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 March 31, 2005
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ______________
Commission File number 000-26287
Axeda Systems Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 23-2763854
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
21 Oxford Road
Mansfield, Massachusetts 02048
---------------------------
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (508) 337-9200
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
---------------------------
On May 13, 2005, 32,900,984 shares of the registrant's Common Stock, $0.001 par
value, were outstanding.
AXEDA SYSTEMS INC.
FORM 10-Q
Quarter Ended March 31, 2005
Table of Contents
Page
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements (unaudited)
Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004 .......................2
Consolidated Statements of Operations for the three months ended March 31, 2005 and 2004......3
Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004......4
Notes to the Consolidated Financial Statements ...............................................5
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations ........12
Item 3 Quantitative and Qualitative Disclosures About Market Risk ...................................28
Item 4 Controls and Procedures ......................................................................28
PART II - OTHER INFORMATION
Item 1 Legal Proceedings ............................................................................28
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds .................................29
Item 3 Defaults Upon Senior Securities ..............................................................29
Item 4 Submission of Matters to a Vote of Security Holders ..........................................29
Item 5 Other Information ............................................................................29
Item 6 Exhibits .....................................................................................29
Signatures ...................................................................................30
Exhibit Index ................................................................................31
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
PART I FINANCIAL INFORMATION
Item 1: Financial Statements
AXEDA SYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(unaudited)
March 31, December 31,
2005 2004
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 1,841 $ 2,429
Accounts receivable, net 4,173 4,108
Prepaid expenses and other current assets 647 714
--------- ---------
Total current assets 6,661 7,251
Furniture and equipment, net 1,147 1,308
Goodwill 3,640 3,640
Identified intangible assets, net 830 949
Other assets 949 946
--------- ---------
Total assets $ 13,227 $ 14,094
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of note payable $ 751 $ 293
Accounts payable 1,560 1,436
Accrued expenses 3,963 3,923
Income taxes payable 888 780
Deferred revenue 1,604 1,521
--------- ---------
Total current liabilities 8,766 7,953
Non-current liabilities:
Note payable, less current portion 1,820 2,052
Other non-current liabilities 92 103
Financing-related liabilities -- 3,243
--------- ---------
Total liabilities 10,678 13,351
--------- ---------
Commitments and contingencies (Note 5)
Stockholders' equity:
Preferred stock, $0.001 par value; 5,000,000 shares authorized
in 2005 and 2004, none issued or outstanding -- --
Common stock, $0.001 par value; 100,000,000 shares authorized
in 2005 and 50,000,000 shares authorized in 2004; 33,476,938
shares issued in 2005 and 33,173,288 shares issued in 2004 33 33
Additional paid-in capital 150,091 148,027
Deferred stock compensation (90) (90)
Accumulated deficit (146,414) (146,179)
Accumulated other comprehensive income 309 332
Treasury stock at cost, 603,800 shares in 2005 and 2004 (1,380) (1,380)
--------- ---------
Total stockholders' equity 2,549 743
--------- ---------
Total liabilities and stockholders' equity $ 13,227 $ 14,094
========= =========
See accompanying notes to the consolidated financial statements
2
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
(Unaudited)
Three Months Ended March 31,
----------------------------
2005 2004
---- ----
Revenues:
License $ 2,285 $ 2,334
Services and maintenance 1,581 1,181
Hardware 2 20
------------ ------------
Total revenues 3,868 3,535
------------ ------------
Cost of revenues:
License 123 194
Services and maintenance 768 1,123
Software amortization 112 112
------------ ------------
Total cost of revenues 1,003 1,429
------------ ------------
Gross profit 2,865 2,106
------------ ------------
Research and development (R&D)
Other R&D expense 884 1,091
Sales and marketing (S&M)
Non-cash compensation -- 45
Other S&M expense 1,554 2,126
General and administrative (G&A)
Non-cash compensation -- 30
Other G&A expense 1,287 1,898
Depreciation and amortization 196 263
------------ ------------
Total operating costs 3,921 5,453
------------ ------------
Operating loss (1,056) (3,347)
Interest income (expense), net (390) (12)
Other income 1,317 740
------------ ------------
Loss before provision for income taxes (129) (2,619)
Provision for income taxes 106 20
------------ ------------
Net loss $ (235) $ (2,639)
============ ============
Basic and diluted net loss per weighted
average common share outstanding $ (0.01) $ (0.08)
============ ============
Weighted average number of common shares
outstanding used in calculation of basic
and diluted net loss per common share 32,776,796 32,413,006
============ ============
See accompanying notes to the consolidated financial statements.
3
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended March 31,
----------------------------
2005 2004
--------- ----------
Cash flows from operating activities:
Net loss $ (235) $(2,639)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 308 375
Unrealized gain on financing-related liabilities (1,310) (739)
Non-cash interest expense 303 --
Non-cash compensation -- 75
Provision for doubtful accounts -- 7
Changes in items affecting operations:
Accounts receivable (65) 36
Prepaid expenses and other current assets 67 (37)
Other assets (3) 10
Accounts payable 124 103
Accrued expenses and non-current liabilities 66 104
Income taxes payable 108 (39)
Deferred revenue 83 (294)
------- -------
Net cash used in operating activities (554) (3,038)
------- -------
Cash flows from investing activities:
Capital expenditures (38) (40)
------- -------
Net cash used in investing activities (38) (40)
------- -------
Cash flows from financing activities:
Net proceeds from exercise of stock options 14 23
Net repayments under bank line of credit -- (308)
------- -------
Net cash provided by (used in) financing activities 14 (285)
------- -------
Effect of exchange rate changes on cash and cash equivalents (10) 27
------- -------
Net decrease in cash and cash equivalents (588) (3,336)
Cash and cash equivalents:
Beginning of period 2,429 9,617
------- -------
End of period $ 1,841 $ 6,281
======= =======
See accompanying notes to the consolidated financial statements.
4
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 - Overview
Axeda Systems Inc. is a software and services company providing solutions
in an emerging market known as Machine To Machine, or M2M. Solutions in the
M2M market enable communications between people, devices, and systems and
turn the resulting data into information companies can act upon. We
develop, market and sell software products and services used by multiple
industries and customers worldwide for device relationship management, or
DRM, a segment of the M2M market, to access and exploit information located
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
2003, our revenues have been substantially generated from selling DRM
products and services.
On October 5, 2004, we issued a secured convertible term note, or the Note,
in the principal amount of $4,500 and received net proceeds of $3,910. The
Note is convertible into shares of our common stock at an initial fixed
conversion price of $0.48 per share. The Note has a term of three years and
accrues interest at the prime rate plus 2% per year.
We have sustained significant losses from operations and negative cash
flows from operations since our inception. There can be no assurances that
we will be able to generate sufficient revenues or positive cash flows from
operations necessary to achieve or sustain profitability in the short or
long term. For the quarters ended March 31, 2005 and 2004 our net losses
were $235 and $2,639, respectively,, and negative cash flows from
operations were $504 and $3,038, respectively.
The report of our independent registered public accounting firm on our
December 31, 2004 consolidated financial statements included an explanatory
paragraph indicating there is substantial doubt about our ability to
continue as a going concern. Management has developed and begun to
implement a plan to address this issue and allow us to continue as a going
concern through at least the first quarter of 2006. This plan includes
additional financing from new and current investors, continued
cost-cutting, and stabilizing and growing our revenue streams. Although we
believe the plan will be realized, there is no assurance that these events
will occur, or that any financing will be on terms favorable to us. The
accompanying unaudited consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
b) Basis of Presentation
The interim consolidated financial statements of Axeda 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 our financial position,
results of operations and cash flows for the interim periods presented. 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, 2004. The interim results presented are not necessarily
indicative of results for any subsequent quarter or for the year ending
December 31, 2005.
c) Principles of Consolidation
The unaudited consolidated financial statements include our financial
statements and the financial statements of our wholly-owned subsidiaries.
