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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
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Commission File Number 000-23597
EXTENDED SYSTEMS INCORPORATED
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 82-0399670
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5777 NORTH MEEKER AVENUE, BOISE, ID 83713
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (208) 322-7575
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [_] No [X]
The number of shares outstanding of the Registrant's Common Stock as of
September 30, 2003, was 14,040,230.
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EXTENDED SYSTEMS INCORPORATED
FORM 10-Q
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
--------------------
Condensed Consolidated Balance Sheets
as of September 30, 2003 and June 30, 2003 ..................... 3
Condensed Consolidated Statements of Operations
for the Three Months Ended September 30, 2003 and 2002 ......... 4
Condensed Consolidated Statements of Comprehensive Loss
for the Three Months Ended September 30, 2003 and 2002 ......... 4
Condensed Consolidated Statements of Cash Flows
for the Three Months Ended September 30, 2003 and 2002 ......... 5
Notes to Condensed Consolidated Financial Statements ........... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations .................. 15
---------------------------------------------
Item 3. Quantitative and Qualitative Disclosures about Market Risk ..... 33
----------------------------------------------------------
Item 4. Controls and Procedures ........................................ 33
-----------------------
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .............................................. 34
-----------------
Item 6. Exhibits and Reports on Form 8-K ............................... 35
--------------------------------
(Items 2,3, 4 and 5 of Part II are not applicable
and have been omitted)
SIGNATURES ..................................................... 36
CERTIFICATIONS
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
--------------------
EXTENDED SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
(unaudited)
SEPTEMBER 30, JUNE 30,
2003 2003
------------ ------------
ASSETS
Current:
Cash and cash equivalents ................................................. $ 7,811 $ 3,502
Receivables, net of allowances of $838 and $831 ........................... 5,868 5,644
Prepaids and other ........................................................ 814 966
------------ ------------
Total current assets ................................................... 14,493 10,112
Property and equipment, net .................................................. 5,192 5,293
Goodwill ..................................................................... 12,489 12,489
Intangibles, net ............................................................. 1,009 1,197
Other long-term assets ....................................................... 142 --
------------ ------------
Total assets ........................................................... $ 33,325 $ 29,091
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current:
Accounts payable .......................................................... $ 2,678 $ 2,314
Accrued expenses .......................................................... 3,079 2,888
Deferred revenue .......................................................... 2,570 2,961
Accrued restructuring ..................................................... 957 722
Current portion of long-term debt ......................................... 434 434
Current portion of capital leases ......................................... 23 22
------------ ------------
Total current liabilities .............................................. 9,741 9,341
Non-current:
Long-term debt ............................................................ 5,017 325
Capital leases ............................................................ 36 42
Other long-term liabilities ............................................... 133 127
------------ ------------
Total non-current liabilities .......................................... 5,186 494
------------ ------------
Total liabilities ...................................................... 14,927 9,835
Commitments and contingencies--Note 11
Stockholders' equity:
Preferred stock; $0.001 par value per share, 5,000 shares authorized;
no shares issued or outstanding ........................................ -- --
Common stock; $0.001 par value per share, 75,000 shares authorized;
14,040 and 13,977 shares issued and outstanding ........................ 14 14
Additional paid-in capital ................................................ 45,117 44,481
Treasury stock; $0.001 par value per share, 261 and 261 common shares...... -- --
Accumulated deficit ....................................................... (25,319) (23,884)
Accumulated other comprehensive loss ...................................... (1,414) (1,355)
------------ ------------
Total stockholders' equity ............................................. 18,398 19,256
------------ ------------
Total liabilities and stockholders' equity ............................. $ 33,325 $ 29,091
============ ============
The accompanying notes are an integral part of
the condensed consolidated financial statements.
3
EXTENDED SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2003 2002
------------ ------------
Revenue:
License fees and royalties ................................................ $ 5,771 $ 4,989
Services and other ........................................................ 1,784 920
------------ ------------
Total net revenue ...................................................... 7,555 5,909
Costs and expenses:
Cost of license fees and royalties ........................................ 271 272
Cost of services and other ................................................ 951 545
Research and development .................................................. 1,552 1,953
Acquired in-process research and development............................... -- 430
Marketing and sales ....................................................... 3,599 3,289
General and administrative ................................................ 1,613 1,124
Restructuring charges ..................................................... 1,068 136
------------ ------------
Total costs and expenses ............................................... 9,054 7,749
Loss from operations ................................................... (1,499) (1,840)
Other expense (income), net .................................................. (60) 26
Interest expense ............................................................. 34 130
------------ ------------
Loss before income taxes ............................................... (1,473) (1,996)
Income tax provision (benefit) ............................................... 4 (4)
------------ ------------
Loss from continuing operations ........................................ (1,477) (1,992)
Discontinued operations, net of tax:
Income from discontinued operations .................................... 41 28
------------ ------------
Net loss ............................................................... $ (1,436) $ (1,964)
============ ============
Basic and diluted loss per share:
Loss from continuing operations ........................................... $ (0.11) $ (0.16)
Earnings from discontinued operations ..................................... 0.01 0.00
------------ ------------
Net loss per share ........................................................... $ (0.10) $ (0.16)
============ ============
Number of shares used in per share calculations:
Basic and diluted ......................................................... 14,011 12,096
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
SEPTEMBER 30,
------------------------------
2003 2002
------------ ------------
Net loss...................................................................... $ (1,436) $ (1,964)
Change in currency translation................................................ (57) 39
------------ ------------
Comprehensive loss......................................................... $ (1,493) $ (1,925)
============ ============
The accompanying notes are an integral part of
the condensed consolidated financial statements.
4
EXTENDED SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
THREE MONTHS ENDED SEPTEMBER 30,
------------------------------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .................................................................. $ (1,436) $ (1,964)
Adjustments to reconcile net loss to net cash used by operating activities:
Provision for bad debts ................................................ 21 60
Provision for write-down of inventory .................................. -- 86
Depreciation and amortization .......................................... 446 451
Stock compensation ..................................................... 437 --
Acquired in-process research and development ........................... -- 430
Other .................................................................. -- 184
Changes in assets and liabilities, net of effect of acquisitions:
Receivables ......................................................... (100) 385
Prepaids and other assets ........................................... (28) (316)
Accounts payable and accrued expenses ............................... 648 294
Deferred revenue .................................................... (414) (347)
------------ ------------
Net cash used by operating activities ............................. (426) (737)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment ........................................ (153) (5)
Acquisition - ViaFone ..................................................... -- 1,119
Other investing activities ................................................ 19 150
------------ ------------
Net cash (used) provided by investing activities .................. (134) 1,264
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale-and-leaseback of building .............................. 4,800 --
Proceeds from the issuance of common stock ................................ 180 --
Payments on long-term debt ................................................ (114) (60)
------------ ------------
Net cash provided (used) by financing activities .................. 4,866 (60)
Effect of exchange rate changes on cash ................................... 3 39
------------ ------------
Net increase in cash and cash equivalents ................................. 4,309 506
CASH AND CASH EQUIVALENTS:
Beginning of period ....................................................... 3,502 5,439
------------ ------------
End of period ............................................................. $ 7,811 $ 5,945
============ ============
The accompanying notes are an integral part of
the condensed consolidated financial statements.
5
EXTENDED SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------
(unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements include Extended
Systems Incorporated, a Delaware corporation, and its subsidiaries. We have
eliminated all significant intercompany accounts and transactions. Tabular
amounts are in thousands, except years, percentages and per share amounts.
We have prepared these condensed consolidated financial statements without audit
pursuant to the rules and regulations of the Securities and Exchange Commission
(the "SEC"). In the opinion of management, these unaudited condensed
consolidated financial statements include all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of our financial
position as of September 30, 2003, and our results of operations and cash flows
for the three months ended September 30, 2003 and September 30, 2002. The
results for these interim periods are not necessarily indicative of the expected
results for any other interim period or the year ending June 30, 2004. These
condensed consolidated financial statements should be read in conjunction with
our audited consolidated financial statements and related notes thereto included
in our Annual Report on Form 10-K for the fiscal year ended June 30, 2003. The
condensed consolidated balance sheet at June 30, 2003 was derived from audited
financial statements but does not include all the information and footnotes
required by generally accepted accounting principles for complete financial
statements.
The preparation of financial statements in conformity with generally accepted
accounting principles requires that we make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of our financial statements. It
also requires that we make estimates and assumptions that affect the reported
amounts of our revenue and expenses during the reporting periods. Our actual
results could differ from those estimates.
As a result of discontinuing our infrared hardware business in the first quarter
of fiscal 2003, we have reclassified our condensed consolidated statement of
operations and other related disclosures for all periods presented to present
the results of these businesses as discontinued operations. We have made other
reclassifications to the condensed consolidated financial statements to conform
the presentations. These reclassifications had no impact on the net loss for the
years presented.
We have a history of incurring losses from operations and have an accumulated
deficit of approximately $25.3 million as of September 30, 2003. For the quarter
ended September 30, 2003, we incurred a loss from operations of approximately
$1.4 million, and negative cash flows from operations of approximately $426,000.
At September 30, 2003, we had cash and cash equivalents of $7.8 million.
Subsequent to that date we closed the sale of our excess land adjacent to our
headquarters building in Boise, generating additional net cash proceeds of $1.5
million. Management believes that our existing working capital and borrowing
capacity, the funds we have generated from the property transaction and the
funds we expect to generate from our operations will be sufficient to fund our
anticipated working capital and capital expenditure requirements through at
least September 30, 2004.
Management cannot be certain, however, that the underlying assumed levels of
revenues and expenses will be accurate. If operating results were to fail to
meet management's expectations, we could be required to seek additional sources
of liquidity. These sources of liquidity could include raising funds through
public or private debt financing, borrowing against our line of credit or
offering additional equity securities. If additional funds are raised through
the issuance of equity securities, substantial dilution to our stockholders
could result. In the event additional funds are required, adequate funds may not
be available when needed or may not be available on favorable terms, which could
have a negative effect on our business and results of operations.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING CHANGES. In January 2003, the FASB issued Interpretation No. 46 ("FIN
46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No.
51." FIN 46 requires certain variable interest entities to be consolidated by
the primary beneficiary of the entity if the equity investors in the entity do
not have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period ending after December 15, 2003. We believe we have no
investment in or contractual relationship or other business relationship with a
6
variable interest entity, and therefore, the adoption of this interpretation did
not have any impact on our financial position or results of operations.
CURRENCY TRANSLATION. Our international subsidiaries use their local currency as
their functional currency. We translate assets and liabilities of international
subsidiaries into U.S. dollars using exchange rates in effect at the balance
sheet date, and we report gains and losses from this translation process as a
component of comprehensive income or loss. We translate revenue and expenses
into U.S. dollars using the average exchange rate for the period.
From time to time, we enter into foreign currency forward contracts, typically
against the Canadian dollar, euro and the British pound sterling to manage
fluctuations in the value of foreign currencies on transactions with our
international subsidiaries, thereby limiting our risk that would otherwise
result from changes in currency exchange rates. While these instruments are
subject to fluctuations in value, these fluctuations are generally offset by
fluctuations in the value of the underlying asset or liability being managed.
These forward contracts do not qualify for hedge accounting under SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, and, as such, the
contracts are recorded in the consolidated balance sheet at fair value. We
report a net currency gain or loss based on changes in the fair value of forward
contracts combined with the changes in fair value of the underlying asset or
liability being managed. As of September 30, 2003, we had no forward contracts
in place. As of September 30, 2002, we had forward contracts with a nominal
value of $4.6 million in place against the Canadian dollar, euro and British
pound sterling, which matured within 30 days. We recognized a net currency
exchange gain of $59,000 for the quarter ended September 30, 2003 and a net
currency exchange loss of $55,000 for the three months ended September 30, 2002.
EARNINGS OR LOSS PER SHARE. We compute basic earnings or loss per share by
dividing net income or loss by our weighted average number of common shares
outstanding during the period. We compute diluted earnings or loss per share by
dividing net income or loss by the weighted average number of common shares
outstanding increased by the additional common shares that would be outstanding
if we had issued the potential dilutive common shares. We exclude from the
diluted earnings or loss per share computations stock options and warrants to
the extent that their effect would have been antidilutive.
Our diluted earnings or loss per share computations exclude the following common
stock equivalents as the impact of their inclusion would have been antidilutive
for the three months ended September 30:
2003 2002
-------- --------
Stock options........................................ 3,314 3,257
Warrants............................................. 35 35
NOTE 3. STOCK-BASED COMPENSATION PLANS
We apply Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and its related interpretations to measure compensation
expense for stock-based compensation plans. If compensation expense for our
stock option plans had been determined under SFAS No. 123, our net loss would
have been equal to the proforma amounts indicated below for the three months
ended September 30:
2003 2002
-------- --------
Net loss attributed to common shares, as reported.... $ (1,436) $ (1,964)
Add:
Stock-based employee compensation expense included
in reported net income, net of tax effects ....... 437 --
Less:
Stock-based employee compensation expense determined
under a fair value based method for all grants,
net of tax effects................................ (1,136) (1,262)
-------- --------
Net loss attributable to common shares, proforma..... $ (2,135) $ (3,226)
Basic and diluted loss per share:
Net loss, as reported............................. $ (0.10) $ (0.16)
Net loss, proforma................................ $ (0.15) $ (0.26)
7
We determined the fair value of options at the date of grant using the
Black-Scholes option-pricing model. We assumed no future dividends would be
paid. The other weighted-average assumptions and the weighted-average fair
values of stock options are as follows for the three months ended September 30:
2003 2002
-------- --------
Risk-free interest rate:
Option plans...................................... 4.04% 4.55%
Expected life in years:
Option plans...................................... 7.6 7.6
Volatility factor.................................... 101.7% 102.7%
Dividend yield....................................... 0% 0%
NOTE 4. DISCONTINUED OPERATIONS
In the first quarter of fiscal 2003, we adopted a formal plan to exit our
infrared hardware business as a result of an expected decline in sales of these
products and our desire to increase our focus on our core software businesses.
