SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the Quarter Ended June 30, 2002
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ______________ Commission
File number 000-26287
Axeda Systems Inc. (Exact Name of Registrant as Specified in Its Charter)
Delaware 23-2763854
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
257 Great Valley Parkway
Malvern, Pennsylvania 19355
---------------------------
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (800) 700-0362
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
---------------------------
On August 12, 2002, 27,213,417 shares of the Registrant's Common Stock, $.001
par value, were outstanding.
AXEDA SYSTEMS INC.
FORM 10-Q
QUARTER ENDED JUNE 30, 2002
- --------------------------------------------------------------------------------
INDEX
Page
Part I Financial Information
Item 1 Financial Statements
Consolidated Balance Sheets at June 30, 2002 (unaudited) and December 31, 2001 2
Consolidated Statements of Operations for the three months ended June 30, 2002 and 2001 3
(unaudited).
Consolidated Statements of Operations for the six months ended June 30, 2002 and 2001 4
(unaudited).
Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001 5
(unaudited).
Notes to Consolidated Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 29
Item 3 Quantitative and Qualitative Disclosures About Market Risk 53
Part II Other Information
Item 1 Legal Proceedings 71
Item 2 Changes in Securities 72
Item 3 Defaults Upon Senior Securities 72
Item 4 Submission of Matters to a Vote of Security Holders 72
Item 5 Other Information 72
Item 6 Exhibits and Reports on Form 8-K 73
1
AXEDA SYSTEMS INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
PART I
ITEM 1: FINANCIAL STATEMENTS
June 30, December 31,
2002 2001
------------ ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents, including restricted cash of $1,399 in 2002
and $2,549 in 2001 .................................................... $ 30,737 $ 47,349
Accounts receivable, net of allowance for doubtful accounts of $247 in
2002 and $179 in 2001 .................................................. 3,590 4,623
Inventories, net ....................................................... 25 2,070
Prepaid expenses ....................................................... 555 934
Loans receivable - officers, net ....................................... -- 34
Other current assets ................................................... 481 685
------ ------
Total current assets ............................................... 35,388 55,695
Furniture and equipment, net ........................................... 2,463 2,567
Goodwill ............................................................... 20,623 20,819
Identified intangible assets, net of accumulated amortization of $1,378
in 2002 and $192 in 2001 .............................................. 8,367 9,553
Other assets ........................................................... 732 472
------ ------
Total assets ....................................................... $ 67,573 $ 89,106
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable ....................................... $ 331 $ 2,149
Accounts payable ....................................................... 3,305 5,047
Accrued expenses ....................................................... 8,119 8,928
Income taxes payable ................................................... 407 1,075
Deferred revenue ....................................................... 2,768 926
------ ------
Total current liabilities .......................................... 14,930 18,125
Non-current liabilities:
Notes payable, less current portion .................................... 112 187
Other non-current liabilities .......................................... 1,361 1,428
----- -----
Total liabilities .................................................... 16,403 19,740
------ ------
Commitments and contingencies (note 13) ...................................
Stockholders' equity:
Preferred stock, $.001 par value; 5,000,000 shares authorized in 2002
and 2001, none issued or outstanding .................................. -- --
Common stock, $.001 par value 50,000,000 authorized; 27,728,059 shares
issued in 2002 and 27,274,962 in 2001 ................................. 28 27
Additional paid-in capital ............................................. 143,804 143,454
Deferred stock compensation ............................................ (890) (1,842)
Accumulated deficit .................................................... (90,538) (70,953)
Accumulated other comprehensive income ................................. 146 21
Treasury stock at cost, 603,800 shares in 2002 and 583,800 shares in 2001 (1,380) (1,341)
------ ------
Total stockholders' equity ......................................... 51,170 69,366
------ ------
Total liabilities and stockholders' equity ......................... $ 67,573 $ 89,106
========= =========
See accompanying notes to consolidated financial statements.
2
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
Three Months Ended June 30,
2002 2001
------------------- -------------------
(unaudited) (unaudited)
Revenues:
License ............................................................... $ 2,578 $ 673
Services and maintenance .............................................. 674 --
Hardware .............................................................. 291 121
------------ ------------
Total revenues ............................................................ 3,543 794
------------ ------------
Cost of revenues:
License ............................................................... 782 432
Services and maintenance .............................................. 990 --
Hardware .............................................................. 243 104
Software amortization ................................................. 525 --
Inventory charges ..................................................... -- 13,420
------------ ------------
Total cost of revenues .................................................... 2,540 13,956
------------ ------------
Gross profit .............................................................. 1,003 (13,162)
Research and development
Non-cash compensation ................................................. 34 116
Other research and development expense ................................ 2,090 999
Sales and marketing
Non-cash compensation ................................................. 19 --
Other selling and marketing expense ................................... 4,990 842
General and administrative
Non-cash compensation ................................................. 239 48
Other general and administrative expense .............................. 3,076 1,588
Provision for doubtful accounts, net of recoveries of $90 in 2002 ..... (67) 658
Depreciation and amortization ............................................. 330 389
Special charges ........................................................... 820 --
------------ ------------
Operating loss .................................................... (10,528) (17,802)
Loss on sales of assets ................................................... 37 --
Interest (income) expense, net and other (income) expense, net ............ (90) (681)
------------ ------------
Loss before provision for income taxes (benefit) .......................... (10,475) (17,121)
Provision for income taxes (benefit) ................................. -- (1,171)
------------ ------------
Net loss .................................................................. $ (10,475) $ (15,950)
============ ============
Basic and diluted net loss per weighted average common share outstanding .. $ (0.39) $ (0.89)
============ ============
Weighted average number of common shares outstanding used in calculation of
basic and diluted net loss per common share .............................. 26,986,387 17,840,876
============ ============
See accompanying notes to consolidated financial statements.
3
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
Six Months Ended June 30,
2002 2001
------------------- -------------------
(unaudited) (unaudited)
Revenues:
License ............................................................... $ 5,618 $ 3,036
Services and maintenance .............................................. 1,217 407
Hardware .............................................................. 1,348 167
------------ ------------
Total revenues ............................................................ 8,183 3,610
------------ ------------
Cost of revenues:
License ............................................................... 1,817 955
Services and maintenance .............................................. 1,707 94
Hardware .............................................................. 1,252 141
Software amortization ................................................. 1,054 --
Inventory charges...................................................... -- 13,420
------------ ------------
Total cost of revenues .................................................... 5,830 14,610
------------ ------------
Gross profit .............................................................. 2,353 (11,000)
Research and development
Non-cash compensation ................................................. 98 1,854
Other research and development expense ................................ 4,322 3,406
Sales and marketing
Non-cash compensation ................................................. 38 69
Other selling and marketing expense ................................... 9,792 4,334
General and administrative
Non-cash compensation ................................................. 1,099 112
Other general and administrative expense .............................. 6,094 3,877
Provision for doubtful accounts, net of recoveries of $90 in 2002 ..... (22) 784
Depreciation and amortization ............................................. 640 2,055
Special charges ........................................................... 820 --
------------ ------------
Operating loss .................................................... (20,528) (27,491)
(Gain) loss on sales of assets ............................................ 37 (52,037)
Interest (income) expense, net and other (income) expense, net ............ (310) (1,047)
------------ ------------
Income (loss) before provision for income taxes (benefit) ................. (20,255) 25,593
Provision for income taxes (benefit) ................................. (668) 1,808
------------ ------------
Net income (loss) ......................................................... $ (19,587) $ 23,785
============ ============
Basic net income (loss) per weighted average common share outstanding...... $ (0.73) $ 1.35
============ ============
Diluted net income (loss) per weighted average common share outstanding... $ (0.73) $ 1.30
============ ============
Weighted average number of common shares outstanding used in calculation of
basic net income (loss) per common share................................ 26,888,325 17,629,136
============ ============
Weighted average number of common shares outstanding used in calculation of 26,888,325 18,284,292
diluted net income (loss) per common share................................ ============ ============
See accompanying notes to consolidated financial statements.
4
AXEDA SYSTEMS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Six Months Ended June 30,
--------------------------------------
2002 2001
------------------- ------------------
(unaudited) (unaudited)
Cash flows from operating activities:
Net income (loss) ....................................................... $(19,587) $ 23,785
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Depreciation and amortization ......................................... 1,694 2,055
(Gain) loss on sales of assets ........................................ 371 (52,037)
Non-cash compensation and other expenses .............................. 1,220 1,602
Deferred income taxes ................................................. -- 564
Provision for doubtful accounts ....................................... 68 1,645
Provision for inventory ............................................... -- 13,930
Changes in items affecting operations (excluding the effects of acquisitions
and divestitures):
Accounts receivable ................................................... 965 2,607
Inventories ........................................................... 2,045 (1,325)
Loan receivable--officer .............................................. 34 35
Prepaid expenses and other current assets ............................. 583 (1,713)
Goodwill, other assets and intangible assets .......................... (224) (1,486)
Accounts payable ...................................................... (1,582) (7,677)
Accrued expenses and other non-current liabilities .................... (861) 1,500
Income taxes payable .................................................. (668) 1,760
Deferred revenue ...................................................... 1,842 (1,128)
-------- --------
Net cash used in operating activities ..................................... (14,100) (15,883)
-------- --------
Cash flows from investing activities:
Capital expenditures .................................................... (797) (353)
Net proceeds from sales of assets ....................................... -- 68,112
-------- --------
Net cash provided by (used in) investing activities ....................... (797) 67,759
-------- --------
Cash flows from financing activities:
Repayments under capital lease obligations .............................. -- (38)
Net proceeds from exercise of stock options and warrants ................ 53 1,502
Repayments of long-term debt ............................................ (1,893) --
-------- --------
Net cash provided by (used in) financing activities ....................... (1,840) 1,464
-------- --------
Effect of exchange rate changes on cash and cash equivalents..................... 125 (20)
-------- --------
Net increase (decrease) in cash and cash equivalents............................ (16,612) 53,320
Cash and cash equivalents, including restricted cash of $1,399 in 2002 and
$2,549 in 2001:
Beginning of period............................................................ 47,349 9,615
------------ ----------
End of period .......................................... .. ................... $30,737 $62,935
============ ===========
Supplemental disclosure of non-cash investing and financing activities:
Settlement of pre-acquisition liability related to acquisition of eMation .. $ 160 $ -
Fair value of 20,000 shares of Axeda common stock received in connection
with the settlement of a loan receivable .................................. 39 -
Supplemental disclosure of cash flow information:
Interest paid...................... ....................................... $ 67 $ 1
Income tax refund........................................................... (308) -
See accompanying notes to consolidated financial statements.
5
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Information with respect to June 30, 2002 and 2001 is unaudited)
1) Summary of Significant Accounting Policies
a) Description of Business (note 6, note 7 and note 8)
Axeda Systems Inc. ("we", "our", "us" or "Axeda"), which changed its
name from RAVISENT Technologies Inc. in January 2002, develops, markets
and sells software products and technologies used by multiple
industries and customers worldwide for Device Relationship Management
("DRM") Systems, data visualization, data acquisition and control and
communication through the Internet. We distribute our DRM products
through direct sales to original equipment manufacturers ("OEM's") and
enterprise customers, as well as through distributors and value-added
resellers. We maintain regional sales and support offices for DRM in
the United States, Japan, France, Israel and the Netherlands.
During the quarter ended June 30, 2002, our revenues were substantially
generated from selling DRM solutions, digital video solutions to
personal computer ("PC") OEMs and inventories. During 2001 our revenues
were substantially generated from selling digital video solutions and
Internet appliance ("IA") devices to PC, consumer electronics ("CE")
and IA OEM's. In December 2001, we purchased all of the outstanding
capital stock of eMation, Ltd., a private company organized under the
laws of the State of Israel and headquartered near Boston,
Massachusetts, for the purpose of acquiring a company with greater
opportunity than our existing product line. As a result of the
acquisition, we are a provider of DRM solutions. See note 6-Acquisition
for the description and accounting for the acquisition of eMation.
Prior to June 2002 we also designed, developed, licensed and marketed
core-based modular software solutions that enabled digital video and
audio stream management in PC systems. Our PC solutions enabled
decoding (playback) and encoding (recording) of multimedia formats such
as digital versatile disk ("DVD"); direct broadcast satellite ("DBS")
and high-definition television ("HDTV") on existing personal computers.
Our digital video products customers consisted principally of PC and
computer graphics card OEM's. In May 2002 we entered into a Software
Distribution Agreement (the "Agreement") with Sonic IP, Inc. ("Sonic"),
a wholly-owned subsidiary of Sonic Solutions. As a result, we are
exiting the digital media market (note 8).
In March 2001, we sold the assets of our CE and IA businesses (note 7).
We have sustained significant operating losses and negative cash flows
from operations since our inception. For the six months ended June 30,
2002 and 2001, our net losses excluding gains on sales of assets, were
$19.6 million and $28.3 million, respectively. We plan to continue to
invest in product development and sales and marketing. There can be no
assurances that we will be able to generate sufficient revenues
necessary to achieve or sustain profitability in the short or long
term. However, management believes that the current cash and cash
equivalent amounts will be sufficient to sustain our operations through
2003.
6
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
b) Basis of Presentation
Our interim consolidated financial statements for the three and six
months ended June 30, 2002 and 2001, included herein, have been
prepared by us, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC"). Certain information and
footnote disclosures normally included in financial statements prepared
in accordance with accounting principles generally accepted in the
United States have been condensed or omitted pursuant to such rules and
regulations relating to interim financial statements. In the opinion of
management, the accompanying unaudited interim consolidated financial
statements reflect all adjustments consisting only of normal recurring
items, as well as the accounting changes to adopt SFAS 141, "Business
Combinations," and SFAS 142, "Goodwill and Other Intangible Assets,"
necessary to present fairly our financial position at June 30, 2002,
the results of our operations for the three and six months ended June
30, 2002 and 2001 and our cash flows for the six months ended June 30,
2002 and 2001. The unaudited consolidated financial statements included
in this Form 10-Q should be read in conjunction with the audited
consolidated financial statements and notes thereto, included in our
Form 10-K for the year ended December 31, 2001. The interim results
presented are not necessarily indicative of results for any subsequent
quarter or for the year ending December 31, 2002.
c) Principles of Consolidation
The consolidated financial statements include the financial statements
of Axeda Systems Inc. and its wholly owned subsidiaries. All
significant intercompany balances and transactions have been eliminated
in consolidation.
d) Cash and Cash Equivalents
For purposes of the statement of cash flows, we consider all highly
liquid instruments purchased with an original maturity of three months
or less to be cash equivalents.
e) Revenue Recognition
In 2001, our primary revenue categories consisted of: software licenses
for PC and CE products, including DVD; IA products, including Internet
browser software and hardware reference designs; services for PC, CE
and IA products, including non-recurring engineering customization and
development services; and hardware for PC products, primarily DVD
boards and IA products, including Internet set-top boxes, and
integrated circuit boards (note 7 and note 8). Since December 2001, we
license our DRM system products to customers in the industrial,
building automation, technology, medical instrumentation and office and
semiconductor equipment industries (note 6).
We recognize software revenues in accordance with the American
Institute of Certified Public Accountants' ("AICPA") Statement of
Position 97-2, "Software Revenue Recognition" ("SOP 97-2"), as amended
by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition,
With Respect to Certain Transactions" ("SOP 98-9"). License revenues
are recognized in the period in which the license agreement is signed,
the fee is fixed and determinable, delivery of the technology has
occurred requiring no significant production modification or
customization and collectibility is probable. Royalties representing
software license fees paid on a per unit basis are recognized when
earned, which is generally based on receiving notification from
licensees stating the number of products sold which incorporate the
licensed technology from us and for which license fees, based on a per
unit basis, are due. The terms of the license agreements generally
require the licensees to notify us within 15 to 30 days of the end of
the quarter during which the sales of the licensees' products take
place. In a number of cases, we record the revenue in the quarter
following the sale of the licensee's products to our customers.
7
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
For software arrangements that include multiple elements, SOP 97-2
requires us to allocate the fee to the individual elements based on
vendor-specific objective evidence of fair value ("VSOE"), regardless
of the prices stated within the contract. VSOE is limited to the price
charged when the element is sold separately or, for an element that is
not yet sold separately, the price established by management having the
relevant authority. When there is VSOE for the undelivered elements in
multiple-element arrangements that are not accounted for using contract
accounting, we allocate revenue to the delivered elements of the
arrangement using the residual value method. Therefore, we defer
revenues from the arrangement fee equal to the fair value of the
undelivered elements and the difference between the total arrangement
fee and the amount deferred for the undelivered elements is recognized
as revenue related to the delivered elements. The fair value of
maintenance and postcontract customer support ("PCS") obligations are
based upon separate sales of renewals to other customers or upon
renewal rates quoted in the contracts. The fair value of services, such
as training or consulting, is based upon our separate sales of these
services to other customers.
When VSOE does not exist to allocate revenue to each of the various
elements of an arrangement and revenue cannot be allocated using the
residual value method, the entire fee from the arrangement is deferred
until the earlier of the establishment of VSOE or the delivery of all
the elements of the arrangement. In cases where a license grants a
customer unspecified upgrade rights, the license fee is deferred and
recognized ratably over the term of the arrangement. Billed amounts due
from the customers in excess of revenue recognized are recorded as
deferred revenue.
Hardware revenues are recognized upon shipment of products to
customers. For hardware transactions where no software is involved, we
apply the provisions of Staff Accounting Bulletin 101 "Revenue
Recognition" ("SAB 101") issued by the U.S. Securities and Exchange
Commission ("SEC").
We recognize revenue for maintenance services ratably over the contract
term. Our training and consulting services are billed based on hourly
rates or fixed fees, and we generally recognizes revenue as these
services are performed.
We recognize services revenues in accordance with the provisions of
AICPA Statement of Position 81-1, "Accounting for Performance of
Construction-Type and Certain Production-Type Contracts" ("SOP 81-1").
Revenues related to services are recognized upon delivery of the
service in the case of time and material contracts. Revenues related to
development contracts involving significant modification or
customization of hardware or software under development arrangements
are recognized using the percentage-of-completion method, based on the
efforts-expended method or based on performance milestones specified in
the contract where such milestones fairly reflect progress toward
contract completion. For software license arrangements that include
services requiring significant modification or customization of the
licensed software, we apply the percentage-of-completion method of
contract accounting to the entire arrangement. Losses on contracts are
recognized for the entire anticipated loss, if any, as soon as the loss
becomes evident.
8
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
f) Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
On an ongoing basis, we evaluate our estimates, including those related
to revenue recognition, provision for doubtful accounts and returns,
fair value of acquired intangible assets and goodwill, useful lives of
intangible assets and property and equipment, income taxes, and
contingencies and litigation, among others. We base our estimates on
historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, 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 could differ from the estimates made by management with
respect to these items and other items that require management's
estimates.
g) Foreign Currency Translation
We consider the functional currency of our foreign subsidiaries to be
the local currency, and accordingly, the foreign currency is translated
into U.S. dollars using exchange rates in effect at period end for
assets and liabilities and average exchange rates during each reporting
period for the results of operations. Adjustments resulting from
translation of foreign subsidiary financial statements are reported in
accumulated other comprehensive income (loss). Gains or losses on
foreign currency transactions are recognized in current operations and
have not been significant to our operating results in any period
presented.
h) Inventories
Inventories are valued at the lower of cost or market. Cost is
determined using the first-in, first-out method ("FIFO"). Inventories
are net of reserves of approximately $5.9 million and $21.3 million at
June 30, 2002 and December 31, 2001, respectively.
i) Computer Software Costs
Computer software costs consist of purchased software capitalized under
the provisions of Statement of Financial Accounting Standards No. 86,
"Computer Software to be Sold, Leased or Otherwise Marketed" ("SFAS
86"). Amortization of capitalized software costs is computed on a
straight-line basis over the estimated economic life of the product or
on a basis using the ratio of current revenue to the total of current
and anticipated future revenue, whichever is greater, and included in
cost of revenues in the accompanying statement of operations. To date,
no internally developed software costs have been capitalized. All other
research and development expenditures are charged to research and
development expense in the period incurred.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use,"
which provides guidance on accounting for such costs. SOP 98-1 requires
computer software costs that are incurred in the preliminary project
stage to be expensed as incurred. Once the capitalization criteria of
SOP 98-1 have been met, directly attributable development costs should
be capitalized. It also provides that upgrade and maintenance costs
should be expensed. The Company's treatment of such costs has
historically been consistent with SOP 98-1, with the costs capitalized
being amortized over the expected useful life of the software, ranging
from three to five years.
9
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
j) Computation of Net Income (Loss) Per Share
We compute earnings per share in accordance with SFAS No. 128,
"Computation of Earnings Per Share" ("SFAS 128"). In accordance with
SFAS 128, basic earnings per share is computed using the weighted
average number of common shares outstanding during the period. Diluted
earnings per share is computed using the weighted average number of
common and dilutive potential common shares outstanding during the
period. Potential common shares consist of the incremental common
shares issuable upon the exercise of stock options and warrants (using
the treasury stock method), and the incremental common shares issuable
upon the conversion of the convertible preferred stock (using the
if-converted method). Potential common shares are excluded from the
calculation if their effect is anti-dilutive.