All significant intercompany balances and transactions have been eliminated
in consolidation.
5
d) Cash and Cash Equivalents
We consider all highly liquid instruments purchased with an original
maturity of three months or less to be cash equivalents.
e) Revenue Recognition
We recognize software revenues in accordance with Statement of Position, or
SOP, 97-2, "Software Revenue Recognition," or SOP 97-2, as amended by SOP
98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect
to Certain Transactions," or SOP 98-9. License revenues are recognized in
the period in which persuasive evidence of an arrangement exists, the fee
is fixed or determinable, delivery of the technology has occurred requiring
no significant production, modification or customization and collectibility
is probable.
f) Financial Instruments
Our financial instruments principally consist of cash and cash equivalents,
accounts receivable, accounts payable, and a note payable. Cash and cash
equivalents, accounts receivable and accounts payable are carried at cost,
which approximates fair value. The estimated fair value of the note payable
is approximately $4,226.
g) Computation of Earnings Per Share
We compute earnings per share, or EPS, in accordance with SFAS No. 128,
"Computation of Earnings Per Share," or SFAS 128. In accordance with SFAS
128, basic earnings per share is computed using the weighted average number
of common shares outstanding during the period. Diluted earnings per share
is computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period. Common equivalent shares
consist of the incremental common shares issuable upon the exercise of
stock options and warrants (using the treasury stock method), and the
incremental common shares issuable upon the conversion of the convertible
debt (using the if-converted method). Common equivalent shares are excluded
from the calculation if their effect is anti-dilutive.
i) Quarter Ended March 31, 2005
Options to purchase 6,514,075 shares of common stock with a
weighted-average exercise price of $1.13 per share were outstanding
during the three months ended March 31, 2005 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 3,586,965 options that were vested, with a weighted average
exercise price of $1.38 per share, of which 1,394,018 were vested and
in the money, with a weighted average exercise price of $0.37 per
share. The options have various expiration dates during the next ten
years.
Warrants to purchase 6,587,010 shares of common stock with a
weighted-average exercise price of $1.01 per share were vested and
outstanding during the three months ended March 31, 2005, but were not
included in the calculation of diluted EPS because the effects of
assumed exercise would have an anti-dilutive effect on EPS. The
outstanding warrants include 2,550,000 that were vested and in the
money, with a weighted average exercise price of $0.53 per share. The
warrants have various expiration dates during the next five years.
In addition, 9,323,752 shares issuable upon conversion of debt to
common stock were excluded from EPS because the effects of assumed
conversion would have an anti-dilutive effect on EPS.
ii) Quarter Ended March 31, 2004
Options to purchase 6,364,989 shares of common stock with a
weighted-average exercise price of $1.71 per share were outstanding
during the three months ended March 31, 2004 but were not included in
the computation of diluted EPS because the effects of assumed exercise
would have an anti-dilutive effect on EPS. The outstanding options
include 3,303,064 options that were vested, with a weighted average
exercise price of $2.02 per share, of which 1,438,226 were vested and
in the money, with a weighted average exercise price of $0.19 per
share. The options have various expiration dates during the next ten
years.
Warrants to purchase 2,689,377 shares of common stock with a
weighted-average exercise price of $1.99 per share were vested and
outstanding during the three months ended March 31, 2004, but were not
included in the calculation of diluted EPS because the effects of
assumed 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.
6
h) Stock-based Compensation (see Note 1i)
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.
We account for our stock-based employee compensation plan under the
recognition and measurement principles of APB 25 and related
interpretations. The following table illustrates the effect on net loss and
net loss per share if we had applied the fair value recognition provisions
of SFAS 123 to stock-based compensation:
Three Months Ended March 31,
----------------------------
2005 2004
------- -------
Net loss, as reported $ (235) $(2,639)
Add: Stock-based employee compensation
included in reported net loss -- 75
Deduct: Stock-based employee compensation
expense determined under fair value based
method for all awards (188) (454)
------- -------
Pro forma $ (423) $(3,018)
======= =======
Net loss per common share - basic and diluted:
As reported $ (0.01) $ (0.08)
======= =======
Pro forma $ (0.01) $ (0.09)
======= =======
We used the following assumptions to determine the fair value of stock
options granted using the Black-Scholes option pricing model for the
quarters ended March 31, 2005 and 2004:
2005 2004
---- ----
Dividend yield 0% 0%
Expected volatility 122% 112%
Average expected option life 4 years 4 years
Risk-free interest rate 3.92% 1.12%
In March 2005 we granted options to purchase 325,000 shares of our common
stock to our chief financial officer, with an exercise price of $0.56 per
share, which was equal to the fair market value of our common stock on the
date of grant.
i) Recent Accounting Pronouncements
On April 21, 2005, the SEC approved a new rule for public companies that
delays the effective date of SFAS No. 123R "Share-Based Payment," or SFAS
123R, to annual periods beginning after June 15, 2005. Therefore, we will
postpone the adoption of SFAS 123R until the first quarter of 2006.
SFAS 123R 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.
j) Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
7
2) Acquired Intangible Assets
Acquired intangible assets that are subject to amortization consist of the
following:
Gross Carrying Amount Accumulated Amortization
March 31, 2005 and December
31, 2004 March 31, 2005 December 31, 2004
-------- -------------- -----------------
Developed technology* $ 210 $210 $ 210
Core technology 1,840 1,056 944
Customer base 110 64 57
--- -- --
Total $ 2,160 $1,330 $ 1,211
======= ======== ========
* - fully amortized as of March 31, 2005 and December 31, 2004
Aggregate amortization expense was $119 for each of the three months ended March
31, 2005 and 2004.
3) Accrued Expenses
Accrued expenses consist of the following:
March 31, December 31,
2005 2004
---- ----
Legal and professional fees $ 401 $ 319
Payroll and related costs 1,349 1,065
Royalties to Israeli government agencies 550 734
Sales, excise and other taxes 590 480
Severance 282 520
Unutilized leased facilities 282 302
Other 509 503
--- ---
Total accrued expenses $3,963 $3,923
======= ======
4) Financing-related Liabilities
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.
Equity derivative contracts accounted for as permanent equity are recorded at
their initial fair value and subsequent changes in fair value are not recognized
unless a change in the contracts' classification occurs. Equity derivative
contracts not qualifying for permanent equity accounting are recorded at fair
value as an asset or liability with subsequent changes in fair value recognized
through the statement of operations.
EITF 00-19 provides that the ability to keep SEC filings current is beyond the
control of a registrant. Therefore, the potential liquidated damages we could
have been required to pay pursuant to the registration rights agreements if we
failed to keep our registration statements effective were potential net cash
settlements pursuant to EITF 00-19. While we viewed these liquidated damages
contingencies as neither probable nor reasonably estimable, through February 16,
2005 we recorded the estimated fair value of the warrants issued to Laurus
Master Fund, Ltd., or Laurus, and Special Situations Private Equity Fund, L.P.
and its affiliates, or SSF, as a financing-related liability in the consolidated
balance sheets in accordance with EITF 00-19. The fair value of the
financing-related liability was 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.
8
a) Amendments of Agreements with Laurus and SSF
On February 16, 2005, we amended a series of agreements relating to Laurus
and SSF. Specifically, we:
o amended the registration rights agreement with SSF such that any
liquidated damages that may arise for failure to file a new registration
statement for any shares that may be issued to SSF in the future, to cause
such registration statement to become effective, or to maintain the
effectiveness of such registration statement would be payable in
unregistered shares of common stock rather than cash and we would be
obligated to use our best efforts to subsequently register the shares;
o amended the securities purchase agreement with Laurus such that any
liquidated damages that may arise for failure to deliver shares of common
stock upon conversion of Laurus' Note in a timely manner would be payable
in a warrant to purchase unregistered shares of common stock rather than
cash and we would be obligated to use our best efforts to subsequently
register the underlying shares; and
o amended the registration rights agreement with Laurus such that any
liquidated damages that may arise for failure to file a registration
statement for any shares that may be issued to Laurus in the future to
cause such registration statement to become effective, to maintain the
effectiveness of such registration statement or to keep our common stock
listed or quoted would be payable in a warrant to purchase unregistered
shares of common stock rather than cash and we would be obligated to use
our best efforts to subsequently register the underlying shares.