As a part of that plan, we wrote down our infrared hardware inventory to its
estimated net realizable value. Additionally, in June 2002, we sold our
wholly-owned subsidiary, Extended Systems Singapore Pte Limited. The results of
these operations have been accounted for as discontinued operations for all
periods presented in accordance with SFAS No. 144 and Accounting Principles
Bulletin No. 30. Amounts in the financial statements and related notes for all
periods shown have been reclassified to reflect the discontinued operations.
Operating results for the discontinued operations are reported, net of tax,
under "Income (loss) from discontinued operations" on the accompanying Condensed
Consolidated Statements of Operations.
The following summarizes the results of discontinued operations for the three
months ended September 30:
2003 2002
-------- --------
Net revenue.......................................... $ 140 $ 320
Gross profit......................................... 69 44
Income before income taxes........................... 64 44
Income tax provision................................. 23 16
Income from discontinued operations, net of taxes.... 41 28
Earnings per share from discontinued operations:
Basic and diluted.................................. .01 --
NOTE 5. RESTRUCTURING CHARGES
We recorded $1,073,000 in workforce reduction costs during the three months
ended September 30, 2003, of which $1,068,000 was related to continuing
operations and $5,000 was related to our discontinued operations. The
restructuring charges consist primarily of severance, benefits, and other costs
related to the resignation of Steven Simpson, our former President and Chief
Executive Officer, and the termination of 10 employees from our marketing and
sales, research and development, administration and operations groups. Of the
terminated employees, seven were located in the United States and three were in
Europe. The restructuring charge includes $437,000 of non-cash compensation
resulting from the accelerated vesting of employee stock options that is not
included in the table below.
A summary of accrued restructuring charges is as follows:
Workforce Facilities
Reduction and Other
Costs Costs Total
-------- -------- --------
Balance at June 30, 2003 ............................ $ 188 $ 534 $ 722
Costs incurred in first quarter of fiscal 2004....... 636 -- 636
Cash payments ....................................... (255) (146) (401)
-------- -------- --------
Balance at September 30, 2003 ....................... $ 569 $ 388 $ 957
======== ======== ========
8
NOTE 6. GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS
Goodwill is reviewed annually for impairment or more frequently if indicators of
impairment arise. We completed our annual impairment assessment in the fourth
quarter of fiscal 2003 and concluded that goodwill was not impaired.
Goodwill and other identified intangible assets relate to our acquisition of
Rand Software Corporation in 1998, Oval (1415) Limited in 1999, and AppReach and
ViaFone Inc. in 2002. Our goodwill and other identifiable intangible assets
consist of the following:
AS OF SEPTEMBER 30, 2003 AS OF JUNE 30, 2003
---------------------------------------- ----------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
---------- ---------- ---------- ---------- ---------- ----------
Goodwill ...................... $ 12,489 $ -- $ 12,489 $ 12,489 $ -- $ 12,489
Purchased technology........... 3,691 (2,745) 946 3,691 (2,561) 1,130
Customer relationships......... 80 (17) 63 80 (13) 67
Non-compete covenants.......... 6 (6) -- 6 (6) --
Other ......................... 5 (5) -- 5 (5) --
---------- ---------- ---------- ---------- ---------- ----------
Total ......................... $ 16,271 $ (2,773) $ 13,498 $ 16,271 $ (2,585) $ 13,686
========== ========== ========== ========== ========== ==========
Amortization of other intangible assets, reported as a component of cost of net
revenue, was $188,000 and $160,000 for the quarters ended September 30, 2003 and
2002, respectively. Based on the identified intangible assets recorded at
September 30, 2003, the estimated future amortization expense for the remaining
nine months of fiscal 2004, and fiscal 2005, 2006, 2007 and 2008 is $432,000,
$204,000, $172,000, $172,000, and $28,000, respectively.
NOTE 7. BUSINESS COMBINATIONS
VIAFONE, INC. In August 2002, we completed our acquisition of ViaFone. ViaFone
was a privately-held, leading provider of real-time, mobile platform and mobile
application modules that connect field sales and service employees with critical
business systems, information and processes of their enterprise. As a result of
the acquisition, we expect to benefit from the licensing of ViaFone's software
technology and from the addition of an experienced professional services
organization. We also expect to benefit from the strong cross-selling
opportunities present within each company's customer base and strategic
relationships. The adjusted total purchase price of $10.6 million consisted of
$9.9 million of Extended Systems common stock (2,550,000 shares issued based on
the average stock price for the five trading days surrounding May 28, 2002) and
$0.7 million of direct transaction costs. The total purchase price decreased by
$87,000 in the second quarter of fiscal 2003 due to an $87,000 decrease in
direct transaction costs resulting from the true-up of accrued transaction costs
at the time of payment. In exchange for the Extended Systems common stock
issued, all outstanding shares of ViaFone common and preferred stock were
acquired. As part of the acquisition agreement, an additional 450,000 shares of
Extended Systems common stock were issued to shareholders of ViaFone and placed
in an escrow fund for a period of up to one year to be used as the exclusive
source of reimbursement to us for breaches of certain terms of the agreement,
including, among other provisions, failure of ViaFone to achieve certain revenue
and net loss targets for the nine months ended September 30, 2002. ViaFone did
not meet these revenue and net loss targets, and all 450,000 shares held in
escrow were returned to us in December 2002 to satisfy our claims against the
escrow. In accordance with the applicable provisions of the Delaware General
Corporation Law, all 450,000 shares automatically became treasury stock.
The transaction was accounted for as a purchase pursuant to SFAS No. 141. The
purchase price was allocated as follows:
AMORTIZATION
PERIOD AMOUNT
---------- ----------
Existing technology........................... 5 yrs. $ 780
In-process research and development........... n/a 430
Net tangible assets/liabilities (1)........... n/a (1,041)
Customer relationships........................ 5 yrs. 80
Goodwill (2).................................. n/a 10,410
----------
Purchase price (3)............................ $ 10,659
==========
9
(1) This amount reflects a net adjustment of $111,000 in the second quarter, a
net adjustment of $346,000 in the third quarter and a net adjustment of
$17,000 in the fourth quarter to the fair values of certain assets acquired
and liabilities assumed from ViaFone.
(2) This amount reflects a reduction in accrued direct acquisition costs of
$87,000 and net adjustments to the fair values of certain assets acquired
and liabilities assumed from ViaFone in the second, third and fourth
quarters of fiscal 2003 of $111,000, $346,000 and $17,000 respectively.
(3) This amount reflects a reduction in accrued direct acquisition costs of
$87,000.
The adjusted estimated fair value of tangible assets acquired and liabilities
assumed as of the purchase date are as follows:
Current assets................................ $ 4,722
Property and equipment........................ 589
----------
Total assets acquired......................... 5,311
Current liabilities........................... (4,943)
Deferred revenue.............................. (491)
Non-current liabilities....................... (918)
----------
Net tangible assets acquired.................. $ (1,041)
==========
Pursuant to SFAS No. 142, goodwill related to the acquisition is not amortized
and is tested at least annually for impairment. This goodwill is not deductible
for tax purposes.
The purchased in-process research and development was charged to operations at
the time of acquisition as it had not yet reached technological feasibility and
had no alternative future use. The value assigned to in-process research and
development was determined by estimating the costs to develop the purchased
in-process research and development into a commercially viable product,
estimating the resulting net cash flows from sale of those products once
commercially viable, and discounting the net cash flows to their present values
using discount rates of either 19% or 21%, depending on the technology. These
rates were based on the industry segment for the technology, the nature of the
products to be developed, the length of time to complete development, and the
overall maturity and history of the development team. The in-process research
and development percentage of completion was estimated to range from 50% to 80%.
As of June 30, 2003, the projects in process at the time of acquisition had been
completed with no material differences in the cost to complete from that
originally estimated.
AS OF AS OF
SEPTEMBER 30, JUNE 30,
NOTE 8. RECEIVABLES 2003 2003
---------- ----------
Accounts receivable........................... $ 6,519 $ 6,338
Other receivables............................. 151 98
Allowance for doubtful accounts............... (802) (792)
---------- ----------
$ 5,868 $ 5,644
========== ==========
AS OF AS OF
SEPTEMBER 30, JUNE 30,
NOTE 9. PROPERTY AND EQUIPMENT 2003 2003
---------- ----------
Land and land improvements.................... $ 1,007 $ 1,007
Buildings..................................... 5,944 5,798
Computer equipment............................ 5,707 5,702
Furniture and fixtures........................ 2,322 2,308
---------- ----------
14,980 14,815
Less accumulated depreciation................. (9,788) (9,522)
---------- ----------
$ 5,192 $ 5,293
========== ==========
10
AS OF AS OF
SEPTEMBER 30, JUNE 30,
NOTE 10. ACCRUED EXPENSES 2003 2003
---------- ----------
Accrued payroll and related benefits.......... $ 1,522 $ 1,336
Accrued warranty and support costs............ 147 141
Other 1,410 1,411
---------- ----------
$ 3,079 $ 2,888
========== ==========
NOTE 11. COMMITMENTS AND CONTINGENCIES
COMMITMENTS. We currently lease office space at our locations in Boise, Idaho;
Herrenberg, Germany; Toronto, Canada; Corvallis, Oregon; Paris, France; Bristol,
England; San Diego, California; American Fork, Utah; and `s-Hertogenbosch, the
Netherlands. We also lease certain equipment under non-cancelable operating and
capital leases. Lease expense under operating lease agreements was $227,000 and
$156,000 for the three months ended September 30, 2003 and 2002, respectively.
On September 26, 2003, we closed a transaction with Hopkins Financial Services
for the sale-and-leaseback of our headquarters building and land in Boise,
Idaho. Because we have a 10-year option to repurchase the building and land at a
price of $5.1 million and we sublet more than a small portion of the building
space, the sale-and-leaseback was recorded as a financing transaction and is
shown as $4.8 million of long-term debt on our balance sheet at September 30,
2003. As part of the agreement, we entered into a 10-year master lease for the
building with annual lease payments equal to 9.2% of the sale price. We are also
obligated to pay all expenses associated with the building during our lease,
including the costs of property taxes, insurance, operating expenses and
repairs.
On October 24, 2003, we entered into a lease termination agreement with
Epinions.com, the lessor of our office space in Brisbane, California. In
exchange for a termination fee of $255,000 to be paid in seven equal monthly
installments from November 2003 to May 2004, our lease was terminated on October
31. As part of the termination agreement, Epinions.com agreed to release us from
the $120,000 letter of credit that secured our rental payments.
Upon completion of our acquisition of ViaFone on August 30, 2002, we assumed
$1.1 million of term debt with Silicon Valley Bank ("SVB"). We restructured that
debt into a term loan due in 30 equal monthly installments bearing interest at
8%. The term loan is collateralized by certain of our assets, requires us to
maintain certain financial ratios and is scheduled to be paid in full by March
2005. At September 30, 2003, the loan balance was $651,000.
Our minimum future contractual commitments associated with our operational
restructuring, indebtedness and lease obligations as of September 30, 2003 are
as follows (in thousands):
YEAR ENDING JUNE 30,
----------------------------------------------------
2004 2005 2006 2007 2008 THEREAFTER TOTAL
-------- -------- -------- -------- -------- -------- --------
Restructuring-related commitments:
Operating leases (1) (3) ........ $ 388 $ -- $ -- $ -- $ -- $ -- $ 388
Other commitments:
SVB debt principal (2) .......... 326 325 -- -- -- -- 651
SVB debt interest ............... 31 11 -- -- -- -- 42
Payment pursuant to building
sale-and-leaseback (2) ........ 331 442 442 442 442 2,317 4,416
Post-retirement benefits ........ 15 15 15 15 15 58 133
Capital leases (2) .............. 21 28 12 7 -- -- 68
Operating leases (3) ............ 535 354 204 170 156 155 1,574
-------- -------- -------- -------- -------- -------- --------
Total other commitments ............ 1,259 1,175 673 634 613 2,530 6,884
-------- -------- -------- -------- -------- -------- --------
Total commitments .................. $ 1,647 $ 1,175 $ 673 $ 634 $ 613 $ 2,530 $ 7,272
======== ======== ======== ======== ======== ======== ========
(1) The restructuring accrual related to the Brisbane lease obligation is
reported as an accrued expense in the current liabilities section.
(2) The term debt and capital leases are reported on the balance sheet as
current and non-current liabilities, depending on the timing of when
payments are due.
11
(3) The Brisbane lease was terminated as of October 31, 2003 in exchange for a
termination fee of $255,000 to be paid over seven equal monthly
installments. This amount is not shown as a commitment as of September 30,
2003. Of the $388,000 Brisbane lease obligation reported as a restructuring
related commitment for 2004, $48,000 was paid in October 2003 and the
balance of $340,000 is no longer due as a result of the lease termination.
Included in the 2004 operating leases commitment of $535,000 is $198,000 of
Brisbane lease obligations, of which $25,000 was paid in October 2003. The
balance of $173,000 is no longer due as a result of the lease termination.
Non-current capital lease obligations are as follows (in thousands):
AS OF
SEPTEMBER 30,
2003
------------
Gross capital lease obligations....................... $ 68
Less imputed interest................................. (9)
------------
Present value of net minimum lease payments........... 59
Less current portion.................................. (23)
------------
Non-current capital lease obligations................. $ 36
============
GUARANTEES. We have provided a letter of credit that secures our rental payments
at our Brisbane, California location. We could be required to perform under this
guarantee if we were to default with respect to any of the terms, provisions,
covenants, or conditions of the lease agreement. This guarantee is renewed
annually for successive one-year terms until the expiration of our lease on May
31, 2004. The maximum potential amount of future payments we could be required
to make under this letter of credit as of September 30, 2003 is $120,000. As
part of the agreement to terminate our lease, our landlord, Epinions.com, agreed
to release us from this guarantee.