The following is a reconciliation of the numerators and denominators of
the basic and diluted EPS computations for net income (in thousands,
except per share data):
i) Three Months Ended June 30, 2002
Options to purchase approximately 4.7 million shares of common
stock with a weighted-average exercise price of $2.47 were
outstanding during the three months ended June 30, 2002 but were
not included in the computation of diluted EPS because the effects
of assumed conversion or exercise would have an anti-dilutive
effect on EPS. The outstanding options include 1.9 million options
that are vested, with a weighted average exercise price of $3.06,
of which 1.3 million are vested and in the money, with a weighted
average exercise price of $1.06. The options have various
expiration dates during the next 10 years.
Warrants to purchase approximately 0.5 million shares of common
stock with a weighted-average exercise price of $3.28 were vested
and outstanding during the three months ended June 30, 2002, but
were not included in the calculation of diluted EPS because the
effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding warrants include 0.2
million warrants that are vested and in the money, with a weighted
average exercise price of $0.28. The warrants are fully vested and
have various expiration dates during the next 5 years.
ii) Six Months Ended June 30, 2002
Options to purchase approximately 4.7 million shares of common
stock with a weighted-average exercise price of $2.47 were
outstanding during the six months ended June 30, 2002 but were not
included in the computation of diluted EPS because the effects of
assumed conversion or exercise would have an anti-dilutive effect
on EPS. The outstanding options include 1.9 million options that
are vested, with a weighted average exercise price of $3.06, of
which 1.5 million are vested and in the money, with a weighted
average exercise price of $1.26. The options have various
expiration dates during the next 10 years.
Warrants to purchase approximately 0.5 million shares of common
stock with a weighted-average exercise price of $3.28 were vested
and outstanding during the six months ended June 30, 2002, but
were not included in the calculation of diluted EPS because the
effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding warrants include 0.2
million warrants that are vested and exercisable, with a weighted
average exercise price of $0.28. The warrants expire at various
dates during the next 5 years.
10
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
iii) Three Months Ended June 30, 2001
Options to purchase approximately 1.6 million shares of common
stock with a weighted-average exercise price of $4.30 were
outstanding during the three months ended June 30, 2001 but were
not included in the computation of diluted EPS because the effects
of assumed conversion or exercise would have an anti-dilutive
effect on EPS. The outstanding options include 0.5 million options
that are vested, with a weighted average exercise price of $5.95,
of which 0.03 million are vested and in the money, with a weighted
average exercise price of $0.03.
Warrants to purchase approximately 0.3 million shares of common
stock with a weighted-average exercise price of $1.35 were vested
and outstanding during the three months ended June 30, 2001, but
were not included in the calculation of diluted EPS because the
effects of assumed conversion or exercise would have an
anti-dilutive effect on EPS. The outstanding warrants include 0.2
million warrants that are vested and in the money, with a weighted
average exercise price of $0.22. The warrants expire have at
various dates during the next 5 years.
iv) Six Months Ended June 30, 2001
For the Six Months Ended June 30, 2001
(in thousands, except per share data)
-------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- -------------- --------
Net income available to common
stockholders ...................... $23,785
Basic EPS
Net income available to common
stockholders .................. 23,785 17,629 $ 1.35
====== ====== ========
Effect of Dilutive Securities
Warrants .......................... -- 221
Outstanding options ............... -- 53
Contingently issuable shares ...... -- 381
------ ------ --------
Diluted EPS
Net income available to common
stockholders and assumed conversions $23,785 18,284 $ 1.30
======= ====== ========
Options to purchase approximately 1.0 million shares of common
stock at various exercise prices were outstanding during the six
months ended June 30, 2001 but were not included in the
computation of diluted EPS because the corresponding exercise
prices of the options were greater than the average market price
of the common shares.
Warrants to purchase approximately 0.1 million shares of common
stock, issued at various exercise prices were outstanding during
the six months ended June 30, 2001, but were not included in the
calculation of diluted EPS because the corresponding exercise
prices were greater than the average market price of the common
shares.
11
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
k) Stock Options
We account for our employee stock-based compensation plans using the
intrinsic value method. As such, deferred compensation is recorded on
the date of grant if the current market price of the underlying stock
exceeds the exercise price. We record and measure deferred compensation
for options granted to non-employees at their fair value. Deferred
compensation is expensed over the vesting period of the stock option.
l) Intangible Assets and Goodwill
In July 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 141, "Business Combinations" ("SFAS 141)" and SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 requires
that the purchase method of accounting be used for all business
combinations. SFAS 141 also specifies criteria that intangible assets
acquired in a purchase method business combination must meet to be
recognized and reported apart from goodwill, noting that any purchase
price allocable to an assembled workforce must be recognized and
reported in goodwill. SFAS 142, which was effective January 1, 2002,
requires that intangible assets with indefinite useful lives should not
be amortized until their lives are determined to be finite and all
other intangible assets with finite lives must be amortized over their
useful lives to their estimated residual values. SFAS 142 also requires
that goodwill not be amortized, but instead be tested for impairment in
accordance with the provisions of SFAS 142 at least annually or between
annual tests upon the occurrence of certain events or upon certain
changes in circumstances. Intangible assets with finite useful lives
are reviewed for impairment in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). See "Impairment of Long-lived Assets," below.
We adopted SFAS 141 in 2001. Effective July 1, 2001, we adopted certain
provisions of SFAS 142, as required in the transition guidance
contained therein, and adopted the remaining provisions on January 1,
2002. There was not a cumulative transition adjustment upon adoption as
of July 1, 2001 or January 1, 2002. SFAS 141 and SFAS 142 required us
to perform the following as of January 1, 2002: (i) review goodwill and
intangible assets for possible reclassifications; (ii) reassess the
lives of intangible assets; and (iii) perform a transitional goodwill
impairment test. We reviewed the balances of goodwill and identifiable
intangibles and determined that we did not have any amounts that were
required to be reclassified from goodwill to identifiable intangible
assets, or vice versa. We also reviewed the useful lives of our
identifiable intangible assets and determined that the original
estimated useful lives remain appropriate. We completed the
transitional goodwill impairment test and determined that we did not
have a transitional impairment of goodwill.
As required by SFAS 142, we have not amortized goodwill associated with
acquisitions completed after June 30, 2001 for any period presented and
ceased amortization of goodwill associated with acquisitions completed
prior to July 1, 2001, effective January 1, 2002. Prior to January 1,
2002, we amortized goodwill associated with the pre-July 1, 2001
acquisitions over four years using the straight-line method.
Identifiable intangible assets (acquired technology, patent
applications and customer base) are currently amortized over two or
five years using the straight-line method. Refer to notes 4 and 5 for
further discussion of our intangible assets and goodwill.
12
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
m) Impairment of Long-Lived Assets
We test goodwill for impairment in accordance with SFAS 142. SFAS 142
requires that goodwill be tested for impairment at the "reporting unit
level" ("Reporting Unit") at least annually and more frequently upon
the occurrence of certain events, as defined by SFAS 142. Goodwill is
tested for impairment annually, in the fourth quarter, in a two-step
process. First, we determine if the carrying amount of the Reporting
Unit exceeds the "fair value" of the Reporting Unit, which would
indicate that goodwill may be impaired. If we determine that goodwill
may be impaired, we compare the "implied fair value" of the goodwill,
as defined by SFAS 142, to its carrying amount to determine if there is
an impairment loss. If the carrying amount exceeds the implied fair
value, we will record an impairment charge for the excess, if any, but
not in an amount in excess of the carrying amount, in the period in
which the determination of an impairment is made. As of June 30, 2002,
we do not have goodwill that we consider to be impaired.
On January 1, 2002, we adopted SFAS No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which
supersedes certain provisions of APB Opinion No. 30 "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment
of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" ("APB 30"), and supersedes SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" ("SFAS 121"). There was no adjustment
required upon adoption of SFAS 144. In accordance with SFAS 144, we
evaluate long-lived assets, including intangible assets other than
goodwill, for impairment whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable
based on expected undiscounted cash flows attributable to that asset.
The amount of any impairment is measured as the difference between the
carrying value and the fair value of the impaired asset. SFAS 144
provides guidance on how a long-lived asset that is used as part of a
group should be evaluated for impairment, establishes criteria for when
a long-lived asset is held for sale, and prescribes the accounting for
a long-lived asset that will be disposed of other than by sale. SFAS
144 retains the basic provisions of APB 30 on how to present
discontinued operations in the income statement, but broadens that
presentation to include a component of an entity (rather than a segment
of a business). We do not have any long-lived assets we consider to be
impaired.
n) Reclassifications
Certain prior year amounts have been reclassified to conform with the
current year presentation.
o) Recent Accounting Pronouncements
In July 2002 the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). The standard
requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. Examples of costs covered by
the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. Previous
accounting guidance was provided by Emerging Issues Task Force Issue
No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring) ("EITF 94-3")." SFAS 146 replaces EITF
94-3. We do not expect the adoption of SFAS 146 to have a significant
impact on our results of operations, financial position or cash flows.
13
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2) Comprehensive Income (Loss)
The components of comprehensive income (loss) are as follows (in
thousands):
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
------------- -------------- ----------- ------------
Net income (loss) ..................... $(10,475) $(15,950) $(19,587) $ 23,785
Foreign currency translation adjustment 201 (3) 125 (20)
Unrealized gain on available-for-sale
investment ............................ -- (39) -- (21)
-------- -------- -------- --------
Comprehensive income (loss) ........... $(10,274) $(15,992) $(19,462) $ 23,744
======== ======== ======== ========
3) Inventories
Inventories, net consist of the following (in thousands):
June 30, December 31,
2002 2001
--------- --------
Raw materials ... $25 $ 936
Finished products -- 1,134
--- ------
Inventories, net $25 $2,070
=== ======
4) Intangible Assets
Acquired intangible assets that are subject to amortization at June 30,
2002 and December 31, 2001, consist of the following (in thousands):
Gross Carrying Amount Accumulated Amortization
--------------------- ------------------------
June 30, December 31, June 30, December 31,
2002 2001 2002 2001
-------------- --------------- ----------- ------------
Developed technology $ 1,378 $ 1,378 $402 $ 55
Core technology 7,055 7,055 823 116
Patent applications 990 990 115 16
Customer base 322 322 38 5
--- --- --- ---
Total $ 9,745 $ 9,745 $1,378 $ 192
======= ======= ====== =====
Aggregate amortization expense was approximately $591,000 and $1,186,000
for the three and six months ended June 30, 2002, respectively. Estimated
aggregate expense for the six-month period from July 1, 2002 to December
31, 2002, and each of the years thereafter, is as follows (in thousands):
Charged to:
-----------
Cost of Operating
Total revenues expense
----- -------- -------
Period ending December 31,
2002 ..................... ..... $ 1,181 $ 1,050 $ 131
2003 ..................... ...... 2,305 2,043 262
2004 ..................... ...... 1,673 1,411 262
2005 ..................... ...... 1,673 1,411 262
2006 ..................... ...... 1,535 1,294 241
14
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5) Goodwill
The changes in the gross carrying amount of goodwill for the six months
ended June 30, 2002 are as follows (in thousands):
DRM Systems
-----------
Balance as of December 31, 2001 ......................$ 20,819
Goodwill adjustments during the period, net ............ (196)
-----
Balance as of June 30, 2002 ..........................$ 20,623
========
Goodwill adjustments primarily represent increases for additional
professional fees related to the purchase of eMation of approximately
$76,000 and adjustments to liabilities assumed on the date of acquisition
of approximately $272,000 that were settled at amounts less than the
present values estimated on the date of the acquisition.
Goodwill acquired in 2001 is not expected to be deductible for income tax
purposes.
Summarized below are the effects on net income (loss) and net income (loss)
per share data, if we had followed the amortization provisions of SFAS 142
for all periods presented (in thousands, except per share amounts):
For Three Months Ended June 30,
-------------------------------
2002 2001
----------- ---------
Reported net income (loss) ....... $(10,475) $ (15,950)
Add Back: Goodwill amortization . -- 286
-------- ----------
Adjusted net income (loss) ....... $(10,475) $ (15,664)
======== ==========
Basic earnings (loss) per share:
Reported net income (loss) ..... $ (0.39) $ (0.89)
Goodwill amortization .......... -- 0.01
-------- ----------
Adjusted net income (loss) ..... $ (0.39) $ (0.88)
======== ==========
Diluted earnings (loss) per share:
Reported net income (loss) ..... $ (0.39) $ (0.89)
Goodwill amortization .......... -- 0.01
-------- ----------
Adjusted net income (loss) ..... $ (0.39) $ (0.88)
======== ==========
For Six Months Ended June 30,
2002 2001
--------------- ---------------
Reported net income (loss) ....... $ (19,587) $ 23,785
Add Back: Goodwill amortization . -- 1,730
---------- ----------
Adjusted net income (loss) ....... $ (19,587) $ 25,515
========== ==========
Basic earnings (loss) per share:
Reported net income (loss) ..... $ (0.73) $ 1.35
Goodwill amortization .......... -- 0.10
---------- ----------
Adjusted net income (loss) ..... $ (0.73) $ 1.45
========== ==========
Diluted earnings (loss) per share:
Reported net income (loss) ..... $ (0.73) $ 1.30
Goodwill amortization .......... -- 0.10
---------- ----------
Adjusted net income (loss) ..... $ (0.73) $ 1.40
========== ==========
15
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6) Acquisition
On December 7, 2001, we acquired all of the outstanding shares of eMation,
Ltd., a private company organized under the laws of the State of Israel and
headquartered near Boston, Massachusetts, a developer of Internet-based
solutions that extract and manage information from intelligent devices and
make that information available to people and business systems. We acquired
eMation to acquire a company with greater opportunity than our existing
product line. As a result of the acquisition, we are a provider of DRM
solutions worldwide. We also expect to reduce costs through economies of
scale. The results of eMation's operations are included in our consolidated
financial statements since the date of acquisition.
We acquired eMation in consideration for: 8 million shares of Axeda common
stock, valued at approximately $17.4 million; the assumption of 1,428,710
shares of Axeda common stock reserved for issuance upon exercise of assumed
eMation stock options, 530,000 of which are exercisable for $0.01 per share
and the remaining 898,710 exercisable at $2.14 per share; options
exercisable for up to 113,600 shares of Axeda common stock issued at
closing pursuant to our 1999 Stock Incentive Plan exercisable at $2.14; and
warrants exercisable for up to 7,000 shares of Axeda common stock
exercisable at $2.14 issued to ex-employees of eMation in consideration for
cancellation of outstanding options to purchase shares of eMation. The
aggregate value of these issued and assumed options and warrants was
approximately $2.6 million. The total combined value of the securities
assumed and issued was approximately $20 million and we incurred
transaction costs of approximately $3.4 million related to the eMation
acquisition, for an aggregate purchase price of $23.4 million. We also
issued or assumed warrants at closing exercisable for up to 115,238 shares
of Axeda common stock with exercise prices ranging from $2.14 to $21.51 per
share to holders of warrants exercisable for shares of eMation. We also
assumed approximately $5 million of eMation net debt. The acquisition was
recorded under the purchase method of accounting.
Unaudited Pro Forma Financial Information
The following unaudited pro forma financial information presents the
results of our operations for the three and six months ended June 30,
2001 as if the acquisition occurred on January 1, 2001. The unaudited
pro forma financial information for the three and six months ended June
30, 2001 does not necessarily reflect the results of operations that
would have resulted had the acquisition occurred on January 1, 2001,
nor is it necessarily indicative of future results (in thousands except
per share data).
Three Months Ended Six Months Ended
June 30, 2001 June 30, 2001
------------- ------------
Revenues ........................... $ 3,406 $ 8,868
=========== ==========
Net income (loss) .................. $ (20,080) $ 15,500
========== ==========
Basic net income (loss) per weighted
average common share outstanding ..... $ (0.78) $ 0.60
========== ==========
Diluted net income (loss) per weighted
average common share outstanding...... $ (0.78) $ 0.58
========== ==========
16
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7) Sales of Assets
a) Sale of Consumer Electronics Assets
On March 1, 2001, pursuant to an Asset Acquisition Agreement, we sold
certain assets related to our CE business to STMicroelectronics NV
("STMicroelectronics"), a Dutch corporation. The assets sold included
certain contracts, equipment, intangible assets, intellectual property,
prepaid expenses, accounts receivable and other assets primarily
related to the operations of the CE business. In connection with the
sale, we and STMicroelectronics entered into certain agreements
including an Assignment and Assumption of Lease with respect to our
former corporate headquarters office facility located in Malvern,
Pennsylvania. Certain employees of ours entered into employment
agreements with STMicroelectronics. Pursuant to the terms of the Asset
Acquisition Agreement, STMicroelectronics paid approximately $55.6
million in cash consideration, of which $0.7 million remains held in
escrow by a third party for indemnification purposes until September
2002 and is included in restricted cash in the consolidated balance
sheet as of June 30, 2002. In connection with the asset sale, we and
certain of our subsidiaries granted to STMicroelectronics certain
non-exclusive rights to license and distribute certain of our
technology used in our IA products (note 7b) and PC products.
We recorded a gain on the sale of approximately $47.5 million during
the quarter ended March 31, 2001. The net gain was calculated as
follows (in thousands):
Sale price ..................................... $ 55,602
Accounts receivable acquired ................... (261)
Accrued expenses assumed ....................... 137
Net book value of deferred stock compensation .. (498)
Net book value of furniture and equipment sold . (2,036)
Net book value of goodwill and intangible assets (968)
Other assets ................................... (18)
Employee transition and inducement costs ....... (2,956)
Professional and legal fees .................... (1,487)
--------
Gain on sale of CE assets ...................... $ 47,515
========
17
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
b) Sale of Internet Appliance Assets
On March 23, 2001, pursuant to an Asset Acquisition Agreement, we sold
certain assets related to our IA business to Phoenix Technologies Ltd.
("Phoenix"), a Delaware corporation. The assets sold included certain
contracts, equipment, intangible assets, intellectual property and
prepaid expenses primarily related to the operations of the IA
business, including those purchased from Teknema. Certain employees of
ours entered into employment agreements with Phoenix Technologies, Ltd.
Pursuant to the terms of the Asset Acquisition Agreement, Phoenix paid
$18 million in cash consideration, of which $1.8 million was being held
by a third party in escrow for indemnification purposes until March
2002. In March 2002, we received $1.3 million, including interest of
approximately $0.05 million, of the amount held in escrow. The
remaining escrow balance of approximately $0.55 million has been
withheld pending the settlement of a claim submitted by Phoenix and is
included in restricted cash in the consolidated balance sheet as of
June 30, 2002. We are unable to predict the resolution of this matter,
or reasonably estimate any amount of loss given the current status of
this matter. Any escrow amounts not returned to us will be recorded as
a charge to the gain on sale of assets in the period in which such
determination is made. In June 2002 we initiated an arbitration
proceeding with the International Chamber of Commerce (No. 12 203/JNK)
seeking an order that the entire $0.55 million be disbursed to Axeda.
Phoenix has not yet filed an answer or counterclaim, and no hearing
date has yet been set.
We recorded a gain on the sale of approximately $4.5 million during the
quarter ended March 31, 2001. The net gain was calculated as follows
(in thousands):
Sale Price ..................................... $ 18,000
Prepaid expenses ............................... (954)
Net book value of deferred stock compensation .. (121)
Net book value of furniture and equipment sold . (466)
Net book value of goodwill and intangible assets (10,586)
License fee .................................... (250)
Employee transition and inducement costs ....... (763)
Professional and legal fees incurred ........... (338)
--------
Gain on sale of IA assets ...................... $ 4,522
========
c) Unaudited Pro Forma Financial Information
The following unaudited pro forma financial information presents our
results of operations for the six months ended June 30, 2001, as if the
dispositions occurred on January 1, 2001, after giving effect to
certain adjustments, primarily revenues and personnel costs associated
with the disposed businesses, amortization of goodwill, the gains
recorded upon the dispositions and income taxes. The unaudited pro
forma financial information for the six months ended June 30, 2001 does
not necessarily reflect the results of operations that would have
occurred had the dispositions been completed on January 1, 2001 (in
thousands except per share data).
