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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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Commission File Number 000-23597
EXTENDED SYSTEMS INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 82-0399670
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5777 NORTH MEEKER AVENUE, BOISE, ID 83713
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (208) 322-7575
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|
The number of shares outstanding of the Registrant's Common Stock as of March
31, 2004, was 14,665,188.
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EXTENDED SYSTEMS INCORPORATED
FORM 10-Q
FOR THE NINE MONTHS ENDED MARCH 31, 2004
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2004 and
June 30, 2003 (unaudited) 3
Condensed Consolidated Statements of Operations for the Three
and Nine Months Ended March 31, 2004 and 2003 (unaudited) 4
Condensed Consolidated Statements of Comprehensive Loss for the
Three and Nine Months Ended March 31, 2004 and 2003 (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended March 31, 2004 and 2003 (unaudited) 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations 16
---------------------
Item 3. Quantitative and Qualitative Disclosures about Market Risk 34
----------------------------------------------------------
Item 4. Controls and Procedures 34
-----------------------
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 35
-----------------
Item 6. Exhibits and Reports on Form 8-K 35
--------------------------------
(Items 2,3, 4 and 5 of Part II are not applicable and have been
omitted)
SIGNATURES
CERTIFICATIONS
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EXTENDED SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par values)
(unaudited)
MARCH 31, JUNE 30,
2004 2003
---------- ----------
ASSETS
Current:
Cash and cash equivalents ......................................................... $ 7,756 $ 3,502
Receivables, net of allowances of $392 and $831 ................................... 6,292 5,644
Prepaid and other ................................................................. 961 966
---------- ----------
Total current assets .......................................................... 15,009 10,112
Property and equipment, net ............................................................ 4,362 5,293
Goodwill ............................................................................... 12,489 12,489
Intangibles, net ....................................................................... 715 1,197
Other long-term assets ................................................................. 134 --
---------- ----------
Total assets .................................................................. $ 32,709 $ 29,091
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current:
Accounts payable .................................................................. $ 2,153 $ 2,314
Accrued expenses .................................................................. 3,674 2,888
Deferred revenue .................................................................. 3,168 2,961
Accrued restructuring ............................................................. 312 722
Current portion of long-term debt ................................................. 434 434
Current portion of capital leases ................................................. 24 22
---------- ----------
Total current liabilities ..................................................... 9,765 9,341
Non-current:
Long-term debt .................................................................... 4,800 325
Capital leases .................................................................... 24 42
Other long-term liabilities ....................................................... 133 127
---------- ----------
Total non-current liabilities ................................................. 4,957 494
---------- ----------
Total liabilities ............................................................. 14,722 9,835
Commitments and contingencies--Note 10
Stockholders' equity:
Preferred stock; $0.001 par value per share, 5,000 shares authorized; no
shares issued or outstanding .................................................... -- --
Common stock; $0.001 par value per share, 75,000 shares authorized; 14,665 and
13,977 shares issued and outstanding ............................................ 15 14
Additional paid-in capital ........................................................ 47,045 44,481
Treasury stock; $0.001 par value per share, 17 and 261 common shares .............. -- --
Accumulated deficit ............................................................... (26,946) (23,884)
Unamortized stock-based compensation .............................................. (413) --
Accumulated other comprehensive loss .............................................. (1,714) (1,355)
---------- ----------
Total stockholders' equity .................................................... 17,987 19,256
---------- ----------
Total liabilities and stockholders' equity .................................... $ 32,709 $ 29,091
========== ==========
The accompanying notes are an integral part of the condensed consolidated financial statements.
3
EXTENDED SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
---------------------- ----------------------
2004 2003 2004 2003
-------- -------- -------- --------
Revenue:
License fees and royalties ............................. $ 6,076 $ 5,696 $ 18,904 $ 16,012
Services and other ..................................... 2,231 1,665 5,465 4,141
-------- -------- -------- --------
Total net revenue .................................. 8,307 7,361 24,369 20,153
Cost and expenses:
Cost of license fees and royalties ..................... 132 99 358 317
Cost of services and other ............................. 911 785 2,704 2,311
Research and development ............................... 1,669 1,709 4,595 5,558
Acquired in-process research and development ........... -- -- -- 430
Marketing and sales .................................... 3,901 3,830 11,541 10,761
General and administrative ............................. 1,131 814 3,395 2,763
Restructuring charges .................................. 117 361 1,446 497
Patent litigation fees, license and settlement ......... 2,080 426 3,425 984
Non-cash stock compensation ............................ 169 -- 337 --
Amortization of purchased technology ................... 138 188 482 537
-------- -------- -------- --------
Total costs and expenses ............................ 10,248 8,212 28,283 24,158
Loss from operations ................................ (1,941) (851) (3,914) (4,005)
Other income (expense), net ................................ 4 42 46 (58)
Gain on sale of land ....................................... -- -- 1,058 --
Interest expense ........................................... (139) (65) (318) (264)
-------- -------- -------- --------
Loss before income taxes ........................... (2,076) (874) (3,128) (4,327)
Income tax provision (benefit) ............................. 9 (79) 22 (133)
-------- -------- -------- --------
Loss from continuing operations .................... (2,085) (795) (3,150) (4,194)
Income from discontinued operations, net of tax .... -- 147 88 316
-------- -------- -------- --------
Net loss ........................................... $ (2,085) $ (648) $ (3,062) $ (3,878)
======== ======== ======== ========
Basic earnings (loss) per share:
Loss from continuing operations ........................ $ (0.14) $ (0.06) $ (0.22) $ (0.31)
Earnings from discontinued operations .................. $ 0.00 $ 0.01 $ 0.00 $ 0.02
-------- -------- -------- --------
Net loss per share ......................................... $ (0.14) $ (0.05) $ (0.22) $ (0.29)
======== ======== ======== ========
Diluted earnings (loss) per share:
Loss from continuing operations ........................ $ (0.14) $ (0.06) $ (0.22) $ (0.31)
Earnings from discontinued operations .................. $ 0.00 $ 0.01 $ 0.00 $ 0.02
-------- -------- -------- --------
Net loss per share ......................................... $ (0.14) $ (0.05) $ (0.22) $ (0.29)
======== ======== ======== ========
Number of shares used in per share calculations:
Basic .................................................. 14,601 13,821 14,236 13,221
Diluted ................................................ 14,601 13,821 14,236 13,221
The accompanying notes are an integral part of the condensed consolidated financial statements.
4
EXTENDED SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
----------------------------------------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net loss ............................... $ (2,085) $ (648) $ (3,062) $ (3,878)
Change in currency translation, net .... 1 (167) (359) (207)
---------- ---------- ---------- ----------
Comprehensive income (loss) ........ $ (2,084) $ (815) $ (3,421) $ (4,085)
========== ========== ========== ==========
The accompanying notes are an integral part of the condensed consolidated financial statements.
5
EXTENDED SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
NINE MONTHS ENDED
MARCH 31,
--------------------------
2004 2003
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ....................................................................... $ (3,062) $ (3,878)
Adjustments to reconcile net loss to net cash used by operating activities:
Provision for bad debts .................................................... 123 110
Depreciation and amortization .............................................. 1,189 1,418
Stock compensation ......................................................... 893 --
Acquired in-process research and development ............................... -- 430
Other ...................................................................... -- 283
Gain on sale of property and equipment ..................................... (1,001)
Changes in assets and liabilities, net of effect of acquisitions:
Receivables ............................................................. (122) (871)
Prepaid and other assets ................................................ (283) 470
Accounts payable and accrued expenses ................................... (639) (605)
Deferred revenue ........................................................ 135 (331)
---------- ----------
Net cash used by operating activities ............................... (2,767) (2,974)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ............................................. (310) (82)
Proceeds from sale of property and equipment ................................... 1,564 --
Acquisition - ViaFone, net cash acquired ....................................... -- 1,119
Other investing activities ..................................................... 19 156
---------- ----------
Net cash provided by investing activities ........................... 1,273 1,193
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale-and-leaseback of building ................................... 4,800 --
Proceeds from the issuance of common stock ..................................... 1,240 101
Payments on long-term debt ..................................................... (342) (342)
Borrowings on line of credit ................................................... -- 290
---------- ----------
Net cash provided by financing activities ........................... 5,698 49
Effect of exchange rate changes on cash ........................................ 50 (28)
---------- ----------
Net increase (decrease) in cash and cash equivalents ........................... 4,254 (1,760)
CASH AND CASH EQUIVALENTS:
Beginning of period ............................................................ 3,502 5,439
---------- ----------
End of period .................................................................. $ 7,756 $ 3,679
========== ==========
The accompanying notes are an integral part of the condensed consolidated financial statements.
6
EXTENDED SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------
(unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements include Extended
Systems Incorporated, a Delaware corporation, and its subsidiaries. We have
eliminated all significant intercompany accounts and transactions. Tabular
amounts are in thousands, except years, percentages and per share amounts.
We have prepared these condensed consolidated financial statements without audit
pursuant to the rules and regulations of the Securities and Exchange Commission
(the "SEC"). In the opinion of management, these unaudited condensed
consolidated financial statements include all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of our financial
position as of March 31, 2004, and our results of operations and cash flows for
the three and nine months ended March 31, 2004 and March 31, 2003. The results
for these interim periods are not necessarily indicative of the expected results
for any other interim period or the year ending June 30, 2004. These condensed
consolidated financial statements should be read in conjunction with our audited
consolidated financial statements and related notes thereto included in our
Annual Report on Form 10-K for the fiscal year ended June 30, 2003. The
condensed consolidated balance sheet at June 30, 2003 was derived from audited
financial statements but does not include all the information and footnotes
required by generally accepted accounting principles for complete financial
statements.
The preparation of financial statements in conformity with generally accepted
accounting principles requires that we make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of our financial statements. It
also requires that we make estimates and assumptions that affect the reported
amounts of our revenue and expenses during the reporting periods. Our actual
results could differ from those estimates.
As a result of discontinuing our infrared hardware business in the first quarter
of fiscal 2003, we have reclassified our condensed consolidated statement of
operations and other related disclosures for all periods presented to present
the results of these businesses as discontinued operations. We have made other
reclassifications to the condensed consolidated financial statements to conform
the presentations. These reclassifications had no impact on the net loss for the
years presented.
We have a history of incurring losses from operations and have an accumulated
deficit of approximately $26.9 million as of March 31, 2004. For the nine months
ended March 31, 2004, we incurred a loss from operations of approximately $3.1
million, and negative cash flows from operations of approximately $2.8 million.
At March 31, 2004, we had cash and cash equivalents of $7.8 million. Management
believes that our existing working capital and borrowing capacity will be
sufficient to fund our anticipated working capital and capital expenditure
requirements through at least March 31, 2005.
Management cannot be certain, however, that the underlying assumed levels of
revenues and expenses will be accurate. If operating results were to fail to
meet management's expectations, we could be required to seek additional sources
of liquidity. These sources of liquidity could include raising funds through
public or private debt financing, borrowing against our line of credit or
offering additional equity securities. If additional funds are raised through
the issuance of equity securities, substantial dilution to our stockholders
could result. In the event additional funds are required, adequate funds may not
be available when needed or may not be available on favorable terms, which could
have a negative effect on our business and results of operations.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING DEVELOPMENTS. In January 2003, the FASB issued Interpretation No. 46
("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of
ARB No. 51." FIN 46 requires certain variable interest entities to be
consolidated by the primary beneficiary of the entity if the equity investors in
the entity do not have the characteristics of a controlling financial interest
or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties.
FIN 46 is effective for all new variable interest entities created or acquired
after January 31, 2003. For variable interest entities created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or annual period ending after December 15, 2003. We believe we have no
investment in or contractual relationship or other business relationship with a
variable interest entity, and therefore, the adoption of this interpretation did
not have any impact on our financial position or results of operations.
7
In May 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." SFAS No. 150 requires that
certain financial instruments, which under previous guidance were accounted for
as equity, must now be accounted for as liabilities. The financial instruments
affected include mandatorily redeemable stock, certain financial instruments
that require or may require the issuer to buy back some of its shares in
exchange for cash or other assets and certain obligations that can be settled
with shares of stock. SFAS No. 150 was effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise was effective
beginning July 1, 2003. The adoption of this statement did not have any impact
on our financial position or results of operations.
CURRENCY TRANSLATION. Our international subsidiaries use their local currency as
their functional currency. We translate assets and liabilities of international
subsidiaries into U.S. dollars using exchange rates in effect at the balance
sheet date, and we report gains and losses from this translation process as a
component of comprehensive income or loss. We translate revenue and expenses
into U.S. dollars using the average exchange rate for the period.
From time to time, we enter into foreign currency forward contracts, typically
against the Canadian dollar, euro and the British pound sterling to manage
fluctuations in the value of foreign currencies on transactions with our
international subsidiaries, thereby limiting our risk that would otherwise
result from changes in currency exchange rates. While these instruments are
subject to fluctuations in value, these fluctuations are generally offset by
fluctuations in the value of the underlying asset or liability being managed.
