce goodwill to the extent such assets are realized and a
portion of the gross deferred tax assets will reduce equity to the
extent such assets are realized.
Subsequent to December 31, 2001, the Job Creation and Worker
Assistance Act of 2002 was enacted. The Act allows net operating loss
carryforwards to 2001 and 2002 tax years to offset 100% of alternative
minimum taxable income. Accordingly, we did not owe federal
alternative minimum tax liability for 2001 and, in 2002, we received a
refund of alternative minimum taxes paid in 2001. We recorded this tax
benefit of $668 in the first quarter of 2002.
15) Defined Contribution Plan
We have a defined contribution plan for qualified employees as defined in the
plan. Participants may contribute up to 20% of pre-tax compensation, as defined.
Under the plan, we can make discretionary contributions. In addition, in
December 2001, we assumed the defined contribution plan of eMation. Both plans
are Internal Revenue Code section 401(k) plans. Both plans provide for employer
matching contributions for all participants equal to 50% of salary reductions of
up to 6% of a participant's compensation. During 2001 and prior to the
acquisition, eMation paid its matching contribution to the plan. We paid
matching contributions totaling $207 and $275 for both plans in 2003 and 2002,
respectively.
16) Segment and Major Customer Information
We operate in a single industry segment, which is the development and licensing
of our technology.
We had the following customers that combined represented in excess of 15%, 28%
and 37% of revenues for the years ended December 31, 2003, 2002 and 2001,
respectively:
December 31,
------------
Customer 2003 2002 2001
- -------- ---- ---- ----
1 .................................. $ 970 $2,512 $1,250
2 .................................. $ 557 $1,823 $ 990
3 .................................. $ 493 $ 694 $ 585
75
We sell and license our technology to customers primarily in North America,
Europe and Asia. A majority of our revenues are derived from our North American
operations, and our total revenues were derived from the following geographic
regions:
Year Ended December 31,
-----------------------
Country/ Geographic Region 2003 2002 2001
- -------------------------- ---- ---- ----
North America:
United States .................... $ 5,556 $ 8,459 $ 4,461
Canada ........................... 265 1,912 1,208
------- ------- -------
Total - North America ....... 5,821 10,371 5,669
------- ------- -------
Europe:
Italy ............................ 240 247 4
Germany .......................... 573 1,330 525
France ........................... 1,425 1,778 419
Netherlands ...................... 461 785 --
Switzerland ...................... 1,213 707 --
United Kingdom ................... 536 466 --
Belgium .......................... 390 162 --
Other ............................ 615 569 419
------- ------- -------
Total - Europe .............. 5,453 6,044 1,367
------- ------- -------
Asia-Pacific:
Israel ........................... 326 450 42
Japan ............................ 1,352 856 390
Other ............................ 113 261 106
------- ------- -------
Total - Asia-Pacific ........ 1,791 1,567 538
------- ------- -------
Other ................................. 129 147 15
------- ------- -------
Total ................................. $13,194 $18,129 $ 7,589
======= ======= =======
17) Segment Reporting
Segment information is presented in accordance with Statement of Financial
Account Standards No. 131, or SFAS 131, "Disclosures About Segments Of An
Enterprise And Related Information." This standard requires segmentation based
upon our internal organization and disclosure of revenue and operating income
based upon internal accounting methods. For the year ended December 31, 2003 DRM
was our reportable segment.
DRM was created as a result of the acquisition of eMation in December 2001 (note
4), this segment provides 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.
Other is comprised of our former PC business, the assets of which were sold in
May 2002, and our former CE and IA businesses, the assets of which were sold in
March of 2001.
76
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.
