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 June 30, 2004

 

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)

 

 

One Tower Lane, 28th Floor

Oakbrook Terrace, Illinois 60181

(Address of principal executive offices, including zip code)

 

(630) 472-9600

(Registrant’s telephone number, including area code)

 

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 July 23, 2004, was 17,306,491.

 

 

APROPOS TECHNOLOGY, INC.

TABLE OF CONTENTS

 

Part I.	Financial Information
Item 1.	Financial Statements (Unaudited)
	Condensed consolidated balance sheets at June 30, 2004 and December 31, 2003
	Condensed consolidated statements of operations for the three and six months ended June 30, 2004 and 2003
	Condensed consolidated statements of cash flows for the six months ended June 30, 2004 and 2003
	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
Certifications

 

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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

 

		June 30 2004			December 31 2003
		(Unaudited)			(Note 1)
Assets
Current assets :
Cash and cash equivalents		$	39,405		$	38,265
Short-term investments		1,515			1,000
Accounts receivable, less allowances for doubtful accounts of $187 at June 30, 2004 and $265 at December 31, 2003		2,423			2,895
Inventory		41			73
Prepaid expenses and other current assets		662			588
Total current assets		44,046			42,821
Equipment, net		663			921
Other assets		24			199
Total assets		$	44,733		$	43,941
Liabilities and shareholders’ equity
Current liabilities :
Accounts payable		$	142		$	81
Accrued expenses		960			1,179
Accrued compensation and related accruals		531			377
Accrued restructuring, current portion		516			438
Advance payments from customers		99			186
Deferred revenues		3,474			3,296
Total current liabilities		5,722			5,557
Accrued restructuring, less current portion		360			560
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, 17,306,491 shares issued and outstanding at June 30, 2004; 17,257,225 issued and 16,946,114 outstanding at December 31, 2003		173			173
Additional paid-in capital		102,574			102,263
Treasury stock, at cost		—			(392		)
Accumulated deficit		(64,096		)	(64,220		)
Total shareholders’ equity		38,651			37,824
Total liabilities and shareholders’ equity		$	44,733		$	43,941

 

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 June 30						Six months ended June 30
		2004			2003			2004			2003
Revenue
Software licenses		$	1,638		$	1,587		$	3,625		$	3,648
Services and other		3,330			3,069			6,503			6,165
Total revenue		4,968			4,656			10,128			9,813
Cost of goods and services
Cost of software		116			133			287			203
Cost of services and other		1,020			1,175			1,871			2,332
Total cost of goods and services		1,136			1,308			2,158			2,535
Gross margin		3,832			3,348			7,970			7,278
Operating expenses
Sales and marketing		1,760			1,924			3,433			4,208
Research and development		1,032			1,500			2,084			3,195
General and administrative		946			1,424			2,043			2,991
Stock compensation charge		—			75			—			150
Restructuring and other charges		88			—			456			448
Total operating expenses		3,826			4,923			8,016			10,992
Income (loss) from operations		6			(1,575		)	(46		)	(3,714		)
Other income (expense)
Interest income		107			123			203			283
Other, net		(4		)	(12		)	(33		)	(4		)
Total other income (expense)		103			111			170			279
Net income (loss)		$	109		$	(1,464	)	$	124		$	(3,435	)
Net income (loss) per share
Basic		$	0.01		$	(0.09	)	$	0.01		$	(0.21	)
Diluted		$	0.01		$	(0.09	)	$	0.01		$	(0.21	)
Weighted average shares outstanding
Basic		17,273			16,729			17,188			16,702
Diluted		18,614			16,729			18,575			16,702

 

See notes to condensed consolidated financial statements.