We have also provided a guarantee that secures our rental payments at our
Bristol, England location. We could be required to perform under this guarantee
if we were to default with respect to any of the terms, provisions, covenants,
or conditions of the lease agreement. This guarantee is valid until the
expiration of our lease on January 13, 2005. The maximum potential amount of
future payments we could be required to make under this letter of credit as of
September 30, 2003 is approximately $25,000.
INDEMNIFICATIONS. We enter into standard indemnification agreements in our
ordinary course of business. Pursuant to these agreements, we indemnify, defend,
hold harmless, and agree to reimburse the indemnified party for losses suffered
or incurred by the indemnified party in connection with any U.S. patent,
copyright or other intellectual property infringement claim by any third party
with respect to our products. The term of these indemnification agreements is
generally perpetual any time after execution of the agreement. The maximum
potential amount of future payments we could be required to make under these
indemnification agreements is unlimited. To date, we have not incurred costs to
defend lawsuits or settle claims related to these indemnification agreements.
As permitted under Delaware law, we have agreements whereby we indemnify our
officers and directors for certain events or occurrences while the officer or
director is, or was, serving at our request in such capacity. The term of the
indemnification period is for the officer's or director's lifetime. The maximum
potential amount of future payments we could be required to make under these
indemnification agreements is unlimited; however, we have a director and officer
insurance policy that limits our exposure and may enable us to recover a portion
of any future amounts paid. We have not incurred costs to defend lawsuits or
settle claims related to these indemnification agreements.
From time to time we enter into indemnification agreements in our ordinary
course of business with certain service providers, such as financial
consultants, whereby we indemnify such service providers from claims, losses,
damages, liabilities, or other costs or expenses arising out of or related to
their services. The maximum potential amount of future payments we could be
required to make under these indemnification agreements in unlimited. To date,
we have not incurred costs to defend lawsuits or settle claims related to these
indemnifications.
WARRANTIES. We offer warranties on both our software products and discontinued
hardware products. We record an accrual for the estimated future costs
associated with warranty claims based upon our historical experience and our
estimate of future costs. We also include in the warranty reserve an accrual for
the estimated future costs associated with free support that we provide on
certain products. The adequacy of our warranty reserve is reviewed at least
quarterly and if necessary, adjustments are made.
12
The following table reconciles the changes in our warranty reserve for the three
months ended September 30, 2003:
Balance at June 30, 2003.............................. $ 141
Accrual for warranty reserve for sales made during
the three months ended September 30, 2003........... 59
Warranty expirations during the three months ended
September 30, 2003.................................. (53)
------------
Balance at September 30, 2003......................... $ 147
============
LINE OF CREDIT. On January 15, 2002, we entered into a loan and security
agreement with SVB, under which we can access up to $5.0 million of financing in
the form of a demand line of credit. Our borrowing capacity is limited to 75% of
eligible accounts receivable, net of current payments due on our long-term debt.
Certain of our assets collateralize the line of credit. Interest on any
borrowings will be paid at prime plus one percent but not less than 5.5%. The
line of credit agreement requires us to maintain certain financial ratios and
expires on January 15, 2004. As of September 30, 2003, we had no outstanding
borrowings on the line of credit and we were in compliance with all financial
covenants required under the line of credit.
LITIGATION. On April 22, 2002, Pumatech, Inc. filed a patent infringement action
against us in the U.S. District Court in Northern California. An amended
complaint was filed on May 28, 2002. The action alleges that our XTNDConnect
server and desktop synchronization products infringe on seven of Pumatech's
synchronization-related patents, that our alleged use of the trademark
"Satellite Forms" constitutes trademark infringement, and that other alleged
actions constitute unfair competition and interference with contract. The action
seeks an injunction against further sales of our server and desktop
synchronization products and use of the allegedly infringing trademark, as well
as unspecified damages and attorneys' fees. On June 25, 2002, we filed an answer
and counterclaim in response to Pumatech's complaint in which we deny Pumatech's
charges, raise a number of affirmative defenses and request a declaration from
the court that Pumatech synchronization software patents are invalid and not
infringed by our products. On December 11, 2002, Pumatech filed a second amended
complaint, which adds allegations that unspecified synchronization products
infringe an eighth Pumatech patent. On December 31, 2002, we filed an amended
answer and counterclaim in which we deny all of Pumatech's charges, including
this additional charge, and amend our defenses and counterclaims to include this
additional patent. On August 1, 2003 the Honorable Judge D. Lowell Jensen,
United States District Judge, issued his Claims Construction Ruling on the
interpretation, definition, and scope of the claims in the suit. We believe that
the Court's ruling has significantly narrowed claims in five of the Pumatech
patents. The Court also ruled that it could not correct an error that appears in
all asserted claims of Pumatech's '676 patent. This error must be corrected in
reissue proceedings in the Patent Office. Until the Patent Office issues
corrected claims, no synchronization software can infringe the '676 patent, and
it is unlikely that such a correction would have any retroactive effect. As a
result, if any of our products are ultimately held to be infringing this patent,
it is unlikely that Pumatech would be entitled to damages for any period prior
to the reissue date. We have petitioned the U.S. Patent Office for reexamination
of three of the Pumatech patents. The Patent Office has issued an Office Action
for each of the three patents rejecting all Pumatech patent claims over the
prior art for two of the patents and rejecting all claims on which we requested
reexamination for the other patent. As a result of the reexamination process, we
expect the patents to be significantly narrowed or rejected by the Patent Office
in their entirety. If the patents are amended and reissued, and we are
ultimately held to be infringing one of the reissued patents, it is unlikely
that Pumatech would be entitled to damages for any period preceding the reissue
date. Discovery and other pretrial proceedings are on going; trial is currently
scheduled for April 2004.
We believe that we have numerous meritorious defenses to Pumatech's claims and
we intend to continue to defend the suit vigorously. However, litigation is
inherently uncertain, and we may not prevail in our defenses or counterclaims.
If Pumatech prevails in one or more of its claims, we could be required to pay
substantial damages for past sales of infringing products, to cease selling
specific of our server or desktop synchronization products that are held to
infringe a Pumatech patent, to pay royalties on the sales of specific products
that are held to infringe a Pumatech patent, or some combination of these
results. We may also incur significant development costs to redesign certain of
our products to ensure that they are non-infringing. Any of such outcomes could
have a material adverse effect on our business and financial position. In
addition, litigation is frequently expensive and time-consuming, and management
may be required to spend significant time in the defense of the suit; such costs
and the diversion of management time could have a material adverse effect on our
business. The ultimate outcome of any litigation is uncertain and the range of
loss that could occur upon resolution of this matter is not estimable. We cannot
estimate the costs of any potential settlement. Were an unfavorable outcome to
occur, the impact could be material to our financial position, results of
operations, or cash flows.
13
We are also, from time-to-time, a party to legal disputes and proceedings
arising in the ordinary course of general business activities. After taking into
consideration legal counsel's evaluation of such disputes, we do not believe
their outcome will have a material effect on our financial position or results
of operations.
NOTE 12. INCOME TAXES
For the three months ended September 30, 2003, we recorded income tax expense
related primarily to foreign withholding taxes of $27,000. The income tax
expense associated with continuing operations was $4,000 and that associated
with discontinued operations was $23,000. For the three months ended September
30, 2002, we recorded income tax expense related primarily to foreign
withholding taxes of $12,000. The income tax expense associated with
discontinued operations was $16,000. The tax benefit of $4,000 for continuing
operations consists of $12,000 of foreign withholding taxes, offset by a tax
benefit of $16,000.
NOTE 13. BUSINESS SEGMENT, GEOGRAPHIC AREA DATA AND MAJOR CUSTOMERS
We determine our reportable segments by evaluating our management and internal
reporting structure based primarily on the nature of the products offered to
customers and type or class of customers.
At September 30, 2003, we had only one operating segment. Our mobile information
management segment includes both mobile data management and wireless
connectivity solutions that enable mobile users to access, collect, synchronize
and print information on demand. Our products include wireless connectivity
products, data synchronization and management software and client/server
database management systems with remote access capabilities. We sell mobile
information management products primarily to original equipment manufacturers,
application developers, enterprises and computer resellers.
No customers accounted for more than 10% of our net revenue from continuing
operations in the three months ended September 30, 2003. In the three months
ended September 30, 2002, revenue from IBM (including Lotus Development
Corporation, a subsidiary of IBM), an original equipment manufacturer customer
of our XTNDConnect products, accounted for 11% of our net revenue from
continuing operations.
NOTE 14. SUBSEQUENT EVENTS
On October 15, 2003, we closed the sale to Brighton Investments, LLC of
approximately 16 acres of excess land adjacent to our headquarters building in
Boise, Idaho. We received approximately $1.5 million in net cash proceeds after
deducting fees related to the transaction. We expect to report a gain on the
sale of approximately $1.1 million in the second quarter of fiscal 2004.
On October 24, 2003, we entered into a lease termination agreement with
Epinions.com, the lessor of our office space in Brisbane, California. In
exchange for a termination fee of $255,000 to be paid in seven equal monthly
installments from November 2003 to May 2004, our lease was terminated on October
31. As part of the termination agreement, Epinions.com agreed to release us from
the $120,000 letter of credit that secured our rental payments.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In addition to historical information, this Quarterly Report on Form 10-Q
contains forward-looking statements. The words "expects," "anticipates,"
"believes," "intends," "will" and similar expressions identify forward-looking
statements that are based upon information currently available to us, speak only
as of the date hereof and are subject to certain risks and uncertainties. These
forward-looking statements include, but are not limited to, statements
regarding:
o levels of software product license fees and royalties;
o levels of international sales;
o levels of service revenue;
o levels of original equipment manufacturer sales;
o anticipated gross margin;
o staffing and expense levels;
o future profitability;
o future results of operations;
o future operating cash flows;
o levels of accounts receivable;
o levels of capital expenditures;
o anticipated costs of research and development;
o sufficiency of working capital and borrowing capacity;
o anticipated cash funding needs;
o resolution of claims made by Pumatech, Inc.;
o expected benefits from our acquisition of ViaFone;
o the benefits of future acquisitions; and
o effects of fluctuations in exchange rates.
We assume no obligation to update any forward-looking statements and our actual
results may differ materially from the results discussed in such forward-looking
statements. Factors that may cause a difference include, but are not limited to,
those discussed under "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors That May Affect Future Results and
Market Price of Stock." You should also carefully review the risk factors
described in other documents that we file from time to time with the Securities
and Exchange Commission, including our 2003 Annual Report on Form 10-K and other
Quarterly Reports on Form 10-Q that we will file in fiscal 2004. All period
references are to our fiscal quarters ended September 30, 2003, and 2002, and
our fiscal years ended June 30, 2003 and 2002, unless otherwise indicated. All
tabular amounts are in thousands, except percentages.
SIGNIFICANT EVENTS
- ------------------
On October 15, 2003, we closed the sale to Brighton Investments, LLC of
approximately 16 acres of excess land adjacent to our headquarters building in
Boise, Idaho. We received approximately $1.5 million in net cash proceeds after
deducting fees related to the transaction. We expect to report a gain on the
sale of approximately $1.1 million in the second quarter of fiscal 2004.
On October 24, 2003, we entered into a lease termination agreement with
Epinions.com, the lessor of our office space in Brisbane, California. In
exchange for a termination fee of $255,000 to be paid in seven equal monthly
installments from November 2003 to May 2004, our lease was terminated on October
31. As part of the termination agreement, Epinions.com agreed to release us from
the $120,000 letter of credit that secured our rental payments.
On November 10, 2003, Karla Rosa, our former Vice President of Finance and Chief
Financial Officer, resigned from the company. As a result, we expect to record a
restructuring charge of approximately $162,000 in the second quarter of fiscal
2004, consisting of $99,000 of severance-related costs to be paid over a six
month period beginning January 2004 and $63,000 of non-cash compensation
resulting from extension of exercise dates and accelerated vesting of employee
stock options.
OVERVIEW
- --------
We classify our product offerings into one operating segment, our mobile
information management segment, which consists of products and services that
extend enterprise applications to mobile and wireless environments. The products
in our mobile information management segment include data synchronization and
management software, wireless connectivity products and client/server database
management systems with remote access capabilities. Until April 2001, we also
marketed and sold enterprise Internet appliances.
15
We sell our mobile information management products primarily to enterprises,
original equipment manufacturers ("OEMs"), application developers and resellers
both directly and through our e-commerce storefronts on the Internet. We derive
revenue from:
o software license fees and royalties;
o support and maintenance fees; and
o professional services, including non-recurring development fees that we
generate when we adapt products to customers' specifications and consulting
services.
Our future results of operations will be highly dependent upon the success of
our software products and services, specifically our Mobile Groupware Solutions,
our Mobile Solutions Platforms and Tools, our Mobile Business Solutions, and our
Wireless Connectivity Software. We expect the license fees and royalties
generated by these products to continue to constitute a significant majority of
our revenue.
We derive a significant amount of our revenue from sales to customers outside of
the United States, principally from our international sales subsidiaries,
overseas original equipment manufacturers and from a limited number of
international distributors. Based on the region in which the customer resides,
net revenue from continuing operations was as follows for the three months ended
September 30:
NET REVENUE PERCENTAGES BY REGION 2003 2002
-------------------
Domestic................................................ 43% 54%
International:
Europe............................................... 43 35
Asia................................................. 12 7
Other regions........................................ 2 4
-------------------
Total international............................... 57 46
-------------------
Net revenue from continuing operations...... 100% 100%
===================
The percentage of revenue from Europe increased in the first quarter of fiscal
2004 as compared to the first quarter of fiscal 2003 as a result of a 55%
increase in European revenue primarily driven by both an increase in local
currency sales by our European sales subsidiaries and an increase in revenue
caused by the decrease in the strength of the US dollar as compared to the euro
and British pound sterling. The relative weakening of the US dollar resulted in
sales by our European subsidiaries being greater in U.S. dollars than they would
have been had the exchange rate remained constant for the two periods. European
revenue also increased due to an increase in royalties from a European OEM
customer.
