UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the quarterly period ended September 30, 2004
OR
[_] 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 November 12, 2004, 32,541,060 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 September 30, 2004 (unaudited) and December 31, 2003 2
Consolidated Statements of Operations for the three months ended September 30, 2004 and 3
2003 (unaudited)
Consolidated Statements of Operations for the nine months ended September 30, 2004 and 4
2003 (unaudited)
Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 5
2003 (unaudited)
Notes to the Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 3 Quantitative and Qualitative Disclosures About Market Risk 32
Item 4 Controls and Procedures 32
Part II Other Information
Item 1 Legal Proceedings 33
Item 6 Exhibits 35
Signatures 36
Exhibit Index 37
Exhibit 4.1
Exhibit 4.2
Exhibit 4.3
Exhibit 4.4
Exhibit 10.1
Exhibit 10.2
Exhibit 10.3
Exhibit 10.4
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
PART I FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS (unaudited)
AXEDA SYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
September 30, December 31,
2004 2003
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 1,369 $ 9,617
Accounts receivable, net 2,656 3,200
Prepaid expenses 489 307
Other current assets 235 121
--------- ---------
Total current assets 4,749 13,245
Furniture and equipment, net 1,530 2,229
Goodwill 3,640 3,640
Identified intangible assets, net 1,067 1,423
Other assets 288 349
--------- ---------
Total assets $ 11,274 $ 20,886
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 130 $ 417
Accounts payable 1,479 1,253
Accrued expenses 4,434 4,866
Income taxes payable 641 733
Deferred revenue 1,414 1,422
--------- ---------
Total current liabilities 8,098 8,691
Non-current liabilities:
Other non-current liabilities 103 862
Financing-related liability 584 2,608
--------- ---------
Total liabilities 8,785 12,161
--------- ---------
Commitments and contingencies (note 7)
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; 33,134,860
shares issued in 2004 and 32,913,211 shares issued in 2003 33 33
Additional paid-in capital 146,682 146,644
Deferred stock compensation (151) (310)
Accumulated deficit (142,903) (136,488)
Accumulated other comprehensive income 208 226
Treasury stock at cost, 603,800 shares in 2004 and 2003 (1,380) (1,380)
--------- ---------
Total stockholders' equity 2,489 8,725
--------- ---------
Total liabilities and stockholders' equity $ 11,274 $ 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 September 30,
2004 2003
---- ----
Revenues:
License $1,700 $ 2,575
Services and maintenance 1,021 924
Hardware 17 104
-- ---
Total revenues 2,738 3,603
----- -----
Cost of revenues:
License 104 151
Services and maintenance 730 757
Software amortization 112 159
--- ---
Total cost of revenues 946 1,067
--- -----
Gross profit 1,792 2,536
----- -----
Research and development (R&D)
Non-cash compensation - 28
Other R&D expense 944 969
Sales and marketing (S&M)
Non-cash compensation - 10
Other S&M expense 1,760 1,777
General and administrative (G&A)
Non-cash compensation 9 108
Other G&A expense 1,329 1,747
Depreciation and amortization 322 278
--- ---
Total operating expenses 4,364 4,917
----- -----
Operating loss (2,572) (2,381)
Interest income (expense), net (5) (24)
Other income (expense), net 1,241 639
----- ---
Loss before provision for income taxes (1,336) (1,766)
Provision for income taxes 16 45
-- --
Net loss $ (1,352) $ (1,811)
========= =========
Basic and diluted net loss per weighted average common share
outstanding $ (0.04) $ (0.07)
======== ========
Weighted average number of common shares outstanding used in
calculation of basic and diluted net loss per common share 32,511,455 27,741,394
========== ==========
See accompanying notes to the consolidated financial statements.
3
Nine Months Ended September 30,
2004 2003
---- ----
Revenues:
License $5,611 $ 7,050
Services and maintenance 3,454 2,457
Hardware 103 287
--- ---
Total revenues 9,168 9,794
----- -----
Cost of revenues:
License 534 976
Services and maintenance 2,703 2,794
Hardware - 1
Software amortization 336 475
--- ---
Total cost of revenues 3,573 4,246
----- -----
Gross profit 5,595 5,548
----- -----
Research and development (R&D)
Non-cash compensation 2 84
Other R&D expense 3,066 4,090
Sales and marketing (S&M)
Non-cash compensation 43 27
Other S&M expense 5,732 6,558
General and administrative (G&A)
Non-cash compensation 68 381
Other G&A expense 4,314 6,264
Depreciation and amortization 840 848
--- ---
Total operating expenses 14,065 18,252
------ ------
Operating loss (8,470) (12,704)
Gain on disposal of assets 110 743
Interest income (expense), net (35) 29
Other income (expense), net 2,026 621
----- ---
Loss before provision for income taxes (6,369) (11,311)
Provision for income taxes 46 140
-- ---
Net loss $ (6,415) $ (11,451)
========= ==========
Basic and diluted net loss per weighted average common share
outstanding $ (0.20) $ (0.42)
======== ========
Weighted average number of common shares outstanding used in
calculation of basic and diluted net loss per common share 32,465,580 27,390,836
========== ==========
See accompanying notes to the consolidated financial statements.
4
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30,
2004 2003
---- ----
Cash flows from operating activities:
Net loss $ (6,415) $ (11,451)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 1,176 1,323
Gain on disposals of assets (110) (729)
Unrealized gain on financing-related liability (2,024) (645)
Non-cash settlement (720) -
Non-cash compensation and other expenses 113 492
Provision for doubtful accounts 4 (59)
Changes in items affecting operations:
Accounts receivable 540 (111)
Prepaid expenses and other current assets (296) 276
Goodwill, intangible assets and other assets 61 78
Accounts payable 226 (1,264)
Accrued expenses (303) (1,708)
Income taxes payable (92) 147
Deferred revenue (8) 166
--- ---
Net cash used in operating activities (7,848) (13,485)
------- --------
Cash flows from investing activities:
Capital expenditures (148) (111)
----- -----
Net cash used in investing activities (148) (111)
----- -----
Cash flows from financing activities:
Net repayment under bank line of credit (287) 448
Net proceeds from issuance of common stock - 5,597
Repayments of long-term debt and other non-current liabilities (27) (226)
Net proceeds from exercise of stock options 52 8
-- -
Net cash provided by (used in) financing activities (262) 5,827
----- -----
Effect of exchange rate changes on cash and cash equivalents 10 59
-- --
Net decrease in cash and cash equivalents (8,248) (7,710)
Cash and cash equivalents:
Beginning of period 9,617 19,065
----- ------
End of period, including restricted cash of $100 in 2003 $1,369 $11,355
====== =======
See accompanying notes to the consolidated financial statements.
5
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (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
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 nine months ended September 30, 2004 and 2003, our
net losses were $6,415 and $11,451, respectively, and negative cash flows from
operating activities were $7,848 and $13,485, respectively. There can be no
assurances that we will be able to generate sufficient revenues or positive cash
flows from operating activities 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 2005
based on forecasted year over year growth in revenues. 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 would likely be materially adversely affected. We cannot assure you
that if additional financing is needed, the additional financing will be
available to us on favorable terms when required, or at all.
On October 5, 2004, we issued a three-year secured convertible term note to
Laurus Master Fund, Ltd., or Laurus, in the principal amount of $4,500 (note
12).
b) Basis of Presentation
The interim consolidated financial statements of Axeda as of September 30, 2004
and for the three and nine months ended September 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 September 30,
2004, the results of our operations for the three and nine months ended
September 30, 2004 and 2003 and our cash flows for the nine months ended
September 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.
c) Principles of Consolidation
The consolidated financial statements include our financial statements and the
financial statements of our wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
6
d) Cash and Cash Equivalents
For purposes of the statement of cash flows, we consider all highly liquid
instruments purchased with 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 as to whether the delivered item has value to the
customer on a standalone basis and whether we have 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 6).
