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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 MARCH 31, 2005
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
Commission File Number 000-23597
EXTENDED SYSTEMS INCORPORATED
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(Exact name of registrant as specified in its charter)
DELAWARE 82-0399670
- ------------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5777 NORTH MEEKER AVENUE, BOISE, ID 83713
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(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 March
31, 2005, was 15,576,033
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EXTENDED SYSTEMS INCORPORATED
FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2005
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements ............................................ 3
Condensed Consolidated Balance Sheets as of
March 31, 2005 (unaudited) and June 30, 2004 .................... 3
Condensed Consolidated Statements of Operations
for the Three and Nine Months Ended March 31, 2005
and 2004 (unaudited) ............................................ 4
Condensed Consolidated Statements of Comprehensive
Income (Loss) for the Three and Nine Months Ended
March 31, 2005 and 2004 (unaudited) ............................. 5
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended March 31, 2005 and 2004
(unaudited) ..................................................... 6
Condensed Consolidated Statement of Stockholders'
Equity for the Nine Months Ended March 31, 2005
(unaudited) ..................................................... 7
Notes to Condensed Consolidated Financial
Statements (unaudited) .......................................... 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ....................................... 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk ...... 39
Item 4. Controls and Procedures ......................................... 40
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ............................................... 41
Item 6. Exhibits ........................................................ 41
(Items 2, 3, 4, and 5 of Part II are not
applicable and have been omitted)
SIGNATURES ...................................................... 42
2
PART I. FINANCIAL INFORMATON
ITEM 1. FINANCIAL STATEMENTS
EXTENDED SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
(unaudited)
MARCH 31, JUNE 30,
2005 2004
------------ ------------
ASSETS
Current:
Cash and cash equivalents ............................................. $ 9,756 $ 7,225
Receivables, net of allowances of $659 and $446 ....................... 7,780 6,772
Prepaid and other ..................................................... 1,170 1,449
------------ ------------
Total current assets ............................................. 18,706 15,446
Property and equipment, net ........................................... 4,869 4,331
Construction in progress .............................................. -- 384
Goodwill .............................................................. 12,489 12,489
Intangibles, net ...................................................... 416 576
Other long-term assets ................................................ 113 130
------------ ------------
Total assets ..................................................... $ 36,593 $ 33,356
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current:
Accounts payable ...................................................... $ 1,331 $ 1,639
Accrued expenses ...................................................... 4,268 3,556
Deferred revenue ...................................................... 3,065 3,569
Accrued restructuring ................................................. -- 116
Current portion of long-term debt ..................................... -- 325
Current portion of capital leases ..................................... 15 25
------------ ------------
Total current liabilities ........................................ 8,679 9,230
Non-current:
Long-term debt ........................................................ 4,800 4,800
Capital leases ........................................................ 9 17
Other long-term liabilities ........................................... 152 153
------------ ------------
Total non-current liabilities .................................... 4,961 4,970
------------ ------------
Total liabilities ..................................................... 13,640 14,200
Commitments and contingencies - Note 10
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;
15,576 and 15,078 shares issued and outstanding .................. 16 15
Additional paid-in capital ............................................ 49,318 48,005
Treasury stock; $0.001 par value per share; 4 and 0 common shares ..... -- --
Accumulated deficit ................................................... (23,811) (27,134)
Unamortized stock-based compensation .................................. (101) (231)
Accumulated other comprehensive loss .................................. (2,469) (1,499)
------------ ------------
Total stockholders' equity ....................................... 22,953 19,156
------------ ------------
Total liabilities and stockholders' equity ....................... $ 36,593 $ 33,356
============ ============
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 MARCH 31, NINE MONTHS ENDED MARCH 31,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Revenue:
License fees and royalties ............................. $ 9,437 $ 6,076 $ 22,878 $ 18,904
Services and other ..................................... 2,135 2,231 6,481 5,465
------------ ------------ ------------ ------------
Total net revenue .................................. 11,572 8,307 29,359 24,369
Costs and expenses:
Cost of license fees and royalties ..................... 102 132 296 358
Cost of services and other ............................. 1,197 1,062 3,144 3,200
Amortization of identifiable intangibles ............... 43 138 161 482
Research and development ............................... 2,081 1,824 5,702 4,988
Marketing and sales .................................... 3,938 3,371 11,145 10,043
General and administrative ............................. 1,642 1,355 4,372 4,004
Restructuring charges .................................. -- 117 -- 1,446
Patent litigation fees, license and settlement ......... -- 2,080 -- 3,425
Non-cash stock-based compensation ...................... 38 169 477 337
------------ ------------ ------------ ------------
Total costs and expenses ........................... 9,041 10,248 25,297 28,283
------------ ------------ ------------ ------------
Income (loss) from operations ...................... 2,531 (1,941) 4,062 (3,914)
Other income (expense), net ............................ (106) 4 (194) 46
Gain on sale of land ................................... -- -- -- 1,058
Interest expense ....................................... (126) (139) (392) (318)
------------ ------------ ------------ ------------
Income (loss) before income taxes .................. 2,299 (2,076) 3,476 (3,128)
Income tax provision ................................... 121 9 153 22
------------ ------------ ------------ ------------
Income (loss) from continuing operations ........... 2,178 (2,085) 3,323 (3,150)
Discontinued operations, net of tax:
Income from discontinued operations ................ -- -- -- 88
------------ ------------ ------------ ------------
Net income (loss) .................................. $ 2,178 $ (2,085) $ 3,323 $ (3,062)
============ ============ ============ ============
Basic earnings (loss) per share:
Earnings (loss) from continuing operations ......... $ 0.14 $ (0.14) $ 0.22 $ (0.22)
Earnings from discontinued operations .............. -- -- -- --
------------ ------------ ------------ ------------
Net earnings (loss) per share .......................... $ 0.14 $ (0.14) $ 0.22 $ (0.22)
============ ============ ============ ============
Diluted earnings (loss) per share:
Earnings (loss) from continuing operations ......... $ 0.14 $ (0.14) $ 0.21 $ (0.22)
Earnings from discontinued operations .............. -- -- -- --
------------ ------------ ------------ ------------
Net earnings (loss) per share .......................... $ 0.14 $ (0.14) $ 0.21 $ (0.22)
============ ============ ============ ============
Number of shares used in per share calculations:
Basic .............................................. 15,438 14,601 15,214 14,236
Diluted ............................................ 15,860 14,601 15,461 14,236
The accompanying notes are an integral part of the condensed consolidated financial statements
4
EXTENDED SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)
THREE MONTHS ENDED MARCH 31, NINE MONTHS ENDED MARCH 31,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net income(loss) ....................................... $ 2,178 $ (2,085) $ 3,323 $ (3,062)
Change in currency translation ......................... (71) 1 (970) (359)
------------ ------------ ------------ ------------
Comprehensive income (loss) ........................ $ 2,107 $ (2,084) $ 2,353 $ (3,421)
============ ============ ============ ============
The accompanying notes are an integral part of the condensed consolidated financial statements
5
EXTENDED SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
NINE MONTHS ENDED MARCH 31,
----------------------------
2005 2004
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ................................................ $ 3,323 $ (3,062)
Adjustments to reconcile net income (loss) to net
cash provided (used) by operating activities:
Provision for bad debts ...................................... 158 123
Depreciation and amortization ................................ 671 1,189
Stock-based compensation ..................................... 477 893
Gain on sale of property and equipment ....................... -- (1,001)
Changes in assets and liabilities:
Receivables ............................................. (985) (122)
Prepaid and other assets ................................ 297 (283)
Accounts payable and accrued expenses ................... (855) (639)
Deferred revenue ........................................ (534) 135
------------ ------------
Net cash provided (used) by operating activities ................. 2,552 (2,767)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ............................................. (667) (310)
Proceeds from sale of property and equipment ..................... -- 1,564
Other investing activities ....................................... -- 19
------------ ------------
Net cash provided (used) by investing activities ................. (667) 1,273
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale-and-leaseback of building ..................... -- 4,800
Proceeds from the issuance of common stock ....................... 966 1,240
Payments on long-term debt and capital leases .................... (343) (342)
------------ ------------
Net cash provided by financing activities ........................ 623 5,698
Effect of exchange rates on cash ....................................... 23 50
------------ ------------
Net increase in cash and cash equivalents .............................. 2,531 4,254
CASH AND CASH EQUIVALENTS:
Beginning of period .............................................. 7,225 3,502
------------ ------------
End of period .................................................... $ 9,756 $ 7,756
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 349 $ 270
Taxes paid $ 97 $ 81
The accompanying notes are an integral part of the condensed consolidated financial statements
6
EXTENDED SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED MARCH 31, 2005
(in thousands)
(unaudited)
ACCUMULATED
COMMON STOCK ADDITIONAL UNAMORTIZED OTHER TOTAL
-------------------------- PAID-IN ACCUMULATED STOCK-BASED COMPREHENSIVE STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT COMPENSATION LOSS EQUITY
---------- ------------ ------------ ------------ ------------ ------------ ------------
Balance at July 1, 2004....... 15,078 $ 15 $ 48,005 $ (27,134) $ (231) $ (1,499) $ 19,156
Net Income.................... -- -- -- 3,323 -- -- 3,323
Translation adjustment........ -- -- -- -- -- (970) (970)
Stock issued from stock
option exercises............ 446 1 965 -- -- -- 966
Compensatory options.......... -- -- 214 -- -- -- 214
Restricted stock grants....... 56 -- 152 -- (152) -- --
Restricted stock amortization. -- -- -- -- 263 -- 263
Restricted stock repurchase... (4) -- (18) -- 19 -- 1
---------- ------------ ------------ ------------ ------------ ------------ ------------
Balance at March 31, 2005..... 15,576 $ 16 $ 49,318 $ (23,811) $ (101) $ (2,469) $ 22,953
========== ============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of the condensed consolidated financial statements
7
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. All
significant intercompany accounts and transactions have been eliminated in
consolidation. Tabular amounts are in thousands, except years, percentages and
per share amounts.