These forward contracts do not qualify for hedge accounting under SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, and, as such, the
contracts are recorded in the consolidated balance sheet at fair value. We
report a net currency gain or loss based on changes in the fair value of forward
contracts combined with the changes in fair value of the underlying asset or
liability being managed. As of March 31, 2004, we had forward contracts with a
nominal value of $9.3 million that matured within 30 days in place against the
Canadian dollar, euro and British pound sterling. We had no forward contracts in
place as of March 31, 2003. We recognized net currency exchange losses of
approximately $45,000 and $17,000 for the three and nine months ended March 31,
2004, respectively and a net currency exchange gain of approximately $36,000 and
a net loss of approximately $82,000 for the three and nine months ended March
31, 2003, respectively.
EARNINGS OR LOSS PER SHARE. We compute basic earnings or loss per share by
dividing net income or loss by our weighted average number of common shares
outstanding during the period. We compute diluted earnings or loss per share by
dividing net income or loss by the weighted average number of common shares
outstanding increased by the additional common shares that would be outstanding
if we had issued the potential dilutive common shares. We exclude from the
diluted earnings or loss per share computations stock options and warrants to
the extent that their effect would have been antidilutive.
Our diluted earnings or loss per share computations exclude the following common
stock equivalents, as the impact of their inclusion would have been antidilutive
for the following periods:
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
-----------------------------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Stock Options ........... 3,346 3,501 3,346 3,501
Warrants ................ 35 35 35 35
8
NOTE 3. STOCK-BASED COMPENSATION PLANS
We apply Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and its related interpretations to measure compensation
expense for stock-based compensation plans. If compensation expense for our
stock option plans had been determined under SFAS No. 123, our net loss would
have been equal to the pro-forma amounts indicated below for the three and nine
months ended March 31:
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
--------------------------------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net loss attributed to common shares, as reported ..................... $ (2,085) $ (648) $ (3,062) $ (3,878)
Add:
Stock-based employee compensation expense included
in reported net loss, net of tax effects .............................. 42 -- 598 --
Less:
Stock-based employee compensation expense determined
under a fair value based method for all grants, net of tax effects .... (746) (1,291) (4,088) (4,275)
-------- -------- -------- --------
Net loss attributed to common shares, pro-forma ....................... $ (2,789) $ (1,939) $ (6,552) $ (8,153)
======== ======== ======== ========
Basic and diluted loss per share:
Net loss, as reported ................................................. $ (0.14) $ (0.05) $ (0.22) $ (0.29)
Net loss, pro-forma ................................................... $ (0.19) $ (0.14) $ (0.46) $ (0.62)
We determined the fair value of options at the date of grant using the
Black-Scholes option-pricing model. We assumed no future dividends would be
paid. The other weighted-average assumptions are as follows for the three and
nine months ended March 31:
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
----------------------------------------------------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Risk-free interest rate:
Option plans ................. 3.75% 3.6% 3.75-4.04% 3.9%
Purchase plan ................ 0.0% 3.7% 0.0 - 3.84% 3.7%
Expected life in years:
Option plans ................. 7.63 7.6 7.6 - 7.63 7.6
Purchase plan ................ 0.0 0.5 0. 0 - 0.5 0.5
Volatility factor:
Option plans ................. 101.4% 102.4% 101.4 -103.1% 102.4%
Purchase plan ................ 0.0% 0.0% 0 - 103.1% 0.0%
Dividend yield ................. 0.0% 0.0% 0.0% 0.0%
9
NOTE 4. DISCONTINUED OPERATIONS
In the first quarter of fiscal 2003, we adopted a formal plan to exit our
infrared hardware business as a result of an expected decline in sales of these
products and our desire to increase our focus on our core software businesses.
As a part of that plan, we wrote down our infrared hardware inventory to its
estimated net realizable value. The results of this operation have been
accounted for as discontinued operations for all periods presented in accordance
with SFAS No. 144 and Accounting Principles Bulletin No. 30. Amounts in the
financial statements and related notes for all periods shown have been
reclassified to reflect the discontinued operations. Operating results for the
discontinued operations are reported, net of tax, under "Income (loss) from
discontinued operations" on the accompanying Condensed Consolidated Statements
of Operations.
The following summarizes the results of discontinued operations:
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
-----------------------------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net revenue ........................................ $ -- $ 520 $ 169 $ 1,143
Income before taxes ................................ -- 239 140 480
Income tax provision ............................... -- 87 52 188
Income from discontinued operations, net of tax .... -- 147 88 316
Earnings per share from discontinued operations:
Basic and diluted ............................. $ 0.00 $ 0.01 $ 0.00 $ 0.02
NOTE 5. RESTRUCTURING CHARGES
We recorded $117,000 and $1.451 million in workforce reduction costs for the
three and nine months ended March 31, 2004, respectively. Of the $1.451 million
recorded for the nine months ended March 31, 2004, $1.446 million related to
continuing operations and the balance of $5,000 was recorded as an expense of
our discontinued operations. For the three and nine months ended March 31, 2004,
the restructuring charge includes $55,000 and $554,000, respectively, of
non-cash compensation resulting from the accelerated vesting of employee stock
options and restricted stock that is not included in the table below. The
restructuring charges for the third quarter of fiscal 2004 consist primarily of
severance, benefits, and other costs related to the termination of 5 employees
in our administration, marketing and sales, and research and development groups
in the United States. The restructuring charges in the first and second quarters
of fiscal 2004 consist primarily of severance, benefits, and other costs related
to the resignations of Karla Rosa, our former Vice President of Finance and
Chief Financial Officer, and Steven Simpson, our former President and Chief
Executive Officer and the termination of 13 employees in our marketing and
sales, research and development, administration and operations groups.
A summary of accrued restructuring charges is as follows:
Workforce Facilities
Reduction and Other
Costs Costs Total
-------- -------- --------
Balance at June 30, 2003 ....................................................... $ 188 $ 534 $ 722
Costs incurred in first quarter of fiscal 2004 ................................. 636 -- 636
Cash payments .................................................................. (255) (146) (401)
-------- -------- --------
Balance at September 30, 2003 .................................................. $ 569 $ 388 $ 957
Costs incurred in second quarter of fiscal 2004 ................................ 199 -- 199
Other Adjustments (1) .......................................................... -- (340) (340)
Cash payments .................................................................. (151) (48) (199)
-------- -------- --------
Balance at December 31, 2003 ................................................... $ 617 $ -- $ 617
Costs incurred in third quarter of fiscal 2004 and true-up of prior amounts .... 62 -- 62
Cash payments .................................................................. (367) -- (367)
-------- -------- --------
Balance at March 31, 2004 ...................................................... $ 312 $ -- $ 312
======== ======== ========
(1) As a result of the Brisbane lease termination during the quarter, the
balance as of October 31, 2003 of restructuring charges related to the lease was
reversed. See Note 10.
10
NOTE 6. GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS
Goodwill is reviewed annually for impairment or more frequently if indicators of
impairment arise. We completed our annual impairment assessment in the fourth
quarter of fiscal 2003 and concluded that goodwill was not impaired.
Goodwill and other identified intangible assets relate to our acquisition of
Rand Software Corporation in 1998, Oval (1415) Limited in 1999, and AppReach and
ViaFone Inc. in 2002. Our goodwill and other identifiable intangible assets
consist of the following:
AS OF MARCH 31, AS OF JUNE 30,
2004 2003
-----------------------------------------------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
-------- -------- -------- -------- -------- --------
Goodwill ................................ $ 12,489 $ -- $ 12,489 $ 12,489 $ -- $ 12,489
Intangibles:
Purchased technology .................. 3,691 (3,031) 660 3,691 (2,561) 1,130
Customer relationships ................ 80 (25) 55 80 (13) 67
Non-compete covenants ................. 6 (6) -- 6 (6) --
Other ................................. 5 (5) -- 5 (5) --
-------- -------- -------- -------- -------- --------
Total intangibles ................... 3,782 (3,067) 715 3,782 (2,585) 1,197
-------- -------- -------- -------- -------- --------
Total goodwill and other intangibles .... $ 16,271 $ (3,067) $ 13,204 $ 16,271 $ (2,585) $ 13,686
======== ======== ======== ======== ======== ========
Amortization of non-goodwill intangible assets was $138,000 and $188,000 for the
quarters ended March 31, 2004 and 2003, respectively, and was $482,000 and
$537,000 for the nine months ended March 31, 2004 and March 31, 2003,
respectively. Based on the identified intangible assets recorded at March 31,
2004, the estimated future amortization expense for the remaining nine months of
fiscal 2004, and fiscal 2005, 2006, 2007 and 2008 is $138,000, $204,000,
$172,000, $172,000, and $29,000, respectively.
AS OF AS OF
MARCH 31, JUNE 30,
NOTE 7. RECEIVABLES 2004 2003
-------- --------
Accounts receivable .................................... $ 6,547 $ 6,377
Other receivables ...................................... 137 98
Allowance for doubtful accounts and product returns .... (392) (831)
-------- --------
$ 6,292 $ 5,644
======== ========
AS OF AS OF
MARCH 31, JUNE 30,
NOTE 8. PROPERTY AND EQUIPMENT 2004 2003
-------- --------
Land and land improvements ............................. $ 533 $ 1,007
Buildings .............................................. 5,904 5,798
Computer equipment ..................................... 5,667 5,702
Furniture and fixtures ................................. 2,328 2,308
-------- --------
14,432 14,815
Less accumulated depreciation .......................... (10,070) (9,522)
-------- --------
$ 4,362 $ 5,293
======== ========
11
AS OF AS OF
MARCH 31, JUNE 30,
NOTE 9. ACCRUED EXPENSES 2004 2003
-------- --------
Accrued payroll and related benefits ................... $ 1,739 $ 1,336
Accrued warranty and support costs ..................... 148 141
Other .................................................. 1,787 1,411
-------- --------
$ 3,674 $ 2,888
======== ========
NOTE 10. COMMITMENTS AND CONTINGENCIES
COMMITMENTS. We currently lease office space at our locations in Boise, Idaho;
Herrenberg, Germany; Toronto, Canada; Corvallis, Oregon; Paris, France; Bristol,
England; San Diego, California; American Fork, Utah; and `s-Hertogenbosch, the
Netherlands. We also lease certain equipment under non-cancelable operating and
capital leases. Lease expense under operating lease agreements was $153,000 and
$221,000 for the three months ended March 31, 2004 and 2003, respectively. For
the nine months ended March 31, 2004 and 2003, operating lease expense was
$559,000 and $566,000, respectively.
On September 26, 2003, we closed a transaction with Hopkins Financial Services
for the sale-and-leaseback of our headquarters building and land in Boise,
Idaho. Because we have a 10-year option to repurchase the building and land at a
price of $5.1 million and we sublet more than a small portion of the building
space, the sale-and-leaseback was recorded as a financing transaction and is
shown as $4.8 million of long-term debt on our balance sheet at March 31, 2004.
As part of the agreement, we entered into a 10-year master lease for the
building with annual lease payments equal to 9.2% of the sale price. We are also
obligated to pay all expenses associated with the building during our lease,
including the costs of property taxes, insurance, operating expenses and
repairs.
On October 24, 2003, we entered into a lease termination agreement with
Epinions.com, the lessor of our office space in Brisbane, California. In
exchange for a termination fee of $255,000 to be paid in seven equal monthly
installments from November 2003 to May 2004, our lease was terminated on October
31. As part of the termination agreement, Epinions.com released us from the
$120,000 letter of credit that collateralized our rental payments.
Upon completion of our acquisition of ViaFone on August 30, 2002, we assumed
$1.1 million of term debt with Silicon Valley Bank ("SVB"). We restructured that
debt into a term loan due in 30 equal monthly installments bearing interest at
8%. The term loan is collateralized by certain of our assets, requires us to
maintain certain financial ratios and is scheduled to be paid in full by March
2005. At March 31, 2004, the loan balance was $434,000.
Our minimum future contractual commitments associated with our operational
indebtedness and lease obligations as of March 31, 2004 are as follows (in
thousands):
YEAR ENDING JUNE 30,
------------------------------------------------------------
2004 2005 2006 2007 2008 THEREAFTER TOTAL
------ ------ ------ ------ ------ ------ ------
SVB debt principal (1) ............................. $ 108 $ 326 $ -- $ -- $ -- $ -- $ 434
SVB debt interest .................................. 8 11 -- -- -- -- 19
Payment pursuant to building sale-and-leaseback .... 110 442 442 442 442 2,317 4,195
Brisbane lease termination fee ..................... 73 -- -- -- -- -- 73
Capital leases (1) ................................. 7 28 12 7 -- -- 54
Operating leases ................................... 116 380 222 186 171 171 1,246
Post-retirement benefits ........................... 15 15 15 15 15 58 133
------ ------ ------ ------ ------ ------ ------
Total commitments ................................ $ 437 $1,202 $ 691 $ 650 $ 628 $2,546 $6,154
====== ====== ====== ====== ====== ====== ======
(1) These amounts are reported on the balance sheet as current and non-current
liabilities, depending on the timing of when payments are due.
12
Non-current capital lease obligations are as follows (in thousands):
AS OF
MARCH 31, 2004
--------
Gross capital lease obligations ................ $ 54
Less imputed interest .......................... (6)
--------
Present value of net minimum lease payments .... 48
Less current portion ........................... (24)
--------
Non-current capital lease obligations .......... $ 24
========
GUARANTEES. We have provided a guarantee that secures our rental payments at our
Bristol, England location. We could be required to perform under this guarantee
if we were to default with respect to any of the terms, provisions, covenants,
or conditions of the lease agreement. This guarantee is valid until the
expiration of our lease on January 13, 2005. The maximum potential amount of
future payments we could be required to make under this letter of credit as of
March 31, 2004 is approximately $25,000.
