10-Q 1 xedaform10-q_09302005.txt 10-Q 9-30-2005 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2005 [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ______________ Commission File number 000-26287 Axeda Systems Inc. (Exact Name of Registrant as Specified in Its Charter) Delaware 23-2763854 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 25 Forbes Blvd. Foxborough, Massachusetts 02035 --------------------------- (Address of Principal Executive Offices) Registrant's Telephone Number, Including Area Code: (508) 337-9200 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 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X --------------------------- On November 18, 2005, 32,920,984 shares of the registrant's Common Stock, $0.001 par value, were outstanding. AXEDA SYSTEMS INC. FORM 10-Q Quarter Ended September 30, 2005 Table of Contents Page ---- PART I - FINANCIAL INFORMATION Item 1 Financial Statements (unaudited) Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004 2 Consolidated Statements of Operations for the three months ended September 30, 2005 and 2004 3 Consolidated Statements of Operations for the nine months ended September 30, 2005 and 2004 4 Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004 5 Notes to the Consolidated Financial Statements 6 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item 3 Quantitative and Qualitative Disclosures About Market Risk 36 Item 4 Controls and Procedures 36 PART II - OTHER INFORMATION Item 1 Legal Proceedings 37 Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 39 Item 3 Defaults Upon Senior Securities 39 Item 4 Submission of Matters to a Vote of Security Holders 39 Item 5 Other Information 39 Item 6 Exhibits 39 Signatures 40 Exhibit Index 41 Exhibit 31.1 Exhibit 31.2 Exhibit 32.1

PART 1 FINANCIAL INFORMATION Item 1: Financial Statements (unaudited) AXEDA SYSTEMS INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data) September 30, December 31, 2005 2004 ---- ---- ASSETS Current assets: Cash and cash equivalents $1,484 $ 2,429 Accounts receivable, net of allowance for bad debts of $79 at September 30, 2005, and $88 at December 31, 2004 3,727 4,108 Prepaid expenses and other current assets 1,166 714 ----- --- Total current assets 6,377 7,251 Furniture and equipment, net of accumulated allowances for depreciation of $1,327 at September 30, 2005, and $1,524 at December 31, 2004 584 1,308 Goodwill 3,640 3,640 Identified intangible assets, net 593 949 Other assets 313 946 --- --- Total assets $ 11,507 $ 14,094 ======== ========= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Bridge loans $1,500 - Note payable, net of debt discounts of $1,385 at September 30, 2005 and $907 at December 31, 2004 3,090 293 Accounts payable 1,412 1,436 Accrued expenses 3,170 3,923 Income taxes payable 938 780 Deferred revenue 1,708 1,521 ----- ----- Total current liabilities 11,818 7,953 Non-current liabilities: Note payable, net of current portion and debt discount of $- at September 30, 2005 and $1,248 at December 31, 2004 - 2,052 Other non-current liabilities 47 103 Financing-related liabilities - 3,243 - ----- Total liabilities 11,865 13,351 ------ ------ Commitments and contingencies (Note 7) Stockholders' equity (deficit): Preferred stock, $0.001 par value; 5,000,000 shares authorized in 2005 and 2004, none issued or outstanding - - Common stock, $0.001 par value; 100,000,000 shares authorized in 2005 and 50,000,000 shares authorized in 2004; 33,512,938 shares issued in 2005 and 33,173,288 shares issued in 2004 33 33 Additional paid-in capital 150,301 148,027 Deferred stock compensation (90) (90) Accumulated deficit (149,471) (146,179) Accumulated other comprehensive income 249 332 Treasury stock at cost, 603,800 shares in 2005 and 2004 (1,380) (1,380) ------- ------- Total stockholders' equity (deficit) (358) 743 --- --- Total liabilities and stockholders' equity (deficit) $ 11,507 $ 14,094 ======== ========

See accompanying notes to the consolidated financial statements. 2 AXEDA SYSTEMS INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited) Three Months Ended September 30, -------------------------------- 2005 2004 ------------ ------------ Revenues: License ................................................. $ 1,860 $ 1,700 Services and maintenance ................................ 1,514 1,021 Hardware ................................................ 1 17 ------------ ------------ Total revenues ........................................ 3,375 2,738 ------------ ------------ Cost of revenues: License ................................................. 99 104 Services and maintenance ................................ 598 730 Software amortization ................................... 112 112 ------------ ------------ Total cost of revenues ................................ 809 946 ------------ ------------ Gross profit .......................................... 2,566 1,792 ------------ ------------ Research and development (R&D) ............................ 678 944 Sales and marketing (S&M) ................................. 1,112 1,760 General and administrative (G&A) .......................... 1,371 1,338 Depreciation and amortization ............................. 425 322 ------------ ------------ Total operating costs ................................. 3,586 4,364 ------------ ------------ Operating loss ........................................ (1,020) (2,572) Interest income (expense), net ............................ (493) (5) Other income (expense), net ............................... 55 1,241 ------------ ------------ Loss before income taxes .................................. (1,458) (1,336) Provision for income taxes ........................... 50 16 ------------ ------------ Net loss .................................................. $ (1,508) $ (1,352) ============ ============ Basic and diluted net loss per weighted average common share outstanding ................................. $ (0.05) $ (0.04) ============ ============ Weighted average number of common shares outstanding used in calculation of basic and diluted net loss per common share ......................................... 32,912,288 32,511,455 ============ ============

See accompanying notes to the consolidated financial statements. 3 AXEDA SYSTEMS INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited) Nine Months Ended September 30, ------------------------------- 2005 2004 ------------ ------------ Revenues: License ................................................. $ 6,136 $ 5,611 Services and maintenance ................................ 4,528 3,454 Hardware ................................................ 9 103 ------------ ------------ Total revenues ........................................ 10,673 9,168 ------------ ------------ Cost of revenues: License ................................................. 297 534 Services and maintenance ................................ 2,080 2,703 Software amortization ................................... 336 336 ------------ ------------ Total cost of revenues ................................ 2,713 3,573 ------------ ------------ Gross profit .......................................... 7,960 5,595 ------------ ------------ Research and development (R&D) ............................ 2,364 3,068 Sales and marketing (S&M) ................................. 4,104 5,775 General and administrative (G&A) .......................... 3,906 4,382 Depreciation and amortization ............................. 807 840 ------------ ------------ Total operating costs ................................. 11,181 14,065 ------------ ------------ Operating loss ........................................ (3,221) (8,470) Interest income (expense), net ............................ (1,286) (35) Other income (expense), net ............................... 1,373 2,136 ------------ ------------ Loss before income taxes .................................. (3,134) (6,369) Provision for income taxes ........................... 158 46 ------------ ------------ Net loss .................................................. $ (3,292) $ (6,415) ============ ============ Basic and diluted net loss per weighted average common share outstanding ................................ $ (0.10) $ (0.20) ============ ============ Weighted average number of common shares outstanding used in calculation of basic and diluted net loss per common share ........................................ 32,862,995 32,465,580 ============ ============

See accompanying notes to the consolidated financial statements. 4 AXEDA SYSTEMS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Nine Months Ended September 30, ------------------------------- 2005 2004 ------- ------- Cash flows from operating activities: Net loss .................................................................... $(3,292) $(6,415) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization ............................................... 1,143 1,176 Unrealized gains on financing-related liabilities ........................... (1,310) (2,024) Gain on disposal of assets .................................................. -- (110) Non-cash interest expense ................................................... 822 -- Non-cash settlement ......................................................... -- (720) Non-cash compensation ....................................................... -- 113 Provision for doubtful accounts (net of recoveries) ......................... (9) 4 Changes in items affecting operations: Accounts receivable ......................................................... 390 540 Prepaid expenses and other current assets ................................... 82 (296) Other assets ................................................................ 310 61 Accounts payable ............................................................ (24) 226 Accrued expenses and non-current liabilities ................................ (772) (303) Income taxes payable ........................................................ 158 (92) Deferred revenue ............................................................ 187 (8) ------- ------- Net cash used in operating activities ..................................... (2,315) (7,848) ------- ------- Cash flows from investing activities: Capital expenditures ........................................................ (79) (148) ------- ------- Net cash used in investing activities ..................................... (79) (148) ------- ------- Cash flows from financing activities: Proceeds from issuance of bridge loans ..................................... 1,500 -- Net proceeds from exercise of stock options ................................ 14 52 Net repayments under bank line of credit .................................... -- (287) Net repayments of other non-current liabilities ............................. -- (27) ------- ------- Net cash provided by (used in) financing activities ....................... 1,514 (262) ------- ------- Effect of exchange rate changes on cash and cash equivalents .................. (65) 10 ------- ------- Net decrease in cash and cash equivalents ............................... (945) (8,248) Cash and cash equivalents: Beginning of period ......................................................... 2,429 9,617 ------- ------- End of period ............................................................... $ 1,484 $ 1,369 ======= =======

See accompanying notes to the consolidated financial statements. 5 AXEDA SYSTEMS INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (unaudited) All amounts are in thousands, except share and per share amounts, unless noted otherwise. 1) Summary of Significant Accounting Policies a) Description of Business - Overview Axeda Systems Inc. is a software and services company providing solutions in an emerging market known as Machine To Machine, or M2M. Solutions in the M2M market enable communications between people, devices, and systems and turn the resulting data into information companies can act upon. We develop, market and sell software products and services used by multiple industries and customers worldwide for device relationship management, or DRM, a segment of the M2M market, to access and exploit information located within remote machines, devices and facilities. We distribute our DRM products through direct sales to original equipment manufacturers, or OEMs, and enterprise customers, as well as through distributors and value-added resellers. We maintain regional sales and support offices in the United States and France. In December 2001 we purchased all of the outstanding capital stock of eMation, Ltd., or eMation, a private company organized under the laws of the State of Israel and headquartered near Boston, Massachusetts. Since 2003, our revenues have been substantially generated from selling DRM products and services, or DRM business. The DRM business, with revenues primarily in the United States, Germany and Japan is our flagship product. We complement our DRM products with professional services, training, and support offerings. We leverage our mix of experience in embedded systems, enterprise software, and the Internet to solve difficult problems with practical solutions. We also separately sell, mainly in Europe, various software products that support our Industrial Technology for Automation business (ITA business) comprised of Axeda ITA, Axeda@aGlance/IT, Axeda Web@aGlance and Axeda FactorySoft OPC. b) Going-Concern Exception in the Report of our Independent Registered Public Accounting Firm Contained in our Annual Report for the Year Ended December 31, 2004 We have sustained significant losses from operations and negative cash flows from operations since inception. For the nine months ended September 30, 2005 and for the years ended December 31, 2004 and 2003, the operating losses sustained were $3,221, $9,590 and $14,978, respectively. The report of our independent registered public accounting firm on our audited consolidated financial statements for the year ended December 31, 2004 included an explanatory paragraph indicating that there is substantial doubt about our ability to continue as a going concern. Since July 1, 2005, we have been in default under the Laurus Secured Convertible Term Note, or Note, issued to Laurus Master Fund, Ltd, or Laurus, for failing to pay when due interest under the Note for June, July, August and September 2005, as well as the July, August and September 2005 principal payments. Article IV of the Note defines "Events of Default" as the failure to pay any installment of principal or interest within three days of the due date, and that upon the occurrence and continuance of an Event of Default, Laurus may make all sums of principal, interest and other fees then remaining unpaid immediately due and payable. In the event of such an acceleration, the amount due and owing to Laurus shall be one hundred twenty percent (120%) of the outstanding principal amount, plus accrued and unpaid interest and fees. In addition, the registration rights agreement entered into in connection with the Note states that if our shares are not traded on a "Trading Market", which does not include the "Pink Sheets", where our shares of common stock currently trade, then Axeda is obligated to issue certain warrants to Laurus, and our failure to do so also constitutes a default under the Note. In a Letter Agreement dated July 8, 2005 between Axeda Systems Inc. and Laurus, Laurus agreed to accept payment in full in cash of the outstanding principal and accrued and unpaid interest simultaneously with the closing of the JMI Asset Sale, in full satisfaction of our obligations (see discussion included herein at Part I, Item 2- Management's Discussion and Analysis of Financial Condition and Results of Operations). However, in the event bankruptcy proceedings are initiated by or against us prior to the closing of the JMI Asset Sale, the default penalties described above would resume. 