Six Months Ended
June 30, 2001
-------------
Revenues ........................................... $ 3,163
========
Net loss ........................................... $(21,231)
========
Basic and diluted net loss per weighted average
common share outstanding .......................... $ (1.20)
========
18
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8) Transaction with Sonic Solutions
In May 2002 we entered into a Software Distribution Agreement (the
"Agreement") with Sonic IP, Inc. ("Sonic"), a wholly-owned subsidiary
of Sonic Solutions. As a result, we are exiting the digital media
market (see discussion of Services, below) and, as of June 30, 2002,
have terminated or assigned to Sonic, substantially all of the customer
contracts of our PC business. Under the terms of the Agreement, Sonic
paid us $2 million for the exclusive and perpetual license to all of
the intellectual property ("IP") of our PC business, which was
delivered effective with the closing of the Agreement, and for certain
furniture and computer equipment ("the "Equipment"). The Equipment,
which had a net book value totaling approximately $331,000, was used by
the employees of our PC business and was not essential to the
functionality of the licensed IP. Sonic also received certain
trademarks and World Wide Web domain names associated with the PC
business. In connection with the closing of the Agreement,
approximately 10 of our employees in the PC business accepted
employment offers from Sonic and we paid inducements to those employees
related to their acceptance totaling approximately $106,000. These
inducements were paid in June 2002 and are included in special charges
in the accompanying statements of operations. In addition, the Axeda
stock options held by certain of these employees were modified to
accelerate vesting upon termination. We recorded a charge for the three
and six months ending June 30, 2002 of approximately $24,000 related to
the modifications, which is included in special charges in the
statements of operations. Under the terms of the Agreement we also
agreed to designate our remaining approximately 14 employees of the PC
business to provide unspecified services to Sonic to create
improvements, R&D information, and computer software (collectively, the
"Services") through December 31, 2002. We will provide the Services for
May through August 2002 as part of the base license agreement without
additional charge to Sonic. If Sonic wishes to maintain the Services
agreement through December 31, 2002, then Sonic will pay Axeda
$422,777, which approximates our cost, for the Services provided from
August to December 31, 2002, pro rated to the date of termination of
the Services. The Services fees will be recognized on a straight-line
basis as services revenues as Sonic utilizes the Services from August
to December 2002 and are payable semi-monthly in arrears on the 15th
and 30th of each month beginning August 2002.
Because we did not have vendor-specific evidence of fair value for each
of the elements of this license arrangement (note 1e), and because we
are providing the Services to Sonic after the initial delivery of the
licensed IP, we are recognizing the $2 million license fee on a
straight-line basis over seven months, which is the period that we have
agreed to provide the Services. For the three and six months ended June
30, 2002 we have recognized approximately $286,000 of license revenues
under this arrangement. Except for the amortization of the license fee
and the Services fees described above, we do not expect to record
material revenues related to our PC business subsequent to June 30,
2002. Approximately $166,000 of the net book value of the Equipment was
charged to expense and is included in special charges in the
accompanying statements of operations. The remaining net book value of
the Equipment of $165,000, which is attributed to Equipment that will
continue to be utilized by our employees who have not been offered and
who have not accepted employment offers from Sonic prior to December 31
2002, is being amortized over the seven-month term of the Services.
19
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Also as part of our strategy to exit the PC business, we vacated our
offices in San Jose, California in May 2002, and in July 2002 we
terminated our lease for this facility. The original term of the lease
ended in March 2005 and, as of June 30, 2002, would have required
minimum lease payments totaling $779,000 plus operating expenses of
approximately $264,000. We paid approximately $135,000, including
$64,000 held by the lessor as security from the inception of the lease,
in July 2002 to the lessor as an inducement to cancel the lease. We
also paid $210,000 in cash in July 2002 and, for nominal consideration,
sold furniture, computer equipment and leasehold improvements to the
new lessee as incentives to the new lessee to enter into a lease for
the premises with the lessor. The total cash payments of $345,000,
including the foregone security deposit, and the net book value of the
assets sold of $168,000 are included in special charges in the
accompanying statements of operations.
A summary of special charges recorded in the quarter, all in connection
with our exit from the PC business, is as follows:
Amount
Description ($-`000's)
----------- ----------
Net book value of equipment .. $166
Employee termination expenses 130
Inducements to other employees 11
Lease termination costs ...... 513
---
Total special charges ........ $820
====
9) Notes Payable
a) Note Payable - Bank Leumi
In connection with the closing of the share purchase agreement to
acquire eMation on December 7, 2001, we acquired the balance of
$1,650,000 of eMation's amount outstanding under a $1,700,000 line of
credit with Bank Leumi in Israel. The line of credit was paid in full
in January 2002, including interest of approximately $21,000.
b) Equipment Line of Credit
As of June 30, 2002, we had approximately $406,000 outstanding on an
equipment line of credit with EVP with interest rates ranging from 12%
to 13% and payments due monthly over a 36 month period. The line of
credit was available to finance purchases of capital equipment through
September 30, 2001. In connection with the agreement, EVP has a senior
security interest in substantially all of eMation's capital equipment.
In addition, the line of credit agreement requires us to provide EVP
with copies of quarterly financial statements within 45 days of the end
of each quarter and audited annual financial statements within 90 days
of the end of each year as well as other information and notifications
regarding eMation's financial and operating results.
As of June 30, 2002, we were in compliance with all of our covenants to
EVP.
20
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10) Accrued Expenses
Accrued expenses consist of the following:
June 30, December 31,
2002 2001
-------- --------
Legal and professional fees ............ $1,449 $2,708
Payroll and related costs .............. 2,860 2,951
Severance .............................. 413 899
Unutilized leased facility ............. 508 107
Royalties to Israeli government agencies 689 620
Legal settlements ...................... 277 277
Accrued Dolby royalties ................ 39 122
Sales, excise and other taxes .......... 363 192
Other .................................. 1,521 1,052
----- -----
Total ............................. $8,119 $8,928
====== ======
11) Equity Transactions
a) Treasury Stock
In May 2002 we reached an agreement with a former officer to re-pay a
portion of the remaining balance of an original loan for $160,000 that
was originally extended to the officer in February 2000. The officer
previously paid $15,000 of the loan, leaving a balance of $145,000,
which was fully reserved during the fourth quarter of 2001. Under the
agreement, in June 2002, the former officer paid us $50,000 and
surrendered 20,000 shares of Axeda common stock held by the former
officer. On the day that we received the shares, the fair market value
of our common stock was $1.97 per share. As a result, we recorded
treasury stock during the quarter of $39,400 and a reduction of $90,000
to the provision for doubtful accounts.
b) Exchangeable Preferred Stock
In May 2002 a former principal stockholder of Cinax Designs, Inc., a
company that we purchased in August 2000, exchanged 271,839 shares of
exchangeable preferred stock ("preferred stock") of our subsidiary,
Ravisent British Columbia Inc. ("Ravisent BC") issued in connection
with the acquisition (Note 1j). Shares of our common stock issued for
this transaction total 756,807 and 484,968 as of June 30, 2002 and
December 31, 2001, respectively, and are recorded as issued and
outstanding for financial reporting and earnings per share purposes,
including 271,839 shares and 311,826 shares of preferred stock which
were exchanged in 2002 and 2001, respectively. As the remaining
unexchanged shares of preferred stock totaling 14,692 shares are
exchanged by the preferred stockholders, such shares will be recognized
as issued and outstanding. The shares of preferred stock are
exchangeable, at the option of the holder at any time, on a one-for-one
basis, into shares of our common stock, have an automatic redemption
into shares of our common stock on August 1, 2005, and contain
certain dividend restrictions, as defined.
21
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
c) Employee Stock Options Granted
In April 2002 we granted 260,000 stock options to employees, including
65,000 to two of our directors, with an exercise price per share equal
to the fair market value of our common stock and ranging from $2.63 to
$2.67.
In February 2002 we granted 1,012,200 stock options to employees,
including 100,000 to our current Chief Executive Officer ("CEO"), with
an exercise price per share equal to not less than the fair market
value of our common stock on the date of grant and ranging from $2.53
to $3.03.
In February 2002 we granted 20,000 stock options to employees with an
exercise price of $0.01 per share, which was less than the fair market
value of our common stock on the date of grant. We have recorded
approximately $50,000 of deferred stock compensation, which is being
amortized over the vesting term of 2 years.
d) Accelerated Vesting
Under the terms of the employment agreement with our current CEO,
100,000 options with an exercise price of $0.01 per share, which were
granted to the current CEO in August 2001, that, under the terms of the
award would have vested from February 2002 to August 2003, were to vest
in February 2002 upon the continued employment of the current CEO as of
and after that date. Upon the continued employment of the current CEO
as of and after February 2002, the respective options vested and were
exercisable. For the six months ended June 30, 2002, we recorded a
charge of approximately $164,000 on the date of the acceleration, which
is included in non-cash compensation general and administrative expense
in the accompanying statement of operations, for deferred stock
compensation that was initially recorded in August 2001.
e) Amendment to 1999 Stock Incentive Plan
In June 2002 our stockholders approved the proposal to increase the
number of shares available for issuance under our 1999 Stock Incentive
Plan from 3,225,000 shares to 3,725,000 shares, excluding the annual
automatic increase shares.
12) Related Party Transactions
In January 2002, under the terms of the separation agreement with our
former CEO as director, we modified the terms our stock options awarded
during the term of employment with us to immediately vest all remaining
outstanding stock options awarded and to permit the continued exercise of
the options subsequent to termination until the earlier of the expiration
date for the respective options or January 9, 2005. We recorded a charge of
approximately $206,000 related to the accelerated vesting, primarily for
the remaining balance of deferred stock compensation that was initially
recorded in June 1999 and July 2001, and $223,000 related to the
modification for continued exercisability of the options, resulting
primarily from the incremental intrinsic value on the date of the
modification of options granted in July 1997 and July 2001. The total
charge of approximately $429,000 is included in non-cash compensation
general and administrative expense in the accompanying statement of
operations for the six months ended June 30, 2002. In addition, we forgave
loans totaling approximately $414,000, including interest of approximately
$16,000. The loan forgiveness and related employment taxes, totaling
approximately $600,000 were accrued and charged to general and
administrative expense in December 2001.
22
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13) Commitments and Contingencies
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. The lawsuit alleges violations of Sections 11,
12(a)(2) and 15 of the Securities Exchange Act of 1933 and Section 10(b) of
the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder
against one or both of the Company and the individual defendants. The
claims are based on allegations that the underwriter defendants agreed to
allocate stock in the Company's 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. 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. This
lawsuit is part of the massive "IPO allocation" litigation involving the
conduct of underwriters in allocating shares of successful initial public
offerings. We believe that more than one hundred and eighty other companies
have been named in more than eight hundred identical lawsuits that have
been filed by some of the same plaintiffs' law firms. Certain of our
employees are members of the putative classes alleged in these actions and
therefore may have interests adverse to us with respect to the alleged
claims in these actions. We believe that such lawsuit and claims are
without merit and that we have meritorious defenses to the actions. We plan
to vigorously defend the litigation. However, failure to successfully
defend this action could substantially harm our results of operations,
liquidity and financial condition.
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
Exchange Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934, and Rule 10b-5 promulgated thereunder and seeks unspecified
damages on behalf of a purported class of purchasers of our stock during
the period stated above. On July 3, 2000, we filed a motion to dismiss the
consolidated and amended class action complaint. The motion is presently
fully briefed and the parties are awaiting a hearing date to be set for the
motion. In connection with our initial public offering, we purchased
directors and officers insurance that provides us with protection from
claims made against our officers, directors or us arising from claims
including but not limited to any written demand for damages and any civil,
criminal, administrative, or regulatory proceedings and appeals. Certain of
our employees and certain holders of 5% or more of our common stock are
members of the putative classes alleged in these actions and therefore may
have interests adverse to us with respect to the alleged claims in these
actions. We believe that such lawsuits or claims are without merit and that
we have meritorious defenses to the actions. We plan to vigorously defend
the litigation. However, failure to successfully defend these actions could
substantially harm our results of operations, liquidity and financial
condition.
23
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Various third parties have notified us, as well as some of our customers,
that our products infringe patents held by such third parties. We have
received notices of up to an aggregate of five million dollars asserting
rights under the indemnification provisions and warranty provisions of our
license agreements from several customers relating to such claims of
infringement. We have not determined whether and to what extent the patents
held by such third parties are valid and whether and to what extent our
products may infringe such patents. We are unable to predict the outcome of
these matters, however we are able to reasonably estimate an amount of
possible loss given the current status of certain of these matters, and
have accrued $375,000, which is included in other general and
administrative expense in the accompanying statements of operations.
In May 2002, we received preliminary notification from a customer, who
licenses our DVD products on a per-unit basis, that the customer may have
incorrectly reported to us, its sales of our products from October to
December 2001. These sales were reported to us in January 2002 and were
included in our license revenues for the quarter ended March 31, 2002. The
notification indicated that actual sales of products by the customer to
end-users may have been less than the actual units initially reported to us
by the customer. We evaluated the merits of the notification, engaged the
customer in discussion, and determined that the adjustment was correct and
has resulted in a decrease of approximately $120,000 in both license
revenues and license cost of revenues in the quarter ended June 30, 2002.
We also discussed a corrective action plan with the customer that included
a description of controls put in place by the customer which are designed
to prevent future reporting corrections.
In May 2002, we entered into a lease for approximately 35,000 square feet
of space in an office building in the same business park as our current
offices located in Mansfield, Massachusetts. This facility is leased at an
annual rental of approximately $310,000, plus operating expenses, utilities
and taxes, and will be used for research and development, sales and support
and administrative activities. The lease commenced in June 2002, expires in
July 2007, and provides for free rent through September 2002. We will
record the net lease expense on a straight-line basis over the term of the
lease. Axeda obtained an irrevocable, cash-secured, standby letter of
credit (the "letter of credit") from a bank as security and for the benefit
of the lessor for $0.15 million. The letter of credit expires in August
2003 and provides for automatic one-year renewals, but not beyond August
2007. The letter of credit is secured by a certificate of deposit for $0.15
million from the same bank, and also expires in August 2003. This amount is
restricted for withdrawal and is included in other assets (non-current) in
our consolidated balance sheets. We commenced our occupation of the offices
in July 2002 and expect to fully occupy this facility during the third
quarter of 2002 The lease for 89 Forbes Boulevard expires in July 2004 and
requires minimum annual rental payments of approximately $270,000. We are
actively attempting to sublease this office, but there can be no assurances
that we will be able to secure another tenant on acceptable terms.
In June 2002 we entered into a Software License Agreement ("the Agreement")
with a vendor to provide server and client software that will be
incorporated into our DRM Enterprise Server products beginning in August
2002. License fees are due and payable at the rate of 2.5% of each billable
sale, as defined. Under the Agreement, we agreed to pay a minimum,
non-refundable prepaid license fee of $400,000 (the "minimum license fee"),
which is payable in installments. We paid $100,000 in July 2002, and are
required to pay $100,000 on June 30, 2003 and the remaining $200,000 on
December 15, 2003. In addition to the license fees for billable sales, we
owe the vendor approximately $37,000 for a development software license fee
(the "development fee") for certain of the vendor's report products to be
used solely for development and test purposes. The license fee for the
development software will be credited against the minimum license fee. We
are also obligated to purchase annual maintenance from the vendor at a rate
of 18% of the cumulative license fee for billable sales and 18% of the
development fee. The annual maintenance fees are payable in advance and may
not be credited against the minimum license fee.
From time to time, we have received, and expect to continue to receive,
notices of claims of infringement of other parties' proprietary rights and
other claims in the ordinary course of business. Management believes the
amount of the ultimate liability with respect to these claims will not
materially affect our financial position, results of operations, or cash
flows.
24
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14) Segment Information
We operate in a single industry segment, which is the development and
licensing of our technology.
We sell and license our technology to customers primarily in North America
and Europe. The net income (loss) from operations for all periods presented
is derived primarily from our North American operations, which generates
revenues from the following geographic regions:
Three Months Ended June 30,
-------------------------------------------------------------------
Country/ Geographic Region 2002 2001
- -------------------------- ---- ----
$ - `000's % of total $ - `000's % of total
---------- ---------- ---------- ----------
North America:
United States $ 1,201 34% $ 354 45%
Canada 579 16 255 32
---------------- ------------- ---------------- ------------
Total - North America 1,780 50 609 77
---------------- ------------- ---------------- ------------
Europe:
Germany 292 8 109 14
France 434 12 6 1
Netherlands 176 5 - -
Switzerland 166 5 - -
United Kingdom 115 3 - -
Other 227 7 - -
---------------- ------------- ---------------- ------------
Total - Europe 1,410 40 115 15
---------------- ------------- ---------------- ------------
Asia-Pacific:
Israel 68 2 - -
Japan 160 5 68 8
Other 89 2 2 -
---------------- ------------- ---------------- ------------
Total - Asia-Pacific 317 9 70 8
---------------- ------------- ---------------- ------------
South America - Other 36 1 - -
---------------- ------------- ---------------- ------------
Total $ 3,543 100% $ 794 100%
================ ============= ================ ============
25
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Six Months Ended June 30,
-------------------------------------------------------------------
Country/ Geographic Region 2002 2001
- -------------------------- ---- ----
$ - `000's % of total $ - `000's % of total
---------- ---------- ---------- ----------
North America:
United States $ 3,273 40% $ 2,274 63%
Canada 1,256 15 858 24
---------------- ------------- ---------------- ------------
Total - North America 4,529 55 3,132 87
---------------- ------------- ---------------- ------------
Europe:
Germany 565 7 173 5
France 1,032 13 21 1
Netherlands 439 5 - -
Switzerland 224 3 - -
United Kingdom 239 3 12 -
Turkey - - 6 -
Other 431 5 10 -
---------------- ------------- ---------------- ------------
Total - Europe 2,930 36 222 6
---------------- ------------- ---------------- ------------
Asia-Pacific:
Israel 169 2 - -
Japan 372 5 253 7
Other 122 1 2 -
---------------- ------------- ---------------- ------------
Total - Asia-Pacific 663 8 255 7
---------------- ------------- ---------------- ------------
South America - Other 61 1 1 -
---------------- ------------- ---------------- ------------
Total $ 8,183 100% $ 3,610 100%
================ ============= ================ ============
15) Segment Reporting
Segment information is presented in accordance with Statement of Financial
Accounting Standards No. 131 ("SFAS 131"), "Disclosures About Segments Of
An Enterprise And Related Information." This standard requires segmentation
based upon our internal organization and disclosure of revenue and
operating income based upon internal accounting methods. For the six months
ended June 30, 2002 we had three reportable segments: device relationship
management ("DRM") systems, personal computer ("PC") and Internet appliance
("IA") (note 6, note 7 and note 8). For the six months ended June 30, 2001,
we also had a consumer electronics ("CE") segment.
DRM Systems: Created as a result of the acquisition of eMation in December
2001 (note 6), this segment provides a distributed software solution
designed to enable businesses to remotely monitor, manage and service
intelligent devices. DRM enables the live exchange of information via the
Internet, between remotely deployed "intelligent devices" (instruments,
equipment, machines, facilities, appliances, vehicles, sensors or systems
incorporating computer-based control technology) and the people that build,
service and use them. The Axeda DRMTM System enables manufacturers and
service providers to use the Internet to establish and manage continuous
connections with devices deployed at their customers' facilities, allowing
them to stay in touch with their products throughout their lifecycle,
tapping the value of remote device information with new, automated
e-service, operations monitoring, and e-commerce offerings. The product
offerings enable customers to gain business insight and benefits from live
information sources by helping them capitalize on the wealth of previously
unavailable device performance and usage data.
26
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PC: This segment designs, develops, licenses and markets core-based modular
software solutions that enable digital video and audio stream management in
PC systems. The segment also provides supporting hardware designs to
selected customers as well as customization services and customer support.
The segments solutions enable decoding (playback) and encoding (recording)
of multimedia formats such as digital versatile disk ("DVD"); direct
broadcast satellite ("DBS") and high-definition television ("HDTV") on
personal computers (note 8).
CE: This segment designed, developed, licensed and marketed core-based
modular software solutions that enable digital video and audio stream
management in CE devices. The segment also provided supporting hardware
designs to selected customers as well as customization services and
customer support. The segments solutions enable decoding (playback) and
encoding (recording) of multimedia formats such as digital versatile disk
("DVD"); direct broadcast satellite ("DBS") and high-definition television
("HDTV") on existing CE platforms (note 7a).
IA: Our Internet technology segment was involved in the development of
products for the emerging market in information appliances. The segment
sold IA hardware reference designs and software technology through
intellectual property licenses and agreements with Internet service
providers. This segment provided us with a number of Internet-related
products, including an efficient web browser, and several IA reference
designs including a Web Pad design, Internet ready TV and monitor designs
and an Internet-ready screenphone (note 7b). Revenues from this segment are
the result of the sales of remaining inventories purchased for this
business.
We evaluate operating segment performance based on revenue and gross
profit. We have not historically evaluated segment performance based on
operating income nor allocated assets to individual operating segments.
