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 June 30, 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 o No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No o
---------------------------
On August 13, 2004, 32,515,227 shares of the Registrant's Common
Stock, $0.001 par value, were outstanding.
AXEDA SYSTEMS INC.
FORM 10-Q
INDEX
Page
Part I Financial Information
Item 1 Financial Statements
Consolidated Balance Sheets as of June 30, 2004 (unaudited) and December 31, 2003 2
Consolidated Statements of Operations for the three months ended June 30, 2004 and 2003 3
(unaudited)
Consolidated Statements of Operations for the six months ended June 30, 2004 and 2003
(unaudited) 4
Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003 5
(unaudited)
Notes to the Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 15
Item 3 Quantitative and Qualitative Disclosures About Market Risk 34
Item 4 Controls and Procedures 34
Part II Other Information
Item 1 Legal Proceedings 35
Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities 36
Item 3 Defaults Upon Senior Securities 37
Item 4 Submission of Matters to a Vote of Security Holders 37
Item 5 Other Information 37
Item 6 Exhibits and Reports on Form 8-K 39
Signatures 40
Exhibit Index 41
Exhibit 10.1
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)
June 30, December 31,
2004 2003
---- ----
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 4,001 $ 9,617
Accounts receivable, net 2,901 3,200
Prepaid expenses 249 307
Other current assets 114 121
--- ---
Total current assets 7,265 13,245
Furniture and equipment, net 1,779 2,229
Goodwill 3,640 3,640
Identified intangible assets, net 1,186 1,423
Other assets 338 349
--- ---
Total assets $ 14,208 $ 20,886
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable $ 300 $ 417
Accounts payable 1,334 1,253
Accrued expenses 4,060 4,866
Income taxes payable 635 733
Deferred revenue 1,401 1,422
----- -----
Total current liabilities 7,730 8,691
Non-current liabilities:
Other non-current liabilities 850 862
Financing-related liability 1,824 2,608
----- -----
Total liabilities 10,404 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, $0.001 par value; 50,000,000 shares authorized; 33,077,237 shares
issued in 2004 and 32,913,211 shares issued in 2003 33 33
Additional paid-in capital 146,657 146,644
Deferred stock compensation (161) (310)
Accumulated deficit (141,551) (136,488)
Accumulated other comprehensive income 206 226
Treasury stock at cost, 603,800 shares in 2004 and 2003 (1,380) (1,380)
------- -------
Total stockholders' equity 3,804 8,725
----- -----
Total liabilities and stockholders' equity $ 14,208 $ 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 June 30,
---------------------------
2004 2003
---- ----
Revenues:
License $1,577 $ 2,158
Services and maintenance 1,252 570
Hardware 66 46
-- --
Total revenues 2,895 2,774
----- -----
Cost of revenues:
License 236 314
Services and maintenance 850 1,025
Hardware - 1
Software amortization 112 159
--- ---
Total cost of revenues 1,198 1,499
----- -----
Gross profit 1,697 1,275
----- -----
Research and development (R&D)
Non-cash compensation 2 28
Other R&D expense 1,031 1,407
Sales and marketing (S&M)
Non-cash compensation (2) 6
Other S&M expense 1,846 2,276
General and administrative (G&A)
Non-cash compensation 29 170
Other G&A expense 1,087 1,956
Depreciation and amortization 255 262
--- ---
Total operating expenses 4,248 6,105
----- -----
Operating loss (2,551) (4,830)
Gain on disposal of assets 110 -
Interest income (expense), net (18) 22
Other income (expense), net 45 -
-- -
Loss before provision for income taxes (2,414) (4,808)
Provision for income taxes 10 45
-- --
Net loss $ (2,424) $ (4,853)
========= =========
Basic and diluted net loss per weighted average common share
outstanding $ (0.07) $ (0.18)
======== ========
Weighted average number of common shares outstanding used in
calculation of basic and diluted net loss per common share 32,471,541 27,245,700
========== ==========
See accompanying notes to the consolidated financial statements.
3
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Six Months Ended June 30,
-------------------------
2004 2003
---- ----
Revenues:
License $3,911 $ 4,475
Services and maintenance 2,433 1,533
Hardware 86 183
-- ---
Total revenues 6,430 6,191
----- -----
Cost of revenues:
License 430 825
Services and maintenance 1,973 2,037
Hardware - 1
Software amortization 224 316
--- ---
Total cost of revenues 2,627 3,179
----- -----
Gross profit 3,803 3,012
----- -----
Research and development (R&D)
Non-cash compensation 2 56
Other R&D expense 2,122 3,121
Sales and marketing (S&M)
Non-cash compensation 43 17
Other S&M expense 3,972 4,781
General and administrative (G&A)
Non-cash compensation 59 273
Other G&A expense 2,985 4,517
Depreciation and amortization 518 570
--- ---
Total operating expenses 9,701 13,335
----- ------
Operating loss (5,898) (10,323)
Gain on disposal of assets 110 743
Interest income (expense), net (30) 53
Other income (expense), net 785 (18)
--- ----
Loss before provision for income taxes (5,033) (9,545)
Provision for income taxes 30 95
-- --
Net loss $ (5,063) $ (9,640)
========= =========
Basic and diluted net loss per weighted average common share
outstanding $ (0.16) $ (0.35)
======== ========
Weighted average number of common shares outstanding used in
calculation of basic and diluted net loss per common share 32,442,390 27,212,652
========== ==========
See accompanying notes to the consolidated financial statements.
4
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended June 30,
2004 2003
---- ----
Cash flows from operating activities:
Net loss $ (5,063) $ (9,640)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 742 886
Gain on disposals of assets (110) (729)
Unrealized gain on financing-related liability (784) -
Non-cash compensation and other expenses 104 346
Provision for doubtful accounts 7 (16)
Changes in items affecting operations:
Accounts receivable 292 222
Prepaid expenses and other current assets 65 265
Goodwill, intangible assets and other assets 11 19
Accounts payable 81 (876)
Accrued expenses (677) (1,803)
Income taxes payable (98) 102
Deferred revenue (21) (179)
---- -----
Net cash used in operating activities (5,451) (11,403)
------- --------
Cash flows from investing activities:
Capital expenditures (82) (101)
---- -----
Net cash used in investing activities (82) (101)
---- -----
Cash flows from financing activities:
Net repayment under bank line of credit (117) 367
Repayments of long-term debt and other non-current liabilities - (175)
Net proceeds from exercise of stock options 27 1
-- -
Net cash provided by (used in) financing activities (90) 193
---- ---
Effect of exchange rate changes on cash and cash equivalents 7 6
- -
Net decrease in cash and cash equivalents (5,616) (11,305)
Cash and cash equivalents:
Beginning of period 9,617 19,065
----- ------
End of period, including restricted cash of $100 in 2003 $4,001 $7,760
====== ======
See accompanying notes to the consolidated financial statements.
5
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Information with respect to June 30, 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 six months ended June 30, 2004 and 2003, our net
losses were $5,063 and $9,640, respectively, and negative cash flows from
operations were $5,451 and $11,403, respectively. There can be no assurances
that we will be able to generate sufficient revenues or positive cash flows from
operations necessary to achieve or sustain profitability in the short or long
term.
Based upon our current cash resources and revised financial projections for the
remainder of the year, we currently anticipate that our available funds and cash
flows from operations should be sufficient to meet our cash needs through
December 31, 2004. As such, we will require additional financing to fund our
operations through December 2005. We intend to obtain sufficient financing to
fund our operations, along with cash flows from operations, so that this planned
financing combined with additional restructuring efforts will allow us
sufficient cash resources to meet our cash needs through at least December 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
cannot assure you that the additional financing will be available to us on
favorable terms when required, or at all. If we raise additional funds through
the issuance of equity, equity-linked or debt securities, those securities may
have rights, preferences or privileges senior to the rights of our common stock,
and our stockholders may experience dilution.
Effective at the opening of business on August 5, 2004, listing of our common
stock was transferred to The Nasdaq SmallCap Market from The Nasdaq National
Market, and continues to trade under the symbol XEDA. The transfer follows the
decision of a Nasdaq Listing Qualifications Panel, received on August 3, 2004,
which was based primarily on our stockholders' equity being below the minimum
$10,000 shareholders' equity requirement for continued listing on The Nasdaq
National Market.
b) Basis of Presentation
The interim consolidated financial statements of Axeda for the three and six
months ended June 30, 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 June 30, 2004, the results of our operations for the three
and six months ended June 30, 2004 and 2003 and our cash flows for the six
months ended June 30, 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.
