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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

For the fiscal year ended December 31, 2004

For the transition period from              to             

Commission file number: 000-26287

Axeda Systems Inc.

(Exact name of registrant as specified in its charter)

Registrant’s Telephone Number, Including Area Code: (508) 337-9200

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.001 per share

(Title of class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in the definitive proxy statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

The aggregate market value of such common stock held by non-affiliates of the registrant, based on the closing price of such shares on the NASDAQ National Market was approximately $20,222,187 as of June 30, 2004. Shares of common stock held by each executive officer and director and each person known to us who beneficially owns 5% or more of our outstanding common stock have been excluded from this computation in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares of registrant’s common stock outstanding as of March 30, 2005 was 32,872,670.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement prepared in connection with its 2005 Annual Meeting of Stockholders, which is expected to be filed with the Securities and Exchange Commission on or before May 2, 2005, are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated. The table of Exhibits filed appears on page 80.

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Axeda Systems Inc.

Form 10-K Annual Report

Year Ended December 31, 2004

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Cautionary Statement Concerning Forward-Looking Statements

This Annual Report on Form 10-K, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, that involve a number of risks and uncertainties. Such statements are based on current expectations of future events that involve a number of risks and uncertainties that may cause the actual events to differ materially from those discussed herein. In addition, such forward-looking statements are necessarily dependent upon assumptions, estimates and dates that may be incorrect or imprecise and involve known and unknown risks and other factors. Accordingly, any forward-looking statements included herein do not purport to be predictions of future events or circumstances and may not be realized. Forward-looking statements can be identified by, among other things, the use of forward-looking terminology such as “believes,” “expects,” “may,” “could,” “will,” “should,” “seeks,” “pro forma,” “potential,” “anticipates,” “predicts,” “plans,” “estimates,” or “intends,” or the negative of any thereof, or other variations thereon or comparable terminology, or by discussions of strategy or intentions. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. Forward-looking statements should be considered in light of various important factors, including those set forth in this report under the caption “Risk Factors” and elsewhere herein. All forward-looking statements, and reasons why results may differ, that are included in this report are made as of the date of this report, and except as required by law, we disclaim any obligations to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein or reasons why results might differ to reflect future events or developments. References herein to “Axeda,” “we,” “our,” and “us” collectively refer to Axeda Systems Inc., a Delaware corporation, and all of its direct and indirect U.S., Israeli, Japanese, European and Canadian subsidiaries.

PART I

ITEM 1. BUSINESS

This Annual Report on Form 10-K includes certain registered trademarks and tradenames of Axeda Systems Inc. Axeda, Axeda Systems, Axeda DRM, Axeda Device Relationship Management System, Axeda Agent, Axeda Applications, Axeda Enterprise, Axeda Software Management, Axeda Usage, Axeda Access, Axeda Service, Axeda Device, Axeda Administration, Axeda Supervisor, Axeda Connector, Axeda Gateway, Axeda Builder, Wizcon, Axeda @aGlance/IT, Axeda Web@aGlance, Axeda FactorySoft OPC, Firewall-Friendly and Access. Insight. In Real Time. are trademarks of Axeda Systems Inc. All other trademarks are property of their respective owners.

OVERVIEW

Axeda is a software and services company providing solutions in an emerging market known as Machine To Machine, or M2M. Solutions in the M2M market enable communications between people, devices, and systems and turn the resulting data into information that companies can act upon. Axeda is a leading provider of device relationship management, or DRM, software and services, a segment of the M2M market focused on solutions for original equipment manufacturers, or OEMs. Our flagship product, the Axeda DRM system, helps manufacturing and service organizations increase revenue while lowering costs by proactively monitoring and managing devices deployed at customer sites around the world. Axeda DRM is a highly scalable, field-proven, and comprehensive remote management solution that leverages its patented Firewall-Friendly^™ technology to enable M2M communication by utilizing the public Internet.

Our customers include Global 2000 companies in many markets including medical instrument, life sciences, enterprise technology, office and print production systems, industrial, and building automation. Representative customers include: Abbott Laboratories, Kodak Versamark, Inc. and Network Appliance, Inc.

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COMPANY HISTORY

We were incorporated in Pennsylvania in April 1994 as Quadrant Sales International, Inc. and changed our name to Quadrant International, Inc. in May 1994. In April 1999, we changed our name to Divicore Inc. and then reincorporated in Delaware as RAVISENT Technologies Inc. in June 1999. We changed our name to Axeda Systems Inc. in January 2002.

On December 7, 2001, we acquired all of the outstanding shares of eMation, Ltd., or eMation, a private company organized under the laws of the State of Israel. The acquisition gave us an entry into the DRM market. During 2002 our revenues were increasingly generated from selling DRM products and since 2002, substantially all of our revenues have been generated from sales of DRM products. Our revenues in 2001 were substantially generated from sales from our Internet Appliance, or IA, business, our consumer electronics, or CE, business and our personal computer, or PC, business. Each of these businesses has been divested as follows:

Our DRM and other products generated the following revenues for the last three years:

A description of our segments is provided in Note 13 to the consolidated financial statements included at Item 8 herein. Asset and revenue information about the geographic areas we operate in is included in Notes 10 and 13 to the consolidated financial statements, filed herewith at Item 8.

DRM INDUSTRY BACKGROUND

Computer-based control systems are increasingly the heart of new devices, machines or systems made today. These intelligent systems consist of hardware and software that is used to control the operation of the device as it is running, perform diagnostics, and enable external systems or people to input or query data that may be generated during operation. Depending on the cost and the complexity of the device, all of this capability may be embedded within the device itself or portions of it may reside on external computers that perform a supervisory control function for one or more related devices.

Intelligent devices generate valuable information as they are operating. Initially, this information was only made available locally through custom control interfaces on the device itself. As embedded systems and PC technology became pervasive and inexpensive, these devices moved to “soft” interfaces where operators worked at computer screens to monitor and control devices. These soft interfaces could be local to the device or more recently, could be remotely accessible via computer networks. In many markets and for many devices, this remains the state of the art today.

eMation, a company we acquired in December 2001, has built and marketed products to address real-time device control and data management needs in the industrial automation market since the late 1980s. These products include supervisory control and data acquisition, or SCADA, systems for single or multiple devices. They feature computer-based human-machine interface, or HMI, capability for local monitoring, and offer sophisticated features for enabling remote control,

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monitoring, HMI, and data management of device data via proprietary networks or the Internet. Our communications technology enables multiple supervisory systems or other real-time control and data management applications to be connected over networks to remote operators or software systems.

eMation identified an opportunity in the late 1990s to develop a “DRM system” to use the Internet to enable businesses to remotely monitor, manage and service intelligent devices. The growth of the Internet provided an ubiquitous, open, global network to tap into the data locked within intelligent devices. Devices contain valuable information that could be used to control and monitor not only their output, but also their health and operation. Businesses could work better if these devices could communicate and if everyone in a business could tap directly into the information within the devices they sell and service, or the systems they use. For example, companies could benefit if they could tell when machines are out of raw materials or about to fail, how many times they were used in a week, how a facility was operating, or what features were most popular in products in use by their customers. Based on this information, companies could lower costs, operate more efficiently, and add new sources of revenue.

AXEDA DRM SOLUTIONS

The Axeda DRM system is a software solution that leverages the Internet to provide real-time, continuous exchange of information between remote devices, business systems and people. It allows timely, accurate and unbiased information to be communicated automatically, via the Internet, between remote devices deployed at customer facilities and external service personnel or enterprise business systems. Patented Axeda technology allows intelligent devices securely positioned behind customer firewalls to have secure two-way Internet-based communication with external sales and service personnel and their enterprise applications. This enables companies to connect directly to their deployed products rather than relying on feedback filtered through their users.

The Axeda DRM system can be used on a stand-alone basis where, for example, personnel in a service department use the system on a day-to-day basis to monitor and diagnose remote devices installed at customer sites. Further, Axeda DRM solutions can be used to feed information to existing installed enterprise software systems. These could include enterprise resource planning, customer relationship management, or CRM, and supply chain and asset management systems.

The Axeda DRM system is our major business focus. We complement our DRM products with professional services, training, and support offerings. We leverage our mix of experience in embedded systems, enterprise software, and the Internet to solve difficult problems with practical solutions. We also continue to separately sell the Axeda Supervisor, Axeda @aGlance/IT, Axeda Web@aGlance and Axeda FactorySoft OPC to support our industrial automation business.

OUR STRATEGY

Our objective is to be the leading provider of DRM solutions and services in targeted industries. Key elements of our strategy include:

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MARKETS

We market our DRM solutions to device OEMs and strategic large-scale end users in a variety of industries. We target specific industries that have significant service costs and uptime requirements as well as complex, intelligent systems. Our current target industries are:

We believe these industries have the greatest current need and most appropriate systems for our DRM solutions because they utilize complex, computer controlled, electro-mechanical devices that cannot afford downtime. They also often use “consumables” in their operations that operators want to automatically and remotely monitor and re-supply.

PRODUCTS AND SERVICES

The Axeda DRM system is a distributed software system that lets companies use the Internet to remotely monitor, manage, and service intelligent devices deployed at their customers’ sites. It consists of three main components with Axeda Agent software deployed in or near the remote device, an Axeda Enterprise server that centrally receives and securely manages the information flowing to and from remote devices, and Axeda Applications that let field service or other enterprise personnel access, analyze, process and use the DRM device information for business purposes. Axeda Agent software is configured to monitor specific device data, process or filter it locally, and securely package the information for sending to and from the device through the customer’s firewalls. Axeda Enterprise software manages the two-way information communication with devices, collects, stores and manages this information, and triggers actions per specified business rules. Axeda Applications provide a family of web browser-based software solutions that use device data and connectivity for a variety of business processes including remote diagnostics and repair, usage tracking, access and control, and software release management. Certain Axeda Applications control the administration and configuration of the DRM system itself.

Axeda Applications

Axeda Applications employ web-architected interfaces for remote device administration, application sharing, usage tracking, software management, diagnostics and data visualization. Whether remotely calibrating a product at a customer site, administering a remote desktop, graphing real-time data for a device, or updating profile information in hundreds of installed products, Axeda DRM users access all information via their standard web browsers. No special client-side software is required. Axeda Applications currently include:

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Axeda Enterprise

Axeda Enterprise server software provides a secure, fault-tolerant infrastructure for communicating and managing the information exchange between remote devices and businesses. Axeda Enterprise software acts as a device data center, storing and managing live and historical information in a secure environment. Business rules drive automated device data analysis and notification of people or initiate transactions with other enterprise business systems such as billing, maintenance, help-desk, inventory, re-supply, ordering and asset management. The Axeda Enterprise SDK (software development kit) adds the ability to customize Axeda Applications and create new custom applications that leverage the power of the Axeda DRM system. Sophisticated security features assure data is encrypted and authenticated as it moves between devices and users. Access controls assure only the right people can access designated devices. An integrated reporting engine enables data to be published and analyzed.