6 Management has developed and begun to implement a plan to address this issue, which includes the sale of our DRM business. That plan also includes efforts, which thus far have been been unsuccesful, to find a buyer for, or to engage in strategic partnerships involving the ITA business. There can be no assurance that we will successfully implement our plan, or that we will be able to continue as a going concern. If we continue to own the DRM businessand/or if we continue to be unsuccessful in ofur efforts to find a buyer or strategic partner for our ITA business, we will need to receive additional financing from new or current investors and potential strategic partners. Such financing may not be available on favorable terms, if it is available at all. In the absence of finding such additional financing and/or strategic partners, it is likely that we will have to commence proceedings under the Bankruptcy Code. The accompanying unaudited consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. c) Sale of DRM Business and Assets Sale to ASOC Acquisition Corp. Effective September 1, 2005 we entered into a definitive asset purchase agreement to sell, subject to Shareholder approval, our DRM business and related assets to ASOC Acquisition Corp., a new corporation formed and owned by JMI Equity Fund V, L.P. and JMI Equity Fund V (AI), L.P., or JMI, for $7,000 plus the assumption of certain liabilities related to the DRM business. The DRM business to be sold includes our Axeda DRM software systems designed to remotely monitor, manage and service intelligent devices deployed at end-user sites. The DRM business includes Axeda Agent software, an Axeda Enterprise server and Axeda Applications and related products and services. The assets include customer and partner agreements, intellectual property, and certain furniture and equipment used in the DRM business. The DRM business revenues have been derived principally from sales to customers located in the United States, Japan and Europe. The DRM business to be sold does not include the assets that are employed in connection with the production, distribution and sale of the Industrial Technology for Automation products, or ITA business, that are marketed, primarily in Europe, as the "Axeda Supervisor" or "Wizcon" product family. The DRM business does not constitute a separate legal entity. The DRM business is conducted primarily by our operating subsidiary corporation in the United States, Axeda Systems Operating Company, Inc., but also includes most of the business activities of our subsidiaries in Japan and Germany, and also a small part of the activity of our subsidiary in France. Since the Sale of the DRM business has not been approved by the stockholders, and their vote on the DRM Asset Sale is not scheduled until December 2, 2005, the DRM business is not shown as discontinued operations because Statement of Financial Accounting Standards No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets," requires approval by the highest level of management required for approval of the sale, which is the stockholders, in order to utilize discontinued operations accounting. However, the Definitive Proxy Statement-Amendment 1 filed with the SEC on October 31, 2005, which is incorporated herein by reference in its entirety, includes pro forma financial information indicating the impact of the DRM Asset sale on our financial position and operations (Annex C to the Definitive Proxy Statement), and DRM business historical balance sheets and statements of operations (Annex D to the Definitive Proxy Statement). In connection with the transaction, JMI has provided $1,500 of bridge loans, $600 of which was advanced to us in July 2005, and the remaining $900 was advanced to us in September 2005 following signing of the definitive documents. The bridge loans bear interest at the rate of 7% per annum and are secured by security interests in the assets of our DRM business. We anticipate that the $7,000 of proceeds we will receive upon closing of the Asset Purchase Agreement will be reduced by the $1,530 principal and accrued interest on our borrowings from JMI (See Note 6). In addition, we expect to use a portion of the remaining net proceeds to pay: o the combined balance of $4,725, as of November 30, 2005, of principal and accrued interest that we owe to Laurus, and o anticipated transaction costs of $550, and o working capital requirements of $195.. 7 d) Use of Estimates The preparation of the accompanying Balance Sheet and Statement of Operations requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate the reasonableness of our estimates, including those related to bad debts, intangible assets, income taxes, warranty obligations, purchase commitments and contingencies. These estimates are based upon historical experience and on various other assumptions that are believed to be reasonable under the circumstances at the time of the estimate, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. e) Basis of Presentation The interim consolidated financial statements of Axeda included herein have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments, consisting of normal recurring items, necessary to present fairly our financial position, results of operations and cash flows for the interim periods presented. The unaudited consolidated financial statements included in this Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto, included in our Form 10-K for the year ended December 31, 2004 filed with the SEC, which is incorporated herein by reference in its' entirety. The interim results presented are not necessarily indicative of results for any subsequent quarter or for the year ending December 31, 2005. If our stockholders approve the sale of the DRM business at our December 2, 2005 special meeting of stockholders, the DRM business revenue, costs and expenses will be eliminated from our consolidated statement of operations, as will the DRM assets that will be sold and liabilities that will be assumed. The Definitive Proxy Statement filed with the SEC on October 31, 2005, which is incorporated herein by reference in its' entirety, includes Pro-forma Financial Statement indicating the impact of the DRM Asset sale on our financial statements (Annex C), and DRM business historical Balance Sheets and Income Statements (Annex D). f) Revenue Recognition We recognize software revenues in accordance with Statement of Position, or SOP, 97-2, "Software Revenue Recognition," or SOP 97-2, as amended by SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions," or SOP 98-9. License revenues are recognized in the period in which persuasive evidence of an arrangement exists, the fee is fixed or determinable, delivery of the technology has occurred requiring no significant production, modification or customization and collectibility is probable. g) Financial Instruments Our financial instruments principally consist of cash and cash equivalents, accounts receivable, accounts payable, and notes payable. Cash and cash equivalents, accounts receivable, accounts payable, and the bridge loans and note payable are carried at cost, which approximates fair value. 8 h) Computation of Earnings Per Share We compute earnings per share, or EPS, in accordance with SFAS No. 128, "Computation of Earnings Per Share," or SFAS 128. In accordance with SFAS 128, basic earnings per share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of the incremental common shares issuable upon the exercise of stock options and warrants (using the treasury stock method), and the incremental common shares issuable upon the conversion of the convertible debt (using the if-converted method). Common equivalent shares are excluded from the calculation if their effect is anti-dilutive. (i) September 30, 2005 Options to purchase 6,224,848 shares of common stock with a weighted-average exercise price of $1.13 per share were outstanding as of September 30, 2005, but were not included in the computation of diluted EPS because the effects of assumed exercise would have an anti-dilutive effect on EPS. The outstanding options include 3,693,413 options that were vested, with a weighted average exercise price of $1.39 per share, of which 1,016,000 were vested and in the money, with a weighted average exercise price of $0.01 per share. The options have various expiration dates during the next ten years. Warrants to purchase 6,570,344 shares of common stock with a weighted-average exercise price of $1.01 per share were vested and outstanding as of September 30, 2005, but were not included in the calculation of diluted EPS because the effects of assumed exercise would have an anti-dilutive effect on EPS. No outstanding warrants were vested and in the money as of September 30, 2005. The outstanding warrants have various expiration dates during the next five years. In addition, 9,323,752 shares issuable upon conversion of debt to common stock were excluded from the computation of diluted EPS because the effects of assumed conversion would have an anti-dilutive effect on EPS. (ii) September 30, 2004 Options to purchase 5,609,100 shares of common stock with a weighted-average exercise price of $1.42 per share were outstanding as of September 30, 2004 but were not included in the computation of diluted EPS because the effects of assumed exercise would have an anti-dilutive effect on EPS. The outstanding options include 3,601,937 options that are vested, with a weighted average exercise price of $1.48 per share, of which 1,392,461 were vested and in the money, with a weighted average exercise price of $0.10 per share. The options have various expiration dates during the next ten years. Warrants to purchase 2,696,219 shares of common stock with a weighted-average exercise price of $1.96 per share were vested and outstanding as of September 30, 2004, but were not included in the calculation of diluted EPS because the effects of assumed conversion or exercise would have an anti-dilutive effect on EPS. No outstanding warrants were vested and in the money. The warrants have various expiration dates during the next five years. The outstanding warrants include 2,459,050 warrants whose exercise price was lowered from $1.71 per share to $1.69 per share as a result of and effective upon the closing of our Laurus financing in October 2004. In addition, in December 2004 the exercise price of these warrants was reduced from $1.69 per share to $1.35 per share in accordance with the terms of the warrants and with shareholder approval. 9 k) Stock-based Compensation SFAS No. 123, "Accounting for Stock-based Compensation," or SFAS 123, and SFAS 148 "Accounting for Stock Based Compensation - Transition and Disclosure provides companies the alternative to adopt the fair value method for expense recognition of employee stock options and stock-based awards or to continue to account for such items using the intrinsic value method as outlined under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," or APB 25, with pro forma disclosures of results of operations as if the fair value method had been applied. We account for our stock-based employee compensation plan under the recognition and measurement principles of APB 25 and related interpretations. The following table illustrates the effect on net loss and net loss per share if we had applied the fair value recognition provisions of SFAS 123 to stock-based compensation: Three Months Ended Nine Months Ended ------------------ ----------------- September 30, September 30, ------------- ------------- 2005 2004 2005 2004 ---------- ------- ------- ------- Net loss, as reported ................................. $ (1,508) $(1,352) $(3,292) $(6,415) Add: Stock-based employee compensation included in reported net loss ........................ -- 9 -- 113 Deduct: Stock-based employee compensation expense determined under fair value based method for all awards ................................ (221) (277) (652) (986) ---------- ------- ------- ------- Pro forma net loss .................................... $ (1,729) $(1,620) $(3,944) $(7,288) ========== ======= ======= ======= Net loss per common share - basic and diluted: As reported ...................................... $ (0.05) $ (0.04) $ (0.10) $ (0.20) ========== ======= ======= ======= Pro forma ........................................ $ (0.05) $ (0.05) $ (0.12) $ (0.22) ========== ======= ======= =======