6
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.
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.
We recognize revenue for certain arrangements where products and certain
services are bundled in accordance with Emerging Issues Task Force, or EITF,
Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables," or EITF
00-21. In applying the concepts of EITF 00-21, we must determine whether the
deliverables are separable into multiple units of accounting. We allocate the
total fee on such arrangements to the individual deliverables either based on
their relative fair values or using the residual method, as circumstances
dictate. We then recognize revenue on each deliverable in accordance with our
policies for product and services revenue recognition. The application of EITF
00-21 includes judgments whether the delivered item has value to the customer on
a standalone basis and whether we have established objective and reliable
evidence of fair value for the undelivered items. Our ability to recognize
revenue in the future may be affected if actual selling prices are significantly
less than the fair values.
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, or SFAS, No. 128, "Computation of Earnings Per Share," or
SFAS 128. In accordance with SFAS 128, basic earnings per share is computed
using the weighted average number of common shares outstanding during the
period. Diluted earnings per share is computed using the weighted average number
of common and dilutive common equivalent shares outstanding during the period.
Common equivalent shares consist of the incremental common shares issuable upon
the exercise of stock options and warrants (using the treasury stock method).
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 June 30, 2004
Options to purchase 5,854,011shares of common stock with a weighted-average
exercise price of $1.43 were outstanding during the three months ended June 30,
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 3,276,450 options that are vested, with a weighted average
exercise price of $1.48, of which 1,557,222 are vested and in the money, with a
weighted average exercise price of $0.20. The options have various expiration
dates during the next ten years.
Warrants to purchase 2,683,736 shares of common stock with a weighted-average
exercise price of $1.97 were vested and outstanding during the three months
ended June 30, 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. The outstanding warrants include 8,927 warrants
that are vested and in the money, with a weighted average exercise price of
$1.03. The warrants have various expiration dates during the next five years.
7
ii) Six Months Ended June 30, 2004
Options to purchase 5,854,011 shares of common stock with a weighted-average
exercise price of $1.43 were outstanding during the six months ended June 30,
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 3,276,450 options that are vested, with a weighted average
exercise price of $1.48, of which 1,557,222 are vested and in the money, with a
weighted average exercise price of $0.20. The options have various expiration
dates during the next ten years.
Warrants to purchase 2,701,100 shares of common stock with a weighted-average
exercise price of $1.97 were vested and outstanding during the six months ended
June 30, 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. The outstanding warrants include 14,135 warrants that are vested and in
the money, with a weighted average exercise price of $1.03. The warrants have
various expiration dates during the next five years.
iii) Three Months Ended June 30, 2003
Options to purchase 4,914,669 shares of common stock with a weighted-average
exercise price of $1.77 were outstanding during the three months ended June 30,
2003 but were not included in the computation of diluted EPS because the effects
of assumed conversion or exercise would have an anti-dilutive effect on EPS. The
outstanding options include 2,503,245 options that are vested, with a weighted
average exercise price of $2.33, of which 848,327 are 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.
Warrants to purchase 567,060 shares of common stock with a weighted-average
exercise price of $2.70 were vested and outstanding during the three months
ended June 30, 2003, but were not included in the calculation of diluted EPS
because the effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding warrants include 343,919 warrants
that are vested and in the money, with a weighted average exercise price of
$0.33. The warrants have various expiration dates during the next five years.
iv) Six Months Ended June 30, 2003
Options to purchase 4,914,669 shares of common stock with a weighted-average
exercise price of $1.77 were outstanding during the six months ended June 30,
2003 but were not included in the computation of diluted EPS because the effects
of assumed conversion or exercise would have an anti-dilutive effect on EPS. The
outstanding options include 2,503,245 options that are vested, with a weighted
average exercise price of $2.33, of which 848,327 are 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.
Warrants to purchase 565,625 shares of common stock with a weighted-average
exercise price of $2.70 were vested and outstanding during the six months ended
June 30, 2003, but were not included in the calculation of diluted EPS because
the effects of assumed conversion or exercise would have an anti-dilutive effect
on EPS. The outstanding warrants include 287,967 warrants that are vested and in
the money, with a weighted average exercise price of $0.24. The warrants have
various expiration dates during the next five years.
8
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 June 30, 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 June 30, Six Months Ended June 30,
--------------------------- --------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net loss, as reported .......................................... $ (2,424) $ (4,853) $ (5,063) $ (9,640)
Add: Stock-based employee compensation
included in reported net loss, net of
related tax effects ............................................ 29 204 104 346
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards .............................. (447) (808) (883) (1,312)
-------- -------- -------- --------
Pro forma net loss ............................................. $ (2,842) $ (5,457) $ (5,842) $(10,606)
======== ======== ======== ========
Net loss per common share basic and diluted:
As reported ............................................... $ (0.07) $ (0.18) $ (0.16) $ (0.35)
======== ======== ======== ========
Pro forma ................................................. $ (0.09) $ (0.20) $ (0.18) $ (0.39)
======== ======== ======== ========
We used the following assumptions to determine the fair value of stock options
granted using the Black-Scholes option-price model:
June 30,
--------------------------------------
2004 2003
---- ----
Dividend yield 0% 0%
Expected volatility 92% - 192% 0% - 192%
Average expected option life 4 years 4 years
Risk-free interest rate 1.02% - 5.71% 1.02% - 5.73%
For the six months ended June 30, 2004, we granted 840,000 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 $1.06 to $1.28.
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.
9
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 the recoverability of goodwill and intangible
assets and valuation allowances for accounts receivable and deferred tax assets.
Actual results could differ from those estimates.
k) Recent Accounting Pronouncements
On March 31, 2004, the Financial Accounting Standards Board, or FASB, 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 APB 25 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 measurement date, which is generally 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. The FASB
began its redeliberations of this statement in July 2004, and set a goal of
completing its redeliberations and issuing a final statement in the second half
of 2004. 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 July
20, 2004 the U.S. House of Representatives approved a bill (H.R.3574) to replace
the guidance that the FASB set forth in this exposure draft. The bill stipulates
that the fair value of all options to purchase the stock of a company granted
after December 31, 2004, to a named executive officer (defined as the CEO and
the four other most highly compensated executive officers of the company) must
be expensed, but only if both the company's annual revenue and market
capitalization surpass $25,000. Voluntary expensing is permitted under the bill,
which additionally requires improved employee stock option transparency and
reporting disclosures.
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.
2) Supplemental Disclosure of Balance Sheet Information
Provision for Doubtful Accounts
Accounts receivable are net of provisions for doubtful accounts of $75
and $68 as of June 30, 2004 and December 31, 2003, respectively.
Acquired Identified Intangible Assets
Accumulated amortization at June 30, 2004 and December 31, 2003 was
$974 and $737, respectively.
3) Line of Credit
In May 2004 we renewed our 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 2005, bears interest at the prime rate plus 1% (5.25% at June
30, 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 June 30,
2004, we were in compliance with our covenants and $452 was available, with $300
outstanding under the terms of the Line.
In connection with renewing the Line, we issued a warrant to the Bank to acquire
19,342 shares of our common stock at an exercise price of $1.03 per share and
which expires in May 2009. The estimated fair value of the warrant of $16 was
recorded as debt issuance costs, and is being amortized over the one-year term
of the Line and included in interest expense.
10
At June 30, 2004 there were no letters of credit or other amounts for bank
services outstanding under the Line.
4) Accrued Expenses
Accrued expenses consist of the following:
June 30, December 31,
2004 2003
---- ----
Legal and professional fees ........................ $ 488 $ 558
Payroll and related costs .......................... 1,172 1,477
Royalties to Israeli government agencies ........... 875 759
Sales, excise and other taxes ...................... 136 266
Severance .......................................... 184 88
Unutilized leased facilities ....................... 537 547
Other .............................................. 668 1,171
------ ------
$4,060 $4,866
====== ======
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.