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 (calculated 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 September 30, 2004
Options to purchase 5,609,100 shares of common stock with a weighted-average
exercise price of $1.42 per share were outstanding during the three months ended
September 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 3,601,937 options that are vested, with a
weighted average exercise price of $1.48 per share, of which 1,413,294 are
vested and in the money, with a weighted average exercise price of $0.10 per
share. The options have various expiration dates during the next ten years.
Warrants to purchase 2,694,151 shares of common stock with a weighted-average
exercise price of $1.96 per share were vested and outstanding during the three
months ended September 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. No outstanding warrants were vested and in the
money. The warrants have various expiration dates during the next five years.
The outstanding warrants include 2,459,050 warrants (note 6) whose exercise
price was lowered from $1.71 per share to $1.69 per share as a result of and
effective upon the closing of our financing in October 2004 (note 12). In
addition, these warrants are subject to a further reduction of the exercise
price from $1.69 per share to $1.35 per share, subject to stockholder approval
at our next annual meeting of stockholders.
7
ii) Nine Months Ended September 30, 2004
Options to purchase 5,609,100 shares of common stock with a weighted-average
exercise price of $1.42 per share were outstanding during the nine months ended
September 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 3,601,937 options that are vested, with a
weighted average exercise price of $1.48 per share, of which 1,568,528 are
vested and in the money, with a weighted average exercise price of $0.18 per
share. The options have various expiration dates during the next ten years.
Warrants to purchase 2,694,151 shares of common stock with a weighted-average
exercise price of $1.96 per share were vested and outstanding during the nine
months ended September 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. No outstanding warrants were vested and in the
money. The warrants have various expiration dates during the next five years.
The outstanding warrants include 2,459,050 warrants (note 6) whose exercise
price was lowered from $1.71 per share to $1.69 per share as a result of and
effective upon the closing of our financing in October 2004 (note 12). In
addition, these warrants are subject to a further reduction of the exercise
price from $1.69 per share to $1.35 per share, subject to stockholder approval
at our next annual meeting of stockholders.
iii) Three Months Ended September 30, 2003
Options to purchase 5,728,911 shares of common stock with a weighted-average
exercise price of $1.76 per share were outstanding during the three months ended
September 30, 2003 but were not included in the computation of diluted EPS
because the effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding options include 2,725,947 options
that are vested, with a weighted average exercise price of $2.21 per share, of
which 1,064,387 are vested and in the money, with a weighted average exercise
price of $0.12 per share. The options have various expiration dates during the
next ten years.
Warrants to purchase 439,475 shares of common stock with a weighted-average
exercise price of $3.72 per share were vested and outstanding on a weighted
average basis, including 213,830 warrants which were not exercisable as of
September 30, 2003, during the three months ended September 30, 2003, but were
not included in the calculation of diluted EPS because the effects of assumed
conversion or exercise would have an anti-dilutive effect on EPS. The
outstanding warrants include 43,042 warrants that are vested and in the money,
with a weighted average exercise price of $1.39 per share. The warrants have
various expiration dates during the next five years.
iv) Nine Months Ended September 30, 2003
Options to purchase 5,728,911 shares of common stock with a weighted-average
exercise price of $1.76 per share were outstanding during the nine months ended
September 30, 2003 but were not included in the computation of diluted EPS
because the effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding options include 2,725,947 options
that are vested, with a weighted average exercise price of $2.21 per share, of
which 1,041,859 are vested and in the money, with a weighted average exercise
price of $0.09 per share. The options have various expiration dates during the
next ten years.
Warrants to purchase 279,371 shares of common stock with a weighted-average
exercise price of $4.89 per share were vested and outstanding, on a weighted
average basis, including 72,060 warrants which were not exercisable as of
September 30, 2003, during the nine months ended September 30, 2003, but were
not included in the calculation of diluted EPS because the effects of assumed
conversion or exercise would have an anti-dilutive effect on EPS. No outstanding
warrants were vested and in the money. 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 September 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 September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2004 2003 2004 2003
---- ---- ---- ----
Net loss, as reported $ (1,352) $(1,811) $(6,415) $ (11,451)
Add: Stock-based employee compensation
included in reported net loss, net of
related tax effects 9 146 113 492
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards (277) (742) (986) (2,054)
----- ----- ----- -------
Pro forma net loss $(1,620) $ (2,407) $ (7,288) $ (13,013)
========== ========= ========= ==========
Net loss per common share - basic and
diluted:
As reported $(0.04) $(0.07) $(0.20) $(0.42)
======= ======= ======= =======
Pro forma $(0.05) $(0.09) $(0.22) $(0.48)
======= ======= ======= =======
We used the following assumptions to determine the fair value of stock options
granted using the Black-Scholes option-price model:
September 30,
----------------------------------------
2004 2003
---- ----
Dividend yield 0% 0%
Expected volatility 86% - 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 nine months ended September 30, 2004, we granted 843,000 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 $0.87 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 2006, 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
continued its redeliberations of this statement through October 2004, which
began 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 $72
and $68 as of September 30, 2004 and December 31, 2003, respectively.
3) Acquired Intangible Assets
Acquired intangible assets that are subject to amortization at September
30, 2004 and December 31, 2003, consist of the following:
Gross Carrying Amount Accumulated Amortization
--------------------- ------------------------
2004 2003 2004 2003
---- ---- ---- ----
Developed Technology $ 210 $ 210 $210 $ 21
Core Technology 1,840 1,840 833 497
Customer Base 110 110 50 30
--- --- -- --
Total $ 2,160 $ 2,160 $1,093 $ 737
======= ======= ======= ======
10
Aggregate amortization expense was $356 and $498 for the nine months ended
September 30, 2004 and 2003, respectively, and $664 for the year ended December
31, 2003. Estimated aggregate expense for the quarter ending December 31, 2004
and for each of the next 2 years is as follows:
Charged to:
-----------
Cost of Operating
Total revenues expense
----- -------- -------
Year ending December 31,
2004 $ 119 $ 112 $ 7
2005 474 447 27
2006 474 447 27
Thereafter - - -
4) Goodwill
The changes in the gross carrying amount of goodwill, all attributable to
our DRM segment, for the nine months ended September 30, 2004 and the year ended
December 31, 2003are as follows:
Balance as of December 31, 2002 $ 3,651
=======
Other (11)
====
Balance as of December 31, 2003 $ 3,640
=======
Nine months ended September 30, 2004 -
----
Balance as of September 30, 2004 $3,640
======
Goodwill is not deductible for income tax purposes.
5) Accrued Expenses
Accrued expenses consist of the following:
September 30, December 31,
2004 2003
---- ----
Legal and professional fees $ 587 $ 558
Payroll and related costs 958 1,477
Royalties to Israeli government agencies 904 759
Sales, excise and other taxes 93 266
Severance 718 88
Unutilized leased facilities 102 547
Other 1,072 1,171
----- -----
$4,434 $4,866
====== ======
6) 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. The exercise price was lowered from $1.71 per share to
$1.69 per share as a result of and effective upon the closing of our financing
in October 2004 (note 12). In addition, these warrants are subject to a further
reduction of the exercise price from $1.69 per share to $1.35 per share, subject
to stockholder approval at our next annual meeting of stockholders.
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.
11
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 September 30,
2004 was $583. The change in fair value from December 31, 2003 to September 30,
2004 of $2,025 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:
September 30, December 31,
2004 2003
-------------- ------------
Current market price/share $0.45 $1.36
Exercise price/share $1.71 $1.71
Dividend yield 0% 0%
Expected volatility 108% 115%
Expected life 3.98 years 4.73 years
Risk-free interest rate 3.17% 3.13%
7) Commitments and Contingencies
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 was lifted. On September 24, 2004 the
Defendants filed a stipulation with the court, suspending motion and discovery
deadlines pending negotiation of the settlement documents. On October 23, 2004,
the parties through their respective counsel executed a memorandum of
understanding to settle the class action for $7,000. Although we believe that
such lawsuits or claims are without merit and that we have meritorious defenses
to the actions, we plan to settle the litigation pursuant to the October 23,
2004 memorandum of understanding. We have been informed by our directors' and
officers' liability insurance carriers that the full amount of the cash
settlement will be paid directly by them.