Effective in February 2005, as a result of these amendments, the accounting
and reporting requirements of EITF 00-19 no longer apply, and the estimated
fair value of the financing-related liabilities after the mark-to-market
valuation adjustment as of February 16, 2005 of $1,934 was reclassified as
additional paid-in capital.
The estimated fair values of the warrants issued to Laurus and SSF were
calculated using the Black-Scholes model using the following assumptions:
February 16, 2005 March 31, 2004
----------------- --------------
Laurus SSF SSF
------ --- ---
Current market price per share $0.53 $0.53 $1.06
Exercise price per share $0.53 $1.35 $1.71
Dividend yield 0% 0% 0%
Expected volatility 107% 107% 111%
Expected life 4.62 years 3.60 years 4.48 years
Risk-free interest rate 3.77% 3.69% 2.96%
On May 4, 2005, we amended the Note and several of the related agreements
for the primary purpose of postponing the principal payments due in May and
June 2005, of $150 each, until September and October 2007, respectively. In
exchange for these amendments, we issued to Laurus a warrant to purchase
750,000 shares of our common stock at an exercise price of $0.37 per share.
The warrant is exercisable for a term of five years and has an estimated
fair value of approximately $300 which will be amortized over the remaining
term of the loan as additional non-cash interest expense.
9
5) 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. On approximately September 23, 2004, the parties to the class
action reached an agreement in principle to settle the class action for $7,000
million. On September 24, 2004, the defendants filed a stipulation with the
Court, suspending motion and discovery deadlines pending negotiation of the
settlement documents. On December 15, 2004, the parties filed with the Court a
Stipulation and Agreement of Settlement to settle the class action for $7,000
million. The Court issued a Preliminary Approval Order on December 21, 2004. A
fairness hearing was held on April 6, 2005. On April 18, 2005, the Court issued
its Order and Final Judgment approving the settlement. Our directors' and
officers' liability insurance carriers paid the full amount of the cash
settlement.
OTHER
We have accrued for estimated losses in the accompanying unaudited 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.
Management's current estimated range of liability related to our pending legal
claims is based on claims for which management can estimate the amount or range
of loss. Because of the uncertainties related to both the amount and range of
loss on the remaining pending legal claims, management is unable to make a
reasonable estimate of the liability that could result from an unfavorable
outcome. As additional information becomes available, we will assess the
potential liability related to our pending legal claims and revise our
estimates. Such revisions in our estimates of the potential liability could
materially impact our results of operations, financial position and cash flows.
6) Segment and Major Customer Information
Segment information is presented in accordance with SFAS No. 131, "Disclosures
About Segments Of An Enterprise And Related Information," or SFAS 131. SFAS 131
requires segmentation based upon our internal organization and disclosure of
revenue and operating income based upon internal accounting methods.
We evaluate operating segment performance based on revenue and gross profit. We
have not historically evaluated segment performance based on operating income or
allocated assets to our individual operating segments.
Three Months Ended March 31,
2005 2004
Revenues:
DRM $ 3,866 $ 3,515
Other 2 20
-- --
Total $ 3,868 $ 3,535
======= =======
Gross profit:
DRM $ 2,863 $ 2,086
Other 2 20
-- --
Total $ 2,865 $ 2,106
======= =======
Three customers accounted for 28%, or $1,082, and 37%, or $1,323, of revenues
for the quarters ended March 31, 2005 and 2004, respectively
10
We sell and license our technology to customers primarily in North America,
Europe and Asia. Our North American operations generated 49% and 37% of our
revenues in the three months ended March 31, 2005 and 2004, respectively, and
our total revenues were derived from the following geographic regions (based on
where the customer is located):
Three Months Ended March 31,
----------------------------------------------
Country/ Geographic Region 2005 2004
- -------------------------- -------------------- ----------------------
Amount % of Total Amount % of Total
------ ---------- ------ ----------
North America:
United States $1,884 49% $1,297 37%
Canada -- -- 9 --
------ ------ ------ ------
Total - North America 1,884 49 1,306 37
------ ------ ------ ------
Europe:
Germany 160 4 121 3
France 615 16 389 11
Netherlands 168 4 222 6
Switzerland 230 6 305 9
United Kingdom 129 3 146 4
Other 269 8 341 10
--- - --- --
Total - Europe 1,571 41 1,524 43
----- -- ----- --
Asia:
Israel 199 5 18 --
Japan 146 3 627 18
Other 28 1 34 1
----- -- ----- --
Total - Asia 373 9 679 19
----- -- ----- --
Other 40 1 26 1
----- -- ----- --
Total $3,868 100% $3,535 100%
====== === ====== ===
7) Consolidated Statements of Cash Flows
Supplemental disclosure of cash flow information:
Three Months Ended March 31,
----------------------------
2005 2004
---- ----
Cash paid during the period for:
Interest $ 1 $ 2
==== ====
Income taxes $ 9 $ 59
==== ====
Non-cash financing activities:
Issuance of 220,578 shares of common stock in connection
with convertible term note (principal and interest) $106 $-
==== ====
Reclassification of financing-related liability to permanent
equity (see Note 4a) $1,934 $-
====== ====
8) Comprehensive Loss
The components of comprehensive loss are as follows:
Three Months Ended March 31,
----------------------------
2005 2004
------- -------
Net loss $ (235) $(2,639)
Foreign currency translation adjustment (23) (5)
------- -------
Comprehensive loss $ (258) $(2,644)
======= =======
11
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 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," "could," "will," "should,"
"seeks," "pro forma," "potential," "anticipates," "predicts," "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, readers are cautioned not to place undue reliance on
such forward-looking statements. Forward-looking statements should be considered
in light of various important factors, including those set forth in this report
under the caption "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 AND RECENT EVENTS
On August 26, 2004, we received a letter from the staff of The NASDAQ Stock
Market informing us 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 had 180 calendar days, or until February
22, 2005, to regain compliance. On November 26, 2004, we received another letter
from The NASDAQ Stock Market informing us that we also did not comply with
Marketplace Rule 4310(c)(2)(B) which requires a company to have a minimum of
$2.5 million in stockholders' equity or $35million market value of listed
securities or $0.5 million of net income from continuing operations for the most
recently completed fiscal year or two of the three most recently completed
fiscal years. We submitted our plan to regain compliance with these rules on
December 13, 2004. On January 7, 2005, The NASDAQ Stock Market informed us that
we did not provide a definitive plan evidencing our ability to achieve near term
compliance with the continued listing requirements or sustain such compliance
over an extended period of time and that our common stock would be delisted.