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 June 30, 2004
was $1,824. The change in fair value from December 31, 2003 to March 31, 2004 of
$739, and from March 31, 2004 to June 30, 2004 of $45, totaling $784 for the six
months ended June 30, 2004, was recorded as other income in the consolidated
statements 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 using the following assumptions:
June 30, 2004 December 31, 2003
--------------- ------------------
Current market price/share ............... $ 1.07 $ 1.36
Exercise price/share ..................... $ 1.71 $ 1.71
Dividend yield ........................... 0% 0%
Expected volatility ...................... 109% 115%
Expected life ............................ 4.23 years 4.73 years
Risk-free interest rate .................. 3.63% 3.13%
11
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 consisting of intellectual property, commercial, employment and
other matters, which arise in the ordinary course of business. In accordance
with SFAS 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 16%, or $464, and 25%, or $1,588, of total
revenues for the three and six months ended June 30, 2004. Three customers
accounted for 30%, or $828, and 20%, or $1,228, of total revenues for the three
and six months ended June 30, 2003, respectively.
12
We sell and license our technology to customers primarily in North America,
Europe and Asia. Our North American operations generated 44% and 34%,
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 June 30,
---------------------------
Country/ Geographic Region 2004 2003
- -------------------------- ------------------- ---------------------
Amount % of Total Amount % of Total
North America:
United States ............ $1,107 38% $ 944 34%
Canada ................... -- -- 10 --
------ ------ ------ ------
Total - North America 1,107 38 954 34
------ ------ ------ ------
Europe:
Germany .................. 175 6 174 6
France ................... 355 12 349 13
Netherlands .............. 134 5 117 4
Switzerland .............. 320 11 192 7
United Kingdom ........... 63 2 52 2
Other .................... 398 14 221 8
------ ------ ------ ------
Total - Europe ...... 1,445 50 1,105 40
------ ------ ------ ------
Asia-Pacific:
Israel ................... 131 5 39 1
Japan .................... 168 6 587 21
Other .................... 12 -- 74 3
------ ------ ------ ------
Total - Asia-Pacific 311 11 700 25
------ ------ ------ ------
Other ......................... 32 1 15 1
------ ------ ------ ------
Total ................ $2,895 100% $2,774 100%
===== ====== ====== ======
Six Months Ended June 30,
---------------------------
Country/ Geographic Region 2004 2003
- -------------------------- ------------------- ---------------------
Amount % of Total Amount % of Total
North America:
United States ............ $2,404 38% $2,179 35%
Canada ................... 9 -- 260 4
------ ------ ------ ------
Total - North America 2,413 38 2,439 39
------ ------ ------ ------
Europe:
Germany .................. 296 5 307 5
France ................... 744 12 752 12
Netherlands .............. 356 6 230 4
Switzerland .............. 616 10 405 7
United Kingdom ........... 209 3 94 2
Other .................... 748 12 506 8
------ ------ ------ ------
Total - Europe ...... 2,969 46 2,294 37
------ ------ ------ ------
Asia-Pacific:
Israel ................... 149 2 179 3
Japan .................... 794 12 1,127 18
Other .................... 47 1 85 1
------ ------ ------ ------
Total - Asia-Pacific 990 15 1,391 22
------ ------ ------ ------
Other ......................... 58 1 67 1
------ ------ ------ ------
Total ................ $6,430 100% $6,191 100%
====== ====== ====== ======
13
8) Segment Reporting
Segment information is presented in accordance with SFAS 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 June 30, Six Months Ended June 30,
--------------------------- -------------------------
2004 2003 2004 2003
------ ------ ------ ------
Revenues:
DRM ..................... $2,829 $2,728 $6,344 $5,759
Other ................... 66 46 86 432
------ ------ ------ ------
Total ........... $2,895 $2,774 $6,430 $6,191
====== ====== ====== ======
Gross profit:
DRM ................ $1,631 $1,230 $3,717 $2,830
Other .............. 66 45 86 182
------ ------ ------ ------
Total ........... $1,697 $1,275 $3,803 $3,012
====== ====== ====== ======
9) Consolidated Statements of Cash Flows
Supplemental disclosure of cash flow information:
Six Months Ended June 30,
2004 2003
---- ----
Cash paid during the period for:
Interest $ 3 $ 22
==== =====
Income taxes 99 -
== ==
10) Comprehensive Income (Loss)
The components of comprehensive loss are as follows:
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net loss ................... $(2,424) $(4,853) $(5,063) $(9,640)
Foreign currency translation
adjustment ................. (20) 42 7 6
------- ------- ------- -------
Comprehensive loss ......... $(2,444) $(4,811) $(5,056) $(9,634)
======= ======= ======= =======
14
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-Q, including the following Management's
Discussion And Analysis Of Financial Condition And Results Of Operations,
contains 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 materially and
adversely from those discussed herein. 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. Readers are referred to risks and
uncertainties identified in this "Management's Discussion And Analysis Of
Financial Condition And Results Of Operations," under "Risk Factors" and
elsewhere herein. 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 further, below.
We currently operate in three principal regions: the United States, Europe and
Japan. Total revenues increased by $0.1 million in the second quarter of 2004
compared to the second quarter of 2003. Despite the continued difficult capital
spending climate, our DRM revenues increased by $0.6 million in the first half
of 2004 compared to the same period in 2003, due to increases in our service
engagements. These net increases were driven by an accelerated acquisition of
new customer accounts, as well as additional spending by our increasing base of
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.
15
Despite the 10% growth in DRM revenues in the first half 2004 over the first
half of 2003, revenues were adversely affected by delays in the purchasing
decision of certain prospects and customers near the end of the quarter and
competition in the DRM space. This slowdown in corporate spending has been
observed industry-wide among CRM and ERP companies, and has been attributed to
concerns about job growth in the future, uncertainty in the current geopolitical
climate, and uncertainty about the outcome of the upcoming U.S. presidential
election. The Company also formally launched its hosted DRM offering during the
second quarter of 2004, and this resulted in our deferral of licensing revenue
for these customers into future periods.
For the first half of 2004 our operating expenses decreased by $3.6 million, or
27%, 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 December 31, 2004.
At June 30, 2004, our cash balance was $4.0 million compared with $9.6 million
at year-end 2003. Operating results and our liquidity position are discussed
further below.