Three Months Ended June 30,
-------------------------------------------
2002 2001*
--------------------- --------------------
% Total % Total
($-`000's) revenues ($-`000's) revenues
---------- -------- ---------- --------
Revenue:
DRM Systems ........................ $ 2,204 62% $ -- -%
PC ................................. 1,070 30 719 91
IA ................................. 269 8 75 9
CE ................................. -- -- -- --
------ --- ---- ---
Total .................... $3,543 100% $794 100%
====== ==== ===== ====
Gross profit :
DRM Systems (excluding software
amortization of $525 in 2002) ..... $ 993 28% $ -- -%
PC ................................. 508 14 241 31
IA (excludes inventory charges of
$13,420 in 2001)................... 27 1 17 2
CE ................................. -- -- -- --
------ ----- ----- -----
Total (excludes software amortization of
$525 in 2002 and inventory charges of
$13,420 in 2001) ...........................$ 1,528 43% $ 258 33%
====== ===== ====== ====
27
AXEDA SYSTEMS INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Six Months Ended June 30,
-------------------------------------------
2002 2001*
-------------------- ---------------------
% Total % Total
($-`000's) revenues ($-`000's) revenues
---------- -------- ---------- --------
Revenue:
DRM Systems ........................ $4,698 57% $ -- -%
PC ................................. 2,177 27 3,088 85
IA ................................. 1,308 16 101 3
CE ................................. -- -- 421 12
------ --- ------ ---
Total .................... $8,183 100% $3,610 100%
====== ==== ====== ====
Gross profit:
DRM Systems (excluding software
amortization of $1,054 in 2002).... $2,488 30% $ -- 0%
PC ................................. 861 11 2,078 58
IA (excludes inventory charges of
$13,420 in 2001) .................. 58 1 15 --
CE ................................. -- -- 327 9
------ --- ------ ---
Total (excludes software amortization of
$1,054 in 2002 inventory charges of
$13,420 in 2001) $3,407 42% $2,420 67%
====== ==== ====== ====
* - Does not include eMation, which was acquired in December 2001 (note 6).
28
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 2:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion of our financial condition and our results of
operations should be read in conjunction with the unaudited condensed
consolidated financial statements and notes thereto included elsewhere in this
report. The information herein contains forward-looking statements within the
meaning of 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 of future results to differ from those
discussed herein. Such factors include, but are not limited to: the transition
in businesses we are currently undergoing; fluctuating quarterly operating
results; uncertainties in the market for DRM systems and the potential for
growth in the pervasive computing market; declining sales of our legacy
products; the current economic slowdown and our dependence on the cyclical
software industry; our ability to integrate acquisitions; present and future
competition; our ability to manage technological change and respond to evolving
industry standards; our ability to manage growth and attract and retain
additional personnel; the long sales cycle for DRM systems; limited distribution
channels; the difficulty of protecting proprietary rights; the potential for
defects in products; claims for damages asserted against us; our ability to
raise capital; the potential for NASDAQ delisting if the trading price of our
stock remains below $1.00; risks from international operations; and others
discussed in this section and in Item 3 under "Factors That May Affect Future
Results." 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," "will," "should," "seeks,"
"pro forma," "anticipates," "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, prospective
investors are cautioned not to place undue reliance on such forward-looking
statements. All forward-looking statements and reasons why results may differ
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.
The following is a summary of the topics of Management's Discussion And Analysis
of Financial Condition and Results of Operations and where they can be found in
this section:
Description Page(s)
---------------------------------------------------------------------- --------
Overview and Recent Events ........................................... 30 - 33
---------------------------------------------------------------------- --------
DRM .................................................................. 33
---------------------------------------------------------------------- --------
Results of Operations - Three Months Ended June 30, 2002 and 2001 .... 34 - 38
---------------------------------------------------------------------- --------
Results of Operations - Six Months Ended June 30, 2002 and 2001 ...... 39 - 44
---------------------------------------------------------------------- --------
Acquired In-process Research and Development ......................... 45
---------------------------------------------------------------------- --------
Liquidity and Capital Resources ...................................... 46 - 48
---------------------------------------------------------------------- --------
Critical Accounting Policies ......................................... 49 - 52
---------------------------------------------------------------------- --------
Recent Accounting Pronouncements ..................................... 52
---------------------------------------------------------------------- --------
29
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Overview and Recent Events
In May 2002 we entered into a Software Distribution Agreement (the "Agreement")
with Sonic IP, Inc. ("Sonic"), a wholly-owned subsidiary of Sonic Solutions. As
a result, we are exiting the digital media market (see discussion of Services,
below) and, as of June 30, 2002, have terminated or assigned to Sonic,
substantially all of the customer contracts of our PC business. To date we have
been unable to cancel or assign one customer contract, which, if not cancelled,
will result in equal amounts of license revenues and cost of license revenues
through December 31, 2002, when the contract with that customer expires. Under
the terms of the Agreement, Sonic paid us $2 million for the exclusive and
perpetual license to all of the intellectual property ("IP") of our PC business,
which was delivered effective with the closing of the Agreement, and for certain
furniture and computer equipment ("the "Equipment"). The Equipment, which had a
net book value totaling approximately $331,000, was used by the employees of our
PC business and was not essential to the functionality of the licensed IP. Sonic
also received certain trademarks and World Wide Web domain names associated with
the PC business. In connection with the closing of the Agreement, 10 of our
employees in the PC business accepted employment offers from Sonic and we paid
inducements to those employees related to their acceptance totaling
approximately $106,000. These inducements were paid in June 2002 and are
included in special charges in the accompanying statements of operations. In
addition, the Axeda stock options held by certain of these employees were
modified to accelerate vesting upon termination. We recorded a charge for the
three and six months ending June 30, 2002 of approximately $24,000 related to
the modifications, which is included in special charges in the statements of
operations. Under the terms of the Agreement we also agreed to designate our
remaining approximately 14 employees of the PC business to provide unspecified
services to Sonic to create improvements, R&D information, and computer software
(collectively, the "Services") through December 31, 2002. We will provide the
Services for May through August 2002 as part of the base license agreement
without additional charge to Sonic. If Sonic wishes to maintain the Services
agreement through December 31, 2002, then Sonic will pay Axeda $422,777, which
approximates our cost, for the Services provided from August to December 31,
2002, pro rated to the date of termination of the Services. The Services fees
will be recognized on a straight-line basis as services revenues as Sonic
utilizes the Services from August to December 2002 and are payable semi-monthly
in arrears on the 15th and 30th of each month beginning August 2002.
Because we did not have vendor-specific evidence of fair value for each of the
elements of this license arrangement (note 1e), and because we are providing
Services to Sonic after the initial delivery of the licensed IP, we are
recognizing the $2 million license fee on a straight-line basis over seven
months, which is the period that we have agreed to provide the Services. For the
three and six months ended June 30, 2002 we have recognized approximately
$286,000 of license revenues under this arrangement. Except for the amortization
of the license fee and the Services fees described above, we do not expect to
record material revenues related to our PC business subsequent to June 30, 2002.
Revenues and gross profit for our PC business for the six months ended June 30,
2002 were approximately $2.2 million and $0.9 million, respectively. Revenues
and gross profit for our PC business for the six months ended June 30, 2001 were
approximately $3.1 million and $2.1 million, respectively. Approximately
$166,000 of the net book value of the Equipment was charged to expense and is
included in special charges in the accompanying statements of operations. The
remaining net book value of the Equipment of $165,000, which is attributed to
Equipment that will continue to be utilized by our employees who have not been
offered and who have not accepted employment offers from Sonic prior to December
31 2002, will be amortized over the seven-month term of the Services.
30
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
In May 2002 we vacated our offices in San Jose, California, and in July 2002 we
terminated our lease for this facility as part of our strategy to exit the PC
business. The original term of the lease ended in March 2005 and, as of June 30,
2002, would have required minimum lease payments totaling $779,000 plus
operating expenses of approximately $264,000. We paid approximately $135,000,
including $64,000 held by the lessor as security from the inception of the
lease, in July 2002 to the lessor as an inducement to cancel the lease. We also
paid $210,000 in cash in July 2002 and, for nominal consideration, sold
furniture, computer equipment and leasehold improvements to the new lessee as
incentives to the new lessee to enter into a lease for the premises with the
lessor. The total cash payments of $345,000, including the foregone security
deposit, and the net book value of the assets sold of $168,000 are included in
special charges in the accompanying statements of operations.
The quarter ending June 30, 2002 marked the second period in which we reported a
full quarter's activity of Axeda Systems, Ltd. (formerly eMation, Ltd.
("eMation"), a private company organized under the laws of the State of Israel,
which we acquired on December 7, 2001. The acquisition provided us with an
immediate entry into the enterprise software and services market. We now provide
a new category of enterprise software products called Device Relationship
Management ("DRM"), which allows companies to utilize the Internet or wireless
communications to access and exploit hidden information within remote machines,
devices and facilities. For the three months ended June 30, 2002 revenues from
our DRM business were approximately $2.2 million or 62% of our total revenues
for the quarter. Excluding non-cash software amortization, gross profit for the
DRM business was approximately $1.0 million or 45% of our total DRM revenues.
Over the course of 2001 we completed several transactions transforming our
product offerings and shifting the markets in which we compete. Prior to March
2001, we designed, developed, licensed and marketed innovative modular software
solutions that enabled digital video and audio stream management in PC systems,
CE devices and Internet appliances. We also licensed supporting hardware designs
to select customers, provided customization services and customer support. In
addition, we also sold Internet appliances and components to telecommunications
companies, Internet service providers and others. Our product offerings included
a software or hardware Internet set-top box solution, which included all of the
intellectual property, software, hardware design and manufacturing design
necessary for a manufacturer or Internet service provider to launch an
affordable product and Nucleo, a hardware reference design based on our ARM-7500
processors with e-SurferTM - a thin customizable browser designed specifically
for Internet appliances.
During the first quarter of 2001 we sold substantially all of the assets of our
consumer electronics ("CE") and Internet appliance ("IA") businesses and in the
process raised approximately $73.6 million, enabling us to pursue other
strategic alternatives. Effective as of March 1, 2001, pursuant to an asset
acquisition agreement dated as of January 18, 2001, along with our subsidiaries,
Ravisent I.P., Inc., Ravisent Operating Company, Inc. and VIONA Development Hard
and Software Engineering GmbH & Co. KG, we sold and licensed substantially all
of our assets related to our CE business to STMicroelectronics, NV, a Dutch
corporation, STMicroelectronics, Inc., a Delaware corporation, and
STMicroelectronics GmbH (collectively, STMicroelectronics). The assets sold and
licensed included contracts, equipment, intangible assets, intellectual
property, prepaid expenses, accounts receivable and other assets primarily
related to the operation of the CE business. In addition, approximately 76 of
our employees, most of whom were associated with our CE business, accepted
employment with STMicroelectronics in connection with the asset sale. Pursuant
to the terms of the asset acquisition agreement, STMicroelectronics paid
approximately $55.6 million in cash consideration, of which $0.7 million is
being held by a third party in escrow for indemnification purposes until
September 2002. In connection with the asset sale, we granted to
STMicroelectronics certain non-exclusive rights to license and distribute
certain of our technology used in our IA products and our PC products. In
addition, we agreed not to compete in significant aspects of the CE market until
March 1, 2006. Revenues and gross margin for the CE business totaled
approximately $0.4 million, or 12% of total revenues, and $0.3 million, or 14%
of total gross profit, respectively, for the six months ended June 30, 2001.
These amounts are not necessarily indicative of the results that would have been
obtained for any future period.
31
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Effective as of March 23, 2001, pursuant to an asset acquisition agreement dated
as of March 21, 2001, along with certain of our subsidiaries, we sold
substantially all of the assets, excluding inventory, related to our IA business
to Phoenix Technologies Ltd., a Delaware corporation, for $18 million in cash
consideration, of which $1.8 million was being held in escrow by a third party
for indemnification purposes until March 2002. In March 2002 we received $1.3
million, including interest of approximately $0.05 million. The remaining
balance of approximately $0.55 million has been withheld pending the settlement
of a claim submitted by Phoenix. In June 2002 we initiated an arbitration
proceeding with the International Chamber of Commerce (No. 12 203/JNK) seeking
an order that the entire $550,000 be disbursed to Axeda. Phoenix has not yet
filed an answer or counterclaim, and no hearing date has yet been set. We are
unable to predict the resolution of this matters, or reasonably estimate a range
of possible loss given the current status of this matter. Any escrow amounts not
returned to us will be recorded as a charge to the gain on sale of assets in the
period in which such determination is made. The assets sold included certain of
the contracts, equipment, intangible assets, intellectual property, prepaid
expenses and other assets primarily related to the operation of the IA business.
Under the asset acquisition agreement, Phoenix Technologies purchased our
e-Surfer embedded software Internet browser and related hardware designs for the
IA market. In addition, in connection with this asset sale, 13 of our employees
associated with the IA business accepted employment with Phoenix Technologies.
Revenues and gross margin for the IA business totaled approximately $0.3
million, or 8% of total revenues, and less than $0.1 million, or 2% of total
gross profit excluding software amortization for the six months ended June 30,
2002. Revenues and gross margin for the IA business totaled approximately $0.08
million, or 9% of total revenues, and $0.02 million, or 7% of total gross profit
excluding inventory charges for the quarter ended June 30, 2001. These amounts
are not necessarily indicative of the results that would have been obtained for
any future period. [In the future, any revenue and gross margins, from this
business are expected to be nominal as inventory is either sold in the open
market or scrapped.
On December 7, 2001, we acquired all of the outstanding shares of eMation, Ltd.
("eMation"), pursuant to a share purchase agreement amended and restated as of
October 5, 2001, in consideration for: 8 million shares of our common stock;
options exercisable for up to 1,428,710 shares of our common stock in connection
with assumed eMation stock options, 530,000 of which are exercisable for $0.01
per share and the remaining 898,710 exercisable at $2.14 per share; options
exercisable at $2.14 for up to 113,600 shares of our common stock issued at
closing pursuant to our 1999 Stock Incentive Plan; and warrants exercisable for
up to 7,000 shares of our common stock exercisable at $2.14 issued to
ex-employees of eMation in consideration for cancellation of outstanding options
to purchase shares of eMation. We also issued warrants at closing exercisable
for up to 108,238 shares of our common stock with exercise prices ranging from
$4.88 to $21.51 per share to holders of warrants exercisable for shares of
eMation. The total combined value of the securities assumed and issued was
approximately $20 million. Pursuant to the lock-up agreement executed by each
selling eMation shareholder, each shareholder agreed not to directly or
indirectly transfer any shares or rights relating to the shares of Axeda common
stock received pursuant to the share purchase agreement until the one year
anniversary of the closing, subject to certain exceptions. Axeda common stock
issued and to be issued to the selling eMation shareholders will not be
registered at the time of issuance.
The acquisition was recorded under the purchase method of accounting. We
incurred transaction costs of approximately $3.4 million related to the eMation
acquisition and assumed approximately $5 million of eMation net debt. Prior to
the acquisition, we loaned a total of $4.3 million to eMation for working
capital purposes. We also paid sign-on bonuses of $0.3 million to three of
eMation's executives. In connection with the acquisition, we expensed $3.1
million of the purchase price as acquired in-process research and development
("IPR&D") and recorded identifiable intangible assets and goodwill of
approximately $9.7 million and $20.8 million, respectively. In accordance with
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets" ("SFAS 142"), certain provisions of which were adopted
in 2001 and the remaining provisions on January 1, 2002, we no longer amortize
goodwill, but instead test it for impairment at least annually and at the same
time every year.
32
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
An aggregate of 1.6 million shares of our common stock issued in the eMation
acquisition has been deposited with a third party escrow agent to be held in
escrow to compensate us for certain losses and taxes that may arise as a result
of the eMation acquisition. The shareholders' agent appointed pursuant to the
share purchase agreement agreed to us submitting a claim on the escrow fund for
the return of 23,843 shares of our common stock in consideration for our
issuance of certain warrants at the closing. This escrow arrangement will expire
on December 7, 2002 and any shares remaining in escrow will be returned to
former eMation shareholders.
We believe that comparing different periods of our operating results is not
meaningful and you should not rely on the results for any previous period as an
indication of our future performance because our business model has changed
significantly since the sale of assets as described above and has further
changed with the acquisition of eMation in December 2001 and the license to
Sonic in May 2002. We expect our future license and services and maintenance
revenues to be increasingly driven by our DRM products and services. We acquired
eMation, founded in 1988, in December 2001. eMation historically derived its
main source of revenue from its industrial automation products, which are now
component sof our DRM system. While we continue to sell the components of the
DRM system, such as the Axeda Supervisor, Axeda @aGlance/IT and Axeda
FactorySoft OPC, to support our traditional industrial automation business. We
expect that sales of these product will decrease in the future as we devote most
of our resources to the development and support of our DRM system.
In the quarter ending June 30, 2002, two customers ATi Technologies Inc. and
Sonic Solutions accounted for 15% and 9%, respectively, of our total revenues
and 19% and, 19%, respectively, of our total gross profit excluding software
amortization. As we continue to shift our strategic focus to our recently
acquired DRM business, we expect early adopters of the DRM technology to
significantly influence our revenue results.
DRM
Since December 7, 2001, our main strategic focus has been the enterprise
software and services market. Our revenue recognition policy with respect to DRM
related licenses, maintenance agreements and services arrangements will remain
consistent with our current practice. Thus far, our DRM licensing arrangements
have consisted of up-front license fees accompanied by maintenance fees at a
fixed percentage with renewable annual amounts. To date we have not sold our DRM
license fees individually and therefore do not have vendor-specific objective
evidence of fair value ("VSOE") for this element. However, when offered with our
DRM maintenance, which we sell at a fixed percentage on an annual renewable
basis, we apply the provisions of Statement of Position 98-9, "Modification of
SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions."
Under this method, revenue is allocated to each delivered element using the
residual method based upon the fair value of the undelivered elements, which in
our case is the deferred maintenance. Revenues from license fees also consist of
fees paid on a per-unit basis for certain DRM products. In cases where we sell
our DRM products on a per-unit basis, revenues are recognized when the product
ships to an original equipment manufacturer ("OEM") or distributor. Services and
maintenance revenues consist of maintenance and support agreements, consulting
fees, and training. Prepaid maintenance fees are initially deferred and
recognized on a ratable basis over the one-year maintenance period. Services
revenues are recognized on a time and material basis.
33
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Results of Operations
Three Months Ended June 30, 2002 Compared to Three Months Ended June 30, 2001.
The following table sets forth, for the periods indicated, the amount and
percentage of total revenues represented by certain items reflected in our
consolidated statements of operations:
Axeda Systems Inc.
Unaudited Consolidated Statements of Operations Data
(Amounts in thousands)
Three Months Ended June 30,
------------------------------------------------------
2002 2001
----------------------- ---------------------------
Percentage of Percentage of
Amount Revenues Amount Revenues
------ -------- ------ --------
Revenues:
License ...................................... $ 2,578 72.8% $ 673 84.8%
Services and maintenance ..................... 674 19.0 -- --
Hardware ..................................... 291 8.2 121 15.2
--- --- --- ----
Total revenues ............................. 3,543 100.0 794 100.0
----- ----- --- -----
Cost of revenues:
License ...................................... 782 22.1 432 54.4
Services and maintenance ..................... 990 27.9 -- --
Hardware ..................................... 243 6.9 104 13.1
Software amortization ........................ 525 14.8 -- --
Inventory charges ............................ -- -- 13,420 1,690.2
----- ----- ----- -------
Total cost of revenues ..................... 2,540 71.7 13,956 1,757.7
----- ----- ------ -------
Gross profit .................................... 1,003 28.3 (13,162) (1,657.7)
Research and development
Non-cash compensation ....................... 34 1.0 116 14.6
Other research and development expense ...... 2,090 59.0 999 125.8
Sales and marketing
Non-cash compensation ....................... 19 0.5 -- --
Other selling and marketing expense ......... 4,990 140.8 842 106.1
General and administrative
Non-cash compensation ....................... 239 6.8 48 6.0
Other general and administrative expense .... 3,076 86.8 1,588 200.0
Provision for doubtful accounts ............. (67) (1.9) 658 82.9
Depreciation and amortization ................... 330 9.3 389 49.0
Special charges ................................. 820 23.1 -- --
----- ----- --- -----
Operating loss .................................. (10,528) (297.1) (17,802) (2,242.1)
Losses on sales of assets ....................... 37 1.0 -- --
Interest (income) expense, net and other (income)
expense, net ................................... (90) (2.5) (681) (85.8)
----- ----- ----- -----
Loss before income tax benefit .................. (10,475) (295.6) (17,121) (2,156.3)
Income tax benefit .............................. -- -- (1,171) (147.5)
----- ----- ------- -------
Net loss ........................................ $(10,475) (295.6)% $(15,950) (2,008.8)%
======== ====== ======== ===========
34
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Revenues. Total revenues increased by 346%, or $2.7 million, from $0.8 million
in the quarter ending June 30, 2001 to $3.5 million during the quarter ending
June 30, 2002. Sales from our DRM systems added $2.2 million while sales from
our PC licenses and Internet Appliance hardware added approximately $0.4 and
$0.2 million, respectively, to our total revenues in the quarter ended June 30,
2002. Revenues from license, services and maintenance and hardware increased
approximately $1.9 million, $0.7 million, and $0.2 million, respectively, from
the prior year. The overall increase in revenues was due to the addition of our
DRM solutions, resulting from our acquisition of eMation in December 2001, of
$2.2 million and increased sales relating to our PC business of $0.4 million.
License revenues increased by approximately $1.9 million from $0.7 million for
the quarter ended June 30, 2001 to $2.6 million for the quarter ended June 30,
2002. The increase was mainly attributable to the addition of sales of DRM
products of $ 1.5 million and increased PC licenses of $0.4 million. The
increase in PC revenues is attributable to increased sales of our PC products to
a PC graphics component manufacturer of $0.5 million. We have licensed our
CineMaster DVD product ("CineMaster") to such PC graphics component manufacturer
on a per-unit basis since October 1, 2001 (see "Critical Accounting Policies").