 

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Apropos Technology, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

In thousands

 

		Six months ended June 30
		2004			2003
Cash flows from operating activities
Net income (loss)		$	124		$	(3,435	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		250			606
Provision for doubtful accounts		—			27
Stock compensation charge		—			150
Non-cash restructuring charge		420			—
Changes in operating assets and liabilities:
Accounts receivable		471			44
Inventory		32			(61		)
Prepaid expenses and other current assets		(74		)	(92		)
Other assets		6			10
Accounts payable		61			50
Accrued expenses		(219		)	(538		)
Accrued compensation and related accruals		154			(261		)
Accrued restructuring		(269		)	—
Advanced payments from customers		(87		)	(114		)
Deferred revenue		178			881
Net cash provided by (used in) operating activities		1,047			(2,733		)
Cash flows from investing activities
Maturities and sales of short-term investments		—			20,593
Purchases of short-term investments		(514		)	(5,470		)
Purchases of equipment		(96		)	(46		)
Net cash provided by (used in) investing activities		(610		)	15,067
Cash flows from financing activities
Proceeds from exercise of options		639			54
Proceeds from employee stock purchase plan		64			54
Net cash provided by financing activities		703			108
Net change in cash and cash equivalents		1,140			12,442
Cash and cash equivalents, beginning of period		38,265			19,333
Cash and cash equivalents, end of period		$	39,405		$	31,775

 

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, 2003, 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, 2003, included with its Annual Report on Form 10-K filed with the SEC on March 30, 2004.  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.              Income or Loss Per Share

 

Basic net income or loss per share is based upon the net income or loss and upon the weighted-average number of common shares outstanding during the period.  Diluted net income per common share adjusts for the effect of common share equivalents, such as stock options and stock warrants, net of assumed repurchases, 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 the respective period presented.  Accordingly, diluted net loss per share is the same as basic net loss per share.

 

		Three months ended June 30						Six months ended June 30
In thousands, except per share amounts		2004			2003			2004			2003
Basic Income (loss) per share
Net income (loss)		$	109		$	(1,464	)	$	124		$	(3,435	)
Weighted average shares outstanding		17,273			16,729			17,188			16,702
Income (loss) per share		$	0.01		$	(0.09	)	$	0.01		$	(0.21	)
Diluted Income per share
Net income		$	109					$	124
Shares:
Weighted average shares outstanding		17,273						17,188
Assumed option exercises		1,326						1,372
Assumed warrant exercises		15						15
Weighted average shares outstanding, as adjusted		18,614						18,575
Diluted income per share		$	0.01					$	0.01

 

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3.              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.

 

In accordance with the interim disclosure provisions of SFAS No. 148, the pro forma effect on the Company’s net income (loss) had compensation expense been recorded for the three and six months ended June 30, 2004 and 2003, respectively, as determined under the fair value method, is shown below.

 

		Three months ended June 30						Six months ended June 30
In thousands, except per share amounts		2004			2003			2004			2003
Net income (loss), as reported		$	109		$	(1,464	)	$	124		$	(3,435	)
Add: Stock-based employee compensation expense included in reported net income (loss)		—			75			—			150
Less: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects		(215		)	(327		)	(433		)	(669		)
Net loss, pro forma		$	(106	)	$	(1,716	)	$	(309	)	$	(3,984	)
Basic net income (loss) per share, as reported		$	0.01		$	(0.09	)	$	0.01		$	(0.21	)
Basic net loss per share, pro forma		$	(0.01	)	$	(0.10	)	$	(0.02	)	$	(0.24	)
Diluted net income per share, as reported		$	0.01					$	0.01

 

Options to purchase 2,499,683 Common Shares with exercise prices of $0.10 to $22.00 per share were outstanding as of June 30, 2004, and options to purchase 2,958,510 Common Shares with exercise prices of  $0.10 to $22.00 per share were outstanding as of June 30, 2003.

 

4.              Geographic Information

 

Revenues derived from customers outside of North America accounted for 17.1% and 25.4% of the Company’s total revenues in the three months ended June 30, 2004 and 2003, respectively.  Revenues derived from customers outside of North America accounted for 18.1% and 26.3% of the Company’s total revenues in the six months ended June 30, 2004 and 2003, 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.

 

5.              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 February 25, 2004, the Company along with all other defendants, signed an agreement in principle to settle this litigation in consideration of a payment of $4.5 million, to be paid by the Company’s insurer.  No settlement monies will be due from the Company itself.  The settlement documents have been filed with the Court, and on May 6, 2004, the Court preliminarily approved their form.  Consummation of the proposed settlement is conditioned upon, among other things, negotiating, executing, and filing

 

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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 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 court has entered an order staying 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 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.  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.

 

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.

 

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While the Company cannot guarantee the outcome of the above 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, 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 condition or results of operations, or cash flows.