We expect that international sales will continue to represent a substantial
portion of our net revenue in the foreseeable future and will comprise between
45% and 55% of our net revenue for the remaining quarters of fiscal 2004.
Revenue generated from sales to OEMs and t o companies that license our software
to include in their own software offerings has fluctuated in the past. We expect
it will also fluctuate in future quarters, because demand in these markets is
difficult to predict, as it is dependent upon the timing of customer projects
and the effectiveness of customer marketing efforts.
We sell our products directly to end-user customers and also market and sell
many of our products through multiple indirect channels, primarily distributors
and resellers. We intend to continue to strengthen our relationships with
partners and expect more business to come from these relationships in the
remaining quarters of fiscal 2004. No customers accounted for more than 10% of
our net revenue from continuing operations in the three months ended September
30, 2003. In the three months ended September 30, 2002, revenue from IBM
(including Lotus Development Corporation, a subsidiary of IBM), an original
equipment manufacturer customer of our XTNDConnect products, accounted for 11%
of our net revenue from continuing operations.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
In preparing our consolidated financial statements in conformity with accounting
principles generally accepted in the United States, we make estimates,
assumptions and judgments that can have a material impact on our net revenue,
operating income and net income (loss), as well as on the value of certain
assets on our consolidated balance sheet. We believe that the estimates,
assumptions and judgments involved in the accounting policies described below
have the greatest potential impact on our consolidated financial statements, so
we consider these to be our critical accounting policies. The policies described
below are not intended to be a comprehensive list of all our accounting
policies. In many cases, the accounting treatment of a particular transaction is
specifically dictated by generally
16
accepted accounting principles, with no need to apply any judgment of
management. There are also areas in which management's judgment in selecting any
available alternative would not produce a materially different result. Our
audited consolidated financial statements and notes thereto contain our
significant accounting policies and other disclosures required by generally
accepted accounting principles. The accounting policies that we consider
critical to an understanding of the consolidated financial statements are
highlighted below.
REVENUE RECOGNITION
To recognize software revenue we apply the provisions of Statement of Position
97-2, SOFTWARE REVENUE RECOGNITION (SOP 97-2), as amended by SOP 98-9, and
generally recognize revenue when all of the following criteria are met: (1)
persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the
fee is fixed or determinable and (4) collection of the resulting receivable is
reasonably assured.
At the time of the transaction, we assess whether the fee associated with our
revenue transactions is fixed or determinable, based on the payment terms
associated with the transaction. If a significant portion of a fee is due after
the shorter of our normal payment terms or 90 days, we account for the fee as
not being fixed or determinable. In these cases, we recognize revenue as the
fees become due and payable. If we had assessed the fixed or determinable
criterion differently, the timing and amount of our revenue recognition may have
differed materially from that reported.
At the time of the transaction we also assess whether or not collection is
reasonably assured based on a number of factors, including past transaction
history with the customer and credit-worthiness of the customer. We do not
request collateral from our customers. If we determine that collection of a fee
is not reasonably assured, we defer recognition of the fee as revenue, and
recognize revenue at the time collection becomes reasonably assured, which is
generally upon receipt of cash. If we assessed collectibility differently, the
timing and amount of our revenue recognition may have differed materially from
that reported.
For arrangements with multiple obligations (for instance, undelivered
maintenance and support), we allocate revenue to each component of the
arrangement using the residual value method. This means that we defer revenue
from the total fees associated with the arrangement equivalent to the
vendor-specific objective evidence of fair value of the elements of the
arrangement that have not yet been delivered. The vendor-specific objective
evidence of fair value of an undelivered element is generally established by
using historical evidence specific to Extended Systems. For example, the
vendor-specific objective evidence of fair value for maintenance and support is
based upon separate sales of renewals to other customers or upon the renewal
rates quoted in the contracts, and the fair value of services, such as training
or consulting, is based upon separate sales by us of these services to other
customers. If we allocated the respective fair values of the elements
differently, the timing of our revenue recognition may have differed materially
from that reported. For certain of our products, we do not sell maintenance
separately but do provide minimal support and bug fixes and, from time to time,
minor enhancements to ensure that the products comply with their warranty
provisions. Accordingly, we allow for warranty costs at the time the product
revenue is recognized.
When we license our software to OEMs or to companies that include our software
in their software offering, royalty revenue is generally recognized when
customers report to us the sale of software to their end user customer. In cases
where the arrangement with our customer provides for a prepaid nonrefundable
royalty, we generally recognize revenue when persuasive evidence of an
arrangement exits, delivery has occurred, the fee is fixed or determinable and
collection of the resulting receivable is reasonably assured.
We recognize revenue for support and maintenance services ratably over the
contract term, which is usually 12 months, and we generally recognize revenue
from training services as these services are performed. For professional
services that involve significant implementation, customization, or modification
of our software that is essential to the functionality of the software, we
generally recognize both the service and related software license revenue over
the period of the engagement, using the percentage-of-completion method. In
cases where our professional services involve customizations for which the
amount of customization effort cannot be reasonably estimated, where significant
uncertainty about the project completion exists, or where an arrangement
provides for customer acceptance, we defer the contract revenue under the
completed contract method of accounting until the uncertainty is sufficiently
resolved or the contract is complete. If we were to make different judgments or
utilize different estimates of the total amount of work we expect to be required
to complete an engagement, the timing of our revenue recognition from period to
period, as well as the related margins, might differ materially from that
previously reported.
17
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS
We assess the impairment of identifiable intangibles, fixed assets and goodwill
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable. Goodwill is reviewed for impairment annually in accordance
with SFAS No. 142, " Goodwill and Other Intangible Assets." Factors we consider
important that could trigger an impairment review include, but are not limited
to: (1) significant under performance relative to historical or projected future
operating results, (2) significant changes in the manner of our use of the
acquired assets or the strategy for our overall business, (3) significant
negative industry or economic trends, (4) a significant decline in our stock
price for a sustained period, and (5) our market capitalization relative to net
book value. When we determine that the carrying value of long-lived assets may
not be recoverable based upon the existence of one or more of the above
indicators of impairment, we measure any impairment based on a market
capitalization approach when the information is readily available. When the
information is not readily available, we use a projected discounted cash flow
method using a discount rate commensurate with the risk inherent in our current
business model to measure any impairment. If we made different judgments or
utilized different estimates our measurement of any impairment may have differed
materially from that reported.
INCOME TAXES
On a quarterly basis we evaluate our deferred tax asset balance for
realizability. To the extent we believe it is more likely than not that some or
all of our deferred tax assets will not be realized, we establish a valuation
allowance against the deferred tax assets. As of June 30, 2003, we had recorded
a valuation allowance against 100 percent of our net deferred tax assets due to
uncertainties related to our ability to utilize our deferred tax assets,
primarily consisting of certain net operating losses carried forward and foreign
tax credits, before they expire. This valuation allowance was recorded based on
our estimates of future U.S. and foreign jurisdiction taxable income and our
judgments regarding the periods over which our deferred tax assets will be
recoverable. If we made different judgments or utilized different estimates, the
amount or timing of the valuation allowance recorded may have differed
materially from that reported. In the event that actual results differ from
these estimates or we adjust these estimates in future periods, we may need to
reduce the valuation allowance, potentially resulting in an income tax benefit
in the period of reduction, which could materially impact our financial position
and results of operations.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain an allowance for doubtful accounts based on a continuous review of
customer accounts, payment patterns and specific collection issues. Where
specific collection issues are identified, we record a specific allowance based
on the amount that we believe will not be collected. For accounts where specific
collection issues are not identified, we record an allowance based on the age of
the receivable and historical collection patterns. If we made different
judgments or utilized different estimates, the timing and amount of our
allowance may have differed materially from that reported.
RESULTS OF CONTINUING OPERATIONS
- --------------------------------
The following section sets forth our results of continuing operations for the
fiscal quarters ended September 30, 2003 and 2002:
NET REVENUE
- -----------
THREE MONTHS ENDED SEPTEMBER 30,
2003 % CHANGE 2002
-----------------------------
Revenue:
License fees and royalties.............. $ 5,771 16% $ 4,989
Services and other...................... 1,784 94 920
-------- --------
Total net revenue.................... $ 7,555 28% $ 5,909
======== ========
LICENSE FEES AND ROYALTIES. License and royalty revenue consists of fees for
licenses of our software products. The growth in revenue in the first quarter of
fiscal 2004 compared to the first quarter of fiscal 2003 was primarily
attributable to an 18% increase in license and royalty revenue from our Mobile
Groupware, Mobile Solutions Platforms and Tools and Mobile Business Solutions
products related primarily to an increase in software licenses sold and a 40%
increase in license fees and royalties from our Wireless Connectivity Software
products related to an increase in software development kits sold.
18
We expect revenue from license fees and royalties to increase in the remaining
quarters of fiscal 2004. This increase is expected to come primarily from
increased licensing of our OneBridge products, including our Groupware, Mobile
Solutions Platform and Mobile Business Solutions products.
SERVICES AND OTHER. Services revenue consists primarily of support and
maintenance contracts sold to our customers and fees for professional services.
Our professional services typically consist of standard product installations,
training, significant customization of our software products and non-recurring
engineering ("NRE"). The primary driver of the increase in service revenue for
the first quarter of fiscal 2004 as compared to the first quarter of fiscal 2003
was the 287% increase in professional services revenue we saw as a result of
adding a dedicated professional services group to our solutions kit in the first
quarter of fiscal 2003 in connection with the ViaFone acquisition. We also saw a
60% increase in support and maintenance revenue in the first quarter of fiscal
2004 as compared to the first quarter of fiscal 2003.
We expect service revenue to increase in the remaining quarters of fiscal 2004.
Although we expect an overall increase in the amount of billable hours of our
professional services group, service revenue may fluctuate from quarter to
quarter based on the amount of revenue we may be required to defer under our
revenue recognition policy and the timing of services engagements.
Cost of Revenue
- --------------- THREE MONTHS ENDED SEPTEMBER 30,
2003 GROSS MARGIN 2002 GROSS MARGIN
--------------------------------------------
License fees and royalties..... $ 271 95% $ 272 95%
Services and other............. 951 47 545 41
LICENSE FEES AND ROYALTIES. The cost of license and royalty revenue consists
primarily of amortization of purchased technology and royalties for the use of
third-party software. Although license and royalty revenue increased 16%, there
was no significant change in the cost of license fees and royalties in the first
quarter of fiscal 2004 compared to the same period in fiscal 2003. An increase
in amortization of purchased technology related to the acquisition of ViaFone
and an increase in product costs was offset by a decrease in overhead costs
related to our restructurings in fiscal 2003. Royalty expense decreased in the
first quarter of fiscal 2004 as compared to the same period in the prior year as
a result of a change in the mix of products sold and a lower royalty rate paid
on certain third-party software.
We expect the cost of license fees and royalties to increase in absolute dollars
in the remaining quarters of fiscal 2004 as a result of an expected increase in
revenue from license fees and royalties. An expected reduction in operations
costs and in amortization expense of purchased technology, resulting from a
portion of our purchased technology becoming fully amortized in the second
quarter of fiscal 2004, is expected to be offset by an increase in royalty costs
as a result of an expected increase in revenue. We expect gross margin on
license fees and royalties to be in a range of 93 to 96 percent in the remaining
quarters of fiscal 2004.
We report amortization of non-goodwill intangibles, primarily consisting of
purchased technology, as a component of cost of license fees and royalty
revenue. Amortization of non-goodwill intangibles was $188,000 in the first
quarter of fiscal 2004 and $160,000 in the first quarter of fiscal 2003. The net
increase in the first quarter of fiscal 2004 compared to the first quarter of
fiscal 2003 resulted from the addition of non-goodwill intangibles in connection
with our acquisition of ViaFone in the first quarter of fiscal 2003.
We expect a decrease in amortization of non-goodwill intangibles in the
remaining quarters of fiscal 2004 as a result of a portion of our purchased
technology becoming fully amortized in the second quarter of fiscal 2004.
SERVICES AND OTHER. The cost of services and other consists primarily of
compensation and benefits for our professional services and post-sales support
personnel. The cost of services increased 75% in the first quarter of fiscal
2004 compared to the first quarter of fiscal 2003 primarily due to the addition
of a dedicated professional services organization in the first quarter of fiscal
2003 in conjunction with our acquisition of ViaFone.
Gross margin on services revenue decreased in the first quarter of fiscal 2004
as compared to the first quarter of fiscal 2003. The decline is primarily the
result of a higher percentage of professional services revenue, which typically
generates lower margins than support and maintenance revenue, in the first
quarter of fiscal 2004 relative to support and maintenance revenue.
19
We expect the cost of services in absolute dollars to increase in the remaining
quarters of fiscal 2004 as a result of an expected increase in professional
services revenue. We expect gross margin on services and other revenue to be in
the range of 45 to 55 percent. This range is driven by the mix between
professional services and support and maintenance revenue and the utilization
rate of our professional services personnel. Given the high level of fixed costs
associated with the professional services group, our inability to generate
sufficient services revenue to absorb these fixed costs could lead to lower or
negative gross margins.
Research and Development Expenses
- ---------------------------------
THREE MONTHS ENDED SEPTEMBER 30,
2003 %CHANGE 2002
---------------------------------
Research and development.............. $ 1,552 (21)% $ 1,953
as a % of net revenue........... 21% 33%
Research and development expenses generally consist of salaries and other
personnel costs of our research and development teams, consulting costs and
facility expenses. The decrease in research and development expenses in the
first quarter of fiscal 2004 as compared to the same quarter in fiscal 2003 was
primarily the result of a $269,000 reduction in personnel costs. This reduction
in personnel was achieved by a combination of improved processes, elimination of
unnecessary function, and clear ownership and focus. At September 30, 2003 we
had 56 full-time equivalent research and development personnel, a decrease from
the 92 full-time equivalent personnel at the same time last year.
In connection with our acquisition of ViaFone in August 2002, we incurred an
in-process research and development charge of $430,000 in the first quarter of
fiscal 2003.