12
SECURITIES ALLOCATION CLASS ACTION
On November 27, 2001, a putative shareholder class action was filed against us,
certain of our officers and directors, or the Individual Defendants, and several
investment banks, or the Underwriter Defendants, 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, or the Court, purportedly on behalf
of investors who purchased our stock between July 15, 1999 and December 6, 2000,
of the Plaintiffs. 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. The 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. On July 15,
2003, the Company's board of directors approved the terms of a settlement
proposal as set forth in a Memorandum of Understanding (the "MOU"), which has
now been memorialized in a settlement agreement, an Insurer-Insured Agreement,
an Agreement Among Insurers, and a Special Counsel Agreement.
The settlement agreement and related agreements set forth the terms of a
settlement between us, 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 our release and the release
of the Individual Defendants for the conduct alleged in the action to be
wrongful. We agree to undertake certain responsibilities, including agreeing to
assign away, not assert, or release certain potential claims that we may have
against our underwriters. It is anticipated that any potential financial
obligation of ours to the Plaintiffs pursuant to the terms of the settlement
agreement and related agreements will be covered by existing insurance. . The
agreement is 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. On August 4, 2004 the Plaintiffs and Issuer
Defendants filed replies to the Underwriter Defendants. On October 13, 2004 the
Court determined the criteria for Section 11 class certifications, and certified
the Section 11 class in four of the six cases that were the subject of class
certification motions, noting that the Court's intention was to provide strong
guidance to all parties regarding class certification in the remaining two
cases. The Plaintiffs have not yet moved to certify a class in our case.
If the settlement does not occur, and litigation against us continues, we
believe we have meritorious defenses and intend to defend the case vigorously.
We 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.
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 $15,000 for breach of contract and fraud, and
unspecified punitive damages and attorney's fees. On May 2, 2003, we moved to
dismiss all claims against RTIAG. On or about June 23, 2003, IPM filed an
amended complaint adding RTIAG as a party in the action and providing further
specificity on the fraud allegation. We withdrew our motion to dismiss shortly
thereafter. 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 $2,732, 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.
13
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 was heard on September 7, 2004 and was denied by the court. A
case settlement hearing on our counterclaim was is also scheduled forheld in
September 2004, which was also denied by the Court. We filed a motion for
summary judgment on our counterclaim on October 26, 2004, which is scheduled to
be heard on November 30, 2004. On approximately November 9, 2004, IPM filed its
opposition to our October 26, 2004 motion for summary judgment. We have until
November 16, 2004 to file a reply to IPM's opposition.
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
No. 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 the United States District Court for the District
of Massachusetts against Questra Corporation , one of our competitors, for
infringement of this patent. On November 9, 2004 Questra filed an answer to our
complaint, without filing a substantive counterclaim.
On November 10, 2004 Questra filed a lawsuit in the United States District Court
for the Northern district of California against us alleging infringement of U.S.
patent No. 6,377,162, titled "Medical Diagnostic Field Service Method and
Apparatus." , The suit seeks injunctive relief and unspecified monetary damages.
As the complaint was only served November 12, 2004, we are currently reviewing
the matter, including the limits of any potential exposure, with outside
counsel. We plan to vigorously assert all applicable defenses to the litigation,
and in particular will be investigating not only the patent's potential
infringement limitations, but also its core validity and enforceability by
Questra. We are unable to predict the outcome of this matter or reasonably
estimate an amount of loss given its current status.
LEASE
In connection with our acquisition of eMation. Ltd., or eMation, in December
2001, we recorded an unutilized lease obligation of $1,200. Until February 2003
we made payments under the lease totaling $180, resulting in a balance of $1,020
as of September 30, 2004. In May 2003 the lessor provided us with formal notice
of termination of the lease and from June 2003 until May 2004, filed various
complaints against us alleging payment due for rent and other charges under the
lease. On October 18, 2004 we entered into a settlement and release agreement
with the lessor to settle all charges, suits and claims against us. Under the
terms of the settlement and release agreement, we will pay $300 payable in two
installments of $150 each. The first installment was paid on October 20, 2004,
and the second installment is due on October 1, 2005As a result of the
settlement we reversed $720 of the liability, which is included as a reduction
of other general and administrative expense in the accompanying consolidated
statements of operations for the three and nne months ended September 30, 2004.
OTHER
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.
14
8) 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 30%, or $815, and 20%, or $1,821, of total
revenues for the three and nine months ended September 30, 2004, respectively.
Three customers accounted for 35%, or $1,275, and 18%, or $1,728, of total
revenues for the three and nine months ended September 30, 2003, respectively.
15
We sell and license our technology to customers primarily in North America,
Europe and Asia. Our total revenues were derived from the following geographic
regions (based on where the customer is located):
Three Months Ended September 30,
Country/ Geographic Region 2004 2003
- -------------------------- ---- ----
Amount % of Total Amount % of Total
North America:
United States $ 1,045 38% $ 1,700 48%
Canada - - - -
- - - -
Total - North America 1,045 38 1,700 48
----- -- ----- --
Europe:
Germany 110 4 141 4
France 160 6 275 8
Netherlands 159 6 111 3
Switzerland 617 23 492 14
United Kingdom 115 4 268 7
Other 228 8 412 11
--- - --- --
Total - Europe 1,389 51 1,699 47
----- -- ----- --
Asia-Pacific:
Israel 78 3 49 1
Japan 148 5 110 3
Other 24 1 11 -
-- - -- -
Total - Asia-Pacific 250 9 170 4
--- - --- -
Other 54 2 34 1
-- - -- -
Total $ 2,738 100% $ 3,603 100%
======= ==== ======== ====
Nine Months Ended September 30,
-------------------------------
Country/ Geographic Region 2004 2003
- -------------------------- ---- ----
Amount % of Total Amount % of Total
------ ---------- ------ ----------
North America:
United States $3,448 38% $ 3,882 39%
Canada 9 - 260 3
- - --- -
Total - North America 3,457 38 4,142 42
----- -- ----- --
Europe:
Germany 406 4 413 4
France 904 10 1,073 11
Netherlands 515 6 341 3
Switzerland 1,233 13 908 9
United Kingdom 324 4 365 4
Other 976 11 904 10
--- -- --- --
Total - Europe 4,358 48 4,004 41
----- -- ----- --
Asia-Pacific:
Israel 227 2 214 2
Japan 942 10 1,237 13
Other 71 1 95 1
-- - -- -
Total - Asia-Pacific 1,240 13 1,546 16
----- -- ----- --
Other 113 1 102 1
--- - --- -
Total $ 9,168 100% $ 9,794 100%
======= ==== ======== ====
9) 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.
16
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 Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
---- ---- ---- ----
Revenues:
DRM $ 2,721 $ 3,499 $9,065 $9,258
Other 17 104 103 536
-- --- --- ---
Total $ 2,738 $ 3,603 $9,168 $9,794
======== ======= ====== ======
Gross profit:
DRM $ 1,775 $ 2,432 $5,492 $5,262
Other 17 104 103 286
-- --- --- ---
Total $ 1,792 $ 2,536 $5,595 $5,548
======= ======== ====== ======
10) Consolidated Statements of Cash Flows
Supplemental disclosure of cash flow information:
Nine Months Ended
September 30,
-------------------------
2004 2003
---- ----
Cash paid during the period for:
Interest $ 5 $ 32
==== =====
Income taxes 99 33
== ==
11) Comprehensive Income (Loss)
The components of comprehensive loss are as follows:
Three Months Ended September 30, Nine Months Ended
September 30,
2004 2003 2004 2003
---- ---- ---- ----
Net loss $(1,352) $(1,811) $(6,415) $(11,451)
Foreign currency translation
adjustment 2 53 10 59
- -- ---- --
Comprehensive loss $(1,350) $(1,758) $(6,405) $(11,392)
======== ======== ======== =========
17
12) Subsequent Events - Private Placement
On October 5, 2004, we we issued a secured convertible term note, or the Note,
in the principal amount of $4,500 to Laurus Master Fund, Ltd., or Laurus. The
Note is convertible into shares of our common stock at an initial conversion
price of $0.48 per share. Pursuant to these agreements, we also issued to Laurus
a warrant, or the Warrant, to purchase up to 2,500,000 shares of our common
stock at an exercise price of $0.53 per share with a term of five years.