INDEMNIFICATIONS. We enter into standard indemnification agreements in our
ordinary course of business. Pursuant to these agreements, we indemnify, defend,
hold harmless, and agree to reimburse the indemnified party for losses suffered
or incurred by the indemnified party in connection with any U.S. patent,
copyright or other intellectual property infringement claim by any third party
with respect to our products. The term of these indemnification agreements is
generally perpetual any time after execution of the agreement. The maximum
potential amount of future payments we could be required to make under these
indemnification agreements is unlimited. To date, we have not incurred costs to
defend lawsuits or settle claims related to these indemnification agreements.
As permitted under Delaware law, we have agreements whereby we indemnify our
officers and directors for certain events or occurrences while the officer or
director is, or was, serving at our request in such capacity. The term of the
indemnification period is for the officer's or director's lifetime. The maximum
potential amount of future payments we could be required to make under these
indemnification agreements is unlimited; however, we have a director and officer
insurance policy that limits our exposure and may enable us to recover a portion
of any future amounts paid. We have not incurred costs to defend lawsuits or
settle claims related to these indemnification agreements.
From time to time we enter into indemnification agreements in our ordinary
course of business with certain service providers, such as financial
consultants, whereby we indemnify such service providers from claims, losses,
damages, liabilities, or other costs or expenses arising out of or related to
their services. The maximum potential amount of future payments we could be
required to make under these indemnification agreements in unlimited. To date,
we have not incurred costs to defend lawsuits or settle claims related to these
indemnifications.
WARRANTIES. We offer warranties on both our software products and discontinued
hardware products. We record an accrual for the estimated future costs
associated with warranty claims based upon our historical experience and our
estimate of future costs. We also include in the warranty accrual an amount for
the estimated future costs associated with free support that we provide on
certain products. The adequacy of our warranty accrual is reviewed at least
quarterly and if necessary, adjustments are made.
The following table reconciles the changes in our warranty accrual for the nine
months ended March 31, 2004:
Balance at June 30, 2003 ................................................... $ 141
Accrual for sales made during the three months ended September 30, 2003 .... 59
Warranty expirations during the three months ended September 30, 2003 ...... (53)
--------
Balance at September 30, 2003 .............................................. $ 147
Accrual for sales made during the three months ended December 31, 2003 ..... 73
Warranty expirations during the three months ended December 31, 2003 ....... (72)
--------
Balance at December 31, 2003 ............................................... $ 148
Accrual for sales made during the three months ended March 31, 2004 ........ 73
Warranty expirations during the three months ended March 31, 2004 .......... (73)
--------
Balance at March 31, 2004 .................................................. $ 148
========
LINE OF CREDIT. On January 15, 2002, we entered into a loan and security
agreement with SVB, under which we can access up to $5.0 million of financing in
the form of a demand line of credit. Our borrowing capacity is limited to 75% of
eligible accounts receivable, net of current payments due on our long-term debt.
Certain of our assets collateralize the line of credit. Interest on any
borrowings will be paid at prime plus one percent but not less than 5.5%. The
line of
13
credit agreement requires us to maintain certain financial ratios and expires in
June 2004. As of March 31, 2004, we had no outstanding borrowings on the line of
credit and we were in compliance with all financial covenants required under the
line of credit.
LITIGATION. On March 4, 2004 we mutually agreed with Intellisync Corporation
("Intellisync"), formerly known as Pumatech, Inc., to settle the patent
infringement lawsuit initiated by Intellisync on April 22, 2002. Both companies
agreed to settle all claims and to immediately terminate litigation proceedings.
In connection with the settlement, we made a one-time payment to Intellisync of
$2.0 million and received a license to certain Intellisync patents. This payment
covers estimated past and future royalties on revenue related to our products
shipped and covered under Intellisync's licensed patents. Both companies have
agreed there will be no further patent litigation actions for a period of five
(5) years and that Intellisync will release all of our customers from any claims
of infringement relating to their purchase and future use of our products. For
the three months ended March 31, 2004, based on revenues related to our products
covered by the license, we expensed $1,570,000 of the one-time payment. The
balance of $430,000 was capitalized and will be amortized over future years.
We are also, from time-to-time, a party to legal disputes and proceedings
arising in the ordinary course of general business activities. After taking into
consideration legal counsel's evaluation of such disputes, we do not believe
their outcome will have a material effect on our financial position or results
of operations.
NOTE 11. INCOME TAXES
For the three months ended March 31, 2004, we recorded income tax expense for
continuing operations, related primarily to foreign withholding taxes, of
$9,000. There was no income tax expense or benefit associated with discontinued
operations for the period. For the nine months ended March 31, 2004, we recorded
income tax expense, related primarily to foreign withholding taxes, of $74,000.
The income tax expense associated with continuing operations was $22,000 and
that associated with discontinued operations was $52,000.
For the three months ended March 31, 2003, we recorded income tax expense,
related primarily to foreign withholding taxes, of $8,000. The income tax
benefit associated with continuing operations was $79,000 and the income tax
expense associated with discontinued operations was $87,000. For the nine months
ended March 31, 2003, we recorded income tax expense, related primarily to
foreign withholding taxes, of $55,000. The income tax benefit associated with
continuing operations was $133,000 and the income tax expense associated with
discontinued operations was $188,000.
NOTE 12. BUSINESS SEGMENT, GEOGRAPHIC AREA DATA AND MAJOR CUSTOMERS
We determine our reportable segments by evaluating our management and internal
reporting structure based primarily on the nature of the products offered to
customers and type or class of customers.
At March 31, 2004, we had one operating segment. Our mobile information
management segment includes both mobile data management and wireless
connectivity solutions that enable mobile users to access, collect, synchronize
and print information on demand. Our products include wireless connectivity
products, data synchronization and management software and client/server
database management systems with remote access capabilities. We sell mobile
information management products primarily to original equipment manufacturers,
application developers, enterprises and computer resellers.
Our headquarters is located in the United States. We have research and
development facilities in the United States, United Kingdom and Canada. We
conduct sales, marketing and customer service activities throughout the world
and we have sales offices in North America and Western Europe. Geographic
revenue information is based on the location of the customer.
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------------------------------
NET REVENUE PERCENTAGES BY REGION 2004 2003 2004 2003
------ ------ ------ ------
Domestic ..................................................... 43% 55% 41% 51%
International:
Europe
Comprehensive loss ...................................... 51 40 50 41
Asia ...................................................... 4 4 7 5
Other regions ............................................. 2 1 2 3
------ ------ ------ ------
Total international .................................. 57% 45% 59% 49%
------ ------ ------ ------
Net revenue from continuing operations .... 100% 100% 100% 100%
====== ====== ====== ======
14
Substantially all of our long-lived assets are in the United States.
No customers accounted for more than 10% of our net revenue from continuing
operations in the three or nine months ended March 31, 2004 and 2003.
NOTE 13. RESTRICTED STOCK
On October 31, 2003, the Company granted 134,941 shares of restricted stock to
employees with a purchase price equal to $0.001. The issuance of the restricted
stock grants to employees resulted in an aggregate of $595,000 of unamortized
stock-based compensation, which is being amortized as a non-cash compensation
charge as the restrictions lapse (the vesting period). The restricted stock
charge was calculated based on the closing price of Extended Systems common
stock on October 31, 2003.
On December 11, 2003, the Company granted 32,681 shares of restricted stock to
directors with a purchase price equal to $0.001. The issuance of the restricted
stock grants to directors resulted in an aggregate of $152,000 of unamortized
stock-based compensation, which is being amortized as a non-cash compensation
charge as the restrictions lapse (the vesting period). The restricted stock
charge was calculated based on the closing price of Extended Systems common
stock on December 11, 2003.
The Company amortizes non-cash stock compensation charges on a straight-line
basis over the vesting period. The restricted stock awards granted to employees
vest 100% on the first anniversary of the grant date. The restricted stock
awards granted to directors vest in the amount of one-third on the first
anniversary of the grant date and one-third in each of the following two years.
The director options will lapse in full on the first anniversary of the grant
date if the director attends the required number of board meetings held during
the year. If an employee or director terminates service before vesting is
complete, the restricted stock is repurchased from the individual and any
compensation expense previously recognized is reversed thereby reducing the
amount of stock-based compensation amortization during the period.
During the three and nine months ended March 31, 2004 the Company recognized
stock compensation expense of $169,000 and $337,000, respectively, related to
the above restricted-stock grants.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In addition to historical information, this Quarterly Report on Form 10-Q
contains forward-looking statements. The words "expects," "anticipates,"
"believes," "intends," "will" and similar expressions identify forward-looking
statements that are based upon information currently available to us, speak only
as of the date hereof and are subject to certain risks and uncertainties. These
forward-looking statements include, but are not limited to, statements
regarding:
o levels of software product license fees and royalties;
o levels of international sales;
o levels of service revenue;
o levels of original equipment manufacturer sales;
o anticipated gross margin;
o staffing and expense levels;
o future profitability;
o future results of operations;
o future operating cash flows;
o levels of accounts receivable;
o levels of capital expenditures;
o anticipated costs of research and development;
o sufficiency of working capital and borrowing capacity;
o anticipated cash funding needs;
o expected benefits from our acquisition of ViaFone; and
o the benefits of future acquisitions.
We assume no obligation to update any forward-looking statements and our actual
results may differ materially from the results discussed in such forward-looking
statements. Factors that may cause a difference include, but are not limited to,
those discussed under "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors That May Affect Future Results and
Market Price of Stock." You should also carefully review the risk factors
described in other documents that we file from time to time with the Securities
and Exchange Commission, including our 2003 Annual Report on Form 10-K and other
Quarterly Reports on Form 10-Q that we have filed in fiscal 2004. All period
references are to our third fiscal quarters ended March 31, 2004, and 2003, the
nine months ended March 31, 2004 and 2003 and our fiscal years ended June 30,
2004 and 2003, unless otherwise indicated. All tabular amounts are in thousands,
except percentages.
OVERVIEW
- --------
We plan to grow the business through a concentrated focus on our Mobile
Solutions family of products. During the first quarter of fiscal 2004, we
announced the launch of our OneBridge Mobile Groupware solution with our
patent-pending IP-based push technology. This was the first wireless e-mail
solution in the market to proactively send live e-mail to mobile users using
Palm, Pocket PC or Symbian based devices. During the third quarter of fiscal
2004, we introduced into the market the same Push technology in our overall
Mobile Solutions Platform, which allows our customers to push any type of data
to mobile devices. Our customer base currently uses these products primarily in
applications that mobilize email and personal contact and calendar information.
However, we are also seeing a growing trend where utilizing our products, our
customers are mobilizing their mission critical information, such as field
service requests and inventory availability that can be sent instantly to field
workers with wireless devices. This immediate access to corporate data can
deliver significant increases in productivity, reduction of cycle times,
improved asset management and faster response times to customer needs. The
latest release of our OneBridge products adds support for new dual-purpose
devices including Sony Ericsson's P800 and P900, palmOne's Treo 600, Orange's
M100 Pocket PC Phone and Smartphone SPV E200, and O2's XDA II.
We continue to add and work closely with partners such as Siemens, palmOne,
Orange, Sony Ericsson and others to build our awareness and influence in the
enterprise marketplace. During the third quarter we began activities with
Messaging Architects, a Novell Premier Level DeveloperNet partner, to provide
Novell GroupWise users with wireless access to e-mail and PIM (personal
information management) information on a wide array of mobile devices, including
Palm and Pocket PC-based devices. This capability is based upon our OneBridge
Mobile Groupware platform. During the third quarter we also announced signing a
Master Alliance Agreement with HP that allows for collaborative marketing
efforts on mobile and wireless solutions. This arrangement is designed to
combine our mobile application solution products with HP's products and services
capability to deliver a framework on which enterprises can build their mobility
strategies. With this alliance we plan to address three key areas for enterprise
accounts with mobile needs -- mail and messaging, field service automation and
sales force automation.
16
Our partner activities have resulted in the initiation of several pilot projects
we intend to launch with our partners; however, there can be no certainty that
these pilot projects will lead to future sales.
A portion of our revenue today comes from selling our mobile email products to
large enterprises. Our plans for additional growth come from delivering mobile
applications to these customers and new customers. These plans include working
closely with our partners to develop and implement the mobile applications
customers will need to enable them to manage mission critical business
processes. We expect to increase the amount of business we do together with
partners; however, there can be no assurance that current and prospective
partners will participate with us or that acceptable agreements can be
negotiated with partners.
Since introducing our wireless email and data products, wireless carriers have
entered into discussions to partner with us. We believe the open nature of our
products gives us a competitive advantage over other alternatives available in
the marketplace. Our products enable information technology and network managers
to select the network provider and service level agreement for their
organization according to their requirements and the users can select from a
broad choice of mobile devices that satisfies their unique need. During the
third quarter we announced signing an agreement with Rogers AT&T, Canada's
leading wireless communications service provider, where Extended Systems has
been designated as a preferred vendor to enable the delivery of wireless
application data to Rogers AT&T enterprise customers. In selected European
countries, Orange, one of the UK's most popular wireless carriers, is offering
our OneBridge Mobile Groupware solution to its customers. Orange will provide
the solution to customers on their featured devices including the Orange SPV
E200 and palmOne's Treo 600. We expect to increase the amount of business we do
together with wireless carriers; however, there can be no assurance that the
wireless carriers will be successful in marketing our products to their
enterprise customers.