16
Results of Operations
Three and Six Months Ended June 30, 2004 Compared to Three and Six Months Ended
June 30, 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 June 30, Six Months Ended June 30,
------------------------------------------ ------------------------------------------
2004 2003 2004 2003
-------------------- ------------------- -------------------- ----------------------
Percent of Percent of Percent of Percent of
Amount Revenues Amount Revenues Amount Revenues Amount Revenues
------ -------- ------ -------- ------ -------- ------ --------
Revenues:
License ....................... $ 1,577 54.5% $ 2,158 77.8% $ 3,911 60.8% $ 4,475 72.3%
Services and maintenance ...... 1,252 43.2 570 20.5 2,433 37.8 1,533 24.8
Hardware ...................... 66 2.3 46 1.7 86 1.3 183 2.9
-------- ----- -------- ----- -------- ------ -------- -----
Total revenues .............. 2,895 100.0 2,774 100.0 6,430 100.0 6,191 100.0
-------- ----- -------- ----- -------- ------ -------- -----
Cost of revenues:
License ....................... 236 8.1 314 11.3 430 6.7 825 13.3
Services and maintenance ...... 850 29.4 1,025 37.0 1,973 30.7 2,037 32.9
Hardware ...................... -- -- 1 -- -- -- 1 --
Software amortization ......... 112 3.9 159 5.7 224 3.5 316 5.1
-------- ----- -------- ----- -------- ------ -------- -----
Total cost of revenues ...... 1,198 41.4 1,499 54.0 2,627 40.9 3,179 51.3
-------- ----- -------- ----- -------- ------ -------- -----
Gross profit .................. 1,697 58.6 1,275 46.0 3,803 59.1 3,012 48.7
-------- ----- -------- ----- -------- ------ -------- -----
Research and development(R&D)
Non-cash compensation ........ 2 0.1 28 1.0 2 0.1 56 0.9
Other R&D expense ............ 1,031 35.6 1,407 50.7 2,122 33.0 3,121 50.4
Sales and marketing (S&M)
Non-cash compensation ........ (2) (0.1) 6 0.2 43 0.7 17 0.3
Other S&M expense ............ 1,846 63.8 2,276 82.1 3,972 61.8 4,781 77.2
General and administrative (G&A)
Non-cash compensation ........ 29 1.0 170 6.1 59 0.9 273 4.4
Other G&A expense ............ 1,087 37.6 1,956 70.5 2,985 46.4 4,517 73.0
Depreciation and amortization .... 255 8.8 262 9.5 518 8.0 570 9.2
-------- ----- -------- ----- -------- ------ -------- -----
Total operating expenses ...... 4,248 146.8 6,105 220.1 9,701 150.9 13,335 215.4
-------- ----- -------- ----- -------- ------ -------- -----
Operating loss ................ (2,551) (88.2) (4,830) (174.1) (5,898) (91.7) (10,323) (166.7)
Gain on disposal of assets ....... 110 3.8 -- -- 110 1.7 743 12.0
Interest income (expense), net and
other income (expense), net ...... 27 1.0 22 0.8 755 11.7 35 0.5
-------- ----- -------- ----- -------- ------ -------- -----
Loss before income tax ........ (2,414) (83.4) (4,808) (173.3) (5,033) (78.3) (9,545) (154.2)
Provision for income taxes ....... 10 0.3 45 1.6 30 0.5 95 1.5
-------- ----- -------- ----- -------- ------ -------- -----
Net loss ...................... $ (2,424) (83.7)% $ (4,853) (174.9)% (5,063) (78.8)% $(9,640) (155.7)%
======== ===== ======== ===== ======== ====== ======== =====
17
Results of Operations
REVENUES. Overall revenues increased by $0.1 million or 4% and $0.2 million or
4%, to $2.9 million and $6.4 million, during the three and six months ended June
30, 2004, respectively, compared to the same periods in 2003. Sales of our DRM
solutions increased $0.1 million or 4% and $0.6 million or 10%, while hardware
sales were relatively flat and decreased $0.1 million during the three and six
months ended June 30, 2004, respectively.
License revenues for the three and six months ended June 30, 2004 decreased by
approximately $0.6 million in each period, compared to the same periods in 2003.
The decrease in license revenues for the three months and six months ended June
30, 2004 was due to reduced sales from our Japanese and U.S. subsidiaries of
$0.5 million and $0.1 million respectively, compared to the same periods in
2003. For the balance of 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 to $0.1 million for the six months ended June 30, 2004, from $0.2
million for the six months ended June 30, 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 $0.7 million and $0.9 million, or
120% and 59%, for the three and six months ended June 30, 2004, respectively,
compared to the same periods in 2003. The increases over the three and six-month
periods, in comparison to the same periods in 2003, are due to a significant
increase in demand for professional services in connection with existing DRM
installations, as well as additional maintenance plans sold with new DRM
systems. We anticipate services and maintenance revenues will vary, as work in
this area is subject to our customers' requirement and approval process.
Historically, the majority of our revenues have been derived from a small number
of customers. However, since entering the enterprise software market, our
revenues are becoming less concentrated. For the three and six month periods
ended June 30, 2004, our top three customers accounted for $0.5 million, or 16%,
and $1.6 million or 25% of our total revenues, respectively. For the three and
six month periods ended June 30, 2003, our top three customers accounted for
$0.8 million, or 29%, and $1.2 million, or 20%, of our total revenues,
respectively. In the future, we expect our revenues to be less concentrated as
sales of our software and services span a wider customer base. There has also
been a shift in industry-wide buying patterns for enterprise software, from
large up-front purchases to smaller, more frequent purchases over time. Finally,
the introduction of our hosted offering is also expected to reduce revenue
concentration in the future.
We sell our DRM system solutions primarily to companies in the industrial and
building automation, high technology devices, medical instrumentation, and
office automation industries. In the quarter ended June 30, 2004, customers
based in North America accounted for 38% of our revenues. We anticipate that
revenues from international operations will continue to represent a significant
portion of our revenues.
COST OF REVENUES. Cost of revenues decreased by $0.3 million and $0.6 million,
or 20% and 17%, respectively, to $1.2 million and $2.6 million for the three and
six months ended June 30, 2004, respectively, compared to the same periods in
2003.
Cost of revenues for license fees for the three and six months ended June 30,
2004 decreased by approximately $0.1 million and $0.4 million, respectively,
compared to the same periods in 2003. While the $0.1 million decrease in cost of
license revenues for the quarter ended June 30, 2004 is due to reduced
production costs in our overseas locations, the $0.4 million decrease for the
six months ended June 30, 2004, is due to decreased license fees associated with
our discontinued PC products of $0.2 million, and a decrease in DRM costs of
$0.2 million, resulting from the closure of our Israeli operations during the
first quarter of 2003 and decreased product and packaging costs, as a result of
our ongoing cost management initiatives. We expect our cost of license fees as a
percentage of license revenues to decline, as our license revenues are now
comprised entirely of our DRM products.
Cost of revenues for services and maintenance decreased by $0.2 million and $0.1
million for the three and six months ending June 30, 2004, respectively,
compared to the same periods in 2003. The $0.2 million decrease in cost of
services and maintenance for the three months ended June 30, 2004 is due to a
$0.1 million decrease in travel expense and a $0.1 million decrease in severance
expense compared to the prior year. We expect our cost of services and
maintenance as a percentage of services and maintenance revenues to decline, to
reflect cost savings from our restructuring activities, but may vary as our
services revenues change.
18
Software amortization of our developed and core technologies for the three and
six months ending June 30, 2004 decreased less than $0.1 million and $0.1
million, respectively, compared to the same periods in 2003, due to the full
amortization of certain identified intangibles. Non-cash amortization of
acquired technology will represent approximately $0.5 million of our cost of
revenues for the year ending December 31, 2004.
GROSS PROFIT. Gross profit increased $0.4 million and $0.8 million, or 33% and
26%, to $1.7 million and $3.8 million for the three and six months ended June
30, 2004, respectively, compared to the same periods in 2003. The increase in
gross profit is attributable to an increase in services and maintenance revenues
due to increased capacity utilization, the closure of our Israeli operations and
reduced software amortization expense.
For the three and six month periods ended June 30, 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 46% to 59%
for the quarters ended June 30, 2003 and June 30, 2004, respectively and 49% to
59% for the six months ended June 30, 2003 and June 30, 2004, respectively. The
overall improvement in gross profit margin is directly due to our services and
maintenance operations, which experienced positive margins for the six months
ended June 30, 2004 versus negative margins in 2003. These improvements were
accomplished by significantly increasing the number of billable consulting
engagements, while simultaneously decreasing the cost of operations through
better capacity utilization.
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, quality assurance and testing.
R&D expenses decreased $0.4 million and $1.0 million, or 27% and 32%, to $1.0
million and $2.1 million for the three and six months ending June 30, 2004,
respectively, compared to the same periods in 2003.
The decrease in other R&D expense during the quarter ended June 30, 2004 from
the prior year was due to decreases in staff and staff related expense of $0.2
million, severance expense of $0.1 million and $0.1 million of other expense.
The decrease in other R&D expense for the six months ended June 30, 2004 was due
to decreases in staff and staff related expense of $0.5 million, lower expenses
associated with the closure of our Israeli operations and severance totaling
$0.3 million and $0.2 million of other expense. As a percentage of revenues,
other R&D expenses decreased from 51% to 36%, and 50% to 33% for the three and
six months ended June 30, 2004, compared to the same periods in 2003. 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 if and as our future
revenues increase.
OTHER SALES AND MARKETING ("S&M") EXPENSE. Other S&M expense consists of
salaries, travel expenses and costs associated with trade shows, advertising and
other sales and marketing efforts, as well as technical support costs. Other S&M
expense decreased approximately $0.4 million and $0.8 million, or 19% and 17%,
to $1.8 million and $4.0 million for the three and six months ended June 30,
2004, respectively, compared to the same periods in 2003.
