UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

ý        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITITES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2003

 

OR

 

o        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                     to                     

 

Commission File number 000-30654

 

APROPOS TECHNOLOGY, INC.

(Exact name of registrant as specified in its charter)

 

 

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  ý    No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes  o    No  ý

 

The number of shares outstanding of the registrant’s Common Shares, par value $0.01 per share, as of October 31, 2003, was 16,898,260.

 

 

APROPOS TECHNOLOGY, INC.

TABLE OF CONTENTS

 

Part I.	Financial Information
Item 1.	Financial Statements (Unaudited)
	Condensed consolidated balance sheets at September 30, 2003 and  December 31, 2002
	Condensed consolidated statements of operations for the three and nine months ended September 30, 2003 and 2002
	Condensed consolidated statements of cash flows for the nine months ended September 30, 2003 and 2002
	Notes to condensed consolidated financial statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
Part II.	Other Information
Item 1.	Legal Proceedings
Item 2.	Changes in Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
Signatures

 

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Part I.              Financial Information.

 

Item 1.           Financial Statements.

 

Apropos Technology, Inc.
Condensed Consolidated Balance Sheets

In thousands, except share and per share amounts

 

		September 30 2003			December 31 2002
		(Unaudited)			(Note 1)
Assets
Current assets :
Cash and cash equivalents		$	37,753		$	19,333
Short-term investments		1,149			22,718
Accounts receivable, less allowances for doubtful accounts of $265 at September 30, 2003 and $474 at December 31, 2002		2,449			2,837
Inventory		159			194
Prepaid expenses and other current assets		594			1,016
Total current assets		42,104			46,098
Equipment, net		1,060			2,174
Other assets		231			240
Total assets		$	43,395		$	48,512
Liabilities and shareholders’ equity
Current liabilities :
Accounts payable		$	133		$	127
Accrued expenses		1,338			1,515
Accrued restructuring		573			420
Accrued compensation and related accruals		271			658
Advance payments from customers		119			235
Deferred revenues		3,437			2,747
Total current liabilities		5,871			5,702
Accrued restructuring, less current portion		659			—
Commitments and contingencies		—			—
Shareholders’ equity :
Preferred shares, $0.01 par value, 5,000,000 shares authorized, no shares issued and outstanding		—			—
Common shares, $0.01 par value, 60,000,000 shares authorized, 17,176,648 shares issued and 16,865,537 shares outstanding at September 30, 2003; 16,971,940 issued and 16,660,829 outstanding at December 31, 2002		172			170
Additional paid-in capital		102,066			101,578
Treasury stock, at cost		(392		)	(392		)
Accumulated deficit		(64,981		)	(58,546		)
Total shareholders’ equity		36,865			42,810
Total liabilities and shareholders’ equity		$	43,395		$	48,512

 

See notes to condensed consolidated financial statements.

 

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Apropos Technology, Inc.
Condensed Consolidated Statements of Operations

(Unaudited)
In thousands, except per share amounts

 

		Three months ended September 30						Nine months ended September 30
		2003			2002			2003			2002
Revenue
Software licenses		$	1,677		$	2,085		$	5,326		$	6,638
Services and other		3,034			3,138			9,199			9,255
Total revenue		4,711			5,223			14,525			15,893
Cost of goods and services
Cost of software		91			81			294			310
Cost of services and other		1,003			1,469			3,336			4,356
Total cost of goods and services		1,094			1,550			3,630			4,666
Gross margin		3,617			3,673			10,895			11,227
Operating expenses
Sales and marketing		1,628			3,443			5,836			10,852
Research and development		1,117			1,967			4,312			5,991
General and administrative		1,475			1,929			4,466			5,937
Stock compensation charge		75			107			225			322
Restructuring and other charges		2,427			869			2,875			869
Total operating expenses		6,722			8,315			17,714			23,971
Loss from operations		(3,105		)	(4,642		)	(6,819		)	(12,744		)
Other income (expense)
Interest income		99			236			382			748
Other, net		5			9			2			(7		)
Total other income (expense)		104			245			384			741
Net loss		$	(3,001	)	$	(4,397	)	$	(6,435	)	$	(12,003	)
Basic and diluted net loss per share		$	(0.18	)	$	(0.26	)	$	(0.38	)	$	(0.72	)
Weighted-average number of shares outstanding		16,842			16,750			16,749			16,754

 

See notes to condensed consolidated financial statements.

 

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Apropos Technology, Inc.
Condensed Consolidated Statements of Cash Flows

(Unaudited)
In thousands

 

		Nine months ended September 30
		2003			2002
Cash flows from operating activities
Net loss		$	(6,435	)	$	(12,003	)
Adjustments to reconcile net loss to net cash used in operating activities :
Depreciation and amortization		845			1,076
Provision for doubtful accounts		36			275
Stock compensation charge		225			322
Non-cash portion of restructuring charge		392
Changes in operating assets and liabilities :
Accounts receivable		353			882
Inventory		35			82
Prepaid expenses and other current assets		422			37
Other assets		8			20
Accounts payable		7			(383		)
Accrued expenses		635			412
Accrued compensation and related accruals		(387		)	162
Advanced payments from customers		(116		)	34
Deferred revenue		689			109
Net cash used in operating activities		(3,291		)	(8,975		)
Cash flows used in investing activities
Maturities and sales of short-term investments		27,039			42,447
Purchases of short-term investments		(5,470		)	(32,812		)
Purchases of equipment		(123		)	(256		)
Net cash provided by investing activities		21,446			9,379
Cash flows provided by financing activities
Proceeds from exercise of options		211			48
Proceeds from employee stock purchase plan		54			89
Net cash provided by financing activities		265			137
Net change in cash and cash equivalents		18,420			541
Cash and cash equivalents, beginning of period		19,333			17,548
Cash and cash equivalents, end of period		$	37,753		$	18,089

 

See notes to condensed consolidated financial statements.