The Note has a term of three years and accrues interest at the prime rate plus
2% per year (6.75% as of October 5, 2004). Interest on the principal amount is
payable monthly, in arrears, beginning on November 1, 2004 and on the first
business day of each consecutive calendar month thereafter until the maturity
date. Under the terms of the Note, the monthly interest payment and the monthly
principal payment are payable either in cash at 102% of the respective monthly
amortization amounts or, if certain criteria are met, in shares of our common
stock. The minimum monthly principal repayment of $150 commences on May 1, 2005,
and continues through the October 5, 2007 maturity date. The principal criteria
for the monthly payments to be made in shares of our common stock include:
o the effectiveness of a current registration statement covering the
shares of our common stock into which the principal and interest under
the Note are convertible;
o an average closing price of our common stock for the previous five
trading days greater than or equal to 110% of the fixed conversion
price; and
o the amount of such conversion not exceeding 25% of the aggregate
dollar trading volume of our common stock for the previous 10 trading
days.
We may prepay the Note at any time by paying 120% of the principal amount then
outstanding, together with accrued but unpaid interest thereon, on or before
October 5, 2006, or by paying 115% of the principal amount then outstanding,
together with accrued but unpaid interest thereon, after October 5, 2006. Upon
an event of default under the Note, Laurus may demand repayment at a rate of
120% of the outstanding principal and interest amount of the Note if it occurs
on or before October 5, 2006 and at a rate of 115% of the outstanding principal
and interest amount of the Note if it occurs after October 5, 2006. If the Note
remains outstanding after an event of default that is not cured, the interest
rate increases to 1.5% per month. Events of default include:
o a failure to make payments under the Note when due;
o a material breach of the transaction documents by us;
o bankruptcy related events;
o a change of control transaction without prior approval; and
o events of default under other agreements to which we are a party.
On a month-by-month basis, if we register the shares of common stock issuable
upon conversion of the Note and upon exercise of the Warrant on a registration
statement declared effective by the Securities and Exchange Commission, the
interest rate on the Note is subject to reduction by 1% for every 25% increase
in the market price of our common stock above the conversion price of the Note,
but in no event shall the interest rate be less than zero percent.
Laurus also has the option to convert all or a portion of the Note into shares
of our common stock at any time, subject to limitations described below, at a
conversion price of $0.48 per share, subject to adjustment as described below.
The Note is currently convertible into 9,375,000 shares of our common stock,
excluding the conversion of any accrued interest. The conversion price is
adjustable on a weighted average basis upon certain future issuance of
securities by us at a price less than the conversion price then in effect. There
are a number of limitations on Laurus' ability to convert the Note and exercise
the Warrant. These limitations include:
o Laurus may not convert the Note or exercise the Warrant for a number
of shares that would cause all shares then held by Laurus to exceed
4.99% of our outstanding shares of common stock unless there has been
an event of default or Laurus provides us with 75 days prior notice.
o Laurus has also agreed that it will not convert the Note or exercise
the Warrant for more than 6,491,440 shares of common stock at a
weighted average exercise price of below $0.47 unless the issuance of
the shares has been approved by our stockholders.
18
o Finally, Laurus agreed that it would not convert the Note and exercise
the Warrant for more than 8,202,012 shares of common stock until our
stockholders approved an increase in our authorized number of shares
of common stock.
We covenanted that we would promptly call a stockholders meeting to solicit
approval of an increase in the number of shares of our common stock authorized
for issuance and approval of the issuance of more than 6,491,440 shares of
common stock at a price of less than $0.47 per share. The Note is secured by a
blanket first priority lien on substantially all of our assets and the assets of
some of our U.S. subsidiaries, and by a pledge of the stock of some of our U.S.
subsidiaries.
We were obligated to file a registration statement on Form S-3 (or if Form S-3
is not available another appropriate form) registering the resale of shares of
our common stock issuable upon conversion of the Note and exercise of the
Warrant by November 4, 2004 and to have such Statement declared effective by the
Securities and Exchange Commission, or SEC, by no later than January 13, 2005.
We timely filed a registration statement on Form S-3 on October 26, 2004, which
has not yet been declared effective. If the registration statement is not
declared effective within the timeframe described, if the registration statement
is suspended other than as permitted in the Registration Rights Agreement, or if
our common stock is not listed for three consecutive trading days, we are
obligated to pay Laurus additional cash fees. The cash fees are 1.5% of the
original principal amount of the Note for each 30 day period in which we fail to
take these actions.
In May 2004 we renewed our loan and security agreement with Silicon Valley Bank
through June 2005, 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). On September 30, 2004, $493 was
available, with $130 outstanding, which was repaid on October 1, 2004. At
September 30, 2004 there were no letters of credit or other amounts for bank
services outstanding under the Line. On October 5, 2004, in order to complete
the financing with Laurus, we cancelled the Line and paid Silicon Valley Bank a
termination fee of $20.
19
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 have been
generated from selling DRM products.
Through September 30, 2004 we have recorded approximately $1.3 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 October 5, 2004, we entered into definitive agreements with Laurus Master
Fund, Ltd., or Laurus, pursuant to which we issued to Laurus a secured
convertible term note, or the Note, in the principal amount of $4.5 million
convertible into shares of our common stock at a conversion price of $0.48 per
share. Pursuant to these agreements, we also issued to Laurus a warrant, or the
Warrant, to purchase up to 2,500,000 shares of our common stock at an exercise
price of $0.53 per share with a term of five years. Under the terms of the Note,
the monthly interest payment and the monthly principal payment are payable
either in cash at 102% of the respective monthly amortization amounts or, if
certain criteria are met, in shares of our common stock. The minimum monthly
principal repayment of $150,000 commences on May 1, 2005, and continues through
the October 5, 2007 maturity date.
20
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. The exercise price will be reduced to
$1.35 per share subject to our stockholder approval at our annual stockholders
meeting. Operating results and our liquidity position are discussed further,
below.
We currently operate in two principal regions: the United States and Europe. As
a result of the difficult capital spending climate, our DRM revenues decreased
by $0.4 million through September 2004 compared to the same period in 2003,
primarily due to decreases in our licensing revenues. Although our license
revenues alone declined by $1.4 million, due in-part to downward pricing
pressure, our service revenues increased $1.0 million due to a greater number of
new service customer accounts and additional spending by our existing base of
customers. While recurring sales from existing customers and the timing of more
widespread adoption of our product remains difficult to predict, we believe our
DRM revenues will increase in 2004, from the prior year, due to further orders
from our current customer base, our sales pipeline and improvements in the
marketplace.
For the nine months ended September 30, 2004, our 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 customer relationship
management ("CRM") and enterprise resource planning ("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 U.S.
presidential election. We also formally launched our hosted DRM offering during
the second quarter of 2004, and this resulted in our deferral of licensing
revenue for certain customers into future periods.
For the nine months ended September 30, 2004, our operating expenses decreased
by $4.2 million, or 23%, compared to the same period for the prior year. We
believe the cost reductions combined with an increase in revenues and our
October 2004 private placement will be sufficient to allow us to meet our cash
needs through December 31, 2005.
At September 30, 2004, our cash balance was $1.4 million compared with $9.6
million at year-end 2003. Operating results and our liquidity position are
discussed further below.
