SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period Ended March 31, 2004
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ______________
Commission File number 000-26287
Axeda Systems Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 23-2763854
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
21 Oxford Road
Mansfield, Massachusetts 02048
---------------------------
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (508) 337-9200
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
---------------------------
On May 12, 2004, 32,469,862 shares of the Registrant's Common Stock, $0.001 par
value, were outstanding.
AXEDA SYSTEMS INC.
FORM 10-Q
INDEX
Page
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PART I FINANCIAL INFORMATION
ITEM 1 Financial Statements
Consolidated Balance Sheets as of March 31, 2004 (unaudited) and December 31, 2003 2
Consolidated Statements of Operations for the three months ended March 31, 2004 and 2003 3
(unaudited)
Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003 4
(unaudited)
Notes to the Consolidated Financial Statements 5
ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 13
ITEM 3 Quantitative and Qualitative Disclosures About Market Risk 32
ITEM 4 Controls and Procedures 32
PART II OTHER INFORMATION
ITEM 1 Legal Proceedings 33
ITEM 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 34
ITEM 3 Defaults Upon Senior Securities 34
ITEM 4 Submission of Matters to a Vote of Security Holders 34
ITEM 5 Other Information 34
ITEM 6 Exhibits and Reports on Form 8-K 34
Signatures 35
Exhibit Index 36
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
PART I FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
AXEDA SYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
March 31, December 31,
2004 2003
---- ----
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents ............................................. $ 6,281 $ 9,617
Accounts receivable, net .............................................. 3,156 3,200
Prepaid expenses ...................................................... 290 307
Other current assets .................................................. 175 121
--------- ---------
Total current assets ................................................ 9,902 13,245
Furniture and equipment, net .......................................... 1,982 2,229
Goodwill .............................................................. 3,640 3,640
Identified intangible assets, net ..................................... 1,304 1,423
Other assets .......................................................... 339 349
--------- ---------
Total assets ........................................................ $ 17,167 $ 20,886
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable ...................................... $ 109 $ 417
Accounts payable ...................................................... 1,356 1,253
Accrued expenses ...................................................... 4,995 4,866
Income taxes payable .................................................. 694 733
Deferred revenue ...................................................... 1,128 1,422
--------- ---------
Total current liabilities ........................................... 8,282 8,691
Non-current liabilities:
Other non-current liabilities ......................................... 816 862
Financing-related liability ........................................... 1,869 2,608
--------- ---------
Total liabilities ................................................... 10,967 12,161
--------- ---------
Commitments and contingencies (note 6)
Stockholders' equity:
Preferred stock, $0.001 par value; 5,000,000 shares authorized
in 2004 and 2003, none issued or outstanding ........................ -- --
Common stock, $.001 par value; 50,000,000 shares authorized; 33,073,662
shares issued in 2004 and 32,913,211 shares issued in 2003 .......... 33 33
Additional paid-in capital ............................................ 146,688 146,644
Deferred stock compensation ........................................... (235) (310)
Accumulated deficit ................................................... (139,127) (136,488)
Accumulated other comprehensive income ................................ 221 226
Treasury stock at cost, 603,800 shares in 2004 and 2003 ............... (1,380) (1,380)
--------- ---------
Total stockholders' equity .......................................... 6,200 8,725
--------- ---------
Total liabilities and stockholders' equity .......................... $ 17,167 $ 20,886
========= =========
See accompanying notes to the consolidated financial statements.
2
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Three Months Ended March 31,
----------------------------
2004 2003
------------ ------------
Revenues:
License ................................................................. $ 2,334 $ 2,317
Services and maintenance ................................................ 1,181 963
Hardware ................................................................ 20 137
------------ ------------
Total revenues ........................................................ 3,535 3,417
------------ ------------
Cost of revenues:
License ................................................................. 194 511
Services and maintenance ................................................ 1,123 1,012
Software amortization ................................................... 112 157
------------ ------------
Total cost of revenues ................................................ 1,429 1,680
------------ ------------
Gross profit .......................................................... 2,106 1,737
------------ ------------
Research and development (R&D)
Non-cash compensation ................................................... -- 28
Other R&D expense ....................................................... 1,091 1,714
Sales and marketing
Non-cash compensation ................................................... 45 11
Other selling and marketing expense ..................................... 2,126 2,505
General and administrative
Non-cash compensation ................................................... 30 103
Other general and administrative expense ................................ 1,898 2,561
Depreciation and amortization ........................................... 263 308
------------ ------------
Total operating expenses .............................................. 5,453 7,230
------------ ------------
Operating loss ........................................................ (3,347) (5,493)
Gain on disposal of assets ................................................ -- 729
Interest income (expense), net ............................................ (12) 31
Other income (expense), net ............................................... 740 (4)
------------ ------------
Loss before provision for income taxes .................................... (2,619) (4,737)
Provision for income taxes ........................................... 20 50
------------ ------------
Net loss .................................................................. $ (2,639) $ (4,787)
============ ============
Basic and diluted net loss per weighted average common share
outstanding ............................................................. $ (0.08) $ (0.18)
============ ============
Weighted average number of common shares outstanding used in
calculation of basic and diluted net loss per common share .............. 32,413,006 27,179,237
============ ============
See accompanying notes to the consolidated financial statements.