Intelligent Agents

Axeda Agent products at the device allow distributed monitoring, communications and control. These software products run on or are attached to devices, allowing local data processing and two-way, Firewall-Friendly communications with the enterprise. Axeda DRM enables large-scale deployment of proactive device management solutions by utilizing distributed processing to execute business rules both near the device in the field and at the central enterprise system.

Axeda Agents are fully portable across the most popular operating systems and are easily integrated with existing designs or serve as the basis for entirely new products. Intelligent Agent technology is offered in a variety of forms: embedded within the chip or control processor, in an attached gateway, or as a full supervisory system capable of managing multiple devices or a whole facility.

Axeda Agents provide data acquisition, local decision-making, and web user interface for intelligent devices and systems. Axeda Agents also pool the information from multiple devices in a local area and send it to the Axeda Enterprise server, providing a single interface between multiple devices and the enterprise. Axeda Agents include the functionality and extensible markup language, or XML, processing needed to perform two-way Firewall-Friendly communication between a group of local devices and the Axeda Enterprise server. Axeda Agents currently include:

Axeda Builder provides a graphical development studio for creation, deployment and remote administration of Axeda Agent applications.

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Axeda Policy Manager is a server-based software application that resides on the customer’s network, providing a comprehensive and granular set of permission settings that continuously governs all Axeda Agent behavior. This includes which kinds of data and files can leave the device, and which activities the OEM can conduct on the device. This control applies to every kind of Axeda DRM activity including remote diagnostics, sending software upgrades, retrieving log files, running Axeda Access sessions and executing commands and scripts. Control can be either automatic based on the set policy or configured to notify the customer that an action request is pending, for example retrieving an error log file, and wait for the customer to accept or deny the request. All activity is recorded in a local audit file, a key requirement for Sarbanes-Oxley compliance.

Axeda Supervisor builds on this core agent capability and provides local control for complex systems of devices such as building controls or plant floors, sending system-wide data to the Axeda Enterprise server and enabling central control and monitoring of geographically dispersed systems. Combining both discrete and process control with the Internet, Axeda Supervisor supplies the software tools businesses need to build a complete automation solution. Axeda Supervisor can be used as part of a full Axeda DRM system, or independently on a stand-alone basis, as may be required by our industrial automation customers.

A comprehensive library of customizable drivers, industry standard protocols, and sophisticated programs complete the connection between Axeda Agents and the device. These can include custom device drivers, pre-built industry standard interfaces, or multi-protocol toolkits developed by Axeda, including Axeda @aGlance/IT, Axeda Web@aGlance and Axeda FactorySoft OPC.

DRM Professional Services

Axeda delivers experienced project and system integration services designed to provide clients with DRM solutions that meet their specific business needs in the shortest time possible. Our software developers and application engineers have a broad range of technical and commercial e-business experience. Our methodology begins with a detailed evaluation of the business issues surrounding the Internet enabling of the client’s products, systems and services. Other services include installation, application and device driver development, deployment support, migration and tuning. Axeda also provides a range of educational and support services to assure successful 24x7 ongoing operation.

STRATEGIC ALLIANCES

We have and will continue to enter into strategic alliances with experienced technology, systems, consulting and distribution companies carefully selected for their expertise in systems integration, hardware, software, enterprise applications and other critical services. Our existing relationships include:

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SALES AND MARKETING

Our sales and marketing strategy is focused on target account selling in specific industries. The majority of our direct sales resources are targeted toward direct sales of DRM to large OEMs in the United States, Europe and Japan. We apply an integrated sales and marketing strategy with target account marketing efforts focused on media and analyst relations, product marketing, web sites, sales tools, targeted lead generation, executive events, direct marketing promotions and trade shows in target industries. These direct resources are leveraged in the industrial automation market through a network of OEMs, distributors and systems integrators who sell our industrial automation products to end users

CUSTOMERS

We target our DRM solutions to OEMs that build and support intelligent devices in industries that have significant service costs and uptime requirements. We currently serve Global 2000 companies in the medical instrument, life sciences, enterprise technology, office and print production systems and industrial and building automation industries. Our customers include Abbott Laboratories, Applied Biosystems Group, Bayer A.G., Beckman Coulter Inc., The Boeing Company, BrainLAB GmbH, CERN, Chiron Corporation, Comverse Technology, Inc., Egenera, Inc., Elekta AB, EMC Corporation, Fr. Sauter AG, Fuji Photo Film USA, Inc., Fujifilm Medical Systems USA, Inc., Hitachi High-Technologies Corporation - Kasado Works, Idexx Laboratories, Inc., Kodak Versamark, Inc., Network Appliance, Inc., Noritsu Koki Co., Ltd., Olympus Diagnostic Systems Group, Tecan Group, Varian Medical Systems, Inc., Wako Pure Chemical Industries, Ltd. and Xeikon International NV.

The following examples illustrate how our customers are using Axeda DRM to enhance and expand their businesses.

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facing kiosks at retail customers and professional photo processing labs, preventing the costly effects of downtime and unnecessary field service visits. Fuji Photo Film USA markets its Axeda DRM-enabled solution as Fujifilm Intelligent Device Services (FIDS).

For the year ended December 31, 2004, our top five customers accounted for $3.7 million, or 29%, of our total revenues.

RESEARCH AND DEVELOPMENT

We believe that our future success depends in large part on our ability to enhance existing products, reduce product cost and develop new products that maintain technological competitiveness. We believe that we must continually enhance the performance and flexibility of our current products and successfully introduce new products. Product development involves several functional groups within our organization and is designed to provide a framework for defining and addressing the activities required to bring product concepts and development projects to market.

For the years ended December 31, 2004, 2003 and 2002, our DRM business had research and development expenditures, excluding non-cash compensation, totaling $4.0 million, $5.0 million and $7.2 million, respectively.

The majority of our DRM product line is developed at our research and development headquarters in Mansfield, Massachusetts.

COMPETITION

Competition for DRM solutions within the M2M market is emerging and expected to grow stronger. The principal competitive factors that affect our performance in the DRM market are:

The Axeda DRM system faces competition from custom software development by in-house developers within the machine and device manufacturers that are our prime sales targets, or from system integrators doing custom product development. These companies may choose to deploy their own information technology personnel or utilize system integrators to write new code or rewrite existing applications in an effort to develop their own information extraction solutions. As a result, prospective clients may decide against purchasing and implementing externally developed software and, instead, may develop their own solutions similar to our DRM solutions.

Although Axeda has established a leadership position in the markets we serve, a number of vertical market solution suppliers have also begun to market device management infrastructures for use in specific industries. Today, companies such as Brooks-PRI Automation, Inc. (semiconductor), Questra Corporation (medical and office), NextNine, Ltd. (enterprise technology and telecom) and Motive, Inc. (enterprise technology and telecom), compete in specific market segments that we operate in.

We also expect to see new or increased competition from several areas, including device-networking companies from the broader M2M market and providers of industrial automation products.

We expect competition to intensify as the DRM market matures. We expect that competition will increase in the near term and that our primary long-term competitors may not yet have entered the market.

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INTELLECTUAL PROPERTY

Our success is heavily dependent upon our proprietary technology. To protect our proprietary rights, we rely on a combination of patent, copyright, trade secret and trademark laws. In June of 2004, we were awarded a patent by the United States Patent and Trademark Office (No. 6,757,714) for a key element of our Firewall-Friendly^™ method of communication over the Internet. The patent protects one of our inventions relating to enabling remote “devices” — machines, appliances, instruments, and computers — to securely communicate their health and status to enterprise computer systems. We also have an additional eleven patent applications pending in the United States and seven patent applications pending internationally with respect to our DRM technology. We have registered the trademark “AXEDA” in the U.S. Patent and Trademark Office, and have numerous corresponding trademark registrations or applications filed for “AXEDA” in foreign jurisdictions. As a part of our regular business processes, we generally enter into nondisclosure agreements with employees, consultants, distributors and corporate partners, as appropriate, and limit access to and distribution of our software, documentation and other proprietary information. Further, our software licensing agreements provide for protection of our intellectual property within our software.

EMPLOYEES

As of March 18, 2005, we employed 90 individuals. None of our employees are represented by a labor union. We have not experienced any work stoppages and consider our relations with employees to be good.

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RISK FACTORS

Investing in our common stock involves a high degree of risk. In addition to the other information in this Annual Report on Form 10-K and the information incorporated by reference herein, you should carefully consider the risks described below before purchasing our common stock. If any of the following risks occur, our business could be materially harmed, and our financial condition and results of operations could be materially and adversely affected. As a result, the price of our common stock could decline, and you could lose all or part of your investment.

IF WE FAIL TO COMPLY WITH THE CONDITIONS OF OUR EXCEPTION PERMITTING OUR CONTINUED LISTING ON THE NASDAQ SMALLCAP MARKET, OUR COMMON STOCK WILL BE DELISTED, WHICH MAY CAUSE OUR STOCK PRICE TO DECLINE AND YOU MAY EXPERIENCE A DECLINE IN YOUR ABILITY TO TRADE OUR STOCK.

We have been granted continued inclusion on The Nasdaq SmallCap Market by a Nasdaq Listing Qualifications Panel, or the Panel, under an exception to the stockholders’ equity/market value of listed securities/net income requirement and the minimum bid price requirement, as set forth in Nasdaq Marketplace Rules 4310(c)(2)(B) and 4310(c)(4). This continued inclusion on The Nasdaq SmallCap Market is pursuant to the following conditions:

If we fail to evidence stockholders’ equity of at least $2.5 million or otherwise fail to satisfy any other requirement for continued listing, then the Panel will promptly conduct a written or oral hearing with respect to the failure and render a determination with respect to our continued listing on The Nasdaq SmallCap Market, which could result in a delisting of our common stock. The Panel will continue to monitor our ongoing compliance with the minimum stockholders’ equity threshold until we have demonstrated an ability to sustain compliance with the rule. In addition, the Panel has reserved the right to reconsider the terms of the exception based on any event, condition or circumstance that exists or develops that would, in the opinion of the Panel, make continued listing of our securities inadvisable or unwarranted.

If we are unable to maintain our listing on The Nasdaq SmallCap Market, our common stock will be delisted from The Nasdaq SmallCap Market and we will likely seek to list our common stock on the OTC Bulletin Board or another quotation system, market or exchange for which we could then qualify. We cannot guarantee, however, that if we are unable to maintain our listing on The Nasdaq SmallCap Market that we would be eligible for listing on the OTC Bulletin Board or another quotation system, market or exchange, or, that if we do become listed on the OTC Bulletin Board or another quotation system, market or exchange that there would be no interruption in the trading of our common stock or that we would be able to maintain our listing on such quotation system, market or exchange. If our common stock is not listed on any quotation system, market or exchange, we could incur penalties under certain agreements to which we are a party, including under the terms of our agreements relating to the convertible promissory notes and warrants we issued to

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Laurus Master Fund, Ltd., or Laurus, on October 5, 2004 which provide for penalties if our stock is not listed for more than three consecutive trading days. In addition, if our common stock is delisted from The Nasdaq SmallCap Market, or if our common stock is not listed on any other quotation system, market or exchange for any period, the market price of our common stock could decline and you may experience difficulty in trading our stock, regardless of whether we are able to list our common stock on another quotation system, market or exchange.