We used the following assumptions to determine the fair value of stock options granted using the Black-Scholes option pricing model for the three and nine months ended September 30, 2005 and 2004: 2005 2004 ---- ---- Dividend yield 0% 0% Expected volatility 122% 86% - 112% Average expected option life 4 years 4 years Risk-free interest rate 3.92% 1.17% - 2.16% l) Recent Accounting Pronouncements On April 21, 2005, the SEC approved a new rule for public companies that delays the effective date of SFAS No. 123R "Share-Based Payment," or SFAS 123R, to annual periods beginning after June 15, 2005. Therefore, we will postpone the adoption of SFAS 123R until the first quarter of 2006. SFAS 123R will eliminate our ability, starting in 2006, to account for stock-based awards granted to employees using the intrinsic value method prescribed by APB 25, and instead requires that such awards be accounted for using a fair value based method, which will require us to measure the compensation expense for all such awards, including stock options, at fair value at the grant date. Compensation expense will then be recognized over the service or vesting period. We are evaluating the requirements of SFAS 123R and expect that the adoption of SFAS 123R will have a material impact on our consolidated results of operations. We have not yet determined the effect of adopting SFAS 123R, nor have we determined the method that we will use to adopt it. However, had we adopted SFAS 123R in the current year, the impact of that standard would have been similar to the current pro forma disclosures under SFAS 123. 10 m) Reclassifications Certain prior year amounts have been reclassified to conform to the current year presentation. 2) Acquired Intangible Assets Acquired intangible assets that are subject to amortization consist of the following: Gross Carrying Amount --------------------- Accumulated Amortization September 30 2005 and ----------------------- December 31, September 30, December 31, 2004 2005 2004 ----------------- ------------- ------------ Developed technology $ 210 $ 210 $ 210 Core technology 1,840 1,281 944 Customer base 110 76 57 --- -- -- Total $ 2,160 $ 1,567 $ 1,211 ======= ======== ======== Aggregate amortization expense was $119 for each of the three months ended September 30, 2005 and 2004, and $356 and $356 for the nine months ended September 30, 2005 and 2004, respectively. 3) Accrued Expenses Accrued expenses consist of the following: September 30, December 31, 2005 2004 ---- ---- Legal and professional fees $ 381 $ 319 Payroll and related costs 899 1,065 Royalties to Israeli government agencies 586 734 Sales, excise and other taxes 534 480 Severance 127 520 Unutilized leased facilities 11 302 Other 632 503 --- --- Total accrued expenses $3,170 $3,923 ====== ====== 4) Income Tax Expense Income tax expense consists of current provisions for estimated foreign income taxes of $50 and $158 for the three and nine months ended September 30, 2005, respectively, and $16 and $46 for the three and nine months ended September 30, 2004, respectively. 5) Financing-related Liabilities The Financial Accounting Standards Board, or FASB, Emerging Issues Task Force, or EITF, issued EITF 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock," or EITF 00-19, which addresses accounting for equity derivative contracts indexed to, and potentially settled in, a company's own stock, or equity derivatives, by providing guidance for distinguishing between permanent equity, temporary equity and assets and liabilities. EITF 00-19 addresses and clarifies whether specific contract provisions or other circumstances cause a net-share or physical settlement alternative to be within or outside the control of the issuer. Equity derivative contracts accounted for as permanent equity are recorded at their initial fair value and subsequent changes in fair value are not recognized unless a change in the contracts' classification occurs. Equity derivative contracts not qualifying for permanent equity accounting are recorded at fair value as an asset or liability with subsequent changes in fair value recognized through the statement of operations. 11 EITF 00-19 considers that the ability to keep SEC filings current is beyond the control of a registrant, and therefore do not qualify for permanent equity accounting. The potential liquidated damages we were required to pay pursuant to the registration rights agreements if we failed to keep our registration statements effective were considered to be potential net cash settlements pursuant to EITF 00-19. Therefore, in accordance with EITF 00-19, through February 16, 2005 we recorded the estimated fair value of the warrants issued to Laurus and Special Situations Private Equity Fund, L.P. and its affiliates, collectively SSF, as a financing-related liability in the consolidated balance sheets, and the fair value of the financing-related liability was adjusted at each balance sheet date, with the non-cash change in fair value reported in the consolidated statement of operations as other income or expense. a) February 16, 2005 Amendments of Agreements with Laurus and SSF On February 16, 2005, we amended a series of agreements relating to Laurus and SSF. Specifically, we: o amended the registration rights agreement with SSF such that any liquidated damages that may arise for failure to: a) file a new registration statement for any shares that may be issued to SSF in the future, to cause such registration statement to become effective, or to maintain the effectiveness of such registration statement would be payable in unregistered shares of common stock rather than cash and we would be obligated to use our best efforts to subsequently register the shares; o amended the securities purchase agreement with Laurus such that any liquidated damages that may arise for failure to deliver shares of common stock upon conversion of Laurus' Note in a timely manner would be payable in a warrant to purchase unregistered shares of common stock rather than cash and we would be obligated to use our best efforts to subsequently register the underlying shares; and o amended the registration rights agreement with Laurus such that any liquidated damages that may arise for failure to file a registration statement for any shares that may be issued to Laurus in the future, to cause such registration statement to become effective, to maintain the effectiveness of such registration statement or to keep our common stock listed or quoted would be payable in a warrant to purchase unregistered shares of common stock rather than cash and we would be obligated to use our best efforts to subsequently register the underlying shares. Effective in February 2005, as a result of these amendments, the accounting and reporting requirements for our financing related liabilities now qualify for permanent equity accounting under EITF 00-19, and therefore, the estimated fair value of the financing related liabilities of $1,934 was reclassified as additional paid-in capital. The estimated fair values of the warrants issued to Laurus and to SSF were calculated using the Black-Scholes model using the following assumptions: February 16, 2005 February 16, 2005 September 30, 2004 ----------------- ----------------- ------------------ Laurus SSF SSF ------ --- --- Current market price/share $0.53 $0.53 $0.45 Exercise price/share $0.53 $1.35 $1.71 Dividend yield 0% 0% 0% Expected volatility 107% 107% 108% Expected life 4.62 years 3.6 years 3.98 years Risk-free interest rate 3.77% 3.69% 3.17%

b) May 4, 2005 Amendment of Agreements with Laurus On May 4, 2005, we amended the Note and several of the related agreements for the primary purpose of postponing the principal payments due in May and June 2005, of $150 each, until September and October 2007, respectively. In exchange for these amendments, we issued to Laurus a warrant to purchase 750,000 shares of our common stock at an exercise price of $0.37 per share. The warrant is exercisable for a term of five years and has an estimated fair value of approximately $211, which is being amortized over the remaining term of the loan as additional non-cash interest expense. 12 c) Default Under Laurus Note and July 8, 2005 Letter Agreement with Laurus To induce Laurus to subordinate its security interest and to provide all other consents necessary for the transactions with JMI, in July 2005 we entered into a letter agreement with Laurus in which we agreed that we would pay to Laurus in full in cash all outstanding principal and accrued and unpaid interest owed to Laurus simultaneously with the closing of the JMI transaction. This payment will be deemed to be in full satisfaction of all of our obligations to Laurus, and we will not be required to pay to Laurus the prepayment penalty that would have required payment of 120% of the outstanding principal and accrued and unpaid interest owed to Laurus. If bankruptcy proceedings are initiated by or against us prior to the closing of the JMI transaction, then we will again become obligated to pay the prepayment penalty and any other obligations that may arise. Because failure to pay principal when due is an event of default under the terms of the Note payable to Laurus and we have not paid the principal payments for July through October 2005, we are in default under the Laurus Note. As a result, the unpaid loan principal balance of $4,475 is now reflected in our consolidated balance sheet as a current liability as of September 30, 2005, net of debt discounts of $1,385. 6) Bridge Loans In July and September 2005 we received an aggregate of $1,500 of bridge loans from JMI. The bridge loans bear interest at the rate of 7% per annum and are secured by security interests in the assets of our DRM business. As of September 30, 2005 interest due and accrued under the bridge loans is $13. Pursuant to the terms of a subordination agreement which Laurus has entered into with JMI and us, Laurus has agreed to subordinate its right to payment of the note we issued to it, and its security interest in those assets, so that JMI holds a senior secured lien therein to the extent of the first $600 of bridge loans that JMI provides to us. With respect to the $900 balance of the bridge loans, JMI's security interest in the assets of our DRM business will be pari passu with the security interest held by Laurus in the same assets. The bridge loans are expected be repaid at the closing of the sale of our DRM business to ASOC Acquisition Corp. in December 2005 (See Note 1c). 7) Commitments and Contingencies From time to time, we have received notices of claims of infringement of other parties' proprietary rights and other claims in the ordinary course of our business. We have accrued for estimated losses in the accompanying consolidated financial statements for those matters where we believe the likelihood of an adverse outcome is probable and the amount of the loss is reasonably estimable. The adverse resolution of any one or more of these matters could have a material adverse effect on our business, financial condition or results of operations. Questra Patent Infringement Litigation On June 30, 2004, we announced that we were awarded a patent by the United States Patent and Trademark Office for a key element of our Firewall-Friendly method of communication over the Internet. The patent protects one of our inventions relating to enabling remote "devices" -- machines, appliances, instruments, and computers -- to securely communicate their health and status to enterprise computer systems. On June 30, 2004, we filed a complaint in the United States District Court for the District of Massachusetts against Questra Corporation, one of our competitors, for infringement of this patent. On November 10, 2004, Questra filed a patent infringement lawsuit against us in the United States District Court for the Northern District of California charging us with infringement of U.S. Patent No. 6,377,162 and seeking injunctive relief and unspecified monetary damages. On September 14, 2005 we reached an agreement with Questra to settle all pending patent litigation between Axeda and Questra. Under the terms of the confidential settlement, the parties have agreed, among other things, to cross-license the patents that were involved in the litigation and to dismiss the pending claims with prejudice. The parties have also agreed to a two-year covenant prohibiting the companies from filing against each other any additional patent infringement suits. The parties have agreed to keep the terms of the settlement confidential except to the extent disclosure is required by the securities laws of the United States or any other applicable jurisdiction. 13 SECURITIES ALLOCATION CLASS ACTION On November 27, 2001, a putative shareholder class action was filed against us, certain of our officers and directors, and several investment banks that were underwriters of our initial public offering. The action was filed in the United States District Court for the Southern District of New York, purportedly on behalf of investors, who purchased our stock between July 15, 1999 and December 6, 2000. A Consolidated Amended Complaint, which is now the operative complaint, was filed on April 19, 2002. The lawsuit alleges violations of Sections 11 and 15 of the Securities Act of 1933 and Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder against one or both of us and our officers and directors. The claims are based on allegations that the underwriter defendants agreed to allocate stock in our July 15, 1999 initial public offering to certain investors in exchange for excessive and undisclosed commissions and agreements by those investors to make additional purchases in the aftermarket at pre-determined prices. The plaintiffs allege that the prospectus for our initial public offering was false and misleading in violation of the securities laws, because it did not disclose these arrangements. The action seeks damages in an unspecified amount. Similar "IPO allocation" actions have been filed against over 300 other issuers that have had initial public offerings since 1998 and all are included in a single coordinated proceeding in the Southern District of New York. Our board of directors approved a settlement agreement and related agreements which set forth the terms of a settlement among us, our officers and directors, the plaintiff class, the vast majority of the other approximately 300 issuer defendants and the individual defendants currently or formerly associated with these companies. Among other provisions, the settlement agreement provides for a release of us and our officers and directors for the conduct alleged in the action to be wrongful. We would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims we may have against the underwriters. The settlement agreement also provides a guaranteed recovery of $1 billion to plaintiffs for the cases relating to all of the approximately 300 issuers. To the extent that the underwriter defendants settle all of the cases for at least $1 billion, no payment will be required under the issuers' settlement agreement. To the extent that the underwriter defendants settle for less than $1 billion, the issuers are required to make up the difference. It is anticipated that any potential financial obligation we have to plaintiffs pursuant to the terms of the settlement agreement and related agreements will be covered by existing insurance. We currently are not aware of any material limitations on the expected recovery of any potential financial obligation to plaintiffs from our insurance carriers. Our carriers appear solvent, and we are not aware of any uncertainties as to the legal sufficiency of an insurance claim with respect to any recovery by plaintiffs. Therefore, we do not expect that the settlement will involve any payment by us. If material limitations on the expected recovery of any potential financial obligation to the plaintiffs from our insurance carriers should arise, our maximum financial obligation to the plaintiffs pursuant to the settlement agreement would be less than $3,400. On February 15, 2005, the Court granted preliminary approval of the settlement agreement, subject to certain modifications consistent with its opinion. Those modifications have been made and the issuers and the plaintiffs have submitted to the Court a revised settlement agreement for approval. There is no assurance that the Court will grant final approval to the settlement. If the settlement agreement currently before the Court, as revised in accordance with the preliminary approval order, is accepted by the Court, then we anticipate that any potential financial obligation we may have to the plaintiffs pursuant to the terms of the settlement agreement and related agreements will be covered by existing insurance. If the settlement agreement is not approved and we are found liable, we are unable to estimate or predict the potential damages that might be awarded, whether such damages would be greater than the Company's insurance coverage, and whether such damages would have a material impact on our results of operations or financial condition in any future period. If the settlement does not occur, and litigation against us continues, we believe we have meritorious defenses and intend to defend the case vigorously. 