3
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended March 31,
----------------------------
2004 2003
-------- --------
Cash flows from operating activities:
Net loss ............................................................................. $ (2,639) $ (4,787)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ........................................................ 375 465
Gain on disposals of assets .......................................................... -- (729)
Unrealized gain on financing-related liability ....................................... (739) --
Non-cash compensation and other expenses ............................................. 75 142
Provision for doubtful accounts ...................................................... 7 --
Changes in items affecting operations:
Accounts receivable .................................................................. 36 443
Prepaid expenses and other current assets ............................................ (37) (93)
Goodwill, intangible assets and other assets ......................................... 10 (4)
Accounts payable ..................................................................... 103 (273)
Accrued expenses ..................................................................... 104 (1,674)
Income taxes payable ................................................................. (39) 57
Deferred revenue ..................................................................... (294) (377)
-------- --------
Net cash used in operating activities .............................................. (3,038) (6,830)
-------- --------
Cash flows from investing activities:
Capital expenditures ................................................................. (40) (105)
-------- --------
Net cash used in investing activities .............................................. (40) (105)
-------- --------
Cash flows from financing activities:
Net repayment under bank line of credit .............................................. (308) --
Repayments of long-term debt and other non-current liabilities ....................... -- (121)
Net proceeds from exercise of stock options ......................................... 23 --
-------- --------
Net cash used in financing activities .............................................. (285) (121)
-------- --------
Effect of exchange rate changes on cash and cash equivalents ........................... 27 48
-------- --------
Net decrease in cash and cash equivalents .............................................. (3,336) (7,008)
Cash and cash equivalents:
Beginning of period .................................................................. 9,617 19,065
-------- --------
End of period, including restricted cash of $100 in 2003 ............................. $ 6,281 $ 12,057
======== ========
See accompanying notes to the consolidated financial statements.
4
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Information with respect to March 31, 2004 and 2003 is unaudited)
All amounts are in thousands, except share and per share amounts, unless noted
otherwise.
1) Summary of Significant Accounting Policies
a) Description of Business and Liquidity
Axeda Systems Inc., 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 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.
Since 2002 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 quarters ended March 31, 2004
and 2003, our net losses were $2,639 and $4,787, respectively, and
negative cash flows from operations were $3,038 and $6,830,
respectively. There can be no assurances that we will be able to
generate sufficient revenues necessary to achieve or sustain
profitability in the short or long term, or positive cash flows from
operations. Management believes that the cash and cash equivalents as
of March 31, 2004 will be sufficient to sustain our operations through
at least 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.
In 2003 we recorded approximately $1,400 in restructuring charges to
reduce staffing levels, terminate certain leases and consolidate our
operations. Combined with our expected continued year over year growth
in DRM Systems revenues, we believe that our 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) Basis of Presentation
The interim consolidated financial statements of Axeda for the three
months ended March 31, 2004 and 2003 included herein have been
prepared by us, without audit, pursuant to the rules and regulations
of the Securities and Exchange Commission, or SEC. Certain information
and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted
in the United States of America, or GAAP, have been condensed or
omitted pursuant to such rules and regulations relating to interim
financial statements. In the opinion of management, the accompanying
unaudited interim consolidated financial statements reflect all
adjustments, consisting of normal recurring items, necessary to
present fairly the financial position of Axeda at March 31, 2004, the
results of our operations for the three months ended March 31, 2004
and 2003 and our cash flows for the three months ended March 31, 2004
and 2003. The unaudited consolidated financial statements included in
this Form 10-Q should be read in conjunction with the audited
consolidated financial statements and notes thereto, included in our
Form 10-K for the year ended December 31, 2003. The interim results
presented are not necessarily indicative of results for any subsequent
quarter or for the year ending December 31, 2004.
c) Principles of Consolidation
The consolidated financial statements include our financial statements
and the financial statements of our wholly-owned subsidiaries. All
significant intercompany balances and transactions have been
eliminated in consolidation.
5
d) Cash and Cash Equivalents
For purposes of the statement of cash flows, we consider all highly
liquid instruments purchased with a maturity of three months or less
to be cash equivalents.
e) Revenue Recognition
We recognize software revenues in accordance with the American
Institute of Certified Public Accountants' Statement of Position, or
SOP, 97-2, "Software Revenue Recognition" as amended by SOP 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect
to Certain Transactions." Software 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.
f) Financial Instruments
Our financial instruments principally consist of cash and cash
equivalents, accounts receivable, accounts payable and notes payable
that are carried at cost, which approximates fair value. The
financing-related liability financial instrument is recorded at fair
value (note 5).
g) Computation of Earnings Per Share
We compute earnings per share, or EPS, in accordance with Statement of
Financial Accounting Standards No. 128, "Computation of Earnings Per
Share," or SFAS 128. In accordance with SFAS 128, basic earnings per
share is computed using the weighted average number of common shares
outstanding during the period. Diluted earnings per share is computed
using the weighted average number of common and dilutive common
equivalent shares outstanding during the period. Common equivalent
shares consist of the incremental common shares issuable upon the
exercise of stock options and warrants (using the treasury stock
method). Common equivalent shares are excluded from the calculation if
their effect is anti-dilutive.
The following potential shares of common stock have been excluded from
the computation of diluted net loss per share for all periods
presented because the effect would have been anti-dilutive:
i) Three Months Ended March 31, 2004
Options to purchase 6,364,989 shares of common stock with a
weighted-average exercise price of $1.71 were outstanding during
the three months ended March 31, 2004 but were not included in
the computation of diluted EPS because the effects of assumed
exercise would have an anti-dilutive effect on EPS. The
outstanding options include 3,303,064 options that are vested,
with a weighted average exercise price of $2.02, of which
1,438,226 are vested and in the money, with a weighted average
exercise price of $0.19. The options have various expiration
dates during the next ten years.
Warrants to purchase 2,689,377 shares of common stock with a
weighted-average exercise price of $1.99 were vested and
outstanding during the three months ended March 31, 2004, but
were not included in the calculation of diluted EPS because the
effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. No outstanding warrants were vested
and in the money. The warrants have various expiration dates
during the next five years.
ii) Three Months Ended March 31, 2003
Options to purchase 4,986,272 shares of common stock with a
weighted-average exercise price of $1.95 were outstanding during
the three months ended March 31, 2003, but were not included in
the computation of diluted EPS because the effects of assumed
exercise would have an anti-dilutive effect on EPS. The
outstanding options include 2,405,989 options that are vested,
with a weighted average exercise price of $2.62, of which 798,637
were vested and in the money, with a weighted average exercise
price of $0.01. The options have various expiration dates during
the next ten years.
6
Warrants to purchase 564,191 shares of common stock with a
weighted-average exercise price of $2.80 were vested and
outstanding during the three months ended March 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
187,967 warrants that are vested and in the money, with a
weighted average exercise price of $0.06. The warrants have
various expiration dates during the next five years.
h) 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.
At March 31, 2004 we have two stock-based employee compensation plans.