 

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Apropos Technology, Inc.
Notes To Condensed Consolidated Financial Statements
(Unaudited)

 

1.              Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X.  Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed, or omitted, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  In management’s opinion, the statements include all adjustments necessary (which are of a normal and recurring nature) for the fair presentation of the results of the interim periods presented.

 

The balance sheet at December 31, 2002, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

 

These financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2002, included with its Annual Report on Form 10-K filed with the SEC on March 31, 2003.  The results of operations for the interim periods presented are not necessarily indicative of the results of operations to be expected for any other interim period or for the full fiscal year.

 

2.              Loss Per Share and stock based compensation

 

Loss per share

 

Basic net loss per share is based upon the net loss and upon the weighted-average number of Common Shares outstanding during the period.  Diluted net loss per common share adjusts for the effect of common share equivalents, such as convertible securities, stock options, and stock warrants, only in the periods presented in which such effect would have been dilutive.  Diluted net loss per share is not presented separately, as the effect of the common share equivalents is anti-dilutive for each of the periods presented.  Accordingly, diluted net loss per share is the same as basic net loss per share.

 

Stock-Based Compensation

 

The Company has elected to determine the value of stock-based compensation arrangements under the provisions of Accounting Principles Board, or APB, Opinion No. 25 “Accounting for Stock Issued to Employees.” The pro forma disclosures required under Statement of Financial Accounting Standards, or SFAS No. 148, “Accounting for Stock Based Compensation Transition and Disclosure–an Amendment of SFAS No. 123” are included below. SFAS No. 123, “Accounting for Stock Based Compensation” permits the use of either a fair value based method or the intrinsic value method to measure the expense associated with stock-based compensation arrangements.

 

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In accordance with the interim disclosure provisions of SFAS No. 148, the pro forma effect on the Company’s net loss had compensation expense been recorded for the three and nine months ended September 30, 2003 and 2002, respectively, as determined under the fair value method, is shown below.

 

		Three months ended September 30						Nine months ended September 30
in thousands, except per share amounts		2003			2002			2003			2002
Net loss, as reported		$	3,001		$	4,397		$	6,435		$	12,003
Less: Stock-based employee compensation expense included in reported net loss		(75		)	(107		)	(225		)	(322		)
Add: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects		296			413			995			1,184
Net loss, pro forma		$	3,222		$	4,703		$	7,205		$	12,865
Basic and diluted net loss per share, as reported		$	0.18		$	0.26		$	0.38		$	0.72
Basic and diluted net loss per share, pro forma		$	0.19		$	0.28		$	0.43		$	0.77

 

Options to purchase 2,690,615 Common Shares with exercise prices of $0.10 to $22.00 per share were outstanding as of September 30, 2003, and options to purchase 2,373,232 Common Shares with exercise prices of  $0.10 to $22.00 per share were outstanding as of September 30, 2002.

 

3.              Geographic Information

 

Revenues derived from customers outside of North America accounted for 21.7% and 20.9% of the Company’s total revenues for the three months ended September 30, 2003 and 2002, respectively, and 24.8% and 28.0% of the Company’s total revenues for the nine months ended September 30, 2003 and 2002, respectively.

 

The Company attributes its revenues to countries based on the country in which the client is located. The Company’s long-lived assets located outside the United States are not considered material.

 

4.              Litigation and contingencies

 

In November 2001, the Company was named as a defendant in several shareholder class action litigations that have been filed in federal court in Chicago against the Company, certain of its current and former directors and officers, and the underwriters of the Company’s initial public offering.  These litigations are allegedly brought on behalf of purchasers of the Company’s stock, and assert that the Company violated the federal securities laws by making misstatements and omissions in its Registration Statement and Prospectus in connection with the Company’s initial public offering in February 2000.  The plaintiffs seek unspecified damages.  In April 2002 an amended consolidated complaint was filed which supersedes the original, separate complaints.  On March 31, 2003, the Court issued its decision on the motion of the Company and other defendants to dismiss the case, granting that motion in part and denying it in part.  The discovery process in the case has now begun.  Although legal proceedings are inherently uncertain and their ultimate outcome cannot be predicted with certainty, the Company believes the allegations are without merit and intends to defend the litigation vigorously.

 

The Company has been named as a nominal defendant in a shareholder derivative action filed in February 2002 against certain of its present and former directors and officers.  The complaint alleges, among other things, that the alleged conduct challenged in the securities cases pending against the Company in Chicago (described above) constitutes a breach of the defendants’ fiduciary duties to the Company.  The complaint seeks unspecified money damages and other relief ostensibly on behalf of the Company.  In August 2002, the plaintiffs filed an amended complaint.  The parties have jointly asked the court to stay the action in its entirety pending the outcome of the above-described securities cases in Chicago.  Although legal proceedings are inherently uncertain and their ultimate outcome cannot be predicted with certainty, the Company believes the allegations are without merit and intends to defend the litigation vigorously.