We appealed the staff's determination to a NASDAQ Listing Qualifications Panel
at a hearing that was held on February 17, 2005. As a result of the hearing, we
were granted continued inclusion on The Nasdaq SmallCap Market under an
exception to the stockholders' equity/market value of listed securities/net
income requirement and the minimum bid price requirement. This continued
inclusion on The Nasdaq SmallCap Market was pursuant to the following
conditions:
o On or before April 30, 2005, we had to publicly announce that we had
stockholders' equity of at least $2.5 million as of March 31, 2005 on
an actual basis.
o If, on or before April 30, 2005, we showed stockholders' equity of at
least $5.0 million, then we would have an extension through August 15,
2005 to evidence compliance with the $1.00 closing bid price
requirement, and immediately thereafter, a closing bid price of at
least $1.00 per share for at least ten consecutive business days (or
such longer period requested by The NASDAQ Stock Market to demonstrate
our ability to maintain long-term compliance with the minimum bid
price requirement).
o If we did not show stockholders' equity of at least $5.0 million on or
before April 30, 2005, then we must show compliance with the $1.00
closing bid price requirement on or before June 30, 2005 and a closing
bid price of at least $1.00 per share for at least ten consecutive
business days (or such longer period requested by The NASDAQ Stock
Market to demonstrate our ability to maintain long-term compliance
with the minimum bid price requirement).
o Our financial statements contained in all periodic reports filed with
the Securities and Exchange Commission and The NASDAQ Stock Market for
reporting periods ending on or before April 30, 2006 must evidence
stockholders' equity of at least $2.5 million.
12
On May 2, 2005 our publicly reported total stockholders' equity exceeded $2.5
million as of March 31, 2005, in compliance with the March 2005 decision of a
NASDAQ Listings Qualifications Panel. We therefore continue to qualify for
continued conditional listing on The Nasdaq SmallCap Market. We must evidence
compliance with the $1.00 per share closing bid price requirement on or before
June 30, 2005 and a closing bid price of at least $1.00 per share for at least
ten consecutive business days thereafter to continue to qualify for continued
listing on The Nasdaq SmallCap Market.
For the three months ended March 31, 2005, our operating expenses decreased by
$1.5 million, or 28%, and our net loss decreased by $2.4 million, or 91%,
compared to the prior year quarter, which reflects the reduction in our cost
structure and increase in revenues.
On October 5, 2004, we entered into definitive agreements with Laurus Master
Fund, Ltd., or Laurus, pursuant to which we issued to Laurus a note in the
principal amount of $4.5 million convertible into shares of our common stock at
an initial fixed conversion price of $0.48 per share. We also issued to Laurus a
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. Interest on the
principal amount is payable monthly, in arrears until the maturity date. The
minimum monthly principal repayment of $0.15 million commences on July 1, 2005,
and continues through the October 5, 2007 maturity date. Principal and interest
are payable in shares of common stock if certain criteria are met.
On September 23, 2003, we issued 4,918,100 shares of our common stock to certain
accredited investors affiliated with Special Situations Private Equity Fund,
L.P., or SSF, in a private placement of our common stock. The shares were sold
at a price of $1.22 per share with net proceeds of approximately $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. Our transaction with Laurus triggered an adjustment to
the exercise price of the SSF warrants. The effect of this adjustment was to
make the SSF warrants exercisable for an additional 655,747 shares, or 3,114,797
shares in the aggregate, at an adjusted exercise price of $1.35 per share.
In February 2005, we amended several of our agreements with Laurus and SSF. We
amended the registration rights agreement with SSF such that any liquidated
damages that may arise for failure to file a registration statement for any
shares that may be issued to SSF in the future, to cause such registration
statement to become effective or to maintain the effectiveness of such
registration statement would be payable in unregistered shares of common stock,
rather than cash and we would be obligated to use our best efforts to
subsequently register the shares. We amended the securities purchase agreement
and registration rights agreement with Laurus such that any liquidated damages
that may arise for failure to deliver shares of common stock upon conversion of
Laurus' note in a timely manner would be payable in a warrant to purchase
unregistered shares of common stock rather than cash and we would be obligated
to use our best efforts to subsequently register the underlying shares. In
addition, any liquidated damages that may arise for failure to file a
registration statement for any shares that may be issued to Laurus in the
future, to cause such registration statement to become effective, to maintain
the effectiveness of such registration statement or to keep our common stock
listed or quoted would be payable in a warrant to purchase unregistered shares
of common stock rather than cash and we would be obligated to use our best
efforts to subsequently register the underlying shares. Effective in February
2005, as a result of these amendments, the mark-to-market accounting and
reporting requirements no longer apply.
On May 4, 2005, we amended the Note and several related agreements for the
primary purpose of having Laurus postpone our repayment of principal in May and
June 2005. These principal repayments will become payable in September 2007 and
October 2007, respectively. In exchange for these amendments, we issued to
Laurus a warrant to purchase 750,000 shares of our common stock at an exercise
price of $0.37 per share. The warrant is exercisable for a term of five years.
At March 31, 2005 our cash and cash equivalents balance was $1.9 million,
compared with $2.4 million as of December 31, 2004. The report of our
independent registered public accounting firm on our December 31, 2004
consolidated financial statements included an explanatory paragraph indicating
there is substantial doubt about our ability to continue as a going concern.
Management has developed and begun to implement a plan to address this issue and
allow us to continue as a going concern through at least the first quarter of
2006. This plan includes additional financing from new and current investors,
continued cost-cutting, and stabilizing and growing our revenue streams.
Although we believe the plan will be realized, there is no assurance that these
events will occur, or that any financing will be on terms favorable to us. Our
unaudited consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
13
Axeda Systems Inc. is a software and services company providing solutions in an
emerging market known as Machine To Machine, or M2M. We develop, market and sell
software products and services used by multiple industries and customers
worldwide for device relationship management, or DRM, , a segment of the M2M
market, to access and exploit information located 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. Our flagship product, the Axeda
DRM system, helps manufacturing and service organizations increase revenue while
lowering costs by proactively monitoring and managing devices deployed at
customer sites around the world. Our customers include Global 2000 companies in
many markets including medical instrument, life sciences, enterprise technology,
office and print production systems, industrial, and building automation.
Representative customers include: Abbott Laboratories, Kodak Versamark, Inc. and
Network Appliance, Inc.
We currently operate in three principal regions: the United States, Europe and
Japan. Despite the continued difficult capital spending climate, our overall
revenues increased by $0.3 million in 2005 due to an increase in services and
maintenance revenues of $0.4 million, offset by decreases in license and
hardware revenues of $0.1 million. The $0.3 million increase in total revenues
in 2005 is due to increases in the U.S. and Europe, partially offset by
decreases in Japan. These net increases were driven by additional spending by
our existing customers, as well as an accelerated acquisition of new customer
accounts. While recurring sales from existing customers and the timing of more
widespread adoption of our product remains difficult to predict, we believe
overall revenues will continue to increase in 2005 due to further orders from
our current customer base, our sales pipeline and improvements in the
marketplace.
14
RESULTS OF OPERATIONS
Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004.
The following table sets forth for the periods indicated, the amount and
percentage of total revenues represented by certain items reflected in our
unaudited consolidated statements of operations:
Axeda Systems Inc.
Unaudited Consolidated Statements of Operations
(In thousands)
Three Months Ended March 31,
2005 2004
------- ------
Percent of Percent of
Amount Revenues Amount Revenues
Revenues:
License $ 2,285 59.1% $ 2,334 66.0%
Services and maintenance 1,581 40.9 1,181 33.4
Hardware 2 -- 20 0.6
------- ------- ------ ------
Total revenues 3,868 100.0 3,535 100.0
------- ------- ------ ------
Cost of revenues:
License 123 3.2 194 5.5
Services and maintenance 768 19.8 1,123 31.8
Software amortization 112 2.9 112 3.1
------- ------- ------ ------
Total cost of revenues 1,003 25.9 1,429 40.4
------- ------- ------- ------
Gross profit 2,865 74.1 2,106 59.6
------- ------- ------- ------
Research and development (R&D)
Other R&D expense 884 22.8 1,091 30.9
Sales and marketing (S&M)
Non-cash compensation -- -- 45 1.3
Other S&M expense 1,554 40.2 2,126 60.1
General and administrative (G&A)
Non-cash compensation -- -- 30 0.9
Other G&A expense 1,287 33.3 1,898 53.7
Depreciation and amortization 196 5.1 263 7.4
------- ------- ------ ------
Total operating costs 3,921 101.4 5,453 154.3
------- ------- ------ ------
Operating loss (1,056) (27.3) (3,347) (94.7)
Interest income (expense), net (390) (10.1) (12) (.3)
Other income 1,317 34.1 740 20.9
----- ---- --- ----
Loss before provision for income taxes (129) (3.3) (2,619) (74.1)
Provision for income taxes 106 (2.8) 20 0.6
------- ------- ------- ------
Net loss $ (235) (6.1) $(2,639) (74.7)
======= ======= ======= ======
15
RESULTS OF OPERATIONS
REVENUES. Our DRM revenues increased by $0.4 million, or 10%, in the first
quarter of 2005 to $3.9 million, compared to $3.5 million in the first quarter
of 2004. This increase in revenue was driven by an accelerated acquisition of
new customer accounts, as well as additional spending by our existing customers.