21
Results of Operations
Three and Nine Months Ended September 30, 2004 Compared to Three and Nine Months
Ended September 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 September 30, Nine Months Ended September 30,
--------------------------------------------- -------------------------------------------
2004 2003 2004 2003
---- ---- ---- ----
Percent of Percent of Percent of Percent of
Amount Revenues Amount Revenues Amount Revenues Amount Revenues
------ -------- ------ -------- ------ -------- ------ --------
Revenues:
License $1,700 62.1% $ 2,575 71.5% $5,611 61.2% $ 7,050 72.0%
Services and maintenance 1,021 37.3 924 25.6 3,454 37.7 2,457 25.1
Hardware 17 0.6 104 2.9 103 1.1 287 2.9
-- --- --- --- --- --- --- ---
Total revenues 2,738 100.0 3,603 100.0 9,168 100.0 9,794 100.0
----- ----- ----- ----- ----- ----- ----- -----
Cost of revenues:
License 104 3.8 151 4.2 534 5.8 976 10.0
Services and maintenance 730 26.66 757 21.0 2,703 29.5 2,794 28.5
Hardware - - - - - - 1 -
Software amortization 112 4.1 159 4.4 336 3.7 475 4.8
--- --- --- --- --- --- --- ---
Total cost of revenues 946 34.5 1,067 29.6 3,573 39.0 4,246 43.3
--- ---- ----- ---- ----- ---- ----- ----
Gross profit 1,792 65.5 2,536 70.4 5,595 61.0 5,548 56.7
----- ---- ----- ---- ----- ---- ----- ----
Research and development(R&D)
Non-cash compensation - - 28 0.8 2 - 84 0.9
Other R&D expense 944 34.5 969 26.9 3,066 33.4 4,090 41.8
Sales and marketing (S&M)
Non-cash compensation - - 10 0.3 43 0.5 27 0.3
Other S&M expense 1,760 64.3 1,777 49.3 5,732 62.5 6,558 66.9
General and administrative (G&A)
Non-cash compensation 9 0.3 108 3.0 68 0.7 381 3.9
Other G&A expense 1,329 48.5 1,747 48.5 4,314 47.1 6,264 64.0
Depreciation and amortization 322 11.8 278 7.7 840 9.2 848 8.6
--- ---- --- --- --- --- --- ---
Total operating expenses 4,364 159.4 4,917 136.5 14,065 153.4 18,252 186.4
----- ----- ----- ----- ------ ----- ------ -----
Operating loss (2,572) (93.9) (2,381) (66.1) (8,470) (92.4) (12,704) (129.7)
Gain on disposal of assets - - - - 110 1.2 743 7.6
Interest income (expense), net and
other income (expense), net 1,236 45.1 615 17.1 1,991 21.7 650 6.9
----- ---- --- ---- ----- ---- --- ---
Loss before income tax (1,336) (48.8) (1,766) (49.0) (6,369) (69.5) (11,311) (115.2)
Provision for income taxes 16 0.6 45 1.2 46 0.5 140 1.4
-- --- -- --- -- --- --- ---
Net loss $(1,352) (49.4) % $ (1,811) (50.2)% $(6,415) (70.0) % $ (11,451) (116.6) %
======== ======== ========= ======= ======== ======== ========== =========
22
AXEDA SYSTEMS INC.
Results of Operations
REVENUES. Overall, revenues decreased by $0.9 million or 24% and $0.6 million or
6%, to $2.7 million and $9.2 million, during the three and nine months ended
September 30, 2004, respectively, compared to the same periods in 2003. Sales of
our DRM solutions decreased $0.8 million or 22% and $0.4 million or 5%, while
hardware sales decreased $0.1 million and $0.2 million during the three and nine
months ended September 30, 2004, respectively.
License revenues for the three and nine months ended September 30, 2004
decreased by $0.9 million and $1.4 million respectively, compared to the same
periods in 2003. The decrease in license revenues was due to reduced license
sales from new accounts for the three and nine months ended September 30, 2004
compared to the prior periods. We believe the decrease in new orders was due in
part to new customers questions concerning our financial viability. For the
fourth quarter of 2004, we expect DRM license revenues to increase compared to
2003 as we attract additional new orders after having closed on our Private
Placement in October 2004.
Decreased sales of fully-reserved, outdated components of our former Internet
appliance, or IA, business resulted in a decline in hardware revenues of $0.2
million to $0.1 million for the nine months ended September 30, 2004, from $0.3
million for the nine months ended September 30, 2003. In the future, 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 $0.1 million and $1.0 million, or
10% and 41%, for the three and nine months ended September 30, 2004,
respectively, compared to the same periods in 2003. The increases over the three
and nine month periods, in comparison to the same periods in 2003, are due to
increased demand for professional services from existing DRM customer
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' requirements and approval processes.
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 nine month periods
ended September 30, 2004, our top three customers accounted for $0.8 million, or
30%, and $1.8 million or 20% of our total revenues, respectively. For the three
and nine month periods ended September 30, 2003, our top three customers
accounted for $1.2 million, or 35%, and $1.7 million, or 18%, 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 September 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 $0.1 million and $0.7 million,
or 11% and 16%, respectively, to $0.9 million and $3.6 million for the three and
nine months ended September 30, 2004, respectively, compared to the same periods
in 2003.
Cost of revenues for license fees for the nine months ended September 30, 2004
decreased by approximately $0.4 million compared to the same period in 2003. The
$0.4 million decrease for the nine months ended September 30, 2004 is due to
decreased license fees associated with our discontinued personal computer ("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 $0.1 million for the
nine months ending September 30, 2004 compared to the same period in 2003. The
$0.1 million decrease in cost of services and maintenance for the nine months
ended September 30, 2004 is due to a $0.1 million decrease in travel expense.
Additionally, the company recorded $0.1 million in severance expense in the
current and prior year. We expect our cost of services and maintenance as a
percentage of services and maintenance revenues to decline, as a result of
savings from our restructuring activities, but may vary as our services revenues
change.
23
Software amortization of our developed and core technologies for the nine months
ending September 30, 2004 decreased $0.1 million, compared to the same period 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 decreased $0.7 million, or 29%, to $1.8 million for
the three months ended September 30, 2004 compared to the same period in 2003.
Gross profit remained relatively consistent for the nine months ended September
30, 2004 compared to the same period in 2003. The decrease in gross profit in
the third quarter is attributable to a decrease in license revenues.
For the three and nine month periods ended September 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 decreased
from 70% to 65% for the quarters ended September 30, 2003 and September 30,
2004, respectively and increased from 57% to 61% for the nine months ended
September 30, 2003 and September 30, 2004, respectively. The decrease in gross
margin for the three months ended September 30, 2004 was directly attributable
to lower license revenues compared to the same period in 2003. The increase in
gross margin for the nine months ended September 30, 2004 was due to an increase
in services and maintenance revenues due to increased capacity utilization, the
closure of our Israeli operations and reduced software amortization expense
compared to the same period in 2003.
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 $1.0 million or 25% to $3.1 million for the nine months
ended September 30, 2004 compared to the same period in 2003.
The decrease in other R&D expense for the nine months ended September 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 42% to 33% for the nine months ended
September 30, 2004, compared to the same period in 2003. We expect other R&D
expense to decrease 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 $0.8 million, or 13%, to $5.7 million for the
nine months ended September 30, 2004, compared to the same period in 2003.
Reduced staff and staff related expense, bonus and travel expense contributed
$0.5 million, $0.2 million and $0.1 million to the decrease in other S&M expense
for the nine months ended September 30, 2004 compared to the prior year.
Severance expense of $0.4 million for the nine months ended September 30, 2004
was approximately the same as severance expense for the prior period in 2003. As
a percentage of revenues, other S&M expense decreased from 67% to 63%, for the
nine months ended September 30, 2004, compared to the same period in 2003. We
expect other S&M expense to decrease 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 $0.4 million and
$2.0 million, or 24% and 31%, to $1.3 million and $4.3 million for the three and
nine months ended September 30, 2004, respectively, compared to the same periods
in 2003. As a percentage of total revenues, other general and administrative
expenses remained relatively consistent at 49%, and decreased from 64% to 47% of
total revenues for the three and nine months ended September 30, 2004,
respectively.