 

6.              Restructuring and other charges

 

In the second quarter of 2004, the Company recorded a charge of $88,000 related to the consolidation of the corporate headquarters.  This adjustment to the existing reserve is due to the fact the Company has been unable to find a tenant to sublet the excess facility space and thereby delayed the start of anticipated sublet income by six months.

 

In the first quarter of 2004, the Company recorded a charge of $368,000.  In late January 2004, the U.K. operations moved into new premises that are more suitable for their current staffing levels.  The old facility, which had a lease through March 2005, was in use until the move.  The U.K. lease termination charge of approximately $309,000, consisted of forfeiture of the rent deposit, abandonment of assets, and other direct disposal costs.  Additionally, the Company recorded an adjustment of $59,000 for the reserve related to the consolidation of the corporate headquarters.  This adjustment is due to the fact the Company has been unable to find a tenant to sublet the excess facility space and thereby delayed the start of anticipated sublet income by three months.

 

In the first quarter of 2003, the Company recorded a charge of $448,000.  This charge related to staff reductions of 30 persons.

 

A summary of the restructuring and other charge, is as follows:

 

In thousands		Employee termination costs			Facility termination costs			Asset impairment charge			Other			Total
Balance as of December 31, 2002		396			—			—			24			420
2003 Provision		448			—			—			—			448
2003 Adjustments		—			—			—			—			—
2003 Cash Payments		(791		)	—			—			(13		)	(804		)
2003 Non-cash charge offs		—			—			—			—			—
Balance as of June 30, 2003		$	53		$	—		$	—		$	11		$	64

 

In thousands		Employee termination costs			Facility termination costs			Asset impairment charge			Other			Total
Balance as of December 31, 2003		$	6		$	981		$	—		$	11		$	998
2004 Provision		—			205			104			—			309
2004 Adjustments		—			147			—			—			147
2004 Cash Payments		—			(305		)	—			—			(305		)
2004 Non-cash charge offs		—			(169		)	(104		)	—			(273		)
Balance as of June 30, 2004		$	6		$	859		$	—		$	11		$	876

 

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Included in Accrued restructuring at June 30, 2004 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.  The remaining  $859,000, of which $360,000 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.

 

7.              Subsequent event

 

On August 2, 2004, the Company announced that David McCrabb has been named interim President and Chief Executive Officer of the Company and will be assuming this role in mid-August.

 

Kevin Kerns, the previous President and Chief Executive Officer, resigned from the Board of Directors effective August 2, 2004.

 

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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.  These and other risks are 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, 2003, 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 upon delivery. The Company recognizes revenue from fees for professional services when they are 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 markets its solution to its customers 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 19.5% and 24.2% of the Company’s total revenue for the three months ended June 30, 2004 and 2003, respectively. Revenue generated via resellers and OEMs accounted for 28.4%, and 25.9% of the Company’s total revenue for the six months ended June 30, 2004 and 2003, 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.

 

The Company relies on its customers and resellers to submit purchase orders for its product and services.  In addition, the Company enters into general sales contracts with its customers and resellers; however, none of its customers or resellers is obligated to purchase its product or its services pursuant to these contracts. 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

 

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•                                          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 customer and end when product is shipped. The length of the sales cycle for customer orders depends on a number of factors including:

 

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

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

•                                          a customer’s budgetary constraints;

•                                          the timing of a customer’s budget cycles;

•                                          concerns of the Company’s customer 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 of North America accounted for 17.1% and 25.4% of the Company’s total revenues in the three months ended June 30, 2004 and 2003, respectively.  Revenues derived from customers outside of North America accounted for 18.1% and 26.3% of the Company’s total revenues in the six months ended June 30, 2004 and 2003, respectively.  Management expects the portion of the Company’s total revenue derived from sales to customers outside the United States to be comparable in the foreseeable future.

 

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

 

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

•                                          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; and

•                                          the cost of reimbursable travel included in revenue.

 

The Company recognizes costs of software, implementation services, support and training services as they are incurred.

 

 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.

 

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.

 

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 Other income and expenses.  Other income and expense relates primarily to interest earned and/or owed. Interest income is generated by the investment of cash raised in rounds of equity financing, most notably the IPO in February 2000. Interest expense is generated primarily from outstanding debt and certain capitalized obligations, including any capital leases.