14 8) Segment and Major Customer Information Segment information is presented in accordance with SFAS No. 131, "Disclosures About Segments Of An Enterprise And Related Information," or SFAS 131. SFAS 131 requires segmentation based upon our internal organization and disclosure of revenue and operating income based upon internal accounting methods. We evaluate operating segment performance based on revenue and gross profit. We have not historically evaluated segment performance based on operating income or allocated assets to our individual operating segments. Three Months Ended Nine Months Ended ------------------ ----------------- September 30, September 30, ------------- ------------- 2005 2004 2005 2004 ------- ------- ------- ------- Revenues: DRM .................. $ 3,374 $ 2,721 $10,664 $ 9,065 Other ................ 1 17 9 103 ------- ------- ------- ------- Total .............. $ 3,375 $ 2,738 $10,673 $ 9,168 ======= ======= ======= ======= Gross profit: DRM .................. $ 2,565 $ 1,775 $ 7,951 $ 5,492 Other ................ 1 17 9 103 ------- ------- ------- ------- Total .............. $ 2,566 $ 1,792 $ 7,960 $ 5,595 ======= ======= ======= ======= Customer Concentration Three customers accounted for 30%, or $1,022, and 36%, or $1,036, of revenues for the quarters ended September 30, 2005 and 2004, respectively. Three customers accounted for 19%, or $2,059, and 20%, or $1,821, of revenues for the nine months ended September 30, 2005 and 2004, respectively. Geographic Sources of Revenue We sell and license our technology to customers primarily in North America, Europe and Asia. Our North American operations generated 57% and 38% of our revenues in the three months ended September 30, 2005 and 2004, respectively, and 55% and 38% of our revenues for the nine months ended September 30, 2005 and 2004, respectively. Our total revenues for the three and nine months ended September 30, 2005 and 2004 were derived from the following geographic regions (based on where the customer is located): Three Months Ended September 30, ---------------------------------- 2005 2004 ---------------- ---------------- % of % of Country/ Geographic Region Amount Total Amount Total -------------------------- ------ ----- ------ ----- North America: United States ............ $1,942 57% $1,045 38% Canada ................... -- -- -- ------ ------ ------ ------ Total - North America 1,942 57 1,045 38 ------ ------ ------ ------ Europe: Germany .................. 129 4 110 4 France ................... 343 10 160 6 Netherlands .............. 113 3 159 6 Switzerland .............. 91 3 617 23 United Kingdom ........... 51 2 115 4 Other .................... 270 8 228 8 ------ ------ ------ ------ Total - Europe ...... 997 30 1,389 51 ------ ------ ------ ------ Other: Israel ................... 108 3 78 3 Japan .................... 189 6 148 5 Other .................... 139 4 78 3 ------ ------ ------ ------ Total - Other ....... 436 13 304 11 ------ ------ ------ ------ Total ................ $3,375 100% $2,738 100% ====== === ====== === 15 Nine Months Ended September 30, ---------------------------------- 2005 2004 ---------------- ---------------- % of % of Country/ Geographic Region Amount Total Amount Total -------------------------- ------ ----- ------ ----- North America: United States ............ $ 5,862 55% $ 3,448 38% Canada ................... 3 -- 9 -- ------- ------- ------- ------- Total - North America 5,865 55 3,457 38 ------- ------- ------- ------- Europe: Germany .................. 438 4 406 4 France ................... 1,316 12 904 10 Netherlands .............. 414 4 515 6 Switzerland .............. 487 5 1,233 13 United Kingdom ........... 318 3 324 4 Other .................... 731 7 976 11 ------- ------- ------- ------- Total - Europe ...... 3,704 35 4,358 48 ------- ------- ------- ------- Other: Israel ................... 386 4 227 2 Japan .................... 435 4 942 10 Other .................... 283 184 2 ------- ------- ------- 2 Total - Other ....... 1,104 10 1,353 14 ------- ------- ------- ------- Total ................ $10,673 100% $ 9,168 100% ======= === ======= === 9) Consolidated Statements of Cash Flows Supplemental disclosure of cash flow information: Nine Months Ended September 30, ------------------------------- 2005 2004 ------- ------- Cash paid during the period for: Interest .................................................... $ 60 $ 3 ======= ======= Income taxes (refund) ....................................... $ (21) $ 99 ======= ======= Non-cash financing activities: Reclassification of financing-related liabilities to permanent equity ....................................... $ 1,934 $- ======= ======= Issuance of warrant ......................................... $ 211 $- ======= =======

10) Comprehensive Loss The components of comprehensive loss are as follows: Three Months Ended Nine Months Ended September 30, September 30, 2005 2004 2005 2004 ------------ ------- ------- ------- Net loss ........................................... $ (1,508) $(1,352) $(3,292) $(6,415) Foreign currency translation adjustment ............ 2 2 (83) (18) ------------ ------- ------- ------- Comprehensive loss ................................. $ (1,506) $(1,350) $(3,395) $(6,433) ============ ======= ======= =======

16 Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations This Quarterly Report on Form 10-Q, including the following Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, that involve a number of risks and uncertainties. Such statements are based on current expectations of future events that involve a number of risks and uncertainties that may cause the actual events to differ materially from those discussed herein. In addition, such forward-looking statements are necessarily dependent upon assumptions, estimates and dates that may be incorrect or imprecise and involve known and unknown risks and other factors. Accordingly, any forward-looking statements included herein do not purport to be predictions of future events or circumstances and may not be realized. Forward-looking statements can be identified by, among other things, the use of forward-looking terminology such as "believes," "expects," "may," "could," "will," "should," "seeks," "pro forma," "potential," "anticipates," "predicts," "plans," "estimates," or "intends," or the negative of any thereof, or other variations thereon or comparable terminology, or by discussions of strategy or intentions. Given these uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. Forward-looking statements should be considered in light of various important factors, including those set forth in this report under the caption "Risk Factors" and elsewhere herein. All forward-looking statements, and reasons why results may differ, that are included in this report are made as of the date of this report, and except as required by law, we disclaim any obligations to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained herein or reasons why results might differ to reflect future events or developments. References herein to "Axeda," "we," "our," and "us" collectively refer to Axeda Systems Inc., a Delaware corporation, and all of its direct and indirect U.S., Israeli, Japanese, European and Canadian subsidiaries. OVERVIEW AND RECENT EVENTS On June 29, 2005, we entered into a non-binding letter of intent to sell our DRM business and related assets to JMI Equity Fund V, L.P., or JMI, a Baltimore and San Diego-based private equity firm. In the event this asset sale is consummated as currently contemplated, we expect the DRM business to continue to operate in the ordinary course following the closing of the asset sale as a private company funded by JMI, with JMI assuming support and maintenance services for existing customers. We expect the key operational employees of the DRM business to continue with the new company in their current roles to prevent interruption of business operations. In July 2005, to induce Laurus Master Fund, Ltd., or Laurus, to subordinate its security interest and to provide all other consents necessary for the transactions with JMI, we entered into a letter agreement with Laurus in which we agreed that we would pay to Laurus in full in cash all outstanding principal and accrued and unpaid interest owed to Laurus simultaneously with the closing of the JMI transaction. This payment will be deemed to be in full satisfaction of all of our obligations to Laurus In July and September 2005 we received an aggregate of $1,500 of bridge loans from JMI. Effective on September 1, 2005, as described in detail in our definitive proxy statement, as amended, filed on October 31, 2005, which is incorporated by reference herein in its entirety, we entered into a definitive asset purchase agreement to sell, subject to Shareholder approval, our DRM business and related assets to ASOC Acquisition Corp., a new corporation formed and owned by JMI Equity Fund V, L.P. and JMI Equity Fund V (AI), L.P., or JMI, for $7,000 plus the assumption of certain liabilities related to the DRM business. The DRM business to be sold includes our Axeda DRM software systems designed to remotely monitor, manage and service intelligent devices deployed at end-user sites. The Axeda DRM software systems include Axeda Agent software, an Axeda Enterprise server and Axeda Applications and related products and services. The assets include customer and partner agreements, intellectual property, and certain furniture and equipment used in the DRM business. The DRM business revenues have been derived principally from sales to customers located in the United States, Japan and Europe. The DRM business to be sold does not include the assets that are employed in connection with the production, distribution and sale of the industrial automation products that are marketed, primarily in Europe, as the "Axeda Supervisor" or "Wizcon" product family, which is also referred to as the Industrial Technology for Automation, or ITA business. The DRM business does not constitute a separate legal entity. The DRM business is conducted primarily by our operating subsidiary corporation in the United States, Axeda Systems Operating Company, Inc., but also includes most of the business activities of our subsidiaries in Japan and Germany, and also a small part of the activity of our subsidiary in France. 17 In connection with the transaction, JMI has provided $1,500 of bridge loans. The bridge loans bear interest at the rate of 7% per annum and are secured by security interests in the assets of our DRM business. We anticipate that the $7,000 of proceeds we will receive upon closing of the Asset Purchase Agreement will be reduced by the $1,500 principal plus accrued interest of approximately $30 on our borrowings from JMI. In addition, we expect to use a portion of the remaining net proceeds to pay: o the estimated combined balance of $4,725, as of November 30, 2005, of principal and accrued interest that we owe to Laurus, and o anticipated transaction costs of $550, and o working capital requirements of $195. We will seek the approval of our stockholders to consummate the proposed transaction at the Special Meeting of Stockholders' Meeting to be held on December 2, 2005. There can be no assurance that we will receive such stockholder approval. If the sale of our DRM business to JMI is consummated, substantially all of our revenue will be derived from our remaining assets, the ITA business. We do not have experience operating our business with this single product family and we do not expect that the revenues to be generated from the ITA business will be sufficient to allow us to continue to operate as a going concern. We have recently received some inquiries from third parties who have indicated that they may be interested in acquiring the ITA business. We would consider selling the ITA business if we were offered favorable terms. However, there can be no assurances that a suitable acquirer will be identified and that we could negotiate a favorable price and terms for such transaction. If sales of both the DRM business and the ITA business are consummated, we would expect to use the proceeds to pay our creditors, including Laurus. To the extent that not all of our obligations to creditors would be satisfied with the proceeds of such sales, we would most likely commence proceedings under the Bankruptcy Code. If the sale of the DRM business is not consummated o we do not believe we will be able to repay our secured indebtedness to JMI or to Laurus; and o JMI will have the option of acquiring the secured indebtedness that we owe to Laurus. If JMI does not exercise that option, then Laurus will have the option of acquiring the indebtedness that we owe to JMI. If either of those two secured creditors exercises its option, the acquiring creditor will be in a position to foreclose on the combined $6,000,000 security interest covering our DRM business and assets, and thereby acquire title to the DRM business and assets without consummating the proposed sale of the DRM business. If that occurs, we will not receive any part of the $7,000,000 purchase price that we would receive upon consummation of the sale. If the sale of the DRM business is not consummated, and even if it is, but we are unable to sell or find a strategic buyer for the ITA business on favorable terms, it is very likely that we will have to commence proceedings under the Bankruptcy Code. On July 7, 2005, our common stock was delisted from The Nasdaq SmallCap Market because we did not achieve a $1.00 minimum bid price by June 30, 2005 required under an exception to the minimum bid price requirement we had been granted to permit our continued inclusion in such market. Since July 7, 2005, quotations for our common stock have appeared in the "Pink Sheets." Our operating loss for the three and nine months ended September 30, 2005 decreased by $1,552, or 60%, to $1,020, and decreased by $5,249, or 62%, to $3,221, compared to the prior year periods, which reflects the increase in revenues and the reduction in our cost of revenues and operating costs. For the three and nine months ended September 30, 2005, our operating expenses decreased by $778, or 18%, to $3,586, and decreased by $2,884, or 21%, to $11,181, respectively, compared to the prior year periods due mainly to prior years' staffing reductions in research and development, and sales and marketing departments. 