WE MAY NOT HAVE SUFFICIENT FUNDS TO REPAY OUR OBLIGATIONS TO LAURUS WHEN THEY BECOME DUE.

If we are not able to use shares of our common stock to repay the principal and interest on the convertible term note, or the Note, held by Laurus, we may not have sufficient funds to repay Laurus when our debt obligations to Laurus become due. Laurus must convert the monthly principal and interest into shares of our common stock if the following criteria are met:

In addition, we will not be able to issue more than 6,491,440 shares of common stock at a price of below $0.47 unless these issuances are approved by our stockholders.

Accordingly, we may be required to obtain the funds necessary to repay these obligations either through refinancing, the issuance of additional equity or debt securities or the sale of assets. We may be unable to obtain the funds needed, if any, to repay the obligations from any one or more of these sources on favorable economic terms or at all. We have also granted Laurus a right of first refusal on any debt or equity financings that we complete before October 3, 2005. This may impede our ability to secure additional funding because it may discourage third parties from making an offer that Laurus may match. If we are unable to obtain funds to repay this indebtedness, we may be forced to dispose of assets or take other actions on disadvantageous terms, which could result in losses and could have a material adverse effect on our financial condition and results of operations.

THE TERMS OF OUR DEBT OBLIGATIONS TO LAURUS SUBJECT US TO THE RISK OF FORECLOSURE ON SUBSTANTIALLY ALL OF OUR ASSETS.

To secure the payment of all obligations owed to Laurus, we have granted to Laurus a security interest in, and lien upon, substantially all of our property and assets. The occurrence of an event of default under any of our obligations could subject us to foreclosure by Laurus on substantially all of our assets to the extent necessary to repay any amounts due. Any defaults and resulting foreclosure would have a material adverse effect on our financial condition.

WE HAVE NEVER BEEN PROFITABLE AND MAY NEVER ACHIEVE PROFITABILITY IN THE FUTURE.

We had a net loss of approximately $9.7 million for the year ended December 31, 2004. To date, we have not achieved operating profitability on an annual basis and have an accumulated deficit of $146.2 million as of December 31, 2004. We have invested and continue to invest significant resources in product

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development, selling and marketing, services and support, and administrative expenses. To achieve profitability, we will need to increase revenues and/or reduce expenses significantly. We cannot assure you that our revenues will grow or that we will achieve or maintain profitability in the future.

OUR FUTURE SUCCESS DEPENDS UPON THE ACCEPTANCE OF OUR DRM SYSTEM SOLUTIONS.

Our future growth will be driven by sales of Axeda DRM systems and related services. We acquired eMation, Ltd., or eMation, in December 2001. eMation was founded in 1988 and historically derived its main source of revenues from its industrial automation products. We offer the Axeda DRM system and also continue to separately sell Axeda Supervisor, Axeda @aGlance/IT, Axeda Web @aGlance and Axeda FactorySoft OPC to support our industrial automation business. The market for DRM system solutions is new and evolving. If the market for our products fails to grow or grows more slowly than we anticipate, our business will suffer.

WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY.

Competition in the market for DRM solutions is emerging and expected to grow stronger. We expect that competition will increase in the near term and that our primary long-term competitors may not yet have entered the market. Our future competitors may have significantly more personnel or greater financial, technical, marketing and other resources than either our current competitors or we do. Also, due to our present financial condition, customers and current and potential partners may decide not to conduct business with us or may reduce or terminate the business they conduct with us. Furthermore, our future competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements than we can. Also, future competitors may have greater name recognition and more extensive customer bases that they can leverage. Increased competition could result in price reductions, fewer customer orders, reduced gross profit margins and loss of market share, any of which could have a material adverse effect on our business.

WE MAY NOT BE ABLE TO KEEP PACE WITH TECHNOLOGICAL ADVANCES.

The process of remotely extracting and managing information from intelligent devices will likely be characterized by rapid technological change, frequent new product introductions and emerging industry standards. We also expect that the rapid evolution of Internet-based applications and standards, as well as general technology trends such as changes in or introductions of operating systems will require us to adapt our products to remain competitive. Our products could become obsolete and unmarketable if we are unable to quickly adapt to new technologies or standards. To be successful, we will need to develop and introduce new products and product enhancements that respond to technological changes, evolving industry standards and other market changes and developments in a timely manner and on a cost-effective basis. Although we plan to continue to spend substantial amounts on research and development in the future, we cannot assure you that we will develop new products and product enhancements successfully or that our products will achieve broad market acceptance. Our failure to respond in a timely and cost-effective manner to new and evolving technologies and other market changes and developments could have a material adverse effect on our business.

OUR SALES CYCLE FOR DRM SYSTEMS IS LONG AND MAY BE CYCLICAL AND WE TYPICALLY RELY ON LARGE CONTRACTS FROM RELATIVELY FEW DRM CUSTOMERS, WHICH MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE.

Our sales cycle is lengthy and may be subject to business cycles. Our DRM system sales typically involve significant capital investment decisions by prospective customers, as well as a significant amount of time to educate them as to the benefits of our products. As a result, companies spend a substantial amount of time performing internal reviews and obtaining capital expenditure approvals before purchasing our products. It may take up to nine to twelve months or more from the time we first contact a prospective customer before receiving an initial order. The length of our DRM system sales cycle may also depend on a number of additional factors, including but not limited to the following:

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Furthermore, our software license revenues may result from a relatively small number of sales, some of which may generate disproportionately large revenues.

VARIATIONS IN THE LENGTH OF OUR SALES CYCLES COULD CAUSE REVENUES TO FLUCTUATE GREATLY FROM PERIOD TO PERIOD.

Because we have typically recognized a substantial portion of our software revenue in the last month of a quarter, any delay in the licensing of our products could cause significant variations in our revenue from quarter to quarter. These fluctuations could cause our operating results to suffer in some future periods because our operating expenses are relatively fixed over the short term and we devote significant time and resources on prospective clients.

A VARIATION IN THE CONVERSION OF OUR REVENUE PIPELINE TO CONTRACTS COULD ADVERSELY AFFECT OUR REVENUES AND ABILITY TO FORECAST OPERATIONS.

Our revenue pipeline estimates may not consistently correlate to actual revenues in a particular quarter or over a longer period of time. There has been a shift in industry-wide buying patterns for enterprise software, from large up-front purchases to smaller, more frequent purchases over time. A variation in the revenue pipeline or in the conversion of the revenue pipeline into contracts could cause us to plan or budget inaccurately and thereby could adversely affect our business, financial condition or results of operations.

IT MAY BE DIFFICULT, TIME-CONSUMING AND EXPENSIVE FOR OUR CUSTOMERS TO INTEGRATE OUR DRM SOLUTIONS WITH THEIR PRODUCTS, AND THEY MAY BE UNABLE TO DEPLOY THEIR PRODUCTS SUCCESSFULLY OR OTHERWISE ACHIEVE THE BENEFITS ATTRIBUTABLE TO OUR DRM SOLUTIONS.

Our customers often desire to integrate our DRM solutions with their existing products, computer systems and software programs. This can be complex, time-consuming and expensive, and may cause delays in the deployment of our customers’ products. As a result, some customers may have difficulty or be unable to integrate our products successfully or otherwise achieve the benefits attributable to our products. Delayed or ineffective integration of our DRM solutions may limit our ability to expand our revenues, and may result in customer dissatisfaction, causing harm to our reputation.

WE HAVE UNDERTAKEN A NUMBER OF MEASURES TO REDUCE OUR OPERATING EXPENSES AND THESE AND OTHER EXPENSE REDUCTION MEASURES MAY HAVE NEGATIVE CONSEQUENCES.

Beginning in the second quarter of 2002, we initiated a series of steps designed to consolidate and streamline our operations, and decrease our operating losses and corresponding use of cash, including reducing our number of global offices by more than 50%, reducing staffing levels by 53% by eliminating or not replacing 111 employees, engaging partners to provide us with variable staffing capabilities to meet peak demand periods and by closely monitoring our infrastructure costs. Although it is not possible to anticipate all potential effects the implementation of these expense control measures will have on us or our development, these activities have and could continue to have a negative effect on our business and operations. The extent and ramifications of these measures will be dependent upon our ability to raise additional financing, the timing of the receipt of financing and the amount of such financing, if any. We continue to evaluate our cost structure, and continue to take additional measures to reduce expenses. We recorded charges of $1.4 million in 2004 to reduce staffing levels and further consolidate our operations.

WE ARE DEPENDENT UPON OUR KEY MANAGEMENT FOR OUR FUTURE SUCCESS, AND FEW OF OUR KEY PERSONNEL ARE OBLIGATED TO STAY WITH US.

Our success depends on the efforts and abilities of our senior management and certain other key personnel. Many of our key employees are employed at will. Our business could be harmed if any of these or other key employees left or was seriously injured and unable to work and we were unable to find a qualified replacement.

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OUR GROWTH WILL BE LIMITED IF WE ARE UNABLE TO EXPAND OUR INDIRECT DISTRIBUTION SALES CHANNELS.

We currently have relationships with only a limited number of indirect distribution channels, consisting of relationships with independent software vendors, software distributors and system integrators. Nevertheless, we have derived, and we anticipate that we will continue to derive, a significant portion of our revenues from these relationships.

Our future growth will be limited if:

If any of these circumstances occurs, we will have to devote substantially more resources to the sales, marketing, distribution, implementation and support of our products than we otherwise would, and our own efforts may not be as effective as those of our indirect distribution channels.

INCREASED SALES THROUGH INDIRECT CHANNELS MAY ADVERSELY AFFECT OUR OPERATING PERFORMANCE.

Even if our marketing efforts through indirect channels are successful and result in increased sales, our average selling prices and operating margins could be adversely affected because of the lower unit prices that we receive when selling through indirect channels.

WE MAY DEPEND ON OUR STRATEGIC PARTNERS AND OTHER THIRD PARTIES FOR SALES AND IMPLEMENTATION OF OUR PRODUCTS. IF WE FAIL TO DERIVE BENEFITS FROM OUR EXISTING AND FUTURE STRATEGIC RELATIONSHIPS, OUR BUSINESS WILL SUFFER.

From time to time, we have collaborated with other companies in areas such as marketing, distribution or implementation. Maintaining these and other relationships is a meaningful part of our business strategy. However, some of our current and potential strategic partners are either actual or potential competitors, which may impair the viability of these relationships. In addition, some of our relationships have failed to meet expectations and may fail to meet expectations in the future. A failure by us to maintain existing strategic relationships or enter into successful new strategic relationships in the future could seriously harm our business, operating results and financial condition.

OUR BUSINESS MODEL DEPENDS UPON LICENSING OUR INTELLECTUAL PROPERTY, AND IF WE FAIL OR ARE UNABLE TO PROTECT OUR PROPRIETARY RIGHTS, OUR BUSINESS COULD BE HARMED.