License revenues decreased 2% to $2.3 million, comparing the first quarters of
2005 and 2004, due in part to the deferral of $0.1 million of certain revenues
pending customer acceptance.
Services and maintenance revenues increased during the same period by 34% to
$1.6 million due to greater demand for our professional services in connection
with the expansion of existing DRM installations, additional maintenance plans
sold with new DRM systems licenses and increasing sales of our hosting solution,
which was launched in the second quarter of 2004.
While recurring sales from existing customers and the timing of more widespread
adoption of our product remains difficult to predict, we believe overall
revenues will increase in 2005 due to further orders from our current customer
base, the size of our sales pipeline and improvements in the marketplace.
Currency movements in the first quarter of 2005 increased revenues by $0.1
million as compared to the first quarter of 2004 due to more favorable exchange
rates. Increases in net revenues due to currency movements are primarily due to
the weakness versus the respective prior year quarter of the U.S. dollar against
the Euro. Although we cannot predict the future movements in currency rates, any
future strengthening of the U.S. dollar against foreign currencies will have an
unfavorable impact on our revenues in 2005.
COST OF REVENUES. For the first quarter of 2005 cost of revenues decreased by
$0.4 million, or 30%, to $1 million compared to $1.4 million in the first
quarter of 2004, due to decreases in staff and staff-related expenses, resulting
from our ongoing cost monitoring initiatives.
Cost of license revenues decreased $0.1 million, or 37%, to $0.1 million due to
lower third-party licensing costs, including no charge in the quarter ended
March 31, 2005 related to royalties that had been due to the Office of the Chief
Scientist in Israel, because the remaining amounts due for those royalties were
charged in the quarter ended March 31, 2004.
Cost of services and maintenance decreased $0.4 million, or 32%, during the same
period, of which $0.3 million is due to the workforce reduction actions
implemented in 2002 through 2004, and $0.1 million is attributable to reduced
severance expense from the prior year.
Currency movements in the first quarter of 2005 increased expenses (operating
and cost of revenues) by $0.1 million as compared to the first quarter of 2004
due to unfavorable exchange rates. Increases in expenses due to currency
movements are due primarily to the weakness versus prior year quarter of the
U.S. dollar against the Euro. Although we cannot predict the future movements in
currency rates, any future strengthening of the U.S. dollar against foreign
currencies will have a favorable impact on our expenses.
GROSS PROFIT. Gross profit increased 36% to $2.9 million in the first quarter of
2005, compared to $2.1 million in the first quarter of 2004 due to the 10%
increase in DRM revenues and the 30% decrease in cost of revenues discussed
above.
The increase in services and maintenance profitability in the quarter, compared
to the prior year quarter, was due to the staffing efficiencies achieved by
previous cost reduction actions commencing in 2002 and continuing through 2004.
We expect services and maintenance gross profit margin to continue to increase
slightly as services and maintenance revenues increase, including revenues from
sales of our hosting service.
The gross profit margin on license revenues for the quarters ended March 31,
2005 and 2004 was 95% and 92%, respectively. The increase in gross profit margin
from license revenues is due to the lower third-party costs described above.
16
OTHER R&D EXPENSE. Other R&D expense consists of staff, staff-related,
professional and other development-related support costs associated with the
development of new DRM products, quality assurance and testing. Other R&D
expense for the quarter ended March 31, 2005 decreased $0.2 million, or 19%, to
$0.9 million, compared with the prior year quarter. The decrease in other R&D
expense for the quarter ended March 31, 2005 was due to decreases in staff and
staff-related expenses of $0.1 million, and the reclassification of $0.1 million
to services and maintenance cost of revenues for the cost of R&D personnel
utilized for professional services engagements. Other R&D expense as a
percentage of total revenues decreased from 31% in 2004 to 23% in 2005, due
primarily to the reduction in other R&D expense and the increase in revenues. We
expect other R&D expense to continue to decrease in 2005 and also expect other
R&D expense to decrease as a percentage of revenues, as we grow our revenues and
optimize our development team to meet our current business requirements.
OTHER S&M EXPENSE. Other S&M expense consists of salaries, travel expenses and
costs associated with trade shows, advertising and other sales and marketing
efforts. Other S&M expense for the quarter ended March 31, 2005 decreased $0.6
million to $1.6 million, or 27%, as compared with the prior year quarter.
Reduced staff and staff-related expense, travel, severance, and other expense
contributed $0.2 million, $0.1 million, $0.2 million, and $0.1 million,
respectively, to the decrease in other S&M expense for the quarter ended March
31, 2005 compared to the prior year quarter, which were partially offset by an
increase in commissions of $0.1 million. As a percentage of revenues, other S&M
expense decreased from 60% to 40% for the quarter ended March 31, 2005, compared
to the same period in 2004, due to reduced S&M expense from the prior year and
the increase in revenues. We expect other S&M expense to decrease in 2005 as a
result of the reorganization that took place in 2004. Additionally, we expect
other S&M expense as a percentage of revenues to decrease as our future revenues
increase.
OTHER G&A EXPENSE. Other G&A expense consists of staff, staff-related, and
support costs for our finance, human resources, legal and other management
departments. Other G&A expense for the quarter ended March 31, 2005 decreased
$0.6 million to $1.3 million, or 32%, as compared with the prior year quarter.
The decrease was due to the prior year staff reductions resulting in reduced
staff and related compensation expense of $0.5 million, changes in insurance
coverage and more favorable premiums resulting in cost savings of $0.1 million
and reductions in travel expenses of $0.1 million as part of our ongoing cost
management initiatives. These decreases were partially offset by an increase in
third party consulting fees of $0.1 million. Other G&A expense as a percentage
of total revenues decreased from 54% in the first quarter of 2004 to 33% in the
first quarter of 2005 due to the reduction in other G&A expense and the increase
in revenues. In 2005, we expect other G&A expense to continue to decrease based
on cost reductions that occurred in 2004, and we also expect other G&A expense
to decrease as a percentage of revenues, as our future revenues increase.
INTEREST INCOME (EXPENSE), NET. Net interest expense increased by $0.4 million
to $0.4 million for the quarter ended March 31, 2005 compared to a nominal
amount of net interest expense for the same period in 2004. The increase is the
result of the amortization totaling $0.3 million of original issue discount and
deferred financing costs incurred in securing the convertible note financing in
October 2004, as well as the coupon interest on the note of $0.1 million.
OTHER INCOME. Other income consists primarily of the mark-to-market non-cash
gain related to the financing-related liabilities recorded in connection with
the SSF and Laurus financings. For the quarter ended March 31, 2005, we recorded
a net mark-to-market non-cash gain of $1.3 million, as compared to $0.7 million
for the quarter ended March 31, 2004. The mark-to-market non-cash gain is
primarily attributable to a lower stock price as of the respective valuation
dates compared to the stock price as of the end of the respective preceding
year. We were required to adjust the fair value of the financing-related
liabilities associated with the warrants held by Laurus and SSF as of the date
of the amendments. The increase in first quarter 2005 income as compared to the
first quarter of 2004 is because there were two financing-related liabilities in
2005 as compared to one in 2004.