18 Interest expense was $493 in the quarter and $1,286 in the nine-month period compared to minimal expense in the prior same periods due to the Laurus convertible debt financing. Interest expense includes the nominal stated interest and amortization of the beneficial conversion feature of the note and the amortization of the value of the warrants issued to Laurus in connection with the Note financing as required by GAAP. At September 30, 2005 our cash and cash equivalents balance was $1,484, compared with $2,429 as of December 31, 2004 due mainly to the $2,315 net cash used in operations, offset partially by the $1,500 Bridge Loan from JMI. Going-Concern Exception in the Report of our Independent Registered Public Accounting Firm Contained in our Annual Report for the Year Ended December 31, 2004 We have sustained significant losses from operations and negative cash flows from operations since inception. For the nine months ended September 30, 2005 and 2004 our operating losses were $3,221 and $8,470, respectively. The report of our independent registered public accounting firm on our December 31, 2004 consolidated financial statements included an explanatory paragraph indicating there is substantial doubt about our ability to continue as a going concern. Since July 1, 2005, we have been in default under the Laurus Secured Convertible Term Note, or Note, issued to Laurus Master Fund, Ltd, or Laurus, for failing to pay when due interest under the Note for June, July, August and September 2005, as well as the July, August and September 2005 principal payments. Article IV of the Note defines "Events of Default" as the failure to pay any installment of principal or interest within three days of the due date, and that upon the occurrence and continuance of an Event of Default, Laurus may make all sums of principal, interest and other fees then remaining unpaid immediately due and payable. In the event of such an acceleration, the amount due and owing to Laurus shall be one hundred twenty percent (120%) of the outstanding principal amount, plus accrued and unpaid interest and fees. In addition, the registration rights agreement entered into in connection with the Note states that if our shares are not traded on a "Trading Market", which does not include the "Pink Sheets", where our shares of common stock currently trade, then Axeda is obligated to issue certain warrants to Laurus, and our failure to do so also constitutes a default under the Note. In a Letter Agreement dated July 8, 2005 between Axeda Systems Inc. and Laurus, Laurus agreed to accept payment in full in cash of the outstanding principal and accrued and unpaid interest simultaneously with the closing of the JMI Asset Sale, in full satisfaction of our obligations. However, in the event bankruptcy proceedings are initiated by or against us prior to the closing of the JMI Asset Sale, the default penalties described above would resume. Management has developed and begun to implement a plan to address this issue, which includes the sale of our DRM business and may include the sale of our ITA business. However, there can be no assurance that we will successfully implement our plan or that we will be able to continue as a going concern. Our plan also requires us to receive additional financing from new or current investors if we do not sell our DRM business or find a buyer or partner for our ITA business. We do not expect such financing to be available on favorable terms, if at all. Our unaudited consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. FINANCING TRANSACTIONS Bridge Loans from JMI In connection with the DRM Asset Sale, JMI has provided $1,500 of bridge loans, $600 of which was advanced to us in July 2005, and the remaining $900 was advanced to us in September 2005 following the signing of the definitive documents. The bridge loans bear interest at the rate of 7% per annum and are secured by security interests in the assets of our DRM business. It is anticipated that the JMI Bridge Loans and accrued interest will be paid to JMI out of the DRM sales proceeds at the Closing. Laurus Note Payable On October 5, 2004, we issued to Laurus, a secured convertible term note, or the Note, in the principal amount of $4,500 and received net proceeds of $3,910. The Note is convertible into shares of our common stock at an initial fixed conversion price of $0.48 per share. The Note has a term of three years and accrues interest at the prime rate plus 2% per year (8.75% as of September 30, 2005). On May 4, 2005, we amended our note with Laurus and several related agreements for the primary purpose of having Laurus postpone our required repayment of principal in May and June 2005. These principal repayments will become payable in September 2007 and October 2007, respectively, subject to the earlier repayment as contemplated by the transaction with JMI discussed above. In exchange for these amendments, we issued to Laurus a warrant to purchase 750,000 shares of our common stock at an exercise price of $0.37 per share. The warrant is exercisable for a term of five years and the estimated fair value of the warrant of $211 is being amortized as additional interest expense over the term of the loan. 19 As of July 1, 2005, we are in default under the Note for failing to pay interest due under the Note for June July, August and September 2005, as well as the July, August and September 2005 principal payments when due. In a Letter Agreement dated July 8, 2005 between Axeda Systems Inc. and Laurus, Laurus agreed to accept payment in full in cash of the outstanding principal and accrued and unpaid interest simultaneously with the closing of the DRM Asset Sale, in full satisfaction of our obligations. However, in the event bankruptcy proceedings are initiated by or against us prior to the closing of the DRM asset sale with ASOC Acquisition Corp, the applicable default penalties would resume. LEASES On July 11, 2005 we entered into a Letter of Intent to sublease 14,711 square feet of space in Foxborough, MA, which is in the same industrial/office complex as our current offices. In October 2005 we finalized the sublease agreement, which proposes annual rent of $125, plus operating expenses, utilities and taxes, for the 18-month term of September 29, 2005 to March 31, 2007. In July 2005, we entered into a Sublease Termination Agreement for our offices in Mansfield, MA under which we were obligated to surrender these premises on or before October 1, 2005 or the Termination Date, rather than the current lease termination date of July 2007. This termination agreement provided for no rental liability from July 1, 2005 to the Termination Date. The security deposit of $150 and related letter of credit were reduced by $100 upon the signing of the Termination Agreement, and by another $25 upon the signed lease for alternate space, and the final $25 will be returned after surrendering the premises and the final inspection. With the finalizing of the Sublease Agreement for our office in Foxborough, MA on September 29, 2005, our lease commitments, including rent, utilities and taxes, will be reduced by approximately $582 over the remaining lease term, compared to the Mansfield, MA sublease. 20 RESULTS OF OPERATIONS Three and Nine Months Ended September 30, 2005 Results of Operations, Compared to Three and Nine Months Ended September 30, 2004. The following table sets forth, for the periods indicated, the amount and percentage of total revenues represented by certain items reflected in our consolidated statements of operations: Axeda Systems Inc. Unaudited Consolidated Statements of Operations (In thousands) Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 2005 2004 2005 2004 ---------------------- --------------------- ------------------- --------------------- Percent of Percent of Percent of Percent of Amount Revenues Amount Revenues Amount Revenues Amount Revenues ------ -------- ------ -------- ------ -------- ------ -------- Revenues: License ........................... $ 1,860 55.1% $ 1,700 62.1% $ 6,136 57.5% $ 5,611 61.2% Services and maintenance .......... 1,514 44.9 1,021 37.3 4,528 42.4 3,454 37.7 Hardware .......................... 1 0.0 17 .6 9 0.1 103 1.1 -------- ----- -------- ---- -------- ---- -------- ---- Total revenues .................. 3,375 100.0 2,738 100.0 10,673 100.0 9,168 100.0 -------- ----- -------- ---- -------- ---- -------- ---- Cost of revenues: License ........................... 99 3.0 104 3.8 297 2.8 534 5.8 Services and maintenance .......... 598 17.7 730 26.6 2,080 19.5 2,703 29.5 Software amortization ............. 112 3.3 112 4.1 336 3.1 336 3.7 --- --- --- --- --- --- --- --- Total cost of revenues 809 24.0 946 34.5 2,713 25.4 3,573 39.0 --- ---- --- ---- ----- ---- ----- ---- Gross profit ...................... 2,566 76.0 1,792 65.5 7,960 74.6 5,595 61.0 -------- ----- -------- ---- -------- ---- -------- ---- Research and development (R&D) ....... 678 20.1 944 34.5 2,364 22.2 3,068 33.4 Sales and marketing (S&M) ............ 1,112 32.9 1,760 64.3 4,104 38.5 5,775 63.0 General and administrative (G&A) ..... 1,371 40.6 1,338 48.8 3,906 36.6 4,382 47.8 Depreciation and amortization ........ 425 12.6 322 11.8 807 7.5 840 9.2 -------- ----- -------- ---- -------- ---- -------- ---- Total operating costs ............. 3,586 106.2 4,364 159.4 11,181 104.8 14,065 153.4 -------- ----- -------- ---- -------- ---- -------- ---- Operating loss .................... (1,020) (30.2) (2,572) (93.9) (3,221) (30.2) (8,470) (92.4) Gain (loss) on disposal of assets .... (3) -- -- - (2) -- 110 1.2 Interest income (expense), net ....... (493) (14.7) (5) - (1,286) (12.0) (35) (.4) Other income (expense), net .......... 58 1.7 1,241 45.1 1,375 12.9 2,026 22.1 -------- ----- -------- ---- -------- ---- -------- ---- Loss before income taxes .......... (1,458) (43.2) (1,336) (48.8) (3,134) (29.3) (6,369) (69.5) Provision for income taxes ........... 50 1.5 16 0.6 158 1.5 46 0.5 -------- ----- -------- ---- -------- ---- -------- ---- Net loss .......................... $ (1,508) (44.7) $ (1,352) (49.4) $ (3,292) (30.8) $ (6,415) (70.0) ======== ===== ======== ===== ======== ===== ======== =====

21 RESULTS OF OPERATIONS REVENUES. Overall revenues increased by $637, or 23%, to $3,375 in the third quarter of 2005 compared to the 2004 third quarter, and increased by $1,505, or 16%, to $10,673 for the first nine months of 2005, compared to the same period in 2004. This revenue increase was driven by higher DRM revenues resulting from the continued acquisition of new customer accounts, additional spending by our existing customers and the increase in maintenance revenue due to continued growth. License revenues in the third quarter of 2005 increased by $160, or 9%, to $1,860 compared to the 2004 third quarter, and increased by $525, or 9%, to $6,136 in the first nine months of 2005 compared to the same period in 2004 due to sales contracts from both existing and new customers in the current year periods, and continued customer acceptance of our DRM solutions for M2M communication. Services and maintenance revenues in the third quarter of 2005 increased by $493, or 48%, to $1,514 compared to the 2004 third quarter, and increased by $1,074, or 31%, to $4,528 in the first nine months of 2005 compared to the same period in 2004 due to greater demand for our professional services in connection with the expansion of existing DRM system installations, additional maintenance plans sold with new DRM systems licenses and increasing sales of our hosted DRM system solution, which was launched in the second quarter of 2004. COST OF REVENUES. For the third quarter of 2005 total cost of revenues was $809, which was $137, or 14%, lower than the 2004 third quarter. Total cost of revenues was $2,713 for the first nine months of 2005, which was $860, or 24%, lower compared to the same period in 2004, due primarily to decreases in staff and staff-related expenses, resulting from our ongoing cost monitoring initiatives, and reductions in charges for bundled third-party software. Cost of license revenues in the third quarter of 2005 decreased by $5, or 4.8%, to $99, compared to $104 in the third quarter of 2004, and cost of license revenues in the first nine months of 2005 decreased by $237, or 44%, to $297 compared to $534 in the same period in 2004. These decreases are primarily because of reductions in charges for third-party software bundled with our DRM system products, reductions in hardware sold as components of bundled solutions and reductions in royalties owed to the Office of the Chief Scientist in Israel in connection with sales of our ITA products, for which contractual obligations ended in the first quarter 2004. Cost of services and maintenance decreased by $132, or 18%, to $598 in the third quarter of 2005, compared to $730 in the third quarter of 2004, and for the first nine months of 2005 cost of services and maintenance revenue of $2,080 decreased by $623, or 23%, compared to the same period last year. The 2005 decreases in cost of services and maintenance revenue was achieved although services and maintenance revenues increased by 48% and 31% for the three and nine months ended, respectively, due to higher employee productivity driven by prior years' workforce reductions, including the closing of our office in Japan in September 2004, offset by increases in the costs of other internal resources and utilization of lower-cost, third party consultants to meet peak demand. GROSS PROFIT. Gross profit increased by $774, or 43%, to $2,566 in the third quarter of 2005, compared to $1,792 in the third quarter of 2004, and, in the first nine months of 2005, increased by $2,365, or 42%, to $7,960 due primarily to the increase in revenues, combined with the reductions in cost of revenues as discussed above. RESEARCH AND DEVELOPMENT EXPENSE (R&D). R&D consists of staff, staff-related, professional and other development-related support costs associated with the development of new products, quality assurance and product testing. R&D for the quarter ended September 30, 2005 decreased $266, or 28%, to $678, compared with the prior year quarter. This change included decreases in staff and staff-related expenses of $160, and the reclassification of $90 to services and maintenance cost of revenues for the cost of R&D personnel utilized for professional services engagements. For the nine months ended September 30, 2005, R&D decreased $702, or 23%, to $2,364 due primarily to decreases in staff and staff-related expenses of $465 and the reclassification of $205 to services and maintenance cost of revenues for the cost of R&D personnel utilized for professional services engagements. As a percentage of total revenues, R&D decreased from 35% to 20% for the third quarter of 2005 compared to the same quarter in 2004, and decreased from 33% to 22% for the nine months ended September 30, 2005 compared to the same period in 2004. These percentage decreases are due primarily to the reduction in R&D and the increase in total revenues. 