The accompanying condensed consolidated financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission
(the "SEC"). Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States have been condensed or omitted pursuant to such
rules and regulations. These accounting principles were applied on a basis
consistent with those of the consolidated financial statements contained in our
Annual Report on Form 10-K for the fiscal year ended June 30, 2004. We have
prepared these condensed consolidated financial statements without audit
pursuant to the rules and regulations of 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 March 31, 2005, and our
results of operations and cash flows for the three months and nine months ended
March 31, 2005 and March 31, 2004. 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, 2005. These condensed consolidated financial statements
should be read in conjunction with our audited consolidated financial statements
and related notes included in our Annual Report on Form 10-K for the fiscal year
ended June 30, 2004.
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.
We have a history of incurring losses from operations and have an accumulated
deficit of approximately $24 million as of March 31, 2005. However, for the nine
months ended March 31, 2005, we recorded income from operations of approximately
$4.1 million and operating activities provided $2.6 million of cash. At March
31, 2005, we had cash and cash equivalents of $9.8 million.
We believe our existing working capital and borrowing capacity will be
sufficient to fund our anticipated working capital and capital expenditure
requirements through at least March 31, 2006. We cannot be certain, however,
that the underlying assumed levels of revenues and expenses will be accurate. If
operating results were to fail to meet our 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 DEVELOPMENTS. On December 16, 2004, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 123(R), "Share-Based Payment." SFAS No. 123(R) requires companies
to measure all stock-based compensation awards using a fair value method and
record such expense in their consolidated financial statements. In addition, the
adoption of SFAS No. 123(R) will require additional accounting related to the
income tax effects and additional disclosure regarding the cash flow effects
resulting from share-based payment arrangements. SFAS No. 123(R) is effective
beginning the first quarter of our fiscal year ending June 30, 2006. We are
currently assessing the impact of SFAS No. 123(R) on our stock-based
compensation programs. However, we expect that the requirement to expense stock
options and other equity interests that have been or will be granted to
employees will significantly increase our operating expenses and result in lower
earnings per share.
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. Also included in comprehensive income
or loss are adjustments that result from the translation of U.S. dollar
denominated intercompany loans that are considered to be permanent in nature. We
translate revenue and expenses into U.S. dollars using a weighted average
exchange rate for the period.
From time to time, we enter into foreign currency forward contracts, typically
with respect to the euro, Canadian dollar, and British pound sterling to manage
fluctuations in the value of foreign currencies on transactions with our
international subsidiaries, thereby limiting the risk that would otherwise
result from changes in currency exchange rates. Although 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
8
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. We had
no forward contracts in place as of March 31, 2005. As of March 31, 2004, we had
forward contracts with a nominal value of approximately $9.3 million, each of
which matured within 30 days, in place with respect to the Canadian dollar, euro
and British pound sterling. We recognized net currency exchange losses of
approximately $167 thousand and $380 thousand for the three and nine months
ended March 31, 2005 and net currency exchange losses of approximately $45
thousand and $17 thousand for the three and nine months ended March 31, 2004.
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 stock options and warrants that could potentially dilute
earnings per share. We exclude stock options and warrants from diluted earnings
or loss per share to the extent that their effect on the computation is
antidilutive.
Our diluted earnings or loss per share computations exclude the following common
stock equivalents, as the affect of their inclusion would have been antidilutive
for the following periods:
THREE MONTHS ENDED MARCH 31, NINE MONTHS ENDED MARCH 31,
--------------------------- ---------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Stock options .... 1,965 3,346 2,037 3,346
Warrants ......... 35 35 35 35
RECLASSIFICATIONS. We have reclassified certain prior year amounts to conform to
the current year presentation, including a reclassification between components
of income (loss) from operations, between components of current assets and
between components of current liabilities. These reclassifications had no impact
on net income (loss), income (loss) from operations, total costs and expenses,
total current assets or total current liabilities for the periods presented.
REVENUE RECOGNITION. We apply the provisions of Statement of Position 97-2,
SOFTWARE REVENUE RECOGNITION (SOP 97-2), as amended by SOP 98-9, and recognize
software 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.
We assess whether the fee associated with a transaction is fixed or determinable
at the time of the transaction, based on the payment terms associated with the
transaction. If payment terms are extended for a significant portion of the fee
or if there is a risk that the customer will expect a concession, we do not
consider the fee fixed or determinable. In these cases, we recognize revenue as
the fee becomes due and payable. If we were to assess the fixed or determinable
criterion differently, the timing and amount of our revenue recognition might
differ 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 were to assess our ability to collect
differently, the timing and amount of our revenue recognition might differ
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 had 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, patches, bug fixes and other
modifications to ensure that the products comply with their warranty provisions.
Accordingly, we allow for warranty costs for these products at the time the
product revenue is recognized.
When a contractual relationship with one of our customers stipulates the
submission of a royalty report to us, revenue is generally recorded when the
royalty report is received and recognized in the period that the report covers.
If a royalty report is not received by the desired date to facilitate the
closing of the books for a given fiscal period and there exists the basis to
make a fair and reasonable estimate of the revenue related to that royalty
report, this estimate will be recorded as revenue. Estimated royalty fees and
revenues are subsequently adjusted based upon actual amounts realized. If the
actual amount realized differs materially from the recorded estimate and is
reported to us after an estimate has been recorded and before financial results
are announced externally, the recorded amount will be adjusted to reflect the
actual amount realized. If the amount differs and is reported after financial
results are announced externally or does not differ materially, the adjustment
will be made in the subsequent fiscal period.
9
In cases where the arrangement with our customer provides for a prepaid
nonrefundable royalty, we 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 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. We recognize no
more than 90% of the total contract amount until project acceptance is obtained.
In cases where our professional services involve customizations for which the
amount of customization effort cannot be reasonably estimated, or where
significant uncertainty about the project completion or customer acceptance
exists, we defer the contract revenue under the completed contract method of
accounting until the uncertainty is sufficiently resolved or the contract is
complete and accepted by the customer. If we were to make different judgments or
use 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
reported.