The per-unit license fee sales price of CineMaster to the customer now includes
the cost of Dolby technologies licensed by us from Dolby. In April 2002, we
received a royalty report from the customer detailing the customer's sales of
CineMaster from January to March 2002 and the related amount of licensing fees
due, which includes the license fees for Dolby. Under the agreement with the
customer, the amount due from the customer for the Dolby royalties is equal to
our cost. Since we are obligated to collect and remit royalties to Dolby for
sales of our products incorporating Dolby technologies, our revenues
attributable to this customer now include the total sales price for the DVD
product sold to the customer, including the amount attributable to technologies
licensed by us from Dolby. The related cost of revenues includes the cost of the
Dolby royalties. As a result, there is no margin on the Dolby invoicing under
this arrangement for the three months ended June 30, 2002. Such amounts included
in license revenues and cost of license revenues totaled approximately $ 0.5
million for the quarter ended June 30, 2002. In addition, the increase in PC
revenues resulted from new revenues associated with the Agreement with Sonic of
$0.3 million and increased sales of DVD products from our Internet web site of
$0.1 million. The increases in PC sales were offset by a decrease of $0.6
million attributable to weak demand for PC-related products resulting in lower
sales volumes and increased competition resulting in lower per unit selling
prices in the PC DVD market. We also canceled or assigned all of our customer
contracts connected with the PC business effective with the Agreement with
Sonic, which resulted in a loss of any revenues from our PC business for the
month of June 2002 and all periods thereafter. In the future we expect license
revenues to increase as software solutions related to our DRM system products
contribute to this revenue stream.
Hardware revenues increased by approximately $0.2 million for the quarter ended
June 30, 2002 from $0.1 million for the quarter ended June 30, 2001 due to
increased sales of components related to Internet appliances and Internet
set-top boxes. We expect hardware revenues and related gross profit to be
minimal as we continue to dispose of our current inventories.
Services and maintenance revenues increased to $0.7 million for the quarter
ended June 30, 2002 and was attributable to services and maintenance plans sold
with our DRM system products, which contributed $0.7 million during the quarter
ended June 30, 2002.
Historically, the majority of our revenues have been derived from a small number
of customers. However, during the quarter ended June 30, 2002, our top two
customers comprised of a PC graphics component manufacturer and a supplier of
authoring systems for digital media production, accounted for $0.8 million or
24% of our total revenues. No other customer accounted for more than 5% of our
total revenues. In the quarter ended June 30, 2001, two customers accounted
for 50% of our total revenues. In the future, we expect our revenues to be less
concentrated as sales of our enterprise software and services span a wider
customer base and we expect customers of our DRM solutions to increase our
revenues.
35
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
We sell our DRM system solutions to Global 2000 companies in the industrial and
building automation, high technology devices, medical instrumentation,
semiconductor equipment, and office automation industries. In the three and six
months ended June 30, 2002 companies based in North America accounted for 50%
and 55%, respectively, of our total revenues. In the future we expect the
majority of our revenues to be derived from companies based in North America.
Cost of Revenues. Cost of revenues decreased $11.4 million or 82% from $14
million for the quarter ended June 30, 2001 to $2.5 million for the quarter
ended June 30, 2002. The decrease was a result of a $13.4 million inventory
charge recorded during the quarter ended June 30, 2001, offset by increases
relating to our license, services and maintenance and hardware revenues of
approximately $0.4 million, $1.0 million, and $0.1 million, respectively, from
the prior year. In addition, we are amortizing developed and core technologies,
acquired in the eMation acquisition, which added $0.5 million to our cost of
revenues for the quarter, ended June 30, 2002.
The $0.4 million increase in cost of license revenues over the prior year is due
to an additional $0.3 million in costs associated with our DRM solution and a
slight increase in our PC cost of licenses. The net increase in our PC cost of
license revenues was due to the new license arrangement we have with a PC
graphics component manufacturer, as previously described (see "Revenues,"
above), and increases in Dolby royalty rates due to reduced sales of products
incorporating Dolby, offset by decreases in Dolby fees in total, attributable to
lower sales of our PC products. The increase of $0.1 million in cost of hardware
revenues corresponds directly to the increase in our hardware sales. The $1.0
million increase in cost of services and maintenance is attributable to the $0.9
million increase from our DRM system services and maintenance plans for the
quarter ended June 30, 2002 and $0.1 million relating to our PC business. We
expect our cost of revenues related to licenses as a percentage of license
revenues to decrease in the future as our license revenues shift more to our DRM
products. The addition of non-cash amortization of acquired technology will
partially offset this future decrease in cost of revenues as a percentage of
total revenues, and will represent approximately $2.1 million of our cost of
revenues for the year ending December 31, 2002.
Gross Profit. Excluding the $13.4 million charge for inventory recorded in June
30, 2001 and the $0.5 million software amortization expense recorded in June 30,
2002, gross profit increased by approximately $1.2 million, or 492%, from 0.3
million for the quarter ended June 30, 2001 to $1.5 million for the quarter
ended June 30, 2002. The increase is directly attributable to increases in
license revenues associated with our DRM Systems sales.
For the quarter ended June 30, 2002, 73% of our total revenues were derived from
licenses, and 19% from services and maintenance, in comparison to 85% and 0%,
respectively, in 2001. Historically the gross profit percentage from license
revenues and services revenues is higher than that from hardware sales. As a
percentage of total revenues, gross profit, excluding the charges recorded for
inventory and software amortization, increased from 33% for the quarter ended
June 30, 2001 to 43% for the quarter ended June 30, 2002, due to a more
favorable product mix. Gross profit from our DRM products, excluding non-cash
software amortization, for the quarter ending June 30, 2002 was 45%.
Research and Development Expense. Other research and development expenses
consist of staff, staff-related, professional and other development related
support costs associated with the development of new products, customization of
existing products for customers, quality assurance and testing. Research and
development expenses increased 109%, from $1.0 million for the quarter ended
June 30, 2001 to $2.1 million for the quarter ended June 30, 2002.
The increase in research and development expenses was due the addition of staff
expenses related to the DRM development team of approximately $1.6 million
partially offset by $0.5 million in reductions in the PC development team and
related professional fees. As a percentage of total revenues, other research and
development expenses decreased from 126% to 59%. The decrease in research and
development expenses as a percentage of total revenues resulted from higher
revenues. We expect research and development expenses to increase in 2002,
compared to 2001, as we continue to invest in product development for our
enterprise software and services offerings.
Non-cash Compensation Research and Development Expense. Non-cash research and
development expense consists of compensation related to stock options. Non-cash
research and development expense decreased 71% from $0.11 million for the
quarter ended June 30, 2001 to $0.03 million for the quarter ended June 30,
2002. The decrease of $0.08 million from the prior year is mainly due to the
immediate recognition in March 2001 of prepaid and deferred stock compensation,
that would have continued to vest through September 2003, related to reductions
in staffing in connection with the closing of our Vancouver office in March
2001. No similar expense was recorded in the second quarter of 2002.
36
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Sales and Marketing Expense. Other selling and marketing expenses consist of
salaries, travel expenses and costs associated with trade shows, advertising and
other marketing efforts, as well as technical support costs. Sales and marketing
expenses increased approximately $4.1 million or 493% from $0.8 million for the
quarter ended June 30, 2001 to $5.0 million for the quarter ended June 30, 2002.
The increase in sales and marketing expense is attributable to the inclusion of
the eMation sales and marketing team and the addition of our new professional
services group, which contributed $3.6 and $1.3 million, respectively, to the
increase for the quarter ended June 30, 2002. Partially offsetting this increase
was a $0.8 million reduction in expense relating to the PC sales and marketing
teams. As a percentage of total revenues, sales and marketing expenses increased
from 106% to 141%. We expect sales and marketing expenses to increase in 2002,
compared to 2001, as we continue to invest in our sales force for our enterprise
software and services offerings.
Other General and Administrative Expense. Other general and administrative
expenses consist of staff, staff related, and support costs for our finance,
human resources, information systems and other management departments. Other
general and administrative expenses increased $1.5 million or 94% from $1.6
million for the quarter ended June 30, 2001 to $3.1 million for the quarter
ended June 30, 2002. As a percentage of total revenues, other general and
administrative expenses decreased from 200% to 87% of total revenues due to the
proportionally larger increase in total revenues.
The increase in other general and administrative expenses was due to the
addition of the eMation general and administrative function, which contributed
$0.8 million to the increase, estimated patent and intellectual property
accruals of $0.4 million, and $0.3 million in non-capitalizable professional
fees associated with the acquisition of eMation and our corporate identity. We
expect total general and administrative expenses for 2002 to approximate the
total 2001 amount, as we focus on our infrastructure needs and reduce
unnecessary overhead expenses.
Non-cash Compensation General and Administrative Expense. Non-cash general and
administrative expense consists of amortization of compensation related to stock
options. Non-cash general and administrative expense increased from $0.0 million
for the quarter ended June 30, 2001 to $0.2 million for the quarter ended June
30, 2002. The $0.2 increase is attributable to amortization of deferred
compensation recorded in connection with stock options granted to employees
between July and December 2001 at less than fair market value. No similar
expense was recorded in the second quarter of 2001.
Provision for Doubtful Accounts. The provision for doubtful accounts represents
management's best estimate of the doubtful accounts for each period. During the
quarter ended June 30, 2002 we recovered approximately $0.1 million of
previously reserved accounts resulting in a reversal of this expense. In the
future we expect this expense to vary slightly as a result of improved credit
and collection efforts and increased revenues.
Depreciation and Amortization. We recorded depreciation and amortization of $0.3
million for the quarter ended June 30, 2002, compared to $0.4 million for the
quarter ended June 30, 2001. Reduced amortization expense of $0.2 million
resulting from the impairment of our Cinax goodwill in December 2001 was
partially offset by additional depreciation expense of $0.2 million resulting
from the eMation acquisition. On a quarterly basis, we expect depreciation and
amortization expense to be approximately the same for the balance of the year
ended December 31, 2002.
37
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Under SFAS No. 142, goodwill acquired in a business combination after June 30,
2001 is no longer amortized. The provisions of SFAS No. 142 require that
goodwill be tested for impairment on an annual basis at the same time every
year. Accordingly, we have not recorded amortization expense in 2002 for
goodwill of approximately $20.8 million acquired in our purchase of eMation in
December 2001. Intangible assets acquired in a business combination and
recognized as an asset apart from goodwill must arise from contractual or other
legal rights or otherwise are separable. Under SFAS No. 142, recognized
intangible assets with finite useful lives are amortized over the period which
the assets are expected to contribute directly or indirectly to the our future
cash flows. We recorded identified intangible assets totaling approximately $9.7
million in connection with our purchase of eMation, comprised of developed and
core technologies of approximately $1.4 million and $7.0 million, respectively,
patent applications of approximately $1.0 million and customer base of
approximately $0.3 million. The developed and core technologies are being
amortized over their estimated useful lives of 2 and 5 years, respectively, and
are recorded as cost of revenues, which totaled $0.5 million for the quarter
ended June 30, 2002. The patent applications and customer base are being
amortized over their estimated useful lives of 5 years and are included with
operating expenses, which totaled approximately $0.1 million for the quarter
ended June 30, 2002.
Special Charges. Special charges for the three months ended June 30, 2002
consist of items related to our exit from the PC business in May 2002. The
charges include $0.3 million for furniture and equipment and employee
inducements related to our license agreement with Sonic Solutions and lease
termination costs and inducements totaling approximately $0.5 million, including
$0.2 million for furniture and equipment, for our San Jose facility.
Interest (Income) and Expense, net and Other, net. Net interest income decreased
by $0.6 million, or 87%, for the quarter ended June 30, 2002 compared to the
comparable period in 2001. The decrease is the result of lower average cash
balances and lower bank interest rates in 2002.
38
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Results of Operations
Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001.
The following table sets forth, for the periods indicated, the amount and
percentage of total revenues represented by certain items reflected in our
consolidated statements of operations:
Axeda Systems Inc.
Unaudited Consolidated Statements of Operations Data
(Amounts in thousands)
Six Months Ended June 30,
------------------------------------------------------
2002 2001
------------------------- ----------------------------
Percentage of Percentage of
Amount Revenues Amount Revenues
------ -------- ------ --------
Revenues:
License ...................................... $ 5,618 68.6% $ 3,036 84.1%
Services and maintenance ..................... 1,217 14.9 407 11.3
Hardware ..................................... 1,348 16.5 167 4.6
----- ---- --- ---
Total revenues ............................. 8,183 100.0 3,610 100.0
----- ----- ----- -----
Cost of revenues:
License ...................................... 1,817 22.2 955 26.5
Services and maintenance ..................... 1,707 20.8 94 2.6
Hardware ..................................... 1,252 15.3 141 3.9
Software amortization ........................ 1,054 12.9 -- --
Inventory charges ............................ -- -- 13,420 371.7
----- ----- ------ -----
Total cost of revenues ..................... 5,830 71.2 14,610 404.7
----- ---- ------ -----
Gross profit .................................... 2,353 28.8 (11,000) (304.7)
Research and development
Non-cash compensation ....................... 98 1.2 1,854 51.4
Other research and development expense ...... 4,322 52.8 3,406 94.3
Sales and marketing
Non-cash compensation ....................... 38 0.5 69 1.9
Other selling and marketing expense ......... 9,792 119.7 4,334 120.1
General and administrative
Non-cash compensation ....................... 1,099 13.4 112 3.1
Other general and administrative expense .... 6,094 74.5 3,877 107.4
Provision for doubtful accounts ............. (22) (0.2) 784 21.7
Depreciation and amortization ................... 640 7.8 2,055 56.9
Special charges ................................. 820 10.0 -- --
----- ---- ------ -----
Operating loss .................................. (20,528) (250.9) (27,491) (761.5)
(Gains) losses on sales of assets ............... 37 0.5 (52,037) (1,441.5)
Interest (income) expense, net and other (income)
expense, net ................................... (310) (3.8) (1,047) (29.0)
---- ---- ------ -----
Income (loss) before provision for income taxes
(benefit) ...................................... (20,255) (247.6) 25,593 709.0
Provision for income taxes (benefit) ............ (668) (8.2) 1,808 50.1
---- ---- ----- ----
Net income (loss) ............................... $(19,587) (239.4)% $ 23,785 658.9%
======== ====== ======== =====
39
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Revenues. Total revenues increased by 127%, or $4.6 million, from $3.6 million
in the six months ended ending June 30, 2001 to $8.2 million during the six
months ending June 30, 2002. Sales from our DRM systems and Internet appliance
inventories added $4.7 million and $1.2 million, respectively, to our total
revenues in the six months ended June 30, 2002 and were partially offset by
decreases of $0.9 million and $0.4 million in our PC and CE businesses,
respectively, over the prior year. Revenues across our license, services and
maintenance and hardware streams increased $2.6 million, $0.8 million, and $1.2
million, respectively, from the prior year. The overall increase in revenues was
due to the inclusion of our DRM solutions for the current quarter and increased
sales of our inventories.
License revenues increased by approximately $ 2.6 million from $3.0 million for
the six months ended June 30, 2001 to $5.6 million for the six months ended June
30, 2002. The increase was mainly attributable to the addition of sales of DRM
products of $3.5 million offset by a decrease in PC revenues of $0.9 million.
The $0.9 million net decrease in PC revenues was mainly attributable to the loss
of a significant licensing customer from the prior year offset by increases in
our former web-based sales of PC products. Additionally, revenue decreases in
several OEMs have been offset by an increase in revenues to a PC graphics
component manufacturer. We have licensed our CineMaster DVD product
("CineMaster") to such PC graphics component manufacturer on a per-unit basis
since October 1, 2001 (see "Critical Accounting Policies"). The per-unit sales
price of CineMaster to the customer now includes the cost of Dolby technologies
licensed by us from Dolby. The new agreement provided for a royalty-free license
for CineMaster, but not Dolby, for the quarter ended December 31, 2001. In 2002,
we received two royalty reports from the customer detailing the customer's sales
of CineMaster from October to March 2002 and the related amount of Dolby
licensing fees due. Under the agreement with the customer, the amount due from
the customer for the Dolby royalties is equal to our cost. Since we are
obligated to collect and remit royalties to Dolby for sales of our products
incorporating Dolby technologies, our revenues attributable to this customer now
include the total sales price for the DVD product sold to the customer,
including the amount attributable to technologies licensed by us from Dolby. The
related cost of revenues includes the cost of the Dolby royalties. As a result,
there is no margin on the Dolby invoicing under this arrangement for the six
months ended June 30, 2002. Such amounts included in license revenues and cost
of license revenues totaled approximately $1.1 million for the six months ended
June 30, 2002. In the future we expect license revenues to increase as software
solutions related to our DRM system products contribute to this revenue stream.
Hardware revenues increased by approximately $1.2 million for the six months
ended June 30, 2002 from $0.2 million for the six months ended June 30, 2001 due
to increased sales of components related to Internet appliances, and, to a
lesser extent, Internet set-top boxes. We expect hardware revenues and related
gross profit to be minimal as we continue to dispose of our current inventories.
Services and maintenance revenues increased 199% from $0.4 million for the six
months ended June 30, 2001 to $1.2 million for the six months ended June 30,
2002. The increase was attributable to services and maintenance plans sold with
our DRM system products, which contributed $1.2 million during the six months
ended June 30, 2002, offset by a decrease in services of $0.4 million associated
with our former CE business, which was sold to STMicroelectronics in March 2001.
Historically, the majority of our revenues have been derived from a small number
of customers. For the six months ended June 30, 2002, our top three customers,
comprised of a PC, IA, and DRM customer, who are a PC graphics component
manufacturer, a materials broker, anda producer of control systems and building
management systems, respectively, accounted for $2.2 million or 26% of our total
revenues. In the six months ended June 30, 2001, two customers accounted for 55%
of our total revenues. In the future, we expect our revenues to be less
concentrated as sales of our enterprise software and services span a wider
customer base and we expect customers of our DRM solutions to increase our
revenues.
40
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
We sell our DRM system solutions to Global 2000 companies in the industrial and
building automation, high technology devices, medical instrumentation,
semiconductor equipment, and office automation industries. In the six months
ended June 30, 2002 companies based in North America accounted for 55% of our
revenues. In the future we expect a greater portion of our revenues to be
derived outside of North America.
Cost of Revenues. Cost of revenues decreased $8.8 million or 60% from $14.6
million for the six months ended June 30, 2001 to $5.8 million for the six
months ended June 30, 2002. The decrease was a result of a $13.4 million
inventory charge recorded during the quarter ended June 30, 2001, partially
offset by increases relating to our license, services and maintenance and
hardware of approximately $0.9 million, $ 1.6 million, and $ 1.1 million,
respectively, from the prior year. In addition, we are amortizing developed and
core technologies, acquired in the eMation acquisition, which added $1.0 million
to our cost of revenues for the six months ended June 30, 2002.
The $0.9 million increase in cost of license revenues over the prior year is due
to an additional $0.6 million in costs associated with our DRM solution and a
net increase of $0.3 million for our PC products. The net increase in our PC
cost of license revenues was due to the new license arrangement we have with a
PC graphics component manufacturer, as previously described (see "Revenues,"
above), and increases in Dolby royalty rates due to reduced sales of products
incorporating Dolby, offset by decreases in Dolby fees in total, attributable to
lower sales of our PC products. The increase of $1.1 million in cost of hardware
revenues corresponds directly to the increase in our hardware sales. The $1.6
million increase in cost of services and maintenance is attributable to the $1.6
million increase from our DRM system services and maintenance plans and $0.1
increase in services related to our PC business offset by a $0.1 million
decrease in services related to our former CE business. We expect our cost of
revenues related to licenses as a percentage of license revenues to decrease in
the future as our license revenues shift more to our DRM products. The addition
of non-cash amortization of acquired technology will partially offset this
future decrease in cost of revenues as a percentage of total revenues, and will
represent approximately $2.1 million of our cost of revenues for the year ending
December 31, 2002.
41
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Gross Profit. Excluding the $13.4 million charge for inventory recorded in June
30, 2001 and the $1.0 million software amortization expense recorded in the six
months ended June 30, 2002, gross profit increased by $1.0 million, or 41%, from
2.4 million for the six months ended June 30, 2001 to $3.4 million for the six
months ended June 30, 2002. The increase is directly attributable increases in
license revenues associated with our DRM Systems sales.
For the six months ended June 30, 2002, 69% of our total revenues were derived
from licenses, and 15% from services and maintenance, in comparison to 84% and
11%, respectively, in 2001. Historically the gross profit percentage from
license revenues and services revenues is higher than that from hardware sales.
As a percentage of total revenues, gross profit, excluding the charges recorded
for inventory and software amortization, decreased from 67% for the six months
ended June 30, 2001 to 42% for the six months ended June 30, 2002, due to
negative gross profit from our services and maintenance operations due to our
expansion of these operations in the first quarter of 2002 and the large number
of non-billable proofs of concepts delivered to prospective customers during the
quarter, the sale of the assets of our CE business in March 2001 and a less
favorable mix of licensing products in our PC business. Excluding the
significant PC customer from the prior year, gross profit for the six months
ended June 30, 2001 would have been 50%.