 

In November 2001, the Company was named as a defendant in shareholder class action litigation that has been filed in federal court in New York City against the Company and certain of its current and former officers and

 

7

 

the underwriters of the Company’s initial public offering (“IPO”).  This lawsuit alleges, among other things, that the underwriters of the Company’s IPO improperly required their customers to pay the underwriters excessive commissions and to agree to buy additional shares of the Company’s stock in the aftermarket as conditions of receiving shares in the Company’s IPO.  The lawsuit further claims that these supposed practices of the underwriters should have been disclosed in the Company’s IPO prospectus and registration statement. In April 2002, an amended complaint was filed which, like the original complaint, alleges violations of the registration and antifraud provisions of the federal securities laws and seeks unspecified damages.  The Company understands that various other plaintiffs have filed substantially similar class action cases against approximately 300 other publicly traded companies and their public offering underwriters in New York City, which along with the case against the Company have all been transferred to a single federal district judge for purposes of coordinated case management.  In July 2002, the Company, together with the other issuers named as defendants in these coordinated proceedings, filed a collective motion to dismiss the consolidated amended complaints against them on various legal grounds common to all or most of the issuer defendants.  This motion is currently pending.  In October 2002, the Court approved a stipulation providing for the dismissal of the individual defendants without prejudice.  In February 2003, the Court issued a decision granting in part and denying in part the motion to dismiss the litigation filed by the Company and the other issuer defendants.  The claims against the Company under the antifraud provisions of the securities laws were dismissed with prejudice; the claims under the registration provisions of the securities laws were not dismissed as to the Company or virtually any other issuer defendant.  Although legal proceedings are inherently uncertain and their ultimate outcome cannot be predicted with certainty, the Company believes that the claims against it are without merit, and intends to defend the litigation vigorously.

 

In June 2003, the Company elected to participate in a proposed settlement agreement with the plaintiffs in this litigation.  If ultimately approved by the Court, this proposed settlement would result in a dismissal, with prejudice, of all claims in the litigation against the Company and against any of the other issuer defendants who elect to participate in the proposed settlement, together with the current or former officers and directors of participating issuers who were named as individual defendants. The proposed settlement does not provide for the resolution of any claims against the underwriter defendants, and the litigation as against those defendants is continuing. The proposed settlement provides that the class members in the class action cases brought against the participating issuer defendants will be guaranteed a recovery of $1 billion by insurers of the participating issuer defendants.  If recoveries totaling $1 billion or more are obtained by the class members from the underwriter defendants, however, the monetary obligations to the class members under the proposed settlement will be satisfied. In addition, the Company and any other participating issuer defendants will be required to assign to the class members certain claims that they may have against the underwriters of their IPOs.

 

The proposed settlement contemplates that any amounts necessary to fund the settlement or settlement-related expenses would come from participating issuers’ directors and officers liability insurance policy proceeds as opposed to funds of the participating issuer defendants themselves. A participating issuer defendant could be required to contribute to the costs of the settlement if that issuer’s insurance coverage were insufficient to pay that issuer’s allocable share of the settlement costs. The Company expects that its insurance proceeds will be sufficient for these purposes and that it will not otherwise be required to contribute to the proposed settlement. Consummation of the proposed settlement is conditioned upon, among other things, negotiating, executing, and filing with the Court final settlement documents, and final approval by the Court. If the proposed settlement described above is not consummated, the Company intends to continue to defend the litigation vigorously.  Moreover, if the proposed settlement is not consummated, the Company believes that the underwriters may have an obligation to indemnify it for the legal fees and other costs of defending this suit. While the Company cannot guarantee the outcome of these proceedings, the Company believes that the final result of these actions will have no material effect on its consolidated financial condition, results of operations or cash flows.

 

The Company is a party in various other disputes and litigation that have arisen in the course of the Company’s business. In the opinion of management, based upon consultation with legal counsel, although legal proceedings can not be predicted with certainty, the ultimate outcome of these disputes and lawsuits are not expected to have a material impact on the Company’s financial position or results of operations.

 

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5.              Restructuring and other charges

 

In the third quarter of 2003, the Company conducted an extensive review of its operations to better align its operating cost structure with current revenue levels.  This review focused on staffing levels, facility needs and long-lived assets utilized in the business.  As a result of this review, the Company recorded a Restructuring and other charges of $2.4 million.  This charge was comprised of three components:  a charge related to staff reductions of $738,000, a facility termination charge of $1.3 million and an asset impairment charge of $345,000.  The staff reduction charge related to staff reductions of 33 persons in July 2003.  The charge for staff reductions was based on the severance payments and residual benefits to be paid.  The facility termination charge related to leased space that the Company ceased use on August 31, 2003.  This facility termination charge is comprised of future lease obligations and related expenses offset by anticipated income from subletting the space.  This facility termination charge also includes $47,000 related to disposal of assets that were abandoned as part of the exit plan.  The asset impairment charge related to software infrastructure systems and furniture and fixtures.  As a result of these staff reductions, these assets no longer provided benefit to the Company and therefore abandoned.  The asset impairment charge was based on the net book value of the assets as of September 30, 2003, the date of abandonment.

 

In the first quarter of 2003, the Company recorded a charge of $448,000.  This charge related to staff reductions of 30 persons.  As of September 30, 2003, these funds were fully disbursed.