 

Income taxes. The Company provides for income taxes under the liability method, which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns.  Under this method, a valuation allowance is required against net deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.  Management evaluates the recoverability of the deferred tax assets and the level of the valuation allowance. At such time as it is determined that it is more likely than not that deferred tax assets are realizable, the valuation allowance will be appropriately reduced.

 

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.

 

 

Quarter Ended June 30, 2004, Compared to Quarter Ended June 30, 2003

 

Revenue. Revenue increased 6.7% to $5.0 million in the quarter ended June 30, 2004, from $4.7 million in the quarter ended June 30, 2003.

 

Revenue from software licenses increased 3.2% to $1.64 million in the quarter ended June 30, 2004, from $1.59 million in the quarter ended June 30, 2003.  The Company primarily attributes this increase in software revenue to larger orders from new customers added in the second quarter of 2004 compared to the second quarter of 2003.

 

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Revenue from services and other, consisting of professional services, customer support and rebillable costs, increased 8.5% to $3.3 million in the quarter ended June 30, 2004, from $3.1 million in the quarter ended June 30, 2003.  The Company primarily attributes this increase to increased customer support revenue as a result of the Company’s expanding customer base, and to increased professional services revenue, which included the greater use of subcontracted services, due to increasing demand for implementing system upgrades.

 

Gross margin. Gross margins improved to 77.1% of total revenue in the quarter ended June 30, 2004, from 71.9% of total revenue in the quarter ended June 30, 2003. This improvement is due primarily to improved implementation and customer staff support utilization.

 

Gross margins from software licenses increased to 92.9% of software revenue in the quarter ended June 30, 2004 from 91.6% of software revenue in the quarter ended June 30, 2003. Product costs consist primarily of third party software used in conjunction with the Company’s software.

 

Gross margin from services and other represented 69.4% of services and other revenue in the quarter ended June 30, 2004, and 61.7% of services and other revenue in the quarter ended June 30, 2003.  This improvement is due to improved implementation and customer staff support utilization.

 

Operating expenses. Operating expenses decreased 22.3% to $3.8 million in the quarter ended June 30, 2004, from $4.9 million in the quarter ended June 30, 2003.  This decrease primarily reflects lower staffing levels in the second quarter 2004 compared to the second quarter 2003. Total operating headcount decreased by 24.0% to 73 employees at June 30, 2004, from 96 employees at June 30, 2003. As a percentage of total revenue, operating expenses were 77.0% in the quarter ended June 30, 2004, and 105.7% in the quarter ended June 30, 2003.

 

Sales and marketing expenses decreased 8.6% to $1.8 million in the quarter ended June 30, 2004, from $1.9 million in the quarter ended June 30, 2003.  The decrease in sales and marketing expenses resulted primarily from lower personnel costs, as a result of fewer personnel, offset to a lesser extent by higher commission expense due to higher commissionable sales.

 

Research and development expenses decreased 31.2% to $1.0 million in the quarter ended June 30, 2004, from $1.5 million in the quarter ended June 30, 2003.  The decrease in research and development expenses related primarily from reductions in personnel.

 

General and administrative expenses decreased 33.5% to $0.9 million in the quarter ended June 30, 2004, from $1.4 million in the quarter ended June 30, 2003.  The decreases in general and administrative expenses were primarily due to lower facility costs related to the consolidation of the corporate facility, lower legal fees, lower insurance costs and lower personnel costs, as a result of fewer personnel.

 

Stock compensation charge decreased 100% to $0 in the quarter ended June 30, 2004, from $75,000 in the quarter ended June 30, 2003. The decrease was due to all options issued prior to the IPO having become fully vested.  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.

 

Restructuring and other charges.  In the second quarter of 2004, the Company recorded a charge of $88,000.  This adjustment of $88,000 to the existing reserve related to the consolidation of the corporate headquarters.  This adjustment is due to the fact the Company has been unable to find a tenant to sublet the excess facility space and thereby delayed the start of anticipated sublet income by six months.