In the remaining quarters of fiscal 2004, we expect our research and development
costs to remain relatively constant in absolute dollars.
Marketing and Sales Expenses
- ----------------------------
THREE MONTHS ENDED SEPTEMBER 30,
2003 %CHANGE 2002
---------------------------------
Marketing and Sales................... $ 3,599 9% $ 3,289
as a % of net revenue........... 48% 56%
Marketing and sales expenses consist primarily of salaries, commissions and
other personnel costs of our sales, marketing, and pre-sales support staff, and
promotional expenses. The increase in marketing and sales expenses in the first
quarter of fiscal 2004 compared to the first quarter of fiscal 2003 was
primarily due to an increase of approximately $130,000 in third party
commissions and approximately $64,000 in personnel costs. Although the number of
personnel is down in the first quarter of fiscal 2004 relative to the first
quarter of fiscal 2003, personnel costs are up due to increased sales
compensation, which is partially offset by a decrease in personnel costs for our
marketing and pre-sales support staff. In addition, there was only one month of
personnel costs included in the first quarter of fiscal 2003 for eleven
employees that joined the company in August of 2003 in connection with the
ViaFone acquisition. At September 30, 2003, we had 97 full-time equivalent
marketing, sales, and support personnel and contractors, as compared to 113
full-time equivalent personnel and contractors at the same time last year.
We expect marketing and sales expenses to increase in absolute dollars in the
remaining quarters of fiscal 2004 as a result of an expected increase in
revenue, although we expect these expenses to decrease as a percentage of net
revenue. We expect that the increase in marketing and sales expenses in fiscal
2004 will be primarily attributable to increased sales compensation.
20
General and Administrative Expenses
- -----------------------------------
THREE MONTHS ENDED SEPTEMBER 30,
2003 %CHANGE 2002
---------------------------------
General and administrative............ $ 1,613 44% $ 1,124
as a % of net revenue........... 21% 19%
General and administrative expenses primarily consist of salaries and other
personnel costs for our finance, management information systems, human resources
and other administrative groups, as well as professional fees and directors' and
officers' insurance costs. The increase in general and administrative expenses
in the first quarter of fiscal 2004 as compared t o the first quarter of fiscal
2003 was primarily attributable to an increase of $521,000 in professional
services costs. This increase in professional services costs consisted primarily
of $435,000 in increased legal fees related to our patent litigation with
Pumatech and $575,000 of legal and other professional services costs related to
failed acquisition activities. These increases were offset in part by the
reversal during the first quarter of fiscal 2004 of approximately $513,000 of
accrued professional services costs related to the failed merger with Palm, Inc.
in 2001.
We expect general and administrative expenses in absolute dollars and as a
percentage of net revenue to decrease in the remaining quarters of fiscal 2004
primarily as a result of an expected decrease in professional services costs
relative to the first quarter. We expect this decrease will be offset in part by
an increase in non-cash compensation expense if a change in the compensation
plan for our independent board of directors providing for the grant of
restricted stock is approved by our stockholders at our 2003 Annual Meeting. At
September 30, 2003, we had 22 full-time equivalent employees in administration,
as compared to 30 full-time equivalent personnel at the same time last year.
Restructuring Charge
- --------------------
We recorded $1,073,000 in workforce reduction costs during the three months
ended September 30, 2003, of which $1,068,000 was related to continuing
operations and $5,000 was related to our discontinued operations. The
restructuring charges consist primarily of severance, benefits, and other costs
related to the resignation of Steven Simpson, our former President and Chief
Executive Officer, and the termination of ten employees from our marketing and
sales, research and development, administration and operations groups. Of the
terminated employees, seven were located in the United States and three were in
Europe. The restructuring charge includes $437,000 of non-cash compensation
resulting from the accelerated vesting of employee stock options that is not
included in the table below.
A summary of accrued restructuring charges is as follows:
WORKFORCE
REDUCTION FACILITIES AND
COSTS OTHER COSTS TOTAL
--------- -------------- -------
Balance at June 30, 2003......................... $ 188 $ 534 $ 722
Costs incurred in first quarter of fiscal 2004... 636 -- 636
Cash payments.................................... (255) (146) (401)
--------- -------------- -------
Balance at September 30, 2003.................... $ 569 $ 388 $ 957
========= ============== =======
Other Expense (Income)
- ----------------------
THREE MONTHS ENDED SEPTEMBER 30,
2003 % CHANGE 2002
-------------------------------
Foreign currency exchange (gain) loss............ $ (59) 207% $ 55
Interest (income)................................ (3) (83) (18)
Rent Income...................................... (47) 0 --
Other net expense (income)....................... 49 545 (11)
-------------------------------
Total other expense (income)............... $ (60) 331% $ 26
======== =========
Other expense and income consists primarily of foreign currency exchange gains
or losses related to the mark-to-market of intercompany amounts owed to us by
our international subsidiaries, rental income from the portion of our
headquarters facility that we sublease and interest income earned on cash, cash
equivalents and short-term investment balances. We recognized a foreign currency
exchange gain in the first quarter of fiscal 2004 as a result of the significant
decrease in the strength of the U.S. dollar relative to the euro, British pound
sterling and Canadian
21
dollar during the final month of the quarter at a time when we were not entering
into foreign currency forward contracts. In the first quarter of fiscal 2003, we
recognized an exchange loss as a result of our intercompany balance forecasts
differing from projections in a period of currency volatility. For additional
information on our foreign currency exposure see Item 3 of this Form 10-Q.
Interest income declined in the first quarter of fiscal 2004 as compared to the
same period in fiscal 2003 due to a decline in the amount of cash invested and
declines in short-term interest rates during fiscal 2003. In the first quarter
of fiscal 2004 we recorded rent income from subleasing to third parties a
portion of the unused space at our headquarters facility. As this sublease was
signed in the fourth quarter of fiscal 2003, we recorded no rent income in the
first quarter of fiscal 2003.
The amount of any foreign currency exchange gain or loss for the remaining
quarters of fiscal 2004 will depend upon currency volatility, the amount of our
intercompany balances and whether we decide to enter into foreign currency
forward contracts in future quarters. We have entered into foreign currency
forward contracts in the second quarter of fiscal 2004.
We expect interest income to increase in fiscal 2004 as a result of our
increased cash, cash equivalents and short-term investments balances at
September 30, 2003 and our expected balances for the remainder of fiscal 2004.
Interest Expense
- ----------------
THREE MONTHS ENDED SEPTEMBER 30,
2003 % CHANGE 2002
--------------------------------
Interest expense......................... $ 34 (74)% $ 130
as a % of revenue...................... 0.5% 2%
Interest expense for the quarter ended September 30, 2003 consists primarily of
interest paid on the SV B term debt. Interest expense for the quarter ended
September 30, 2002 consists primarily of warrant expense amortization related to
entering into our line of credit agreement with SVB in January 2002 and interest
paid on the SVB term debt. Interest expense decreased in the first quarter of
fiscal 2004 as compared to the first quarter of fiscal 2003 primarily as a
result of our completing in fiscal 2003 amortization of the SVB warrant expense.
We expect interest expense in each of the remaining quarters of fiscal 2004 to
increase by approximately $110,000 as a result of entering into the
sale-and-leaseback agreement for our building, which we accounted for as a
financing transaction.
Income Tax Provision (Benefit)
- ------------------------------
THREE MONTHS ENDED SEPTEMBER 30,
2003 % CHANGE 2002
--------------------------------
Income tax provision (benefit)........... $ 4 (200)% $ (4)
as a % of income (loss) before taxes... (0.3)% 0.2%
For the three months ended September 30, 2003, we recorded an income tax
provision related primarily to foreign withholding taxes of $27,000. The income
tax expense associated with continuing operations was $4,000 and that associated
with discontinued operations was $23,000. For the three months ended September
30, 2002, we recorded an income tax provision related primarily to foreign
withholding taxes of $12,000. The income tax expense associated with
discontinued operations was $16,000. The tax benefit of $4,000 for continuing
operations consists of $12,000 of foreign withholding taxes, offset by a tax
benefit of $16,000.
We expect to record an income tax provision related to payments of foreign taxes
of approximately $25,000 per quarter for the remainder of fiscal 2004. We expect
that any provision we would otherwise record will be offset by our utilization
of net operating loss carryforwards.
22
RESULTS OF DISCONTINUED OPERATIONS
- ----------------------------------
The following summarizes the results of discontinued operations:
THREE MONTHS ENDED SEPTEMBER 30,
2003 % CHANGE 2002
--------------------------------
Net revenue.................................. $ 140 (56)% $ 320
Income from discontinued
operations, net of taxes.................... 41 46 28
Our revenue from discontinued operations for the first quarter of fiscal 2004
consisted of revenue from our discontinued infrared hardware business, for which
we adopted a formal exit plan in the first quarter of fiscal 2003. Although our
infrared hardware business was discontinued in the first quarter of fiscal 2003,
we continued to see revenue throughout fiscal 2003 as customers continued to
place last-time orders and we saw revenue in the first quarter of fiscal 2004 as
we shipped final orders. The decrease in net revenue from discontinued
operations in the first quarter of fiscal 2004 compared to the first quarter of
fiscal 2003 was a result of winding down the infrared hardware business.
Income from discontinued operations was higher in fiscal 2004 compared to fiscal
2003 as a result of minimizing expenses related to the infrared hardware
business once these operations were discontinued. We do not expect income from
discontinued operations to be significant in the remainder of fiscal 2004.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
- ----------------------------------------------------
NET CASH USED BY OPERATING ACTIVITIES
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2003 2002
--------------- ---------------
Net cash used by operating activities...... $ (426) $ (737)
Net cash used by operating activities in the first quarter of fiscal 2004 was
primarily the result of our net loss, a $414,000 decrease in deferred revenue
and a $100,000 increase in receivables, adjusted for such non-cash items as
depreciation, amortization and stock compensation. These cash uses were
partially offset by a $648,000 increase in accounts payable and accrued
expenses. Net cash used by operating activities in first quarter of fiscal 2003
was primarily the result of our net loss, a decrease of $347,000 in deferred
revenue and a $341,000 increase in prepaid assets, adjusted for such non-cash
items as depreciation, amortization, and acquired in-process research and
development. These cash uses were partially offset by a decrease of $385,000 in
receivables and an increase of $294,000 in accounts payable and accrued
expenses.
Accounts receivable, net of allowances, were $5.9 million and $4.5 million at
September 30, 2003 and 2002, respectively. The increase in accounts receivable
from the first quarter of fiscal 2003 to the same period in fiscal 2004 was due
primarily to an increase in total net revenue, but was offset partially by a
decrease in DSOs (days sales outstanding). We expect that our accounts
receivable will increase in the remainder of fiscal 2004 as a result of an
expected increase in net revenues. Accounts receivable may also increase in the
future if net revenue from international customers becomes a higher percentage
of our net revenue. Generally, these customers have longer payment cycles.
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2003 2002
------------- -----------------
Net cash provided (used) by
investing activities...................... $(134) $1,264
Net cash used by investing activities in the first quarter of fiscal 2004 was
primarily the result of tenant improvements we made to the subleased portion of
the unused space at our headquarters building pursuant to our lease agreement
for the space. Net cash provided by investing activities in the first quarter of
fiscal 2003 was primarily the result of completing the acquisition of ViaFone.
As part of our continued effort to control cash and expenses, we did not make
significant investments in property and equipment in either the first quarter of
fiscal 2004 or 2003.
We plan to incur aggregate capital expenditures of approximately $300,000 during
the remainder of fiscal 2004, primarily for tenant improvements, software,
system improvements and personal computers.
23
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2003 2002
--------------- ---------------
Net cash provided (used) by
financing activities...................... $4,866 $(60)
Net cash provided by financing activities in the first quarter of fiscal 2004
consisted primarily of $4.8 million in cash proceeds we received from the
sale-and-leaseback of our headquarters building in Boise, Idaho. Net cash used
by financing activities in the first quarter of fiscal 2003 resulted from
payments on term debt assumed as part of our acquisition of ViaFone.
On January 15, 2002, we entered into a loan and security agreement with Silicon
Valley Bank, under which we can currently access up to $5.0 million of financing
in the form of a demand line of credit, subject to current accounts receivable
balances. The line of credit is collateralized by certain of our assets.
Interest on any borrowings will be paid at prime plus one percent but not less
than 5.5%. The line of credit agreement requires us to maintain certain
financial ratios and expires on January 15, 2004. We are in compliance with all
covenants and there are no outstanding draws on this facility.
Upon completion of our acquisition of ViaFone on August 30, 2002, we assumed
$1.1 million of term debt with SVB. This debt has been restructured into a term
loan due in 30 equal monthly installments bearing interest at 8%. The term loan
is collateralized by certain of our assets, requires us to maintain certain
financial ratios and is scheduled to be paid in full by March 2005.
On September 26, 2003, we closed the sale-and-leaseback of our headquarters
building and approximately eight acres of land and received approximately $4.6
million in net cash proceeds after deducting transaction costs. As part of the
agreement, we entered into a 10-year master lease for the building with annual
payments equal to approximately $442,000. In fiscal 2004, we will make payments
of approximately $331,000. On October 15, 2003, we closed the sale to Brighton
Investments, LLC of approximately 16.2 acres of excess land adjacent to our
headquarters building in Boise, Idaho. We received approximately $1.5 million in
net cash proceeds after deducting fees related to the transaction. We expect to
report a gain on the sale of approximately $1.1 million in the second quarter of
fiscal 2004.
We believe that our existing working capital, the funds from the
sale-and-leaseback of our Boise headquarters building, the funds from the sale
of our excess land, our borrowing capacity and the funds we expect to generate
from our operations will be sufficient to fund our anticipated working capital
and capital expenditure requirements for the next 12 months. We cannot be
certain, however, that our underlying assumed levels of revenue and expenses
will be accurate. If our operating results were to fail to meet our expectations
or if Pumatech litigation fees, accounts receivable, or other assets were to
require a greater use of cash than is currently anticipated, we could be
required to seek additional sources of liquidity. In addition, if the Pumatech
litigation were to have an unfavorable result for us, we could be required to
pay damages or royalties, or to discontinue sales of certain products, any of
which could result in a greater use of cash than is currently anticipated. This
could also require us to seek additional sources of liquidity. These sources of
liquidity could include raising funds through public or private debt financing,
borrowing against our line of credit or offering additional equity securities.