 

In the third quarter of 2002, the Company recorded a Restructuring and other charges of $869,000.  This charge related to staff reductions of 18 persons, including involuntary terminations of three senior level positions with contractual obligations, and former employee settlement costs.  As of December 31, 2002, there was approximately $420,000 included in Accrued restructuring in the Balance Sheet for undisbursed payments related to this restructuring charge.

 

As of September 30, 2003, there was approximately $1,232,000 included in Accrued restructuring, of which approximately $659,000 has been classified as non-current, in the Balance Sheet for undisbursed payments related to the restructuring charges in the third quarter of 2003 and 2002.  There is approximately $17,000 related to the staff reductions in the third quarter of 2002, which the Company estimates will be disbursed over the next quarter.  There is approximately $24,000 related to the staff reductions in the third quarter of 2003 which the Company estimates will be disbursed over the next quarter.  There is approximately $1,191,000, of which $659,000 is classified as non-current, related to the facility termination costs which the Company estimates will be disbursed over remaining life of the lease through the second quarter of 2006.

 

Reconciliation of the restructuring liability, as of September 30, 2003, is as follows:

 

In thousands		Balance as of 12/31/02			2003 Charge to the Statement of Operations			Cash payments			Non-cash charge offs			Balance as of 9/30/03
Employee termination costs		$	396		$	1,186		$	1,552		$	—		$	30
Facility termination costs		—			1,344			106			47			1,191
Asset impairment charge		—			345			—			345			—
Other		24			—			13			—			11
		$	420		$	2,875		$	1,671		$	392		$	1,232

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Except for historical information, the matters discussed in this Quarterly Report on Form 10-Q are forward-looking statements made pursuant to the safe harbor provisions for forward-looking statements described in the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are based on the Company’s current expectations and are subject to a number of risks, uncertainties, and assumptions relating to the Company’s operations, financial condition, and results of operations.  Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from results expressed or implied in any forward-looking statement made by the Company in this Quarterly Report.  Risks include availability of insurance coverage in connection with the litigation described in note 4 to the Financial Statements and other matters detailed under the caption “Risk Factors Associated with Apropos’ Business and Future Operating Results” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, as filed with the Securities and Exchange Commission.  The Company does not undertake any obligation to revise these forward-looking statements to reflect future events or circumstances.

 

The following discussion should be read in conjunction with the Company’s condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report.

 

Overview

 

The Company develops, markets, and supports a leading real-time, multi-channel interaction management application for managing customer interactions across a variety of communications media, including E-mail, Fax, Web, and Voice.  The Company’s solution enhances customer relationship management applications, such as sales, marketing, and service, through intelligent, value-based management of all interactions.

 

The Company’s operations commenced in January 1989, and, from inception to early 1995, operating activities consisted primarily of research and development and consulting.  As an integral part of the Company’s growth strategy, during February 2000, the Company completed an initial public offering of 3,977,500 Common Shares (the “IPO”) resulting in net proceeds to the Company of approximately $79.3 million.

 

Critical Accounting Policies

 

Revenue.  The Company recognizes revenue from the sale of software and hardware upon delivery. The Company recognizes revenue from fees for implementation services using the percentage of completion method. The Company calculates percentage of completion based on the estimated total number of hours of service required to complete specific tasks in an implementation project and the specific tasks completed. The Company recognizes support and maintenance services ratably over the term of its maintenance contracts, which are typically annual contracts. Training services are recognized as such services are completed.

 

The Company derives revenue principally from the sale of software licenses and from fees for implementation, technical support, and training services.  The Company also derives revenue from reimbursable costs that are invoiced to the customer.  Revenue from reimbursable costs constituted 1.3% and 1.7% of the Company’s total revenue for the three months ended September 30, 2003 and 2002, respectively, and 1.2% and 1.9% of the Company’s total revenue for the nine months ended September 30, 2003 and 2002, respectively, and is included in revenue from services and other.

 

The Company markets its solution to its clients primarily through its direct sales force, value-added resellers, and original equipment manufacturers, or OEMs, in North America, Europe, South America, Asia, Africa, and Australia. Revenue generated via resellers and OEMs accounted for 28.7% and 19.1% of the Company’s total revenue for the three months ended September 30, 2003 and 2002, respectively, and 26.8% and 20.6% of the Company’s total revenue for the nine months ended September 30, 2003 and 2002, respectively.   Management expects that revenue derived from sales to resellers and OEMs may increase as a percentage of total revenue as the Company expands its product capabilities and focuses its sales efforts on its distribution channels.

 

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Although the Company enters into general sales contracts with its clients and resellers, none of its clients or resellers is obligated to purchase its product or its services pursuant to these contracts. The Company relies on its clients and resellers to submit purchase orders for its products and services. All of the Company’s sales contracts contain provisions regarding the following:

•                  product features and pricing;

•                  order dates, rescheduling, and cancellations;

•                  warranties and repair procedures; and

•                  marketing and/or sales support and training obligations.

 

Typically, these contracts provide that the exclusive remedy for breach of the Company’s specified warranty is either a refund of the price paid or modification of the product to satisfy the warranty.