NOTE 3. STOCK-BASED COMPENSATION PLANS
We apply Accounting Principles Board Opinion No. 25 ("APB No. 25"), "Accounting
for Stock Issued to Employees" and its related interpretations to measure
compensation expense for stock-based compensation plans. Under APB No. 25, we
generally recognize no compensation expense with respect to stock option grants
and shares issued under our employee stock purchase plan. Our stock option plans
allow for the issuance of restricted stock awards, under which shares of our
common stock are issued at par value to employees or directors, subject to
vesting restrictions, and for which compensation expense equal to the fair
market value on the date of grant less par value paid is amortized over the
vesting period.
Had we elected to recognize stock-based employee compensation expense based on
the grant date fair value as prescribed by SFAS No. 123, our net income (loss)
would have been equal to the pro forma amounts indicated below for the following
periods:
THREE MONTHS ENDED MARCH 31, NINE MONTHS ENDED MARCH 31,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net income (loss), as reported ............. $ 2,178 $ (2,085) $ 3,323 $ (3,062)
Add: Stock-based compensation included in
reported net income (loss)(1)(2) ..... 38 224 477 893
Less: Stock-based compensation determined
under SFAS No. 123 ................... (480) (928) (2,288) (4,383)
------------ ------------ ------------ ------------
Pro forma net income (loss) ................ $ 1,736 $ (2,789) $ 1,512 $ (6,552)
============ ============ ============ ============
Basic earnings (loss) per share:
As reported .......................... $ 0.14 $ (0.14) $ 0.22 $ (0.22)
Pro forma ............................ $ 0.11 $ (0.19) $ 0.10 $ (0.46)
Diluted earnings (loss) per share:
As reported .......................... $ 0.14 $ (0.14) $ 0.21 $ (0.22)
Pro forma ............................ $ 0.11 $ (0.19) $ 0.10 $ (0.46)
(1) The amount for the three months ended March 31, 2004 includes $169
thousand of non-cash stock-based compensation expense related to the
amortization of restricted stock and $55 thousand of restructuring charges
related to the accelerated vesting of employee stock options and
restricted stock.
(2) The amount for the nine months ended March 31, 2004 includes $337 thousand
of non-cash stock-based compensation expense related to the amortization
of restricted stock and a change in the terms of our 1998 Director Option
Plan and $556 thousand of restructuring charges related to the accelerated
vesting of employee stock options and restricted stock.
We estimated the fair value of shares and options issued pursuant to our
stock-based compensation plans at the date of grant using the Black-Scholes
option-pricing model, which was developed for use in estimating the fair value
of traded options that have no vesting restrictions and are fully transferable.
Option valuation models require the input of assumptions, including the expected
stock price volatility. Our options have characteristics significantly different
from those of traded options, and changes in the input assumptions can
materially affect the fair value estimates. The following weighted-average
assumptions and weighted-average fair values were used in determining our
stock-based compensation under SFAS No. 123 for the options granted during the
following periods:
10
THREE MONTHS ENDED MARCH 31, NINE MONTHS ENDED MARCH 31,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Risk-free interest rate:
Option plans .............. 3.88% 3.75% 3.88% to 4.13% 3.75% to 4.04%
Purchase plan ............. N/A --% N/A --% to 3.84%
Expected life in years:
Option plans .............. 7.1 7.6 2.8-7.6 7.6
Purchase plan ............. N/A -- N/A -- to 0.5
Volatility factor:
Option plans .............. 96.9% 101.4% 96.9% to 99.1% 101.4% to 103.1%
Purchase plan ............. N/A --% N/A --% to 103.1%
Dividend yield .................. --% --% --% --%
Weighted average fair value:
Option plans ..............$ 4.00 $ 4.24 $ 2.51 $ 3.40
Purchase plan .............$ -- $ -- $ -- $ --
On December 31, 2004 our Employee Stock Purchase Plan (the "Plan") was
terminated. No purchase of stock was made under the Plan for the six-month
purchase period ended December 31, 2004. In order to replace the number of
shares of stock and the discounted purchase price employees were expecting to
receive under the Plan, the Board of Directors granted non-qualified stock
options with an exercise price below the fair market value on the date of grant
to employees that were participants in the Plan. This grant resulted in a
non-cash stock-based compensation expense of $214 thousand for the three months
ended December 31, 2004.
NOTE 4. DISCONTINUED OPERATIONS
We exited our infrared hardware business in the quarter ended September 30,
2002, we sold our wholly owned subsidiary, Extended Systems Singapore Pte
Limited, in the quarter ended June 30, 2002 and we sold the assets of our
printing solutions segment in the quarter ended June 30, 2001. The results of
these operations have been accounted for as discontinued operations for all
periods presented in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," and Accounting Principles Board
Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual, and
Infrequently Occurring Events and Transactions." Operating results for the
discontinued operations are reported, net of tax, under "Income from
discontinued operations" on our Statements of Operations.
The following summarizes the results of discontinued operations for the
following periods:
THREE MONTHS ENDED MARCH 31, NINE MONTHS ENDED MARCH 31,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net revenue .................... $ -- $ -- $ -- $ 169
Gross profit ................... -- -- -- 145
Income tax provision ........... -- -- -- 52
Income, net of tax ............. -- -- -- 88
Earnings per share:
Basic and diluted ............ $ -- $ -- $ -- $ --
NOTE 5. RESTRUCTURING CHARGES
We did not incur restructuring charges for the three and nine months ended March
31, 2005. We recorded approximately $117 thousand and $1.4 million in workforce
reduction costs during the three and nine months ended March 31, 2004 that
consisted primarily of severance, benefits, and other costs related to the
resignation of Steven Simpson, our former President and Chief Executive Officer,
and Karla Rosa, our former Vice President of Finance and Chief Financial
Officer, and the termination of 18 employees from our marketing and sales,
research and development, administration and operations groups. Of the
terminated employees, 14 were located in the United States and four were in
Europe. The restructuring charge included $55 thousand and
11
$556 thousand of non-cash stock-based compensation resulting from the
accelerated vesting of employee stock options and restricted stock during the
three and nine months ended March 31, 2004, respectively.
A summary of changes in the accrued restructuring balance for the nine months
ended March 31, 2005 is as follows:
WORKFORCE
REDUCTION COSTS
------------
Balance at July 1, 2004 ....................................... $ 116
Costs incurred in the nine months ended March 31, 2005 ........ --
Cash payments in the nine months ended March 31, 2005 ......... (116)
------------
Balance at March 31, 2005 ..................................... $ --
============
NOTE 6. GOODWILL AND OTHER IDENTIFIABLE INTANGIBLE ASSETS
Goodwill and other identifiable intangible assets relate to our acquisitions of
Rand Software Corporation in 1998, Oval (1415) Limited in 1999, and AppReach and
ViaFone Inc. in 2002.
Goodwill is reviewed annually for impairment or more frequently if indicators of
impairment arise. We completed our annual impairment assessment in the quarter
ended June 30, 2004 and concluded that goodwill was not impaired. The carrying
amount of goodwill as of March 31, 2005 and June 30, 2004 was approximately
$12.5 million.
Other identifiable intangible assets consist of the following:
AS OF MARCH 31, 2005 AS OF JUNE 30, 2004
-------------------------------------- --------------------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION NET AMOUNT AMORTIZATION NET
---------- ---------- ---------- ---------- ---------- ----------
Purchased technology.....$ 3,691 $ (3,314) $ 377 $ 3,691 $ (3,165) $ 526
Customer relationships... 80 (41) 39 80 (30) 50
Non-compete covenants.... 6 (6) -- 6 (6) --
Other.................... 5 (5) -- 5 (5) --
---------- ---------- ---------- ---------- ---------- ----------
$ 3,782 $ (3,366) $ 416 $ 3,782 $ (3,206) $ 576
========== ========== ========== ========== ========== ==========
Amortization of identifiable intangible assets was $43 thousand and $161
thousand for the three and nine months ended March 31, 2005 and was $138
thousand and $482 thousand for the three and nine months ended March 31, 2004.
The purchased technology and customer relationship assets are being amortized
over five years. Based on the identifiable intangible assets recorded at March
31, 2005, the estimated future amortization expense for the remainder of fiscal
2005 and fiscal 2006, 2007, and 2008 is $43 thousand, $172 thousand, $172
thousand, and $29 thousand, respectively.