17
LIQUIDITY AND CAPITAL RESOURCES
Since March 2001, our operations have largely been financed through the sales of
the assets of our former CE and IA businesses, the sale of shares of our common
stock in a private placement transaction with SSF in September 2003 and the
issuance of the convertible term note to Laurus in a private placement
transaction in October 2004. As of March 31, 2005 we had approximately $1.9
million in cash and cash equivalents.
Net cash used in operating activities for the quarter ended March 31, 2005 was
$0.5 million, compared to $3.0 million for the quarter ended March 31, 2004.
Cash used in operating activities for the first quarter of 2005 was primarily
the result of our net loss of approximately $0.2 million and unrealized
financing-related gains of $1.3 million, offset by non-cash expenses of $0.6
million and other increases in working capital of $0.4 million. Cash used in
operating activities for the first quarter of 2004 was primarily the result of
our net loss of $2.6 million, $0.3 million for the net non-cash expenses and
financing-related gain and other changes in working capital of approximately
$0.1 million. The reduction in net cash used in operations is primarily the
result of the lower net loss.
Net cash used in investing activities for the quarters ended March 31, 2005 and
2004 was less than $0.1 million, and consisted of purchases of furniture and
equipment. We have no material commitments for capital expenditures, and we
anticipate minimal spending on capital expenditures as our needs in operations,
infrastructure and personnel arise.
Net cash provided by financing activities was less than $0.1 million for the
quarter ended March 31, 2005 and was received from stock option exercises during
the quarter. In the first quarter of 2004, net cash used in financing activities
was $0.3 million, and consisted primarily of principal payments reducing
indebtedness.
FINANCING EVENTS AND AMENDMENTS
Laurus
On February 16, 2005, we amended the securities purchase agreement with Laurus
such that any liquidated damages that may arise for failure to deliver shares of
common stock upon conversion of Laurus' note in a timely manner, would be
payable in a warrant to purchase unregistered shares of common stock rather than
cash and we would be obligated to use our best efforts to subsequently register
the underlying shares. We also amended the registration rights agreement with
Laurus such that any liquidated damages that may arise for failure to file a
registration statement for any shares that may be issued to Laurusin the future,
to cause such registration statement to become effective, to maintain the
effectiveness of such registration statement or to keep our common stock listed
or quoted would be payable in a warrant to purchase unregistered shares of
common stock rather than cash and we would be obligated to use our best efforts
to subsequently register the underlying shares.
On May 4, 2005, we amended the note issued to Laurus and several related
agreements for the primary purpose of amending some of the due dates for the
repayment of principal. Specifically, the principal payments due in May and June
2005, of $0.15 million each, were postponed until September and October 2007,
respectively. In exchange for these amendments, we issued to Laurus a warrant to
purchase 750,000 shares of our common stock at an exercise price of $0.37 per
share. The warrant is exercisable for a term of five years.
SSF
On September 23, 2003, we issued 4,918,100 shares of our common stock to SSF in
a private placement of our common stock. The shares were sold at $1.22 per share
with net proceeds of $5.6 million.
On February 16, 2005, we amended the registration rights agreement with SSF such
that any liquidated damages that may arise for failure to file a registration
statement for any shares that may be issued to SSF in the future, to cause such
registration statement to become effective or to maintain the effectiveness of
such registration statement would be payable in unregistered shares of common
stock rather than cash and we would be obligated to use our best efforts to
subsequently register the shares.
18
OTHER
We maintain an irrevocable, cash-secured, standby letter of credit from a bank
for $0.15 million as security for our corporate headquarters lease. The letter
of credit expires on August 31, 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 on
August 31, 2005. This amount is restricted for withdrawal and is included in
other assets (non-current) in our consolidated balance sheets.
LACK OF LIQUIDITY AND AVAILABILITY OF FINANCIAL RESOURCES
We have limited financial resources currently available to invest in new
initiatives, additional key personnel, new equipment and operating capital. The
report of our independent registered public accounting firm on our December 31,
2004 consolidated financial statements included an explanatory paragraph
indicating there is substantial doubt about our ability to continue as a going
concern. Management has developed and begun to implement a plan to address this
issue and allow us to continue as a going concern through at least the first
quarter of 2006. This plan includes additional financing from new and current
investors, continued cost cutting, and stabilizing and growing our revenue
streams. Although we believe the plan will be realized, there is no assurance
that these events will occur or that any financing will be on terms favorable to
us. Our unaudited consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
19
FACTORS THAT MAY AFFECT FUTURE RESULTS
RISK FACTORS
Investing in our common stock involves a high degree of risk. In addition to the
other information in this Quarterly Report on Form 10-Q and the information
incorporated by reference herein, you should carefully consider the risks
described below before purchasing our common stock. If any of the following
risks occur, our business could be materially harmed, and our financial
condition and results of operations could be materially and adversely affected.
As a result, the price of our common stock could decline, and you could lose all
or part of your investment.
IF WE FAIL TO COMPLY WITH THE CONDITIONS OF OUR EXCEPTION PERMITTING OUR
CONTINUED LISTING ON THE NASDAQ SMALLCAP MARKET, OUR COMMON STOCK WILL BE
DELISTED, WHICH MAY CAUSE OUR STOCK PRICE TO DECLINE AND YOU MAY EXPERIENCE A
DECLINE IN YOUR ABILITY TO TRADE OUR STOCK.
We have been granted continued inclusion on The Nasdaq SmallCap Market by a
Nasdaq Listing Qualifications Panel, or the Panel, under an exception to the
stockholders' equity/market value of listed securities/net income requirement
and the minimum bid price requirement, as set forth in Nasdaq Marketplace Rules
4310(c)(2)(B) and 4310(c)(4). Because we publicly announced on May 2, 2005 that
we had stockholders' equity of at least $2.5 million as of March 31, 2005 on an
actual basis, we now have until June 30, 2005 to show compliance with the $1.00
closing bid price requirement and a closing bid price of at least $1.00 per
share for at least ten consecutive business days thereafter (or such longer
period requested by The NASDAQ Stock Market, or Nasdaq, to demonstrate our
ability to maintain long-term compliance with the minimum bid price
requirement). In addition, we will lose our conditional listing unless all of
our financial statements contained in all periodic reports filed with the
Securities and Exchange Commission and Nasdaq for reporting periods ending on or
before April 30, 2006 evidence stockholders' equity of at least $2.5 million.
If we fail to evidence stockholders' equity of at least $2.5 million, fail to
achieve a minimum bid price of $1.00 per share by June 30, 2005 or otherwise
fail to satisfy any other requirement for continued listing, then the Panel will
promptly conduct a written or oral hearing with respect to the failure and
render a determination with respect to our continued listing on The Nasdaq
SmallCap Market, which could result in a delisting of our common stock. The
Panel will continue to monitor our ongoing compliance with the minimum
stockholders' equity threshold until we have demonstrated an ability to sustain
compliance with the rule. In addition, the Panel has reserved the right to
reconsider the terms of the exception based on any event, condition or
circumstance that exists or develops that would, in the opinion of the Panel,
make continued listing of our securities inadvisable or unwarranted.
If we are unable to maintain our listing on The Nasdaq SmallCap Market, our
common stock will be delisted from The Nasdaq SmallCap Market and we will likely
seek to list our common stock on the OTC Bulletin Board or another quotation
system, market or exchange for which we could then qualify. We cannot guarantee,
however, that if we are 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, market or exchange, or, that if we do become listed on
the OTC Bulletin Board or another quotation system, market or exchange that
there would be no interruption in the trading of our common stock or that we
would be able to maintain our listing on such quotation system, market or
exchange.