 

The Company has generally experienced a product sales cycle of six to nine months. The Company considers the life of the sales cycle to begin on the first face-to-face meeting with the prospective client and end when product is shipped. The length of the sales cycle for client orders depends on a number of factors including:

•                  a client’s awareness of the capabilities of the type of solutions Apropos sells and the amount of client education required;

•                  concerns that the Company’s client may have about its limited operating history and track record and the Company’s size and financial strength compared to many of its larger competitors;

•                  a client’s budgetary constraints;

•                  the timing of a client’s budget cycles;

•                  concerns of the Company’s client about the introduction of new products by the Company or its competitors that would render its current product noncompetitive or obsolete; and

•                  downturns in general economic conditions, including reductions in demand for contact center services.

 

The Company’s OEM contracts contain additional provisions regarding product technical specifications, labeling instructions, and other instructions regarding customization and rebranding. The Company’s OEM contracts contain volume discounts.

 

Revenues derived from customers outside North America accounted for 21.7% and 20.9% of the Company’s total revenues in the three months ended September 30, 2003 and 2002, respectively, and 24.8% and 28.0% of the Company’s total revenues in the nine months ended September 30, 2003 and 2002, respectively.  Management expects the portion of the Company’s total revenue derived from sales to customers outside North America to be comparable in the foreseeable future.

 

Cost of goods and services.  Cost of goods and services consists primarily of:

•                  the cost of compensation for technical support, education, and professional services personnel;

•                  other costs related to facilities and office equipment for technical support, education, and professional services personnel;

•                  the cost of third party hardware the Company resells as part of its solution; and

•                  payments for third party software used with the Company’s product.

 

The Company recognizes costs of software, maintenance, support and training services, and hardware as they are incurred. Costs of implementation services are recognized using the percentage of completion method described above.

 

 Operating expenses. The Company generally recognizes its operating expenses as they are incurred. Sales and marketing expenses consist primarily of compensation, commission, and travel expenses along with other marketing expenses, including trade shows, public relations, telemarketing campaigns, and other promotional expenses. Research and development expenses consist primarily of compensation expenses for personnel and, to a lesser extent, independent contractors. General and administrative expenses consist primarily of compensation for administrative, financial, and information technology personnel and a number of non-allocable costs, including professional fees, legal fees, accounting fees, and bad debts.

 

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Allowance for doubtful accounts.  The Company maintains an allowance for doubtful accounts to reflect the expected uncollectability of accounts receivable based on past collection history and specific risks identified among uncollected accounts.  Accounts receivable are charged to the allowance for doubtful accounts when the Company has determined that the receivable will not be collected.  Accounts receivable balances are determined to be delinquent when the amount is past due based on the contractual terms with the customer.

 

 Stock compensation charge.  Stock compensation charge represents the difference at the grant date between the exercise price and the pre-IPO deemed fair value of the Common Shares underlying the options. This amount is being amortized over the vesting period of the individual options, which is typically four years. This non-cash expense results in a corresponding increase to shareholders’ equity.  Subsequent to the IPO, the exercise price of all options granted has been equal to the fair market value of the underlying Common Shares, resulting in no compensation charge.

 

 Other income and expenses.  Other income and expense relates primarily to interest earned and foreign currency remeasurement. Interest income is generated by the investment of cash raised in rounds of equity financing, most notably the IPO in February 2000.

 

Results of Operations

 

The following table sets forth, for the periods indicated, the percentage of total revenue represented by certain items included in the Company’s “Condensed Consolidated Statements of Operations” in the condensed consolidated financial statements.  Percentages are calculated from operating results rounded to the nearest thousand and may not equal calculations from the numbers referenced below in this section which may be rounded to the nearest hundred thousand.  Operating performance for any period is not necessarily indicative of performance for any future periods.

 

		Three months ended September 30				Nine months ended September 30
		2003		2002		2003		2002
Revenue
Software licenses		35.6	%	39.9	%	36.7	%	41.8	%
Services and other		64.4	%	60.1	%	63.3	%	58.2	%
Total revenue		100.0	%	100.0	%	100.0	%	100.0	%
Costs of goods and services
Cost of software		1.9	%	1.6	%	2.0	%	2.0	%
Cost of services and other		21.3	%	28.1	%	23.0	%	27.4	%
Total costs of goods and services		23.2	%	29.7	%	25.0	%	29.4	%
Gross margin		76.8	%	70.3	%	75.0	%	70.6	%
Operating expenses
Sales and marketing		34.6	%	65.9	%	40.2	%	68.3	%
Research and development		23.7	%	37.7	%	29.7	%	37.7	%
General and administrative		31.3	%	36.9	%	30.7	%	37.4	%
Stock compensation charge		1.6	%	2.0	%	1.5	%	2.0	%
Restructuring and other charges		51.5	%	16.7	%	19.8	%	5.4	%
Total operating expenses		142.7	%	159.2	%	121.9	%	150.8	%
Operating loss		(65.9	)%	(88.9	)%	(46.9	)%	(80.2	)%
Other income (expense)		2.2	%	4.7	%	2.6	%	4.7	%
Net Loss		(63.7	)%	(84.2	)%	(44.3	)%	(75.5	)%

 

Three Months Ended September 30, 2003, Compared to Three Months Ended September 30, 2002

 

Revenue. Revenue decreased 9.8% to $4.7 million in the quarter ended September 30, 2003, from $5.2 million in the quarter ended September 30, 2002.

 

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Revenue from software licenses decreased 19.6% to $1.7 million in the quarter ended September 30, 2003, from $2.1 million in the quarter ended September 30, 2002.  The Company attributes this decrease in software revenue primarily to lower purchases from existing customers.