If additional funds are raised through the issuance of equity securities,
substantial dilution to our stockholders could result. In the event additional
funds are required, adequate funds may not be available when needed or may not
be available on favorable terms, which could have a negative effect on our
business and results of operations.
We intend to continue to pursue strategic acquisitions of, or strategic
investments in, companies with complementary products, technologies or
distribution networks in order to broaden our mobile information management
product offerings. We currently have no commitments or agreements regarding any
material transaction of this kind; however, we may acquire businesses, products
or technologies in the future. As a result, we may require additional financing
in the future and, if we were required to obtain additional financing in the
future, sources of capital may not be available on terms favorable to us, if at
all.
EFFECTS OF FOREIGN CURRENCY EXCHANGE RATES
- ------------------------------------------
We derive a substantial portion of our net revenue from sales outside of the
United States, principally through our international subsidiaries and through a
limited number of independent distributors and overseas OEMs. Sales made by our
international subsidiaries are generally denominated in each country's
respective currency. Fluctuations in exchange rates could cause our results to
fluctuate when we translate revenue and expenses denominated in other
24
currencies into U.S. dollars. Fluctuations in exchange rates also may make our
products more expensive to OEMs and independent distributors who purchase our
products in U.S. dollars.
We do not hold or issue financial instruments for speculative purposes. From
time to time, we enter into foreign currency forward contracts, typically
against the Canadian dollar, euro and British pound sterling, to manage
fluctuations in the value of foreign currencies on transactions with our
international subsidiaries. While these instruments are subject to fluctuations
in value, these fluctuations are generally offset by fluctuations in the value
of the underlying asset or liability being managed, resulting in minimal net
exposure for us. These forward contracts do not qualify for hedge accounting
under SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, and, as such, the contracts are recorded in the consolidated balance
sheet at fair value. We report a net currency gain or loss based on changes in
the fair value of forward contracts combined with changes in fair value of the
underlying asset or liability being managed. The success of these currency
activities depends upon estimation of intercompany balances denominated in
various foreign currencies. To the extent that these forecasts are overstated or
understated during periods of currency volatility, we could experience
unanticipated currency gains or losses. When determining whether to enter into
foreign currency forward contracts, we also consider the impact that the
settlement of such forward contracts may have on our cash position. To eliminate
a potential cash settlement of a forward position we may, from time to time,
decide not to use foreign currency forward contracts to manage fluctuations in
the value of foreign currencies on transactions with our international
subsidiaries. In a period where we do not enter into foreign currency forward
contracts, we could experience significant non-cash currency gains or losses if
the value of the U.S. dollar strengthens or weakens significantly in relation to
the value of the foreign currencies. We had no forward contracts in place as of
September 30, 2003. As of September 30, 2002, we had forward contracts with a
nominal value of $4.6 million in place against the Canadian dollar, euro and
British pound sterling, which matured within 30 days. We recognized a net
currency exchange gain of $59,000 for the quarter ended September 30, 2003 and a
net currency exchange loss of $55,000 for the three months ended June 30, 2002.
We are entering into foreign currency forward contracts in the second quarter of
fiscal 2004.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
- ----------------------------------------------------------------
WE HAVE A RECENT HISTORY OF LOSSES AND MAY CONTINUE TO GENERATE LOSSES IN FISCAL
2004. Since the third quarter of fiscal 1999, we have devoted significant
financial resources to the research and development of, and marketing and sales
for, our mobile information management software products and, as a result, we
have generated operating losses. We intend to continue to devote significant
financial resources to
product development, to marketing and sales, and to the defense of Pumatech's
claims against us. Our ability to reach break-even from operations and our
ability to reach profitability and positive cash flow from operations in
subsequent periods, will depend on a number of factors, including:
o our ability to generate sufficient revenue and control expenses;
o buying patterns of our enterprise, application developer and OEM customers;
o changes in customer demand for our products; o the timing of customer
orders, which can be influenced by fiscal year-end buying patterns, seasonal
trends or general economic conditions;
o announcements or introductions of new products or services by our
competitors;
o the outcome of our litigation with Pumatech, Inc. and the impact of any
litigation on our financial and management resources;
o delays in our development and introduction of new products and services;
o changes in our pricing policies as a result of increased competition;
o the mix of distribution channels through which we sell our products;
o the market acceptance of our new and enhanced products and the products of
our customers that are application developers and OEMs;
o the market adoption rate of Bluetooth or other technologies on which a
number of our products are based;
o the emergence of new technologies or industry standards;
o normal seasonality that we typically experience in the first quarter of our
fiscal year; and
o a shift in the mix of professional services and licensing revenue, which may
result in fluctuations in our gross margin.
OUR BUSINESS RELIES ON ENTERPRISES IMPLEMENTING MOBILE APPLICATIONS AND DEVICES
AND MAY BE HARMED BY DECLINES IN INFORMATION TECHNOLOGY SPENDING.
The market for our products depends on economic conditions affecting the broader
economic climate and spending on information technology, including mobile
applications and devices. Downturns in the overall economy may cause
25
enterprises to delay implementation of mobile device and application rollouts,
reduce their overall information technology budgets or reduce or cancel orders
for our products. Our OEM customers may also limit development of new products
that incorporate our products or reduce their level of purchases of our products
in the face of slower information technology spending by their customers. The
general weakening of the global economy and weakening of business conditions,
particularly in the information technology, telecommunications, financial
services and manufacturing industry sectors, have resulted in potential
customers experiencing declines in their revenue and operations. In this
environment, customers may experience financial difficulty or cease operations.
While we believe we have adequately factored these conditions into our current
revenue forecasts, if these conditions worsen or continue longer than expected,
demand for our products may be reduced as a result of enterprises reducing
information technology spending on our products and OEMs reducing their use of
our products in their own products. As a result, our revenue may fail to grow or
could decline, which would harm our operating results. If the current economic
slowdown persists or worsens, we also may be forced to reduce our operating
expenses, which could result in additional charges incurred in connection with
restructuring or other cost-cutting measures we may implement. For example, in
both the first and third quarters of fiscal 2003 and the first quarter of fiscal
2004, we announced restructuring plans to reduce costs and improve operating
efficiencies and, as a result, incurred restructuring costs, primarily for
severance payments to terminated employees.
OUR QUARTERLY AND ANNUAL OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY AND FAIL
TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS, WHICH COULD CAUSE
OUR STOCK PRICE TO DECLINE.
Our operating results have fluctuated in the past and may continue to do so in
the future. Our revenue and operating results will vary from quarter to quarter
for many reasons beyond our control, including those described in this section.
If our operating results fall below the expectations of securities analysts or
investors, the price of our stock may fall. In addition, quarter-to-quarter
variations in our revenue and operating results could create uncertainty about
the direction or progress of our business, which could result in a decline in
the price of our stock.
WE FORECAST MANY OF OUR OPERATING EXPENSES BASED ON FORECASTED REVENUE, WHICH IS
DIFFICULT TO PREDICT. IF WE FAIL TO ACCURATELY PREDICT REVENUE IN A PARTICULAR
PERIOD, WE MAY BE UNABLE TO ADJUST OUR EXPENDITURES IN THAT PERIOD AND OUR
OPERATING RESULTS WOULD BE HARMED.
Our quarterly revenue and operating results currently depend in large part on
the volume and timing of orders received within the quarter and on the number of
software seats licensed, which are difficult to forecast. Significant portions
of our expenses are related to personnel and, therefore, are fixed in advance,
based in large part on our forecast of future revenue. If revenue is below
expectations in any given quarter, the adverse impact of the shortfall on our
operating results may be magnified by our inability to adjust personnel and
other expenditures to compensate for the shortfall.
OUR BUSINESS MAY BE HARMED IF PUMATECH PREVAILS IN THE PATENT LITIGATION WITH US
AND THEY ARE AWARDED SIGNIFICANT DAMAGES OR BECOME ENTITLED TO SIGNIFICANT
ROYALTIES, OR IF WE ARE REQUIRED TO CEASE SELLING ANY OF OUR CURRENT PRODUCTS OR
WE IF ARE REQUIRED TO INCUR ADDITIONAL DEVELOPMENT COSTS.
On April 22, 2002, Pumatech, Inc. filed a patent infringement action against us
in the U.S. District Court in Northern California. An amended complaint was
filed on May 28, 2002. The action alleges that our XTNDConnect server and
desktop synchronization products infringe on seven of Pumatech's
synchronization-related patents, that our alleged use of the trademark
"Satellite Forms" constitutes trademark infringement, and that other alleged
actions constitute unfair competition and interference with contract. The action
seeks an injunction against further sales of our server and desktop
synchronization products and use of the allegedly infringing trademark, as well
as unspecified damages and attorneys' fees. On June 25, 2002, we filed an answer
and counterclaim in response to Pumatech's complaint in which we deny Pumatech's
charges, raise a number of affirmative defenses and request a declaration from
the court that Pumatech synchronization software patents are invalid and not
infringed by our products. On December 11, 2002, Pumatech filed a second amended
complaint, which adds allegations that unspecified synchronization products
infringe an eighth Pumatech patent. On December 31, 2002, we filed an amended
answer and counterclaim in which we deny all of Pumatech's charges, including
this additional charge, and amend our defenses and counterclaims to include this
additional patent. On August 1, 2003 the Honorable. Judge D. Lowell Jensen,
United States District Judge, issued his Claims Construction Ruling on the
interpretation, definition, and scope of the claims in the suit. We believe that
the Court's ruling has significantly narrowed claims in five of the Pumatech
patents. The Court also ruled that it could not correct an error that appears in
all asserted claims of Pumatech's '676 patent. This error must be corrected in
reissue proceedings in the Patent Office. Until the Patent Office issues
corrected claims, no synchronization software can infringe the '676 patent, and
it is unlikely that such a correction would have any retroactive effect. As a
result, if any of our products are ultimately held to be infringing this patent,
it is unlikely that
26
Pumatech would be entitled to damages for any period prior to the reissue date.
We have petitioned the U.S. Patent Office for reexamination of three of the
Pumatech patents. The Patent Office has issued an Office Action for each of the
three patents rejecting all Pumatech patent claims over the prior art for two of
the patents and rejecting all claims on which we requested reexamination for the
other patent. As a result of the reexamination process, we expect the patents to
be significantly narrowed or rejected by the Patent Office in their entirety. If
the patents are amended and reissued, and we are ultimately held to be
infringing one of the reissued patents, it is unlikely that Pumatech would be
entitled to damages for any period preceding the reissue date. Discovery and
other pretrial proceedings are on going; trial is currently scheduled for April
2004.
We believe that we have numerous meritorious defenses to Pumatech's claims and
we intend to continue to defend the suit vigorously. However, litigation is
inherently uncertain, and we may not prevail in our defenses or counterclaims.
If Pumatech prevails in one or more of its claims, we could be required to pay
substantial damages for past sales of infringing products, to cease selling
specific of our server or desktop synchronization products that are held to
infringe a Pumatech patent, to pay royalties on the sales of specific products
that are held to infringe a Pumatech patent, or some combination of these
results. We may also incur significant development costs to redesign certain of
our products to ensure that they are non-infringing. Any of such outcomes could
have a material adverse effect on our business and financial position. In
addition, litigation is frequently expensive and time-consuming, and management
may be required to spend significant time in the defense of the suit; such costs
and the diversion of management time could have a material adverse effect on our
business. The ultimate outcome of any litigation is uncertain and the range of
loss that could occur upon resolution of this matter is not estimable. We cannot
estimate the costs of any potential settlement. Were an unfavorable outcome to
occur, the impact could be material to our financial position, results of
operations, or cash flows.
THE SUCCESS OF OUR BUSINESS MAY DEPEND ON US IDENTIFYING AND SECURING ADDITIONAL
SOURCES OF FINANCING, WHICH SOURCES MAY NOT BE AVAILABLE WHEN NEEDED OR MAY NOT
BE AVAILABLE ON FAVORABLE TERMS.
We believe that our existing working capital, the funds from the
sale-and-leaseback of our Boise building, the funds from the sale of our excess
land, our borrowing capacity and the funds we expect to generate from our
operations will be sufficient to fund our anticipated working capital and
capital expenditure requirements for the next 12 months. We cannot be certain,
however, that our underlying assumed levels of revenue and expenses will be
accurate. If our operating results were to fail to meet our expectations or if
Pumatech litigation fees, accounts receivable, or other assets were to require a
greater use of cash than is currently anticipated, we could be required to seek
additional sources of liquidity. In addition, if the Pumatech litigation were to
have an unfavorable result for us, we could be required to pay damages or
royalties, or to discontinue sales, of certain products, any of which could
result in a greater use of cash than is currently anticipated. This could also
require us to seek additional sources of liquidity. These sources of liquidity
could include raising funds through public or private debt financing, borrowing
against our line of credit or offering additional equity securities. If
additional funds are raised through the issuance of equity securities,
substantial dilution to our stockholders could result. In the event additional
funds are required, adequate funds may not be available when needed or may not
be available on favorable terms, which could have a negative effect on our
business and results of operations.
IF THE MARKETS FOR OUR PRODUCTS DO NOT CONTINUE TO GROW OR DO NOT GROW AT
EXPECTED RATES, DEMAND FOR OUR PRODUCTS WOULD BE REDUCED AND OUR BUSINESS WOULD
BE HARMED.
The success of our products currently will rely to a large degree on the
increased use by individuals and enterprises of mobile devices, including
personal digital assistants, cell phones, pagers and laptop and handheld
computers, and on increased use of technologies such as SyncML and Bluetooth.
Even if markets for our products grow, our products may not be successful.