 

Other income and expense. Interest income was $107,000 in the quarter ended June 30, 2004, and $123,000 in the quarter ended June 30, 2003. The decrease in interest income is the result of 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.  At June 30, 2004, the Company had approximately $52.2 million of domestic operating loss carryforwards for federal income tax purposes, which expire beginning in 2011through 2023.  Based on Internal Revenue Code regulations relating to changes in ownership in the Company, utilization of a portion of the net

 

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operating loss carryforwards is subject to annual limitations.  At June 30, 2004, the Company had foreign operating losses of approximately $8.9 million, which may be limited.  The Company’s use of these net operating losses may be limited in future periods.

 

Net income (loss).  The Company recorded its third consecutive quarterly profit in the three months ended June 30, 2004.  The net income for the three months ended June 30, 2004 was $109,000, which included a restructuring charge of $88,000.  The Company recorded a net loss for the three months ended June 30, 2003 of  $1.5 million.  The change is primarily due to an increase in gross margin and lower operating expenses.

 

Six Months Ended June 30, 2004, Compared to Six Months Ended June 30, 2003

 

Revenue. Revenue increased 3.2% to $10.1 million in the six months ended June 30, 2004, from $9.8 million in the six months ended June 30, 2003.

 

Revenue from software licenses remained relatively unchanged at $3.6 million in the six months ended June 30, 2004, from $3.6 million in the six months ended June 30, 2003.

 

Revenue from services and other, consisting of professional services, customer support and rebillable costs, increased 5.5% to $6.5 million in the six months ended June 30, 2004, from $6.2 million in the six months ended June 30, 2003.  The Company attributes this increase to increased customer support revenue as a result of the Company’s expanding customer base.

 

Gross margin. Gross margins improved to 78.7% of total revenue in the six months ended June 30, 2004, from 74.2% of total revenue in the six months ended June 30, 2003. This improvement is due primarily to improved implementation and customer staff support utilization.

 

Gross margins from software licenses decreased to 92.1% of software revenue in the six months ended June 30, 2004 from 94.4% of software revenue in the six months ended June 30, 2003. Product costs consist primarily of third party software used in conjunction with the Company’s software.

 

Gross margin from services and other represented 71.2% of services and other revenue in the six months ended June 30, 2004, and 62.2% of services and other revenue in the six months ended June 30, 2003.  This improvement is due to improved implementation and customer staff support utilization.

 

Operating expenses. Operating expenses decreased 27.1% to $8.0 million in the six months ended June 30, 2004, from $11.0 million in the six months ended June 30, 2003.  This decrease primarily reflects lower staffing levels in the first six months of 2004 compared to the first six months of 2003. Total operating headcount decreased by 24.0% to 73 employees at June 30, 2004, from 96 employees at June 30, 2003. As a percentage of total revenue, operating expenses were 79.1% in the six months ended June 30, 2004, and 112.0% in the six months ended June 30, 2003.

 

Sales and marketing expenses decreased 18.4% to $3.3 million in the six months ended June 30, 2004, from $4.2 million in the six months ended June 30, 2003.  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 34.8% to $2.1 million in the six months ended June 30, 2004, from $3.2 million in the six months ended June 30, 2003.  The decrease in research and development expenses related primarily from reductions in personnel.

 

General and administrative expenses decreased 31.7% to $2.0 million in the six months ended June 30, 2004, from $3.0 million in the six months ended June 30, 2003.  The decreases in general and administrative expenses were primarily due to lower facility costs related to the consolidation of the corporate facility, lower legal fees, lower insurance costs and lower personnel costs, as a result of fewer personnel.

 

Stock compensation charge decreased 100% to $0 in the six months ended June 30, 2004, from $150,000 in the six months ended June 30, 2003. The decrease was due to all options issued prior to the IPO having become fully vested.  Stock compensation charge represents the difference at the grant date between the exercise price and the pre-IPO

 

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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.

 

Restructuring and other charges.  In the six months ended June 30, 2004, the Company recorded a charge of $456,000.  In late January 2004, the U.K. operations moved into new premises that are more suitable for their current staffing levels.  The old facility, which had a lease through March 2005, was in use until the move.  The U.K. lease termination charge of approximately $309,000, consisted of forfeiture of the rent deposit, abandonment of assets, and other direct disposal costs.  Additionally, the Company has recorded adjustments to increase the reserve in the first and second quarters totaling $147,000 related to the consolidation of the corporate headquarters.  These adjustments are due to the fact the Company has been unable to find a tenant to sublet the excess facility space and thereby delayed the start of anticipated sublet income by nine months.  In the first quarter of 2003, the Company recorded a charge of $448,000.  This charge related to staff reductions of 30 persons.