Research and Development Expense. Other research and development expenses
consist of staff, staff-related, professional and other development related
support costs associated with the development of new products, customization of
existing products for customers, quality assurance and testing. Research and
development expenses increased 27%, from $3.4 million for the six months ended
June 30, 2001 to $4.3 million for the six months ended June 30, 2002.
The increase in research and development expenses was due to the addition of
staff expenses related to the DRM development team of approximately $3.1 million
partially offset by $0.7 million from the PC development team and related
professional fees. In addition decreases due to the elimination of the CE and IA
development teams in the first quarter of 2001, contributed approximately $0.7
million and $0.8 million to the decrease as well. As a percentage of total
revenues, other research and development expenses decreased from 94% to 53%. The
decrease in research and development expenses as a percentage of total revenues
resulted from higher revenues. We expect research and development expenses to
increase in 2002, compared to 2001, as we continue to invest in product
development for our enterprise software and services offerings.
Non-cash Compensation Research and Development Expense. Non-cash research and
development expense consists of compensation related to stock options. Non-cash
research and development expense decreased 95% from $1.9 million for the six
months ended June 30, 2001 to $0.1 million for the six months ended June 30,
2002. $1.8 million of the decrease is due to the immediate recognition in March
2001 of prepaid and deferred stock compensation, that would have continued to
vest through September 2003, related to reductions in staffing in connection
with the closing of our Vancouver office in March 2001. The remaining $0.1
million is the result of amortization of deferred compensation recorded in 2001
in connection with stock options granted to employees in September 2000. No
similar expenses were recorded in the second quarter of 2002.
Sales and Marketing Expense. Other selling and marketing expenses consist of
salaries, travel expenses and costs associated with trade shows, advertising and
other marketing efforts, as well as technical support costs. Selling and
marketing expenses increased $5.5 million or 126% from $4.3 million for the six
months ended June 30, 2001 to $9.8 million for the six months ended June 30,
2002.
42
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
The increase in sales and marketing expense is attributable to the inclusion of
the eMation sales and marketing team and the addition of our new professional
services group, which contributed $6.6 and $2.6 million, respectively, to the
increase for the six months ended June 30, 2002. Partially offsetting this
increase was the elimination of the sales and marketing teams associated with
our CE and IA businesses, which resulted in decreases $0.3 million and $1.0
million, respectively, for the quarter ending June 30, 2002. Decreases of
approximately $1.8 million relating to the settlement of a South American
distribution rights agreement and $0.6 million from reduced staff in the PC
sales teams also partially offset the increase. As a percentage of total
revenues, sales and marketing expenses remained unchanged at 120% of revenue. We
expect sales and marketing expenses to increase in 2002, compared to 2001, as we
continue to invest in our sales force for our enterprise software and services
offerings.
Non-cash Compensation Sales and Marketing Expense. Non-cash sales and marketing
expense consists of compensation related to stock options. Non-cash sales and
marketing expense decreased $0.03 million or 45% to $0.04 million for the six
months ended June 30, 2002. The decrease is the result of amortization of
deferred compensation recorded in connection with stock options granted to
employees in May 2000 at less than fair market value. No similar expense was
recorded in the second quarter of 2002.
Other General and Administrative Expense. Other general and administrative
expenses consist of staff, staff related, and support costs for our finance,
human resources, information systems and other management departments. Other
general and administrative expenses increased $2.2 million or 57% from $3.9
million for the six months ended June 30, 2001 to $6.1 million for the six
months ended June 30, 2002. As a percentage of total revenues, other general and
administrative expenses decreased from 107% to 74% of total revenues due to the
proportionally larger increase in total revenues.
The increase in other general and administrative expenses was mainly due to the
addition of the eMation general and administrative function, which contributed
$1.8 million to the increase, and estimated patent and intellectual property
accruals of $0.4 million. We expect total general and administrative expenses
for 2002 to approximate the total 2001 amount, as we focus on our infrastructure
needs and reduce unnecessary overhead expenses.
Non-cash Compensation General and Administrative Expense. Non-cash general and
administrative expense consists of amortization of compensation related to stock
options. Non-cash general and administrative expense increased from $0.1 million
for the six months ended June 30, 2001 to $1.1 million for the six months ended
June 30, 2002. The increase is attributable to a $0.4 million expense incurred
for the acceleration of option vesting in accordance with certain employment
agreements. In addition, $0.4 million of the increase is the result of
amortization of deferred compensation recorded in connection with stock options
granted to employees at less than fair market value granted between July and
December 2001. The remaining portion of the increase is attributable to a
one-time charge of $0.2 million for the modification of stock options held by a
former employee.
Provision for Doubtful Accounts. The provision for doubtful accounts represents
management's best estimate of the doubtful accounts for each period. During the
six months ended June 30, 2002 we had net recoveries of less than $0.1 million
from previously reserved accounts resulting in a reversal of this expense. In
the future we expect this expense vary slightly as a result of improved credit
and collection efforts and increased revenues.
43
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Depreciation and Amortization. We recorded depreciation and amortization of $0.6
million for the six months ended June 30, 2002, compared to $2.1 million for the
six months ended June 30, 2001. The sales of the assets of our CE and IA
businesses, both of which were sold in March 2001, contributed $1.2 million of
the decrease, while the impairment of our Cinax goodwill in December 2001
accounted for $ 0.6 million of the decrease. Offsetting these decreases was an
increase of approximately $0.3 million attributable to depreciation of assets
and amortization of intangibles acquired in the purchase of eMation. We expect
depreciation and amortization expense to be approximately the same for the
balance of the year ending December 31, 2002.
Under SFAS No. 142, goodwill acquired in a business combination after June 30,
2001 is no longer amortized. The provisions of SFAS No. 142 require that
goodwill be tested for impairment on an annual basis at the same time every
year. Accordingly, we have not recorded amortization expense in 2002 for
goodwill of approximately $20.8 million acquired in our purchase of eMation in
December 2001. Intangible assets acquired in a business combination and
recognized as an asset apart from goodwill must arise from contractual or other
legal rights or otherwise are separable. Under SFAS No. 142, recognized
intangible assets with finite useful lives are amortized over the period which
the assets are expected to contribute directly or indirectly to the our future
cash flows. We recorded identified intangible assets totaling approximately $9.7
million in connection with our purchase of eMation, comprised of developed and
core technologies of approximately $1.4 million and $7.0 million, respectively,
patent applications of approximately $1.0 million and customer base of
approximately $0.3 million. The developed and core technologies are being
amortized over their estimated useful lives of 2 and 5 years, respectively, and
are recorded as cost of revenues, which totaled $1.1 million for the six months
ended June 30, 2002. The patent applications and customer base are being
amortized over their estimated useful lives of 5 years and are included with
operating expenses, which totaled approximately $0.1 million for the six months
ended June 30, 2002.
Special Charges. Special charges for the six months ended June 30, 2002 consist
of items related to our exit from the PC business in May 2002. The charges
include $0.3 million for furniture and equipment and employee inducements
related to our license agreement with Sonic Solutions and lease termination
costs and inducements totaling approximately $0.5 million, including $0.2
million for furniture and equipment, for our San Jose facility.
Interest (Income) and Expense, net and Other, net. Net interest income decreased
by $0.7 million, or 70%, for the six months ended June 30, 2002 compared to the
comparable period in 2001. The decrease is the result of lower average cash
balances and lower bank interest rates in 2002.
Provision for Income Taxes (Benefit). The income tax benefit recorded for the
six months ended June 30, 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.
44
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Acquired In-Process Research and Development
In connection with the acquisition of eMation, we expensed $3.1 million of the
purchase price as IPR&D. The potential income streams were discounted using a
15%-25% discount rate for risks, probabilities and uncertainties, including the
stage of development of the technology, viability of target markets, and other
factors.
As of the acquisition date, eMation was conducting ongoing research and
development into its next generation DRM product, as well as enhancing its
WizFactory and @aGlance industrial products. Due to the significant
technological risks relating to the development of these products and the fact
that the products were not completed at the time of the acquisition, the work
effort estimated to bring these products to market was considered in-process
research and development. These development efforts are expected to include
product enhancements and enable the products to perform on an increased number
of platforms. We expect to complete the next generation DRM product, DRM 3.0, in
September 2002. The completion date for the industrial products is also expected
in 2002. These DRM and industrial products, along with any related services and
maintenance, are expected to generate revenues through 2004.
45
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
LIQUIDITY AND CAPITAL RESOURCES
We financed our operations up until 2001 primarily through the issuance and sale
of debt and equity securities to investors including our initial public offering
completed on July 16, 1999. Since March 2001, our operations have also been
financed through the sales of the assets of our CE and IA businesses. As of June
30, 2002, we had approximately $30.7 million in cash and cash equivalents,
including $1.3 million of the proceeds from the sales of the assets of our CE
and IA businesses in March 2001 held in escrow by third parties for
indemnification purposes. The remaining balance held in escrow for the IA sale
of approximately $0.55 million has been withheld pending the settlement of a
claim submitted by Phoenix. We are unable to predict the resolution of this
matter, or reasonably estimate any amount of possible loss given the current
status of this matter. Any escrow amounts not returned to us will be recorded as
a charge to the gain on sale of assets in the period in which such determination
is made. In June 2002 we initiated an arbitration proceeding with the
International Chamber of Commerce (No. 12 203/JNK) seeking an order that the
entire $0.55 million be disbursed to Axeda. Phoenix has not yet filed an answer
or counterclaim, and no hearing date has yet been set.
Net cash used in operating activities for the six months ending June 30, 2002
was $14.1 million. Cash used in operating activities for this period was
primarily the result of our net loss of approximately ($19.6) million, adjusted
for other non-cash charges, including non-cash compensation and depreciation and
amortization totaling approximately $2.9 million, losses on disposals of assets
totaling approximately $0.4 million and other changes in working capital of
approximately $2.2 million. Net cash used in operating activities for the six
months ended June 30, 2001 was $15.9 million. Cash used in operating activities
for this period was primarily the result of net income, adjusted for
non-recurring gains of approximately $52.0 million and non-cash compensation
expense and depreciation and amortization totaling approximately $3.7 million.
Net cash used in investing activities for the six months ending June 30, 2002
was $0.8 million, and consisted of purchases of furniture and equipment. Net
cash provided by investing activities for the six months ended June 30, 2001 was
approximately $67.8 million and consisted primarily of the net proceeds from the
sales of assets of our CE and IA businesses of approximately $68.1 million,
offset by purchases of furniture and equipment of approximately $0.3 million.
In March 2001, we completed the sale of the assets of our CE business to
STMicroelectronics and received approximately $55.6 million in cash
consideration, of which $0.7 million is being held by a third party in escrow
for indemnification purposes until September 2002.
In March 2001, we sold the assets of our IA business, excluding inventory, to
Phoenix Technologies for $18 million in cash consideration, of which $0.55
million remains withheld by a third party pending the settlement of a claim
submitted by Phoenix.
Net cash used in financing activities was $1.8 million for the six months ending
June 30, 2002 and consisted of the repayment of the balance of $1.65 million
under the line of credit acquired in the acquisition of eMation and principal
payments of the equipment line of credit to EVP of approximately $0.2 million.
Net cash provided by financing activities for the six months ended June 30, 2001
was $1.5 million and consisted of proceeds from the exercise of stock options
and warrants.
46
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
As of June 30, 2002, the we had approximately $0.4 million outstanding on an
equipment line of credit with European Venture Partners ("EVP") with interest
rates ranging from 12% to 13% and payments due monthly over a 36 month period.
The line of credit was available to finance purchases of capital equipment until
September 30, 2001. In connection with the agreement, EVP has a senior security
interest in substantially all of eMation's capital equipment. In addition, the
line of credit agreement requires us to provide EVP with copies of quarterly
financial statements within 45 days of the end of each quarter and audited
annual financial statements within 90 days of the end of each year as well as
other information and notifications regarding eMation's financial and operating
results. As of June 30, 2002, we were in compliance with all of our covenants to
EVP.
A portion of our liability for severance pay is calculated pursuant to Israeli
severance pay law based on the most recent salary of the employees multiplied by
the number of years of employment, as of the balance sheet date. Employees are
entitled to one month's salary for each year of employment or a portion thereof.
The liability for all of our employees is fully provided by monthly deposits
with insurance policies and by an accrual, totaling approximately $0.5 million.
The aggregate value of these policies is approximately $0.3 million. The
deposited funds may be withdrawn only upon the fulfillment of the obligation
pursuant to Israeli severance pay law or labor agreements. The value of the
deposited funds is based upon the cash surrender value of these policies.
In May 2002, we entered into a lease for approximately 35,000 square feet of
space in an office building in the same business park as our current offices
located in Mansfield, Massachusetts. This facility is leased at an annual rental
of approximately $310,000, plus operating expenses, utilities and taxes, and
will be used for research and development, sales and support and administrative
activities. The lease commenced in June 2002, expires in July 2007, and provides
for free rent through September 2002. We will record the net lease expense on a
straight-line basis over the term of the lease. Axeda obtained an irrevocable,
cash-secured, standby letter of credit (the "letter of credit") from a bank as
security and for the benefit of the lessor for $0.15 million. The letter of
credit expires in August 2003 and provides for automatic one-year renewals, but
not beyond August 2007. The letter of credit is secured by a certificate of
deposit for $0.15 million from the same bank, and also expires in August 2003.
This amount is restricted for withdrawal and is included in other assets
(non-current) in our consolidated balance sheets. We commenced our occupation of
the offices in July 2002 and expect to fully occupy this facility during the
third quarter of 2002 The lease for 89 Forbes Boulevard expires in July 2004 and
requires minimum annual rental payments of approximately $270,000. We are
actively attempting to sublease this office, but there can be no assurances that
we will be able to secure another tenant on acceptable terms.
As part of our occupancy of this new site in Mansfield, we contracted for
improvements, primarily construction of offices and other improvements, which
will be completed in August 2002. The estimated cost of the improvements is $0.9
million, and we are considering our investment alternatives for these costs,
which include obtaining financing.
In June 2002 we entered into a Software License Agreement ("the Agreement") with
a vendor to provide server and client software that will be incorporated into
our DRM Enterprise Server products beginning in August 2002. License fees are
due and payable at the rate of 2.5% of each billable sale, as defined. Under the
Agreement, we agreed to pay a minimum, non-refundable prepaid license fee of
$400,000 (the "minimum license fee"), which is payable in installments. We paid
$100,000 in July 2002, and are required to pay $100,000 on June 30, 2003 and the
remaining $200,000 on December 15, 2003.
47
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
We maintain approximately 9,000 square feet of office space in Marlborough,
Massachusetts under an operating lease, which is no longer used for operating
purposes. The lease requires annual rental payments totaling approximately $0.2
million and expires in February 2009. The present value of the future lease
payments, discounted at 5%, of approximately $1.1 million was accrued by eMation
as of the date of acquisition and the balance as of June 30, 2002 is
approximately $1.0 million.
During the second quarter we initiated cost reduction actions, which we believe
will reduce our cash operating expenses by approximately one third, with a goal
to reduce our quarterly cash burn rate to $3.0 million by the fourth quarter of
2002. These reductions have centered on selling and marketing and general and
administrative expenses, and in areas not core to the DRM systems growth. We
have also reduced the number of global offices and tightened our infrastructure.
While we began to reduce our cost structure in the second quarter of 2002, the
most sizeable reductions are occurring in the third quarter of 2003. As a result
we expect to incur approximately $2.0 million in charges to lower staffing
levels and to terminate certain leases, and we expect that the cost savings will
be increasing throughout the quarter.
Except for the improvements to our new offices in Mansfield, Massachusetts
described above, we have no other material commitments for capital expenditures,
and we anticipate minimal increases in our capital expenditures as our needs in
operations, infrastructure and personnel arise.
In September 2001, our Board of Directors authorized a stock repurchase program
to acquire up to $10 million worth of shares of our common stock. The shares may
be purchased from time to time at prevailing market prices through open market
or unsolicited negotiated transactions, depending upon market conditions. From
September 2001 to December 2001, we repurchased 383,800 shares for an aggregate
cost of approximately $0.6 million including commissions, at an average market
price per share of approximately $1.58. No shares were repurchased under the
program in the six months ending June 30, 2002.
We believe that our current cash and cash equivalents balance and cash
anticipated to be provided by operations, if any, will be adequate to meet our
cash needs through 2003.
48
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Critical Accounting Policies
In December 2001 the SEC issued Financial Reporting Release No. 60, "Cautionary
Advice Regarding Disclosure About Critical Accounting Policies" ("FRR 60"),
suggesting companies provide additional disclosure and commentary on those
accounting policies considered most critical. FRR 60 considers an accounting
policy to be critical if it is important to our financial condition and results,
and requires significant judgment and estimates on the part of management in its
application. We believe the following represent our critical accounting policies
as contemplated by FRR 60. For a summary of all of our significant accounting
policies, including the critical accounting policies discussed below, see note 1
to the accompanying consolidated financial statements.
We believe the following critical accounting policies affect the more
significant judgments and estimates used in the preparation of our consolidated
financial statements.
Revenue recognition. We derive our revenues from primarily two sources (i)
product revenue, which includes software license, hardware and royalty revenue,
and (ii) services and support revenue which includes software license
maintenance, training, and consulting revenue. As described below, significant
management judgments and estimates must be made and used in connection with the
revenue recognized in any accounting period. Material differences may result in
the amount and timing of our revenue for any period if our management made
different judgments or utilized different estimates.
We license our software products generally on a perpetual basis. Some of our
licenses include maintenance and support, which typically are for periods of one
year.
We apply the provisions of Statement of Position 97-2, "Software Revenue
Recognition," ("SOP 97-2") as amended by Statement of Position 98-9
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions" ("SOP 98-9") to all transactions involving the sale of software
products. For hardware transactions where no software is involved, we apply the
provisions of Staff Accounting Bulletin 101 "Revenue Recognition" ("SAB 101").
We recognize revenue from the sale of software licenses when persuasive evidence
of an arrangement exists, the product has been delivered, the fee is fixed and
determinable and collection of the resulting receivable is reasonably assured.
Delivery generally occurs when product is delivered to a common carrier. If a
significant portion of a fee is due after our normal payment terms, we account
for the fee as not being fixed and determinable. In these cases, we recognize
revenue as the fees become due.
We assess collection based on a number of factors, including the transaction
history and the credit-worthiness of the customer. If we determine that
collection of a fee is not reasonably assured, we defer the fee and recognize
revenue at the time collection becomes reasonably assured, which is generally
upon receipt of cash.
For all sales, except those completed over the Internet, we use either a binding
purchase order or a signed agreement as evidence of an arrangement. For sales
over the Internet, we utilize a third party distributor to process our
transactions. Sales through our distributors are evidenced by a master agreement
governing the relationship together with binding purchase orders on a
transaction-by-transaction basis.
49
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
For multiple-element arrangements that are not accounted for using long-term
contract accounting (for example, undelivered maintenance and support), we
allocate revenue to the delivered elements of the arrangement using the residual
value method when there is VSOE for each of the undelivered elements. We defer
revenue from the arrangement fee equivalent to the fair value of the undelivered
elements and the difference between the total arrangement fee and the amount
deferred for the undelivered elements is recognized as revenue related to the
delivered elements. The fair value of DRM maintenance and postcontract customer
support ("PCS") obligations is based upon separate sales of renewals to other
customers or upon renewal rates quoted in the contracts. The fair value of DRM
services, such as training or consulting, is based upon separate sales by us of
these services to other customers.
Our arrangements do not generally include acceptance clauses. However, if an
arrangement includes an acceptance provision, acceptance occurs upon the earlier
of receipt of a written customer acceptance or expiration of the acceptance
period.
In cases where we engage a third party warehouse or distributor to sell any of
our inventory on consignment, and collectibility is not probable, revenue is not
recognized and inventory is not reduced until cash from the sale is received. In
certain consignment arrangements with distributors, if the period under which a
right to return has expired with no physical return of the inventory, the
inventory is considered sold, assuming all other criteria in SAB 101 are met.
We recognize revenue for maintenance services ratably over the contract term.
Our training and consulting services are billed based on hourly rates, and we
generally recognize revenue as these services are performed. However, if our
services are bundled with a license component and the arrangement requires us to
perform significant work either to alter the underlying software or to build
additional complex interfaces so that the software conforms to the customer's
requirements, we recognize the entire fee using the percentage of completion
method. We estimate the percentage of completion based on the costs incurred to
date as a percentage of the estimated total costs to complete the project.
During our analysis if the work effort to complete a project exceeds our revenue
projections, a loss on the project is immediately recognized.
Provision for doubtful accounts. Management must make estimates of the
uncollectability of our accounts receivables. Management specifically analyzes
accounts receivable and analyzes historical bad debts, customer concentrations,
customer credit-worthiness, current economic trends and changes in our customer
payment terms when evaluating the adequacy of the allowance for doubtful
accounts. Our accounts receivable balance was $3.6 million, net of allowance for
doubtful accounts of $0.2 million as of June 30, 2002.