 

Revenue from services and other, consisting of professional services, customer support, hardware and rebillable costs, decreased 3.3% to $3.0 million in the quarter ended September 30, 2003, from $3.1 million in the quarter ended September 30, 2002.  An increase in customer support revenue to $2.3 million in the third quarter of 2003 from $2.0 million in the third quarter of 2002 as a result of the Company’s expanding customer base was more than offset by lower professional services revenue and related reimbursable costs due to fewer customers purchasing new systems, and to a lesser extent a higher percentage of sales through OEMs and resellers.

 

Gross margin. Gross margins improved to 76.8% of total revenue in the quarter ended September 30, 2003, from 70.3% of total revenue in the quarter ended September 30, 2002. This improvement is due primarily to a smaller professional services organization with higher utilization rates.  This improvement was also due to a lesser extent by lower product costs.

 

Gross margins from software licenses decreased to 94.6% of software revenue in the quarter ended September 30, 2003 from 96.1% of software revenue in the quarter ended September 30, 2002. Product costs consist primarily of third party software used in conjunction with the Company’s software.

 

Gross margin from services and other represented 66.9% of services and other revenue in the quarter ended September 30, 2003, and 53.2% of services and other revenue in the quarter ended September 30, 2002.  This improvement is due primarily to a smaller professional services organization with higher utilization rates.  This improvement was also due to a lesser extent by lower product costs.

 

Operating expenses. Operating expenses decreased 19.2% to $6.7 million in the quarter ended September 30, 2003, from $8.3 million in the quarter ended September 30, 2002.  This decrease primarily reflects lower staffing levels in the third quarter 2003 compared to the third quarter 2002. Total operating headcount decreased by 46.2% to 70 employees at September 30, 2003, from 130 employees at September 30, 2002. Offsetting this decrease to a lesser extent was an increase in restructuring and other charges to $2.4 million in the third quarter of 2003 from $0.9 million in the third quarter of 2002.  As a percentage of total revenue, operating expenses were 142.7% in the quarter ended September 30, 2003, and 159.2% in the quarter ended September 30, 2002.

 

Sales and marketing expenses decreased 52.7% to $1.6 million in the quarter ended September 30, 2003, from $3.4 million in the quarter ended September 30, 2002.  The decrease in sales and marketing expenses resulted primarily from lower personnel costs, as a result of fewer personnel, streamlined marketing programs, and lower commission expense due to lower commissionable sales.

 

Research and development expenses decreased 43.2% to $1.1 million in the quarter ended September 30, 2003, from $2.0 million in the quarter ended September 30, 2002.  The decrease in research and development expenses related primarily from reductions in personnel.

 

General and administrative expenses decreased 23.5% to $1.5 million in the quarter ended September 30, 2003, from $1.9 million in the quarter ended September 30, 2002.  The decreases in general and administrative expenses were primarily due to lower personnel costs related to fewer personnel and lower bad debt expense.  These decreases were offset to a lesser extent by higher insurance and legal costs.

 

Stock compensation charge decreased 29.9% to $75,000 in the quarter ended September 30, 2003, from $107,000 in the quarter ended September 30, 2002. Stock compensation charge represents the difference at the grant date between the exercise price and the pre-IPO deemed fair value of the Common Shares underlying the options.  This amount is being amortized over the vesting period of the individual options, which is typically four years.  This non-cash expense results in a corresponding increase to additional paid in capital.  The decrease from the prior period primarily reflects cancelled options resulting from employees that are no longer employed by the Company and full vesting of the underlying options.

 

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Restructuring and other charges.  In the third quarter of 2003, the Company conducted an extensive review of its operations to better align its operating cost structure with current revenue levels.  This review focused on staffing levels, facility needs and long-lived assets utilized in the business.  As a result of this review, the Company recorded a Restructuring and other charges of $2.4 million.  This charge was comprised of three components:  a charge related to staff reductions of $0.7 million, a facility termination charge of $1.3 million and an asset impairment charge of $0.4 million. In the third quarter of 2002, the Company recorded a Restructuring and other charges of $0.9 million.  This charge related to staff reductions of 18 persons, including involuntary terminations of three senior level positions with contractual obligations, and former employee settlement costs.

 

Other income and expense. Interest income was $99,000 in the quarter ended September 30, 2003, and $236,000 in the quarter ended September 30, 2002. The decrease in interest income is a result of lower cash, cash equivalents, and short-term investment balances and a decline in investment yields.

 

Income taxes.  There has been no provision or benefit for income taxes for any period since 1995 due to the Company’s operating losses.  As of September 30, 2003, the Company had approximately $52.5 million of domestic operating loss carryforwards for federal income tax purposes, which expire beginning in 2011 and foreign operating losses of approximately $9.1 million with no carry forward limits.  The Company’s use of these net operating losses may be limited in future periods.

 

Basic and diluted net loss per share.  Net loss per share decreased 32.1% to $0.18 in the quarter ended September 30, 2003, from $0.26 in the quarter ended September 30, 2002. The decrease in the loss per share is the result of a smaller net loss of $3.0 million for the three months ended September 30, 2003 compared to $4.4 million net loss for the three months ended September 30, 2002.  The number of shares used to compute net loss per share increased 0.5% to 16.84 million in the quarter ended September 30, 2003, from 16.75 million in the quarter ended September 30, 2002.  This increase was principally the result of stock issuances related to the Company’s stock option and employee stock purchase plans offset by treasury shares acquired in the fourth quarter of 2002.