Our ability to compete depends substantially upon our internally developed technology. We have a program for securing and protecting rights in patentable inventions, trademarks, trade secrets and copyrightable materials. However, there can be no assurance that we have taken or will take all necessary steps to protect our intellectual property rights. Our present financial condition may make it more difficult for us to fully enforce our intellectual property rights. If we are not successful in protecting our intellectual property, our business could be substantially harmed. We regard the protection of patentable inventions as being important to our business. We currently have one United States patent granted and eleven United States patent applications pending relating to our DRM business and seven patent applications pending internationally. It is possible that our pending patent applications may not result in the issuance of patents or that our patents may not be broad enough to protect our proprietary rights.

We rely on a combination of laws, such as patent, copyright, trademark and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights. Despite any precautions which we have taken:

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The laws of other countries in which we market our products might offer little or no effective protection of our proprietary technology. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it, which could significantly harm our business.

Any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in the loss of some of our competitive advantage and a decrease in our revenues. Infringement claims and lawsuits, such as the complaint we filed on June 30, 2004 against one of our competitors for infringement of our recently issued patent entitled “Reporting the State of an Apparatus to a Remote Computer,” and the patent infringement lawsuit filed in November 2004 against us by one of our competitors charging us with infringement of U.S. Patent No. 6,377,162, are likely to be expensive to resolve and may not be successful, and will require management’s time and resources and, therefore, could harm our business.

WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS AND REDUCED SALES BECAUSE OF DEFECTS IN OUR PRODUCTS.

Our products are very complex and may contain undetected errors that could harm our reputation, result in product liability or decrease market acceptance of our products. The likelihood of errors is higher when a new product is introduced or when new versions or enhancements are released. Our products are integrated with our customers’ networks and software applications. Errors may also arise as a result of defects in the products and systems into which our products are incorporated. We are unable to test our products in each of the applications in which they are designed to work. It is possible that defects could cause our customers to experience device or application failures. We have an extensive quality assurance process in place and procedures to handle customer complaints and deliver bug fixes. Despite our quality assurance process and that of our customers, defects and errors may be found in new products or in new versions or enhancements of existing products after commercial shipment has begun. We may be required to devote significant financial resources and personnel to correct any defects. Known or unknown errors or defects that affect the operation of our products could result in the following, any of which could harm our business:

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Although some of our licenses with customers contain provisions designed to limit our exposure to potential product liability claims, these contractual limitations on liability may not be enforceable. In addition, our product liability insurance may not be adequate to cover our losses in the event of a product liability claim resulting from defects in our products and may not be available to us in the future.

SUBSTANTIAL LITIGATION REGARDING INTELLECTUAL PROPERTY RIGHTS EXISTS IN OUR INDUSTRY AND WE ARE CURRENTLY SUBJECT TO PATENT INFRINGEMENT LITIGATION THAT COULD HARM OUR BUSINESS.

In June 2004, we filed a complaint in U.S Federal District Court in Massachusetts against Questra Corporation, one of our competitors, for patent infringement. In November 2004, Questra filed a patent infringement lawsuit against us in the United States District Court for the Northern District of California seeking injunctive relief and unspecified monetary damages. Our defenses against the suit brought by Questra may be unsuccessful. At this time, we cannot reasonably estimate the possible range of any loss or damages resulting from this suit due to uncertainty regarding the ultimate outcome. We expect that the Questra litigation will result in future legal and other costs to us, regardless of the outcome, which could be substantial.

There is also a risk that other third-parties, including current and potential competitors and current developers of our intellectual property, will claim that our products, or our customers’ products, infringe on their intellectual property rights or that we have misappropriated their intellectual property. Software, business processes and other property rights in our industry might be increasingly subject to third-party infringement claims as the number of competitors grows and the functionality of products in different industry segments overlaps. Other parties might currently have, or might eventually be issued, patents that infringe on the proprietary rights we use. Any of these third parties might make a claim of infringement against us.

We may be required to pay substantial damages and may be restricted or prohibited from selling our products if it is proven that we have violated the intellectual property rights of Questra or others. The defense of infringement claims and lawsuits, regardless of their outcome, would likely be expensive to resolve and could require a significant portion of management’s time. We cannot assume that we will prevail in intellectual property disputes regarding infringement, misappropriation or other disputes. Litigation in which we are accused of infringement or misappropriation might cause a delay in the introduction of new products, require us to develop non-infringing technology, require us to enter into royalty or license agreements, which might not be available on acceptable terms, or at all, or require us to pay substantial damages, including triple damages if we are held to have willfully infringed a third party’s intellectual property. If a successful claim of infringement was made against us and we could not develop non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, our business could be significantly harmed.

In addition, rather than litigating an infringement matter, we may determine that it is in our best interests to settle the matter. The terms of a settlement may include the payment of damages and our agreement to license technology in exchange for a license fee and ongoing royalties. These fees may be substantial. If we are forced to take any of the actions described above, defend against any claims from third parties or pay any license fees or damages, our business could be harmed.

WE HAVE RECEIVED NOTICES OF CLAIMS RELATED TO OUR FORMER PC PRODUCTS (OR DIGITAL MEDIA PRODUCTS) REGARDING THE ALLEGED INFRINGEMENT OF THIRD PARTIES’ INTELLECTUAL PROPERTY RIGHTS THAT MAY CAUSE US TO PAY DAMAGES.

Some third parties claim to hold patents covering various aspects of digital television, or DTV, high-definition television, or HDTV, and digital versatile disc, or DVD, technology incorporated into our former PC products and our former PC customers’ digital media products and have claimed that various aspects of DTV, HDTV and DVD technology incorporated into our and our customers’ digital media products infringe upon patents held by them, including the following:

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If MPEG LA, DVD6C, 3C or any other third party proves that our former digital media products infringe their proprietary rights, we may be required to pay substantial damages for such past infringement.

We may also be liable to some of our former customers for damages that they incur in connection with intellectual property claims. Some of our license agreements with former customers contain warranties of non-infringement and/or commitments to indemnify our former customers against liability arising from infringement of third-party intellectual property, which may include third-party intellectual property such as the patents held by members of MPEG LA, DVD6C, 3C and others. These commitments may require us to indemnify or pay damages to our former customers for all or a portion of any license fees or other damages, including attorneys’ fees, that they are required to pay or agree to pay to these or other third parties. We have received notices of up to an aggregate of $6.5 million asserting rights under the indemnification provisions and warranty provisions of our license agreements from several of our former digital media products customers. We may be required to pay substantial damages with respect to such indemnification assertions, which could have a material adverse effect on our business, financial condition or results of operations.

OUR BUSINESS IS SUBJECT TO RISKS FROM INTERNATIONAL OPERATIONS SUCH AS LEGAL UNCERTAINTY, TARIFFS AND TRADE BARRIERS AND POLITICAL AND ECONOMIC INSTABILITY.

We conduct business in a number of different countries. We sell products in numerous countries outside of the United States, including France, Switzerland, Japan, Germany, the Netherlands and other countries in Europe, Asia and Latin America. Our operations outside the United States include facilities located in France. For the year ended December 31, 2004, we derived approximately 56% of our revenues from sales to foreign companies. We anticipate that revenues from international operations will continue to represent a significant portion of our revenues. As a result, we are subject to risks associated with selling and operating in foreign countries. For example, some of our contracts with foreign customers are denominated in foreign currencies. We do not currently hedge against the risk of such transactions and as a result, we face a risk of loss related to possible fluctuations in currency exchange rates.

Our geographic diversity requires significant management attention and financial resources in order to develop our international sales, support and distribution channels. We may not be able to maintain international market demand for our products. Our business could be adversely impacted if we are unable to successfully launch our DRM products into our international operations.

Additional risks related to selling and operating in foreign countries include, among others:

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WE ARE SUBJECT TO CONDITIONS ATTACHED TO GOVERNMENTAL GRANTS WE RECEIVED IN ISRAEL.

Prior to being acquired by us in December 2001, eMation received grants in Israel from the Office of the Chief Scientist of Israel’s Ministry of Industry and Trade, or OCS, in the aggregate amount of $1.8 million to fund the development of our Axeda Supervisor product. As of December 31, 2004 we have paid royalties to the OCS in the aggregate amount of $1.4 million. As of December 31, 2004, the remaining $0.4 million of principal liability is accrued in accrued expenses. In March 2005, we paid royalties to the OCS of $0.2 million. We are obligated to pay royalties of 3.0% to 3.5% of revenues derived from sales of products funded through grants received from the OCS, up to a maximum of the total amount of the grants received. The terms of the OCS grants require that we manufacture our products that are developed with such grants in Israel. In addition, we may not transfer the technology developed pursuant to the terms of these grants to third parties without the prior approval of a governmental committee.

Additionally, prior to being acquired by us in December 2001, eMation received grants from the Israeli Government through the Fund for the Encouragement of Marketing Activities, or Marketing Fund, in the aggregate amount of $1.2 million and royalties in the aggregate amount of $0.6 million have been repaid. As of December 31, 2004, $0.3 million is accrued in other current liabilities. We are obligated to pay royalties of 4.0% of revenues derived from sales of products that result from grants received through the Marketing Fund, up to a maximum of the total amount of the grants received.

BECAUSE OF THEIR SIGNIFICANT STOCK OWNERSHIP, OUR OFFICERS AND DIRECTORS CAN EXERT SIGNIFICANT INFLUENCE OVER OUR FUTURE DIRECTION.

As of December 31, 2004, our executive officers, directors and entities affiliated with them, in the aggregate, beneficially owned approximately 4.2 million shares, or approximately 13%, of our outstanding common stock. Assuming the exercise of all stock options exercisable by them within 60 days of December 31, 2004, they would have, in the aggregate, beneficially owned approximately 5.5 million shares, or approximately 16%, of our outstanding common stock. These stockholders, if acting together, would be able to significantly influence all matters requiring approval by our stockholders, including the election of directors, the approval of mergers or other business combination transactions or a sale of all or substantially all of our assets.

CERTAIN PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BY-LAWS MAKE CHANGES OF CONTROL DIFFICULT EVEN IF THEY WOULD BE BENEFICIAL TO OUR STOCKHOLDERS.

Our board of directors has the authority without any further vote or action on the part of our stockholders to issue up to 5 million shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions of the preferred stock. This preferred stock, if it is ever issued, may have preference over and harm the rights of the holders of our common stock. Although the issuance of this preferred stock will provide us with flexibility in connection with possible acquisitions and other corporate purposes, this issuance may make it more difficult for a third party to acquire a majority of our outstanding voting stock. We currently have no plans to issue preferred stock.

Our certificate of incorporation and by-laws include provisions that may have the effect of deterring an unsolicited offer to purchase our stock. These provisions, coupled with the provisions of the Delaware General Corporation Law, may delay or impede a merger, tender offer or proxy contest involving us. Furthermore, our board of directors is divided into three classes, only one of which is elected each year. Directors are only capable of being removed by the affirmative vote of 66 ²/3% or greater of all classes of voting stock. These factors may further delay or prevent a change of control.

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WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY IN THE INTERNET-RELATED PRODUCTS AND SERVICES MARKET.