Year Ended December 31,
-----------------------
2003 2002 2001
-------- -------- --------
Revenues:
DRM .............................. $ 12,622 $ 10,876 $ 1,614
Other ............................ 572 7,253 5,975
-------- -------- --------
Total ....................... $ 13,194 $ 18,129 $ 7,589
======== ======== ========
Gross profit:
DRM .............................. $ 7,231 $ 4,075 $ 1,177
Other ............................ 342 3,764 (15,235)
-------- -------- --------
Total ....................... $ 7,573 $ 7,839 $(14,058)
======== ======== ========
18) Consolidated Statements of Cash Flows
Supplemental disclosure of cash flow information:
Year Ended December 31,
-----------------------
2003 2002 2001
----- ------ ------
Cash paid during the year for:
Interest ................................................................. $ 37 $ 148 $ 20
===== ====== ======
Income taxes (refund) .................................................... -- (308) 308
===== ====== ======
Non-cash investing and financing activities:
Common stock financing-related liability (note 10) ....................... 2,608 -- --
===== ====== ======
Issuance of warrants and options in connection with equity
transactions ........................................................... 114 90 2,262
===== ====== ======
Amortization of deferred stock compensation .............................. 547 1,562 1,353
===== ====== ======
Issuance of warrants in connection with bank line of credit (note 8) ..... 44 -- --
===== ====== ======
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 (note10) ........... -- 39 --
===== ====== ======
77
19) Selected Quarterly Financial Data (unaudited)
Per Share of Common Stock (Loss) Closing Stock Prices
-------------------------------- --------------------
Assuming
Revenues Gross Profit Net Loss Dilution Basic High Low
-------- ------------ -------- -------- ----- ---- ---
2003
- ----
First Quarter (A) $3,417 $1,737 $(4,787) $(0.18) $(0.18) $0.81 $0.32
Second Quarter 2,774 1,275 (4,853) $(0.18) $(0.18) $2.09 $0.30
Third Quarter (B) 3,603 2,536 (1,811) $(0.07) $(0.07) $1.99 $1.19
Fourth Quarter ( C ) 3,400 2,025 (2,157) $(0.07) $(0.07) $2.13 $1.27
----- ----- -------
Total (F) (H) $13,194 $7,573 $(13,608) $(0.48) * $(0.48) *
======= ====== =========
2002
- ----
First Quarter $ 4,640 $ 1,350 $(9,112) $ (0.34) $ (0.34) $3.86 $2.15
Second Quarter (D) 3,543 1,003 (10,475) $(0.39) $(0.39) $3.21 $1.11
Third Quarter 4,369 2,073 (6,311) $(0.23) $(0.23) $1.77 $0.38
Fourth Quarter (E) 5,577 3,413 (26,029) $(0.96) $(0.96) $1.29 $0.25
------ ------ ---------
Total (G) (H) $18,129 7,839 (51,927) $ (1.92) * $ (1.92) *
======== ====== =========
* EPS in each quarter is computed using the weighted-average number of
shares outstanding that quarter while EPS for the year is computed using
the weighted-average number of shares outstanding during the year. Thus,
the sum of the four quarters' EPS may not equal the full-year EPS.
Notes to Selected Quarterly Financial Data (unaudited)
Axeda's net loss per common share in 2003 and 2002 has been affected by
certain unusual or infrequently occurring items. These items consisted
of:
A. First quarter 2003
1) reversal of accruals related to confidential settlement agreement with
Phoenix Technologies of $743 (note 12c) )
B. Third quarter 2003
1) other income for the fair value adjustment of the financing-related
liability of $645 (note 10)
C. Fourth quarter 2003
1) other income for the fair value adjustment of the financing-related
liability of $157 (note 10)
D. Second quarter 2002
1) special charges related to exit from PC business of $820 (note 5)
E. Fourth quarter 2002
1) an impairment charge of $17,124 for goodwill related to the acquisition
of eMation (notes 1f and 4)
2) an impairment charge of $5,290 for identified intangible assets related
to the acquisition of eMation (notes 1f and 4)
3) settlement of an aggregate vendor liability of $1,060 for $550
F. The aggregate net effect of these items in 2003 was to decrease basic and
diluted net loss per share by $0.03 in the first quarter, $0.02 in the third
quarter and $0.01 in the fourth quarter, thereby aggregating net loss of $0.05
per basic and diluted common share outstanding for the year (see Note H below).
G. The aggregate net effect of these items in 2002 was to increase basic and
diluted net loss per share by $0.03 in the second quarter and $0.80 in the
fourth quarter, thereby aggregating net loss of $0.84 per basic and diluted
common share outstanding for the year (see Note H below).
H. Per common share amounts for the quarters and full years have each been
calculated separately. Accordingly, quarterly amounts may not add to the annual
amounts because of differences in the average common shares outstanding during
each period.
78
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Based on their evaluation of our disclosure controls and procedures as of
December 31, 2003, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures (as defined in Rule
13a-15(e) or Rule 15d-15(e) promulgated under the Securities Exchange Act of
1934) were effective as of December 31, 2003. There were no significant changes
in our internal controls over financial reporting during the fourth quarter of
2003.
79
Axeda Systems Inc.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference to our Proxy
Statement for the 2004 Annual Meeting of Stockholders to be filed by Axeda with
the Securities and Exchange Commission on or before April 30, 2004 under the
captions "Election of directors", "Security Ownership of Certain Beneficial
Owners and Management" and "Section 16(a) Beneficial Ownership Reporting
Compliance."