NOTE 7. RECEIVABLES
AS OF MARCH 31, AS OF JUNE 30,
2005 2004
------------ ------------
Accounts receivable ....................................... $ 8,439 $ 7,218
Allowance for doubtful accounts and product returns ....... (659) (446)
------------ ------------
$ 7,780 $ 6,772
============ ============
NOTE 8. PROPERTY AND EQUIPMENT
AS OF MARCH 31, AS OF JUNE 30,
2005 2004
------------ ------------
Land and land improvements................................. $ 533 $ 533
Buildings.................................................. 5,927 5,927
Computer equipment......................................... 5,492 4,480
Furniture and fixtures..................................... 1,869 1,835
------------ ------------
13,821 12,775
Less accumulated depreciation.............................. (8,952) (8,444)
------------ ------------
$ 4,869 $ 4,331
============ ============
12
NOTE 9. ACCRUED EXPENSES
As of March 31, As of June 30,
2005 2004
----------- ----------
Accrued payroll and related benefits............. $ 1,840 $ 1,623
Accrued warranty and support costs............... 161 156
Other............................................ 2,267 1,777
----------- ----------
$ 4,268 $ 3,556
=========== ==========
NOTE 10. 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 $167 thousand
and $153 thousand for the three months ended March 31, 2005 and 2004,
respectively. For the nine months ended March 31, 2005 and 2004, operating lease
expense was $467 thousand and $559 thousand, respectively.
On September 26, 2003, we completed 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 March 31,
2005. 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.
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 had been fully repaid at March 31, 2005.
Our minimum future contractual commitments associated with our operational
restructuring, indebtedness and lease obligations as of March 31, 2005 are as
follows:
Year Ending June 30,
---------------------------------------------------------
2005 2006 2007 2008 2009 Thereafter Total
-------------------------------------------------------------------
Monthly payments pursuant to
building sale-and-leaseback...... $ 110 $ 442 $ 442 $ 442 $ 442 $ 1,875 $ 3,753
Capital leases(1).................. 7 11 6 -- -- -- 24
Operating leases................... 161 566 443 328 276 470 2,244
Post-retirement benefits(1)(2)..... 34 17 17 17 17 67 169
-------------------------------------------------------------------
$ 312 $ 1,036 $ 908 $ 787 $ 735 $ 2,412 $ 6,190
===================================================================
(1) These amounts are reported on the balance sheet as liabilities.
(2) Fiscal 2005 includes $17 thousand of current commitments included in
accrued expenses on the balance sheet.
Capital lease obligations are as follows:
As of
March 31, 2005
--------------
Gross capital lease obligations........................ $ 26
Less: Imputed interest................................ (2)
-----
Present value of net minimum lease payments............ 24
Less: Current portion................................. (15)
-----
Non-current capital lease obligations.................. $ 9
=====
GUARANTEES. Until January 13, 2005, we provided a guarantee for lease payments
at our Bristol, England location. We were not required to provide such a
guarantee under the terms of the new lease agreement we entered into for this
location.
13
INDEMNIFICATIONS. The software license agreements we enter into in our ordinary
course of business contain indemnification provisions for losses suffered or
incurred by the indemnified party in connection with any U.S. patent, copyright
or other intellectual property infringement claim by third parties with respect
to our products. The term of our indemnification obligations 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 to 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, under which we agree to indemnify the 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 is unlimited.
To date, we have not incurred costs to defend lawsuits or settle claims related
to these indemnity obligations.
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.
The following table reconciles the changes in our warranty reserve for the nine
months ended March 31, 2005:
Balance at July 1, 2004............................................. $ 156
Net changes in warranty accrual for the three months
ended September 30, 2004.......................................... --
-------
Balance at September 30, 2004....................................... 156
Net changes in warranty accrual for the three months
ended December 31, 2004........................................... (29)
-------
Balance at December 31, 2004........................................ 127
Net changes in warranty accrual for the three months
ended March 31, 2005.............................................. 34
-------
Balance at March 31, 2005 $ 161
=======
LINE OF CREDIT. We have a demand line of credit with SVB under which we can
borrow up to $2.5 million. Our borrowing capacity is limited to 80% of eligible
accounts receivable. Interest on any borrowings is payable at prime and certain
of our assets secure the line of credit. We are required to maintain certain
financial ratios under the terms of the agreement, which will expire on August
30, 2006. As of March 31, 2005, 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 June 29, 2004 AppForge, Inc. ("AppForge") filed a complaint
against us in the United States District Court for the District of Delaware (the
"Court"). An amended complaint was filed on August 12, 2004 joining Extended
Systems of Idaho, Inc. ("ESI-Idaho") and four of our European subsidiaries.
ESI-Idaho and AppForge had entered into a reseller agreement and incorporation
license agreement related to certain AppForge software. AppForge alleges that
the defendant Extended Systems companies have used AppForge's technology,
copyrighted material, and trademarks in a manner not authorized by the parties'
agreements. We believe that our use and distribution of AppForge's software,
copyrighted material, and trademarks has been within the scope of the parties'
agreements.
The Extended Systems defendants filed a motion with the Court seeking to compel
arbitration and to dismiss or stay the case pending the outcome of arbitration.
On March 28, 2005 the Court ordered the parties to arbitrate, stayed the case
pending arbitration, and ordered that our four European subsidiaries be bound by
any factual adjudications in the arbitration. ESI-Idaho had filed a demand for
arbitration with the American Arbitration Association on July 29, 2004 seeking a
declaration of the parties' respective rights and obligations. AppForge has
filed counterclaims reasserting the charges first made in its court complaint
and also asserting breach of contract. The hearing in the arbitration is
scheduled for September 2005. We believe that we have meritorious defenses
against AppForge's counterclaims, and we will continue to vigorously defend
against them.
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.
14
NOTE 11. INCOME TAXES
We recorded income tax expense from continuing operations of $121 thousand and
$153 thousand for the three and nine months ended March 31, 2005, respectively,
and $9 thousand and $22 thousand for the three and nine months ended March 31,
2004, respectively. The expense related primarily to foreign withholding taxes.
For the three months ended March 31, 2004 we recorded no income tax expense
related to discontinued operations and for the nine months ended March 31, 2004
we recorded $ 52 thousand of income tax expense for discontinued operations.
NOTE 12. 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.
We classify our product offerings into one operating segment, the adaptive
mobility segment, which consists of products and services that extend enterprise
applications to mobile and wireless environments. Our products in the adaptive
mobility segment include enterprise mobility solutions, mobile device solutions
and enterprise database solutions that we sell to enterprises, original
equipment manufacturers, application developers, distributors and valued-added
resellers.
Our headquarters is located in the United States. We have research and
development facilities in the United States, United Kingdom and Canada. We
conduct sales, marketing and customer service activities throughout the world,
and we have sales offices in North America and Western Europe. The following
table presents our geographic revenue information based on the location of the
selling entity.
Three Months Ended Nine Months Ended
March 31, March 31,
------------------ ------------------
2005 2004 2005 2004
-------- -------- -------- --------
Net revenue from Continuing Operations:
North America........................... $ 7,994 $ 4,130 $ 17,557 $ 13,030
Germany.................................. 1,933 2,080 6,727 5,421
Other countries.......................... 1,645 2,097 5,075 5,918
-------- -------- -------- --------
Total net revenue.................. $ 11,572 $ 8,307 $ 29,359 $ 24,369
======== ======== ======== ========
Substantially all of our long-lived assets are in the United States.
In the three months ended March 31, 2005, one customer, Texas Instruments,
accounted for more than 10% of our net revenue from continuing operations. No
customer accounted for greater than 10% of our net revenue from continuing
operations in the nine months ended March 31, 2005 or the three and nine months
ended March 31, 2004.
NOTE 13. RESTRICTED STOCK
In our fiscal year ended June 30, 2004, we granted shares of restricted stock
with a purchase price equal to $.001 per share to certain employees. Annually,
we grant shares of restricted stock with a purchase price equal to $.001 per
share to directors on the date of the annual stockholders' meeting. The issuance
of restricted stock grants results in unamortized stock-based compensation based
on the closing price of Extended Systems common stock on the date of the stock
grants. This compensation is amortized as a stock-based compensation charge as
the restrictions lapse.