Our DRM solutions communicate through public and private networks over the Internet. The success of our products may depend, in part, on our ability to continue developing products that are compatible with the Internet. Critical issues concerning the commercial use of the Internet, including security, privacy, demand, reliability, cost, ease of use, accessibility, quality of service and potential tax or other government regulation, remain unresolved and may affect the use of the Internet as a medium to support the functionality of our products. If these critical issues are not favorably resolved, our business, financial condition or results of operations could be adversely affected.

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ITEM 2. DESCRIPTION OF PROPERTY

In May 2002, we entered into a sublease for approximately 35,000 square feet of space in an office building in Mansfield, Massachusetts. This facility is leased at an annual rental of approximately $310,000, plus operating expenses (approximately $170,000 per year), utilities and taxes, and is used for research and development, sales and support, services and administrative activities. The sublease commenced in June 2002 and expires in July 2007.

In September 2002, we entered into a lease for approximately 4,500 square feet of space in Malvern, Pennsylvania. This facility is leased at an annual rental of approximately $42,000, plus operating expenses (approximately $17,000 per year), utilities and taxes, and is used for administrative activities. The lease commenced in December 2002 and expires in November 2005. We vacated these premises in November 2004 and are seeking a subtenant for the balance of the lease term.

We currently lease an international sales office in France with a total of approximately 9,000 square feet of space. Annual rental for this office is $143,000 for years 2005 through 2009 and $161,000, thereafter. The lease for our office in France expires in 2011, but is cancelable without penalty in 2008, upon six months written notice.

We believe our current facilities will be adequate to fulfill our needs for the foreseeable future.

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ITEM 3. LEGAL PROCEEDINGS

SECURITIES CLASS ACTION

Between February and April 2000, eleven class action lawsuits were filed against us and certain of our officers and directors in the United States District Court for the Eastern District of Pennsylvania. On May 25, 2000, the cases were consolidated under Civil Action No. 00-CV-1014, and entitled “In re RAVISENT Technologies, Inc. Securities Litigation.” Pursuant to the Court’s consolidation order, a consolidated and amended class action complaint was filed on June 14, 2000 with an alleged class period of July 15, 1999 through April 27, 2000. This complaint alleges violations of the federal securities laws, specifically Sections 11 and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder. On July 3, 2000, we and the other defendants filed a motion to dismiss the consolidated and amended class action complaint. On July 13, 2004, the Court denied the motion. On approximately September 23, 2004, the parties to the class action reached an agreement in principle to settle the class action for $7 million. On September 24, 2004, the defendants filed a stipulation with the Court, suspending motion and discovery deadlines pending negotiation of the settlement documents. Although we believe that such lawsuits or claims are without merit and that we have meritorious defenses to the actions, we plan to settle the litigation pursuant to the September 23, 2004 agreement in principle. On December 15, 2004, the parties filed with the Court a Stipulation and Agreement of Settlement to settle the class action for $7 million. Under the terms of the settlement, our insurers have paid the settlement amount into an interest-bearing account for the benefit of the class pending final approval of the settlement by the Court. The Court issued a Preliminary Approval Order on December 21, 2004. A fairness hearing was held on April 6, 2005. At the hearing, the presiding judge indicated that he would approve the settlement. We are awaiting the final order.We have been informed by our directors’ and officers’ liability insurance carriers that the full amount of the cash settlement will be paid by them. If the settlement does not occur, and litigation against us continues, we believe we have meritorious defenses and intend to defend the case vigorously. We cannot predict whether or when a settlement will occur or be finalized and are unable at this time to determine whether the outcome of the litigation will have a material impact on our results of operations or financial condition in any future period. However, failure to successfully defend this action could harm our results of operations, liquidity and financial condition.

SECURITIES ALLOCATION CLASS ACTION

On November 27, 2001, a putative shareholder class action was filed against us, certain of our officers and directors, and several investment banks that were underwriters of our initial public offering. The action was filed in the United States District Court for the Southern District of New York, purportedly on behalf of investors, who purchased our stock between July 15, 1999 and December 6, 2000. A Consolidated Amended Complaint, which is now the operative complaint, was filed on April 19, 2002.

The lawsuit alleges violations of Sections 11 and 15 of the Securities Act of 1933 and Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder against one or both of us and our officers and directors. The claims are based on allegations that the underwriter defendants agreed to allocate stock in our July 15, 1999 initial public offering to certain investors in exchange for excessive and undisclosed commissions and agreements by those investors to make additional purchases in the aftermarket at pre-determined prices. The plaintiffs allege that the prospectus for our initial public offering was false and misleading in violation of the securities laws, because it did not disclose these arrangements. The action seeks damages in an unspecified amount. Similar “IPO allocation” actions have been filed against over 300 other issuers that have had initial public offerings since 1998 and all are included in a single coordinated proceeding in the Southern District of New York.

Our board of directors approved a settlement agreement and related agreements which set forth the terms of a settlement among us, our officers and directors, the plaintiff class, the vast majority of the other approximately 300 issuer defendants and the individual defendants currently or formerly associated with these companies. Among other provisions, the settlement agreement provides for a release of us and our officers and directors for the conduct alleged in the action to be wrongful. We would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims we may have against the underwriters. The settlement agreement also provides a guaranteed recovery of $1 billion to plaintiffs for the cases relating to all of the approximately 300 issuers. To the extent that the underwriter defendants settle all of the cases for at least $1 billion, no payment will be required under the issuers’ settlement agreement. To the extent that the underwriter defendants settle for less than $1 billion, the issuers are required to make up the difference. It is anticipated that any potential financial obligation we have to plaintiffs pursuant to the terms of the settlement agreement and related agreements will be covered by existing insurance. We currently are not aware of any material limitations on the expected recovery of any potential financial obligation to plaintiffs from our insurance carriers. Our carriers appear solvent, and we are not aware of any uncertainties as to the legal sufficiency of an insurance claim with respect to any recovery by plaintiffs. Therefore, we do not expect that the settlement will involve any payment by us. If material limitations on the expected recovery of any potential financial

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obligation to the plaintiffs from our insurance carriers should arise, our maximum financial obligation to the plaintiffs pursuant to the settlement agreement would be less than $3.4 million. On February 15, 2005, the Court granted preliminary approval of the settlement agreement, subject to certain modifications consistent with its opinion. The presiding judge, Judge Scheindlin, ruled that the issuer defendants and the plaintiffs must submit a revised settlement agreement which provides for a mutual bar of all contribution claims by the settling and non-settling parties without barring the parties from pursuing other claims. A conference with Judge Scheindlin is scheduled to be held on April 11, 2005 to discuss the status of the revised settlement agreement. The underwriter defendants will have an opportunity to object to the revised settlement agreement. There is no assurance that the parties to the settlement will be able to agree to a revised settlement agreement consistent with the Court’s opinion, or that the Court will grant final approval to the settlement to the extent the parties reach agreement. If the settlement agreement currently before the Court, as revised in accordance with the preliminary approval order, is accepted by the Court, then we anticipate that any potential financial obligation we may have to the plaintiffs pursuant to the terms of the settlement agreement and related agreements will be covered by existing insurance. If the settlement does not occur, and litigation against us continues, we believe we have meritorious defenses and intend to defend the case vigorously. We cannot predict whether or when a settlement will occur or be finalized and are unable at this time to determine whether the outcome of the litigation will have a material impact on our results of operations or financial condition in any future period. However, failure to successfully defend this action could harm our results of operations, liquidity and financial condition.

IPM

On March 20, 2003, Industria Politecnica Meridionale Spa., or IPM, an Italian corporation, filed a complaint against us in the United States District Court for the Northern District of California. The lawsuit alleged breach of an agreement between IPM and our wholly-owned subsidiary Ravisent Technologies Internet Appliance Group, Inc., or RTIAG, and fraud in connection with the delivery of circuit boards to IPM that were not in compliance with the agreement, and claimed damages of $15 million for breach of contract and fraud, and unspecified punitive damages and attorney’s fees. On May 2, 2003, we moved to dismiss all claims against RTIAG. On or about June 23, 2003, IPM filed an amended complaint adding RTIAG as a party in the action and provided further specificity on the fraud allegation. We withdrew our motion to dismiss shortly thereafter. We filed an answer to the amended complaint on July 3, 2003 denying the breach of contract and fraud claims. RTIAG filed a counterclaim on July 3, 2003 for breach of contract against IPM, seeking damages of $2.7 million, plus interest, fees and costs. IPM filed an answer to the amended complaint on July 22, 2003 denying the breach of contract claims. IPM filed a motion to amend its complaint on February 19, 2004, which was granted on March 30, 2004, and which withdrew its fraud complaint and modified its breach of contract claim to specify that the defendants breached the contract by providing circuit boards which were underpowered, and to an unacceptable extent, incapable of operating in IPM’s products. We filed a motion seeking summary judgment on March 9, 2004. On April 13, 2004, we filed a supplement to our motion for summary judgment. On April 27, 2004, IPM filed a supplemental opposition to our summary judgment motion. We filed a response on May 4, 2004 and our motion for summary judgment was heard on May 18, 2004.

On June 22, 2004, the Court issued an order granting our motion for summary judgment and dismissing IPM’s claims against us. The parties then entered into a written settlement agreement and mutual general release dated January 14, 2005 which called for a “walk-away” settlement with no money or other consideration being exchanged. In connection with the settlement the parties also executed a written stipulation for dismissal of the action with prejudice. The stipulation for dismissal was filed on February 9, 2005 and the entire action was dismissed with prejudice.

QUESTRA

On June 30, 2004, we announced that we were awarded a patent by the United States Patent and Trademark Office for a key element of our Firewall-Friendly method of communication over the Internet. Our U.S. patent (No. 6,757,714) is titled “Reporting The State Of An Apparatus To A Remote Computer.” The patent protects one of our inventions relating to enabling remote “devices” — machines, appliances, instruments, and computers — to securely communicate their health and status to enterprise computer systems. On June 30, 2004, we filed a complaint in U.S Federal District Court in Massachusetts against Questra Corporation, one of our competitors, for infringement of this patent. On November 9, 2004, Questra filed an answer to our complaint, without filing a substantive counterclaim. Discovery is ongoing.

On November 10, 2004, Questra filed a patent infringement lawsuit against us in the United States District Court for the Northern District of California charging us with infringement of U.S. Patent No. 6,377,162 and seeking injunctive relief and unspecified monetary damages. There have been no substantive motions or rulings to date in the case, which remains pending. Discovery is ongoing.

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We believe that such lawsuit and claims are without merit and that we have meritorious defenses to the actions. We are unable to predict the outcome of this matter or reasonably estimate an amount of loss given its current status.