Reduced severance, staff and staff related expense, and travel expense
contributed $0.2 million, $0.1 million and $0.1 million to the decrease in other
S&M expense during the quarter ended June 30, 2004 from the prior year. Reduced
severance, staff and staff related expense, and travel expense contributed $0.2
million, $0.4 million and $0.2 million to the decrease in other S&M expense for
the six months ended June 30, 2004 from the prior year. As a percentage of
revenues, other S&M expense decreased from 82% to 64%, and 77% to 62%,
respectively, for the three and six months ended June 30, 2004, compared to the
same periods in 2003. 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 if and 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 finance, human resources, legal
and other management departments. Other G&A expenses decreased $0.9 million and
$1.5 million, or 44% and 34%, to $1.1 million and $3.0 million for the three and
six months ended June 30, 2004, respectively, compared to the same periods in
2003. As a percentage of total revenues, other general and administrative
expenses decreased from 71% to 38%, and 73% to 46% of total revenues for the
three and six months ended June 30, 2004.
19
The $0.9 million decrease in other G&A expense for the quarter ended June 30,
2004 relates to the reversal of estimated patent and intellectual property
accruals of $0.4 million no longer considered necessary, reduced severance
expense of $0.2 million, reduced insurance expense of $0.1 million, and
decreases in other expense of $0.2 million from the prior year. The $1.5 million
decrease in other G&A expense for the six months ended June 30, 2004 relates to
the reversal of estimated patent and intellectual property accruals of $0.4
million no longer considered necessary and reduced severance expense of $0.4
million. In addition, we reduced staff and related compensation expense by $0.2
million, reduced insurance expense by $0.2 million and reduced other and
professional fees totaling $0.3 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 if and 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 G&A expense decreased $0.1
million and $0.2 million for the quarter and six months ended June 30, 2004,
respectively, from $0.2 million and $0.3 million for the quarter and six months
ended June 30, 2003, respectively. The decrease is attributable to certain
deferred compensation having become fully amortized as a result of the related
stock option awards having fully vested.
DEPRECIATION AND AMORTIZATION. We recorded depreciation and amortization of $0.3
million the three months ended June 30, 2004 and June 30, 2003, respectively,
and depreciation and amortization of $0.5 million and $0.6 million for the six
months ended June 30, 2004 and June 30, 2003.
GAIN ON DISPOSAL OF ASSETS. During the quarter ended June 30, 2004 we determined
that a $0.1 million accrual recorded in connection with the sale of the assets
of our former consumer electronics business in March 2001 was no longer
considered necessary and thus was reversed. 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 six months ended
June 30, 2004.
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 Issue No. 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 three and six month periods
ended June 30, 2004 was less than $0.1 million and $0.8 million, respectively.
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 three and six months ended June 30, 2004 increased revenues and expenses
by $0.1 million and $0.4 million, respectively, 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 loss for 2004.
20
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 June 30, 2004, we had $4.0 million in cash
and cash equivalents.
Net cash used in operating activities for the six months ended June 30, 2004 was
$5.5 million, compared to $11.4 million for the six months ended June 30, 2003.
Cash used in operating activities for the first six months of 2004 was primarily
the result of our net loss of $5.1 million, and other changes in working capital
of approximately $0.5 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 continue to evaluate our cost
structure and in the third quarter, are taking additional measures to reduce
expenses and anticipate recording $1.0 million to $1.5 million in restructuring
charges to reduce staffing levels, terminate certain leases and further
consolidate our operations.
Net cash used in investing activities for the six months ended June 30, 2004 and
2003 was $0.1 million, 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 $0.1 million for the six months ended
June 30, 2004, and consisted of principal payments reducing indebtedness. Net
cash provided by financing activities was $0.2 million for the six months ended
June 30, 2003, and was attributable to borrowings against our line of credit.
In June 2003 we executed a loan and security agreement with Silicon Valley Bank,
that provided 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). In May 2004 we renewed the Line under
substantially the same terms as the prior agreement. As of June 30, 2004, we had
$0.3 million in borrowings under the Line, which were repaid in July 2004. As of
June 30, 2004, we were in compliance with all of our covenants under the Line.
In June 2004 we amended a Software License Agreement, or the Agreement, with a
vendor who provide server and client software that is bundled with our DRM
enterprise server products. License fees are due and payable at the rate of 2.5%
of each billable sale, as defined. Under the Agreement, we agreed to pay an
additional minimum, non-refundable prepaid license fee of $200,000, which is
payable in installments. We paid $100,000 in July 2004, and are required to pay
the remaining $100,000 on December 20, 2004.
As of June 30, 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 upon our current cash resources and revised financial projections for the
remainder of the year we currently anticipate that our available funds and cash
flows from operations should be sufficient to meet our cash needs through
December 31, 2004. As such, we will require additional financing to fund our
operations through December 2005. We intend to obtain sufficient financing to
fund our operations, along with cash flows from operations, so that this planned
financing combined with additional restructuring efforts will allow us
sufficient cash resources to meet our cash needs through at least December 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
cannot assure you that the additional financing will be available to us on
favorable terms when required, or at all. If we raise additional funds through
the issuance of equity, equity-linked or debt securities, those securities may
have rights, preferences or privileges senior to the rights of our common stock,
and our stockholders may experience dilution. See also "Factors That May Affect
Future Results," below.
21
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
included the 1995 Stock Option Plan, or the 1995 Plan, from which we no longer
grant options. During the quarter ended June 30, 2004, all of the remaining
outstanding options under the 1995 Plan expired and were canceled in accordance
with the design and procedures of the 1995 Plan. 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.
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 six
months ended June 30, 2004 and the year ended December 31, 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."
Six Months Ended June Year Ended December 31,
30, 2004 2003
-------- ----
Net grants during the period as % of outstanding shares ......... 2.59% 4.11%
Grants to Named Executive Officers during the period as % of
total options granted ........................................... 14.29% 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 ............................................. 37.08% 34.98%
22
General Option Information
The following table sets forth the summary of activity under the Plans
for the six months ended June 30, 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 ................... (840,000) 840,000 1.18
Exercises ................ -- (102,586) 0.26
Cancellations* ........... 571,230 (604,044) 4.38
Additional shares reserved 969,282 N/A N/A
---------- -----
June 30, 2004 ............ 1,221,838 5,854,011 $ 1.43
========== =====
* The "Number of Shares Available for Options" does not include options under
assumed plans exercisable for 114,631 shares and 32,814 shares that were
cancelled during 2003 and the first six months of 2004, respectively, as no
options will be granted in the future pursuant to these assumed plans.
The following table sets forth a comparison, as of June 30, 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 June 30, 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
------------------------------ --------------------------- ------------------------------
Number of Weighted Average Number of Weighted Average Number of Weighted Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
---------- --------------- ---------- ---------------- ----------- --------------
In-the-money 1,507,000 $ 0.17 595,936 $ 0.55 2,102,936 $ 0.28
Out-of-the-money (1) 1,769,450 $ 2.60 1,981,625 $ 1.62 3,751,075 $ 2.08
--------- --------- ---------
Total options outstanding 3,276,450 $ 1.48 2,577,561 $ 1.38 5,854,011 $ 1.43
========= ========= =========
(1) Out-of-the-money options are those options with an exercise price equal to
or above the closing price of $1.07 as of June 30, 2004, as reported by the
Nasdaq National Market.
23
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 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 14.29% $ 1.17 3/23/2014 $99,732 $260,178
*Based on a total of 840,000 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 six months ended June 30, 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 June 30,
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 June 30, 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 - $ - 660,828 220,172 $356,149 $ 58,711
Dale E. Calder - - 531,249 43,751 337,999 28,001
Thomas J. Fogarty - - 367,498 182,502 258,499 28,001
* Option values based on stock price of $1.07 on June 30, 2004.
24
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 June 30, 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) 5,854,011 $ 1.43 1,221,838
--------- ====== =========
(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.
25
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 $(5.1) million for the six
months ended June 30, 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 COMMON STOCK RECENTLY BEGAN TRADING ON THE NASDAQ SMALLCAP MARKET AND WE
MUST COMPLY WITH CERTAIN LISTING STANDARDS TO MAINTAIN OUR LISTING ON THE NASDAQ
SMALLCAP MARKET; OUR SWITCH TO THE NASDAQ SMALLCAP MARKET COULD HAVE A NEGATIVE
EFFECT ON THE TRADING PRICE AND LIQUIDITY OF OUR COMMON STOCK
On August 5, 2004 our common stock began trading on The Nasdaq SmallCap Market.