Valuation of inventories. We assess the value of our inventories on a periodic
basis based upon numerous factors including expected product or material demand,
current market conditions, technological obsolescence, current cost and net
realizable value. In cases where any of these factors adversely affects our
ability to realize the carrying value of our inventories, an inventory reserve
is recorded. Because the timing and magnitude of these changes to inventories
are difficult to predict, changes to our inventories' value may occur
unexpectedly. Given our inventories balance was $0.03 million as of June 30,
2002, we do not believe any unanticipated events will have a material impact
upon the realization of the inventories' carrying value.
50
AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Valuation of long-lived assets and intangible assets with finite lives
(excluding goodwill). On January 1, 2002, we adopted SFAS No. 144 "Accounting
for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which
supersedes certain provisions of APB Opinion No. 30 "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB
30"), and supersedes SFAS 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121"). There was no
adjustment required upon adoption of SFAS 144. In accordance with SFAS 144, we
evaluate long-lived assets, including intangible assets other than goodwill, for
impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable based on expected undiscounted
cash flows attributable to that asset. The amount of any impairment is measured
as the difference between the carrying value and the fair value of the impaired
asset. We do not have any long-lived assets that we consider to be impaired.
Factors we consider important which could trigger an impairment review include
the following:
o significant underperformance relative to expected historical or projected
future operating results;
o significant changes in the manner of our use of the acquired assets or
the strategy for our overall business;
o significant negative industry or economic trends;
o significant decline in our stock price for a sustained period; and our
market capitalization relative to net book value.
When we determine that the carrying value of identified intangible assets or
long-lived assets may not be recoverable based upon the existence of one or more
of the above indicators of impairment, we measure any impairment based on a
projected discounted cash flow method using a discount rate determined by our
management to be commensurate with the risk inherent in our current business
model. Net identified intangible assets with finite lives and long-lived assets
amounted to $10.8 million as of June 30, 2002 and $12.1 million as of December
31, 2001.
SFAS No. 142, which was effective January 1, 2002, requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with finite useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 144, beginning in 2002 and annually thereafter. As a
result, we are not amortizing approximately $20.8 million of goodwill recorded
in 2001. We adopted certain provisions of SFAS No. 142, as required in the
transition guidance contained therein, in 2001 and adopted the remaining
provisions on January 1, 2002. The application of the transition guidance did
not result in an impairment of goodwill as of January 1, 2002. Goodwill amounted
to approximately $20.6 million as of June 30, 2002 and $20.8 million as of
December 31, 2001. We have not recorded any amounts for intangible assets with
indefinite useful lives as of June 30, 2002 or December 31, 2001.
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AXEDA SYSTEMS INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Contingencies. Management's current estimated range of liability related to its
pending legal claims is based on claims for which our management can estimate
the amount or range of loss. We have recorded our best estimate of the liability
related to those claims, where there is a range of loss. Because of the
uncertainties related to both the amount and range of loss on the remaining
pending legal claims, management is unable to make a reasonable estimate of the
liability that could result from an unfavorable outcome. As additional
information becomes available, we will assess the potential liability related to
our pending legal claims and revise our estimates. Such revisions in our
estimates of the potential liability could materially impact our results of
operations, financial position and cash flows.
Recent Accounting Pronouncements
In July 2002 the FASB issued Statement No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS 146"). The standard requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the standard include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity.
Previous accounting guidance was provided by Emerging Issues Task Force Issue
No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring) ("EITF 94-3")." Statement 146 replaces EITF 94-3. We do not
expect the adoption of SFAS 146 to have a significant impact on our results of
operations, financial position or cash flows.
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AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 3:
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop products in the United States and in Israel and sell such products in
North America, Asia and various countries in Europe. We collect a portion of our
revenues and pay a portion of our operating expenses in foreign currencies. As a
result, our financial results could be affected by factors such as changes in
foreign currency exchange rates or weak economic conditions in foreign markets.
Currently, we do not use derivative instruments to hedge our foreign exchange
risk, although we may do so in the future. Our interest income is sensitive to
changes in the general level of U.S. interest rates, particularly since the
majority of our investments are in short-term instruments. Due to the nature of
our short-term investments, we have concluded that there is no material market
risk exposure. Therefore, no quantitative tabular disclosures are required.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Our business and the value of our shares are subject to numerous risks. Some of
these risks are described above and certain additional risks are described
below. You should carefully consider the risks described below, in addition to
the other information contained in this Report and in our other filings with the
SEC. The risks and uncertainties described below are not the only ones we face.
Additional risks and uncertainties not presently known to us or that we
currently deem immaterial may also affect our business operations. If any of
these risks actually occur, our business, financial condition or results of
operations could be seriously harmed. In that event, the market price for our
common stock could decline and you may lose part or all of your investment.
We have never been profitable and may never achieve profitability in the future
We had a net loss from operations of approximately $20.5 million for the six
months ended June 30, 2002. To date, we have not achieved operating
profitability on an annual basis.
We have invested and continue to invest significant resources in product
development, selling and marketing, services, professional services and support
and administrative expenses. To achieve profitability, we will need to increase
revenues significantly. We cannot assure you that our revenues will grow or that
we will achieve or maintain profitability in the future.
We are currently undergoing a business transition that may adversely affect
our Company
We sold the assets of our CE business and our IA business in March 2001. As part
of these sales, approximately 89 of our employees accepted employment with
either STMicroelectronics or Phoenix Technologies. These employees were
dedicated primarily to research and development activities in the digital media
market. The reduction in our research and development workforce has adversely
affected our ability to offer new products in the digital media market. The
reduction in our sales force adversely affected our ability to sell our digital
media products. Pursuant to the terms of our agreement with STMicroelectronics,
we may not participate in significant aspects of the CE market prior to March
2006. These sales negatively impacted relationships with our partners,
distributors and customers in the digital media market and left us with a
limited digital media offering of products that could be used only in personal
computers. In May 2002 we entered into an exclusive Software Distribution
Agreement with Sonic Solutions, who will license the intellectual property of
our PC and digital media business. As a result, we are exiting the digital media
market. In December 2001, we announced the completion of the eMation
acquisition. Our focus on the DRM business will present challenges different
from those presented by the digital media business. We cannot assure you that
our management team will be successful in managing this new business. If we are
unable to successfully operate the DRM business, our business and operating
results will be adversely affected.
53
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our future success depends upon the acceptance of our DRM solution
We expect our future growth to be increasingly driven by our DRM products and
services. We have limited experience in this market. We acquired eMation in
December 2001. eMation was founded in 1988 and historically derived its main
source of revenue from its industrial automation products.
We offer complete DRM systems and we also continue to separately sell components
of the system, such as the Axeda Supervisor, Axeda @aGlance/IT and Axeda
FactorySoft OPC, to support our traditional industrial automation business.
Factors adversely affecting the pricing of or demand for our DRM systems, such
as competition and technological change, could have a material adverse effect on
our business, financial position and results of operations. If our DRM systems
do not achieve market acceptance or if competitors release new products that
achieve greater market acceptance, have more advanced features, offer better
performance or are more price-competitive, revenues from our DRM systems may not
grow as expected.
Our complete DRM systems will involve significant capital expenditures by our
customers. We have a limited history of selling DRM systems and will have to
devote substantial resources to educate prospective customers about the benefits
of our DRM systems. Even if our DRM systems are effective in reducing our
customers' costs or in providing our customers with new revenue sources, our
target customers may not choose them for technical, cost, support or other
reasons. If the market for our products fails to grow or grows more slowly than
we anticipate, our business will suffer.
Net revenues from our legacy products, which include Axeda Supervisor, Axeda
@aGlance/IT and Axeda FactorySoft OPC, have decreased and we expect that net
revenues from these lines of products will continue to decline in the future as
we focus our efforts on the development of complete DRM systems
Net revenues from eMation's legacy products, which include Axeda Supervisor,
Axeda @aGlance/IT and Axeda FactorySoft OPC, have accounted for a significant
portion of its historical net revenues but have declined recently. We anticipate
that net revenues from .our legacy products will continue to decline in the
future as we plan to continue to focus on the development of our DRM systems. We
do not know if this transition in product development will be successful. If the
expected decline in net revenues attributable to our legacy products is not
offset by increases in net revenues from our DRM system, our business could be
harmed.
54
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Economic conditions could adversely affect our revenue growth and ability
to forecast revenue
The revenue growth of our business depends on the overall demand for DRM
software and services. Because our sales targets are primarily major corporate
customers in the industrial and building automation, high technology devices,
medical instrumentation, semiconductor equipment, and office automation
industries, our business depends on the overall economic conditions and the
economic and business conditions within these industries. Predictions regarding
economic conditions have a low degree of certainty, and further predicting the
effects of the changing economy is even more difficult. Customers may defer or
reconsider purchasing products if they continue to experience a lack of growth
in their business or if the general economy fails to significantly improve. A
softening of demand for computer software caused by a continued weakening of the
economy, domestically or internationally, may result in a decrease in revenues
and growth rates. In addition, the financial, political, economic and other
uncertainties following the terrorist attacks upon the United States have led to
a further weakening of the global economy. Subsequent terrorist acts and/or the
threat of future outbreak or continued escalation of hostilities involving the
United States or other countries could adversely affect the growth rate of our
software license and services revenue and have an adverse effect on our
business, financial condition or results of operations.
We may not be able to successfully make or integrate acquisitions of other
companies
We have in the past and intend in the future to continue to acquire businesses.
Acquisitions are particularly difficult to assess because of rapidly changing
technological standards. If we are unable to successfully integrate
acquisitions, our business could suffer. We may be subject to various risks as a
result of the eMation acquisition and other future acquisitions of this type,
including:
o the possibility that the business cultures may not mesh;
o interruption of the operations of the combined businesses;
o the possibility that management may be distracted from regular business
concerns by the need to integrate operations or operate the businesses
separately which may result in interruption of the operations of the
combined businesses;
o problems in retaining employees;
o challenges in retaining customers;
o anticipated and unanticipated costs relating to additional administrative
or operating expenses of each business; and
o the potential inability to maintain uniform standards, controls,
procedures and policies.
Our historical financial information is of limited value in projecting our
future operating results or evaluating our operating history
We believe that comparing different periods of our operating results is not
meaningful and you should not rely on the results for any previous period as an
indication of our future performance because our business model has changed
significantly since inception and has further changed with the acquisition of
eMation.
55
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
You should expect our quarterly operating results to fluctuate in future periods
and they may fail to meet the expectations of investors, which could cause our
stock price to decline
Our operating results have varied widely in the past, and we expect that they
will continue to vary significantly as we attempt to establish our products in
the DRM market and transition to a new business model. Furthermore, our revenues
and operating results will vary significantly from quarter-to-quarter due to a
number of additional factors, including:
o variations in demand for our products and services, which are relatively
few in number;
o customers' decisions to defer or accelerate orders for our products or
services;
o increased economic uncertainty and political instability world-wide
following the terrorist attacks which began in the United States on
September 11, 2001;
o capital budgeting and purchasing cycles of current and prospective
customers may cause our sales to be seasonal; it is difficult for us to
evaluate the degree to which this seasonality may affect our business;
o the timing of large contracts that materially affect our operating results
in a given quarter;
o delays in introducing new products and services;
o changes in our pricing policies or the pricing policies of our competitors;
o the costs of litigation and intellectual property protection;
o our ability to develop and attain market acceptance of enhancements to our
products;
o new product introductions by competitors;
o the mix of license and services revenues;
o unanticipated customer demands which impact our ability to deliver our
products and ultimately recognize revenues;
o the mix of domestic and international sales;
o costs related to the acquisition of technologies or businesses;
o our ability to attract, integrate, train, retain and motivate sales and
marketing, research and development, administrative and product management
personnel;
o our ability to expand our operations; and
o global economic conditions as well as those specific to the industries we
operate in.
56
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We determine our operating expenses largely on the basis of anticipated revenue
trends and a high percentage of our expenses are fixed in the short term and are
significant. As a result, any delay in generating or recognizing revenues could
cause significant variations in our operating results from quarter-to-quarter
and could result in substantial operating losses.
Due to the foregoing factors, we believe that quarter-to-quarter comparisons of
our operating results are not a good indication of our future performance. In
future quarters, our operating results may be below the expectations of
investors. In this event, the price of our common stock may fall significantly.
We may not be able to compete effectively
Competition in the market for DRM solutions is emerging and expected to grow
stronger. If we are unable to compete effectively, the demand for, or the prices
of, our products may be reduced. To maintain and improve our competitive
position, we must continue to develop and introduce, on a timely and
cost-effective basis, new products, features and services that keep pace with
the evolving needs of our customers. The principal competitive factors that
affect our performance in the DRM market are the following:
o our ability to effectively market and sell our products;
o our customer service and support;
o our product reputation, quality, performance; and
o the price and features of our products such as adaptability,
scalability, the ability to integrate with other products,
functionality, and ease of use.
We compete in a market with companies that may utilize varying approaches to
enable the remote management of information from intelligent devices. One
competitive approach to the Axeda DRM(TM) system today is from custom software
development from 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. However, we are also developing working
relationships with system integrators who may choose to leverage the Axeda DRM
system in their engagements, generating sales for Axeda and additional services
opportunities for them.
A number of vertical market solution suppliers have also begun to market device
management infrastructures for use in specific industries. Today, companies such
as ILS and Brooks Automation (semiconductor), Questra (medical and office),
Invensys (industrial), Imaging Portals (copiers), NextNine (telecom), Motive
(computers), eVend.Net (vending) and WindRiver (home) compete in specific
industries that we operate in.
57
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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. Our future competitors may have
significantly more personnel or greater financial, technical, marketing and
other resources than either our current competitors or we do. 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 harm our business.
We expect to see new or increased competition from several areas, including:
Device Networking - The embedded networking companies are perhaps the most
visible infrastructure companies in this emerging market. We do not develop
networking protocols and our technology generally can work with any open or
proprietary communications protocols. We therefore today see device-networking
companies like NetSilicon, emWare, e-Device, Lantronix, ProSyst, Opto22,
domainLogix, and Echelon as current or potential partners. NetSilicon and Opto22
have entered into strategic alliances with us to promote remote monitoring,
service, and management solutions for devices and equipment across a variety of
industries. We believe that the current focus of these embedded networking
companies is primarily on Internet-enabling devices, which complements our focus
on managing device data remotely via distributed, enterprise-class solutions.
However, in the future these companies may choose to directly compete with us.
Industrial Automation Products - There are a number of automation products
available worldwide from vendors large and small that are used to monitor and
control machines and devices. Some of these PC-based HMI/SCADA software
companies have focused on extending their business upward to Web-based access
and enterprise application integration typically to support e-manufacturing.
Today, these companies compete directly with our Axeda Supervisor(TM) product.
Over time we could see these companies as competitors in the full DRM market.
These companies include WonderWare, Intellution, Indusoft, Afcon, Iconics, IndX,
Rockwell Automation, Siemens and GE Fanuc.
e-Business Platforms - We see the large CRM companies, network management
vendors and e-business technology platform providers such as Siebel Systems,
Oracle, IBM, SAP, BEA, PeopleSoft, Sun Microsystems, Hewlett Packard, BMC,
MicroMuse, and Computer Associates as both potential competitors and partners.
These companies have an interest in device networking and pervasive computing
technologies and could choose to extend their offering into DRM. Building on
well-understood and widely available standard infrastructure components, such as
J2EE(R) application servers and relational databases, enables us to interoperate
with and to take advantage of partnering opportunities with these suppliers as
well as their application and systems integration partners. Axeda is a Siebel
Software Partner and our Axeda Integrator(TM) for Siebel provides seamless
integration with the Siebel 2000 Field Service application from Siebel Systems
Inc. However, in the future, these companies may choose to compete directly with
us.
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AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We may not be able to keep pace with technological advances
The process of remotely extracting 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 adversely impact our business.
Our sales cycle for DRM products is long and may be seasonal and we may 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 seasonality. Our 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, before purchasing our products, companies
spend a substantial amount of time performing internal reviews and obtaining
capital expenditure approvals. It may take up to six to nine months or more from
the time we first contact a prospective customer before receiving an initial
order. The length of our sales cycle may also depend on a number of additional
factors, including the following:
o the complexities of the problems our solutions address;
o the breadth of the solution required by the customer, including
the technical, organizational and geographic scope of the
license;
o the sales channel through which the solution is sold;
o the economic conditions in the United States and abroad;
o increased economic uncertainty and political instability
world-wide following the terrorist attacks which began in the
United States on September 11, 2001; and
o any other delays arising from factors beyond our control.
Furthermore, our software license revenues may result from a relatively small
number of sales, some of which generate disproportionately large revenues.
Variations in the length of our sales cycles could cause our revenue to
fluctuate widely from period to period. Because we typically recognize a
substantial portion of our software revenue in the last month of a quarter, any
delay in the license 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 to prospective clients.
59
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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. A slowdown in the
economy, domestically and internationally, has caused and may continue to cause
customer purchasing decisions to be delayed, reduced in amount or canceled, all
of which have reduced and could continue to reduce the rate of conversion of the
pipeline into contracts. A variation in the pipeline or in the conversion of the
pipeline into contracts could cause us to plan or budget inaccurately and
thereby could adversely affect our business, financial condition or results of
operations.
Our Software Products Are Intended To Work Within Complex Business Processes.
Accordingly, Implementation Of Our Products Can Be Difficult, Time-Consuming And
Expensive And Customers May Be Unable To Implement Our Products Successfully Or
Otherwise Achieve The Benefits Attributable To Our Products.
Our products must integrate with the many existing computer systems and software
programs of our customers. This can be complex, time-consuming and expensive,
and may cause delays in the deployment of our products. As a result, some
customers may have difficulty or be unable to implement our products
successfully or otherwise achieve the benefits attributable to our products.
Delayed or ineffective implementation of our software and services may limit our
ability to expand our revenues and may result in customer dissatisfaction, harm
to our reputation and cause issues relating to the collection of accounts
receivable.
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. We have recently hired new managers and may hire key management
personnel as needed. We may not be able to successfully assimilate our recently
hired managers or to hire qualified key management personnel to replace them.
We may not be able to hire and retain qualified employees, which would
impair our ability to grow
Hiring qualified personnel, particularly sales, marketing, engineering and
product management personnel, is very competitive in our industry due to the
limited number of people available with the necessary technical skills and
understanding of the industry. In addition, most of our United States operations
are conducted through our offices in Malvern, Pennsylvania and Mansfield,
Massachusetts. We have in the past and expect in the future to face difficulties
locating qualified personnel in these locations.
Our success depends upon the successful expansion of our sales force
The expansion of our direct sales force and indirect distribution channels will
be difficult, will take time and will be costly. Our growth could be limited if
we fail to achieve this expansion. We need to expand our direct sales force in
order to significantly increase market awareness of our DRM products and to
generate increased revenues. New sales personnel will require training and it
will take time for them to achieve full productivity. There is strong
competition for qualified sales personnel in our business, and we may not be
able to attract and retain a sufficient number of new sales personnel to expand
our operations. Our sales and marketing expenses may increase as a percentage of
revenues while we expand our direct sales force. Unless this expansion results
in a proportionate increase in revenues, our margins and business may be
adversely affected.
60
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We may not achieve future growth if we are unable to expand our indirect
distribution sales channels
We believe that our future success is dependent upon the expansion of indirect
distribution channels, consisting of relationships with independent software
vendors, software distributors and system integrators. We currently have
relationships with only a limited number of these indirect distribution
channels. Nevertheless, we have derived, and we anticipate that we will continue
to derive, a significant portion of our revenues from these relationships.
Our future growth will be limited if:
o we fail to work effectively with indirect distribution channels;
o we fail to increase the number of indirect distribution channels with
which we have relationships;
o the business of one or more of our indirect distribution channels fails;
or
o there is a decrease in the willingness and ability of our indirect
distribution channels to devote sufficient resources and efforts to
marketing and supporting our products.
If any of these circumstances occurs, we will have to devote substantially more
resources to the sales, marketing, distribution, implementation and support of
our products than we otherwise would, and our own efforts may not be as
effective as those of our indirect distribution channels.
Increased sales through indirect channels may adversely affect our operating
performance.
Even if our marketing efforts through indirect channels are successful and
result in increased sales, our average selling prices and operating margins
could be adversely affected because of the lower unit prices that we receive
when selling through indirect channels.
We rely upon technology licensed from third parties, and if we do not maintain
these license arrangements, we may experience delays until replacement
technology is licensed and integrated
We license technology that is used in our products from third parties under
agreements and we may not be able to maintain these license arrangements. This
technology may not continue to be available on commercially reasonable terms, if
at all, and would be difficult to replace. The loss of any of these technology
licenses could result in delays until replacement technology is licensed and
integrated. In addition, any defects in this licensed technology could prevent
the implementation or impair the functionality of our products, delay new
product introductions or injure our reputation. If we are required to enter into
license agreements with third parties for replacement technology, we could be
subject to higher royalty payments.
61
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our business model depends upon licensing our intellectual property, and if we
fail 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. If we are not successful in protecting
our intellectual property, our business could be substantially harmed.