We account for those plans under the recognition and measurement
principles of APB 25 and related interpretations. The following table
illustrates the effect on net loss and net loss per share if we had
applied the fair value recognition provisions of SFAS 123 to
stock-based compensation:
Three Months Ended March 31,
----------------------------
2004 2003
------- -------
Net loss, as reported ........................................... $(2,639) $(4,787)
Add: Stock-based employee compensation
included in reported net loss, net of related
tax effects ..................................................... 75 142
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards ............................... (454) (504)
------- -------
Pro forma net loss .............................................. $(3,018) $(5,149)
======= =======
Net loss per common share - basic and diluted:
As reported ................................................ $ (0.08) $ (0.18)
======= =======
Pro forma .................................................. $ (0.09) $ (0.19)
======= =======
We used the following ranges of assumptions to determine the fair
value of stock options granted using the Black-Scholes option-price
model for the quarters ended March 31, 2004 and 2003:
Dividend yield ............. 0%
Expected volatility ........ 119% - 192%
Average expected option life 4 years
Risk-free interest rate .... 1.02% - 5.71%
In February and March 2004 we granted 824,000 stock options to
employees, including 120,000 to our chief financial officer, with an
exercise price per share equal to the fair market value of our common
stock on the date of grant and ranging from $1.17 to $1.28.
7
i) 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.
j) Use of Estimates
The preparation of financial statements in conformity with GAAP
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.
k) Recent Accounting Pronouncements
On March 31, 2004, the Financial Accounting Standards Board, or FASB,
consistent with recent actions of other accounting agencies and
entities, issued a proposed statement, "Share Based Payment, an
Amendment of FASB Statements No. 123 and 95," relating to the
accounting for equity-based compensation. This statement proposes
changes to GAAP that, if implemented, would require us to record a
charge to compensation expense for stock option grants to employees.
We currently account for stock options under SFAS 123 (note 1h). As
permitted by SFAS 123, we have elected to use the intrinsic value
method prescribed by APB 25 to measure compensation expense for
stock-based awards granted to employees, under which the granting of
stock options is not considered compensation if the option exercise
price is not less than the fair market value of the common stock at
the grant date. The FASB's proposal would eliminate our ability,
starting in 2005, to account for stock-based awards granted to
employees using the intrinsic value method prescribed by APB 25, and
would instead require that such awards be accounted for using a
fair-value based method, which would require us to measure the
compensation expense for all such awards, including stock options, at
fair value at the grant date. Compensation expense would then be
recognized over the service or vesting period. We cannot predict
whether the proposed statement will be adopted, but if adopted it
would have an adverse affect on our results of operations. On May 12,
2004 the U.S. House of Representatives' Capital Markets Subcommittee
approved a bill to bypass the guidance that the FASB set forth in this
Exposure Draft. If the bill passes, it would block the mandatory
expensing of stock options until regulators complete a three-year
study on the economic impact of the FASB's proposal. The bill would
allow the SEC to recognize as "generally accepted" those accounting
principles under which companies need only expense the stock options
they grant to their top five highest-paid executives.
In May 2002 the FASB added a project to its technical agenda to
develop a comprehensive statement on revenue recognition. The FASB
plans to issue an exposure draft of an amendment to FASB Concepts
Statement 5, and a separate exposure draft of a general standard on
revenue recognition in the fourth quarter of 2004.
8
l) Reclassifications
Certain prior year amounts have been reclassified to conform to the
current year presentation.
2) Supplemental Disclosure of Balance Sheet Information
Provision for Doubtful Accounts
Accounts receivable are net of provisions for doubtful accounts of $76
and $68 as of March 31, 2004 and December 31, 2003, respectively.
Acquired Identified Intangible Assets
Accumulated amortization at March 31, 2004 and December 31, 2003 was
$856 and $737, respectively.
3) 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% (5.00% at March 31, 2004), 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 March 31, 2004, we were
in compliance with our covenants and $248 was available, with $109
outstanding under the terms of the Line.
In connection with obtaining the Line, we issued a warrant to the Bank to
acquire 43,042 shares of our common stock at an exercise price of $1.39 per
share and which expires in June 2008. The estimated fair value of the
warrant issued was $44 and was recorded as debt issuance costs. We also
incurred legal and professional fees of approximately $38 in obtaining the
Line. These amounts, totaling $82, are being amortized over the one-year
term of the Line and included in interest expense.
At March 31, 2004 there were no letters of credit or other amounts for bank
services outstanding under the Line.
In May 2004 we renewed the Line under substantially the same terms as the
current Line.
4) Accrued Expenses
Accrued expenses consist of the following:
March 31, December 31,
2004 2003
---- ----
Legal and professional fees ..................................... $ 505 $ 558
Payroll and related costs ....................................... 1,484 1,477
Royalties to Israeli government agencies ........................ 826 759
Sales, excise and other taxes ................................... 316 266
Severance ....................................................... 277 88
Unutilized leased facilities .................................... 567 547
Other ........................................................... 1,020 1,171
------ ------
$4,995 $4,866
====== ======
9
5) Private Placement and Financing-related Liability
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. 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.
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 passes until the registration statement is updated and
declared effective by the SEC.
The FASB's Emerging Issues Task Force, or 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.
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 March 31,
2004 was $1,869. The $739 net change in the fair value from December 31,
2003 was recorded as other income in the consolidated statement of
operations.
The estimated fair value of the warrant, used to determine the estimated
fair value of the financing-related liability, was calculated using the
Black-Scholes model with the following assumptions:
March 31, December 31,
2004 2003
---------- -----------
Current market price/share .................. $ 1.06 $ 1.36
Exercise price/share ........................ $ 1.71 $ 1.71
Dividend yield .............................. 0% 0%
Expected volatility ......................... 111% 115%
Expected life ............................... 4.48 years 4.73 years
Risk-free interest rate ..................... 2.96% 3.13%
10
6) Commitments and Contingencies
In March 2003 we entered into a confidential settlement agreement with
Phoenix Technologies in connection with the sale of the assets of our
former Internet appliance, or IA, business. 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.