 

Nine Months Ended September 30, 2003, Compared to Nine Months Ended September 30, 2002

 

Revenue. Revenue decreased 8.6% to $14.5 million in the nine months ended September 30, 2003, from $15.9 million in the nine months ended September 30, 2002.

 

Revenue from software licenses decreased 19.8% to $5.3 million in the nine months ended September 30, 2003, from $6.6 million in the nine months ended September 30, 2002.  The Company attributes this decrease in software revenue primarily to fewer new customers added in the nine months ended September 30, 2003 compared to the nine months ended September 30, 2002.

 

Revenue from services and other, consisting of professional services, customer support, hardware and rebillable costs, decreased 0.6% to $9.2 million in the nine months ended September 30, 2003, from $9.3 million in the nine months ended September 30, 2002.  An increase in customer support revenue to $6.8 in the nine months ended September 30, 2003 from $5.7 million in the nine months ended September 30, 2002 as a result of the Company’s expanding customer base was more than offset by lower professional services revenue and related reimbursable costs due to fewer customers purchasing new systems.

 

Gross margin. Gross margins improved to 75.0% of total revenue in the nine months ended September 30, 2003, from 70.6% of total revenue in the nine months ended September 30, 2002. This improvement is due primarily to a smaller professional services organization with higher utilization rates.  This improvement was also due to a lesser extent by lower hardware sales and lower reimbursable costs, both of which provide little or no gross margin.

 

Gross margins from software licenses decreased to 94.5% of software revenue in the nine months ended September 30, 2003 from 95.3% of software revenue in the nine months ended September 30, 2002. Product costs consist primarily of third party software used in conjunction with the Company’s software.

 

Gross margin from services and other represented 63.7% of services and other revenue in the nine months ended September 30, 2003, and 52.9% of services and other revenue in the nine months ended September 30, 2002.  This improvement is due primarily to a smaller professional services organization with higher utilization

 

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rates.  This improvement was also due to a lesser extent by lower hardware sales and lower reimbursable costs, both of which provide little or no gross margin.

 

Operating expenses. Operating expenses decreased 26.1% to $17.7 million in the nine months ended September 30, 2003, from $24.0 million in the nine months ended September 30, 2002.  This decrease primarily reflects lower staffing levels in the nine months ended September 30, 2003 compared to the nine months ended September 30, 2002. Total operating headcount decreased by 46.2% to 70 employees at September 30, 2003, from 130 employees at September 30, 2002. As a percentage of total revenue, operating expenses were 121.9% in the nine months ended September 30, 2003, and 150.8% in the nine months ended September 30, 2002.

 

Sales and marketing expenses decreased 46.2% to $5.8 million in the nine months ended September 30, 2003, from $10.9 million in the nine months ended September 30, 2002.  The decrease in sales and marketing expenses resulted primarily from lower personnel costs, as a result of fewer personnel, and streamlined marketing programs.

 

Research and development expenses decreased 28.0% to $4.3 million in the nine months ended September 30, 2003, from $6.0 million in the nine months ended September 30, 2002.  The decrease in research and development expenses related primarily from reductions in personnel, and to a lesser extent by a decreased use of outside consultants.

 

General and administrative expenses decreased 24.8% to $4.5 million in the nine months ended September 30, 2003, from $5.9 million in the nine months ended September 30, 2002.  The decrease in general and administrative expenses was primarily due to lower personnel costs related to fewer personnel, lower bad debt expense and lower professional fees.  These decreases were offset to a lesser extent by higher insurance costs.

 

Stock compensation charge decreased 30.1% to $225,000 in the nine months ended September 30, 2003, from $322,000 in the nine months ended September 30, 2002. Stock compensation charge represents the difference at the grant date between the exercise price and the pre-IPO deemed fair value of the Common Shares underlying the options.  This amount is being amortized over the vesting period of the individual options, which is typically four years.  This non-cash expense results in a corresponding increase to additional paid in capital.  The decrease from the prior period primarily reflects cancelled options resulting from employees that are no longer employed by the Company and full vesting of the underlying options.

 

Restructuring and other charges.  In the nine months ended September 30, 2003, the Company conducted two reviews of its operations to better align its operating cost structure with its revenue levels.  Both the first and third quarter reviews focused on staffing levels while the third quarter review also focused on facility needs and long-lived assets utilized in the business.  As a result of these reviews, the Company recorded a charge of $2.9 million.  This charge was comprised of three components:  a charge related to staff reductions of $1.2 million, a facility termination charge of $1.3 million and an asset impairment charge of $0.4 million. In the third quarter of 2002, the Company recorded a Restructuring and other charges of $869,000.  This charge related to staff reductions of 18 persons, including involuntary terminations of three senior level positions with contractual obligations, and former employee settlement costs.

 

Other income and expense. Interest income was $382,000 in the nine months ended September 30, 2003, and $748,000 in the nine months ended September 30, 2002. The decrease in interest income is a result of lower cash, cash equivalents, and short-term investment balances and a decline in investment yields.