LEASE

In connection with our acquisition of eMation in December 2001, we recorded an unutilized lease obligation of $1.2 million. Through February 2003, we made payments under the lease totaling $0.18 million. In May 2003, the lessor provided us formal notice of termination of the lease and from June 2003 until May 2004, filed various complaints against us in Middlesex District Court, Marlborough Division in the Commonwealth of Massachusetts alleging breach of contract and seeking payment due for rent and other charges under the lease. In October 2004, we entered into a settlement and release agreement with the lessor to settle all charges, suits and claims against us. In October 2004, we signed a Withdrawal of Appeal to withdraw our appeal of the adverse District Court ruling with prejudice. Under the terms of the settlement and release agreement, we are required to pay $0.3 million, payable in two installments of $0.15 million. The first installment was paid on October 20, 2004, and the second installment is due on October 1, 2005, resulting in a balance due of $0.15 million as of December 31, 2004. As a result of the settlement, we reversed $0.7 million of the liability, which is included as a non-cash reduction of other general and administrative expense in the accompanying consolidated statement of operations for the year ended December 31, 2004. The settlement agreement provides that, upon completion of the final payment due to the plaintiff as described above, the plaintiff will execute and file with the Court a Notice of Satisfaction of Judgment to conclude the litigation.

OTHER

From time to time, we have received notices of claims of infringement of other parties’ proprietary rights and other claims in the ordinary course of our business. The adverse resolution of any one or more of these matters could have a material adverse effect on our business, financial condition or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Our 2004 Annual Meeting of Stockholders was held on December 30, 2004. The stockholders adopted the following proposals that were submitted to a vote at such meeting: (1) to elect two of our directors; (2) to ratify the appointment of KPMG LLP as our independent registered public accounting firm for the year ending December 31, 2004; (3) to approve the adjustment to the exercise price of warrants held by Special Situations Private Equity Fund, L.P. and its affiliates, collectively SSF, from $1.69 per share to $1.35 per share; (4) to approve an amendment to our Amended and Restated Certificate of Incorporation to increase the number of shares of our common stock authorized for issuance from 50,000,000 shares to 100,000,000 shares to allow for the full exercise of the warrant issued to SSF, to allow for the full conversion of the note and the full exercise of the warrant issued to Laurus Master Fund, Ltd. and to ensure that we have sufficient shares available for issuance pursuant to our employee benefit programs, possible acquisitions and financings, and other corporate purposes; and (5) to approve an amendment to our 1999 Employee Stock Purchase Plan to increase the total number of shares authorized for issuance under the plan from 500,000 shares to 1,000,000 shares. The results of the votes on these matters are disclosed below.

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The following are the names of each of our other directors whose term of office continued after the annual meeting:

Directors Holding Office Until 2006: Walter L. Threadgill and Dale E. Calder

Directors Holding Office Until 2005: Paul A. Vais and James R. McDonald

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

PRICE RANGE OF COMMON STOCK

On January 14, 2002, we changed our name to Axeda Systems Inc. and effective February 5, 2002 until August 4, 2004, our common stock was quoted on The Nasdaq National Market under the symbol XEDA. Prior to February 5, 2002 and since our initial public offering in July 1999, our common stock was quoted on The Nasdaq National Market under the symbol RVST. On August 5, 2004, our common stock began trading on The Nasdaq SmallCap Market under the symbol XEDA. Prior to July 1999 there was no public market for our common stock. Beginning March 28, 2005, the character “C” was appended to our trading symbol to identify our conditional listing on The Nasdaq SmallCap Market, and our symbol became XEDAC. The “C” will be removed from the symbol upon confirmation of our compliance with the terms of our exception and all other criteria for continued listing. On March 25, 2005, we had 32,872,670 outstanding shares of common stock held by 150 record holders, not including stockholders who beneficially own common stock held in nominee or street name. The following table sets forth, for the periods indicated, the high and low bid prices per share of the common stock as reported on The Nasdaq National Market until August 4, 2004, and The Nasdaq SmallCap Market for periods beginning August 5, 2004.

DIVIDEND POLICY

We have never declared or paid dividends on our capital stock and we do not anticipate declaring or paying cash dividends in the foreseeable future. We anticipate that we will retain all future earnings, if any, for use in our operations and the expansion of our business. In addition, we have agreements with a lender and some of our investors limiting our ability to pay cash dividends. Payments of future dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs and plans for expansion. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

EQUITY COMPENSATION PLAN INFORMATION

The following table gives information about our common stock that may be issued upon the exercise of options, warrants or rights under all of our equity compensation plans as of December 31, 2004:

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ISSUER PURCHASES OF EQUITY SECURITIES

None.

UNREGISTERED SALES OF EQUITY SECURITIES

On October 5, 2004, we issued the Note to Laurus. In January 2005, Laurus converted a portion of the Note into 101,000 shares of our common stock at a price of $0.48 per share. In February 2005, Laurus converted an additional portion of the Note into 8,000 shares of our common stock at a price of $0.48 per share. In February and March 2005, Laurus converted 57,231 shares and 54,347 shares, respectively, for interest due on the Note. We issued these shares of common stock, totaling 220,578 shares, in reliance on Section 4(2) of the Securities Act of 1933, as amended, and Regulation D thereunder, as a transaction not involving any public offering. No advertising or general solicitation was employed in offering the securities, the offerings and sales were made solely to Laurus, and we restricted transfer of the securities in accordance with the requirements of the Securities Act. The recipient of the securities represented its intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof, and appropriate legends were affixed to the instruments issued in such transaction. The shares issued upon such conversions are registered for re-sale pursuant to a Form S-3 registration statement declared effective by the Securities and Exchange Commission on January 12, 2005.

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ITEM 6. SELECTED FINANCIAL DATA

The following selected consolidated financial data (presented in thousands, except per share amounts) are derived from our consolidated financial statements. This data should be read in conjunction with the consolidated financial statements and notes thereto (Item 8), and with “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Notes to Selected Financial Data:

We exited our former PC business pursuant to an exclusive license with Sonic in May 2002 for a $2.0 million license fee.

On December 7, 2001, we acquired all of the outstanding shares of eMation for approximately $20 million.

We sold the assets of our IA business, excluding inventory, to Phoenix Technologies Ltd. for $18 million in March of 2001.

We sold the assets of our CE business to STMicroelectronics, NV in March 2001 for approximately $55.6 million.

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ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with other sections of this Annual Report on Form 10-K including “Item 1: Business,” “Item 6: Selected Financial Data,” and “Item 8: Financial Statements and Supplementary Data.”

All assumptions, anticipations, expectations and forecasts contained herein are forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those projected in the forward-looking statements as a result of various factors, including those described under “Risk Factors” included under Item 1. Except to fulfill our obligations under the federal securities laws, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which it is made.

The preparation of our consolidated financial statements, which are the basis of the following discussion and analysis, requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate the reasonableness of our estimates, including those related to bad debts, intangible assets, income taxes, warranty obligations, purchase commitments and contingencies. These estimates are based upon historical experience and on various other assumptions that are believed to be reasonable under the circumstances at the time of the estimate, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Overview

Axeda is a software and services company providing solutions in an emerging market known as Machine To Machine, or M2M. Solutions in the M2M market enable communications between people, devices, and systems and turn the resulting data into information companies can act upon. We are a leading provider of device relationship management (DRM) software and services, a segment of the M2M market focused on solutions for OEMs. Our flagship product, the Axeda DRM system helps manufacturing and service organizations increase revenue while lowering costs by proactively monitoring and managing devices deployed at customer sites around the world. Axeda DRM is a highly scalable, field-proven, and comprehensive remote management solution that leverages its patented Firewall-Friendly^™ technology to enable M2M communication by utilizing the public Internet.

Our customers include Global 2000 companies in many markets including medical instrument, life sciences, enterprise technology, office and print production systems, industrial, and building automation. Representative customers include: Abbott Laboratories, Kodak Versamark, Inc. and Network Appliance, Inc.

On December 7, 2001, we acquired all of the outstanding shares of eMation, Ltd. The acquisition gave us an entry into the DRM market. During 2002 our revenues were increasingly generated from selling DRM products, and for 2003 and 2004, substantially all of products of our revenues were generated from selling DRM products and services. Our revenues in 2001 were substantially generated from sales of products of our former PC business, our former IA business, and our former CE business. We sold the assets of our IA business, excluding inventory, to Phoenix Technologies Ltd. for $18 million in March of 2001. We also sold the assets of our CE business to STMicroelectronics, NV in March 2001 for approximately $55.6 million. We exited the PC business pursuant to an exclusive license with Sonic IP, Inc. in May 2002 for a $2.0 million license fee.

In the second quarter of 2002, we foresaw that revenue would be short of our expectations due to the macroeconomic climate impacting capital spending as well as slower than expected development of the DRM market. As a result, beginning in the second quarter of 2002, we initiated a series of steps designed to consolidate and streamline our operations and decrease our operating losses and corresponding use of cash. Due to the lower revenue and our lower market capitalization, we determined that the fair value of our reporting unit could not support the carrying value of its intangible assets and, accordingly, recognized a goodwill and identified intangible asset impairment charge of approximately $22.4 million in 2002. No such charge was recorded in 2003 or 2004. In 2002, 2003 and 2004, we reduced staffing levels, terminated certain leases and consolidated our operations resulting in charges of approximately $1.9 million, $1.4 million and $1.4 million, respectively. Combined with our expected continued year over year growth in DRM system revenues, we believe that future operating losses will be lower than historical levels. We will continue to evaluate our cost structure and may undertake additional measures to reduce expenses in the future.

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We currently operate in three principal regions: the United States, Europe and Japan. Overall revenues declined by $0.3 million and $4.9 million in 2004 and 2003, respectively, due to our exit from the PC and IA businesses. Despite the continued difficult capital spending climate, our DRM revenues increased by $0.1 million in 2004 due to increases in the U.S., partially offset by decreases in Europe and Japan, and $1.7 million in 2003, mainly due to increases in the U.S. and Japan, while Europe was relatively unchanged. These net increases were driven by an accelerated acquisition of new customer accounts, as well as additional spending by our existing customers. While recurring sales from existing customers and the timing of more widespread adoption of our product remains difficult to predict, we believe overall revenues will increase in 2005 due to further orders from our current customer base, our sales pipeline and improvements in the marketplace.

For 2004, our operating expenses decreased by $4.5 million, or 20%, compared to the prior year. For 2003, our operating expenses decreased by $38.5 million, or 63%, compared to the prior year. This reflects a reduction in our cost structure and the goodwill and identified intangibles charge of $22.4 million in 2002.

On October 5, 2004, we entered into definitive agreements with Laurus pursuant to which we issued to Laurus a Note in the principal amount of $4.5 million convertible into shares of our common stock at an initial fixed conversion price of $0.48 per share. We also issued to Laurus a warrant to purchase up to 2,500,000 shares of our common stock at an exercise price of $0.53 per share with a term of five years. The Note has a term of three years and accrues interest at the prime rate plus 2% per year. Interest on the principal amount is payable monthly, in arrears until the maturity date. The minimum monthly principal repayment of $0.15 million commences on May 1, 2005, and continues through the October 5, 2007 maturity date. Principal and interest are payable in shares of common stock if certain criteria are met.

On September 23, 2003, we issued 4,918,100 shares of our common stock to certain accredited investors affiliated with Special Situations Private Equity Fund, L.P., collectively SSF, in a private investment in public equity, or PIPE, financing. The shares were sold at a price of $1.22 per share with net proceeds of approximately $5.6 million. We also issued to the investors warrants exercisable for the purchase of up to an aggregate of 2,459,050 shares of our common stock at an initial exercise price of $1.71 per share. Our transaction with Laurus triggered an adjustment to the exercise price of the SSF warrants. The effect of this adjustment was to make the SSF warrants exercisable for an additional 655,747 shares, or 3,114,797 shares in the aggregate, at an adjusted exercise price of $1.35 per share.