22 SALES AND MARKETING EXPENSE (S&M). S&M consists of salaries, travel expenses and costs, advertising and other sales and marketing efforts. S&M for the quarter ended September 30, 2005 decreased $648, or 37%, to $1,112 compared to the prior year quarter. For the nine months ended September 30, 2005 S&M decreased $1,628, or 28%, to $4,104. During the quarter ended September 30, 2005, reduced staff and staff-related expense contributed $400 to the decrease which included the closing of the Japan office in August, 2004, while continued cost reduction efforts led to a decline in various other departmental support costs, which combined for a decrease of an additional $300 from the prior year, offset partially by an increase of $80 in commissions paid due to increase DRM sales in the US. For the nine months ended September 30, 2005, reduced severance and staff reductions including office closings effective September 30, 2004 contributed $200 and $1,200, respectively. Continued cost reduction efforts led to a decline in various other departmental support costs, which combined for a decrease of an additional $500 from the prior year. The nine-month reductions were partially offset by an increase in commissions of $360 due to the increase in revenues. As a percentage of revenues, S&M decreased from 64% to 33% for the third quarter of 2005 compared to the same quarter in 2004, and decreased from 63% to 39% for the nine months ended September 30, 2005 compared to the same period in 2004. These percentage decreases were due to the reduced S&M and the increase in total revenues. GENERAL AND ADMINISTRATIVE EXPENSE (G&A). G&A consists of staff, staff-related expenses, office overhead costs, and outside professional legal and accounting fees, of our finance, human resources, legal and other management departments. G&A for the quarter ended September 30, 2005 increased by $42, or 3%, to $1,371. For the nine months ended September 30, 2005, G&A decreased by $408, or 9%, to $3,906 due to reductions in staff and staff-related expenses of $1,800, as a result of past staff reduction measures taken, reductions in costs of certain insurance coverage of $100, and $200 reduction in other miscellaneous costs. These reductions were offset by the settlement of an assumed lease obligation of an acquired business of $600 in the third quarter of 2004. A similar accrual reversal was not recorded in the current quarter ended September 30, 2005. In addition, increased legal and professional fees related to the patent legal proceedings and proposed asset sale transactions added $1,100 to the increase. As a percentage of revenues, G&A was 41% for the third quarter of 2005 and 49% for the third quarter of 2004, and decreased from 47% to 37% for the nine months ended September 30, 2005 compared to the same period in 2004 due to the increase in total revenues and the reduced G&A. INTEREST INCOME (EXPENSE), NET. Net interest expense for the third quarter of 2005 was $493 and for the nine months ended September 30, 2005 was $1,286, compared to nominal amounts for the same periods in 2004. The increases for the three and nine months ended September 30, 2005 are the result of the issuance of the Note to Laurus in October 2004, the related amortization of original issue discount and debt issuance costs, and the monthly coupon interest due. The debt discount and debt issuance costs are being amortized over the three-year term of the Note. OTHER INCOME, NET. Net other income of $1,375 for the nine months ended September 30, 2005 consists primarily of the reversal in 2005 of the financing-related liabilities recorded in the fourth quarter 2004 in connection with the Laurus and SSF financings. For the same period in 2004 the mark-to-market non-cash gains of $2,026 were primarily attributable to a lower stock price compared to the stock price as of the end of the preceding period. Effective in February 2005, as a result of certain amendments with SSF and Laurus, the accounting and reporting requirements of EITF 00-19 no longer apply, and the estimated fair value of the financing-related liabilities after the mark-to-market valuation adjustment as of February 16, 2005 of $1,934 was reclassified to additional paid-in capital. FOREIGN CURRENCY EFFECTS ON RESULTS OF OPERATIONS. Foreign currency movements for the three months ended September 30, 2005 had no effect on revenues from the same period in the prior year. For the nine months ended September 30, 2005 currency exchange rate movements increased revenues by $130 from the same periods in the prior year due primarily to a strengthening of the U.S. dollar against the Euro beginning in May 2005. 23 LIQUIDITY AND CAPITAL RESOURCES Since March 2001, our operations have largely been financed through the sales of the assets of our former consumer electronics business and our former Internet appliance business, the sale of shares of our common stock in a private placement transaction with Special Situations Private Equity Fund, L.P., or SSF, in September 2003 and the issuance of the convertible term note to Laurus Master Fund, Ltd., or Laurus in a private placement transaction in October 2004. In addition JMI, in connection with the DRM Asset Sale, provided us with a Bridge Loan of $1,500. At September 30, 2005 we had approximately $1,484 in cash and cash equivalents. Net cash used in operations for the nine months ending September 30, 2005 was $945, compared to $8,248 for same period in 2004. Cash used in operating activities for the first nine months of 2005 was primarily the result of our net cash used in operations of $2,315, partially offset by the $1,500 JMI Bridge Loan. Net cash used in operations for the nine months ended September 30, 2004 was $7,848. Cash used in operating activities for the first nine months of 2004 was primarily the result of our net loss of $6,369 and unrealized gains recorded of $2,136. In addition, capital expenditures were $148, and net repayments under the bank line of credit were $287. LACK OF LIQUIDITY AND AVAILABILITY OF FINANCIAL RESOURCES We have limited financial resources currently available to invest in new initiatives, additional key personnel, new equipment and operating capital. The report of our independent registered public accounting firm on our December 31, 2004 consolidated financial statements included an explanatory paragraph indicating there is substantial doubt about our ability to continue as a going concern. Management has developed and begun to implement a plan to address this issue, which includes the sale of our Axeda DRM system business and may also include the sale of our ITA product family business. However, there can be no assurance that we will successfully implement our plan or that we will be able to continue as a going concern. If the DRM business sale does not receive stockholder approval, and/or we are unable to sell or enter a strategic partnership regarding our ITA business, it is unlikely that we will be able to continue our business operations in the absence of our plan also requires us to receive additional financing from new or current investors. We do not expect such financing to be available on favorable terms, if at all. The accompanying unaudited consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. SALE OF DRM BUSINESS AND ASSETS AND BRIDGE LOAN DRM Asset Sale to ASOC Acquisition Corp., a subsidiary of JMI. We entered into a definitive asset purchase agreement to sell, subject to Shareholder approval, our DRM business and related assets to ASOC Acquisition Corp., a new corporation formed and owned by JMI Equity Fund V, L.P. and JMI Equity Fund V (AI), L.P., or JMI, for $7,000 plus the assumption of certain liabilities related to the DRM business. In connection with the transaction, JMI has provided $1,500 of bridge loans, $600 of which was advanced to us in July 2005, and the remaining $900 was advanced to us in September 2005 following signing of the definitive documents. The bridge loans bear interest at the rate of 7% per annum and are secured by security interests in the assets of our DRM business. We anticipate that the $7,000 of proceeds we will receive upon closing of the Asset Purchase Agreement will be reduced by the $1,530 principal and accrued interest on our bridge loan from JMI. In addition, we expect to use the remaining net proceeds as follows: o the estimated combined balance of $4,725, as of November 30, 2005, of principal and accrued interest that we owe to Laurus will be paid, o anticipated transaction costs of $550 will be paid, and o the $195 balance will be added to working capital. 24 Laurus has agreed to subordinate its right to payment of the note we issued to it, and its security interest in those assets, so that JMI holds a senior secured lien therein to the extent of the first $600 of bridge loans that JMI provides to us. To induce Laurus to subordinate its security interest and to provide all other consents necessary for the transactions with JMI, we agreed that we would pay to Laurus in full in cash all outstanding principal and unpaid interest owed to Laurus simultaneously with the closing of the JMI transaction. This payment will be deemed to be in full satisfaction of all of our obligations to Laurus, and we will not be required to pay to Laurus the prepayment penalty that would have required payment of 120% of the outstanding principal and accrued and unpaid interest owed to Laurus. If bankruptcy proceedings are initiated by or against us prior to the closing of the JMI transaction, then we will again become obligated to pay the prepayment penalty and any other obligations that may arise. We have recently received some inquiries from third parties who have indicated that they may be interested in acquiring the ITA product family business. We would consider selling the ITA product family business if we were offered favorable terms. However, there can be no assurances that a suitable acquirer will be identified and that we could negotiate a favorable price and terms for such transaction. If sales of both the Axeda DRM system business and the ITA product family business are consummated, we would expect to use the proceeds to pay our creditors, including Laurus as described above. To the extent that not all of our obligations to creditors were satisfied, we will likely have to commence proceedings under the Bankruptcy Code, or be forced to enter bankruptcy. FINANCING EVENTS AND AMENDMENTS Bridge Loan from JMI In connection with the DRM Asset Sale, JMI has provided $1,500 of bridge loans, $600 of which was advanced to us in July 2005, and the remaining $900 was advanced to us in September 2005 following signing of the definitive documents. The bridge loans bear interest at the rate of 7% per annum and are secured by security interests in the assets of our DRM business. It is anticipated that the JMI Bridge Loans and accrued interest will be paid to JMI out of the DRM sales proceeds at the Closing. Laurus Note Payable On October 5, 2004, we issued to Laurus, a secured convertible term note, or the Note, in the principal amount of $4,500 and received net proceeds of $3,910. The Note is convertible into shares of our common stock at an initial fixed conversion price of $0.48 per share. The Note has a term of three years and accrues interest at the prime rate plus 2% per year (8.75% as of September 30, 2005). On February 16, 2005, we amended the securities purchase agreement with Laurus such that any liquidated damages that may arise for failure to deliver shares of common stock upon conversion of Laurus' Note in a timely manner, would be payable in a warrant to purchase unregistered shares of common stock rather than cash and we would be obligated to use our best efforts to subsequently register the underlying shares. We also amended the registration rights agreement with Laurus such that any liquidated damages that may arise for failure to file a registration statement for any shares that may be issued to Laurus in the future, to cause such registration statement to become effective, to maintain the effectiveness of such registration statement or to keep our common stock listed or quoted would be payable in a warrant to purchase unregistered shares of common stock rather than cash and we would be obligated to use our best efforts to subsequently register the underlying shares. On May 4, 2005, we amended the Note issued to Laurus and several related agreements for the primary purpose of amending some of the due dates for the repayment of principal. Specifically, the principal payments due in May and June 2005, of $150 each which had to be paid in cash because our common stock price was below the level in the Laurus agreements that would have permitted payment of the Laurus Note principal and interest in common stock. The May and June payments were postponed until September and October 2007, respectively. In exchange for these amendments, we issued to Laurus a warrant to purchase 750,000 shares of our common stock at an exercise price of $0.37 per share and with a term of five years. As of July 1, 2005, we are in default under the Note for failing to pay interest due under the Note for June July, August and September 2005, as well as the July, August and September 2005 principal payments when due. In a Letter Agreement dated July 8, 2005 between Axeda Systems Inc. and Laurus, Laurus agreed to accept payment in full in cash of the outstanding principal and accrued and unpaid interest simultaneously with the closing of the DRM Asset Sale, in full satisfaction of our obligations. 25 However, in the event bankruptcy proceedings are initiated by or against us prior to the closing of the DRM asset sale with ASOC Acquisition Corp, the applicable default penalties would resume. Article IV of the Note defines "Events of Default" as the failure to pay any installment of principal or interest within three days of the due date, and that upon the occurrence and continuance of an Event of Default, Laurus may make all sums of principal, interest and other fees then remaining unpaid immediately due and payable. In the event of such an acceleration, the amount due and owing to Laurus shall be one hundred twenty percent (120%) of the outstanding principal amount, plus accrued and unpaid interest and fees. In addition, the Laurus registration rights agreement entered into in connection with the Note states that if our shares are not traded on a "Trading Market", which does not include the "Pink Sheets", where our shares of common stock currently trade, then Axeda is obligated to issue certain warrants to Laurus, and our failure to do so also constitutes a default under the Note. SSF On September 23, 2003, we issued 4,918,100 shares of our common stock to SSF in a private placement of our common stock. The shares were sold at $1.22 per share with net proceeds of $5,597. On February 16, 2005, we amended the registration rights agreement with SSF such that any liquidated damages that may arise for failure to file a registration statement for any shares that may be issued to SSF in the future, to cause such registration statement to become effective or to maintain the effectiveness of such registration statement would be payable in unregistered shares of common stock rather than cash and we would be obligated to use our best efforts to subsequently register the shares. 