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 Statement of
Financial Accounting Standards No. 5, "Accounting for Contingencies," 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.
7) Segment and Major Customer Information
We operate in a single industry segment, which is the development and
licensing of our technology.
Three customers accounted for 37%, or $1,323, of revenues for the quarter
ended March 31, 2004. Three customers accounted for 28%, or $960, of
revenues for the quarter ended March 31, 2003.
We sell and license our technology to customers primarily in North America,
Europe and Asia. Our North American operations generated 37% and 43%,
respectively, of our revenues in 2004 and 2003, and our total revenues were
derived from the following geographic regions (based on where the customer
is located):
Three Months Ended March 31,
-----------------------------------------
2004 2003
------------------- -------------------
Country/ Geographic Region Amount % of Total Amount % of Total
- -------------------------- ------ ---------- ------ ----------
North America:
United States .............................. $1,297 37% $1,235 36%
Canada ..................................... 9 -- 250 7
------ ------ ------ ------
Total - North America ................. 1,306 37 1,485 43
------ ------ ------ ------
Europe:
Germany .................................... 121 3 150 4
France ..................................... 389 11 393 12
Netherlands ................................ 222 6 113 3
Switzerland ................................ 305 9 220 7
United Kingdom ............................. 146 4 42 1
Other ...................................... 341 10 285 8
------ ------ ------ ------
Total - Europe ........................ 1,524 43 1,203 35
------ ------ ------ ------
Asia-Pacific:
Israel ..................................... 18 -- 125 4
Japan ...................................... 627 18 540 16
Other ...................................... 34 1 11 --
------ ------ ------ ------
Total - Asia-Pacific .................. 679 19 676 20
------ ------ ------ ------
Other ........................................... 26 1 53 2
------ ------ ------ ------
Total .................................. $3,535 100% $3,417 100%
====== === ====== ===
11
8) Segment Reporting
Segment information is presented in accordance with Statement of Financial
Account Standards No. 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. DRM is our reportable segment.
For 2004, Other is comprised of our IA business, the assets of which were sold
in March of 2001. For 2003, Other is comprised of our former personal computer,
or PC, business, which we exited in May 2002, our former IA business and our
former consumer electronics, or CE, business, the assets of which were sold in
March of 2001.
We evaluate operating segment performance based on revenue and gross profit. We
have not historically evaluated segment performance based on operating income or
allocated assets to our individual operating segments.
Three Months Ended March 31,
----------------------------
2004 2003
------ ------
Revenues:
DRM ................................................... $3,515 $3,031
Other ................................................. 20 386
------ ------
Total ......................................... $3,535 $3,417
====== ======
Gross profit:
DRM .............................................. $2,086 $1,600
Other ............................................ 20 137
------ ------
Total ......................................... $2,106 $1,737
====== ======
9) Consolidated Statements of Cash Flows
Supplemental disclosure of cash flow information:
Three Months Ended March 31,
----------------------------
2004 2003
--- ---
Cash paid during the period for:
Interest ............................... $ 2 $22
=== ===
Income taxes ........................... 59 --
=== ===
10) Comprehensive Income (Loss)
The components of comprehensive loss are as follows:
Three Months Ended March 31,
----------------------------
2004 2003
------- -------
Net loss ..................................... $(2,639) $(4,787)
Foreign currency translation adjustment ...... 27 48
------- -------
Comprehensive loss ........................... $(2,612) $(4,739)
======= =======
12
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion And Analysis Of Financial
Condition And Results Of Operations, as well as the information
contained elsewhere in this report, contain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as
amended, Section 21E of the Securities Exchange Act of 1934, as
amended, and 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 the NASDAQ National Market to delist out stock; 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.
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, or 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 since 2002,
substantially all of our revenues were generated from selling DRM products.
In 2003, we recorded approximately $1.4 million in restructuring charges to
reduce staffing levels, terminate certain leases and consolidate our operations.
Combined with our expected continued year over year growth in DRM Systems
revenues, we believe that our future operating losses will continue to be lower
than what we have historically experienced. We will continue to evaluate our
cost structure and may undertake additional measures to reduce expenses in the
future.
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. Operating results and our liquidity
position are discussed in further detail, below.
13
We currently operate in three principal regions: the United States, Europe and
Japan. Total revenues increased by $0.1 million in the first quarter of 2004
compared to the first quarter of 2003. Despite the continued difficult capital
spending climate, our DRM revenues increased by $0.5 million in the first
quarter of 2004 compared to the same period in 2003, due to increases in all
three principal regions. 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 the first quarter of 2004 our operating expenses decreased by $1.8 million,
or 25%, compared to the same period for the prior year. 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.
At March 31, 2004, our cash balance was $6.3 million compared with $9.6 million
at year-end 2003. Operating results and our liquidity position are discussed
further below.
14
Results of Operations
Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003.
The following table sets forth, for the periods indicated, the amount and
percentage of total revenues represented by certain items reflected in our
consolidated statements of operations:
Axeda Systems Inc.
Unaudited Consolidated Statements of Operations Data
(In thousands)
Three Months Ended March 31,
-------------------------------------------
2004 2003
------------------ --------------------
Percent of Percent of
Amount Revenues Amount Revenues
------ -------- ------ --------
Revenues:
License ................................................ $ 2,334 66.0% $ 2,317 67.8%
Services and maintenance ............................... 1,181 33.4 963 28.2
Hardware ............................................... 20 0.6 137 4.0
------- ------ ------- ------
Total revenues ....................................... 3,535 100.0 3,417 100.0
------- ------ ------- ------
Cost of revenues:
License ................................................ 194 5.5 511 15.0
Services and maintenance ............................... 1,123 31.8 1,012 29.6
Software amortization .................................. 112 3.1 157 4.6
------- ------ ------- ------
Total cost of revenues ............................... 1,429 40.4 1,680 49.2
------- ------ ------- ------
Gross profit .............................................. 2,106 59.6 1,737 50.8
------- ------ ------- ------
Research and development (R&D)
Non-cash compensation ................................. -- -- 28 0.8
Other R&D expense ..................................... 1,091 30.9 1,714 50.2
Sales and marketing (S&M)
Non-cash compensation ................................. 45 1.3 11 0.3
Other S&M expense ..................................... 2,119 59.9 2,505 73.3
General and administrative (G&A)
Non-cash compensation ................................. 30 0.9 103 3.0
Other G&A expense ..................................... 1,898 53.7 2,570 75.2
Provision for doubtful accounts
(recoveries) .......................................... 7 0.2 (9) (0.3)
Depreciation and amortization ............................. 263 7.4 308 9.0
------- ------ ------- ------
Total operating costs ............................ 5,453 154.3 7,230 211.6
------- ------ ------- ------
Operating loss ............................................ (3,347) (94.7) (5,493) (160.7)
Gain on disposals of assets ............................... -- -- 729 21.7
Interest income (expense), net and other
income (expense), net ................................. 728 20.6 27 0.4
------- ------ ------- ------
Loss before provision for income taxes .................... (2,619) (74.1) (4,737) (138.6)
Provision for income taxes ................................ 20 0.6 50 1.5
------- ------ ------- ------
Net loss .................................................. $(2,639) (74.7)% $(4,787) (140.1)%
======= ====== ======= ======
15
AXEDA SYSTEMS INC.