REVENUE GROWTH
- --------------
We sell our mobile information management products primarily to enterprises,
original equipment manufacturers ("OEMs"), application developers and resellers
both directly and through our e-commerce storefronts on the Internet.
Net revenue from continuing operations for the third quarter of fiscal 2004 was
$8.3 million, which is a 13% increase over the revenues recorded for the third
quarter of last year. Year-to-date our revenues are $24.4 million. We have also
experienced revenue growth in the first nine months of fiscal 2004 with
year-to-date revenues 21% higher than the $20.2 million recorded for the first
nine months of fiscal 2003.
Our third quarter revenue grew across all our product lines in comparison to our
prior year revenues. In comparison to our second quarter, our revenues decreased
2%. We classify our product offerings into one operating segment, our mobile
information management segment, which consists of products and services that
extend enterprise applications to mobile and wireless environments. In the third
quarter and for the first nine months of fiscal 2004 our largest product line
was our Mobile Solutions Product suite, which consists of our One Bridge
products and our XTNDConnect PC products, our second largest product group was
client/server database management systems with remote access capabilities and
the remainder of our sales came from our wireless connectivity Bluetooth and
IrDA products. Our revenue growth in the third quarter and for the first nine
months of fiscal 2004 came from the following product lines:
% GROWTH % GROWTH % GROWTH
3Q FY '04 YTD FY '04 3Q FY '04
COMPARED TO COMPARED TO COMPARED TO
PRODUCT REVENUE GROWTH 3Q FY '03 YTD FY '03 2Q FY '04
---------------------------------------
Mobile Solutions Product Family 8% 14% -2%
Advantage Database Products 3% 2% 1%
Wireless Connectivity Products 2% 5% -1%
---------------------------------------
Total Growth 13% 21% -2%
=======================================
Our future results of operations will be highly dependent upon the success of
our software products and services, specifically our Mobile Solutions Product
Suite and our Wireless Connectivity Software. We expect license fees, royalties
and services revenue generated by these products to continue to constitute the
dominant portion of our revenue. We expect both license revenue and service
revenue to increase in the remaining quarter of fiscal 2004; however, revenue
has fluctuated in the past and may do so again in the future. Fluctuations occur
because the timing
17
of when customers finalize the agreements to purchase our software can be
difficult to predict. In addition, sales of our products to OEMs and to
companies that license our software to include in their own software are
difficult to predict because they are dependent upon the timing of customer
projects and the effectiveness of our customer's marketing efforts. Although we
expect an overall increase in the amount of billable hours of our professional
services group, service revenue may fluctuate from quarter to quarter based on
the amount of revenue we may be required to defer under our revenue recognition
policy and the timing of services engagements.
We derive revenue from:
o software license fees and royalties;
o support and maintenance fees; and
o professional services, including non-recurring development fees that we
generate when we adapt products to customers' specifications and consulting
services.
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
--------------------------------------- ---------------------------------------
2004 % 2003 2004 % 2003
CHANGE CHANGE
--------------------------------------- ---------------------------------------
License fees and royalties .... $ 6,076 7% $ 5,696 $ 18,904 18% $ 16,012
Services and other ............ 2,231 34% 1,665 5,465 32% 4,141
-------- -------- -------- --------
$ 8,307 13% $ 7,361 $ 24,369 21% $ 20,153
LICENSE FEES AND ROYALTIES. License and royalty revenue consists of fees for
licenses of our software products. The growth in revenue in the third quarter of
fiscal 2004 compared to the third quarter of fiscal 2003 was primarily
attributable to a 10% increase in license and royalty revenue from our Advantage
Database products and a 4% increase in our Mobile Solutions product family due
to an increase in licenses sold. The growth in revenue for the first nine months
of fiscal 2004 compared to the first nine months of fiscal 2003 was primarily
attributable to an 18% increase in license and royalty revenue from our Mobile
Solutions product family and a 47% increase in license fees and royalties from
our Wireless Connectivity Software products.
SERVICES AND OTHER. Services revenue consists primarily of support and
maintenance contracts sold to our customers and fees for professional services.
Our professional services typically consist of standard product installations,
training, significant customization of our software products and non-recurring
engineering ("NRE"). Professional services revenue increased by 25% for the
third quarter of fiscal 2004 as compared to the third quarter of fiscal 2003
because of a higher volume of installation, customization, and NRE billings. Our
support and maintenance revenue in the third quarter of fiscal 2004 as compared
to the third quarter of fiscal 2003 also increased by 47%. Professional services
revenue increased for the first nine months of fiscal 2004 as compared to the
first nine months of fiscal 2003 by 23% due to a higher volume of billings. We
also had a 41% increase in support and maintenance revenue in the first nine
months of fiscal 2004 as compared to the first nine months of fiscal 2003.
We derive a significant amount of our revenue from sales to customers outside of
the United States through our European-based sales and support team, overseas
original equipment manufacturers and from a limited number of international
distributors. Based on the region in which the customer resides, net revenue
from continuing operations was as follows for the three and nine months ended
March 31:
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------------------------------
NET REVENUE PERCENTAGES BY REGION 2004 2003 2004 2003
------ ------ ------ ------
Domestic ..................................................... 43% 55% 41% 51%
International:
Europe
Comprehensive loss ...................................... 51 40 50 41
Asia ...................................................... 4 4 7 5
Other regions ............................................. 2 1 2 3
------ ------ ------ ------
Total international .................................. 57% 45% 59% 49%
------ ------ ------ ------
Net revenue from continuing operations .... 100% 100% 100% 100%
====== ====== ====== ======
The percentage of revenue from Europe increased in the third quarter of fiscal
2004 as compared to the third quarter of fiscal 2003, as well as on a
year-to-date basis, as a result of several factors. We have made a significant
investment in our European-based sales and support team, and these investments
have resulted in both obtaining
18
new customers and increasing the amount of purchases from existing customers. We
believe the adoption rate of mobile devices and wireless infrastructure in
Europe is more advanced than in North America and we are benefiting from our
significant presence in this market. Additionally, European revenue increased
due to the decrease in the strength of the US dollar as compared to the Euro and
British Pound Sterling. The relative weakening of the US dollar resulted in
sales to our European customers being greater in U.S. dollars than they would
have been had the exchange rate remained constant for the two periods.
We expect that international sales will continue to represent a substantial
portion of our net revenue in the foreseeable future and will comprise between
55% and 65% of our net revenue for the remaining quarter of fiscal 2004.
COSTS OF REVENUE
- ----------------
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
-------------------------------------- --------------------------------------
GROSS GROSS GROSS GROSS
2004 MARGIN 2003 MARGIN 2004 MARGIN 2003 MARGIN
------ ------ ------ ------ ------ ------ ------ ------
License fees and royalties .... $ 132 98% $ 99 98% $ 358 98% $ 317 98%
Services and other ............ $ 911 59% $ 785 53% $2,704 51% $2,311 44%
LICENSE FEES AND ROYALTIES. The cost of license and royalty revenue consists
primarily of amortization of purchased technology and royalties for the use of
third-party software. Although license and royalty revenue increased 7% and 18%,
respectively, for the third quarter and first nine months of fiscal 2004 as
compared to the same periods in the prior year, there was no significant change
in the cost of license fees and royalties. We expect the cost of license fees
and royalties to increase in absolute dollars in the remaining quarter of fiscal
2004 as a result of an expected increase in revenue from license fees and
royalties. We expect gross margin on license fees and royalties to be in a range
of 98 to 97 percent in the remaining quarter of fiscal 2004.
SERVICES AND OTHER. The cost of services and other consists primarily of
compensation and benefits for our professional services and post-sales support
personnel. The cost of services increased in both the third quarter and first
nine months of fiscal 2004 compared to the same periods in fiscal 2003 primarily
due to the increased number of personnel performing such services.
Gross margin on services revenue increased in the third quarter and the first
nine months of fiscal 2004 as compared to the same periods of fiscal 2003. The
increases are primarily the result of a higher percentage of support and
maintenance revenue, which typically generates higher margins relative to
professional services revenue.
We expect the cost of services in absolute dollars to increase in the remaining
quarter of fiscal 2004 as a result of an expected increase in professional
services revenue. We expect gross margin on services and other revenue to be in
the range of 40 to 55 percent. This range is driven by the mix between
professional services and support and maintenance revenue and the utilization
rate of our professional services personnel. Given the high level of fixed costs
associated with the professional services group, an inability to generate
sufficient services revenue to absorb these fixed costs could lead to lower or
negative gross margins.
PRODUCTIVITY OF R&D RESOURCES
- -----------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
----------------------------- -----------------------------
2004 2003 2004 2003
----------------------------- -----------------------------
Research and development ..... $1,669 (2%) $1,709 $4,595 (17%) $5,558
As a % of net revenue ... 20% 23% 19% 28%
We have had an objective of reducing our overall R&D spending level while
simultaneously increasing productivity. The productivity improvements have been
achieved through a combination of improved processes, elimination of unnecessary
function, and clear ownership and focus. In the third quarter of 2004, we
announced a number of product enhancements or new product releases including:
19
o We incorporated our patent pending IP-based push technology into our
OneBridge Mobile Solutions Platform. This enhancement allows mobile
device users to have live, instant access to information residing on
corporate databases. With this product enhancement, our customers with
mobile employees, such as field service workers or sales
representatives are now able to receive information from corporate
databases wirelessly, with no user initiation required. The OneBridge
Mobile Solutions Platform now supports multiple methods for connecting
mobile devices to corporate information through either browser-based,
transactional, offline synchronization and instant data delivery.
o We released ExtendConnect Mobile Suite, a PC-to-handset
synchronization solution targeted at the mobile handset manufacturers.
This product allows handset manufacturers to implement end-to-end
SyncML v.1.1.2 compliant synchronization capabilities into mobile
phones. The three major components of ExtendConnect Mobile Suite are
an embedded SyncML SDK, a Windows communication suite, and Extended
Systems' XTNDConnect PC desktop synchronization software.
o We delivered our latest Bluetooth SDK, upgraded to be compatible with
the latest specification version 1.2.
Research and development expenses generally consist of salaries and other
personnel costs of our research and development teams, consulting costs and
facility expenses. Research and development expenses in the three months ending
March 31, 2004 as compared to the same period in fiscal 2003 were relatively
unchanged. The decrease in research and development costs in the nine months
ending March 31, 2004 as compared to the same period in fiscal 2003 was
primarily the result of reductions in personnel costs of approximately $910,000
through layoffs, attrition and temporary transfers to support and maintenance
activities. At March 31, 2004 we had 55 full-time equivalent research and
development personnel, a decrease from the 66 full-time equivalent personnel at
the same time last year.
We believe we have achieved many of the productivity goals we set. In the
remaining quarters of fiscal 2004, we do not expect further reductions in R&D
spending and we expect our research and development costs to increase.
EFFECTIVENESS OF THE SALES AND MARKETING ORGANIZATION
- -----------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
---------------------------------- ----------------------------------
2004 CHANGE 2003 2004 CHANGE 2003
---------------------------------- ----------------------------------
Marketing and sales ........... $ 3,901 2% $ 3,830 $ 11,541 7% $ 10,760
As a % of net revenue .... 47% 52% 47% 53%
We have an objective of increasing the effectiveness of the sales and marketing
organization by reducing marketing and sales expense as a percentage of sales.
Marketing and sales expenses consist primarily of salaries, commissions and
other personnel costs of our sales, marketing, and pre-sales support staff. In
the third quarter of 2004 we paid approximately $207,000 more in commissions to
sales employees than in the third quarter of the prior year. Commissions paid to
third parties decreased $124,000 in the same comparison. In addition, our costs
related to hiring new salespersons increased approximately $39,000 and our
travel costs for the sales team increased approximately $55,000 in the third
quarter of fiscal 2004 as compared to the same quarter in fiscal 2003. We
reduced the number of personnel in our marketing and communications department
by 7 people and these reductions resulted in approximately $173,000 less expense
in the third quarter of 2004 as compared to the prior year quarter.
In the first nine months of fiscal 2004 as compared to the first nine months of
fiscal 2003, we paid approximately $626,000 more in commissions to sales
employees and $203,000 more in commissions to third parties. Additionally,
travel costs for the sales team increased approximately $193,000 in the same
comparison. Personnel reductions in our marketing department accounted for a
decrease of approximately $548,000 in expenses. At March 31, 2004 and 2003, we
had 109 full-time equivalent marketing, sales, and support personnel and
contractors.