26 RISK FACTORS THAT MAY AFFECT FUTURE RESULTS Investing in our common stock involves a high degree of risk. In addition to the other information in this Quarterly Report on Form 10-Q and the information incorporated by reference herein, you should carefully consider the risks described below before purchasing our common stock. If any of the following risks occur, our business could be materially harmed, and our financial condition and results of operations could be materially and adversely affected. As a result, the price of our common stock could decline, and you could lose all or part of your investment. DRM ASSET SALE RISK FACTORS You should carefully consider the following risk factors relating to the DRM Asset Sale before deciding to invest in our stock. You should also carefully consider the additional information in the Definitive Proxy Statement filed on October 31, 2005, and the additional information in our other reports on file with the Securities and Exchange Commission including the December 31, 2004 Annual Report filed on SEC Form 10-K filed on April 12, 2005, which are incorporated herein in their entirety. WE MAY SELL SUBSTANTIALLY ALL OF THE ASSETS OF OUR BUSINESS. IF WE DO SO, THERE IS NO ASSURANCE THAT STOCKHOLDERS WOULD RECEIVE ANY OF THE PROCEEDS FROM THE SALE OF OUR ASSETS. The assets involved in the proposed sale of the DRM business to ASOC Acquisition Corp. accounted for approximately 50% of our total revenues in 2003, 49% in 2004 and 59% in the first six months of 2005. Following completion of the sale of our DRM business and assets, if it occurs, we will no longer have the revenue stream generated by those assets. We have recently received some inquiries from third parties who have indicated that they may be interested in acquiring the industrial automation products manufacturing and distribution business through which we market our "Wizcon/Supervisor" product family. We may consider selling the Supervisor products family business if we are offered terms that we view to be favorable. However, there can be no assurances that a suitable acquirer will be identified or that we could negotiate a favorable price and terms for such transaction. Even if we succeed in selling substantially all of our assets, there is no assurance that after the necessary payments to creditors, there would be sufficient funds remaining for distribution to stockholders or that we may not file for or be forced into bankruptcy. THERE ARE NO ASSURANCES THAT THE SALE OF THE DRM BUSINESS AND ASSETS WILL BE COMPLETED. ASOC Acquisition Corp. will not be obligated to complete the sale of the DRM business and assets unless all conditions to ASOC Acquisition Corp.'s obligations are satisfied or waived, including our obligation to assign various contracts and agreements to ASOC Acquisition Corp. and the requirement that our stockholders approve the transaction. There can be no assurance that all of such conditions will be satisfied or waived and that we will receive such stockholder approval. IN THE EVENT THAT THE SALE OF THE DRM BUSINESS IS NOT CONSUMMATED, IT IS LIKELY THAT JMI AND/OR LAURUS WILL FORECLOSE ON SUBSTANTIALLY ALL OF OUR ASSETS, OR THAT WE WILL COMMENCE PROCEEDINGS UNDER THE BANKRUPTCY CODE. Laurus has made a $4,500,000 loan to us. JMI has provided $1,500,000 of Bridge Loans to us. To secure the payment of all obligations owed by us to Laurus, we granted to Laurus a security interest in, and lien upon, all of our assets and the assets of some of our U.S. subsidiaries and we pledged the stock of some of our U.S. subsidiaries to Laurus. To secure the payment of all obligations owed by us to JMI, we granted to JMI a security interest in, and lien upon, substantially all of the assets employed in the DRM business. The JMI Bridge Loans will become due and payable at the time of closing of the asset sale, upon the occurrence of an event of default or termination of the Asset Purchase Agreement for any reason or on December 15, 2005, whichever occurs first. To the extent we are unable to repay the Bridge Loans at such time, we may be subject to foreclosure by JMI on substantially all of the assets of Axeda and certain of its subsidiaries related to the DRM business. In addition, to induce Laurus to subordinate its security interest and to provide all other consents necessary for the transactions with JMI, we agreed that we would pay to Laurus in full in cash all outstanding principal and accrued and unpaid interest owed to Laurus simultaneously with the closing of the JMI transaction. This payment will be deemed to be in full satisfaction of all of our obligations to Laurus, and we will not be required to pay to Laurus the prepayment penalty that would have required payment of 120% of the outstanding principal and accrued and unpaid interest owed to Laurus. If bankruptcy proceedings are initiated by or against us prior to the closing of the JMI transaction, then we will again become obligated to pay the prepayment penalty in accordance with the terms of the Laurus debt and any other obligations that may arise. In the event that the Asset Purchase Agreement is terminated, our indebtedness to JMI and Laurus in the aggregate principal amount of approximately $6 million plus interest will then become due and payable. If that occurs, it is unlikely that we will be able 27 to pay that indebtedness. If either or both of Laurus and JMI commence to foreclose on their respective liens, such actions would substantially and materially adversely affect our financial condition and our ability to remain in business. If the sale of the DRM business is not consummated, and even if it is, but we are unable to sell or find a strategic buyer for the ITA business on favorable terms, it is very likely that we will have to commence proceedings under the Bankruptcy Code. FOLLOWING THE SALE OF THE DRM BUSINESS AND ASSETS, WE MAY NEED ADDITIONAL CAPITAL TO FUND OUR OPERATIONS AND TO REPAY CREDITORS. If we cannot obtain this capital, when and if needed, we will have to significantly curtail our operations and our ability to continue as a going concern may be jeopardized. The net proceeds from the sale of the DRM business and assets will enable us to pay all sums due and owing to Laurus, but will not be sufficient to pay what we owe to our other creditors. Laurus has agreed to subordinate its right to payment of the note we issued to it and its security interest in substantially all of the assets of Axeda and certain of its subsidiaries related to the DRM business, so that JMI holds a senior secured lien on the assets related to the DRM business to the extent of $600,000 of the JMI Bridge Loans, and it holds a secured lien that is pari passu with Laurus' security interest to the extent of the $900,000 balance of the JMI Bridge Loans. To induce Laurus to subordinate its security interest and to provide all other consents necessary for the consummation of the transactions contemplated by the Asset Purchase Agreement, we agreed that we would pay to Laurus in full in cash all outstanding principal and accrued and unpaid interest owed to Laurus simultaneously with the closing of the JMI transaction. This payment will be deemed to be in full satisfaction of all of our obligations to Laurus, and we will not be required to pay to Laurus the prepayment penalty that would have required payment of 120% of the outstanding principal, plus accrued and unpaid interest. If bankruptcy proceedings are initiated by or against us prior to the closing of the Asset Purchase Agreement, then we will again become obligated to pay the prepayment penalty and any other obligations that may arise. Even if the sale of the DRM business and assets is completed, we may require additional capital to fund our operations and repay unsecured creditors. If we require additional capital, we will need to seek external debt or equity financing and/or sell the Supervisor products family business assets following the completion of the sale of the DRM business and assets. In light of our financial condition, sources of funds or other financing may not be available for us in the future or may not be available in amounts we require to operate our business. Finally, we may be unable to obtain financing on terms acceptable to us, if at all. Our failure to obtain capital to finance our working capital needs and pay our obligations to unsecured creditors in adequate amounts and on acceptable terms will negatively impact our business, financial condition and liquidity and we may be forced to dispose of assets or take other actions on disadvantageous terms, which could result in losses and could have a material adverse effect on our financial condition and results of operations. THE FAILURE TO COMPLETE THE ASSET SALE MAY RESULT IN A DECREASE IN THE MARKET VALUE OF OUR COMMON STOCK. The asset sale is subject to a number of contingencies, including approval by our stockholders and other customary closing conditions. We cannot predict whether we will succeed in obtaining the approval of our stockholders. As a result, we cannot assure you that the asset sale will be completed. If our stockholders fail to approve the proposal at the special meeting or if the asset sale is not completed for any other reason, the market price of our common stock may decline. If our stockholders do not approve and adopt the asset sale pursuant to the Asset Purchase Agreement, there may not be any other offers from potential acquirers. If our stockholders do not approve the asset sale, we may seek another strategic transaction, including the sale of all or part of our business. Although we have had such discussions with various parties in the past, none of these parties may now have an interest in a strategic transaction with Axeda or be willing to offer a reasonable purchase price. IF OUR STOCKHOLDERS DO NOT APPROVE THE DRM ASSET SALE OR IF WE DO NOT COMPLETE THE ASSET SALE WE WILL CONTINUE TO FACE CHALLENGES AND UNCERTAINTIES IN OUR ABILITY TO ACHIEVE BUSINESS SUCCESS. 28 We have faced challenges and uncertainties surrounding our ability to successfully execute our business plan, such as our history of operating losses, increasing competition from custom software development by in-house developers and others, the expense of research and development, our reliance on a small number of large customers, a limited number of indirect distribution channels and litigation and claims regarding our intellectual property rights. IF OUR STOCKHOLDERS DO APPROVE AND ADOPT THE ASSET PURCHASE AGREEMENT WE WILL BE UNABLE TO COMPETE WITH THE DRM BUSINESS. We will be unable to compete with the DRM business for five years from the date of the closing. We have agreed for a period of five years from the date of the closing of the asset sale (i) not to solicit or otherwise communicate with any customer of the DRM business for the purpose of inducing such customer to refrain from or to discontinue its relationship with ASOC Acquisition Corp.; and (ii) not to compete with the DRM business. IF THE DRM ASSET SALE IS NOT COMPLETED, WE MAY NOT HAVE SUFFICIENT FUNDS TO REPAY OUR OBLIGATIONS TO LAURUS WHEN THEY BECOME DUE. Because our common stock is currently trading below $0.53 per share, we are not able to use shares of our common stock to repay the principal and interest on the note held by Laurus. In May 2005, we amended the note and several related agreements for the primary purpose of having Laurus postpone our repayment of principal due in May 2005 and June 2005. These principal repayments are payable in September 2007 and October 2007, respectively. If the JMI Asset Sale is not completed, we would be required to obtain the funds necessary to repay our obligations to Laurus or JMI either through refinancing, the issuance of additional equity or debt securities or the sale of assets. We do not believe we would be able to obtain the funds needed to repay those obligations from any one or more of these sources on favorable economic terms or at all. If the DRM Asset Sale is not completed and we are unable to obtain funds to repay this indebtedness, we may be forced to dispose of assets or take other actions on disadvantageous terms, which could result in losses and could have a material adverse effect on our financial condition and results of operations. IF THE DRM ASSET SALE IS NOT ENTERED INTO OR COMPLETED, THE TERMS OF OUR DEBT OBLIGATIONS TO LAURUS AND TO JMI SUBJECT US TO THE RISK OF FORECLOSURE ON SUBSTANTIALLY ALL OF OUR ASSETS. To secure the payment of all obligations owed to Laurusand to JMI, we have granted security interests to each of them in substantially all of our property and assets. Because we are in default under the Laurus obligations, which, under the Note are heightened and accelerated, and because we would be unable, in all likelihood, to repay our indebtedness to JMI and to Laurus if the JMI Asset Sale is not completed, Laurus and JMI could subject us to foreclosure on substantially all of our assets to the extent necessary to repay any amounts due. Any defaults and resulting foreclosures would have a material adverse effect on our financial condition. As of July 1, 2005, we are in default under the Laurus Secured Convertible Term Note, or Note, issued to Laurus Master Fund, Ltd, or Laurus, for failing to pay interest due under the Note for June, July, August, and September 2005, as well as the July, August and September 2005 principal payments when due. Article IV of the Note defines "Events of Default" as the failure to pay any installment of principal or interest within three days of the due date, and that upon the occurrence and continuance of an Event of Default, Laurus may make all sums of principal, interest and other fees then remaining unpaid immediately due and payable. In the event of such an acceleration, the amount due and owing to Laurus shall be one hundred twenty percent (120%) of the outstanding principal amount, plus accrued and unpaid interest and fees. In addition, the registration rights agreement entered into in connection with the Note states that if our shares are not traded on a "Trading Market", which does not include the "Pink Sheets", where our shares of common stock currently trade, then Axeda is obligated to issue certain warrants to Laurus, and our failure to do so also constitutes a default under the Note. In a Letter Agreement dated July 8, 2005 between Axeda Systems Inc. and Laurus, Laurus agreed to accept payment in full in cash of the outstanding principal and accrued and unpaid interest simultaneously with the closing of the JMI Asset Sale, in full satisfaction of our obligations (see discussion included herein at Part I, Item 2- Management's Discussion and Analysis of Financial Condition and Results of Operations). However, in the event bankruptcy proceedings are initiated by or against us prior to the closing of the JMI Asset Sale, the default penalties described above would resume. 