Results of Operations
REVENUES. Overall revenues increased by 3%, or $0.1 million, from $3.4 million
in the quarter ended March 31, 2003 to $3.5 million for the quarter ended March
31, 2004. By segment, sales of our DRM systems products increased $0.5 million,
or 16%, driven by an accelerated acquisition of new customer accounts, as well
as additional spending, including foreign currency movements, by our existing
customers. PC and hardware revenues decreased $0.4 million, or 95%, over the
same period of the prior year. By type, services and maintenance revenues
increased $0.2 million, or 23%, from the prior year, while license revenues were
flat and hardware revenues decreased $0.1 million. See also "Foreign Currency
Effects on Results of Operations" below
Although our overall license revenues were approximately the same during the
quarter ended March 31, 2004 versus the prior year, DRM licensing fees increased
$0.3 million, or 13%. The increase in DRM license revenues was offset by a
corresponding decrease in license revenues of $0.2 million due to our exit from
our former PC business. In 2004 we expect DRM license revenues to increase
compared to 2003 as our DRM software solutions are more widely adopted.
Decreased sales of fully-reserved, outdated components of our former Internet
appliance, or IA, business resulted in a decline in hardware revenues of $0.1
million for the quarter ended March 31, 2004 from $0.1 million for the quarter
ended March 31, 2003. In 2004, we expect hardware revenues and related gross
profit to be minimal due to the decreasing quantities available and the
uncertainty of any future sales.
Services and maintenance revenues increased 23% from $1.0 million for the
quarter ended March 31, 2003 to $1.2 million for the quarter ended March 31,
2004. The increase was attributable to a greater demand for professional
services in connection with existing DRM installations, as well as additional
maintenance plans sold with our DRM Systems.
Since our shift to the enterprise software market our revenues have been less
concentrated, however variations may occur as sales volume to our large
customers fluctuate. For the quarter ended March 31, 2004, our top three
customers accounted for $1.3 million, or 37%, of our total revenues. For the
quarter ended March 31, 2003, our top three customers accounted for $1.0
million, or 28%, of our total revenues. In the future, we expect our revenues to
be less concentrated as sales of our enterprise software and services span a
wider customer base, our maintenance revenues increase and existing customers of
our DRM solutions purchase additional licenses and services.
We sell our DRM system solutions to Global 2000 companies in the medical
instrument, enterprise technology, office and print production systems and
industrial and building automation industries. For the quarter ended March 31,
2004 companies based in North America accounted for 37% of our revenues. We
anticipate that revenues from international operations will continue to
represent a significant portion of our revenues.
COST OF REVENUES. Cost of revenues decreased approximately $0.3 million, or 15%,
from $1.7 million during the quarter ended March 31, 2003 to $1.4 million for
the quarter ended March 31, 2004. Cost of revenues for license fees decreased
approximately $0.3 million from the prior year, while cost of revenues
associated with services and maintenance increased approximately $0.1 million
from the prior year.
The $0.3 million decrease in cost of license revenues from the prior year is due
to a decrease in licensing costs, caused by our exit from the PC business,
associated with our former PC products of $0.2 million, and a decrease in DRM
costs of $0.1 million, resulting from the closure of our Israeli operations and
decreased product and packaging costs, as a result of our ongoing cost
management initiatives. The $0.1 million increase in cost of services and
maintenance is primarily attributable to severance expense incurred in 2004,
which was not incurred in 2003, and unfavorable currency exchange rates in 2004
compared to 2003. We expect our cost of license fees as a percentage of license
revenues to remain about the same through 2004, as our license revenues are
comprised entirely of our DRM products. Non-cash amortization of acquired
technology will represent approximately $0.4 million of our cost of revenues for
the year ending December 31, 2004.
GROSS PROFIT. Gross profit increased by $0.4 million, or 21%, from $1.7 million
for the quarter ended March 31, 2003 to $2.1 million for the quarter ended March
31, 2004. The increase in gross profit is attributable to an increase in
revenues from DRM license fees which has a higher profit margin than the former
PC business, which sustained decreased revenues, services and maintenance, the
closure of our Israeli operations and reduced software amortization expense.
16
For the quarters ended March 31, 2004 and 2003, substantially all of our
revenues were derived from licenses and services and maintenance. As a
percentage of total revenues, gross profit margin increased from 51% for the
quarter ended March 31, 2003 to 60% for the quarter ended March 31, 2004 due to
lower staff compensation costs, as a result of reduced staff, lower product
packaging costs, and the closure of our Israeli operations. The improvement in
gross profit margin from our services and maintenance operations was the result
of an increase in the number of billable consulting engagements.
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 products, customization of existing
products for customers, quality assurance and testing. Other R&D expense
decreased 36%, from $1.7 million for the quarter ended March 31, 2003 to $1.1
million for the quarter ended March 31, 2004.