A portion of the sales and marketing expenses are focused on developing market
awareness of the company and its products through industry media and analysts,
trade shows and other promotional activities. During the third quarter we
incurred expenses related to participation in the Gartner Wireless & Mobile
Summit 2004 in Chicago, Illinois as a Platinum Sponsor; the 3GSM World Congress
2004 in Cannes, France where we launched our ExtendConnect Mobile Suite; and the
CTIA Wireless 2004 in Atlanta, Georgia, where we exhibited with Intel. We also
participated at the CeBIT Conference in Hannover, Germany as a partner of
palmOne, O2 and Sony. Spending on these and other
20
marketing activities increased in the third quarter of fiscal 2004 as compared
to the prior year's third quarter by approximately $29,000 and increased
approximately $137,000 in the first nine months of fiscal 2004 as compared to
the same period in fiscal 2003.
We expect marketing and sales expenses to increase in absolute dollars in the
remaining quarter of fiscal 2004 as a result of an expected increase in revenue,
although we expect these expenses to decrease as a percentage of net revenue. We
expect that the increase in marketing and sales expenses in fiscal 2004 will be
primarily attributable to increased sales compensation.
CONTROL OF GENERAL AND ADMINISTRATIVE EXPENSES
- ----------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, DECEMBER 31,
---------------------------- ----------------------------
2004 CHANGE 2003 2004 CHANGE 2003
---------------------------- ----------------------------
General and administrative ... $1,131 39% $ 814 $3,395 23% $2,763
As a % of net revenue ... 14% 11% 14% 14%
We have an objective to control our general and administrative spending and to
reduce the cost of G&A as a percentage of sales. In the third quarter of 2004
spending increased $317,000 in the quarter as compared to the third quarter of
2003, however, despite this third quarter spending increase and spending
increases earlier in the fiscal year, our general and administrative expenses
remained flat as a percentage of sales for the first nine months of 2004 as
compared to the first nine months of 2003.
General and administrative expenses primarily consist of salaries and other
personnel costs for our finance, management information systems, human resources
and other administrative groups, as well as professional fees for legal and
audit services and directors' and officers' insurance costs. The increase in
general and administrative expenses in the third quarter of fiscal 2004 as
compared to the third quarter of fiscal 2003 was primarily attributable to an
increase of $112,000 in professional services costs for our general legal
services and audit fees. Additionally we incurred $76,000 of increased personnel
related costs as we increased staffing levels in the accounting and finance
organization. The increase in general and administrative expenses for the first
nine months of fiscal 2004 as compared to the first nine months of fiscal 2003
was primarily attributable to an increase of approximately $456,000 in
professional services costs. Included in this increase is an expense in the
first quarter of fiscal 2004 of approximately $575,000 of legal and other
professional services costs related to failed acquisition activities and the
reversal in the first quarter of fiscal 2004 of approximately $513,000 of
accrued professional services costs related to the failed merger with Palm, Inc.
in 2001.
We expect general and administrative expenses as a percentage of net revenue to
remain constant in the remaining quarter of fiscal 2004. We expect decreases in
professional services costs relative to the third quarter; however, these
decreases may be offset by expenses incurred for legal and regulatory compliance
costs associated with being a public company. At March 31, 2004, we had 16
full-time equivalent employees in administration, as compared to 31 full-time
equivalent personnel at the same time last year.
RESTRUCTURING CHARGE
- ---------------------
We recorded $117,000 in workforce reduction costs during the third quarter of
fiscal 2004. The restructuring charges consist primarily of severance, benefits,
and other costs related to the termination of three employees from our research
and development group, one from our sales and marketing group and one from our
human resources group. Of the terminated employees all five were located in the
United States. The restructuring charge includes $55,000 of non-cash
compensation resulting from the accelerated vesting of employee stock options
and restricted stock. We expect to save approximately $35,000 per quarter as a
result of these terminations.
We recorded $1,334,000 in workforce reduction costs during the first and second
quarters of fiscal 2004. The restructuring charges consist primarily of
severance, benefits, and other costs related to the resignations of Steven
Simpson, our former President and Chief Executive Officer, and Karla Rosa, our
former Chief Financial Officer. In addition, we incurred costs related to the
termination of thirteen employees from our marketing and sales, research and
development, operations and general and administration groups. Of the terminated
employees, nine were located in the United States and four were in Europe. The
restructuring charge includes $554,000 of non-cash compensation resulting from
the accelerated vesting of employee stock options.
21
We continue the process of streamlining our business and eliminating unnecessary
functions or redundant positions and locations. We expect restructuring charges
will continue in fourth quarter of this fiscal year.
LITIGATION WITH INTELLISYNC CORPORATION
- ---------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
---------------------------- ----------------------------
2004 2003 2004 2003
---------------------------- ----------------------------
Patent Litigation Fees, License and Settlement .... $2,080 388% $ 426 $3,425 248% $ 984
As a % of net revenue ........................ 25% 6% 14% 5%
On March 4, 2004 we mutually agreed with Intellisync Corporation
("Intellisync"), formerly known as Pumatech, Inc., to settle the patent
infringement lawsuit initiated by Intellisync in April 2002. Both companies
agreed to settle all claims and to immediately terminate litigation proceedings.
In connection with the settlement, we made a one-time payment to Intellisync of
$2.0 million and received a license to certain Intellisync patents. This payment
covers estimated past and future royalties on revenue related to our products
shipped and covered under Intellisync's licensed patents. Both companies have
agreed there will be no further patent litigation actions for a period of five
(5) years and that Intellisync will release all of our customers from any claims
of infringement relating to their purchase and future use of our products. In
our third quarter results we expensed $1,570,000 of the one-time payment based
on revenues related to our products covered by the license. We also incurred
$510,000 of legal expenses before we reached settlement and, combined, these two
amounts total the $2,080,000 expense included in our third quarter results. The
remaining one-time payment balance of $430,000 was capitalized and will be
amortized over future years.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
- ----------------------------------------------------
OVERVIEW
During the first three quarters of fiscal 2004, our liquidity improved as cash
and cash equivalents increased from $3.5 million at June 30, 2003 to $7.8
million at March 31, 2004. This improvement was achieved primarily through the
sale or sale-and-leaseback of non-strategic assets during the first and second
quarter. On September 26, 2003, we closed the sale-and-leaseback of our
headquarters building and land and received approximately $4.6 million in net
cash proceeds after deducting transaction costs. As part of the agreement, we
entered into a 10-year master lease for the building with annual payments equal
to approximately $442,000. In fiscal 2004, we will make payments of
approximately $331,000. On October 15, 2003, we closed the sale of excess land
adjacent to our headquarters building in Boise, Idaho. We received approximately
$1.5 million in net cash proceeds after deducting fees related to the
transaction. Offsetting these cash additions was the one-time payment of $2.0
million made during the third quarter to Intellisync Corporation in settlement
of the patent litigation.
The company continued to incur losses from operations, which have required cash
and cash equivalents to fund these losses. The company has made progress in
reducing the amount of loss from operations and the amount of cash required to
find these losses. The loss from operations including the portion of the
Intellisync settlement expensed during the third quarter was $3.9 million in the
first nine months of fiscal 2004 as compared to $4.0 million in the first nine
months of fiscal 2003. We continue to execute our plans for revenue growth and
expense control to reduce the loss from operations and return the company to
profitable operations; however, we cannot be certain that our underlying assumed
levels of revenue and expenses will be accurate.
Our liquidity is affected by many factors, some of which are based on normal
ongoing operations of our business and some of which arise from uncertainties
related to global economics. In light of the improving economic conditions and
our anticipation of the upswing in corporate spending on information technology
infrastructure, we may now anticipate reaching the point at which we generate
cash in excess of our operating expenses in the fourth quarter of fiscal 2004.
We believe that our existing cash and cash equivalents, together with our
borrowing capacity and the funds we expect to generate from our operations will
be sufficient to fund our anticipated working capital, capital expenditure, debt
maturities and operating expense requirements for the next 12 months. If our
operating results were to fail to meet
22
our expectations or if accounts receivable, or other assets were to require a
greater use of cash than is currently anticipated, we could be required to seek
additional sources of liquidity.
We intend to continue to pursue strategic acquisitions of, or strategic
investments in, companies with complementary products, technologies or
distribution networks in order to broaden our mobile information management
product offerings. We currently have no commitments or agreements regarding any
material transaction of this kind; however, we may acquire businesses, products
or technologies in the future. As a result, we may require additional financing
in the future and, if we were required to obtain additional financing in the
future, sources of capital may not be available on terms favorable to us, if at
all.
NET CASH USED BY OPERATING ACTIVITIES
NINE MONTHS ENDED MARCH 31,
---------------------------
2004 2003
-------- --------
Net cash used by operating activities ......... $ (2,767) $ (2,974)
Net cash used by operating activities in the first nine months of fiscal 2004
was primarily the result of our net loss of $3,062,000, which included $1.6
million of the $2.0 million paid to Intellisync Corporation, in the first nine
months of fiscal 2004. Also included in this loss was a gain of $1,001,000,
primarily from the sale of non-strategic land assets and non-cash charges of
$612,000 for stock compensation related primarily to the severance of the
company's former CEO and CFO. In the second and third quarters of fiscal 2004,
$281,000 of non-cash charges were recorded for restricted stock grants made to
members of the company's Board of Directors and employees. We anticipate charges
of $190,000 in the fourth quarter of fiscal 2004 related to these restricted
stock grants.
The timeliness in the collection of accounts receivable impacts the amount of
cash and cash equivalents. Accounts receivable, net of allowances, were $6.3
million and $5.6 million at March 31, 2004 and June 30, 2003, respectively. Days
sales outstanding (DSO), which is calculated based on the pattern of business
method was 67 and 65 for the quarters ended March 31, 2004 and June 30, 2003.
The increase in accounts receivable from the end of the fiscal 2003 was due
primarily to an increase in total net revenue. We expect that our accounts
receivable will increase in the remainder of fiscal 2004 as a result of an
expected increase in net revenues. Accounts receivable may also increase in the
future if net revenue from international customers becomes a higher percentage
of our net revenue. Generally, these customers have longer payment cycles.
NET CASH PROVIDED BY INVESTING ACTIVITIES
NINE MONTHS ENDED MARCH 31,
---------------------------
2004 2003
-------- --------
Net cash provided by investing activities....... $ 1,273 $ 1,193
Net cash from investing activities in the first nine months fiscal 2004 was
primarily the result of $1.5 million in net cash proceeds from the sale of
non-strategic land. Cash was used in the first nine months of fiscal 2004 for
tenant improvements we made to the subleased portion of the unused space at our
headquarters building pursuant to our lease agreements for the space. Net cash
provided by investing activities in the first half of fiscal 2003 was primarily
the result of completing the acquisition of ViaFone.
We plan to incur aggregate capital expenditures of approximately $675,000 during
the final quarter of fiscal 2004, primarily for infrastructure software.
NET CASH PROVIDED BY FINANCING ACTIVITIES
NINE MONTHS ENDED MARCH 31,
---------------------------
2004 2003
-------- --------
Net cash provided by financing activities....... $ 5,698 $ 49
Net cash provided by financing activities in the first three quarters of fiscal
2004 consisted primarily of $4.8 million in cash proceeds we received from the
sale-and-leaseback of our headquarters building in Boise, Idaho. In addition,
23
$1.2 million of cash was provided by the exercise of employee stock options
during the first nine months of fiscal 2004. Net cash provided by financing
activities in the first three quarters of fiscal 2003 resulted from borrowings
on our line of credit and the exercise of employee stock options, offset by
payments on term debt assumed as part of our acquisition of ViaFone.
On January 15, 2002, we entered into a loan and security agreement with Silicon
Valley Bank, under which we can access up to $5.0 million of financing in the
form of a demand line of credit, subject to the balance of domestic current
accounts receivable balances net of current payments due on our term debt with
SVB. The line of credit is collateralized by certain of our assets. Interest on
any borrowings will be paid at prime plus one percent but not less than 5.5%.
The line of credit agreement requires us to maintain certain financial ratios
and expires on June 30, 2004. We are in compliance with all covenants and there
are no outstanding draws on this facility.
Upon completion of our acquisition of ViaFone on August 30, 2002, we assumed
$1.1 million of term debt with SVB. This debt has been restructured into a term
loan due in 30 equal monthly installments bearing interest at 8%. The term loan
is collateralized by certain of our assets, requires us to maintain certain
financial ratios and is scheduled to be paid in full by March 2005.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
In preparing our consolidated financial statements in conformity with accounting
principles generally accepted in the United States, we make estimates,
assumptions and judgments that can have a material impact on our net revenue,
operating income and net income (loss), as well as on the value of certain
assets on our consolidated balance sheet. We believe that the estimates,
assumptions and judgments involved in the accounting policies described below
have the greatest potential impact on our consolidated financial statements, so
we consider these to be our critical accounting policies. The policies described
below are not intended to be a comprehensive list of all our accounting
policies. In many cases, the accounting treatment of a particular transaction is
specifically dictated by generally accepted accounting principles, with no need
to apply any judgment of management. There are also areas in which management's
judgment in selecting any available alternative would not produce a materially
different result. Our audited consolidated financial statements and notes
thereto contain our significant accounting policies and other disclosures
required by generally accepted accounting principles. The accounting policies
that we consider critical to an understanding of the consolidated financial
statements are highlighted below.
LEGAL CONTINGENCIES
From time-to-time we may be involved in various legal proceedings and claims.
Periodically, but not less than quarterly, we review the status of each
significant matter and assess our potential financial exposure. If the potential
loss from any legal proceeding or claim is considered probable and the amount
can be reasonably estimated, we accrue a liability for the estimated loss.