We amortize non-cash stock-based compensation charges on a straight-line basis
over the vesting period. The restricted stock awards granted to employees in our
fiscal year ended June 30, 2004 vested in full on October 31, 2004, the first
anniversary of the grant date. The restricted stock awards granted to directors
vest in the amount of one-third on the first anniversary of the grant date and
one-third in each of the following two years. If the director attends the
required number of board meetings held during the year, the restrictions on his
awards will lapse in full on the first anniversary of the grant date. If an
employee or director terminates service before vesting is complete, the
restricted stock is repurchased from the individual and any compensation expense
previously recognized is reversed, thereby reducing the amount of stock-based
compensation amortization during the period.
During the three and nine months ended March 31, 2005, we recognized stock-based
compensation expense of $38 thousand and $263 thousand related to the above
restricted stock grants. Compensation expense related to restricted stock grants
was $169 thousand and $282 thousand for the three and nine months ended March
31, 2004.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
- ------------
We begin Management's Discussion and Analysis of Financial Condition and Results
of Operations with an overview to give the reader management's perspective on
our results for the third quarter of fiscal 2005 and our general outlook for the
remainder of the current fiscal year. This is followed by a discussion of the
critical accounting policies we believe are important to understanding the
assumptions and judgments incorporated in our reported financial results. In the
next section, we discuss our Results of
15
Operations for the third quarter and first nine months of fiscal 2005 compared
to the third quarter and first nine months of fiscal 2004. We then provide an
analysis of our liquidity and capital resources.
This discussion and other parts of this Quarterly Report on Form 10-Q contain
forward-looking statements (within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended). These statements are based upon current
expectations that involve risks, uncertainties and assumptions, and we undertake
no obligation to update the forward-looking statements or reflect events or
circumstances after the date of this report. Any statements contained in this
Quarterly Report on Form 10-Q that are not statements of historical fact may be
deemed to be forward-looking statements. These forward-looking statements
include words such as "may," "will," "should," "estimates," "predicts,"
"potential," "continue," "strategy," "believes," "anticipates," "plans,"
"expects," "intends," "outlook," "could," "estimate," "project," "forecast," or
similar expressions that are intended to identify forward-looking statements.
Our actual results may differ materially from the results discussed in these
forward-looking statements. Factors that may cause a difference include, but are
not limited to, those discussed under the sections titled "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Factors That May Affect Future Results and the Market Price of Our
Stock" and "Liquidity, Capital Resources and Financial Condition." The following
discussion should be read in conjunction with the Condensed Consolidated
Financial Statements and notes thereto appearing elsewhere in this Quarterly
Report on Form 10-Q. All yearly references are to our fiscal years ended June
30, 2005 and 2004, unless otherwise indicated. All tabular amounts are in
thousands, except percentages.
OVERVIEW
- --------
We are a leading provider of software and services that delivers solutions to
help companies streamline their business processes and improve workforce
productivity through mobilizing corporate applications and data. The users of
our products are enterprise employees that complete their jobs or portions of
their jobs outside of the company-owned facilities where they have traditionally
accessed, viewed and updated information through wired networks. We also provide
software and expertise that enables our mobile device manufacturer customers to
accelerate their product development cycles and enhance the functionality of new
products they bring to market. The users of our device manufacturer products are
companies that design and sell products that need short-range wireless
communication protocols, such as handset manufacturers and automotive telematics
providers. As the supply chain for these products consolidates, our customer
base is increasingly becoming the chipset manufacturers and original design
manufacturers that supply these industries. Additionally, we provide database
software to customers that develop applications, including mobile applications
that need a reliable, stable and easy to administer database to support their
application needs.
We believe a full understanding of our operating results for the third quarter
of fiscal 2005 requires an understanding of how the mobility solutions market is
evolving and how this evolution influences our financial performance. Although
the mobility solutions market is still in the early phases of development,
organizations are increasingly developing a mobile computing strategy as part of
their plans to increase productivity, improve competitiveness and enhance
customer relationships. Advancing the adoption of enterprise mobility solutions
is the increased availability and capability of powerful mobile devices, such as
PDAs, mobile phones, converged devices and smartphones. Enterprises are
increasingly realizing they can improve their competitiveness by mobilizing
corporate information. However, the tight oversight of capital spending
continues to restrain spending on information technology infrastructure projects
and has caused enterprises to focus spending on mobile technology investments
that can achieve a 12 to 18 month payback. Many companies launch their mobile
strategy with a mobile contacts, calendar, task and e-mail application. Our
mobile solution that meets this need, OneBridge Mobile Groupware, comprises the
dominant portion of our enterprise mobility software revenue. We have
experienced increased competition and the related pricing pressure for our
Groupware products in the marketplace and we expect this trend to continue. Our
plans to grow our enterprise mobility product revenue include an emphasis on
increasing the number of seats deployed to our existing customer base,
increasing the sales of our enhanced security product, OneBridge Mobile Secure,
and increasing the sales of enterprise mobile applications such as mobile field
service.
Device manufacturers are also evolving their products to address this growing
enterprise mobility market. Notebooks, mobile phones and standard PDAs have been
the dominant mobile infrastructure devices. However, as mobile device designers
and marketers have launched campaigns to communicate the added value of
smartphones and converged devices, adoption rates for these devices have
increased. Additionally, other industries such as automotive parts suppliers and
medical device manufacturers have included wireless communication functionality
to enhance the capability of their products to meet customer needs. To address
the growth in this market, the rapid product development cycles, and the demand
for a robust feature set, device manufacturers have increasingly turned to third
party providers like us to provide the technology for short-range wireless
connectivity products.
We believe Europe has been the global leader in the deployment of wireless
infrastructure. The coverage and data capacity of wireless networks developed
more rapidly in Europe than in other global markets, and the market for mobility
solutions has grown most rapidly in Europe. We have a long operating history in
Europe with offices in four countries. We have gained market awareness in Europe
and developed long-standing customer relationships. A significant portion of our
revenue in the third fiscal quarter of 2005 and for the nine months ended March
31, 2005 was derived from European customers purchasing our enterprise mobility
solutions and European device manufacturers introducing successful converged
devices that contained our mobile device solutions products. Our revenue from
our European customers that purchase our products in either British pounds
sterling
16
or euros is affected by changes in the exchange rate between these currencies
and the U.S. dollar. In the first nine months of fiscal 2005 the weakening of
the U.S. dollar positively affected our reported revenue.
In 1993, we introduced our first enterprise database products. We continue to
market and sell these products to application developers and enterprises to
support the data requirements of both mobile and traditional enterprise
applications. Application developers that purchase our enterprise database
products have required a solution that is stable, priced competitively, and does
not require a significant amount of database administration support. We have
developed an extensive network of resellers that market these products globally.
Because these products do not require heavy research and development investment
or significant sales and marketing support, they have been an important and
significant source of positive cash flow for us. Revenue from these products has
declined 2% in the first nine months of fiscal 2005 compared to the first nine
months of fiscal 2004. We expect this product line to continue the trend of flat
to slightly declining revenue for the remainder of fiscal 2005.
In the remaining quarter of fiscal 2005 we plan to continue to direct our
resources at achieving revenue growth by generating more sales of our solutions
to enterprise customers and companies in the mobile device manufacturer supply
chain. We believe enterprise customers will continue investing first in mobile
mail and messaging software and later move toward purchasing mobile applications
that can have an immediate financial impact. Examples of these applications are
field service, supply chain and logistics, healthcare and field sales. We
believe enterprises will choose vendors with knowledge of workflows and business
processes and those that can provide a business case for investment. We expect
to compete directly with both larger companies that have significant resources
and experience and smaller companies that focus on a particular mobile vertical.
We also expect to experience longer sales cycles, which is typical for sales of
larger, essential business applications.