The decrease in other R&D expense during the quarter ended March 31, 2004 from
the prior year was due to decreases in staff and staff related expense of $0.3
million, transition expenses associated with the closure of our Israeli
operations and severance totaling $0.2 million and $0.1 million of other
expense. As a percentage of total revenues, other R&D expense decreased from 50%
to 31% due to lower R&D expenses. We expect other R&D expense to decrease
slightly in 2004 as we optimize our development teams to meet our current
business requirements. Additionally, we expect other R&D expense to decrease as
a percentage of revenues as our future revenues increase.
OTHER SALES AND MARKETING ("S&M") EXPENSE. Other S&M expense consists of
salaries and benefits, travel expenses and costs associated with trade shows,
advertising and other marketing efforts. Other S&M expense decreased $0.4
million, or 15%, from $2.5 million for the quarter ended March 31, 2003 to $2.1
million for the quarter ended March 31, 2004.
Reduced staff and staff related expense and travel expense contributed $0.3
million and $0.1 million, respectively, to the decrease during the quarter ended
March 31, 2004 from the prior year. Additionally, increased severance expense of
$0.1 million was offset by decreased other expense for the quarter ended March
31, 2004. As a percentage of total revenues, other S&M expense decreased from
73% to 60% due to lower S&M expenses. We expect other S&M expense to decrease
slightly in 2004 as we optimize our S&M marketing teams to meet our current
business requirements. Additionally, we expect other S&M expense as a percentage
of revenues to decrease as our future revenues increase.
OTHER GENERAL AND ADMINISTRATIVE ("G&A") EXPENSE. Other G&A expense consists of
staff, staff-related and support costs for our executive, finance, legal, human
resources and information systems departments. Other G&A expense decreased $0.7
million, or 26%, from $2.6 million for the quarter ended March 31, 2003 to $1.9
million for the quarter ended March 31, 2004. As a percentage of total revenues,
other G&A expense decreased from 75% to 54% due to decreased G&A expenses, as
described below.
The $0.7 million decrease in other G&A expense consists of $0.2 million due to
decreased staff and related compensation expense, and $0.2 million of decreased
severance expense from the prior year. In addition, we reduced insurance,
professional fees and other expense each by $0.1 million, as part of our ongoing
cost management initiatives. We expect other G&A expense to decrease in 2004 as
we optimize our general and administrative teams to meet our current business
requirements. Additionally, we expect other G&A expense to decrease as a
percentage of revenues as our future revenues increase.
NON-CASH COMPENSATION G&A EXPENSE. Non-cash G&A expense consists of amortization
of compensation related to stock options. Non-cash compensation G&A expense
decreased $0.1 million for the quarter ended March 31, 2004 from $0.1 million
for the quarter ended March 31, 2003. The decrease is attributable to certain
deferred compensation having become fully amortized as a result of the related
stock option awards having fully vested.
GAIN ON DISPOSALS OF ASSETS. We signed a confidential settlement agreement in
March 2003 for the escrow relating to the sale of the assets of our former IA
business in March 2001. In connection with this settlement agreement, we
reversed accruals of approximately $0.7 million recorded in March 2001 as part
of the sale. No corresponding gains were recorded for the quarter ended March
31, 2004.
17
OTHER INCOME (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 with the SEC for the resale of the shares sold in
the transaction and the shares issuable upon exercise of the warrants. 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 quarter ended March 31, 2004 was $0.7
million. Due to the uncertainty surrounding the variables required by the
valuation model for the financing-related liability and corresponding gain or
loss adjustment, we cannot estimate the future income or expense resulting from
the periodic valuations of the liability.
FOREIGN CURRENCY EFFECTS ON RESULTS OF OPERATIONS. Foreign currency movements
for the quarter ended March 31, 2004 increased revenues and expenses, each by
$0.3 million from the prior year. Increases in revenues and expenses from
foreign currency fluctuations are due 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 changes in foreign currency rates, any
strengthening of the U.S. dollar against the foreign currencies will have an
unfavorable impact on our revenues in 2004, and an equal but opposite favorable
impact on our expenses in 2004. We expect that changes in foreign currencies
will not have a material effect on our net income or net loss for 2004.
18
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 March 31, 2004, we had approximately $6.3
million in cash and cash equivalents.
Net cash used in operating activities for the quarter ended March 31, 2004 was
$3.0 million, compared to $6.8 million for the quarter ended March 31, 2003.
Cash used in operating activities for the first quarter of 2004 was primarily
the result of our net loss of approximately $2.6 million, $0.3 million for the
net non-cash expenses and financing-related gain and other changes in working
capital of approximately $0.1 million. 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 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, terminate
certain leases and consolidate our operations. We will continue to evaluate our
cost structure and may undertake additional measures to reduce expenses in the
future.
Net cash used in investing activities for the quarter ended March 31, 2004 was
less than $0.1 million, as compared to $0.1 million for the quarter ended March
31, 2003, 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 used in financing activities was $0.3 million for the quarter ended
March 31, 2004, compared to $0.1 million for the quarter ended March 31, 2003,
and consisted of principal payments reducing indebtedness in each period.
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 March 31, 2004, we had $0.1 million in
borrowings under the Line, which were repaid in April 2004. As of March 31,
2004, we were in compliance with all of our covenants under the Line. In May
2004 we renewed our line of credit with Silicon Valley Bank under substantially
the same terms as our current agreement.
As of March 31, 2004, we have $1.1 million of estimated accrued costs related to
facilities leases that we no longer occupy. We have made significant efforts to
terminate these leases, but if these leases cannot be terminated or if the
facilities cannot be sublet, we may be required to make these payments over the
respective lease terms.
We maintain an irrevocable, cash-secured, standby letter of credit (the "letter
of credit") from a bank for $0.15 million as security for our corporate
headquarters lease. The letter of credit expires in August 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 in August 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 year over year growth in DRM Systems
revenues and the realization of savings from our already implemented expense
reductions, we expect to have sufficient cash resources to meet our cash needs
through at least 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. In such event, our operations and
liquidity will be materially adversely affected. We will continue to pursue
attractive financing and investment arrangements, and if the capital markets
present other attractive opportunities, we may seek to raise cash through the
sale of equity or issuance of debt. However, additional financing may not be
available when needed and, if such financing is available, it may not be
available on terms favorable to us.