Enterprises and OEMs may not develop sufficient confidence in mobile devices to
deploy our products to a significant degree. Any inability to continue to
penetrate the existing markets for mobile data management and wireless
connectivity product solutions, the failure of current markets to grow, new
markets to develop or these markets to be receptive to our products and
technologies on which our products are based, could harm our business. The
emergence of these markets will be affected by a number of factors beyond our
control.
WE DEPEND ON A NUMBER OF KEY BUSINESS RELATIONSHIPS AND IF WE FAIL TO MAINTAIN
THESE RELATIONSHIPS, OR ARE UNABLE TO DEVELOP NEW RELATIONSHIPS, OUR BUSINESS
WOULD SUFFER.
An important element of our strategy is the development of key business
relationships with other companies that are involved in product development,
joint marketing and the development of mobile communication protocols. If we
fail to maintain our current relationships or are unable to develop new
relationships, our business would suffer. Some of these relationships impose
substantial product support obligations on us, which may not be offset by
significant revenue. The benefits to us may not outweigh or justify our
obligations in these relationships. Also, in order to meet
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our current or future obligations to OEMs, we may be required to allocate
additional internal resources to OEMs' product development projects, which may
delay the completion dates of our other current product development projects.
Our existing key business relationships do not, and any future key business
relationships may not, provide us any exclusive rights. Many of the companies
with which we have established and intend to establish key business
relationships have multiple strategic relationships, and these companies may not
regard their relationships with us as significant. In most of these
relationships, either party may terminate the relationship with little notice.
In addition, these companies may attempt to develop or acquire products that
compete with our products. They may do so on their own or in collaboration with
others, including our competitors. Further, our existing business relationships
may interfere with our ability to enter into other business relationships.
OUR INVESTMENT IN GOODWILL AND INTANGIBLES RESULTING FROM OUR ACQUISITIONS COULD
BECOME IMPAIRED.
As of September 30, 2003, the amount of goodwill and other identifiable
intangibles recorded on our books, net of accumulated amortization, was $13.5
million. We ceased amortizing goodwill upon our adoption of SFAS No. 142 as of
the beginning of fiscal 2003, and we expect to amortize $1.2 million of net
identifiable intangibles in fiscal years 2004 through 2008. However, to the
extent that our goodwill or other identifiable intangibles are considered to be
impaired because circumstances indicate their carrying value may not be
recoverable, all or a portion of these assets may be subject to write-off in the
quarter of impairment. Such impairment and any resulting write-off could have a
negative impact on our results of operations in the period of the write- off.
MARKETS FOR OUR PRODUCTS ARE BECOMING INCREASINGLY COMPETITIVE, WHICH COULD
RESULT IN LOWER PRICES FOR OUR PRODUCTS OR A LOSS OF MARKET SHARE.
We may not compete successfully against current or future competitors, some of
whom have longer operating histories, greater name recognition, more employees
and significantly greater financial, technical, marketing, public relations and
distribution resources. Increased competition may result in price reductions,
reduced margins, loss of market share and a change in our business and marketing
strategies, any of which could harm our business. The competitive environment
may require us to make changes in our products, pricing, licensing, services or
marketing to maintain and extend the market acceptance of our products. Price
concessions or the emergence of other pricing or distribution strategies by our
competitors or us may diminish our revenue.
We compete with:
o mobile data management companies, including Aether Systems, IBM, iAnywhere (a
division of Sybase), Infowave; JP Mobile, Microsoft, Pumatech, RIM and
Synchrologic;
o application mobilization companies, including Everypath, iAnywhere,
Microsoft, and Oracle;
o mobile enterprise solutions companies, including Aether Systems,
Dexterra, and Telispark;
o client/server database providers, including Interbase, Microsoft, Oracle and
Pervasive Software;
o mobile connectivity companies, including IVT Corporation, Open Interface and
Widcomm; and
o internal research and development departments of OEMs, many of whom are our
current customers.
As the markets for mobile information management products grow, we expect
competition from existing competitors to intensify, and we expect new
competitors, including OEMs to which we sell our products, to introduce products
that compete with ours. Additionally, if existing or new competitors were to
merge or form strategic alliances, our market share may be reduced or pressure
may be put on us to reduce prices resulting in reduced revenue and margins.
WE MAY NOT BE ABLE TO SUCCESSFULLY DEVELOP OR INTRODUCE NEW PRODUCTS.
The markets for our products are characterized by:
o rapidly changing technologies;
o evolving industry standards;
o frequent new product introductions; and
o short product life cycles.
Any delays in the introduction or shipment of new or enhanced products, the
inability of our products to achieve market acceptance or problems associated
with new product transitions could harm our business. The product development
process involves a number of risks. Development of new, technologically advanced
products is a complex and uncertain process requiring high levels of innovation,
as well as the accurate anticipation of technological and market trends. The
introduction of new or enhanced products also requires us to manage the
transition from older products to minimize disruption in customer ordering
patterns.
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IF SPECIFIC INDUSTRY-WIDE STANDARDS AND PROTOCOLS UPON WHICH OUR PRODUCTS ARE OR
WILL BE BASED, DO NOT ACHIEVE WIDESPREAD ACCEPTANCE, OUR BUSINESS WOULD BE
HARMED.
We have designed a number of our current and upcoming products to conform to
industry standards and protocols, such as:
o Bluetooth, a short-range radio communication protocol;
o SyncML, a data synchronization protocol; and
o IrDA, a wireless communication protocol created by the Infrared Data
Association.
If these standards and protocols do not achieve acceptance, our business would
be harmed. Even if accepted, these industry-wide specifications may not be
widely adopted, or competing specifications may emerge. In addition,
technologies based on these standards and specifications may not be adopted as
the standard or preferred technologies for wireless connectivity, thereby
discouraging manufacturers of personal computers and mobile devices from
bundling or integrating these technologies in their products.
If our customers do not adopt wireless technologies, demand for our products
would be reduced and our business would be harmed.
Our products support the exchange of data with mobile devices via wired and
wireless connections. Our future growth will depend, in part, on the adoption of
wireless solutions by our customers. The adoption of wireless solutions is
dependent upon the development of 2.5 generation or 3rd generation ("2.5G" or
"3G") networks that are intended to support more complex applications and to
provide end users with a more satisfying user experience than today's networks.
If communication service providers delay their deployment of 2.5G or 3G networks
or fail to roll such networks out successfully, our customers may not adopt
wireless technologies, there could be less demand for our products and services
and our business could be harmed. In addition, if communication service
providers fail to continue to make investments in their networks or invest at a
slower pace in the future, there may be less demand for our products and
services and our business could suffer.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OUR PATENT, TRADEMARK, COPYRIGHT OR
OTHER INTELLECTUAL PROPERTY RIGHTS FROM COMPETITORS, AND WE MAY BE REQUIRED TO
USE A SIGNIFICANT AMOUNT OF OUR RESOURCES TO DEFEND OURSELVES FROM INFRINGEMENT
CLAIMS MADE BY OTHERS.
Our patents, trademarks or copyrights may be invalidated, circumvented or
challenged, and the rights granted under these patents, trademarks and
copyrights might not provide us with any competitive advantage, which could harm
our business. Any of our pending or future patent applications may not be issued
with the scope of the claims we are seeking, if at all. In addition, others may
develop technologies that are similar or superior to our technology, duplicate
our technology or design around our patents. Further, effective intellectual
property protection may be unavailable or limited in some countries outside of
the United States.
Companies in the software industry frequently resort to litigation over
intellectual property rights. If a court finds that we infringe on the
intellectual property rights of any third party, we could be subject to
liabilities, which could harm our business. As a result, we might be required to
seek licenses from other companies or to refrain from using, manufacturing or
selling specific products or using specific processes. Holders of patents and
other intellectual property rights may not offer licenses to use their patents
or other intellectual property rights on acceptable terms, or at all. Failure to
obtain these licenses on commercially reasonable terms or at all could harm our
business.
In order to protect our proprietary rights, we may decide to sue third parties.
Any litigation, whether brought by or against us, could cause us to incur
significant expenses and could divert a large amount of management time and
effort. A claim by us against a third party could, in turn, cause a counterclaim
by the third party against us, which could impair our intellectual property
rights and harm our business.
OUR BUSINESS MAY BE HARMED DUE TO RISKS ASSOCIATED WITH INTERNATIONAL SALES AND
OPERATIONS, WHICH REPRESENT A SUBSTANTIAL PORTION OF OUR REVENUE.
In the first quarter of fiscal 2004, based on the region where the customer
resides, 57% of our revenue was generated from sales outside the United States.
We expect that international sales will continue to represent a substantial
portion of our revenue for the foreseeable future. International sales are
subject to a number of risks, including:
o changes in government regulations;
o export license requirements;
29
o tariffs, taxes and trade barriers;
o fluctuations in currency exchange rates, which could cause our products to
become relatively more expensive to customers in a particular country and
lead to a reduction in sales in that country; longer collection and payment
cycles than those in the United States;
o difficulty in staffing and managing international operations; and
o political and economic instability, including the threat or occurrence of
military and terrorist actions and enhanced national security measures.
OUR BUSINESS MAY BE HARMED IF OUR PROFESSIONAL SERVICES ORGANIZATION DOES NOT
GENERATE AN ACCEPTABLE PROFIT LEVEL.
Our professional services business is subject to a variety of risks including:
o we may be unable to accurately predict staffing requirements and,
therefore, the expense of fulfilling our service contracts may be greater
than we anticipate; and
o we may have an inappropriate level of resources dedicated to the professional
services business in relation to the number of projects we are able to sell,
resulting in a low utilization rate of resources.
If we are unable to operate the professional services organization effectively,
the profitability of this business could decline, or even result in a loss,
which could harm our business.
CURRENCY EXCHANGE RATE FLUCTUATIONS COULD CAUSE OUR OPERATING RESULTS TO
FLUCTUATE.
The transactions made through our subsidiaries in Canada, France, Germany,
Italy, the Netherlands and the United Kingdom are primarily denominated in local
currencies. Accordingly, these international operations expose us to currency
exchange rate fluctuations, which in turn could cause our operating results to
fluctuate when we translate revenue and expenses denominated in other currencies
into U.S. dollars.
From time to time, we enter into foreign currency forward contracts, typically
against the Canadian dollar, euro, and British pound sterling, to manage
currency fluctuations on payments and receipts of foreign currencies on
transactions with our international subsidiaries. The success of these currency
activities depends upon estimation of intercompany balances denominated in
various foreign currencies. To the extent that these forecasts are overstated or
understated during periods of currency volatility, we could experience
unanticipated currency gains or losses. When determining whether to enter into
foreign currency forward contracts, we also consider the impact that the
settlement of such forward contracts may have on our cash position. To eliminate
a potential cash settlement of a forward position we may, from time to time,
decide not to use foreign currency forward contracts to manage fluctuations in
the value of foreign currencies on transactions with our international
subsidiaries. In a period where we do not enter into foreign currency forward
contracts, we could experience significant non-cash currency gains or losses if
the value of the U.S. dollar strengthens or weakens significantly in relation to
the value of the foreign currencies. For example, we recognized foreign currency
exchange gains in the fourth quarter of fiscal 2003 and the first quarter of
fiscal 2004 as a result of the dollar weakening at a time when we were not
entering into foreign currency forward contracts.
IF WE ACCOUNT FOR EMPLOYEE STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS USING
THE FAIR VALUE METHOD, IT COULD SIGNIFICANTLY REDUCE OUR NET INCOME AND EARNINGS
PER SHARE.
There has been ongoing public debate whether employee stock option and employee
stock purchase plans shares should be treated as a compensation expense and, if
so, how to properly value such charges. If we elected or were required to record
an expense for our stock-based compensation plans using the fair value method,
we could have significant accounting charges. For example, in the first quarter
of fiscal 2004, had we accounted for stock-based compensation plans using the
fair-value method prescribed in FASB Statement No. 123 as amended by Statement
148, our net loss would have been increased by approximately $699,000. Although
we are not currently required to record any compensation expense using the fair
value method in connection with option grants that have an exercise price at or
above fair market value at the grant date and for shares issued under our
employee stock purchase plan, it is possible that future laws or regulations
will require us to treat all stock-based compensation as an expense using the
fair value method. See Note 3 of Notes to Condensed Consolidated Financial
Statements for a more detailed presentation of accounting for stock-based
compensation plans.
30
WE DEPEND ON NON-EXCLUSIVE LICENSES FOR SOME OF THE TECHNOLOGY WE USE WITH OUR
PRODUCTS.
We license technology on a non-exclusive basis from several companies for use
with our products and anticipate that we will continue to do so in the future.
For example, we license encryption technology that we include in our OneBridge
Mobile Groupware (formerly XTNDConnect Server) products. Our inability to
continue to license this technology, or to license other technology necessary
for use with our products, could result in the loss of, or delays in the
inclusion of, important features of our products or result in substantial
increases in royalty payments that we would have to pay pursuant to alternative
third-party licenses, any of which could harm our business. In addition, the
effective implementation of our products depends upon the successful operation
of licensed software in conjunction with our products. Any undetected errors in
products resulting from this licensed software may prevent the implementation or
impair the functionality of our products, delay new product introductions and
injure our reputation.
THE COMPLEX COMPUTER SOFTWARE PRODUCTS THAT WE PRODUCE MAY CONTAIN DEFECTS FOR
WHICH WE MAY BE LIABLE.
The complex software products we offer may contain undetected errors when first
introduced or as new versions are released. These errors could result in
dissatisfied customers, product liability claims and the loss of or delay in
market acceptance of new or enhanced products, any of which could harm our
business. Testing of our products is particularly challenging because it is
difficult to simulate the wide variety of computing environments in which our
customers may deploy our products. For example, our mobile information
management products are used in a wide variety of telecommunications
environments. Changes in technology standards or an increase in the number of
telecommunications technologies used in the marketplace may create compatibility
issues with our products and our customers' environments. Accordingly, despite
testing by us and by current and potential customers, errors could be found
after commencement of commercial shipment. A successful product liability claim
brought against us could result in our payment of significant legal fees and
damages, which would harm our business.