Revenue increased $3.3 million in the third quarter of fiscal 2005 compared to
the third quarter of fiscal 2004. This revenue growth was due to a combination
of royalties and prepaid license fees from a sale of our Bluetooth wireless
technology software to Texas Instruments and revenue from a $1.0 million partial
payment received toward claims asserted in a lawsuit against Agilent
Technologies Singapore Pte. Ltd. ("Agilent"), a subsidiary of U.S.-based Agilent
Technologies, Inc., Korea-based Samsung Electronics Co., Ltd., and two Samsung
U.S. affiliates. Our operating expenses declined in the third fiscal quarter of
2005 compared to the third quarter of last year by $1.2 million. Included in
this decline was a $117 thousand decrease in restructuring charges and a $2.0
million decrease in patent litigation fees, license and settlement expense. We
experienced both income from operations of $2.5 million and net income of $2.2
million in the third quarter of fiscal 2005.
USE OF ESTIMATES AND 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 accepted accounting principles, with no need
for management's judgment in their application. There are also areas in which
management's judgment in selecting any available alternative would not produce a
materially different result. The audited consolidated financial statements and
notes thereto included in our Annual Report on Form 10-K for the year ended June
30, 2004 contain our significant accounting policies and other disclosures
required by generally accepted accounting principles. The accounting policies we
consider critical to an understanding of the consolidated financial statements
are highlighted below.
REVENUE RECOGNITION
- -------------------
Revenue recognition rules for software companies are very complex. We follow
specific and detailed guidelines in determining the proper amount of revenue to
be recorded; however, certain judgments must be made by management in
interpreting the rules and in applying our revenue recognition policy. Revenue
results are difficult to predict, and any shortfall in revenue or delay in
recognizing revenue could cause our operating results to vary significantly.
We apply the provisions of Statement of Position 97-2, SOFTWARE REVENUE
RECOGNITION (SOP 97-2), as amended by SOP 98-9, and recognize software 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.
We assess whether the fee associated with a transaction is fixed or determinable
at the time of the transaction, based on the payment terms associated with the
transaction. If payment terms are extended for a significant portion of the fee
or if there is a risk that the customer will expect a concession, we do not
consider the fee fixed or determinable. In these cases, we recognize revenue as
the fee becomes due and payable. If we were to assess the fixed or determinable
criterion differently, the timing and amount of our revenue recognition might
differ 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
17
recognize revenue at the time collection becomes reasonably assured, which is
generally upon receipt of cash. If we were to assess our ability to collect
differently, the timing and amount of our revenue recognition might differ
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, patches, bug fixes and other
modifications to ensure that the products comply with their warranty provisions.
Accordingly, we allow for warranty costs for these products at the time the
product revenue is recognized.
When a contractual relationship with one of our customers stipulates the
submission of a royalty report to us, revenue is generally recorded when the
royalty report is received and recognized in the period that the report covers.
If a royalty report is not received by the desired date to facilitate the
closing of the books for a given fiscal period and there exists the basis to
make a fair and reasonable estimate of the revenue related to that royalty
report, this estimate will be recorded as revenue. Estimated royalty fees and
revenues are subsequently adjusted based upon actual amounts realized. If the
actual amount realized differs materially from the recorded estimate and is
reported to us after an estimate has been recorded and before financial results
are announced externally, the recorded amount will be adjusted to reflect the
actual amount realized. If the amount differs and is reported after financial
results are announced externally or does not differ materially, the adjustment
will be made in the subsequent fiscal period. In cases where the arrangement
with our customer provides for a prepaid nonrefundable royalty, we 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 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. We recognize no
more than 90% of the total contract amount until project acceptance is obtained.
In cases where our professional services involve customizations for which the
amount of customization effort cannot be reasonably estimated, or where
significant uncertainty about the project completion or customer acceptance
exists, we defer the contract revenue under the completed contract method of
accounting until the uncertainty is sufficiently resolved or the contract is
complete and accepted by the customer. If we were to make different judgments or
use 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
reported.
BUSINESS COMBINATIONS AND ACQUIRED INTANGIBLE ASSETS
- ----------------------------------------------------
We account for our purchases of acquired companies in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," and
account for the related acquired intangible assets in accordance with SFAS No.
142, "Goodwill and Other Intangible Assets." In accordance with SFAS No. 141, we
allocate the cost of the acquired companies to the identifiable tangible and
intangible assets acquired and liabilities assumed, with the remaining amount
being classified as goodwill. Certain intangible assets, such as "developed
technologies," are amortized to expense over time, while in-process research and
development costs ("IPR&D"), if any, are immediately expensed in the period the
acquisition is completed. Identifiable intangible assets are currently amortized
over a five-year period using the straight-line method.
The majority of entities we acquire do not have significant tangible assets and,
as a result, a significant portion of the purchase price is typically allocated
to intangible assets and goodwill. Our future operating performance will be
affected by the future amortization of intangible assets, potential charges
related to IPR&D for future acquisitions, and potential impairment charges
related to goodwill. Accordingly, the allocation of the purchase price to
intangible assets and goodwill has a significant effect on our future operating
results. The allocation of the purchase price of the acquired companies to
intangible assets and goodwill requires us to make significant estimates and
assumptions, including estimates of future cash flows expected to be generated
by the acquired assets and the appropriate discount rate for these cash flows.
Should different conditions prevail, material write-downs of intangible assets
and/or goodwill could occur.
Under SFAS No. 142, goodwill is no longer subject to amortization. Rather, we
evaluate goodwill for impairment at least annually, during the fourth quarter of
each fiscal year, or more frequently if events and changes in circumstances
suggest that the carrying amount may not be recoverable. Impairment of goodwill
is tested at the reporting unit level by comparing the reporting unit's carrying
value, including goodwill, to the fair value of the reporting unit. The fair
values of the reporting units are estimated using a combination of the income,
or discounted cash flows, approach and the market approach, which utilizes
comparable companies' data. If the carrying amount of the reporting unit exceeds
its fair value, goodwill is considered impaired and we then compare the "implied
fair value" of the goodwill to its carrying amount to determine the impairment
loss, if any.
18
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. 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
were to make different judgments or use different estimates our measurement of
any impairment might differ 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 March 31, 2005 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 were to make different judgments or used different estimates,
the amount or timing of the valuation allowance recorded might differ materially
from that reported. If actual results differ from these estimates or if 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 affect our financial position and results of
operations.
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES RETURNS
- -------------------------------------------------
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 a reserve based on the age of
the receivable and historical collection patterns. If we were to make different
judgments or used different estimates, the timing and amount of our reserve
might differ materially from that reported.
RESTRUCTURING
- -------------
We report costs associated with employee terminations and other exit activity in
accordance with SFAS No. 112, "Employers' Accounting for Postemployment Benefits
- - an amendment of FASB Statements No. 5 and 43," and SFAS No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities." We record employee
termination benefits as an operating expense when the benefit arrangement is
communicated to the employee and no significant future services are required. We
recognize facility lease termination obligations, net of estimated sublease
income, and other exit costs when we have future payment with no future economic
benefit or a commitment to pay the termination costs of a prior commitment.
These termination and other exit costs are reported at fair value.
DETERMINING FUNCTIONAL CURRENCIES FOR THE PURPOSE OF CONSOLIDATION
- ------------------------------------------------------------------
In preparing our consolidated financial statements, we are required to translate
the financial statements of our international subsidiaries from their functional
currencies, generally the local currency, into U.S. dollars. This process
results in exchange gains and losses, or cumulative translation adjustments,
which are included as a separate part of our net equity under the caption
"Accumulated other comprehensive loss."
Under the relevant accounting guidance, the computation method and treatment of
these translation gains or losses is dependent upon management's determination
of the functional currency of each subsidiary. The functional currency is
determined based on management's judgment and involves consideration of all
relevant economic facts and circumstances affecting the subsidiary. Generally,
the currency in which the subsidiary transacts a majority of its transactions,
including billings, financing, payroll and other expenditures is considered the
functional currency, but any dependency upon the parent and the nature of the
subsidiary's operations is also considered.
Cumulative translation adjustments include any gain or loss associated with the
translation of that subsidiary's financial statements when the functional
currency of any subsidiary is the local currency. However, if the functional
currency were deemed to be the U.S. dollar then any gain or loss associated with
the remeasurement of these financial statements would be included within our
statement of operations. If we dispose of any of our subsidiaries, any
cumulative translation gains or losses would be realized and
19
recorded within our statement of operations in the period during which the
disposal occurs. If we determine that there has been a change in the functional
currency of a subsidiary to the U.S. dollar, any translation gains or losses
arising after the date of change would be included within our statement of
operations.