Significant judgment is required in both the determination of probability and
the determination as to whether an exposure is reasonably estimable. Due to the
uncertainties related to these matters, accruals are based only on the best
information available at the time. As additional information becomes available,
we reassess the potential liability related to our pending litigation and claims
and may revise our estimates. Such revisions could have a material impact on our
results of operations and financial condition.
REVENUE RECOGNITION
To recognize software revenue we apply the provisions of Statement of Position
97-2, SOFTWARE REVENUE RECOGNITION (SOP 97-2), as amended by SOP 98-9, and
generally recognize revenue when all of the following criteria are met: (1)
persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the
fee is fixed or determinable and (4) collection of the resulting receivable is
reasonably assured.
At the time of the transaction, we assess whether the fee associated with our
revenue transactions is fixed or determinable, based on the payment terms
associated with the transaction. If a significant portion of a fee is due after
the shorter of our normal payment terms or 90 days, we account for the fee as
not being fixed or determinable. In these cases, we recognize revenue as the
fees become due and payable. If we had assessed the fixed or determinable
criterion differently, the timing and amount of our revenue recognition may have
differed materially from that reported.
At the time of the transaction we also assess whether or not collection is
reasonably assured based on a number of factors, including past transaction
history with the customer and credit-worthiness of the customer. We do not
request collateral from our customers. If we determine that collection of a fee
is not reasonably assured, we defer recognition of the fee as revenue, and
recognize revenue at the time collection becomes reasonably assured, which is
generally
24
upon receipt of cash. If we assessed collectibles differently, the timing and
amount of our revenue recognition may have differed materially from that
reported.
For arrangements with multiple obligations (for instance, undelivered
maintenance and support), we allocate revenue to each component of the
arrangement using the residual value method. This means that we defer revenue
from the total fees associated with the arrangement equivalent to the
vendor-specific objective evidence of fair value of the elements of the
arrangement that have not yet been delivered. The vendor-specific objective
evidence of fair value of an undelivered element is generally established by
using historical evidence specific to Extended Systems. For example, the
vendor-specific objective evidence of fair value for maintenance and support is
based upon separate sales of renewals to other customers or upon the renewal
rates quoted in the contracts, and the fair value of services, such as training
or consulting, is based upon separate sales by us of these services to other
customers. If we allocated the respective fair values of the elements
differently, the timing of our revenue recognition may have differed materially
from that reported. For certain of our products, we do not sell maintenance
separately but do provide minimal support and bug fixes and, from time to time,
minor enhancements to ensure that the products comply with their warranty
provisions. Accordingly, we allow for warranty costs at the time the product
revenue is recognized.
When we license our software to OEMs or to companies that include our software
in their software offering, royalty revenue is generally recognized when
customers report to us the sale of software to their end user customer. In cases
where the arrangement with our customer provides for a prepaid nonrefundable
royalty, we generally recognize revenue when persuasive evidence of an
arrangement exits, delivery has occurred, the fee is fixed or determinable and
collection of the resulting receivable is reasonably assured.
We recognize revenue for support and maintenance services ratably over the
contract term, which is usually 12 months, and we generally, recognize revenue
from training services as these services are performed. For professional
services that involve significant implementation, customization, or modification
of our software that is essential to the functionality of the software, we
generally recognize both the service and related software license revenue over
the period of the engagement, using the percentage-of-completion method. In
cases where our professional services involve customizations for which the
amount of customization effort cannot be reasonably estimated, where significant
uncertainty about the project completion exists, or where an arrangement
provides for customer acceptance, we defer the contract revenue under the
completed contract method of accounting until the uncertainty is sufficiently
resolved or the contract is complete. If we were to make different judgments or
utilize different estimates of the total amount of work we expect to be required
to complete an engagement, the timing of our revenue recognition from period to
period, as well as the related margins, might differ materially from that
previously reported.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS
We assess the impairment of identifiable intangibles, fixed assets and goodwill
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable. Goodwill is reviewed for impairment annually in accordance
with SFAS No. 142, " Goodwill and Other Intangible Assets." Factors we consider
important that could trigger an impairment review include, but are not limited
to: (1) significant under performance relative to historical or projected future
operating results, (2) significant changes in the manner of our use of the
acquired assets or the strategy for our overall business, (3) significant
negative industry or economic trends, (4) a significant decline in our stock
price for a sustained period, and (5) our market capitalization relative to net
book value. When we determine that the carrying value of long-lived assets may
not be recoverable based upon the existence of one or more of the above
indicators of impairment, we measure any impairment based on a market
capitalization approach when the information is readily available. When the
information is not readily available, we use a projected discounted cash flow
method using a discount rate commensurate with the risk inherent in our current
business model to measure any impairment. If we made different judgments or
utilized different estimates our measurement of any impairment may have differed
materially from that reported.
INCOME TAXES
On a quarterly basis we evaluate our deferred tax asset balance for
realizability. To the extent we believe it is more likely than not that some or
all of our deferred tax assets will not be realized, we establish a valuation
allowance against the deferred tax assets. As of March 31, 2004, we had recorded
a valuation allowance against 100 percent of our net deferred tax assets due to
uncertainties related to our ability to utilize our deferred tax assets,
primarily consisting of certain net operating losses carried forward and foreign
tax credits, before they expire. This valuation allowance was recorded based on
our estimates of future U.S. and foreign jurisdiction taxable income and our
judgments regarding the periods over which our deferred tax assets will be
recoverable. If we made different judgments or utilized different estimates, the
amount or timing of the valuation allowance recorded may have differed
materially from that reported. In the event that actual results differ from
these estimates or we adjust these estimates
25
in future periods, we may need to reduce the valuation allowance, potentially
resulting in an income tax benefit in the period of reduction, which could
materially impact our financial position and results of operations.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain an allowance for doubtful accounts based on a continuous review of
customer accounts, payment patterns and specific collection issues. Where
specific collection issues are identified, we record a specific allowance based
on the amount that we believe will not be collected. For accounts where specific
collection issues are not identified, we record an allowance based on the age of
the receivable and historical collection patterns. If we made different
judgments or utilized different estimates, the timing and amount of our
allowance may have differed materially from that reported.
EFFECTS OF FOREIGN CURRENCY EXCHANGE RATES
- ------------------------------------------
We derive a substantial portion of our net revenue from sales outside of the
United States, principally through our international subsidiaries and through a
limited number of independent distributors and overseas OEMs. Sales made by our
international subsidiaries are generally denominated in each country's
respective currency. Fluctuations in exchange rates could cause our results to
fluctuate when we translate revenue and expenses denominated in other currencies
into U.S. dollars. Fluctuations in exchange rates also may make our products
more expensive to OEMs and independent distributors who purchase our products in
U.S. dollars.
We do not hold or issue financial instruments for speculative purposes. From
time to time, we enter into foreign currency forward contracts, typically
against the Canadian dollar, euro and British pound sterling, to manage
fluctuations in the value of foreign currencies on transactions with our
international subsidiaries. While these instruments are subject to fluctuations
in value, these fluctuations are generally offset by fluctuations in the value
of the underlying asset or liability being managed, resulting in minimal net
exposure for us. These forward contracts do not qualify for hedge accounting
under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, and, as such, the contracts are recorded in the consolidated balance
sheet at fair value. We report a net currency gain or loss based on changes in
the fair value of forward contracts combined with changes in fair value of the
underlying asset or liability being managed. The success of these currency
activities depends upon estimation of intercompany balances denominated in
various foreign currencies. To the extent that these forecasts are overstated or
understated during periods of currency volatility, we could experience
unanticipated currency gains or losses. When determining whether to enter into
foreign currency forward contracts, we also consider the impact that the
settlement of such forward contracts may have on our cash position. To eliminate
a potential cash settlement of a forward position we may, from time to time,
decide not to use foreign currency forward contracts to manage fluctuations in
the value of foreign currencies on transactions with our international
subsidiaries. In a period where we do not enter into foreign currency forward
contracts, we could experience significant non-cash currency gains or losses if
the value of the U.S. dollar strengthens or weakens significantly in relation to
the value of the foreign currencies. As of March 31, 2004, we had forward
contracts with a nominal value of $9.3 million that matured within 30 days in
place against the Canadian dollar, euro and British pound sterling. We had no
forward contracts in place at March 31, 2003. We recognized net currency
exchange losses of approximately $45,000 and $17,000 for the three and nine
months ended March 31, 2004, respectively and a net currency exchange gain of
approximately $36,000 and a net loss of approximately $82,000 for the three and
nine months ended March 31, 2003, respectively. We are entering into foreign
currency forward contracts in the fourth quarter of fiscal 2004.
26
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
- ----------------------------------------------------------------
WE HAVE A RECENT HISTORY OF LOSSES AND MAY CONTINUE TO GENERATE LOSSES IN FISCAL
2004 AND FISCAL 2005.
Since the third quarter of fiscal 1999, we have devoted significant financial
resources to the research and development of, and marketing and sales for, our
mobile information management software products and, as a result, we have
generated operating losses. We intend to continue to devote significant
financial resources to product development and to marketing and sales. Our
ability to reach break-even from operations and our ability to reach
profitability and positive cash flow from operations in subsequent periods, will
depend on a number of factors, including:
o our ability to generate sufficient revenue and control expenses;
o buying patterns of our enterprise, application developer and OEM customers;
o changes in customer demand for our products;
o the timing of customer orders, which can be influenced by fiscal year-end
buying patterns, seasonal trends or general economic conditions;
o announcements or introductions of new products or services by our
competitors;
o the impact of any litigation on our financial and management resources;
o delays in our development and introduction of new products and services;
o changes in our pricing policies as a result of increased competition;
o the mix of distribution channels through which we sell our products;
o the market acceptance of our new and enhanced products and the products of
our customers that are application developers and OEMs;
o the market adoption rate of Bluetooth or other technologies on which a
number of our products are based;
o the emergence of new technologies or industry standards;
o normal seasonality that we typically experience in the first quarter of our
fiscal year; and
o a shift in the mix of professional services and licensing revenue, which
may result in fluctuations in our gross margin.
OUR BUSINESS RELIES ON ENTERPRISES IMPLEMENTING MOBILE APPLICATIONS AND DEVICES
AND MAY BE HARMED BY DECLINES IN INFORMATION TECHNOLOGY SPENDING.
The market for our products depends on economic conditions affecting the broader
economic climate and spending on information technology, including mobile
applications and devices. Downturns in the overall economy may cause enterprises
to delay implementation of mobile device and application rollouts, reduce their
overall information technology budgets or reduce or cancel orders for our
products. Our OEM customers may also limit development of new products that
incorporate our products or reduce their level of purchases of our products in
the face of slower information technology spending by their customers. The
general weakening of the global economy and weakening of business conditions,
particularly in the information technology, telecommunications, financial
services and manufacturing industry sectors, have resulted in potential
customers experiencing declines in their revenue and operations. In this
environment, customers may experience financial difficulty or cease operations.
While we believe we have adequately factored these conditions into our current
revenue forecasts, if these conditions worsen or continue longer than expected,
demand for our products may be reduced as a result of enterprises reducing
information technology spending on our products and OEMs reducing their use of
our products in their own products. As a result, our revenue may fail to grow or
could decline, which would harm our operating results. If the current economic
slowdown persists or worsens, we also may be forced to reduce our operating
expenses, which could result in additional charges incurred in connection with
restructuring or other cost-cutting measures we may implement. For example, in
all three quarters of fiscal 2004 to date, we have incurred restructuring costs,
primarily for severance payments to terminated employees.
OUR QUARTERLY AND ANNUAL OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY AND FAIL
TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS, WHICH COULD CAUSE
OUR STOCK PRICE TO DECLINE.
Our operating results have fluctuated in the past and may continue to do so in
the future. Our revenue and operating results will vary from quarter to quarter
for many reasons beyond our control, including those described in this section.
If our operating results fall below the expectations of securities analysts or
investors, the price of our stock may fall. In addition, quarter-to-quarter
variations in our revenue and operating results could create uncertainty about
the direction or progress of our business, which could result in a decline in
the price of our stock.
WE FORECAST MANY OF OUR OPERATING EXPENSES BASED ON FORECASTED REVENUE, WHICH IS
DIFFICULT TO PREDICT. IF WE FAIL TO ACCURATELY PREDICT REVENUE IN A PARTICULAR
PERIOD, WE MAY BE UNABLE TO ADJUST OUR EXPENDITURES IN THAT PERIOD AND OUR
OPERATING RESULTS WOULD BE HARMED.
27
Our quarterly revenue and operating results currently depend in large part on
the volume and timing of orders received within the quarter and on the number of
software seats licensed, which are difficult to forecast. Significant portions
of our expenses are related to personnel and, therefore, are fixed in advance,
based in large part on our forecast of future revenue. If revenue is below
expectations in any given quarter, the adverse impact of the shortfall on our
operating results may be magnified by our inability to adjust personnel and
other expenditures to compensate for the shortfall.
OUR BUSINESS MAY BE HARMED DUE TO RISKS ASSOCIATED WITH INTERNATIONAL SALES AND
OPERATIONS, WHICH REPRESENT A SUBSTANTIAL PORTION OF OUR REVENUE.
In the third quarter of fiscal 2004, based on the region where the customer
resides, 57% of our revenue was generated from sales outside the United States.