19
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, or 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 one to four
years and expire ten years from the grant date for the 1999 Plan. Option vesting
periods are generally two to five years and expire five to ten years from the
grant date for the 1995 Plan.
All stock option grants to executive officers are made after a review by and
with the approval of the Compensation Committee of the Board of Directors. All
members of the Compensation Committee are independent directors, as defined in
the current and proposed rules applicable to issuers traded on the NASDAQ Stock
Market. See the "Compensation Committee Report in Executive Compensation"
appearing in our 2003 Proxy Statement for further information concerning our
policies and procedures, including those of the Compensation Committee,
regarding the use of stock options.
Distribution and Dilutive Effect of Options
The table below provides information about stock options granted for the
quarters ended March 31, 2004 and 2003 to our Chief Executive Officer, Robert M.
Russell Jr., 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."
Quarter Ended Year Ended
March 31, 2004 December 31, 2003
------- -------
Net grants during the period as % of outstanding shares ............... 2.54% 4.11%
Grants to Named Executive Officers during the period as % of
total options granted ................................................ 14.56% 11.66%
Grants to Named Executive Officers during the period as % of
outstanding shares granted ........................................... 0.37% 0.48%
Cumulative options held by Named Executive Officers as % of total
options outstanding .................................................. 33.05% 34.98%
20
General Option Information
The following table sets forth the summary of activity under the Plans for the
quarter ended March 31, 2004 and the year ended December 31, 2003:
Number of Options Outstanding
-----------------------------
Number of Shares Number of Shares Weighted Average
Available for Issuable on Exercise Exercise Price
Options of Options (per share)
------- ---------- -----------
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 N/A
--------- ---
December 31, 2003 521,326 5,720,641 $1.76
======= =========
Grants (824,000) 824,000 1.18
Exercises - (98,212) 0.23
Cancellations* 81,440 (81,440) 1.44
Additional shares reserved 969,282 N/A N/A
------- ---
March 31, 2004 748,048 6,364,989 $1.71
======= =========
* The "Number of Shares Available for Options" does not include options under
assumed plans exercisable for 114,631 shares that were cancelled during 2003, as
no options will be granted in the future pursuant to these assumed plans. No
options granted subject to these plans were canceled in 2004.
The following table sets forth a comparison, as of March 31, 2004, of the number
of shares subject to our options whose exercise prices were at or below the
closing price of our common stock on March 31, 2004 ("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 ............ 1,395,254 $ 0.16 733,512 $ 0.51 2,128,766 $ 0.28
Out-of-the-money (1) .... 1,907,810 $ 3.39 2,328,213 $ 1.66 4,236,223 $ 2.44
--------- -------- --------- -------- --------- --------
Total options outstanding 3,303,064 $ 2.02 3,061,925 $ 1.38 6,364,989 $ 1.71
========= ======== ========= ======== ========= ========
(1) Out-of-the-money options are those options with an exercise price equal to
or above the closing price of $1.06 as of March 31, 2004, as reported by the
NASDAQ National Market.
21
Executive Options
The following table sets forth information regarding stock options granted
in 2004 to our Named Executive Officers each under our 1999 Plan. Options
were granted with an exercise price equal to 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 120,000 14.56% $ 1.17 3/23/2014 $99,732 $260,178
John C. Roberts - - N/A N/A N/A N/A
*Based on a total of 824,000 shares subject to options granted to employees
under our option plans during 2004.
Stock Option Exercises and Option Holdings
The following table shows stock options exercised by the Named Executive
Officers for the quarter ended March 31, 2004, 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 March 31, 2004, 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 March 31, 2004 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 - $ - 586,829 294,171 $316,924 $ 93,626
Dale E. Calder - - 526,562 48,438 331,734 30,516
Thomas J. Fogarty - - 356,351 193,649 252,984 30,516
John C. Roberts - - 33,332 81,668 14,962 8,138
* Option values based on stock price of $1.06 on March 31, 2004.
22
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 March 31, 2004:
(1) (2) (3)
Number of Securities
Number of Securities Weighted-Average Remaining Available for
to be Issued upon Exercise Price of Future Issuance Under Equity
Exercise of Outstanding Options, Compensation Plans (Excluding
Outstanding Options, Warrants, and Rights Securities Reflected in
Plan Category Warrants, and Rights (per share) Column (1) )
- ------------- --------------------- -------------------- ------------------------------
Equity Compensation Plan Approved by
Shareholders (A) (B) 6,364,989 $ 1.71 748,048
--------- ====== =======
(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, 2004, 969,282 additional shares were reserved for issuance.
Recent Accounting Pronouncements
Information regarding recent accounting pronouncements is provided in note 1k to
the consolidated financial statements included at Part I, Item 1 herein.
23
FACTORS THAT MAY AFFECT FUTURE RESULTS
RISK FACTORS
Our business and industry are 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 $2.6 million for the quarter
ended March 31, 2004. 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.
WE RECEIVED A LETTER FROM NASDAQ STATING THAT WE ARE NOT IN COMPLIANCE WITH THE
MINIMUM EQUITY REQUIREMENTS FOR CONTINUED LISTING ON THE NASDAQ NATIONAL MARKET
Our common stock is currently listed on the Nasdaq National Market, or NASDAQ.
We must satisfy a number of requirements to maintain our listing on the NASDAQ.
We were notified by NASDAQ that our common stock was scheduled for delisting at
the opening of business on May 12, 2004 as a result of falling below the minimum
stockholders' equity requirement for continued listing on the NASDAQ. On May 10,
2004, we appealed the delisting to the Listing Qualifications Panel (the Panel).
As a result of our appeal, the delisting has been postponed pending the Panel's
decision. Despite the postponement of the delisting, we cannot assure you that
our appeal will be successful. We may not be able to satisfy the minimum listing
requirements on a going forward basis.