We have adopted a Code of Business Conduct applicable to all employees and Board
members. A copy of the Corporate Code may be obtained upon request, without
charge, by writing to us at 21 Oxford Road, Mansfield, Massachusetts 02048,
Attn: Director, Investor Relations.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to our Proxy
Statement for the 2004 Annual Meeting of Stockholders to be filed by Axeda with
the Securities and Exchange Commission on or before April 30, 2004 under the
caption "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated by reference to our Proxy
Statement for the 2004 Annual Meeting of Stockholders to be filed by Axeda with
the Securities and Exchange Commission on or before April 30, 2004 under the
captions "Security Ownership of Certain Beneficial Owners and Management" and
"Equity Compensation Plan Information."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to our Proxy
Statement for the 2004 Annual Meeting of Stockholders to be filed by Axeda with
the Securities and Exchange Commission on or before April 30, 2004 under the
caption "Certain Transactions."
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to our Proxy
Statement for the 2004 Annual Meeting of Stockholders to be filed by Axeda with
the Securities and Exchange Commission on or before April 30, 2004 under the
caption "Ratification of Appointment of Auditors."
80
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
a) Documents filed as a part of this Report
(1) Consolidated Financial Statements
The Consolidated Financial Statements of Axeda Systems Inc. and related Notes
thereto as set forth in Item 8 of this Annual Report on Form 10-K begin at page
44.
(2) Financial Statement Schedules
Report of Independent Auditors
The Board of Directors and Stockholders
Axeda Systems Inc.:
Under date of February 2, 2004, we reported on the consolidated balance sheets
of Axeda Systems Inc. and subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of operations, changes in stockholders' equity,
and cash flows for each of the years in the three-year period ended December 31,
2003. In connection with our audits of the aforementioned consolidated financial
statements, we also audited the related consolidated financial statement
schedule. The consolidated financial statement schedule is the responsibility of
the Company's management. Our responsibility is to express an opinion on the
consolidated financial statement schedule based on our audits.
In our opinion, such consolidated financial statement schedule, when considered
in relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
As discussed in Note 1e to the consolidated financial statements, Axeda Systems
Inc. adopted Statement of Financial Accounting Standard No. 142, "Goodwill and
Other Intangible Assets," effective January 1, 2002.
KPMG LLP
Philadelphia, Pennsylvania
February 2, 2004
81
The following consolidated financial statement schedule of Axeda Systems Inc.
for each of the years ended December 31, 2001, 2002 and 2003 should be read in
conjunction with the Consolidated Financial Statements and related Notes thereto
contained herein at Item 8.
Axeda Systems Inc. and Subsidiaries
Schedule of Valuation and Qualifying Accounts
(in thousands)
Balance at Charged Charged to
beginning of to cost and other Balance at
year expense accounts Deductions end of year
---- ------- -------- ---------- -----------
Accounts receivable reserve
- ---------------------------
For the year ended December 31,
2001 ....................................... $2,405 $ 929 $ - $(3,155) $ 179
For the year ended December 31,
2002 ....................................... $ 179 $ (45) $ - $ (50) $ 84
For the year ended December 31, 2003 ....... $ 84 $ (16) $ - $ (-) $ 68
Inventory reserves
- ------------------
For the year ended December 31,
2001 ....................................... $3,800 $18,783 $ - $ (1,264) $21,319
For the year ended December 31,
2002 ....................................... $21,319 $ - $ - $(18,127) $ 3,192
For the year ended December 31,
2003 ....................................... $3,192 $ - $ - $ (110) $ 3,082
Schedules other than the one listed above are omitted because they are not
required or are not applicable, or the required information is shown in the
Consolidated Financial Statements or Notes thereto contained in this Annual
Report on Form 10-K.
(3) Exhibits
The exhibits listed in the accompanying Index to Exhibits are filed or
incorporated by reference as part of this report.
b) Current reports on Form 8-K during the quarter ended December 31, 2003.
On October 30, 2003 the Company submitted an 8-K related to its October 29, 2003
press release announcing, among other things, its financial results for the
third quarter of 2003.
82
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act
of 1934, as amended, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the city of
Mansfield, Commonwealth of Massachusetts on this 24th day of March 2004.
Axeda Systems Inc.
March 24, 2004
By: /s/ Robert M. Russell Jr.
-----------------
Robert M. Russell Jr.
Chief Executive Officer and Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this Annual Report has been signed by the persons whose signatures appear below,
which persons have signed such Annual Report in the capacities and on the dates
indicated.