If our common stock is not listed on any quotation system, market or exchange,
we could incur penalties under certain agreements to which we are a party,
including under the terms of our agreements relating to the convertible
promissory notes and warrants we issued to Laurus on October 5, 2004 which
provide for penalties if our stock is not listed for more than three consecutive
trading days.
If our common stock is delisted from The Nasdaq SmallCap Market, or if our
common stock is not listed on any other quotation system, market or exchange for
any period, the market price of our common stock could decline and you may
experience difficulty in trading our stock, regardless of whether we are able to
list our common stock on another quotation system, market or exchange.
WE MAY NOT HAVE SUFFICIENT FUNDS TO REPAY OUR OBLIGATIONS TO LAURUS WHEN THEY
BECOME DUE.
If we are not able to use shares of our common stock to repay the principal and
interest on the note held by Laurus, we may not have sufficient funds to repay
Laurus when our debt obligations to Laurus become due. Laurus must convert the
monthly principal and interest into shares of our common stock if the following
criteria are met:
o the average closing price of our common stock as reported by
Bloomberg, L.P. on the principal trading exchange or market for our
common stock for the five trading days immediately preceding the
repayment date is greater than or equal to 110% of the conversion
price of the Note (based upon the current conversion price of $0.48,
the average closing price would need to be $0.53);
20
o the amount of such conversion cannot exceed 25% of the aggregate
dollar trading volume of our common stock for the previous 10 trading
days;
o there must be an effective registration statement covering the shares
of our common stock into which the principal and interest under the
Note are convertible or an exemption from registration must be
available pursuant to Rule 144 of the Securities Act; and
o there must be no event of default existing under the Note that has not
been cured or is otherwise waived in writing by Laurus at Laurus'
option.
In addition, we will not be able to issue more than 6,491,440 shares of common
stock at a price of below $0.47 unless these issuances are approved by our
stockholders.
In May 2005, we amended the Note and several related agreements for the primary
purpose of having Laurus postpone our repayment of principal in May 2005 and
June 2005. These principal repayments will become payable in September 2007 and
October 2007, respectively. We may be required to obtain the funds necessary to
repay our 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 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.
WE HAVE NEVER BEEN PROFITABLE AND MAY NEVER ACHIEVE PROFITABILITY IN THE FUTURE.
We had a net loss of approximately $0.2 million for the three months ended March
31, 2005. To date, we have not achieved operating profitability on an annual
basis and have an accumulated deficit of $146.4 million as of March 31, 2005. We
have invested and continue to invest significant resources in product
development, selling and marketing, services and support, and administrative
expenses. To achieve profitability, we will need to increase revenues and/or
reduce expenses significantly. We cannot assure you that our revenues will grow
or that we will achieve or maintain profitability in the future.
OUR FUTURE SUCCESS DEPENDS UPON THE ACCEPTANCE OF OUR DRM SYSTEM SOLUTIONS.
Our future growth will be driven by sales of Axeda DRM systems and related
services. We acquired eMationin 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
Axeda Supervisor, Axeda @aGlance/IT, Axeda Web @aGlance and Axeda FactorySoft
OPC to support our industrial automation business. The market for DRM system
solutions is new and evolving. If the market for our products fails to grow or
grows more slowly than we anticipate, our business will suffer.
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.
21
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.
THE 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 system
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 system 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.
VARIATIONS IN THE LENGTH OF OUR SALES CYCLES COULD CAUSE REVENUES TO FLUCTUATE
GREATLY FROM PERIOD TO PERIOD.
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.
VARIATION IN THE CONVERSION OF OUR REVENUE PIPELINE TO CONTRACTS COULD ADVERSELY
AFFECT OUR REVENUES AND ABILITY TO FORECAST OPERATIONS.
Our revenue pipeline estimates may not consistently correlate to actual revenues
in a particular quarter or over a longer period of time. There has been a shift
in industry-wide buying patterns for enterprise software, from large up-front
purchases to smaller, more frequent purchases over time. A variation in the
revenue pipeline or in the conversion of the revenue pipeline into contracts
could cause us to plan or budget inaccurately and thereby could adversely affect
our business, financial condition or results of operations.
IT MAY BE DIFFICULT, TIME-CONSUMING AND EXPENSIVE FOR OUR CUSTOMERS TO INTEGRATE
OUR DRM SOLUTIONS WITH THEIR PRODUCTS, AND THEY MAY BE UNABLE TO DEPLOY THEIR
PRODUCTS SUCCESSFULLY OR OTHERWISE ACHIEVE THE BENEFITS ATTRIBUTABLE TO OUR DRM
SOLUTIONS.
Our customers often desire to integrate our DRM solutions with their existing
products, computer systems and software programs. This can be complex,
time-consuming and expensive, and may cause delays in the deployment of our
customers' products. As a result, some customers may have difficulty or be
unable to integrate our products successfully or otherwise achieve the benefits
attributable to our products. Delayed or ineffective integration of our DRM
solutions may limit our ability to expand our revenues, and may result in
customer dissatisfaction, causing harm to our reputation.
22
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 more than 50%, reducing staffing levels by 53% by eliminating or not
replacing 111 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 continue to take additional
measures to reduce expenses. We recorded charges of $1.4 million in 2004 to
reduce staffing levels 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.
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.
23
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 being important to our business. We currently have one United States patent
granted and eleven United States patent applications pending relating to our DRM
business and seven 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.
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," and the patent infringement
lawsuit filed in November 2004 against us by one of our competitors charging us
with infringement of U.S. Patent No. 6,377,162, 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:
24
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 AND WE ARE CURRENTLY SUBJECT TO PATENT INFRINGEMENT LITIGATION THAT
COULD HARM OUR BUSINESS.
In June 2004, we filed a complaint in U.S Federal District Court in
Massachusetts against Questra Corporation, one of our competitors, for patent
infringement. In November 2004, Questra filed a patent infringement lawsuit
against us in the United States District Court for the Northern District of
California seeking injunctive relief and unspecified monetary damages. Our
defenses against the suit brought by Questra may be unsuccessful. At this time,
we cannot reasonably estimate the possible range of any loss or damages
resulting from this suit due to uncertainty regarding the ultimate outcome. We
expect that the Questra litigation will result in future legal and other costs
to us, regardless of the outcome, which could be substantial.
There is also a risk that other 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 Questra or others. The defense of infringement
claims and lawsuits, regardless of their outcome, would likely be expensive to
resolve and could require a significant portion of management's time. We cannot
assume that we will prevail in intellectual property disputes regarding
infringement, misappropriation or other disputes. Litigation in which we are
accused of infringement or misappropriation might cause a delay in the
introduction of new products, require us to develop non-infringing technology,
require us to enter into royalty or license agreements, which might not be
available on acceptable terms, or at all, or require us to pay substantial
damages, including triple damages if we are held to have willfully infringed a
third party's intellectual property. If a successful claim of infringement was
made against us and we could not develop non-infringing technology or license
the infringed or similar technology on a timely and cost-effective basis, our
business could be significantly harmed.
In addition, rather than litigating an infringement matter, we may determine
that it is in our best interests to settle the matter. The terms of a settlement
may include the payment of damages and our agreement to license technology in
exchange for a license fee and ongoing royalties. These fees may be substantial.
If we are forced to take any of the actions described above, defend against any
claims from third parties or pay any license fees or damages, our business could
be harmed.
WE HAVE RECEIVED NOTICES OF CLAIMS RELATED TO OUR FORMER PC PRODUCTS (OR DIGITAL
MEDIA PRODUCTS) REGARDING THE ALLEGED INFRINGEMENT OF THIRD PARTIES'
INTELLECTUAL PROPERTY RIGHTS THAT MAY CAUSE US TO PAY DAMAGES.
Some third parties claim to hold patents covering various aspects of digital
television, or DTV, high-definition television, or HDTV, and digital versatile
disc, or DVD, technology incorporated into our former PC products 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:
o 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.