If our common stock is delisted from the NASDAQ, the trading market for such
securities could be disrupted, which could make it difficult for investors to
trade in our common stock. If our common stock is delisted from the NASDAQ, we
will likely apply for listing on the Nasdaq SmallCap Market, the OTC Bulletin
Board or another quotation system or exchange for which we could qualify. This
may have a negative impact on the liquidity and/or price of our common stock. We
cannot guarantee, however, that if we apply for listing on the Nasdaq SmallCap
Market, the OTC Bulletin Board or another quotation system or exchange, we would
be eligible initially for such listing or, that if we do become listed, that we
would be able to maintain eligibility.
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.
24
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.
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.
25
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.
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.
26
WE MAY DEPEND ON OUR STRATEGIC PARTNERS AND OTHER THIRD PARTIES FOR SALES AND
IMPLEMENTATION OF OUR PRODUCTS. IF WE FAIL TO DERIVE BENEFITS FROM OUR EXISTING
AND FUTURE STRATEGIC RELATIONSHIPS, OUR BUSINESS WILL SUFFER.
From time to time, we have collaborated with other companies in areas such as
marketing, distribution or implementation. Maintaining these and other
relationships is a meaningful part of our business strategy. However, some of
our current and potential strategic partners are either actual or potential
competitors, which may impair the viability of these relationships. In addition,
some of our relationships have failed to meet expectations and may fail to meet
expectations in the future. A failure by us to maintain existing strategic
relationships or enter into successful new strategic relationships in the future
could seriously harm our business, operating results and financial condition.
OUR BUSINESS MODEL DEPENDS UPON LICENSING OUR INTELLECTUAL PROPERTY, AND IF WE
FAIL TO PROTECT OUR PROPRIETARY RIGHTS, OUR BUSINESS COULD BE HARMED.
Our ability to compete depends substantially upon our internally developed
technology. We have a program for securing and protecting rights in patentable
inventions, trademarks, trade secrets and copyrightable materials. However,
there can be no assurance that we have taken or will take all necessary steps to
protect our intellectual property rights. If we are not successful in protecting
our intellectual property, our business could be substantially harmed. We regard
the protection of patentable inventions as important to our business. We
currently have 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.
27
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.
28
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 quarter ended March 31, 2004, we derived
approximately 63% 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.
29
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 March 31, 2004, 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
March 31, 2004, $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 March 31, 2004, our executive officers, directors and entities affiliated
with them, in the aggregate, beneficially owned approximately 4.0 million
shares, or approximately 12%, 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.
30
CERTAIN PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BY-LAWS MAKE CHANGES
OF CONTROL DIFFICULT EVEN IF THEY WOULD BE BENEFICIAL TO OUR STOCKHOLDERS.
The board of directors has the authority without any further vote or action on
the part of our stockholders to issue up to 5 million shares of preferred stock
and to determine the price, rights, preferences, privileges and restrictions of
the preferred stock. This preferred stock, if it is ever issued, may have
preference over and harm the rights of the holders of our common stock. Although
the issuance of this preferred stock will provide us with flexibility in
connection with possible acquisitions and other corporate purposes, this
issuance may make it more difficult for a third party to acquire a majority of
our outstanding voting stock. We currently have no plans to issue preferred
stock.
Our certificate of incorporation and by-laws include provisions that may have
the effect of deterring an unsolicited offer to purchase our stock. These
provisions, coupled with the provisions of the Delaware General Corporation Law,
may delay or impede a merger, tender offer or proxy contest involving us.
Furthermore, our board of directors is divided into three classes, only one of
which is elected each year. Directors are only capable of being removed by the
affirmative vote of 66 2/3% or greater of all classes of voting stock. These
factors may further delay or prevent a change of control.
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 periodically 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.
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ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop products in the United States and sell such products in North
America, Asia and various countries in Europe. We collect a portion of our
revenues and pay a portion of our operating expenses in foreign currencies. As a
result, our financial results could be affected by factors such as changes in
foreign currency exchange rates or weak economic conditions in foreign markets.
Currently, we do not use derivative instruments to hedge our foreign exchange
risk, although we may do so in the future. Our interest income is sensitive to
changes in the general level of U.S. interest rates, particularly since the
majority of our investments are in short-term instruments. Due to the nature of
our short-term investments, we have concluded that there is no material market
risk exposure. Therefore, no quantitative tabular disclosures are required.
ITEM 4: CONTROLS AND PROCEDURES
Based on their evaluation of our disclosure controls and procedures as of March
31, 2004, 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 March 31, 2004. There were no changes in our internal control
over financial reporting during the first quarter of 2004 that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
32
AXEDA SYSTEMS INC.
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
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. We were notified in
March 2004 that plaintiffs' counsel intends to submit the settlement agreement
to the presiding Judge for preliminary approval on June 3, 2004. 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. On March
30, 2004, IPM's motion to amend their complaint was granted. On April 13, 2004,
Axeda filed a supplement to its motion for summary judgment. On April 27, 2004,
IPM filed a supplemental opposition to our summary judgment motion. We filed a
response on May 4, 2004. The summary judgment is scheduled to be heard on May
18, 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.
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 (or digital media
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 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. 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.
33
ITEM 2: CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Not applicable.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5: OTHER INFORMATION
Not applicable.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The exhibits listed on the Exhibit Index (following the Signatures
section of this report) are included, or incorporated by reference, in
this quarterly report.
(b) The following reports were filed on Form 8-K during this period:
On February 3, 2004 the Company filed a Current Report on Form 8-K
relating to its February 3, 2004 press release announcing its
financial results for the fourth quarter and year ended December 31,
2003. Under the Form 8-K, the Company furnished, (not filed) pursuant
to Item 12, the press release entitled "Axeda Systems Inc. Reports
Fourth Quarter and Year-End Financial Results."
34
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.
May 14, 2004
Axeda Systems Inc.
/s/ Thomas J. Fogarty
-----------------
Thomas J. Fogarty
Executive Vice President and Chief Financial Officer
35
EXHIBIT INDEX Pursuant to Item 601(a)(2) of Regulation S-K, this Exhibit Index
immediately precedes the exhibits.
The following exhibits are included, or incorporated by reference, in this
Quarterly Report on Form 10-Q (and are numbered in accordance with Item 601 of
Regulation S-K): EXHIBITS
Exhibit Number Exhibit Title
- -------------- -------------
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.
36