24
The $0.4 million decrease in other G&A expense for the quarter ended September
30, 2004 relates to the favorable settlement of outstanding lease litigation for
$0.6 million, reduced bonus and salary expense of $0.3 million and reduced
professional fees and insurance expense of $0.1 million offset by increased
severance expense of $0.6 million versus the prior year. The $2.0 million
decrease in other G&A expense for the nine months ended September 30, 2004
relates to the favorable settlement of outstanding lease litigation of $0.6
million, a $0.2 million decrease related to our Mansfield lease obligation and
the reversal of estimated patent and intellectual property accruals of $0.4
million no longer considered necessary. In addition, we reduced staff and
related compensation expense by $0.4 million, insurance expense by $0.3 million
and professional fees by $0.2 million as part of our ongoing cost management
initiatives. These decreases were partially offset by an increase in severance
expense of $0.2 million for the nine months ended September 30, 2004. 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 $0.3 million for the quarter and nine months ended September 30,
2004, respectively, from $0.1 million and $0.4 million for the quarter and nine
months ended September 30, 2003, respectively. The decrease is attributable to
certain deferred compensation being fully amortized as a result of the related
stock option awards becoming fully vested in the prior years.
DEPRECIATION AND AMORTIZATION. We recorded depreciation and amortization of $0.3
million for the three months ended September 30, 2004 and September 30, 2003,
respectively, and depreciation and amortization of $0.8 million for the nine
months ended September 30, 2004 and September 30, 2003, respectively.
GAIN ON DISPOSAL OF ASSETS. There were no gains or losses on disposal of assets
in the quarters ending September 30, 2004 or September 30, 2003. For the nine
months ended September 30, 2004, we recorded a gain of $0.1million. from the
reversal of a $0.1 million accrual recorded in connection with the sale of the
assets of our former consumer electronics business in March 2001 that was no
longer considered necessary. This compares with a gain of $0.7 million for the
nine months ended September 30, 2003, resulting from a favorable 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.
OTHER INCOME (EXPENSE), NET. We entered into a registration rights agreement
with the investors in our September 2003 private investment in public entity
("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 nine month periods
ended September 30, 2004 was $1.2 million and $2.0 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 nine months ended September 30, 2004 increased revenues and
expenses by $0.5 million and $0.5 million, respectively, from the prior year.
Increases in revenues and expenses from foreign currency fluctuations are due to
the weakness versus the 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.
25
LIQUIDITY AND CAPITAL RESOURCES
Since March 2001, our operations have largely been financed through the sales of
the assets of our Consumer Electronics and Internet Appliance businesses and the
September 2003 PIPE financing. As of September 30, 2004, we had $1.4 million in
cash and cash equivalents.
Net cash used in operating activities for the nine months ended September 30,
2004 was $7.8 million, compared to $13.5 million for the nine months ended
September 30, 2003. Cash used in operating activities for the first nine months
of 2004 was primarily the result of our net loss of $6.4 million and unrealized
gains of $2.1 million offset by non-cash expenses of $0.6 million and other
changes in working capital of approximately $0.1 million. The reduction in net
cash used in operations is primarily the result of the lower net loss.
Beginning in the second quarter of 2002, we initiated a series of steps designed
to consolidate and streamline our operations and decrease our operating losses
and corresponding use of cash. We have halved the number of global offices,
reduced staffing levels by 46% by eliminating or not replacing 96 employees,
engaged partners to provide us with variable staffing capabilities to meet peak
demand periods and have closely monitored our infrastructure costs. In 2002 we
exited the PC business and focused our efforts on several key markets for DRM
Systems products. In 2002 and 2003, we recorded $1.9 million and $1.4 million in
restructuring charges, respectively, to reduce staffing levels, terminate
certain leases and consolidate our operations. We continue to evaluate our cost
structure and in the third quarter of 2004 we recorded $1.1 million in
restructuring charges to reduce staffing levels and further consolidate our
operations.
Net cash used in investing activities for the nine months ended September 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 $0.3 million for the nine months ended
September 30, 2004 and consisted of principal payments reducing indebtedness.
Net cash provided by financing activities was $5.8 million for the nine months
ended September 30, 2003, and primarily consisted of proceeds from the issuance
of common stock of $5.6 million and borrowings under a bank line of credit.
In June 2004, we amended a Software License Agreement, or the Agreement, with a
vendor who provides 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 $0.2 million, which is
payable in installments. We paid $0.1 million in July 2004 and are required to
pay the remaining $0.1 million on December 20, 2004.
As of September 30, 2004, we have $0.5 million of accrued costs related to
leases for facilities that we no longer occupy. In accordance with a settlement
and release agreement relating to $0.4 million of these costs, $0.2 million
waspaid in October 2004, and $0.2 million is due in October 2005.
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 2005 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 2005. This amount is restricted for withdrawal and is
included in other assets (non-current) in our consolidated balance sheets.
On October 5, 2004, we issued a secured convertible term note, or the Note, in
the principal amount of $4.5 million to Laurus Master Fund, Ltd., or Laurus. The
Note is convertible into shares of our common stock at an initial conversion
price of $0.48 per share. Pursuant to the agreements, we also issued to Laurus a
warrant, or the Warrant, to purchase up to 2,500,000 shares of our common stock
at an exercise price of $0.53 per share with a term of five years.
26
The Note has a term of three years and accrues interest at the prime rate plus
2% per year (6.75% as of October 5, 2004). Interest on the principal amount is
payable monthly, in arrears, beginning on November 1, 2004 and on the first
business day of each consecutive calendar month thereafter until the maturity
date. Under the terms of the Note, the monthly interest payment and the monthly
principal payment are payable either in cash at 102% of the respective monthly
amortization amounts or, if certain criteria are met, in shares of our common
stock. The minimum monthly principal repayment of $0.15 million commences on May
1, 2005, and continues through the October 5, 2007 maturity date. Please see
note 12 to the consolidated financial statements for an additional discussion of
the terms of financing with Laurus.
In May 2004 we renewed our loan and security agreement with Silicon Valley Bank
through June 2005, that provided 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). On September 30, 2004, $0.5 million
was available, with $0.1 million outstanding, which was repaid on October 1,
2004. At September 30, 2004 there were no letters of credit or other amounts for
bank services outstanding under the Line. On October 5, 2004, in order to
complete the financing with Laurus, we cancelled the Line and paid Silicon
Valley Bank a termination fee of $20,000.
Based upon our current cash resources and revised financial projections, we
currently anticipate that our available funds and cash flows from operations
should be sufficient to meet our cash needs through 2005 based on forecasted
year over year growth in revenues. 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 if additional financing
is needed, the additional financing will be available to us on favorable terms
when required, or at all. See also "Factors That May Affect Future Results,"
below.
27
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 nine months ended September 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." Mr. Roberts was a Named
Executive Officer during 2003, but his employment terminated effective March 31,
2004. He has since served as a consultant to the company under an independent
contractor agreement with us, under which his options continue to vest and
remain exercisable during the term of such agreement, pursuant to the normal
operation of our 1999 Stock Incentive Plan.
Nine Months Ended Year Ended
September 30, 2004 December 31, 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 14.23% 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 37.81% 34.98%
28
General Option Information
The following table sets forth the summary of activity under the Plans
for the nine months ended September 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 (843,000) 843,000 1.18
Exercises - (118,419) 0.28
Cancellations* 792,787 (836,122) 3.66
Additional shares reserved 969,282 N/A N/A
------- ---
September 30, 2004 1,440,395 5,609,100 $1.42
========= =========
* The "Number of Shares Available for Options" does not include options under
assumed plans exercisable for 114,631 shares and 43,335 shares that were
cancelled during 2003 and the first nine 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 September 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 September 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 1,392,461 $ 0.10 338,277 $ 0.42 1,730,738 $ 0.16
Out-of-the-money (1) 2,209,476 $ 2.35 1,668,886 $ 1.50 3,878,362 $ 1.99
--------- --------- ---------
Total options
outstanding 3,601,937 $ 1.48 2,007,163 $ 1.32 5,609,100 $ 1.42
========= =========
(1) Out-of-the-money options are those options with an exercise price equal to
or above the closing price of $0.45 as of September 30, 2004, as reported by the
Nasdaq National Market.