Based on our assessment of the factors discussed above, we consider the relevant
subsidiary's local currency to be the functional currency for each of our
international subsidiaries. Accordingly, for the quarters ended March 31, 2005
and 2004 a translation loss of $71 thousand and a translation gain of $1
thousand, respectively, were recorded as adjustments to our accumulated other
comprehensive loss. At March 31, 2005 and June 30, 2004, cumulative translation
losses of approximately $2.5 million and $1.5 million were included as part of
accumulated other comprehensive loss within our balance sheet. These translation
losses have accumulated since we formed our first non-U.S. subsidiary in 1991.
Had we determined that the functional currency of our subsidiaries was the U.S.
dollar, we would have computed a remeasurement gain or loss using a different
method and such gain or loss would have been included in our results of
operations for each of the periods presented.
The magnitude of these gains or losses is dependent upon movements in the
exchange rates of the foreign currencies in which we transact business against
the U.S. dollar and the significance of the assets, liabilities, revenue and
expenses denominated in foreign currencies. These currencies include the euro,
the British pound sterling and Canadian dollar. Any future translation gains or
losses could be significantly higher than those noted in each of the periods
presented. In addition, if we determine that a change in the functional currency
of one of our subsidiaries has occurred at any point in time or we sell or
liquidate one of our subsidiaries, we would be required to include any
translation gains or losses from the date of change in our statement of
operations.
LEGAL CONTINGENCIES
- -------------------
From time to time we may be involved in various legal proceedings and claims.
Periodically, but not less than quarterly, we review the status of each
significant matter and assess our potential financial exposure. If the potential
loss from any legal proceeding or claim is considered probable and the amount
can be reasonably estimated, we accrue a liability for the estimated loss.
Significant judgment is required in both the determination of probability and
the determination as to whether an exposure is reasonably estimable. Due to the
uncertainties related to these matters, accruals are based only on the best
information available at the time. As additional information becomes available,
we reassess the potential liability related to our pending litigation and claims
and may revise our estimates. Any revisions could have a material impact on our
results of operations and financial condition.
RESULTS OF OPERATIONS
- ---------------------
CONTINUING OPERATIONS
- ---------------------
The following table sets forth the selected condensed consolidated financial
data, expressed as a percentage of total revenue, for the three and nine months
ended March 31, 2005 and 2004:
20
Three Months Ended Nine Months Ended
March 31, March 31,
-------------- --------------
2005 2004 2005 2004
---- ---- ---- ----
Revenue:
License fees and royalties.............. 82% 73% 78% 78%
Services and other...................... 18 27 22 22
---- ---- ---- ----
Total net revenue 100 100 100 100
Costs and expenses:
Cost of license fees and royalties...... 1 1 1 2
Cost of services and other.............. 10 13 11 13
Amortization of identifiable intangibles 1 2 -- 2
Research and development................ 18 22 19 21
Marketing and sales..................... 34 41 38 41
General and administrative.............. 14 16 15 16
Restructuring charges................... -- 1 -- 6
Patent litigation fees, license and
settlement............................ -- 25 -- 14
Non-cash stock compensation............. -- 2 2 1
---- ---- ---- ----
Total costs and expenses............. 78 123 86 116
---- ---- ---- ----
Income (loss) from operations........ 22 (23) 14 (16)
Other income (expense), net............. (1) -- (1) --
Gain on sale of land.................... -- -- -- 4
Interest expense........................ (1) (2) (1) (1)
---- ---- ---- ----
Income (loss) before income taxes.... 20 (25) 12 (13)
Income tax provision.................... (1) -- (1) --
---- ---- ---- ----
Income (loss) from continuing
operations......................... 19 (25) 11 (13)
Discontinued operations, net of tax:
Income from discontinued operations.. -- -- -- --
---- ---- ---- ----
Net income (loss).................... 19% (25)% 11% (13)%
==== ==== ==== ====
COMPARISON OF THE THREE AND NINE MONTHS ENDED MARCH 31, 2005 AND 2004
Revenue
- -------
The following table presents our license, support and maintenance, and
professional services revenue for the three and nine months ended March 31, 2005
and 2004, and the percentage changes from the prior year.
Three Months Ended Nine Months Ended
March 31, March 31,
---------------------------- -----------------------------
2005 % Change 2004 2005 % Change 2004
---------------------------- -----------------------------
Revenue:
License fees and royalties....... $ 9,437 55% $ 6,076 $ 22,878 21% $ 18,904
Support and maintenance.......... 1,318 9 1,208 3,953 24 3,200
Professional services and other.. 817 (20) 1,023 2,528 12 2,265
-------- ------- -------- --------
Total net revenue................ $ 11,572 39% $ 8,307 $ 29,359 20% $ 24,369
======== ======= ======== ========
We sell our adaptive mobility products to enterprises, original equipment
manufacturers, application developers, distributors and valued-added resellers.
No customer accounted for greater than 10% of revenue from continuing operations
for the first nine months of fiscal 2005 or 2004 or for the third quarter of
fiscal 2004. In the third quarter of fiscal 2005, we licensed our Bluetooth
protocol stack and profiles suite to Texas Instruments and more than 10% of our
third quarter revenue was from this single customer. The sale to Texas
Instruments included both license fees and prepaid royalties and we do not
expect revenues from this customer to exceed 10% of total revenue for the
remaining quarter of fiscal 2005 or for any quarter in fiscal 2006.
LICENSE FEES AND ROYALTIES. The majority of our product license revenue consists
of fees related to products licensed to customers on a perpetual basis. Product
license fees can be associated with a customer's licensing of a given software
product for the first time or with a customer's purchase of the right to run a
previously licensed product on additional computing capacity or by additional
users. Our royalty revenue primarily consists of fees related to our device
solutions products customers prepaying or
21
periodically increasing the number of units they are authorized to use of a
licensed software product and are normally paid on a quarterly basis.
We classify our product offerings into one operating segment, the adaptive
mobility segment, which consists of products and services that extend enterprise
applications to mobile and wireless environments. Our products in the adaptive
mobility segment include enterprise mobility solutions, mobile device solutions
and enterprise database solutions.
The table below presents total net license fees and royalty revenue by product
line and each product line's percentage of license fee and royalty revenue for
the three and nine months ended March 31, 2005 and 2004.
Three Months Ended Nine Months Ended
March 31, March 31,
---------------------------- ----------------------------
2005 % Change 2004 2005 % Change 2004
---------------------------- ----------------------------
License fees and royalties:
Enterprise Mobility Solutions................ $ 2,450 (7)% $ 2,626 $ 8,901 11% $ 8,052
% of license fees and royalty revenue.. 26% 43% 39% 43%
Mobile Device Solutions...................... 5,101 253 1,447 8,524 61 5,281
% of license fees and royalty revenue.. 54% 24% 37% 28%
Enterprise Database Solutions................ 1,886 (6) 2,003 5,453 (2) 5,571
% of license fees and royalty revenue.. 20% 33% 24% 29%
-------- ------- -------- --------
Total net revenue............................ $ 9,437 55% $ 6,076 $ 22,878 21% $ 18,904
======== ======= ======== ========
We sell our enterprise mobility products to corporate customers either directly
or through distributors, valued-added resellers and other channel partners. A
significant portion of our license fee revenue for these products is a result of
our installed customer base deploying additional licenses of OneBridge Mobile
Groupware and sales of this product to new enterprise customers in both Europe
and North America. We believe these customers purchase OneBridge Mobile
Groupware because of its competitive total cost of ownership combined with the
OneBridge platform design, which enables customers to roll out future mobile
applications, such as mobile field service applications on the same devices that
receive e-mail. License fee revenue from our enterprise mobility products
decreased $176 thousand in the third quarter of fiscal 2005 compared to the
third quarter of fiscal 2004 and increased $849 thousand for the nine months
ended March 31, 2005 compared to the nine months ended March 31, 2004. The
decline in license fee revenue for the third quarter was the result of increased
competition in the marketplace and pricing pressure for our OneBridge Mobile
Groupware products. Sales of our security product, OneBridge Mobile Secure, and
our mobile applications were not sufficient to offset this decline. Also during
the third quarter of fiscal 2005, we believe customers delayed their purchase
and deployment of additional seats of our OneBridge Mobile Groupware products,
which contributed to the license fee revenue decline. For the first nine months
of fiscal 2005, the increase in the enterprise mobility product license fee
revenue was the result of several factors, including an OEM sale of our
enterprise XTNDConnect PC product. Additionally, the weakening of the U.S.
dollar compared to the British pound sterling and the euro increased reported
revenue. See "International Revenue" below for further discussion.