 

Income taxes.  There has been no provision or benefit for income taxes for any period since 1995 due to the Company’s operating losses.  As of June 30, 2003, the Company had approximately $52.5 million of domestic operating loss carryforwards for federal income tax purposes, which expire beginning in 2011 and foreign operating losses of approximately $9.1 million with no carry forward limits.  The Company’s use of these net operating losses may be limited in future periods.

 

Basic and diluted net loss per share.  Net loss per share decreased 46.4% to $0.38 in the nine months ended September 30, 2003, from $0.72 in the nine months ended September 30, 2002. The decrease in the loss per share is the result of a smaller net loss of $6.4 million for the nine months ended September 30, 2003 compared to $12.0 million net loss for the nine months ended September 30, 2002.  The number of shares used to compute net

 

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loss per share remained relatively unchanged at 16.75 million in the nine months ended September 30, 2003, compared to the nine months ended September 30, 2002.

 

Liquidity and Capital Resources

 

The Company’s operating activities resulted in net cash outflows of $3.3 million and $9.0 million in the nine months ended September 30, 2003 and 2002, respectively.  The operating cash outflows for these periods resulted from net losses experienced in each of the periods.  The cash used in operations was offset in part in both periods by non-cash charges for amortization of stock-based compensation and depreciation as well as higher amounts of unearned revenue.  Additionally, the cash used in operations in 2003 were offset by a non-cash charge of $0.4 million which related to asset impairment and $1.2 million for facility termination costs.  The Company estimates these funds for the facility termination costs will be completely disbursed through the second quarter of 2006.

 

The Company’s investing activities resulted in net cash inflows of $21.4 million and $9.4 million in the nine months ended September 30, 2003 and 2002, respectively.  This inflow was primarily the result of a decision by management to reduce the length of maturity on the Company’s investments.  The decision caused many investments to be classified as cash and cash equivalents instead of short-term investments.  These inflows were offset in part by capital expenditures of $123,000 and $256,000 in the nine months ended September 30, 2003 and 2002, respectively.

 

Financing activities generated $265,000 and $137,000 in cash in the nine months ended September 30, 2003 and 2002, respectively.  These funds were generated from proceeds received from stock issuances related to the Company’s stock option and employee stock purchase plans.

 

The Company believes that its capital requirements, in large part, depend on future results of operations and, ultimately, achievement of profitability. The Company expects to devote resources to research and development efforts, expand sales channels and marketing programs with an emphasis on lead generation opportunities, fund capital expenditures, and provide for working capital and other general corporate purposes. Management believes that the existing cash and short-term investment balances will be sufficient to meet the working capital and capital expenditure requirements for at least the next twelve months.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

 

Interest Rate Risk

 

The Company’s exposure to market risk for changes in interest rates relate primarily to the change in the amount of interest income the Company can earn on its investments. The Company does not use derivative financial instruments in its investment portfolio. The Company had short-term investments of $1.1 million at September 30, 2003. The Company’s short-term investments consist primarily of highest grade commercial paper and government agency bonds. The Company considers all investments with original maturities of less than one year, but greater than 90 days from the respective balance sheet date to be short-term investments. These investments are subject to interest rate risk and will fall in value if market interest rates increase. The Company believes a hypothetical increase in market interest rates by 10.0% from levels at December 31, 2002, would cause the fair value of these short-term investments to fall by an immaterial amount.  Since the Company is not required to sell these investments before maturity, the Company has the ability to avoid realizing losses on these investments due to a sudden change in market interest rates. On the other hand, declines in the interest rates over time will reduce interest income.

 

Foreign Currency Risk

 

 The Company develops products in the United States and sells these products in North America, Europe, South America, Asia, Africa, and Australia. As a result, its financial results could be affected by various factors, including changes in foreign currency exchange rates or weak economic conditions in foreign markets. As sales are generally made in U.S. dollars or British pound sterling, a strengthening of the dollar or pound could make the Company’s products less competitive in foreign markets. Given the level of income the Company currently derives from its foreign operations, the Company considers this exposure to be minimal. The Company believes a 10.0% change in exchange rates would not have a significant impact on its future earnings.

 

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Item 4.  Controls and Procedures

 

The Company’s Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of  the end of the period covered by this report, that the Company’s disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) are effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.  There were no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2003 that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

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Part II. Other Information.

 

Item 1.  Legal Proceedings.

 

See Note 4 to the Company’s unaudited condensed consolidated financial statements in Item 1 – Part I of this Quarterly Report on Form 10-Q, which is hereby incorporated by reference.

 

Item 2.  Changes in Securities and Use of Proceeds.

 

Not applicable.

 

Item 3.  Defaults Upon Senior Securities.

 

Not applicable.

 

Item 4.  Submission of Matters to a Vote of Security Holders.

 

Not applicable.

 

Item 5.           Other Information.

 

Not applicable.

 

Item 6.  Exhibits and Reports on Form 8-K.

 

(a)          The following exhibits are included herein:

 

31.1             Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2             Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1             Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)         The Company filed the following reports on Form 8-K during the quarter ended June 30, 2003:

 

A Form 8-K, dated July 22, 2003 was filed on July 25, 2003 in response to Items 7, 9 and 12 to file a press release announcing our financial results for the quarter ended June 30, 2003 and to file supplemental information related thereto.

 

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Signatures

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 14, 2003.

 

 

	Apropos Technology, Inc.
	/s/FRANCIS J. LEONARD
	Francis J. Leonard
	Chief Financial Officer and Vice President (Principal Financial Officer and Authorized Officer)

 

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