29
Executive Options
The following table sets forth information regarding stock options granted
in 2004 to our Named Executive Officers 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 14.23% $ 1.17 3/23/2014 $99,732 $260,178
*Based on a total of 843,000 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 nine months ended September 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 September
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 September 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 - $ - 712,245 168,755 $146,598 $ -
Dale E. Calder - - 535,937 39,063 132,719 -
Thomas J. Fogarty - - 375,311 174,689 99,719 -
* Option values based on stock price of $0.45 on September 30, 2004.
30
EQUITY COMPENSATION PLAN INFORMATION
The following table gives information about our common stock that may be issued
upon the exercise of options under all of our Plans as of September 30, 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, ompensation Plans (Excluding
Outstanding Options, Warrants, and Rights C Securities Reflected in
Plan Category Warrants, and Rights (per share) Column (1) )
- ------------- ---------- ------ ------------
Equity Compensation Plan Approved by
Shareholders (A) (B) 5,609,100 $ 1.42 1,440,395
--------- ====== =========
(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 are 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.
31
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 MAY NOT HAVE SUFFICIENT FUNDS TO REPAY OUR OBLIGATIONS TO LAURUS MASTER FUND,
LTD. WHEN THEY BECOME DUE
If we are not able to repay the principal and interest on the note, or the Note,
that we issued to Laurus Master Fund, Ltd., or Laurus, in October 2004 in shares
of our common stock, we may not have sufficient funds to repay Laurus when our
debt obligations to Laurus become due. The principal criteria for the monthly
payments to be made in shares of our common stock include:
o the effectiveness of a current registration statement covering the
shares of our common stock into which the principal and interest under
the Note are convertible;
o a market price of our common stock greater than or equal to 110% of
the conversion price of the Note; and
o the amount of such conversion not exceeding 25% of the aggregate
dollar trading volume of our common stock for the previous ten trading
days.
In addition:
o We will not be able to issue more than an aggregate of 8,202,012
shares of our common stock upon conversion of the Note and exercise of
the Warrant unless our stockholders approve an increase in our
authorized shares of common stock and
o We will not be able to issue more than 6,491,440 shares of common
stock at a weighted average exercise price of below $0.47 unless these
issuances are approved by our stockholders.
Accordingly, we may be required to obtain the funds necessary to repay these
obligations either through refinancing, the issuance of additional equity or
debt securities or the sale of assets. We may be unable to obtain the funds
needed, if any, to repay the obligations from any one or more of these sources
on favorable economic terms or at all. We currently have only approximately
100,000 authorized shares of common stock that have not been reserved for
issuance. We are seeking stockholder approval to increased our authorized shares
of common stock at our annual stockholders meeting to give us the flexibility to
sell shares of common stock, if necessary. We have also granted Laurus a right
of first refusal on any debt or equity financings that we complete before
October 3, 2005. This may impede our ability to secure additional funding
because it may discourage third parties from making an offer that Laurus may
match. If we are unable to obtain funds to repay this indebtedness, we may be
forced to dispose of assets or take other actions on disadvantageous terms,
which could result in losses and could have a material adverse effect on our
financial condition and results of operations.
THE TERMS OF OUR DEBT OBLIGATIONS TO LAURUS SUBJECT US TO THE RISK OF
FORECLOSURE ON SUBSTANTIALLY ALL OF OUR ASSETS
To secure the payment of all obligations owed to Laurus, we have granted to
Laurus a security interest in, and lien upon, substantially all of our property
and assets. The occurrence of an event of default under any of our obligations
could subject us to foreclosure by Laurus on substantially all of our assets to
the extent necessary to repay any amounts due. Any defaults and resulting
foreclosure would have a material adverse effect on our financial condition.
32
WE HAVE NEVER BEEN PROFITABLE AND MAY NEVER ACHIEVE PROFITABILITY IN THE FUTURE
We had a net loss of approximately $6.4 million for the nine months ended
September 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 IS TRADING ON THE NASDAQ SMALLCAP MARKET AND WE MUST COMPLY
WITH CERTAIN LISTING STANDARDS TO MAINTAIN OUR LISTING ON THE NASDAQ SMALLCAP
MARKET
On August 5, 2004 our common stock began trading on The NASDAQ SmallCap Market.
On August 26, 2004, we received a letter from The NASDAQ Stock Market indicating
that our common stock failed to maintain a minimum closing bid price of $1.00
over the previous 30 consecutive trading days as required by Marketplace Rule
4310(c)(4) and that we have 180 calendar days, or until February 22, 2005, to
regain compliance. If, at any time before February 22, 2005, the bid price of
our common stock closes at $1.00 per share or more for a minimum of 10
consecutive business days. The NASDAQ Stock Market will notify us that we are
back in compliance. If we do not regain compliance by February 22, 2005, we may
be granted an additional 180-day period to regain compliance if the minimum bid
price requirement is the only NASDAQ SmallCap Market initial listing requirement
that we do not then satisfy. If we do not regain compliance within the allotted
compliance period (including any extensions that may be granted), The NASDAQ
Stock Market will notify us that our common stock will be delisted from The
Nasdaq SmallCap Market. At such time, we would be entitled to appeal the
determination to a NASDAQ Listing Qualifications Panel. We are currently
reviewing what actions we should take to regain compliance. 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.
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.
33
WE MAY NOT BE ABLE TO KEEP PACE WITH TECHNOLOGICAL ADVANCES
The process of remotely extracting and managing information from intelligent
devices will likely be characterized by rapid technological change, frequent new
product introductions and emerging industry standards. We also expect that the
rapid evolution of Internet-based applications and standards, as well as general
technology trends such as changes in or introductions of operating systems will
require us to adapt our products to remain competitive. Our products could
become obsolete and unmarketable if we are unable to quickly adapt to new
technologies or standards. To be successful, we will need to develop and
introduce new products and product enhancements that respond to technological
changes, evolving industry standards and other market changes and developments
in a timely manner and on a cost-effective basis. Although we plan to continue
to spend substantial amounts on research and development in the future, we
cannot assure you that we will develop new products and product enhancements
successfully or that our products will achieve broad market acceptance. Our
failure to respond in a timely and cost-effective manner to new and evolving
technologies and other market changes and developments could have a material
adverse effect on our business.
OUR SALES CYCLE FOR DRM SYSTEMS IS LONG AND MAY BE CYCLICAL AND WE TYPICALLY
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 business cycles. 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, companies spend a substantial
amount of time performing internal reviews and obtaining capital expenditure
approvals, before purchasing our products. 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 REVENUES TO FLUCTUATE
GREATLY 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 licensing 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 on 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.
34
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% by 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 have taken
additional measures to reduce expenses. We recorded an aggregate of $1.1 million
in restructuring charges . to reduce staffing levels, terminate some leases and
further consolidate our operations.
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 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.
35
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 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:
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.
36
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 to 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 customers 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 diminished market acceptance of our products;
o increased service and warranty costs; and
o litigation costs.
Although some of our licenses with customers contain provisions designed to
limit our exposure to potential product liability claims these contractual
limitations on liability may not be enforceable. In addition, our product
liability insurance may not be adequate to cover our losses in the event of a
product liability claim resulting from defects in our products and may not be
available to us in the future.
SUBSTANTIAL LITIGATION REGARDING INTELLECTUAL PROPERTY RIGHTS EXISTS IN OUR
INDUSTRY
There is a risk that third-parties, including current and potential competitors
and current developers of our intellectual property, will claim that our
products, or our customers' products, infringe on their intellectual property
rights or that we have misappropriated their intellectual property. Software,
business processes and other property rights in our industry might be
increasingly subject to third-party infringement claims as the number of
competitors grows and the functionality of products in different industry
segments overlaps. Other parties might currently have, or might eventually be
issued, patents that infringe on the proprietary rights we use. Any of these
third parties might make a claim of infringement against us.
We may be required to pay substantial damages and may be restricted or
prohibited from selling our products if it is proven that we have violated 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.
37
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, that they are required to pay or agree to pay to
these or other third parties. We have received notices of up to an aggregate of
$6.5 million asserting rights under the indemnification provisions and warranty
provisions of our license agreements from several of our former digital media
products customers. We may be required to pay substantial damages with respect
to such indemnification assertions, which could have a material adverse effect
on our business, financial condition or results of operations.