Although Nasdaq has indicated that we currently meet the requirements for
listing on The Nasdaq SmallCap Market (other than the $1.00 minimum bid price),
there can be no assurance that we will be able to remain in compliance with all
requirements for continued listing on The Nasdaq SmallCap Market, including the
requirement that the minimum bid price of our common stock not be below $1.00
for 30 consecutive business days (followed by a grace period of up to one year
to regain compliance if other core listing standards, other than minimum bid
price, are met). In addition, the transfer of our common stock to The Nasdaq
SmallCap Market could have a negative effect on the trading price or the
liquidity of our common stock. If we were not able to maintain our listing on
The Nasdaq SmallCap Market, we would likely apply for listing on the OTC
Bulletin Board or another quotation system or exchange for which we could
qualify. We cannot guarantee, however, that if we were unable to maintain our
listing on The Nasdaq SmallCap Market, that we would be eligible for listing on
the OTC Bulletin Board or another quotation system or exchange, or, that if we
do become listed, that there would be no interruption in the trading of our
common stock or that we would be able to maintain eligibility.
WE WILL REQUIRE ADDITIONAL FUNDING TO CONTINUE OUR OPERATIONS AS CURRENTLY
PLANNED BEYOND DECEMBER 31, 2004 AND IT MAY BE DIFFICULT TO RAISE NEEDED CAPITAL
IN THE FUTURE, WHICH COULD SIGNIFICANTLY HARM OUR BUSINESS
Based upon our current cash resources and our revised financial projections for
the remainder of the year we currently anticipate that our available funds and
cash flows from operations will be sufficient to meet our cash needs through
December 31, 2004. 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.
26
In order to continue our planned operations beyond approximately December 31,
2004, we will be required to seek additional funds through equity, equity-linked
or debt financing, strategic alliances with corporate partners and others, or
through other sources or strategic transactions. We intend to obtain sufficient
financing to fund our operations, along with cash flows from operations, through
December 2005. There can be no assurance that the financial sources described
above will be available when needed or on terms commercially acceptable to us or
at all. In addition, our common stock is now listed on The Nasdaq SmallCap
Market and under certain Federal and state securities laws, equity financings we
may enter into in the future may be subject to additional state securities laws
and regulations which we were exempt from when we were listed on The Nasdaq
National Market. Such additional laws and regulations could impede or restrict
our ability to raise additional funds from equity financings. If adequate funds
are not available when needed, we will likely 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.
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 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. Also, due to our present financial condition, customers and current and
potential partners may decide not to conduct business with us or may reduce or
terminate the business they conduct with us. 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.
27
OUR SALES CYCLE FOR DRM SYSTEMS IS LONG AND MAY BE SEASONAL AND WE MAY RELY ON
LARGE CONTRACTS FROM RELATIVELY FEW DRM CUSTOMERS, WHICH MAY CAUSE OUR OPERATING
RESULTS TO FLUCTUATE
Our sales cycle is lengthy and may be subject to seasonality. Our DRM Systems
sales typically involve significant capital investment decisions by prospective
customers, as well as a significant amount of time to educate them as to the
benefits of our products. As a result, before purchasing our products, companies
spend a substantial amount of time performing internal reviews and obtaining
capital expenditure approvals. It may take up to nine to twelve months or more
from the time we first contact a prospective customer before receiving an
initial order. The length of our DRM Systems sales cycle may also depend on a
number of additional factors, including but not limited to the following:
o the complexities of the problems our solutions address;
o the breadth of the solution required by the customer, including the
technical, organizational and geographic scope of the license;
o the sales channel through which the solution is sold;
o the economic conditions in the United States and abroad; and
o any other delays arising from factors beyond our control.
Furthermore, our software license revenues may result from a relatively small
number of sales, some of which may generate disproportionately large revenues.
VARIATIONS IN THE LENGTH OF OUR SALES CYCLES COULD CAUSE OUR REVENUE TO
FLUCTUATE WIDELY FROM PERIOD TO PERIOD
Because we have typically recognized a substantial portion of our software
revenue in the last month of a quarter, any delay in the license of our products
could cause significant variations in our revenue from quarter to quarter. These
fluctuations could cause our operating results to suffer in some future periods
because our operating expenses are relatively fixed over the short term and we
devote significant time and resources to prospective clients.
A VARIATION IN THE CONVERSION OF OUR REVENUE PIPELINE TO CONTRACTS COULD
ADVERSELY AFFECT OUR REVENUES AND ABILITY TO FORECAST OPERATIONS
Our revenue pipeline estimates may not consistently correlate to actual revenues
in a particular quarter or over a longer period of time. There has been a shift
in industry-wide buying patterns for enterprise software, from large up-front
purchases to smaller, more frequent purchases over time. A variation in the
revenue pipeline or in the conversion of the revenue pipeline into contracts
could cause us to plan or budget inaccurately and thereby could adversely affect
our business, financial condition or results of operations.
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 HAVE UNDERTAKEN A NUMBER OF MEASURES TO REDUCE OUR OPERATING EXPENSES AND
THESE AND OTHER EXPENSE REDUCTION MEASURES MAY HAVE NEGATIVE CONSEQUENCES
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, including reducing our number of global offices
by 50%, reduced staffing levels by 46%, eliminating or not replacing 96
employees, engaging partners to provide us with variable staffing capabilities
to meet peak demand periods and by closely monitoring our infrastructure costs.
Although it is not possible to anticipate all potential effects the
implementation of these expense control measures will have on us or our
development, these activities have and could continue to have a negative effect
on our business and operations. The extent and ramifications of these measures
will be dependent upon our ability to raise additional financing, the timing of
the receipt of financing and the amount of such financing, if any. We continue
to evaluate our cost structure and in the third quarter of 2004, are taking
additional measures to reduce expenses for the third quarter and beyond.
28
WE ARE DEPENDENT UPON OUR KEY MANAGEMENT FOR OUR FUTURE SUCCESS, AND FEW OF OUR
KEY PERSONNEL ARE OBLIGATED TO STAY WITH US
Our success depends on the efforts and abilities of our senior management and
certain other key personnel. Many of our key employees are employed at will. Our
business could be harmed if any of these or other key employees left or was
seriously injured and unable to work and we were unable to find a qualified
replacement.
OUR FUTURE GROWTH WILL BE LIMITED IF WE ARE UNABLE TO EXPAND OUR INDIRECT
DISTRIBUTION SALES CHANNELS
We currently have relationships with only a limited number of indirect
distribution channels, consisting of relationships with independent software
vendors, software distributors and system integrators. Nevertheless, we have
derived, and we anticipate that we will continue to derive, a significant
portion of our revenues from these relationships.
Our future growth will be limited if:
o we fail to work effectively with indirect distribution channels;
o we fail to increase the number of indirect distribution channels with
which we have relationships;
o the business of one or more of our indirect distribution channels fails;
or
o there is a decrease in the willingness and ability of our indirect
distribution channels to devote sufficient resources and efforts to
marketing and supporting our products.
If any of these circumstances occurs, we will have to devote substantially more
resources to the sales, marketing, distribution, implementation and support of
our products than we otherwise would, and our own efforts may not be as
effective as those of our indirect distribution channels.
INCREASED SALES THROUGH INDIRECT CHANNELS MAY ADVERSELY AFFECT OUR OPERATING
PERFORMANCE
Even if our marketing efforts through indirect channels are successful and
result in increased sales, our average selling prices and operating margins
could be adversely affected because of the lower unit prices that we receive
when selling through indirect channels.
WE MAY DEPEND ON OUR STRATEGIC PARTNERS AND OTHER THIRD PARTIES FOR SALES AND
IMPLEMENTATION OF OUR PRODUCTS. IF WE FAIL TO DERIVE BENEFITS FROM OUR EXISTING
AND FUTURE STRATEGIC RELATIONSHIPS, OUR BUSINESS WILL SUFFER
From time to time, we have collaborated with other companies in areas such as
marketing, distribution or implementation. Maintaining these and other
relationships is a meaningful part of our business strategy. However, some of
our current and potential strategic partners are either actual or potential
competitors, which may impair the viability of these relationships. In addition,
some of our relationships have failed to meet expectations and may fail to meet
expectations in the future. A failure by us to maintain existing strategic
relationships or enter into successful new strategic relationships in the future
could seriously harm our business, operating results and financial condition.