Our pending patents may never be issued, and even if issued, may provide us
with little protection
We regard the protection of patentable inventions as important to our
business. We currently have ten U. S. patent applications pending relating to
our DRM business and three patent applications pending internationally. It is
possible that:
o our pending patent applications may not result in the issuance of
patents;
o our patents may not be broad enough to protect our proprietary rights;
o any issued patent could be successfully challenged by one or more third
parties, which could result in our loss of the right to prevent others
from exploiting the inventions claimed in those patents;
o current and future competitors may independently develop similar
technology, duplicate our products or design around any of our patents;
and
o effective patent protection, if any, may not be available in every
country in which we do business.
We rely upon trademarks, copyrights and trade secrets to protect our proprietary
rights, which are only of limited value
We rely on a combination of laws, such as copyright, trademark and trade secret
laws, and contractual restrictions, such as confidentiality agreements and
licenses, to establish and protect our proprietary rights. Despite any
precautions which we have taken:
o laws and contractual restrictions may not be sufficient to prevent
misappropriation of our technology or deter others from developing
similar technologies;
o other companies may claim common law or other trademark rights based upon
state or foreign law which precede our registration or use of such marks;
o Current federal laws that prohibit software copying provide only limited
protection from software pirates, and effective trademark, copyright and
trade secret protection may be unavailable or limited in certain foreign
countries;
o companies we acquire may not have taken similar precautions to protect
their proprietary rights;
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AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
o policing unauthorized use of our products and trademarks is difficult,
expensive and time-consuming and we are unable to determine the extent
to which piracy of our products and trademarks may occur, particularly
overseas;
o certain of our products are licensed under shrink-wrap license agreements
that are not signed by licensees and therefore may not be binding under
the laws of certain jurisdictions; and
o tamper-resistant copy protection codes in our software may not be
successful in preventing unauthorized use of our software.
The laws of other countries in which we market our products might offer little
or no effective protection of our proprietary technology. Reverse engineering,
unauthorized copying or other misappropriation of our proprietary technology
could enable third parties to benefit from our technology without paying us for
it, which could significantly harm our business.
Any failure to adequately protect our proprietary rights could result in our
competitors offering similar products, potentially resulting in the loss of some
of our competitive advantage and a decrease in our revenue. Infringement claims
and lawsuits would likely be expensive to resolve and would require management's
time and resources and, therefore, could harm our business.
We may be subject to product returns, 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 network 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:
o delay or loss of revenues;
o although we have not lost a customer due to defects, it is foreseeable
that a customer could cancel a contract due to defects;
o diversion of development resources;
o increased product development costs;
o damage to our reputation;
o delay or diminish market acceptance of our products;
o increased service and warranty costs; and
o litigation costs.
63
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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. There is a risk that 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 have received notices of claims, and may receive additional notices of claims
in the future, regarding the alleged infringement of third parties' intellectual
property rights that may result in restrictions or prohibitions on the sale of
our products and cause us to pay license fees and damages.
Some third parties claim to hold patents covering various aspects of DTV, HDTV
and DVD technology incorporated into our and our customers' digital media
products and have claimed that various aspects of DTV, HDTV and DVD technology
incorporated into our and our customers' digital media products infringe upon
patents held by them, including the following:
o Our digital video stream management solutions comply with industry DVD
specifications, which incorporate technology known as MPEG-2 that governs
the process of storing a video input in digital form. In 1998 and/or 1999
we received notice from two of our largest customers that a third party
with a history of litigating its proprietary rights and which has
substantial financial resources has alleged that aspects of MPEG-2
technology infringe upon patents held by the third party. In July 2002, one
of these customers notified us that this third party has sued such customer
for patent infringement, anf the customer is seeking indemnification from
us. The other customer may in the future seek compensation or
indemnification from us arising out of the third party claims. We may be
required to agree to indemnify either or both of these customers to secure
future business or otherwise.
o A group of companies has formed a consortium known as MPEG-LA to enforce
the proprietary rights of other holders of patents covering essential
aspects of MPEG-2 technology that are incorporated into our products.
MPEG-LA has notified us, as well as a number of PC manufacturers, including
our customers, that the distribution of products that incorporate the
MPEG-2 technology infringes patents owned by members of the consortium.
MPEG-LA has requested that these PC manufacturers pay license fees for the
use of the technology covered by MPEG-LA patents.
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AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
o Another group of companies has formed a consortium known as DVD6C (formerly
DVD Patent License Program) to enforce the proprietary rights of other
holders of patents covering essential aspects of DVD technology that are
incorporated into our products. DVD6C has notified us, as well as a number
of PC manufacturers and other companies manufacturing or licensing
DVD-related products, including our customers, that products that
incorporate the DVD technology infringe patents owned by members of the
consortium. DVD6C has requested that we as well as these PC manufacturers
pay license fees for using the DVD6C patents.
o A third party has notified us, as well as two of our customers, that
parental control features of our CineMaster products infringe patents held
by the third party.
o Another consortium of companies, commonly known as 3C, notified a number of
DVD product manufacturers that the members of the consortium hold patents
that are essential to DVD technology, and have requested that such
companies pay license royalties for the use of the technology covered by
the 3C patents.
o A letter dated September 12, 2000 from a third party to one of our
customers who distributes our product claims infringement of a Japanese
utility model patent regarding Internet terminals which can be coupled to a
television set. This third party is seeking a license agreement as a
resolution. We have requested more time to respond and are accumulating
prior art to invalidate the utility model patent.
o A third party has asserted that some of our products infringe one or more
of such third party's patents in the field of all format decoders. The
third party has stated that it was prepared to license the relevant patents
to us on favorable terms. We have been in discussions with such third
party. The third party may seek compensation from us related to this
matter. We do not know if this party has contacted any of our customers
regarding this matter. If so, our customers may in the future seek
compensation or indemnification from us arising out of the third party's
claims. No claim for such payments has been made to date. We have not
determined whether and to what extent that the patents held by the third
party are valid and whether and to what extent our products are covered by
their patents.
We may be liable to some of our customers for damages that they incur in
connection with intellectual property claims. Some of our license agreements,
including many of the agreements we have entered into with our large PC OEM
customers, contain warranties of non-infringement and/or commitments to
indemnify our 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, and others.
These commitments may require us to indemnify or pay damages to our customers
for all or a portion of any license fees or other damages, including attorneys'
fees, they are required to pay or agree to pay these or other third parties. We
have received notices of up to an aggregate of five million dollars asserting
rights under the indemnification provisions and warranty provisions of our
license agreements from several customers. We may be required to pay substantial
damages with respect to such indemnification assertions.
We may be required to pay substantial damages and may be restricted or
prohibited from selling our digital media products if it is proven that we
violate the intellectual property rights of others. If MPEG LA, DVD6C, 3C, or
any other third party proves that our digital media technology infringes its
proprietary rights, we may be required to pay substantial damages for past
infringement.
65
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In addition to the claims described above, we may receive notices of claims of
infringement of other parties' proprietary rights. 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.
It may be difficult to raise needed capital in the future, which could
significantly harm our business
We may require substantial additional capital to finance our future growth and
fund our ongoing research and development activities beyond 2002. Our capital
requirements will depend on many factors, including:
o acceptance of and demand for our products;
o the number and timing of acquisitions and the cost of such acquisitions;
o the costs of developing new products;
o the costs associated with our expansion; and
o the extent to which we invest in new technology and research and
development projects.
Although our current business plan does not foresee the need for further
financing to fund our operations for the next two years, due to risks and
uncertainties in the market place as well as a potential of pursuing further
acquisitions, we may need to raise additional capital. Additionally, to the
extent that the proceeds from the dispositions of our CE and IA assets are
exhausted, and if our existing sources of cash and cash flow from operations, if
any, are insufficient to fund our activities, we may need to raise additional
funds. If we issue additional stock to raise capital, your percentage ownership
in Axeda would be reduced. Additional financing may not be available when needed
and, if such financing is available, it may not be available on terms favorable
to us.
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AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Uncertainties exist regarding our stock repurchase program
On September 27, 2001, we announced that our Board of Directors had approved the
repurchase of up to $10 million worth of our outstanding shares of common stock.
We indicated that we expected to complete these purchases over the next 12
months. Stock repurchase activities are subject to certain pricing restrictions,
stock market forces, management discretion and various regulatory requirements.
As a result, there can be no assurance as to the timing and/or amount of shares
that we may repurchase under this stock repurchase program. From September 2001
to December 2001, we repurchased 383,800 shares for an aggregate cost of
approximately $0.6 million including commissions, at an average market price per
share of approximately $1.58. No shares were repurchased under the program in
the six months ending June 30, 2002.
Failure to comply with NASDAQ's listing standards could result in our delisting
by NASDAQ from the NASDAQ National Market and severely limit the ability to sell
any of our common stock.
Our stock is currently traded on the NASDAQ National Market. Under NASDAQ's
listing maintenance standards, if the closing bid price of our common stock is
under $1.00 per share for 30 consecutive trading days, NASDAQ may choose to
notify us that it may delist our common stock from the NASDAQ National Market.
If the closing bid price of our common stock does not thereafter regain
compliance for a minimum of 10 consecutive trading days during the 90 days
following notification by NASDAQ, NASDAQ may delist our common stock from
trading on the NASDAQ National Market. The trading price of our stock is
currently below $1.00. There can be no assurance that our common stock will
remain eligible for trading on the NASDAQ National Market. If our stock were
delisted, the ability of our stockholders to sell any of our common stock at all
would be severely, if not completely, limited.
Stock-based compensation will negatively affect our operating results
We have recorded deferred compensation in connection with the grant of stock
options to employees where the option exercise price is less than the estimated
fair value of the underlying shares of common stock as determined for financial
reporting purposes. We have recorded deferred compensation, net of forfeitures,
within stockholders' equity of $2.3 million at June 30, 2002, which is being
amortized over the vesting period of the related stock options, ranging from one
to four years. A balance of $0.9 million remains at June 30, 2002 and will be
amortized as follows: $0.3 million in 2002; $0.5 million in 2003; and $0.1
million in 2004.
The amount of stock-based compensation in future periods will increase if we
grant stock options where the exercise price is less than the quoted market
price of the underlying shares or if we modify the terms of existing stock
options. The amount of stock-based compensation amortization in future periods
could decrease if options for which accrued, but unvested deferred compensation
has been recorded, are forfeited.
67
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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
several countries outside the United States, including Israel, France, Holland,
the United Kingdom, Latin America and all of Asia. Our operations outside the
United States include facilities located in Israel, France, Holland, the United
Kingdom and Japan. For the six months ended June 30, 2002, we derived
approximately 60% of our revenues, respectively, 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. We intend to expand our international operations in the future.
Significant management attention and financial resources are needed 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:
o legal uncertainty regarding liability;
o language barriers in business discussions;
o cultural differences in the negotiation of contracts and conflict
resolution;
o time zone differences;
o reduced protection for intellectual property rights in some countries;
o differing labor regulations;
o tariffs, trade barriers and other regulatory barriers;
o problems in collecting accounts receivable;
o political and economic instability;
o changes in diplomatic and trade relationships;
o seasonal reductions in business activity;
o potentially adverse tax consequences;
o changes in a country's or region's political or economic conditions;
o complexity and unexpected changes in local laws and regulations;
o greater difficulty in staffing and managing foreign operations; and
o increased financial accounting and reporting burdens and complexities.
68
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to risks associated with doing business in the State of Israel
Conditions in Israel may affect our operations. Our subsidiary Axeda Systems,
Ltd. (formerly eMation, Ltd.) is incorporated in Israel. We have an office and
approximately 26 employees in Israel and approximately 2% of our sales were made
to customers in Israel for both the three and six months ended June 30, 2002.
Our Axeda Supervisor products (formerly known as WizFactory), are developed in
Israel.
We are directly influenced by the political, economic, and military conditions
affecting Israel and the Middle East. Therefore, any major hostilities involving
Israel or the interruption or curtailment of trade between Israel and its
present trading partners could have a material adverse effect on our operations.
We are subject to conditions attached to governmental grants we have received
In the past, eMation was the beneficiary of certain governmental grants from
government agencies in Israel to encourage development and marketing of
technology under certain conditions. We do not expect to apply for additional
grants of this nature in the future. Through June 30, 2002, eMation received
grants from the Office of the Chief Scientist ("OCS") in the aggregate amount of
$1.8 million and paid royalties to the OCS in the aggregate amount of $1.4
million. As of June 30, 2002, $0.08 million of the remaining potential $0.4
million of principal liability is accrued in other current liabilities. eMation
is obligated to pay royalties of 3.0% to 3.5% of revenues derived from sales of
products funded through grants received from the Office of the Chief Scientist.
The terms of the Office of the Chief Scientist grants require that eMation
manufacture its products that are developed with such grants in Israel. In
addition, eMation 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, through June 30, 2002 eMation received grants from the Israeli
Government through the Fund for the Encouragement of Marketing Activities in the
aggregate amount of $1.2 million and paid royalties in the aggregate amount of
$0.5 million. As of June 30, 2002, $0.6 million of the remaining potential $0.9
million of principal liability is accrued in other current liabilities. eMation
is obligated to pay royalties of 4.0% of revenues derived from sales of products
which result from grants received through the Fund for the Encouragement of
Marketing Activities.
We face risks from the uncertainties of any future governmental regulation
Many of the industries in which our products are used are subject to U.S. and
foreign governmental regulation. We are not currently subject to direct
regulation by any domestic or foreign governmental agency (excluding regulation
by governmental agencies in Israel that have provided grants to us), other than
regulations applicable to businesses generally. However, it is possible that
future laws and regulations may be adopted that regulate our products and the
industries in which they are sold. Our business could be harmed by any new
legislation or regulation, the application of laws and regulations from
jurisdictions whose laws do not currently apply to our business, or the
application of existing laws and regulations to our products and the industries
in which they are sold.
69
AXEDA SYSTEMS INC.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Because of their significant stock ownership, our officers and directors can
exert significant control over our future direction
As of June 30, 2002, our executive officers, directors and entities affiliated
with them, in the aggregate, beneficially owned approximately 6.8 million
shares, or approximately 25% 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
The board of directors has the authority without any further vote or action on
the part of our stockholders to issue up to 5,000,000 shares of preferred stock
and to determine the price, rights, preferences, privileges and restrictions of
the preferred stock. This preferred stock, if it is ever issued, may have
preference over and harm the rights of the holders of our common stock. Although
the issuance of this preferred stock will provide us with flexibility in
connection with possible acquisitions and other corporate purposes, this
issuance may make it more difficult for a third party to acquire a majority of
our outstanding voting stock. We currently have no plans to issue preferred
stock.
Our certificate of incorporation and by-laws include provisions that may have
the effect of deterring an unsolicited offer to purchase our stock. These
provisions, coupled with the provisions of the Delaware General Corporation Law,
may delay or impede a merger, tender offer or proxy contest involving us.
Furthermore, our board of directors is divided into three classes, only one of
which is elected each year. Directors are only capable of being removed by the
affirmative vote of 66 2/3% or greater of all classes of voting stock. These
factors may further delay or prevent a change of control.
We may not be able to compete effectively in the Internet-related products and
services market.
Our DRM solutions communicate through public and private networks over the
Internet. The success of our products may depend, in part, on our ability to
continue developing products that are compatible with the Internet. We cannot
predict with any assurance whether the demand for Internet-related products and
services will increase or decrease in the future. The increased commercial use
of the Internet could require substantial modification and customization of our
products and the introduction of new products.
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 and distribution of our software. If these
critical issues are not favorably resolved, our business, financial condition or
results of operations could be materially and adversely affected.
Our business is subject to changes in financial accounting standards, which may
affect our reported revenue, or the way we conduct business
We prepare our financial statements in conformity with accounting principles
generally accepted in the United States of America ("GAAP"). GAAP are subject to
interpretation by the Financial Accounting Standards Board, the American
Institute of Certified Public Accountants ("AICPA"), the SEC and various bodies
appointed by these organizations to interpret existing rules and create new
accounting policies. In particular, a task force of the Accounting Standards
Executive Committee, a subgroup of the AICPA, meets on a quarterly basis to
review various issues arising under the existing software revenue recognition
rules, and interpretations of these rules. Additional interpretations issued by
the task force may have an adverse effect on how we report revenue or on the way
we conduct our business in the future.
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AXEDA SYSTEMS INC.
LEGAL PROCEEDINGS
PART II: OTHER INFORMATION
Item 1: LEGAL PROCEEDINGS
Between February and April 2000, eleven class action lawsuits were filed against
certain of our current and former officers and directors and us 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 Exchange Act of 1933, Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5
promulgated thereunder and seeks unspecified damages on behalf of a purported
class of purchasers of our stock during the period stated above. On July 3,
2000, we filed a motion to dismiss the consolidated and amended class action
complaint. The motion is presently fully briefed and the parties are waiting for
a hearing date to be set for the motion. Certain of our employees and certain
holders of 5% or more of Axeda common stock are members of the putative classes
alleged in these actions and therefore may have interests adverse to us with
respect to the alleged claims in these actions. We believe that such lawsuits or
claims are without merit and that we have meritorious defenses to the actions.
We plan to vigorously defend the litigation. However, failure to successfully
defend these actions could substantially harm our results of operations,
liquidity and financial condition.
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. The lawsuit alleges violations of Sections 11, 12(a)(2) and 15 of the
Securities Exchange Act of 1933 and Section 10(b) of the Securities Exchange Act
of 1934 and Rule 10b-5 promulgated thereunder against one or both of the Company
and the individual defendants. The claims are based on allegations that the
underwriter defendants agreed to allocate stock in the 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. 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. This lawsuit is
part of the massive "IPO allocation" litigation involving the conduct of
underwriters in allocating shares of successful initial public offerings. We
believe that more than one hundred and eighty other companies have been named in
more than eight hundred identical lawsuits that have been filed by some of the
same plaintiffs' law firms. Certain of our employees are members of the putative
classes alleged in these actions and therefore may have interests adverse to us
with respect to the alleged claims in these actions. We believe that such
lawsuit and claims are without merit and that we have meritorious defenses to
the actions. We plan to vigorously defend the litigation. However, failure to
successfully defend this action could substantially harm our results of
operations, liquidity and financial condition.
From time to time, we have received, and expect to continue to receive, notices
of claims of infringement of other parties' proprietary rights and other claims
in the ordinary course of our business. See "FACTORS THAT MIGHT AFFECT FUTURE
RESULTS - We have received notices of claims and might become involved in
litigation over proprietary rights, which could be costly and time consuming."
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AXEDA SYSTEMS INC.
PART II: ITEM 2 - ITEM 5
Item 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) CHANGES IN SECURITIES: NONE
(b) DIVIDENDS:
We have never declared or paid any dividends on our common stock. We do not
anticipate paying any cash dividends in the foreseeable future. We currently
intend to retain future earnings, if any, to finance operations and the
expansion of our business. Any future determination to pay cash dividends will
be at the discretion of the board of directors and will be dependent upon our
financial condition, operating results, capital requirements and such other
factors as the board of directors deems relevant. Moreover, pursuant to
agreements with our lender, we are prohibited from declaring or paying dividends
without the prior written consent of the lender. See "Management's Discussion
and Analysis of Financial Condition and Results the of Operations-Liquidity and
Capital Resources."
(c) USE OF PROCEEDS:
Not applicable.
Item 3: DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Item 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our 2002 Annual meeting was held on June 17, 2002. The following
proposals were submitted to a vote at such meeting: to elect two
directors to serve for a three-year term ending in the year 2005 or
until their successors are duly elected and qualified; to approve an
amendment to our 1999 Stock Incentive Plan to increase the number of
shares authorized for issuance over the term of the plan (prior to any
future automatic increase) by an additional 500,000 shares; and to
ratify the appointment of KPMG LLP as our independent auditors for the
year ending December 31, 2002. The results of the votes on these
matters are disclosed below.
Votes Withheld or
-------------------------------------------------
Votes For Against or
Withheld Abstain
-------------- ------------- -------------
Directors
Paul A. Vais ............. 21,221,115 675,986 --
James R. McDonald ........ 21,229,595 667,506 --
Amend 1999 Stock Incentive
Plan .................... 20,744,122 1,130,856 22,123
Ratify appointment of KPMG
LLP...................... 21,726,124 46,049 124,928
Item 5: OTHER INFORMATION
None.
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AXEDA SYSTEMS INC.
EXHIBITS AND REPORTS ON FORM 8-K
Item 6:
(a) Exhibits
Exhibit Number Exhibit Title
10.44* Software Distribution Agreement, dated May 24, 2002, by and between Sonics IP, Inc. and
AXEDA SYSTEMS, Inc., RAVISENT I.P., Inc and RAVISENT OPERATING COMPANY, Inc.
* Filed herewith
(b) The following reports were filed on Form 8-K during this period:
On June 14, 2002 Axeda filed a Form 8-K to announce that it entered
into an agreement under which we will license Ravisent Technologies'
digital media technologies to Sonic Solutions and exit the digital
media market.
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AXEDA SYSTEMS INC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange
Act of 1934, as amended, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the city of
Malvern, Commonwealth of Pennsylvania on this 13th day of August 2002.
August 13, 2002
Axeda Systems Inc.
/s/ Thomas J. Fogarty
- ---------------------
Thomas J. Fogarty,
Executive Vice President and Chief Financial Officer
74