OUR BUSINESS IS SUBJECT TO RISKS FROM INTERNATIONAL OPERATIONS SUCH AS LEGAL
UNCERTAINTY, TARIFFS AND TRADE BARRIERS AND POLITICAL AND ECONOMIC INSTABILITY
We conduct business in a number of different countries. We sell products in
numerous countries outside of the United States, including Japan, France,
Switzerland, the Netherlands, Germany and other countries in Europe, Asia and
Latin America. Our operations outside the United States include facilities
located in France. For both the three and nine months ended September 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.
38
Our geographic diversity requires significant management attention and financial
resources 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 RECEIVED IN
ISRAEL
Prior to being acquired by us in December 2001, eMation received grants in
Israel from the Office of the Chief Scientist of Israel's Ministry of Industry
and Trade, or OCS, in the aggregate amount of $1.8 million to fund the
development of our Axeda Supervisor product. We have paid royalties to the OCS
in the aggregate amount of $1.4 million. As of September 30, 2004, the remaining
$0.4 million of principal liability is accrued in accrued expenses. We are
obligated to pay royalties of 3.0% to 3.5% of revenues derived from sales of
products funded through grants received from the OCS, up to a maximum of the
total amount of the grants received. The terms of the OCS grants require that we
manufacture our products that are developed with such grants in Israel. In
addition, we may not transfer the technology developed pursuant to the terms of
these grants to third parties without the prior approval of a governmental
committee.
Additionally, prior to being acquired by us in December 2001, eMation received
grants from the Israeli Government through the Fund for the Encouragement of
Marketing Activities, or Marketing Fund, in the aggregate amount of $1.2 million
and royalties in the aggregate amount of $0.6 million have been repaid. As of
September 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 September 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, and
assuming the exercise of all stock options exercisable by them within 60 days of
September 30, 2004, they would have, in the aggregate, beneficially owned
approximately 6.0 million shares, or approximately 18%, 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.
39
CERTAIN PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BY-LAWS MAKE CHANGES
OF CONTROL DIFFICULT EVEN IF THEY WOULD BE BENEFICIAL TO OUR STOCKHOLDERS
Our 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 the Securities and Exchange Commission
and various bodies appointed by these organizations to interpret existing rules
and create new accounting policies.
40
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 September 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 September 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.
41
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. On approximately
September 23, 2004, the parties to the class action reached an agreement in
principle to settle the class action for $7,000. On September 24, 2004 the
Defendants filed a stipulation with the court, suspending motion and discovery
deadlines pending negotiation of the settlement documents. On October 23, 2004,
the parties to the class action, through their respective counsel, executed a
memorandum of understanding regarding the proposed settlement. Although we
believe that such lawsuits or claims are without merit and that we have
meritorious defenses to the actions, we plan to settle the litigation pursuant
to the October 23, 2004 memorandum of understanding. We have been informed by
our directors' and officers' liability insurance carriers that the full amount
of the cash settlement will be paid by them.
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. On July 15,
2003, the Company's board of directors approved the terms of a settlement
proposal as set forth in a Memorandum of Understanding (the "MOU"), which has
now been memorialized in an executed settlement agreement, an Insurer-Insured
Agreement, an Agreement Among Insurers, and a Special Counsel Agreement. The
settlement agreement and related agreements 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 agrees 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
agreement is 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. On August 4, 2004 the Plaintiffs and Issuer
Defendants filed replies to the Underwriter Defendants. On October 13, 2004 the
Court determined the criteria for Section 11 class certifications, and certified
the Section 11 class in four of the six cases that were the subject of class
certification motions, noting that the Court's intention was to provide strong
guidance to all parties regarding class certification in the remaining two
cases. The Plaintiffs have not yet moved to certify a class in our case.
42
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.
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
was heard on September 7, 2004 and was denied by the court. A case settlement
hearing on our counterclaim was held in September 2004, which was also denied by
the Court. We filed a motion for summary judgment on our counterclaim on October
26, 2004, which is scheduled to be heard on November 30, 2004. On approximately
November 9, 2004, IPM filed its opposition to our October 26, 2004 motion for
summary judgment. We have until November 16, 2004 to file a reply to IPM's
opposition.
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
No. 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 the United States District Court for the District
of Massachusetts against Questra Corporation , one of our competitors, for
infringement of this patent. On November 9, 2004 Questra filed an answer to our
complaint, without filing a substantive counterclaim.
43
On November 10, 2004 Questra filed a lawsuit in the United States District Court
for the Northern district of California against us alleging infringement of U.S.
patent No. 6,377,162, titled "Medical Diagnostic Field Service Method and
Apparatus." , The suit seeks injunctive relief and unspecified monetary damages.
As the complaint was only served November 12, 2004, we are currently reviewing
the matter, including the limits of any potential exposure, with outside
counsel. We plan to vigorously assert all applicable defenses to the litigation,
and in particular will be investigating not only the patent's potential
infringement limitations, but also its core validity and enforceability by
Questra. We are unable to predict the outcome of this matter or reasonably
estimate an amount of loss given its current status.
LEASE
In connection with our acquisition of eMation. Ltd., or eMation, in December
2001, we recorded an unutilized lease obligation of $1,200. Until February 2003
we made payments under the lease totaling $180, resulting in a balance of $1,020
as of September 30, 2004. In May 2003 the lessor provided us with formal notice
of termination of the lease and from June 2003 until May 2004, filed various
complaints against us alleging payment due for rent and other charges under the
lease. On October 18, 2004 we entered into a settlement and release agreement
with the lessor to settle all charges, suits and claims against us. Under the
terms of the settlement and release agreement, we will pay $300,000 payable in
two installments of $150,000 each. The first installment was paid on October 20,
2004, and the second installment is due on October 1, 2005 As a result of the
settlement we reversed $720,000 of the liability, which is included as a
non-cash reduction of other general and administrative expense in the
accompanying consolidated statements of operations for the three and nne months
ended September 30, 2004.
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 6: EXHIBITS
(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.
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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.
November 15, 2004
Axeda Systems Inc.
By: /s/ Robert M. Russell Jr.
----------------------------
Robert M. Russell Jr.
Chairman of the Board and Chief Executive Officer
By: /s/ Thomas J. Fogarty
-----------------
Thomas J. Fogarty
Executive Vice President and Chief Financial Officer
45
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
-------------- -------------
4.1 Securities Purchase Agreement, dated as of October 5, 2004, by and between Axeda Systems Inc. and Laurus
Master Fund, Ltd. (1)
4.2 Secured Convertible Term Note, dated as of October 5, 2004, issued by Axeda Systems Inc. to Laurus Master
Fund, Ltd. (1)
4.3 Common Stock Purchase Warrant, dated as of October 5, 2004, issued by Axeda Systems Inc. to Laurus Master
Fund, Ltd. (1)
4.4 Registration Rights Agreement, dated as of October 5, 2004, by and between Axeda Systems Inc. and Laurus
Master Fund, Ltd. (1)
10.1 Master Security Agreement, dated as of October 5, 2004, by and among Axeda Systems Inc., Axeda Systems
Operating Company, Inc., Liuco, Inc., Ravisent Operating Company Inc., Axeda IP, Inc. and Laurus
Master Fund, Ltd. (1)
10.2 Stock Pledge Agreement, dated as of October 5, 2004, by and between Axeda Systems Inc. and Laurus Master
Fund, Ltd. (1)
10.3 Subsidiary Guaranty, dated as of October 5, 2004, by and among Axeda Systems Operating Company, Inc.,
Liuco, Inc., Ravisent Operating Company Inc. and Laurus Master Fund, Ltd. (1)
10.4 Grant of Security Interest in Patents and Trademarks, dated as of October 5, 2004, by and among Axeda
Systems Inc., Axeda IP, Inc., Axeda Systems Operating Company, Inc. and Laurus Master Fund, Ltd. (1)
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
(1) Incorporated by reference the Registrant's Current Report on Form 8-K dated
October 5, 2004, as filed with the Securities and Exchange Commission on October
12, 2004.