In February 2005, we amended several of our agreements with Laurus and SSF. We amended the Registration Rights Agreement with SSF to make any liquidated damages that may arise payable in unregistered shares of common stock, rather than cash and obligate us to use our best efforts to subsequently register the shares. We amended the Securities Purchase Agreement and Registration Rights Agreement with Laurus to make any liquidated damages that may arise payable in a warrant to purchase unregistered shares of common stock, rather than cash and obligate us to use our best efforts to subsequently register the underlying shares. Effective in February 2005, as a result of these amendments, the accounting and reporting requirements of Financial Accounting Standards Board’s Emerging Issues Task Force, or EITF, Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” or EITF 00-19, will no longer apply. If the agreements had been amended as of December 31, 2004, we would have reported stockholders’ equity of $4.0 million.

At December 31, 2004, our cash and cash equivalents balance was $2.4 million compared with $9.6 million at December 31, 2003.

Geographic Areas

Information pertaining to revenues attributed to our country of domicile, the United States of America, foreign sales in total and individual foreign countries is included in Note 13 of the notes to the consolidated financial statements, filed herewith at “Item 8: Financial Statements and Supplementary Data.” Revenues from individual countries are based upon information available to us regarding our customers’ country of domicile.

Information pertaining to long-lived assets is included in Note 10 of the notes to the consolidated financial statements, filed herewith at “Item 8: Financial Statements and Supplementary Data.”

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Results of Operations

The following table sets forth, for the periods indicated, the dollar amounts and the dollar amounts expressed as a percentage of total revenues reflected in our consolidated statements of operations:

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Revenues. Total revenues for the year ended December 31, 2004 decreased by $0.3 million, or 2%, to $12.9 million from $13.2 million in the previous year. For the year ended December 31, 2004, sales of our DRM solutions increased $0.1 million, while sales of our IA inventories and PC license and services decreased by $0.4 million compared to the prior year.

Currency movements in 2004 and 2003 increased revenues by $0.6 million and $1.0 million, respectively, due to more favorable exchange rates. Increases in net revenues due to currency movements are primarily due to the weakness versus the respective prior year of the U.S. dollar against the Euro, British pound and Japanese yen. Although we cannot predict the future movements in currency rates, any strengthening of the U.S. dollar against these foreign currencies will have an unfavorable impact on our revenues in 2005. Currency effects on our revenues for 2002 were insignificant.

Total revenues for the year ended December 31, 2003 decreased by $4.9 million, or 27%, to $13.2 million from $18.1 million in the previous year. For the year ended December 31, 2003, sales of our DRM solutions increased $1.7 million, while sales of our IA inventories and PC license and services decreased by $6.7 million compared to the prior year.

License revenues for the year ended December 31, 2004 decreased by approximately $1.1 million to $8.0 million, from $9.1 million in the previous year. Lower DRM license sales from new accounts for the year ended December 31, 2004 compared to the previous year contributed $0.9 million to the license revenue decrease while the discontinuation of our former PC business contributed $0.2 million to the decrease. We believe the decrease in new DRM orders was due in part to new customers’ questions concerning our financial viability. License revenues for the year ended December 31, 2003 decreased by approximately $3.6 million to $9.1 million, from $12.8 million in the previous year. The decrease in license revenues was mainly attributable to the discontinuation of our former PC business, which declined by $4.3 million and was partially offset by an increase in DRM license revenues of approximately $0.6 million for the year ended December 31, 2003. Due to the complete shift from our legacy PC and IA businesses to our DRM product line, we do not expect any future license revenues from our former businesses, and we expect DRM system license revenues to increase as our DRM systems are more widely adopted.

Services and maintenance revenues for the year ended December 31, 2004 increased $1.0 million from the prior year to $4.7 million, due to increased demand for professional services from existing DRM installations, as well as additional maintenance plans sold with our DRM systems. Services and maintenance revenues for the year ended December 31, 2003 increased $0.6 million from the prior year to $3.7 million, due to a greater demand for professional services in connection with existing DRM installations, as well as additional maintenance plans sold with our DRM systems. We anticipate services and maintenance revenues will increase as we sell to new customers and also leverage our existing customer base.

Hardware revenues decreased by $0.2 million to $0.2 million, and by $1.9 million to $0.3 million for the years ended December 31, 2004 and December 31, 2003, respectively, due to decreased sales of fully-reserved, outdated components for our former Internet appliances and Internet set-top boxes. In the future, we expect hardware sales to be minimal due to decreasing quantities available and the uncertainty of future sales of these products.

For the years ended December 31, 2004 and 2003, our top five customers accounted for $3.7 million and $2.9 million, or 29% and 22% of our revenues, respectively. In the future, we expect our revenues to be less concentrated as sales of our software and services span a wider customer base. There has also been a shift in industry-wide buying patterns for enterprise software, from large up-front purchases to smaller, more frequent purchases over time. Finally, the introduction of our hosted offering is also expected to reduce revenue concentration in the future.

We sell our DRM solutions primarily to companies in the industrial and building automation, high technology devices, medical instrumentation and office automation industries. For the years ended December 31, 2004 and 2003, customers based in North America accounted for 44% of our revenues. In the year ended December 31, 2002, customers based in North America accounted for 57% of our revenues. We anticipate that revenues from international operations will continue to represent a significant portion of our revenues.

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Cost of Revenues. Cost of revenues for the year ended December 31, 2004 decreased $1.2 million from the prior year to $4.4 million. The decrease was due to: a decrease in PC license and service expense of $0.2 million and $0.3 million, respectively, due to our exit from the PC business; a decrease in software amortization expense of $0.2 million, due to our developed technology intangible asset becoming fully amortized in 2004; and a decrease in other license fees of $0.5 million. Cost of revenues for the year ended December 31, 2003 decreased $4.7 million from the prior year to $5.6 million. The decrease was due to: a decrease in PC license and service expense of $1.5 million and $0.5 million, respectively, due to our exit from the PC business; a decrease in hardware expense of $1.3 million, due to our exit from the IA business; a decrease in software amortization of $1.3 million, due to the impairment of the related intangible assets in 2002; and a decrease in other license fees of $0.2 million.

Cost of revenues for license fees for the year ended December 31, 2004 decreased by approximately $0.7 million, compared to the prior year. The $0.7 million decrease for the year ended December 31, 2004 is due to decreased license fees associated with our discontinued PC products of $0.2 million, a prior year impairment charge related to unutilized software licenses of $0.2 million, decreased DRM royalty expense of $0.2 million, and reductions for estimated liabilities of $0.1 million. Cost of revenues for license fees for the year ended December 31, 2003 decreased by approximately $1.6 million compared to the prior year, mainly due to a decrease in costs associated with our former PC products, caused by our exit from the PC business. We expect our cost of license fees as a percentage of license revenues to decline, as our license revenues are now comprised entirely of our DRM products.

Cost of revenues for services and maintenance for the year ended December 31, 2004 decreased by $0.3 million from the prior year due to a decrease in staff and staff related expense and travel expense which contributed $0.2 million and $0.1 million, respectively. Cost of revenues for services and maintenance for the year ended December 31, 2003 decreased by $0.5 million from the prior year due to a decrease in PC services expense, as a result of our exit from the PC business. We expect our cost of services and maintenance as a percentage of services and maintenance revenues to decrease as we optimize our service teams to meet our current business requirements.

Cost of revenues for hardware sales for the years ended December 31, 2004 and 2003 were nil, due to hardware inventory being fully reserved as of December 31, 2002. Cost of revenues for hardware sales for the year ended December 31, 2002, were $1.3 million. In the future, we expect hardware cost of revenues to continue to be minimal.

Software amortization of our developed and core technologies for the year ended December 31, 2004 decreased by $0.2 million compared to the prior year, due to the full amortization of our developed technology. Software amortization of our developed and core technologies for the year ended December 31, 2003 decreased by $1.3 million compared to the prior year, due to the impairment of our identified intangible assets in the fourth quarter of 2002 that resulted in a decrease to the carrying amount of those assets, and therefore a lower amortizable cost. For the year ending December 31, 2005, we expect non-cash amortization of acquired technology to continue to represent approximately $0.4 million of our cost of revenues.

Currency movements in 2004 and 2003 increased expenses (operating and cost of revenues) by $0.6 million and $1.0 million, respectively, due to unfavorable exchange rates. Increases in expenses due to currency movements are due primarily to the weakness versus prior year of the U.S. dollar against the Euro, the British pound and the Japanese yen. Although we cannot predict the future movements in currency rates, any strengthening of the U.S. dollar against these foreign currencies will have a favorable impact on our expenses. Currency effects on our expenses for 2002 were insignificant.

Gross Profit. Gross profit for the year ended December 31, 2004 increased $0.9 million, or 12%, to $8.4 million, compared to the prior year. The increase in gross profit was due to increases in the improved DRM service and maintenance gross profit and decreases in software amortization expense which contributed $1.3 million and $0.2 million to the gross profit increase, respectively, partially offset by decreases in gross profit of license and hardware sales of $0.4 million and $0.2 million, respectively.

Gross profit for the year ended December 31, 2003 decreased $0.3 million, or 3%, to $7.6 million, compared to the prior year. The decrease in gross profit was due to a decrease in gross profit from sales of our former PC and IA hardware products of $3.4 million due to our exit from these businesses, offset by increases in gross profit from our DRM license fees, DRM service and maintenance revenues and reduced software amortization expenses, which totaled $3.2 million.

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Gross profit as a percentage of total revenues for the year ended December 31, 2004 increased to 66%, from 57% in the prior year, due to improved margins from our DRM professional services and reduced software amortization expense.

Gross profit as a percentage of total revenues for the year ended December 31, 2003 increased to 57%, from 43% in the prior year, due to improved margins from our DRM professional services and reduced software amortization expense.

The gross profit margin on DRM license revenue was 93% for the year ended December 31, 2004, compared to 88% for the prior year, and resulted from reduced license fees and royalty expenses as discussed above. Services and maintenance gross profit margin was 28% for the year ended December 31, 2004, compared to 1% for the prior year. This improvement is due to greater demand for our professional services, additional sales of our maintenance plans, and initial sales for our hosting services, as well as decreases in staff and staff-related expenses and travel expense from the prior year. The improvement in our services margins also reflects an improvement in the billable utilization of professional services employees.

Other Research and Development (R&D) Expense. Other R&D expense consists of staff, staff-related, professional and other development-related support costs associated with the development of new DRM products, quality assurance and testing. Other R&D expense for the year ended December 31, 2004 decreased $1.0 million, or 20%, to $4.0 million, compared with the prior year. The decrease in other R&D expense for the year ended December 31, 2004 was due to decreases in staff and staff-related expenses of $0.6 million, and lower expenses associated with the closure of our Israeli operations and severance totaling $0.3 million and $0.1 million, respectively. Other R&D expenses as a percentage of total revenues decreased from 38% in 2003 to 31% in 2004, due to the reduction in other R&D expense, partially offset by the decrease in revenues. We expect other R&D expense to continue to decrease in 2005 and also expect other R&D expense to decrease as a percentage of revenues, as we optimize our development team to meet our current business requirements.