 

Other income and expense. Interest income was $203,000 in the six months ended June 30, 2004, and $283,000 in the six months ended June 30, 2003. The decrease in interest income is a result of 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.  At June 30, 2004, the Company had approximately $52.2 million of domestic operating loss carryforwards for federal income tax purposes, which expire beginning in 2011through 2023.  Based on Internal Revenue Code regulations relating to changes in ownership in the Company, utilization of a portion of the net operating loss carryforwards is subject to annual limitations.  At June 30, 2004, the Company had foreign operating losses of approximately $8.9 million, which may be limited.  The Company’s use of these net operating losses may be limited in future periods.

 

Net income (loss).  The Company recorded a profit of $124,000 in the six months ended June 30, 2004, which included a restructuring charge of $456,000.  The Company recorded a net loss for the six months ended June 30, 2003 of  $3.4 million.  The change is primarily due to an increase in gross margin and lower operating expenses.

 

Liquidity and Capital Resources

 

The Company’s operating activities resulted in net cash inflows of $1.0 million in the six months ended June 30, 2004 compared to net cash outflows of $2.7 million in the six months ended June 30, 2003.  The operating cash inflows for the six months ended June 30, 2004 resulted primarily from net income increased by non-cash expenses and a decrease in accounts receivable, offset to a lesser extent by decreases in accrued expenses and accrued restructuring.  The operating cash outflows for the six months ended June 30, 2003 resulted from net losses experienced along with increases in prepaid expenses and accounts receivable, offset by an increase in deferred revenue billings.

 

The Company’s investing activities resulted in net cash outflows of $0.6 million in the six months ended June 30, 2004 and net cash inflows of $15.0 million in the six months ended June 30, 2003.  The net outflows in the six months ended June 30, 2004 were the result of the purchase of short-term investments and capital expenditures.  The net cash inflow in the six months ended June 30, 2003 was primarily the 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.  This inflow was offset by capital expenditures in the six months ended June 30, 2003.

 

Financing activities generated $703,000 and $108,000 in cash in the six months ended June 30, 2004 and 2003, respectively.  These funds were generated from proceeds received from stock issuances related to the Company’s stock option and employee stock purchase plans.

 

As of June 30, 2004, the Company had no long-term obligations other than operating leases related to facilities utilized by the Company.  The following table summarizes the minimum lease payments for these operating leases as of June 30, 2004:

 

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in thousands		Operating leases
Through June 30, 2005		$	1,403
Through June 30, 2006		1,248
		$	2,651

 

The Company believes that its capital requirements, in large part, depend on future results of operations and maintaining profitability. The Company expects to devote resources to research and development efforts, to expand sales channels and marketing lead generation programs, to fund capital expenditures, and to provide for working capital and other general corporate purposes. Management believes that the existing cash and short-term investment balances of $40.9 million will be sufficient to meet the working capital and capital expenditure requirements for at least the next twelve months.

 

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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 $1.5 million at June 30, 2004. The Company’s short-term investments consist primarily of 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, 2003, 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.

 

Item 4.  Controls and Procedures

 

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of June 30, 2004. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2004, the Company’s disclosure controls and procedures were (1) designed to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to the Company’s Chief Executive Officer and Chief Financial Officer by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

No change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended June 30, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control 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.

 

On June 8, 2004, the Company’s annual meeting of shareholders was held and the following matters were voted on:

 

The following individuals were elected to the board of directors to serve until the 2007 annual meeting of stockholders and thereafter until their successors are duly elected and qualified:

 

Nominee		Votes for		Votes against		Votes abstained		Broker non-votes
Kenneth D. Barwick		14,450,097		0		141,466		0
Jamie W. Ellertson		14,096,277		0		505,286		0

 

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 Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1                Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)         The Company did not file any reports on Form 8-K during the quarter ended June 30, 2004.

 

A Form 8-K, dated April 22, 2004 was furnished to the Securities and Exchange Commission, but not filed therewith, on April 26, 2004 in response to Items 7, 9 and 12 to furnish a press release announcing the Company’s financial results for the quarter ended March 31, 2004 and to furnish 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 August 13, 2004.

 

 

	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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