We expect that international sales will continue to represent a substantial
portion of our revenue for the foreseeable future. International sales are
subject to a number of risks, including:
o political and economic instability, including the threat or occurrence of
military and terrorist actions and enhanced national security measures;
o changes in government regulations;
o export license requirements;
o tariffs, taxes and trade barriers;
o fluctuations in currency exchange rates, which could cause our products to
become relatively more expensive to customers in a particular country and
lead to a reduction in sales in that country; longer collection and payment
cycles than those in the United States; and
o difficulty in staffing and managing international operations.
THE SUCCESS OF OUR BUSINESS MAY DEPEND ON US IDENTIFYING AND SECURING ADDITIONAL
SOURCES OF FINANCING, WHICH SOURCES MAY NOT BE AVAILABLE WHEN NEEDED OR MAY NOT
BE AVAILABLE ON FAVORABLE TERMS.
We believe that our existing working capital, our borrowing capacity and the
funds we expect to generate from our operations will be sufficient to fund our
anticipated working capital and capital expenditure requirements for the next 12
months. We cannot be certain, however, that our underlying assumed levels of
revenue and expenses will be accurate. If our operating results were to fail to
meet our expectations or if accounts receivable or other assets were to require
a greater use of cash than is currently anticipated, we could be required to
seek additional sources of liquidity. These sources of liquidity could include
raising funds through public or private debt financing, borrowing against our
line of credit or offering additional equity securities. If additional funds are
raised through the issuance of equity securities, substantial dilution to our
stockholders could result. In the event additional funds are required, adequate
funds may not be available when needed or may not be available on favorable
terms, which could have a negative effect on our business and results of
operations.
IF THE MARKETS FOR OUR PRODUCTS DO NOT CONTINUE TO GROW OR DO NOT GROW AT
EXPECTED RATES, DEMAND FOR OUR PRODUCTS WOULD BE REDUCED AND OUR BUSINESS WOULD
BE HARMED.
The success of our products currently will rely to a large degree on the
increased use by individuals and enterprises of mobile devices, including
personal digital assistants, cell phones, pagers and laptop and handheld
computers, and on increased use of technologies such as SyncML and Bluetooth.
Even if markets for our products grow, our products may not be successful.
Enterprises and OEMs may not develop sufficient confidence in mobile devices to
deploy our products to a significant degree. Any inability to continue to
penetrate the existing markets for mobile data management and wireless
connectivity product solutions, the failure of current markets to grow, new
markets to develop or these markets to be receptive to our products and
technologies on which our products are based, could harm our business. The
emergence of these markets will be affected by a number of factors beyond our
control.
WE DEPEND ON A NUMBER OF KEY BUSINESS RELATIONSHIPS AND IF WE FAIL TO MAINTAIN
THESE RELATIONSHIPS, OR ARE UNABLE TO DEVELOP NEW RELATIONSHIPS, OUR BUSINESS
WOULD SUFFER.
An important element of our strategy is the development of key business
relationships with other companies that are involved in product development,
joint marketing and the development of mobile communication protocols. If we
fail to maintain our current relationships or are unable to develop new
relationships, our business would suffer. Some of these relationships impose
substantial product support obligations on us, which may not be offset by
significant revenue. The benefits to us may not outweigh or justify our
obligations in these relationships. Also, in order to meet our current or future
obligations to OEMs, we may be required to allocate additional internal
resources to OEMs'
28
product development projects, which may delay the completion dates of our other
current product development projects.
Our existing key business relationships do not, and any future key business
relationships may not, provide us any exclusive rights. Many of the companies
with which we have established and intend to establish key business
relationships have multiple strategic relationships, and these companies may not
regard their relationships with us as significant. In most of these
relationships, either party may terminate the relationship with little notice.
In addition, these companies may attempt to develop or acquire products that
compete with our products. They may do so on their own or in collaboration with
others, including our competitors. Further, our existing business relationships
may interfere with our ability to enter into other business relationships.
OUR INVESTMENT IN GOODWILL AND INTANGIBLES RESULTING FROM OUR ACQUISITIONS COULD
BECOME IMPAIRED.
As of March 31, 2004, the amount of goodwill and other identifiable intangibles
recorded on our books, net of accumulated amortization, was $13.2 million. We
ceased amortizing goodwill upon our adoption of SFAS No. 142 as of the beginning
of fiscal 2003, and we expect to amortize $715,000 of net identifiable
intangibles in the remainder of fiscal 2004 and fiscal years 2005 through 2008.
However, to the extent that our goodwill or other identifiable intangibles are
considered to be impaired because circumstances indicate their carrying value
may not be recoverable, all or a portion of these assets may be subject to
write-off in the quarter of impairment. Such impairment and any resulting
write-off could have a negative impact on our results of operations in the
period of the write- off.
MARKETS FOR OUR PRODUCTS ARE BECOMING INCREASINGLY COMPETITIVE, WHICH COULD
RESULT IN LOWER PRICES FOR OUR PRODUCTS OR A LOSS OF MARKET SHARE. We may not
compete successfully against current or future competitors, some of whom have
longer operating histories, greater name recognition, more employees and
significantly greater financial, technical, marketing, public relations and
distribution resources. Increased competition may result in price reductions,
reduced margins, loss of market share and a change in our business and marketing
strategies, any of which could harm our business. The competitive environment
may require us to make changes in our products, pricing, licensing, services or
marketing to maintain and extend the market acceptance of our products. Price
concessions or the emergence of other pricing or distribution strategies by our
competitors or us may diminish our revenue.
We compete with:
o mobile data management companies, including Aether Systems, IBM, iAnywhere
(a division of Sybase), Infowave, Intellisync, JP Mobile, Microsoft and
RIM;
o application mobilization companies, including Aligo, Dexterra, Everypath,
iAnywhere, Microsoft, Orsus and Oracle;
o mobile enterprise solutions companies, including Aether Systems, Dexterra,
and Infowave;
o mobile device management solutions companies, including AirPrism, Credant,
iAnywhere, Intellisync and Mobile Automation;
o client/server database providers, including Borland, Interbase, Microsoft,
Oracle and Pervasive Software;
o mobile connectivity companies, including IVT Corporation, Open Interface
and Widcomm; and
o internal research and development departments of OEMs, many of whom are our
current customers.
As the markets for mobile information management products grow, we
expect competition from existing competitors to intensify, and we expect new
competitors, including OEMs to which we sell our products, to introduce products
that compete with ours. Additionally, if existing or new competitors were to
merge or form strategic alliances, our market share may be reduced or pressure
may be put on us to reduce prices resulting in reduced revenue and margins.
WE MAY NOT BE ABLE TO SUCCESSFULLY DEVELOP OR INTRODUCE NEW PRODUCTS.
The markets for our products are characterized by:
o rapidly changing technologies;
o evolving industry standards;
o frequent new product introductions; and
o short product life cycles.
Any delays in the introduction or shipment of new or enhanced products, the
inability of our products to achieve market acceptance or problems associated
with new product transitions could harm our business. The product development
process involves a number of risks. Development of new, technologically advanced
products is a complex and uncertain process requiring high levels of innovation,
as well as the accurate anticipation of
29
technological and market trends. The introduction of new or enhanced products
also requires us to manage the transition from older products to minimize
disruption in customer ordering patterns.
IF SPECIFIC INDUSTRY-WIDE STANDARDS AND PROTOCOLS UPON WHICH OUR PRODUCTS ARE OR
WILL BE BASED, DO NOT ACHIEVE WIDESPREAD ACCEPTANCE, OUR BUSINESS WOULD BE
HARMED.
We have designed a number of our current and upcoming products to conform to
industry standards and protocols, such as:
o Bluetooth, a short-range radio communication protocol;
o SyncML, a data synchronization protocol; and
o IrDA, a wireless communication protocol created by the Infrared Data
Association.
If these standards and protocols do not achieve acceptance, our business would
be harmed. Even if accepted, these industry-wide specifications may not be
widely adopted, or competing specifications may emerge. In addition,
technologies based on these standards and specifications may not be adopted as
the standard or preferred technologies for wireless connectivity, thereby
discouraging manufacturers of personal computers and mobile devices from
bundling or integrating these technologies in their products.
If our customers do not adopt wireless technologies, demand for our products
would be reduced and our business would be harmed.
Our products support the exchange of data with mobile devices via wired and
wireless connections. Our future growth will depend, in part, on the adoption of
wireless solutions by our customers. The adoption of wireless solutions is
dependent upon the development of 2.5 generation or 3rd generation ("2.5G" or
"3G") networks that are intended to support more complex applications and to
provide end users with a more satisfying user experience than today's networks.
If communication service providers delay their deployment of 2.5G or 3G networks
or fail to roll such networks out successfully, our customers may not adopt
wireless technologies, there could be less demand for our products and services
and our business could be harmed. In addition, if communication service
providers fail to continue to make investments in their networks or invest at a
slower pace in the future, there may be less demand for our products and
services and our business could suffer.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OUR PATENT, TRADEMARK, COPYRIGHT OR
OTHER INTELLECTUAL PROPERTY RIGHTS FROM COMPETITORS, AND WE MAY BE REQUIRED TO
USE A SIGNIFICANT AMOUNT OF OUR RESOURCES TO DEFEND OURSELVES FROM INFRINGEMENT
CLAIMS MADE BY OTHERS.
Our patents, trademarks or copyrights may be invalidated, circumvented or
challenged, and the rights granted under these patents, trademarks and
copyrights might not provide us with any competitive advantage, which could harm
our business. Any of our pending or future patent applications may not be issued
with the scope of the claims we are seeking, if at all. In addition, others may
develop technologies that are similar or superior to our technology, duplicate
our technology or design around our patents. Further, effective intellectual
property protection may be unavailable or limited in some countries outside of
the United States.
Companies in the software industry frequently resort to litigation over
intellectual property rights. If a court finds that we infringe on the
intellectual property rights of any third party, we could be subject to
liabilities, which could harm our business. As a result, we might be required to
seek licenses from other companies or to refrain from using, manufacturing or
selling specific products or using specific processes. Holders of patents and
other intellectual property rights may not offer licenses to use their patents
or other intellectual property rights on acceptable terms, or at all. Failure to
obtain these licenses on commercially reasonable terms or at all could harm our
business.
In order to protect our proprietary rights, we may decide to sue third parties.
Any litigation, whether brought by or against us, could cause us to incur
significant expenses and could divert a large amount of management time and
effort. A claim by us against a third party could, in turn, cause a counterclaim
by the third party against us, which could impair our intellectual property
rights and harm our business.
OUR BUSINESS MAY BE HARMED IF OUR PROFESSIONAL SERVICES ORGANIZATION DOES NOT
GENERATE AN ACCEPTABLE PROFIT LEVEL.
Our professional services business is subject to a variety of risks including:
o we may be unable to accurately predict staffing requirements and,
therefore, the expense of fulfilling our service contracts may be greater
than we anticipate; and
30
o we may have an inappropriate level of resources dedicated to the
professional services business in relation to the number of projects we are
able to sell, resulting in a low utilization rate of resources.
If we are unable to operate the professional services organization effectively,
the profitability of this business could decline, or even result in a loss,
which could harm our business.
CURRENCY EXCHANGE RATE FLUCTUATIONS COULD CAUSE OUR OPERATING RESULTS TO
FLUCTUATE.
The transactions made through our subsidiaries in Canada, France, Germany,
Italy, the Netherlands and the United Kingdom are primarily denominated in local
currencies. Accordingly, these international operations expose us to currency
exchange rate fluctuations, which in turn could cause our operating results to
fluctuate when we translate revenue and expenses denominated in other currencies
into U.S. dollars.
From time to time, we enter into foreign currency forward contracts, typically
against the Canadian dollar, euro, and British pound sterling, to manage
currency fluctuations on payments and receipts of foreign currencies on
transactions with our international subsidiaries. The success of these currency
activities depends upon estimation of intercompany balances denominated in
various foreign currencies. To the extent that these forecasts are overstated or
understated during periods of currency volatility, we could experience
unanticipated currency gains or losses. When determining whether to enter into
foreign currency forward contracts, we also consider the impact that the
settlement of such forward contracts may have on our cash position. To eliminate
a potential cash settlement of a forward position we may, from time to time,
decide not to use foreign currency forward contracts to manage fluctuations in
the value of foreign currencies on transactions with our international
subsidiaries. In a period where we do not enter into foreign currency forward
contracts, we could experience significant non-cash currency gains or losses if
the value of the U.S. dollar strengthens or weakens significantly in relation to
the value of the foreign currencies. For example, we recognized foreign currency
exchange gains in the fourth quarter of fiscal 2003 and the first quarter of
fiscal 2004 as a result of the dollar weakening at a time when we were not
entering into foreign currency forward contracts.
IF WE ACCOUNT FOR EMPLOYEE STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS USING
THE FAIR VALUE METHOD, IT COULD SIGNIFICANTLY REDUCE OUR NET INCOME AND EARNINGS
PER SHARE.
There has been ongoing public debate whether employee stock option and employee
stock purchase plans shares should be treated as a compensation expense and, if
so, how to properly value such charges. If we elected or were required to record
an expense for our stock-based compensation plans using the fair value method,
we could have significant accounting charges. For example, in the third quarter
of fiscal 2004, had we accounted for stock-based compensation plans using the
fair-value method prescribed in FASB Statement No. 123 as amended by Statement
148, our net income would have been reduced by approximately $704 million.