OUR STOCK PRICE MAY BE VOLATILE AND COULD DROP SIGNIFICANTLY, RESULTING IN THE
PARTIAL OR TOTAL LOSS OF A STOCKHOLDER'S INVESTMENT.
The trading price of our common stock may fluctuate significantly, which may
cause a stockholder's investment to decrease in value. The following factors may
have a significant impact on the market price of our common stock:
o announcements of acquisitions by us or our competitors;
o changes in our management team;
o our ability to obtain financing when needed;
o quarter-to-quarter variations in our operating results;
o sales of significant numbers of shares within a short period of time;
o developments in or the outcome of our litigation with Pumatech;
o announcements of technological innovations or new products by us or our
competitors;
o general conditions in the computer and mobile device industry;
o general economic conditions and their impact on corporate information
technology spending;
o price and trading volume volatility in the public stock markets in general;
o announcements and updates of our business outlook; and
o changes in security analysts' earnings estimates or recommendations regarding
our competitors, our customers or us.
IF WE ARE UNABLE TO EFFECTIVELY MANAGE OUR GROWTH, OUR BUSINESS WILL SUFFER.
Growth in our business may place a significant strain on our administrative,
operational and financial resources and increase demands on our systems and
controls, which could harm our business. Growth may also result in an increase
in the scope of responsibility for management personnel.
We anticipate that our growth and expansion will require that we recruit, hire,
train and retain new engineering, executive, sales and marketing, and
administrative personnel. Difficulty in recruiting qualified personnel could
require us to incur significant costs to recruit personnel or could limit our
ability to grow. In addition, in order to manage our growth successfully, we
will need to continue to expand and improve our operational, management and
financial systems and controls. The failure to do so could harm our business.
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THE LOSS OF KEY PERSONNEL, OR OUR INABILITY TO ATTRACT AND RETAIN ADDITIONAL
PERSONNEL, MAY HARM OUR BUSINESS.
Our future success will depend on our ability to attract and retain experienced,
highly qualified management, technical, research and development, and sales and
marketing personnel. Competition for qualified personnel in the computer
software industry is intense, and there is a risk that we will have difficulty
recruiting and retaining key employees. In addition, new employees generally
require substantial training, which may require substantial resources and
management attention. If we lose the services of one or more key employees, or
if one or more of them decide to join a competitor or otherwise compete directly
or indirectly with us, our business could be harmed. Searching for replacements
for our key employees could divert management's time and result in increased
operating expenses that may not be offset by either improved productivity or
higher prices. Over the past two years, a number of our senior management
employees have left Extended Systems, including most recently, Steven Simpson,
our former President and Chief Executive Officer, and Karla Rosa, our former
Vice President Finance and Chief Financial Officer, and we cannot assure you
that there will not be additional departures. Any changes in management can be
disruptive to our operations. Uncertainty created by turnover of key employees
could result in reduced confidence in our financial performance, which could
cause fluctuations in our stock price.
SOME ANTI-TAKEOVER PROVISIONS CONTAINED IN OUR CERTIFICATE OF INCORPORATION,
BYLAWS AND STOCKHOLDER RIGHTS PLAN, AS WELL AS PROVISIONS OF DELAWARE LAW, COULD
IMPAIR A TAKEOVER ATTEMPT.
We have provisions in our certificate of incorporation and bylaws, each of
which could have the effect of rendering more difficult or discouraging an
acquisition deemed undesirable by our Board of Directors. These include
provisions:
o dividing our board of directors into three classes, each serving a staggered
three-year term;
o authorizing blank check preferred stock, which could be issued with voting,
liquidation, dividend and other rights superior to its common stock;
o dividend and other rights superior to its common stock;
o limiting the liability of, and providing indemnification to, directors and
officers;
o requiring advance notice of stockholder proposals for business to be
conducted at meetings of stockholders and for nominations of candidates for
election to our Board of Directors;
o specifying that stockholders may take action only at a duly called annual or
special meeting of stockholders.
These provisions, alone or together, could deter or delay hostile takeovers,
proxy contests and changes in control or management of Extended Systems. As a
Delaware corporation, we also are subject to provisions of Delaware law,
including Section 203 of the Delaware General Corporation Law, which prevents
some stockholders from engaging in certain business combinations without
approval of the holders of substantially all of our outstanding common stock.
In June 2003, pursuant to a Preferred Stock Rights Agreement between Extended
Systems and EquiServe Trust Company, N.A., our Board of Directors issued certain
Preferred Share Purchase Rights. The Rights were not intended to prevent a
takeover of Extended Systems. However, the Rights may have the effect of
rendering more difficult or discouraging an acquisition of Extended Systems
deemed undesirable by our Board of Directors. The Rights would cause substantial
dilution to a person or group that attempted to acquire Extended Systems on
terms or in a manner not approved by our Board of Directors, except pursuant to
an offer conditioned upon redemption of the Rights.
Any provision of our certificate of incorporation or bylaws or Delaware law that
has the effect of delaying or deterring a change in control could limit the
opportunity for our stockholders to receive a premium for their shares of common
stock and also could affect the price that some investors are willing to pay for
our common stock.
WE INTEND TO PURSUE ADDITIONAL ACQUISITIONS, AND ANY ACQUISITIONS COULD PROVE
DIFFICULT TO INTEGRATE WITH OUR BUSINESS, DISRUPT OUR BUSINESS, DILUTE
STOCKHOLDER VALUE OR ADVERSELY AFFECT OUR OPERATING RESULTS.
As part of our strategy, we intend to continue to pursue the acquisition of
companies that either complement or expand our existing business. If we fail to
properly evaluate and execute acquisitions, our business would be harmed. We may
not be able to properly evaluate the technology and accurately forecast the
financial impact of the transaction, including accounting charges and
transaction expenses. Acquisitions involve a number of risks and difficulties,
including:
o the integration of acquired technologies with our existing products and
technologies;
o diversion of management's attention and other resources to the assimilation
of the operations and employees of the acquired companies;
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o availability of equity or debt financing on terms favorable to us and our
stockholders;
o integration of management information systems, employees, research and
development, and marketing, sales and support operations;
o expansion into new markets and business areas;
o potential adverse short-term effects on our operating results; and
o retention of customers and employees post-acquisition.
In addition, if we conduct acquisitions using debt or equity securities, our
existing stockholders' investments may be diluted, which could affect the market
price of our stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Substantially all of our liquid investments are at fixed interest rates and,
therefore, the fair value of these instruments is affected by changes in market
interest rates. All of our liquid investments mature within 90 days or less of
September 30, 2003, therefore, we believe that the market risk arising from our
holdings of liquid investments is minimal.
Sales made by our subsidiaries outside the United States are generally
denominated in the foreign country's currency. Fluctuations in exchange rates
between the United States dollar and other currencies could materially harm our
business. From time to time, we enter into foreign currency forward contracts,
typically against the Canadian dollar, euro, and British pound sterling, to
manage fluctuations in the value of foreign currencies on transactions with our
international subsidiaries, thereby limiting our risk that would otherwise
result from changes in exchange rates. We report a net currency gain or loss
based on changes in the fair value of forward contracts combined with changes in
fair value of the underlying asset or liability being managed. The success of
these currency activities depends upon estimation of intercompany balances
denominated in various foreign currencies. To the extent that these forecasts
are overstated or understated during periods of currency volatility, we could
experience unanticipated currency gains or losses. When determining whether to
enter into foreign currency forward contracts, we also consider the impact that
the settlement of such forward contracts may have on our cash position. To
eliminate a potential cash settlement of a forward position we may, from time to
time, decide not to use foreign currency forward contracts to manage
fluctuations in the value of foreign currencies on transactions with our
international subsidiaries. In a period where we do not enter into foreign
currency forward contracts, we could experience significant non-cash currency
gains or losses if the value of the U.S. dollar strengthens or weakens
significantly in relation to the value of the foreign currencies. We had no
forward contracts in place as of September 30, 2003. As of September 30, 2002,
we had forward contracts with a nominal value of $4.6 million in place against
the Canadian dollar, euro and British pound sterling, which matured within 30
days. We recognized a net currency exchange gain of $59,000 for the quarter
ended June 30, 2003 and a net currency exchange loss of $55,000 for the quarter
ended September 30, 2002. We are entering into foreign currency forward
contracts in the second quarter of fiscal 2004.
ITEM 4. CONTROLS AND PROCEDURES
We have carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and
acting Chief Financial Officer, of the effectiveness of the design and operation
of our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) as of the end of the period covered by this Quarterly Report. Based upon
that evaluation, our Chief Executive Officer and acting Chief Financial Officer
concluded that our disclosure controls and procedures are effective to ensure
that material information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission rules and forms. It should be noted, however, that the design of any
system of controls is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions,
regardless of how remote.
There has been no change in our internal control over financial reporting that
occurred during our most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 22, 2002, Pumatech, Inc. filed a patent infringement action against us
in the U.S. District Court in Northern California. An amended complaint was
filed on May 28, 2002. The action alleges that our XTNDConnect server and
desktop synchronization products infringe on seven of Pumatech's
synchronization-related patents, that our alleged use of the trademark
"Satellite Forms" constitutes trademark infringement, and that other alleged
actions constitute unfair competition and interference with contract. The action
seeks an injunction against further sales of our server and desktop
synchronization products and use of the allegedly infringing trademark, as well
as unspecified damages and attorneys' fees. On June 25, 2002, we filed an answer
and counterclaim in response to Pumatech's complaint in which we deny Pumatech's
charges, raise a number of affirmative defenses and request a declaration from
the court that Pumatech synchronization software patents are invalid and not
infringed by our products. On December 11, 2002, Pumatech filed a second amended
complaint, which adds allegations that unspecified synchronization products
infringe an eighth Pumatech patent. On December 31, 2002, we filed an amended
answer and counterclaim in which we deny all of Pumatech's charges, including
this additional charge, and amend our defenses and counterclaims to include this
additional patent. On August 1, 2003 the Honorable Judge D. Lowell Jensen,
United States District Judge, issued his Claims Construction Ruling on the
interpretation, definition, and scope of the claims in the suit. We believe that
the Court's ruling has significantly narrowed claims in five of the Pumatech
patents. The Court also ruled that it could not correct an error that appears in
all asserted claims of Pumatech's '676 patent. This error must be corrected in
reissue proceedings in the Patent Office. Until the Patent Office issues
corrected claims, no synchronization software can infringe the '676 patent, and
it is unlikely that such a correction would have any retroactive effect. As a
result, if any of our products are ultimately held to be infringing this patent,
it is unlikely that Pumatech would be entitled to damages for any period prior
to the reissue date. We have petitioned the U.S. Patent Office for reexamination
of three of the Pumatech patents. The Patent Office has issued an Office Action
for each of the three patents rejecting all Pumatech patent claims over the
prior art for two of the patents and rejecting all claims on which we requested
reexamination for the other patent. As a result of the reexamination process, we
expect the patents to be significantly narrowed or rejected by the Patent Office
in their entirety. If the patents are amended and reissued, and we are
ultimately held to be infringing one of the reissued patents, it is unlikely
that Pumatech would be entitled to damages for any period preceding the reissue
date. Discovery and other pretrial proceedings are on going; trial is currently
scheduled for April 2004.
We believe that we have numerous meritorious defenses to Pumatech's claims and
we intend to continue to defend the suit vigorously. However, litigation is
inherently uncertain, and we may not prevail in our defenses or counterclaims.
If Pumatech prevails in one or more of its claims, we could be required to pay
substantial damages for past sales of infringing products, to cease selling
specific of our server or desktop synchronization products that are held to
infringe a Pumatech patent, to pay royalties on the sales of specific products
that are held to infringe a Pumatech patent, or some combination of these
results. We may also incur significant development costs to redesign certain of
our products to ensure that they are non-infringing. Any of such outcomes could
have a material adverse effect on our business and financial position. In
addition, litigation is frequently expensive and time-consuming, and management
may be required to spend significant time in the defense of the suit; such costs
and the diversion of management time could have a material adverse effect on our
business. The ultimate outcome of any litigation is uncertain and the range of
loss that could occur upon resolution of this matter is not estimable. We cannot
estimate the costs of any potential settlement. Were an unfavorable outcome to
occur, the impact could be material to our financial position, results of
operations, or cash flows.
34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
10.1 Form of Indemnification Agreement between the Company and its
directors and officers.
10.11 Real Estate Purchase Agreement dated September 2, 2003
between Extended Systems of Idaho, Incorporated and Brighton
Investments, LLC.
31 Certification of Executive Officers pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32 Certification of Executive Officers pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) REPORTS ON FORM 8-K
On July 9, 2003, we filed a current report on Form 8-K in connection with the
issuance of a press release dated July 7, 2003 announcing changes in the
composition of our Board of Directors.
On July 31, 2003, we filed a current report on Form 8-K in connection with the
issuance of a press release dated July 28, 2003 announcing our financial results
for the fiscal year ended June 30, 2003.
On August 20, 2003, we filed a current report on Form 8-K in connection with the
issuance of a press release dated August 19, 2003 announcing that we had named
Charles W. Jepson Chief Executive Officer and President of the company and that
former Chief Executive Officer and President Steven D. Simpson had resigned. We
also announced the appointment of two new independent members to our Board of
Directors, James R. Bean and Jody B. Olson.
On September 10, 2003, we filed a current report on Form 8-K in connection with
the issuance of a press release dated September 3, 2003 announcing that we had
entered into definitive agreements for the sale-and-leaseback of our
headquarters building and land and for the sale of 16.2 acres of land adjacent
to our headquarters building.
35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q
to be signed on its behalf by the undersigned, thereunto duly authorized, in
Boise, Idaho, on November 14, 2003.
EXTENDED SYSTEMS INCORPORATED
By: /s/ CHARLES W. JEPSON
-------------------------
CHARLES W. JEPSON
PRESIDENT, CHIEF EXECUTIVE OFFICER,
AND ACTING CHIEF FINANCIAL OFFICER
36