Signature Title Date
/s/ Robert M. Russell Jr. Chief Executive Officer and Chairman of the Board March 24, 2004
Robert M. Russell Jr. (Principal Executive Officer)
/s/ Dale E. Calder Director and President March 24, 2004
Dale E. Calder
/s/ Thomas J. Fogarty Chief Financial Officer, Executive Vice President and March 24, 2004
Thomas J. Fogarty Treasurer (Principal Financial and Accounting Officer)
/s/Paul A. Vais Director March 24, 2004
Paul A. Vais
/s/ Walter L. Threadgill Director March 24, 2004
Walter L. Threadgill
/s/ Bruce J. Ryan Director March 24, 2004
Bruce J. Ryan
/s/ James McDonald Director March 24, 2004
James McDonald
83
AXEDA SYSTEMS INC.
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 Annual Report on Form 10-K (and are numbered in accordance
with Item 601 of Regulation S-K):
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. (2)
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. (3)
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. (7)
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. (10)
4.1 Form of registrant's Specimen Common Stock Certificate. (1)
10.1 Axeda's 1999 Stock Incentive Plan.(1)
10.2 Axeda's 1999 Employee Stock Purchase Plan.(1)
10.3 Form of Directors' and Officers' Indemnification Agreement.(1)
10.4+ Employment Agreement, as amended, dated August 6, 2001 by and between RAVISENT and
Robert M. Russell, Jr. (4)
10.5+ Employment Agreement, dated December 7, 2001 by and between RAVISENT and Dale Calder
(8)
10.6+ Employment Agreement, dated December 7, 2001 by and between RAVISENT and Thomas J.
Fogarty (8)
10.7+ Employment Agreement, dated December 7, 2001 by and between RAVISENT and Francis X.
Brown III (8)
10.8 eMation Ltd. 2001 Share Incentive Plan.(6)
10.9 eMation Ltd. 2001 Share Incentive Plan Form of Stock Option Agreement.(6)
10.10 Form of Assumption Agreement. (6)
10.11@ License and Distribution Agreement, dated July 26, 2002, by and between Electronics for
Imaging, Inc. and Axeda Systems Operating Company, Inc. (9)
10.12@ Software Distribution Agreement, dated May 24, 2002, by and between Sonic IP, Inc. and
AXEDA SYSTEMS, Inc., RAVISENT I.P., Inc and RAVISENT OPERATING COMPANY, Inc. (11)
84
10.13 Loan and Security Agreement, dated June 25, 2003 by and between Axeda Systems
Operating Company, Inc. and Silicon Valley Bank (12)
10.14 Purchase Agreement, dated September 22, 2003, by and among Axeda Systems Inc. and the
investors named on the signature pages thereto. (13)
10.15 Registration Rights Agreement, dated September 23, 2003, by and among Axeda Systems
Inc. and the investors named on the signature pages thereto. (13)
10.16 Form of Common Stock Warrant. (13)
10.17 + Employment Agreement dated September 25, 2003 by and between Axeda Systems Inc. and
John C. Roberts (14)
10.18 Amendment #1 to Electronics for Imaging, Inc. and Axeda Systems Operating Company, Inc.
License and Distribution Agreement, effective August 15, 2003 (14)
10.19+* Employment Agreement, dated as of December 7, 2003 by and between Axeda Systems Inc.
and Thomas J. Fogarty
21.1* Subsidiaries of AXEDA.
23.1* Consent of KPMG LLP, Independent Auditors.
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.
(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 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.
(3) 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.
(4) Incorporated by reference to the registrant's quarterly report on Form 10-Q for the
quarterly period ended September 30, 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 Axeda's registration statement on Form S-8 as filed with
the Securities and Exchange Commission on February 11, 2002.
(7) Incorporated by reference to Axeda's current report on Form 8-K dated February 25, 2002
as filed with the Securities and Exchange Commission on February 27, 2002.
(8) Incorporated by reference to the registrant's annual report on Form 10-K for the period
ended December 31, 2002.
(9) Incorporated by reference to Axeda's quarterly report on Form 10-Q for the quarterly
period ended September 30, 2002.
(10) Incorporated by reference to Axeda's quarterly report on Form 10-Q for the quarterly
period ended March 31, 2002.
(11) Incorporated by reference to Axeda's quarterly report on Form 10-Q for the quarterly
period ended June 30, 2002.
(12) Incorporated by reference to Axeda's quarterly report on Form 10-Q for the quarterly
period ended June 30, 2003.
(13) 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.
(14) Incorporated by reference to Axeda's quarterly report on Form 10-Q for the quarterly
period ended September 30, 2003.
@ Confidential treatment granted for portions of this agreement
+ Compensation plans and arrangements for executives and others
* Filed herewith
85