We sell our mobile device products either directly or through distributors,
primarily to original equipment manufacturers, original design manufacturers and
semiconductor companies that supply the mobile handset, telematics and other
industries. License fees and royalty revenue from our mobile device products
increased $3.7 million in the third quarter of fiscal 2005 compared to the third
quarter of fiscal 2004 and increased $3.2 million for the first nine months of
fiscal 2005 compared to the first nine months of fiscal 2004. The increase in
revenue for the third quarter of fiscal 2005 was due primarily to a license and
prepaid royalty transaction with Texas Instruments. Additionally, during the
third quarter of fiscal 2005 we reported $1.0 million of revenue for a partial
royalty payment received in March in connection with our lawsuit against Agilent
Technologies Singapore Pte. Ltd. ("Agilent"), a subsidiary of U.S.-based Agilent
Technologies, Inc. and Korea-based Samsung Electronics Co., Ltd. and two Samsung
U.S. affiliates ("Samsung"). In the lawsuit, we sought, among other things, to
recover damages or unpaid royalties due as a result of Samsung's use of our
XTNDAccess(TM) IrDA Software Development Kit (SDK) and XTNDAccess(TM) IrFM SDK
solutions ("Ir Software") in combination with Agilent transceiver products. On
April 27, 2005 we entered into a Binding Memorandum of Understanding that
resolved the litigation with Agilent and Samsung. Under the terms of the
agreement we entered into a royalty-bearing license with Samsung for future use
of Ir Software. In addition to the $1.0 million paid to us in March and a second
payment of $500 thousand received in April 2005, the agreement also provides
that Samsung and Agilent will pay us $1.25 million in May 2005, $2.0 million in
August 2005 and a final installment of $1.0 million in December 2005. We record
revenue resulting from this agreement in our fiscal quarter in which the
payments are received. As a result, we expect to record $1.75 million due in
April and May in the fourth quarter of fiscal 2005, $2.0 million due in August
in the first quarter of fiscal 2006 and $1.0 million due in December in the
second quarter of fiscal 2006. As part of the agreement we also granted Samsung
an option to purchase for a lump sum a two-year license to use our Ir Software
and our XTNDConnect PC software in Samsung cell phones. At the conclusion of the
two-year paid up licenses, Samsung would have the option to continue to license
the software at royalty rates not greater than those set out in the agreement.
On May 6, 2005, Samsung notified us they would not exercise their option for the
two year license. Partially offsetting the increase in revenue resulting from
the sale to Texas Instruments and the Agilent and Samsung agreement was a lower
level of royalties from a European handset manufacturer. Although our products
continue to be licensed by the manufacturer, volumes and unit pricing for the
first three quarters of fiscal 2005 were lower than the amounts for the previous
year's comparable periods. We do not expect revenue from this handset
manufacturer to increase significantly in the final quarter of fiscal 2005.
22
Royalty revenue generated from sales of our mobile device manufacturer products
has historically fluctuated from quarter to quarter. We expect it will continue
to fluctuate because demand is dependent upon the timing of customer projects,
which fluctuate, and the effectiveness of our customers marketing efforts.
Additionally, fluctuations can occur due to the nature of the arrangements with
customers, which can vary between quarterly royalty payments that become due as
devices are shipped by the manufacturer and initial one-time payments that allow
the customer either unlimited or a capped number of licenses. Finally, we have
experienced late royalty reporting from some of our customers and despite
efforts to coordinate more closely with customers, we anticipate late reporting
could recur in future quarters.
We sell our database products to enterprise customers and software developers
who write applications utilizing our product's data management capabilities.
License revenue from our enterprise database product lines in the third quarter
of fiscal 2005 declined $117 thousand compared to the third quarter of fiscal
2004. The decline is the result of a reduced number of seats purchased by our
developer and reseller customers to support the sales of their applications.
Revenue for the first nine months of fiscal 2005 was $118 thousand lower than
the revenue recorded in the first nine months of fiscal 2004. We anticipate that
fourth quarter revenue for fiscal 2005 will be lower than the revenue for the
fourth quarter of fiscal 2004 for these products because we offered aggressive
price incentives to our customers in last year's fourth quarter that will not be
repeated in the fourth quarter of fiscal 2005.
SUPPORT AND MAINTENANCE. Support and maintenance revenue is derived
predominantly from our enterprise mobility products and represents the ratable
recognition of fees to enroll customers in our software maintenance and support
programs. Enrollment in these programs generally entitles customers to product
enhancements, technical support services and ongoing updates for compatibility
with new mobile devices and mobile device operating systems. These fees are
generally charged annually, and, for software products sold directly to
enterprises, have been in the range of 15% to 20% of the discounted price of the
product. For software products sold through resellers that provide support
directly to their customers, this range has been 11% to 14%.
Support and maintenance revenue increased $110 thousand in the third quarter of
fiscal 2005 compared to the third quarter of fiscal 2004 and $753 thousand for
the nine months ended March 31, 2005 compared to the nine months ended March 31,
2004. The increases were the result of customers renewing their support and
maintenance contracts combined with the ratable recognition of revenue from new
support and maintenance contracts sold to customers purchasing our products for
the first time in the third quarter of fiscal 2005. Our support and maintenance
revenue depends on both sales of software licenses and renewals of maintenance
agreements by our existing customers. We expect that our support and maintenance
revenue will increase or decrease as our license revenue increases or decreases.
PROFESSIONAL SERVICES. Professional services revenue is derived primarily from
our work related to our enterprise mobility products and consists of fees for
consulting, product installations, training, and developing custom applications
that utilize our middleware products such as OneBridge Mobile Data Suite.
Professional services revenue is driven by our customers purchasing services to
aid them in developing software solutions for their mobile workforce in both
Europe and North America. Additionally, we derive professional services revenue
as we perform custom modifications or porting of our device manufacturer
solutions for OEM customers.
Professional services revenue declined $206 thousand in the third quarter of
fiscal 2005 compared to the third quarter of fiscal 2004 and increased $263
thousand for the nine months ended March 31, 2005 compared to the nine months
ended March 31, 2004. The decline in revenue in the third quarter of fiscal 2005
was the result of customer delays or customer decisions not to proceed with
mobile application projects. The overall higher professional services revenue
for the first three quarters of fiscal 2005 was due to increased customer demand
for services from our enterprise mobility group to build custom applications and
assist with Groupware deployments. Based on the current projects scheduled for
the fourth quarter of fiscal 2005, we expect professional services revenue in
the fourth quarter of fiscal 2005 to be approximately the same as the revenue in
the fourth quarter of fiscal 2004. Revenue from professional services may
fluctuate from quarter to quarter based on customer acceptance criteria included
in contracts, the timing of services engagements and the variability of customer
demand for custom mobile application development.
International Revenue
- ---------------------
We derive a significant amount of our revenue from sales to customers outside of
the United States, principally from our European-based direct-to-enterprise
sales force and channel partners, overseas original design manufacturers and a
number of international distributors. Based on the region in which the customer
resides, the table below presents total net revenue by region and each region's
percentage of total net revenue for the three and nine months ended March 31,
2005 and 2004.
23
Three Months Ended Nine Months Ended
March 31, March 31,
---------------------------- ----------------------------
2005 % Change 2004 2005 % Change 2004
---------------------------- ----------------------------
North America....................... $ 5,660 57% $ 3,604 $ 12,326 25% $ 9,894
% of total net revenue........ 49% 43% 42% 41%
Europe.............................. 3,990 (5) 4,214 13,003 7 12,118
% of total net revenue........ 34