Although we are not currently required to record any compensation expense using
the fair value method in connection with option grants that have an exercise
price at or above fair market value at the grant date and for shares issued
under our employee stock purchase plan, it is possible that future laws or
regulations will require us to treat all stock-based compensation as an expense
using the fair value method. See Note 3 of Notes to Condensed Consolidated
Financial Statements for a more detailed presentation of accounting for
stock-based compensation plans.
WE DEPEND ON NON-EXCLUSIVE LICENSES FOR SOME OF THE TECHNOLOGY WE USE WITH OUR
PRODUCTS.
We license technology on a non-exclusive basis from several companies for use
with our products and anticipate that we will continue to do so in the future.
For example, we license encryption technology that we include in our OneBridge
Mobile Groupware (formerly XTNDConnect Server) products. Our inability to
continue to license this technology, or to license other technology necessary
for use with our products, could result in the loss of, or delays in the
inclusion of, important features of our products or result in substantial
increases in royalty payments that we would have to pay pursuant to alternative
third-party licenses, any of which could harm our business. In addition, the
effective implementation of our products depends upon the successful operation
of licensed software in conjunction with our products. Any undetected errors in
products resulting from this licensed software may prevent the implementation or
impair the functionality of our products, delay new product introductions and
injure our reputation.
THE COMPLEX COMPUTER SOFTWARE PRODUCTS THAT WE PRODUCE MAY CONTAIN DEFECTS FOR
WHICH WE MAY BE LIABLE.
The complex software products we offer may contain undetected errors when first
introduced or as new versions are released. These errors could result in
dissatisfied customers, product liability claims and the loss of or delay in
market acceptance of new or enhanced products, any of which could harm our
business. Testing of our products is particularly challenging because it is
difficult to simulate the wide variety of computing environments in which our
customers may deploy our products. For example, our mobile information
management products are used in a wide
31
variety of telecommunications environments. Changes in technology standards or
an increase in the number of telecommunications technologies used in the
marketplace may create compatibility issues with our products and our customers'
environments. Accordingly, despite testing by us and by current and potential
customers, errors could be found after commencement of commercial shipment. A
successful product liability claim brought against us could result in our
payment of significant legal fees and damages, which would harm our business.
OUR STOCK PRICE MAY BE VOLATILE AND COULD DROP SIGNIFICANTLY, RESULTING IN THE
PARTIAL OR TOTAL LOSS OF A STOCKHOLDER'S INVESTMENT. The trading price of our
common stock may fluctuate significantly, which may cause a stockholder's
investment to decrease in value. The following factors may have a significant
impact on the market price of our common stock:
o announcements of acquisitions by us or our competitors;
o changes in our management team;
o our ability to obtain financing when needed;
o quarter-to-quarter variations in our operating results;
o sales of significant numbers of shares within a short period of time;
o announcements of technological innovations or new products by us or our
competitors;
o general conditions in the computer and mobile device industry;
o general economic conditions and their impact on corporate information
technology spending;
o price and trading volume volatility in the public stock markets in general;
o announcements and updates of our business outlook; and
o changes in security analysts' earnings estimates or recommendations
regarding our competitors, our customers or us.
IF WE ARE UNABLE TO EFFECTIVELY MANAGE OUR GROWTH, OUR BUSINESS WILL SUFFER.
Growth in our business may place a significant strain on our administrative,
operational and financial resources and increase demands on our systems and
controls, which could harm our business. Growth may also result in an increase
in the scope of responsibility for management personnel.
We anticipate that our growth and expansion will require that we recruit, hire,
train and retain new engineering, executive, sales and marketing, and
administrative personnel. Difficulty in recruiting qualified personnel could
require us to incur significant costs to recruit personnel or could limit our
ability to grow. In addition, in order to manage our growth successfully, we
will need to continue to expand and improve our operational, management and
financial systems and controls. The failure to do so could harm our business.
THE LOSS OF KEY PERSONNEL, OR OUR INABILITY TO ATTRACT AND RETAIN ADDITIONAL
PERSONNEL, MAY HARM OUR BUSINESS.
Our future success will depend on our ability to attract and retain experienced,
highly qualified management, technical, research and development, and sales and
marketing personnel. Competition for qualified personnel in the computer
software industry is intense, and there is a risk that we will have difficulty
recruiting and retaining key employees. In addition, new employees generally
require substantial training, which may require substantial resources and
management attention. If we lose the services of one or more key employees, or
if one or more of them decide to join a competitor or otherwise compete directly
or indirectly with us, our business could be harmed. Searching for replacements
for our key employees could divert management's time and result in increased
operating expenses that may not be offset by either improved productivity or
higher prices. Over the past two years, a number of our senior management
employees have left Extended Systems, including most recently, Steven Simpson,
our former President and Chief Executive Officer, and Karla Rosa, our former
Vice President Finance and Chief Financial Officer, and we cannot assure you
that there will not be additional departures. Any changes in management can be
disruptive to our operations. Uncertainty created by turnover of key employees
could result in reduced confidence in our financial performance, which could
cause fluctuations in our stock price.
SOME ANTI-TAKEOVER PROVISIONS CONTAINED IN OUR CERTIFICATE OF INCORPORATION,
BYLAWS AND STOCKHOLDER RIGHTS PLAN, AS WELL AS PROVISIONS OF DELAWARE LAW, COULD
IMPAIR A TAKEOVER ATTEMPT.
We have provisions in our certificate of incorporation and bylaws, each of which
could have the effect of rendering more difficult or discouraging an acquisition
deemed undesirable by our Board of Directors. These include provisions:
o dividing our board of directors into three classes, each serving a
staggered three-year term;
32
o authorizing blank check preferred stock, which could be issued with voting,
liquidation, dividend and other rights superior to its common stock;
o dividend and other rights superior to its common stock;
o limiting the liability of, and providing indemnification to, directors and
officers;
o requiring advance notice of stockholder proposals for business to be
conducted at meetings of stockholders and for nominations of candidates for
election to our Board of Directors;
o specifying that stockholders may take action only at a duly called annual
or special meeting of stockholders.
These provisions, alone or together, could deter or delay hostile takeovers,
proxy contests and changes in control or management of Extended Systems. As a
Delaware corporation, we also are subject to provisions of Delaware law,
including Section 203 of the Delaware General Corporation Law, which prevents
some stockholders from engaging in certain business combinations without
approval of the holders of substantially all of our outstanding common stock.
In June 2003, pursuant to a Preferred Stock Rights Agreement between Extended
Systems and EquiServe Trust Company, N.A., our Board of Directors issued certain
Preferred Share Purchase Rights. The Rights were not intended to prevent a
takeover of Extended Systems. However, the Rights may have the effect of
rendering more difficult or discouraging an acquisition of Extended Systems
deemed undesirable by our Board of Directors. The Rights would cause substantial
dilution to a person or group that attempted to acquire Extended Systems on
terms or in a manner not approved by our Board of Directors, except pursuant to
an offer conditioned upon redemption of the Rights.
Any provision of our certificate of incorporation or bylaws or Delaware law that
has the effect of delaying or deterring a change in control could limit the
opportunity for our stockholders to receive a premium for their shares of common
stock and also could affect the price that some investors are willing to pay for
our common stock.
WE INTEND TO PURSUE ADDITIONAL ACQUISITIONS, AND ANY ACQUISITIONS COULD PROVE
DIFFICULT TO INTEGRATE WITH OUR BUSINESS, DISRUPT OUR BUSINESS, DILUTE
STOCKHOLDER VALUE OR ADVERSELY AFFECT OUR OPERATING RESULTS.
As part of our strategy, we intend to continue to pursue the acquisition of
companies that either complement or expand our existing business. If we fail to
properly evaluate and execute acquisitions, our business would be harmed. We may
not be able to properly evaluate the technology and accurately forecast the
financial impact of the transaction, including accounting charges and
transaction expenses. Acquisitions involve a number of risks and difficulties,
including:
o the integration of acquired technologies with our existing products and
technologies;
o diversion of management's attention and other resources to the assimilation
of the operations and employees of the acquired companies;
o availability of equity or debt financing on terms favorable to us and our
stockholders;
o integration of management information systems, employees, research and
development, and marketing, sales and support operations;
o expansion into new markets and business areas;
o potential adverse short-term effects on our operating results; and
o retention of customers and employees post-acquisition.
In addition, if we conduct acquisitions using debt or equity securities, our
existing stockholders' investments may be diluted, which could affect the market
price of our stock.
33
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Substantially all of our liquid investments are at fixed interest rates and,
therefore, the fair value of these instruments is affected by changes in market
interest rates. All of our liquid investments mature within 90 days or less of
March 31, 2004, therefore, we believe that the market risk arising from our
holdings of liquid investments is minimal.
Sales made by our subsidiaries outside the United States are generally
denominated in the foreign country's currency. Fluctuations in exchange rates
between the United States dollar and other currencies could materially harm our
business. From time to time, we enter into foreign currency forward contracts,
typically against the Canadian dollar, euro, and British pound sterling, to
manage fluctuations in the value of foreign currencies on transactions with our
international subsidiaries, thereby limiting our risk that would otherwise
result from changes in exchange rates. We report a net currency gain or loss
based on changes in the fair value of forward contracts combined with changes in
fair value of the underlying asset or liability being managed. The success of
these currency activities depends upon estimation of intercompany balances
denominated in various foreign currencies. To the extent that these forecasts
are overstated or understated during periods of currency volatility, we could
experience unanticipated currency gains or losses. When determining whether to
enter into foreign currency forward contracts, we also consider the impact that
the settlement of such forward contracts may have on our cash position. To
eliminate a potential cash settlement of a forward position we may, from time to
time, decide not to use foreign currency forward contracts to manage
fluctuations in the value of foreign currencies on transactions with our
international subsidiaries. In a period where we do not enter into foreign
currency forward contracts, we could experience significant non-cash currency
gains or losses if the value of the U.S. dollar strengthens or weakens
significantly in relation to the value of the foreign currencies. As of March
31, 2004, we had forward contracts with a nominal value of $9.3 million that
matured within 30 days in place against the Canadian dollar, euro and British
pound sterling. We had no forward contracts in place at March 31, 2003. We
recognized net currency exchange losses of approximately $45,000 and $17,000 for
the three and nine months ended March 31, 2004, respectively and a net currency
exchange gain of approximately $36,000 and a net loss of approximately $82,000
for the three and nine months ended March 31, 2003, respectively. We are
entering into foreign currency forward contracts in the fourth quarter of fiscal
2004.
ITEM 4. CONTROLS AND PROCEDURES
We have carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, 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 amended (the "Exchange Act")) as
of the end of the period covered by this Quarterly Report. Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective to ensure that
material information required to be disclosed by us in the reports that we file
or submit under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission
rules and forms. It should be noted, however, that the design of any system of
controls is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions, regardless of
how remote.
There has been no change in our internal control over financial reporting that
occurred during our most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On March 4, 2004 we mutually agreed with Intellisync Corporation
("Intellisync"), formerly known as Pumatech, Inc., to settle the patent
infringement lawsuit initiated by Intellisync on April 22, 2002. Both companies
agreed to settle all claims and to immediately terminate litigation proceedings.
In connection with the settlement, we made a one-time payment to Intellisync of
$2.0 million and received a license to certain Intellisync patents. This payment
covers estimated past and future royalties on revenue related to our products
shipped and covered under Intellisync's licensed patents. Both companies have
agreed there will be no further patent litigation actions for a period of five
(5) years and that Intellisync will release all of our customers from any claims
of infringement relating to their purchase and future use of our products.
We are also, from time-to-time, a party to legal disputes and proceedings
arising in the ordinary course of general business activities. After taking into
consideration legal counsel's evaluation of such disputes, we do not believe
their outcome will have a material effect on our financial position or results
of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
10.11 * Settlement and License Agreement dated March 4, 2004 by
and between the Company and Intellisync Corporation
31 Certification of Executive Officers pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32 Certification of Executive Officers pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
* Portions of this agreement have been omitted pursuant to a request for
confidential treatment and the omitted portions have been filed
separately with the Securities and Exchange Commission.
(b) REPORTS ON FORM 8-K
On January 7, 2004, we filed a current report on Form 8-K in connection with the
issuance of a press release dated January 7, 2004 announcing that John M.
Russell had resigned from our Board of Directors.
On January 29, 2004, we furnished a current report on Form 8-K in connection
with the issuance of a press release dated January 29, 2004 announcing our
financial results for our second fiscal quarter ended December 31, 2003.
On March 4, 2004, we filed a current report on Form 8-K in connection with the
issuance of a joint press release with Intellisync Corporation announcing that
the Companies had mutually agreed to settle the patent infringement lawsuit
initiated by Intellisync in April 2002.
35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q
to be signed on its behalf by the undersigned, thereunto duly authorized, in
Boise, Idaho, on May 17, 2004.
EXTENDED SYSTEMS INCORPORATED
By: /s/ CHARLES W. JEPSON
-------------------------------------
CHARLES W. JEPSON
PRESIDENT AND CHIEF EXECUTIVE OFFICER
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