OUR BUSINESS MODEL DEPENDS UPON LICENSING OUR INTELLECTUAL PROPERTY, AND IF WE
FAIL TO OR ARE UNABLE 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. Our present financial condition may
make it more difficult for us to fully enforce 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 one United States Patent and
eleven United States patent applications pending relating to our DRM business
and ten 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 patent, 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:
29
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, such as the complaint we filed on June 30, 2004 against one of our
competitors for infringement of our recently issued patent entitled "Reporting
the State of an Apparatus to a Remote Computer," are likely be expensive to
resolve and may not be successful, and will require management's time and
resources and, therefore, could harm our business.
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS AND REDUCED SALES BECAUSE OF
DEFECTS IN OUR PRODUCTS
Our products are very complex and may contain undetected errors that could harm
our reputation, result in product liability or decrease market acceptance of our
products. The likelihood of errors is higher when a new product is introduced or
when new versions or enhancements are released. Our products are integrated with
our customers' networks and software applications. Errors may also arise as a
result of defects in the products and systems into which our products are
incorporated. We are unable to test our products in each of the applications in
which they are designed to work. It is possible that defects could cause our
customers to experience device or application failures. We have an extensive
quality assurance process in place and procedures to handle customer complaints
and deliver bug fixes. Despite our quality assurance process and that of our
customers, defects and errors may be found in new products or in new versions or
enhancements of existing products after commercial shipment has begun. We may be
required to devote significant financial resources and personnel to correct any
defects. Known or unknown errors or defects that affect the operation of our
products could result in the following, any of which could harm our business:
o delay or loss of revenues;
o it is foreseeable that a customer could cancel a contract due to defects;
o diversion of development resources;
o increased product development costs;
o damage to our reputation;
o delay or diminish market acceptance of our products;
o increased service and warranty costs; and
o litigation costs.
Although some of our licenses with customers contain provisions designed to
limit our exposure to potential product liability claims these contractual
limitations on liability may not be enforceable. In addition, our product
liability insurance may not be adequate to cover our losses in the event of a
product liability claim resulting from defects in our products and may not be
available to us in the future.
30
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.
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.
31
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
numerous countries outside of the United States, including Japan, France,
Switzerland, Germany, the Netherlands, Germany and other countries in Europe,
Asia and Latin America. Our operations outside the United States include
facilities located in France and Japan. For both the three and six months ended
June 30, 2004, we derived approximately 62% 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.
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 June 30, 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.
32
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
June 30, 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 June 30, 2004, our executive officers, directors and entities affiliated
with them, in the aggregate, beneficially owned approximately 4.1 million
shares, or approximately 13%, of our outstanding common stock. These
stockholders, if acting together, would be able to significantly influence all
matters requiring approval by our stockholders, including the election of
directors, the approval of mergers or other business combination transactions or
a sale of all or substantially all of our assets.
CERTAIN PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BY-LAWS MAKE CHANGES
OF CONTROL DIFFICULT EVEN IF THEY WOULD BE BENEFICIAL TO OUR STOCKHOLDERS
The board of directors has the authority without any further vote or action on
the part of our stockholders to issue up to 5 million shares of preferred stock
and to determine the price, rights, preferences, privileges and restrictions of
the preferred stock. This preferred stock, if it is ever issued, may have
preference over and harm the rights of the holders of our common stock. Although
the issuance of this preferred stock will provide us with flexibility in
connection with possible acquisitions and other corporate purposes, this
issuance may make it more difficult for a third party to acquire a majority of
our outstanding voting stock. We currently have no plans to issue preferred
stock.
Our certificate of incorporation and by-laws include provisions that may have
the effect of deterring an unsolicited offer to purchase our stock. These
provisions, coupled with the provisions of the Delaware General Corporation Law,
may delay or impede a merger, tender offer or proxy contest involving us.
Furthermore, our board of directors is divided into three classes, only one of
which is elected each year. Directors are only capable of being removed by the
affirmative vote of 66 2/3% or greater of all classes of voting stock. These
factors may further delay or prevent a change of control.
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.
33
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
As of the end of the quarter ended June 30, 2004, under the supervision and with
the participation of our management, including our chief executive officer and
chief financial officer, we conducted an evaluation of the effectiveness of the
design and operation of our disclosure controls and procedures, as such term is
defined in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities
Exchange Act of 1934, as amended. Based on that evaluation, our chief executive
officer and chief financial officer concluded that our disclosure controls and
procedures were effective as of June 30, 2004 to ensure that information we are
required to disclose in reports that we file or submit under the Securities
Exchange Act of 1934 is (i) recorded, processed, summarized and reported within
the time periods specified in Securities and Exchange Commission rules and
forms, and (ii) accumulated and communicated to our management, including our
chief executive officer and chief financial officer, as appropriate to allow
timely decisions regarding required disclosure.
34
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
SECURITIES CLASS ACTION
Between February and April 2000, eleven class action lawsuits were filed against
us and certain of our officers and directors in the United States District Court
for the Eastern District of Pennsylvania. On May 25, 2000, the cases were
consolidated under Civil Action No. 00-CV-1014, and entitled "In re RAVISENT
Technologies, Inc. Securities Litigation." Pursuant to the court's consolidation
order, a consolidated and amended class action complaint was filed on June 14,
2000 with an alleged class period of July 15, 1999 through April 27, 2000. This
complaint alleges violations of the federal securities laws, specifically
Sections 11 and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder. On
July 3, 2000, we and the other defendants filed a motion to dismiss the
consolidated and amended class action complaint. On July 13, 2004, the Court
denied the motion and the discovery stay has been lifted. We will answer the
consolidated and amended class action complaint in September 2004 and the case
is now in discovery. No trial date has been set.
SECURITIES ALLOCATION CLASS ACTION
On November 27, 2001, a putative shareholder class action was filed against us,
certain of our officers and directors (the "Individual Defendants"), 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. A Consolidated Amended Complaint, which is
now the operative complaint, was filed on April 19, 2002.
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. The action seeks damages in an
unspecified amount.
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. The Company
has approved a settlement agreement and related agreements which set forth the
terms of a settlement between the Company, the Individual Defendants, the
plaintiff class and the vast majority of the other approximately 300 issuer
defendants and the individual defendants currently or formerly associated with
those companies. Among other provisions, the settlement provides for a release
of the Company and the individual defendants for the conduct alleged in the
action to be wrongful. The Company would agree to undertake certain
responsibilities, including agreeing to assign away, not assert, or release
certain potential claims the Company may have against its underwriters. It is
anticipated that any potential financial obligation of the Company to plaintiffs
pursuant to the terms of the settlement agreement and related agreements will be
covered by existing insurance. The settlement agreement has not yet been
executed. The agreement will be subject to approval by the court, which cannot
be assured. A motion for preliminary approval by the court of the proposed
settlement was filed on June 25, 2004. On July 14, 2004, the underwriter
defendants filed a memorandum in Opposition to Plaintiffs' Motion for
Preliminary Approval of Settlement with Defendant Issuers' and Individuals.
Plaintiffs and issuer defendants filed replies on August 4, 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.
The Company cannot predict whether or when a settlement will occur or be
finalized and are unable at this time to determine whether the outcome of the
litigation will have a material impact on its results of operations or financial
condition in any future period. However, failure to successfully defend this
action could harm our results of operations, liquidity and financial condition.
35
IPM
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 was granted, and which withdrew
their fraud complaint and modified 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 and our motion for summary judgment was heard on
May 18, 2004.
On June 22, 2004, the court issued an order granting our motion for summary
judgment and dismissing IPM's claims against us. IPM filed a Motion for Entry
and Certification of Final Judgment on August 2, 2004 so as to permit an appeal
of the summary judgment ruling before trial on Axeda's counterclaim. The motion
is scheduled to be heard on September 7, 2004. A case settlement hearing on our
counterclaim is also scheduled for September 2004.