25
o 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.
o 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 France, Switzerland,
Japan, Germany, the Netherlands and other countries in Europe, Asia and Latin
America. Our operations outside the United States include facilities located in
France. For the quarter ended March 31, 2005, we derived approximately 51% of
our revenues from sales to foreign companies. We anticipate that revenues from
international operations will continue to represent a significant portion of our
revenues. As a result, we are subject to risks associated with selling and
operating in foreign countries. For example, some of our contracts with foreign
customers are denominated in foreign currencies. We do not currently hedge
against the risk of such transactions and as a result, we face a risk of loss
related to possible fluctuations in currency exchange rates.
Our geographic diversity requires significant management attention and financial
resources in order 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 internationally.
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.
26
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. As of March 31, 2005 we have paid
royalties to the OCS in the aggregate amount of $1.6 million. As of March 31,
2005, the remaining $0.2 million of principal liability is accrued in accrued
expenses. We are obligated to pay royalties of 3.0% to 3.5% of revenues derived
from sales of products funded through grants received from the OCS, up to a
maximum of the total amount of the grants received. The terms of the OCS grants
require that we manufacture our products that are developed with such grants in
Israel. In addition, we may not transfer the technology developed pursuant to
the terms of these grants to third parties without the prior approval of a
governmental committee.
Additionally, prior to being acquired by us in December 2001, eMation received
grants from the Israeli Government through the Fund for the Encouragement of
Marketing Activities, or Marketing Fund, in the aggregate amount of $1.2 million
and royalties in the aggregate amount of $0.6 million have been repaid. As of
March 31, 2005, $0.3 million 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.
Assuming the exercise of all stock options exercisable by them within 60 days of
April 30, 2005, they would have, in the aggregate, beneficially owned
approximately 5.7 million shares, or approximately 17%, of our outstanding
common stock. These stockholders, if acting together, would be able to
significantly influence all matters requiring approval by our stockholders,
including the election of directors, the approval of mergers or other business
combination transactions or a sale of all or substantially all of our assets.
CERTAIN PROVISIONS IN 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.
27
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. We
are exposed to certain market risks arising from adverse changes in interest
rates, primarily due to the potential effect of such changes on the note held by
Laurus, as described under "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources." We do
not use interest rate derivative instruments to manage exposure to interest rate
changes. If the interest rate on the note held by Laurus, which accrues at the
prime rate plus 2% per year, were to increase by 1% per year, we would incur
additional interest expense of approximately $41,000 in 2005.
Item 4: Controls and Procedures
Under the supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 as of the end of the period covered by this
report, or the Evaluation Date. Based upon the evaluation, our principal
executive officer and principal financial officer concluded that our disclosure
controls and procedures were effective as of the Evaluation Date. Disclosure
controls are controls and procedures designed to reasonably ensure that
information required to be disclosed in our reports filed under the Exchange
Act, such as this report, is recorded, processed, summarized and reported within
the time periods specified in the SEC's rules and forms. Disclosure controls
include controls and procedures designed to reasonably ensure that such
information is accumulated and communicated to our management, including our
chief executive officer and chief financial officer, as appropriate to allow
timely decisions regarding required disclosure.
In connection with this evaluation, our management identified no changes in our
internal control over financial reporting that occurred during the most recent
fiscal quarter that materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
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. On approximately September 23, 2004, the parties to the class
action reached an agreement in principle to settle the class action for $7.0
million. On September 24, 2004, the defendants filed a stipulation with the
Court, suspending motion and discovery deadlines pending negotiation of the
settlement documents. On December 15, 2004, the parties filed with the Court a
Stipulation and Agreement of Settlement to settle the class action for $7.0
million. The Court issued a Preliminary Approval Order on December 21, 2004. A
fairness hearing was held on April 6, 2005. On April 18, 2005, the Court issued
its Order and Final Judgment approving the settlement. Our directors' and
officers' liability insurance carriers paid the full amount of the cash
settlement.
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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 alleged 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 claimed damages of $15.0 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 provided 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 its
complaint on February 19, 2004, which was granted on March 30, 2004, and which
withdrew its fraud complaint and modified its 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 April 13, 2004, we filed a supplement to our 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. The
parties then entered into a written settlement agreement and mutual general
release dated January 14, 2005 which called for a "walk-away" settlement with no
money or other consideration being exchanged. In connection with the settlement
the parties also executed a written stipulation for dismissal of the action with
prejudice. The stipulation for dismissal was filed on February 9, 2005 and the
entire action was dismissed with prejudice.
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."
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
On May 4, 2005, we issued to Laurus a warrant to purchase 750,000 shares of our
common stock at an exercise price of $0.37 per share in consideration for
postponing the payment of some principal payments on the note. The warrant is
exercisable for a term of five years. We issued the warrant in reliance on
Section 4(2) of the Securities Act of 1933, as amended, and Regulation D
thereunder as a transaction not involving any public offering. No advertising or
general solicitation was employed in offering the warrant, the offering and sale
were made to one entity and we restricted transfer of the warrant in accordance
with the requirements of the Securities Act. The recipient of the warrant
represented its intention to acquire the warrant for investment only and not
with a view to or for sale in connection with any distribution thereof, and
appropriate legends were affixed to the instruments issued in such transaction.
Item 3: Defaults Upon Senior Securities
Not applicable.
Item 4: Submission of Matters To a Vote of Security Holders
Not applicable.
Item 5: Other Information
Not applicable.
Item 6: Exhibits
The exhibits listed on the Exhibit Index (following the Signatures section of
this quarterly 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.
May 16, 2005
Axeda Systems Inc.
/s/ Robert M. Russell Jr.
----------------------------
Robert M. Russell Jr.
Chairman of the Board and Chief Executive Officer
/s/ Karen F. Kupferberg
-----------------
Karen F. Kupferberg
Executive Vice President, Chief Financial Officer and Treasurer
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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
-------------- -------------
3.1 Amended and Restated Certificate of Incorporation, as amended. (1)
3.2 Bylaws of Axeda Systems Inc., as amended by the Board of Directors on February 22, 2002. (2)
4.1 Amendment No. 1 to Registration Rights Agreement, dated as of February 16, 2005, by and among Axeda Systems
Inc., Special Situations Private Equity Fund, L.P., Special Situations Technology Fund, L.P. and Special
Situations Technology Fund II, L.P. (3)
4.2 Amendment No. 1 to Securities Purchase Agreement, dated as of February 16, 2005, by and between Axeda
Systems Inc. and Laurus Master Fund, Ltd. (3)
4.3 Amendment No. 1 to Registration Rights Agreement, dated as of February 16, 2005, by and between Axeda
Systems Inc. and Laurus Master Fund, Ltd. (3)
4.4 Agreement, dated as of May 4, 2005, by and between Axeda Systems Inc. and Laurus Master Fund, Ltd. (4)
4.5 Common Stock Purchase Warrant, dated as of May 4, 2005, issued by Axeda Systems Inc. to Laurus Master Fund,
Ltd. (4)
31.1 Certification of the Chief Executive Officer of Axeda Systems Inc. required pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer of Axeda Systems Inc. required pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer and Chief Financial Officer of Axeda Systems Inc. required
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(1) Incorporated by reference to the registrant's Annual Report on Form 10-K, as
filed with the Securities and Exchange Commission on April 12, 2005.
(2) Incorporated by reference to the registrant's Current Report on Form 8-K,
dated February 25, 2002, as filed with the Securities and Exchange Commission on
February 27, 2002.
(3) Incorporated by reference to the registrant's Current Report on Form 8-K
dated February 16, 2005, as filed with the Securities and Exchange Commission on
February 23, 2005.
(4) Incorporated by reference to the registrant's Current Report on Form 8-K
dated May 2, 2005, as filed with the Securities and Exchange Commission on May
6, 2005.
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