Other R&D expense for the year ended December 31, 2003 decreased $2.2 million, or 30%, to $5.0 million, compared with the prior year. The discontinuance of the PC development team during 2002 in connection with the license to Sonic, contributed $1.6 million to the decrease, and a decrease in staff related expense, consulting fees and other expense, contributed the remaining $0.6 million. Other R&D expenses as a percentage of total revenues decreased from 40% in 2002 to 38% in 2003 due to the reduction in other R&D expense, partially offset by the decrease in revenues.

Non-cash Compensation R&D Expense. Non-cash R&D expense consists of compensation related to stock options. Non-cash R&D expense decreased 98% from $0.1 million for the year ended December 31, 2003, to nil for the year ended December 31, 2004. Non-cash R&D expense decreased 37% from $0.2 million for the year ended December 31, 2002 to $0.1 million for the year ended December 31, 2003.

Other Sales and Marketing (S&M) Expense. Other S&M expense consists of salaries, travel expenses and costs associated with trade shows, advertising and other sales and marketing efforts. Other S&M expense for the year ended December 31, 2004 decreased approximately $1.4 million to $7.0 million, or 17%, as compared with the prior year. Reduced staff and staff-related expense, bonus, royalty, travel, severance, and other expense contributed $0.7 million, $0.2 million, $0.2 million, $0.1 million, $0.1 million and $0.1 million to the decrease in other S&M expense for the year ended December 31, 2004 compared to the prior year. As a percentage of revenues, other S&M expense decreased from 64% to 54% for the year ended December 31, 2004, compared to the same period in 2003, due to reduced S&M expense from the prior year, partially offset by the decrease in revenues. We expect other S&M expense to decrease in 2005 as a result of the reorganization that took place in 2004. Additionally, we expect other S&M expense as a percentage of revenues to decrease as our future revenues increase.

Other S&M expense for the year ended December 31, 2003 decreased approximately $8.2 million, or 49%, to $8.4 million, as compared with the prior year. The elimination of our former business development personnel focused on professional services in 2002, decreases in sales staff headcount, and the elimination of our former PC sales team and initial branding expense contributed $2.8 million, $1.1 million and $0.6 million, respectively, to the decrease in other S&M expense for the year ended December 31, 2003 compared to the prior year. In addition, reduced public relations, trade shows and advertising expense equally contributed approximately $0.7 million for the year ended December 31, 2003 over the prior year. Also, reductions in travel, subcontractors and the closure of our Israeli office each contributed $0.4 million to the decrease in 2003. Finally, reduced marketing and sales collateral material, severance and other

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expenses in 2003 contributed $0.3 million, $0.7 million and $0.7 million, respectively, compared to the prior year. As a percentage of revenues, other S&M expenses decreased from 92% to 64%, due to reduced S&M expense from the prior year, partially offset by the decrease in revenues.

Other General and Administrative (G&A) Expense. Other G&A expense consists of staff, staff-related, and support costs for our finance, human resources, legal and other management departments. Other G&A expense for the year ended December 31, 2004 decreased $1.6 million to $5.8 million, or 22%, as compared with the prior year. The decrease was due to the favorable settlement of outstanding lease litigation of $0.6 million, a $0.2 million decrease related to our Mansfield lease obligation and the reversal of estimated patent and intellectual property accruals that are no longer considered necessary of $0.4 million. In addition, we reduced staff and related compensation expense by $0.3 million, insurance expense by $0.3 million and professional fees by $0.2 million as part of our ongoing cost management initiatives. These decreases were partially offset by an increase in severance expense of $0.4 million for the year ended December 31, 2004. Other G&A expense as a percentage of total revenues decreased from 56% in 2003 to 45% in 2004 due to the reduction in other G&A expense, partially offset by the decrease in revenues. In 2005, we expect other G&A expense to continue to decrease based on cost reductions that occurred throughout 2004, and we also expect other G&A expense to decrease as a percentage of revenues, as our future revenues increase.

Other G&A expense for the year ended December 31, 2003 decreased $3.6 million, or 33%, to $7.4 million as compared with the prior year. Reduced staff-related expense, expenses to support our former PC business and estimated intellectual property expense contributed $1.0 million, $0.5 million and $0.4 million, respectively, to the decrease. Cost reductions associated with the closure of our Israeli office, reduced travel and other expense contributed $0.3 million, $0.2 million and $0.4 million, respectively, to the decrease. In addition, decreased use of consultants and reductions in accruals for estimated liabilities and sales taxes contributed $1.0 million in total to the decrease. The above decreases were partially offset by a $0.3 million increase in severance expense. Other G&A expense as a percentage of total revenues decreased from 61% in 2002 to 56% in 2003, due to the reduction in other G&A expense, partially offset by the decrease in revenues.

Non-cash Compensation G&A Expense. Non-cash G&A expense consists of compensation related to stock options. Non-cash G&A expense decreased from $0.5 million for the year ended December 31, 2003 to $0.1 million for the year ended December 31, 2004. The decrease is primarily attributable to certain deferred stock compensation balances that became fully expensed in 2003 or during 2004, resulting in $0.4 million less expense in 2004. There were no accelerations or significant modifications that resulted in additional non-cash G&A expense in 2004.

Non-cash G&A expense decreased from $1.3 million for the year ended December 31, 2002 to $0.5 million for the year ended December 31, 2003. The decrease is primarily attributable to the acceleration of vesting of $0.4 million and modifications to certain outstanding stock options of $0.2 million in 2002, and certain deferred stock compensation balances that became fully expensed in 2002, resulting in $0.2 million less expense in 2003. There were no accelerations or significant modifications that resulted in additional non-cash G&A expense in 2003.

Depreciation and Amortization. Depreciation and amortization were comparable for the years ended December 31, 2004 and 2003, and amounted to $1.1 million each year. Depreciation and amortization decreased $0.4 million during the year ended December 31, 2003 from $1.6 million in 2002. The $0.4 million decrease during the year ended December 31, 2003 was due to the partial impairment in 2002 of the identified intangible assets recorded in connection with our acquisition of eMation, which contributed $0.2 million, as well as reduced depreciation expense in 2003, which contributed $0.2 million. In 2005, we do not expect any significant changes to depreciation and amortization expense, and anticipate that it will approximate the current year expense.

Special Charges. Special charges for the year ended December 31, 2002 consisted of items related to our exit from the PC business in May 2002. The charges included $0.3 million for write-offs of furniture and equipment and employee termination inducement expenses related to our license agreement with Sonic, and lease termination costs and inducements totaling approximately $0.5 million, including $0.2 million for the write-off of furniture and equipment for our former San Jose facility. No such charge was recorded in 2004 or 2003.

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Impairment Charges. During November 2002, we completed our annual impairment test of goodwill in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, or SFAS 142. Due to adverse market conditions and a slower than expected rate of adoption of our software technology in our industry, we determined that the fair value of our reporting unit could not support the carrying value of its intangible assets and, accordingly, recognized a goodwill and identified intangible asset impairment charge of approximately $22.4 million in 2002. No such charge was recorded in 2004 or 2003. If our current financial projections or related assumptions are modified in the future, we may be required to record additional impairment charges.

Gains (Losses) on Disposals of Assets. For the year ended December 31, 2004, we recorded a gain of approximately $0.1 million as a result of the reversal of a contingent liability related to the sale of the assets of our CE business. In March 2003, we signed a confidential settlement agreement for the escrow relating to the sale of assets of our former IA business, which was sold in March 2001. In connection with this settlement agreement, we reversed expense accruals of approximately $0.7 million recorded in March 2001 as part of the sale. During the year ended December 31, 2002, we recorded charges of $0.1 million for the disposal of certain assets that were no longer utilized or needed for our continuing operations.

Interest Income (Expense), net. Net interest expense increased by $0.4 million to $0.4 million for the year ended December 31, 2004 compared to net interest income of nil for the same period in 2003. The increase is the result of the amortization totaling $0.2 million of original issue discount and deferred financing costs incurred in securing the convertible note financing in October 2004, as well as the coupon interest on the note of $0.1 million. Net interest income decreased by $0.4 million or 96% for the year ended December 31, 2003 compared to the same period in 2002. The decrease was the result of lower average cash balances and lower bank interest rates in 2003.

Other Income (Expense), net. In September 2003 and in October 2004, we entered into registration rights agreements with SSF and Laurus, respectively, pursuant to which we were obligated to file registration statements with the Securities and Exchange Commission, or SEC, for the resale of the shares sold in the transactions, and the shares issuable upon exercise of the warrants. The SEC declared the SSF registration statement effective on October 23, 2003 and the Laurus registration statement effective on January 12, 2005. In the event that sales could not be made because we had not updated the registration statements to keep them effective, we were required to pay, in cash, liquidated damages to SSF and Laurus equal to 1.5% of the purchase price paid by such investor for each thirty-day period or pro rata for any portion thereof after the deadline that passes before the registration statements were updated and declared effective by the SEC. While we viewed the liquidated damages contingency related to the financing-related liability as neither probable nor reasonably estimable, we recorded the estimated fair value of the warrants as a financing-related liability in the consolidated balance sheet in accordance with EITF 00-19. The fair value of the financing-related liabilities are adjusted at each balance sheet date, with the non-cash change in fair value reported in the consolidated statement of operations as other income or expense. The related mark-to-market net non-cash gain for the years ended December 31, 2004 and December 31, 2003 was $0.3 million and $0.8 million, respectively. On February 16, 2005, we amended the agreements with SSF and Laurus to eliminate the obligation to pay liquidated damages in cash. Instead, any liquidated damages owed to SSF are payable in common stock and any liquidated damages owed to Laurus are payable in warrants to purchase common stock. Effective from the date of these amendments, we are no longer required to record the fair value of the financing-related liability or the related non-cash gain or loss.

During the year ended December 31, 2002 we recorded, as other income, $0.5 million in connection with the settlement of a vendor dispute involving inventory for which a portion of our total obligation was forgiven.

Provision for Income Taxes (Benefit). The income tax expense recorded for the years ended December 31, 2004 and 2003 is attributable to the provision for certain foreign income taxes. The income tax benefit recorded for the year ended December 31, 2002 is attributable to the reversal of certain prior year U.S. income tax accruals no longer necessary as a result of newly enacted tax legislation in 2002, and partially offset by a provision for certain foreign income taxes.

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Table of Contents

Quarterly Results of Operations

The following table presents certain unaudited quarterly consolidated statements of operations data for the eight quarters ended December 31, 2004. In the opinion of management, this information has been presented on the same basis as the audited consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K, and all necessary adjustments have been included in the amounts stated below to present fairly the unaudited quarterly results when read in conjunction with our audited consolidated financial statements included at Item 8 herein. Results of operations for any quarter are not necessarily indicative of the results to be expected for the entire year or for any future period.