QUESTRA
On June 30, 2004, we announced that we were awarded a patent by the United
States Patent and Trademark Office for a key element of our
Firewall-Friendly(TM) method of communication over the Internet. Our U.S. patent
(#6,757,714) is titled "Reporting The State Of An Apparatus To A Remote
Computer." The patent protects one of our inventions relating to enabling remote
"devices" -- machines, appliances, instruments, and computers -- to securely
communicate their health and status to enterprise computer systems. On June 30,
2004, we filed a complaint in U.S Federal District Court in Massachusetts
against Questra Corporation, one of our competitors, for infringement of this
patent. We have one hundred and twenty days to serve the complaint from the date
of filing.
OTHER
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.
ITEM 2: CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
(c) Recent sales of unregistered securities
On May 13, 2004, we issued a warrant to purchase 19,342 shares of our
common stock to Silicon Valley Bank, with an exercise price of $1.03
and expiring in May 2009, in connection with the modification of the
2003 loan and security agreement with Silicon Valley Bank. The warrant
was issued in a private placement exempt from registration under the
Securities Act of 1933 pursuant to Section 4(2) of the Act.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
36
ITEM 5: OTHER INFORMATION
(b) Adoption of Procedures by which Stockholders may Recommend Nominees to Our
Board of Directors
Stockholder Nominees
In August 2004, our Board of Directors formed a Nominating and
Governance Committee and adopted procedures by which our stockholders may
recommend nominees to our Board of Directors. The policy of the Nominating and
Governance Committee is to consider properly submitted stockholder nominations
for candidates for membership on the Board as described below under "Identifying
and Evaluating Nominees for Directors." In evaluating such nominations, the
Nominating and Governance Committee seeks to achieve a balance of knowledge,
experience and capability on the Board and to address the membership criteria
set forth under "Director Qualifications."
The Nominating and Governance Committee will consider suggestions of
nominees from stockholders. Stockholders may recommend individuals for
consideration by submitting the materials set forth below to the Company
addressed to the Chairman of the Nominating and Governance Committee at the
Company's address. To be timely, the written materials must be submitted within
the time permitted for submission of a stockholder proposal for inclusion in the
Company's proxy statement for the subject annual meeting.
The written materials must include: (1) all information to relating the
individual recommended that is required to be disclosed pursuant to Regulation
14A under the Securities Exchange Act of 1934 (including such person's written
consent to being named in the proxy statement as a nominee and to serving as a
director if elected); (2) the name(s) and address(es) of the stockholders making
the nomination and the amount of the Company's securities which are owned
beneficially and of record by such Stockholder(s); (3) appropriate biographical
information (including a business address and a telephone number) and a
statement as to the individual's qualifications, with a focus on the criteria
described below; (4) a representation that the stockholder of record is a holder
of record of stock of the Company entitled to vote on the date of submission of
such written materials and (5) any material interest of the stockholder in the
nomination.
Any stockholder nominations proposed for consideration by the
Nominating and Governance Committee should be addressed to:
Chairman of the Nominating and Corporate Governance Committee
Axeda Systems Inc.
21 Oxford Road
Mansfield, MA 02048
Director Qualifications
The Nominating and Governance Committee has established the following
minimum criteria for evaluating prospective board candidates:
o Reputation for integrity, strong moral character and adherence to high
ethical standards.
o Holds or has held a generally recognized position of leadership in the
community and/or chosen field of endeavor, and has demonstrated high levels
of accomplishment.
o Demonstrated business acumen and experience, and ability to exercise
sound business judgments and common sense in matters that relate to the
current and long-term objectives of the Company.
o Ability to read and understand basic financial statements and other
financial information pertaining to the Company.
o Commitment to understand the Company and its business, industry and
strategic objectives.
o Commitment and ability to regularly attend and participate in meetings of
the Board of Directors, Board Committees and stockholders, number of other
company Boards on which the candidate serves and ability to generally
fulfill all responsibilities as a director of the Company.
o Willingness to represent and act in the interests of all stockholders of
the Company rather than the interests of a particular group.
o Good health, and ability to serve.
o For prospective non-employee directors, independence under SEC and
applicable stock exchange rules, and the absence of any conflict of
interest (whether due to a business or personal relationship) or legal
impediment to, or restriction on, the nominee serving as a director.
o Willingness to accept the nomination to serve as a director of the
Company.
37
Other Factors for Potential Consideration
The Nominating and Governance Committee will also consider the
following factors in connection with its evaluation of each prospective nominee:
o Whether the prospective nominee will foster a diversity of skills and
experiences.
o For potential Audit Committee members, whether the nominee possesses the
requisite education, training and experience to qualify as "financially
literate" or as an audit committee "financial expert" under applicable SEC
and stock exchange rules.
o For incumbent directors standing for re-election, the Nominating and
Governance Committee will assess the incumbent director's performance
during his or her term, including the number of meetings attended, level of
participation, and overall contribution to the Company.
o Composition of Board and whether the prospective nominee will add to or
complement the Board's existing strengths
Identifying and Evaluating Nominees for Directors
The Nominating and Governance Committee initiates the process by
preparing a slate of potential candidates who, based on their biographical
information and other information available to the Nominating and Corporate
Governance Committee, appear to meet the criteria specified above and/or who
have specific qualities, skills or experience being sought (based on input from
the full Board).
o Outside Advisors. The Nominating and Governance Committee may engage a
third-party search firm or other advisors to assist in identifying
prospective nominees.
o Nomination of Incumbent Directors. The re-nomination of existing
directors should not be viewed as automatic, but should be based on
continuing qualification under the criteria set forth above.
o For incumbent directors standing for re-election, the Nominating and
Governance Committee will assess the incumbent director's performance
during his or her term, including the number of meetings attended, level of
participation, and overall contribution to the Company; the number of other
company Boards on which the individual serves, composition of the Board at
that time, and any changed circumstances affecting the individual director
which may bear on his or her ability to continue to serve on the Board.
o Management Directors. The number of officers or employees of the Company
serving at any time on the Board should be limited such that, at all times,
a majority of the directors is "independent" under applicable SEC, stock
exchange rules, or over-the-counter market rules.
After reviewing appropriate biographical information and qualifications,
first-time candidates will be interviewed by at least one member of the
Nominating and Governance Committee and by the Chief Executive Officer. Upon
completion of the above procedures, the Nominating and Governance Committee
shall determine the list of potential candidates to be recommended to the full
Board for nomination at the annual meeting. The Board of Directors will select
the slate of nominees only from candidates identified, screened and approved by
the Nominating and Governance Committee.
38
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 the quarter ended
June 30, 2004:
On April 28, 2004 the Company filed a Current Report on Form 8-K relating to its
April 28, 2004 press release announcing its financial results for the first
quarter ended March 31, 2004. Under the Form 8-K, the Company furnished, (not
filed) pursuant to Item 12, the press release entitled "Axeda Systems Inc.
Reports 2004 First Quarter Financial Results."
On June 30, 2004 the Company filed a Current Report on Form 8-K relating to its
June 30, 2004 press release announcing that it has been awarded a patent from
the United States Patent and Trademark Office for a key element of its
Firewall-Friendly(TM) method of communication over the Internet.
39
AXEDA SYSTEMS INC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act
of 1934, as amended, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
August 16, 2004
Axeda Systems Inc.
/s/ Thomas J. Fogarty
-----------------
Thomas J. Fogarty
Executive Vice President and Chief Financial Officer
40
EXHIBIT INDEX
Pursuant to Item 601(a)(2) of Regulation S-K, this Exhibit Index immediately
precedes the exhibits.
The following exhibits are included, or incorporated by reference, in this
Quarterly Report on Form 10-Q (and are numbered in accordance with Item 601 of
Regulation S-K):
EXHIBITS
Exhibit Number Exhibit Title
-------------- --------------------------------------------------------------------------------------------------
10.1 Loan Modification Agreement dated May 12, 2004 by and between Axeda Systems Operating Company, Inc. and
Silicon Valley Bank
31.1 Certification of the Chief Executive Officer of Axeda Systems Inc. required pursuant to Rule
13a-14(a)/15d-14(a)
31.2 Certification of the Chief Financial Officer of Axeda Systems Inc. required pursuant to Rule
13a-14(a)/15d-14(a)
32.1 Certification of the Chief Executive Officer and Chief Financial Officer of Axeda Systems Inc. required
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
41