29 OUR COMMON STOCK WAS DELISTED FROM THE NASDAQ SMALLCAP MARKET, WHICH COULD RESULT IN LOSS OF INVESTORS, LIMITED LIQUIDITY AND CONTRACTUAL PENALTIES. On July 7, 2005, our common stock was delisted from The Nasdaq SmallCap Market because we failed to achieve a $1.00 minimum bid price by June 30, 2005 as required by the terms of an exception we had previously received that allowed our continuous trading on The Nasdaq SmallCap Market. The quotations for our common stock now appear in the "Pink Sheets." There is currently a limited trading market for our common stock on the Pink Sheets. The ability to trade our common stock on the Pink Sheets depends on the presence and investment decisions of willing buyers and sellers. Therefore, the number of investors who are willing to purchase our common stock is limited, the volume of our common stock traded on a daily basis is low, and the liquidity of our common stock is limited. There can be no guarantee that our common stock will be accepted for quotation by any other quotation system, market or exchange. Prices for securities traded solely on the Pink Sheets may be difficult to obtain. As such, our stock has very limited liquidity and marketability. This very limited liquidity, marketability, the reduced public access to quotations for our common stock and lack of a regular trading market for our stock are factors that have contributed to the depression of the market price per share of our common stock. If our common stock is not listed on any quotation system, market or exchange, we could incur penalties under certain agreements to which we are a party, including under the terms of our agreements relating to the convertible promissory notes and warrants we issued to Laurus on October 5, 2004 which provide for penalties if our stock is not listed for more than three consecutive trading days. WE HAVE NEVER BEEN PROFITABLE AND MAY NEVER ACHIEVE PROFITABILITY IN THE FUTURE. We had a net loss of approximately $3,379 for the nine months ended September 30, 2005. To date, we have not achieved operating profitability on an annual basis and have an accumulated deficit of $149,471 as of September 30, 2005. We have invested significant resources in product development, selling and marketing, services and support, and administrative expenses. To achieve profitability, we will need to increase revenues and/or reduce expenses significantly. We cannot assure you that our revenues will grow or that we will achieve or maintain profitability in the future. AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, OUR FUTURE SUCCESS DEPENDS UPON THE ACCEPTANCE OF OUR SOLUTIONS. Our future growth will be driven by sales of our products and related services. If the market for our products fails to grow or grows more slowly than we anticipate, our business will suffer. AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY. Competition in the market for our solutions is emerging and expected to continue to grow stronger. We expect that competition will increase in the near term and that our primary long-term competitors may not yet have entered the market. Our future competitors may have significantly more personnel or greater financial, technical, marketing and other resources than either our current competitors or we do. Also, due to our present financial condition, customers and current and potential partners may decide not to conduct business with us or may reduce or terminate the business they conduct with us. Furthermore, our future competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements than we can. Also, future competitors may have greater name recognition and more extensive customer bases that they can leverage. Increased competition could result in price reductions, fewer customer orders, reduced gross profit margins and loss of market share, any of which could have a material adverse effect on our business. AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, WE MAY NOT BE ABLE TO KEEP PACE WITH TECHNOLOGICAL ADVANCES. The process of remotely obtaining and managing information from intelligent devices will likely be characterized by rapid technological change, frequent new product introductions and emerging industry standards. We also expect that the rapid evolution of Internet-based applications and standards, as well as general technology trends such as changes in or introductions of operating systems, will require us to adapt our products to remain competitive. Our products could become obsolete and unmarketable if we are unable to quickly adapt to new technologies or standards. To be successful, we will need to develop and introduce new products and product enhancements that respond to technological changes, evolving industry standards and other market changes and developments in a timely manner and on a cost-effective basis. We cannot assure you that we will develop new products and product enhancements successfully or that our products will achieve broad market acceptance. Our failure to respond in a timely and cost-effective manner to new and evolving technologies and other market changes and developments could have a material adverse effect on our business. 30 AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, THE SALES CYCLE FOR OUR PRODUCTS IS LONG AND MAY BE CYCLICAL AND WE TYPICALLY RELY ON LARGE CONTRACTS FROM RELATIVELY FEW CUSTOMERS, WHICH MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE. Our sales cycle is lengthy and may be subject to business cycles. Our product sales typically involve significant capital investment decisions by prospective customers, as well as a significant amount of time to educate them as to the benefits of our products. As a result, companies spend a substantial amount of time performing internal reviews and obtaining capital expenditure approvals before purchasing our products. It may take up to nine to twelve months or more from the time we first contact a prospective customer before receiving an initial order. The length of our product sales cycle may also depend on a number of additional factors, including but not limited to the following: o the complexities of the problems our solutions address; o the breadth of the solution required by the customer, including the technical, organizational and geographic scope of the license; o the sales channel through which the solution is sold; o the economic conditions in the United States and abroad; and o any other delays arising from factors beyond our control. AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, IT MAY BE DIFFICULT, TIME-CONSUMING AND EXPENSIVE FOR OUR CUSTOMERS TO INTEGRATE OUR SOLUTIONS WITH THEIR PRODUCTS, AND THEY MAY BE UNABLE TO DEPLOY THEIR PRODUCTS SUCCESSFULLY OR OTHERWISE ACHIEVE THE BENEFITS ATTRIBUTABLE TO OUR SOLUTIONS. Our customers often desire to integrate our solutions with their existing products, computer systems and software programs. This can be complex, time-consuming and expensive, and may cause delays in the deployment of our customers' products. As a result, some customers may have difficulty or be unable to integrate our products successfully or otherwise achieve the benefits attributable to our products. Delayed or ineffective integration of our solutions may limit our ability to expand our revenues, and may result in customer dissatisfaction, causing harm to our reputation. AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, OUR GROWTH WILL BE LIMITED IF WE ARE UNABLE TO EXPAND OUR INDIRECT DISTRIBUTION SALES CHANNELS. We currently have relationships with only a limited number of indirect distribution channels, consisting of relationships with independent software vendors, software distributors and system integrators. Nevertheless, we have derived, and, to the extent that we retain assets, we anticipate that we will continue to derive, a significant portion of our revenues from these relationships. Our future growth will be limited if: o we fail to work effectively with indirect distribution channels; o we fail to increase the number of indirect distribution channels with which we have relationships; o the business of one or more of our indirect distribution channels fails; o there is a decrease in the willingness and ability of our indirect distribution channels to devote sufficient resources and efforts to marketing and supporting our products. If any of these circumstances occurs, we will have to devote substantially more resources to the sales, marketing, distribution, implementation and support of our products than we otherwise would, and our own efforts may not be as effective as those of our indirect distribution channels. AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, INCREASED SALES THROUGH INDIRECT CHANNELS MAY ADVERSELY AFFECT OUR OPERATING PERFORMANCE. Even if our marketing efforts through indirect channels are successful and result in increased sales, our average selling prices and operating margins could be adversely affected because of the lower unit prices that we may receive when selling through indirect channels. AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, WE MAY DEPEND ON OUR STRATEGIC PARTNERS AND OTHER THIRD PARTIES FOR SALES AND IMPLEMENTATION OF OUR PRODUCTS. IF WE FAIL TO DERIVE BENEFITS FROM OUR EXISTING AND FUTURE STRATEGIC RELATIONSHIPS, OUR BUSINESS WILL SUFFER. 31 From time to time, we have collaborated with other companies in areas such as marketing, distribution or implementation. Maintaining these and other relationships is a meaningful part of our business strategy. However, some of our current and potential strategic partners are either actual or potential competitors, which may impair the viability of these relationships. In addition, some of our relationships have failed to meet expectations and may fail to meet expectations in the future. A failure by us to maintain existing strategic relationships or enter into successful new strategic relationships in the future could seriously harm our business, operating results and financial condition. AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, OUR BUSINESS MODEL DEPENDS UPON LICENSING OUR INTELLECTUAL PROPERTY, AND IF WE FAIL OR ARE UNABLE TO PROTECT OUR PROPRIETARY RIGHTS, OUR BUSINESS COULD BE HARMED. Our ability to compete depends substantially upon our internally developed technology. We have a program for securing and protecting rights in patentable inventions, trademarks, trade secrets and copyrightable materials. However, there can be no assurance that we have taken or will take all necessary steps to protect our intellectual property rights. Our present financial condition may make it more difficult for us to fully enforce our intellectual property rights. If we are not successful in protecting our intellectual property, our business could be substantially harmed. We regard the protection of patentable inventions as being important to our business. It is possible that our pending patent applications may not result in the issuance of patents or that our patents may not be broad enough to protect our proprietary rights. We rely on a combination of laws, such as patent, copyright, trademark and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights. Despite any precautions which we have taken: o laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or deter others from developing similar technologies; o other companies may claim common law or other trademark rights based upon state or foreign law which precede our registration or use of such marks; o current federal laws that prohibit software copying provide only limited protection from software pirates, and effective trademark, copyright and trade secret protection may be unavailable or limited in certain foreign countries; o policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we are unable to determine the extent to which piracy of our products and trademarks may occur, particularly overseas; o certain of our products are licensed under shrink-wrap license agreements that are not signed by licensees and therefore may not be binding under the laws of certain jurisdictions; and o tamper-resistant copy protection codes and security buttons may not be successful in preventing unauthorized use of our software. The laws of other countries in which we market our products might offer little or no effective protection of our proprietary technology. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it, which could significantly harm our business. Any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in the loss of some of our competitive advantage and a decrease in our revenues. Infringement claims and lawsuits, such as the complaint we filed on June 30, 2004 against one of our competitors for infringement of our recently issued patent entitled "Reporting the State of an Apparatus to a Remote Computer," and the patent infringement lawsuit filed in November 2004 against us by one of our competitors charging us with infringement of U.S. Patent No. 6,377,162. See the Questra paragraphs in the commitments and contingencies section below as these lawsuits have been resolved and dropped by both parties. AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS AND REDUCED SALES BECAUSE OF DEFECTS IN OUR PRODUCTS. 32 Our products are very complex and may contain undetected errors that could harm our reputation, result in product liability or decrease market acceptance of our products. The likelihood of errors is higher when a new product is introduced or when new versions or enhancements are released. Our products are integrated with our customers' networks and software applications. Errors may also arise as a result of defects in the products and systems into which our products are incorporated. We are unable to test our products in each of the applications in which they are designed to work. It is possible that defects could cause our customers to experience device or application failures. We have an extensive quality assurance process in place and procedures to handle customer complaints and deliver bug fixes. Despite our quality assurance process and that of our customers, defects and errors may be found in new products or in new versions or enhancements of existing products after commercial shipment has begun. We may be required to devote significant financial resources and personnel to correct any defects. Known or unknown errors or defects that affect the operation of our products could result in the following, any of which could harm our business: o delay or loss of revenues; o customers could cancel a contract due to defects; o diversion of development resources; o increased product development costs; o damage to our reputation; o delay or diminished market acceptance of our products; o increased service and warranty costs; o increased litigation costs. Although some of our licenses with customers contain provisions designed to limit our exposure to potential product liability claims, these contractual limitations on liability may not be enforceable. In addition, our product liability insurance may not be adequate to cover our losses in the event of a product liability claim resulting from defects in our products and may not be available to us in the future. WE HAVE UNDERTAKEN A NUMBER OF MEASURES TO REDUCE OUR OPERATING EXPENSES AND THESE AND OTHER EXPENSE REDUCTION MEASURES MAY HAVE NEGATIVE CONSEQUENCES. Beginning in the second quarter of 2002, we initiated a series of steps designed to consolidate and streamline our operations, and decrease our operating losses and corresponding use of cash, including reducing our number of global offices by more than 50%, reducing staffing levels by 53% by eliminating or not replacing 111 employees, engaging partners to provide us with variable staffing capabilities to meet peak demand periods and by closely monitoring our infrastructure costs. Although it is not possible to anticipate all potential effects the implementation of these expense control measures will have on us or our development, these activities have and could continue to have a negative effect on our business and operations. The extent and ramifications of these measures will be dependent upon our ability to raise additional financing, the timing of the receipt of financing and the amount of such financing, if any. We continue to evaluate our cost structure, and continue to take additional measures to reduce expenses. We recorded charges of $1.4 million in 2004 to reduce staffing levels and to continue to consolidate our operations. WE ARE DEPENDENT UPON OUR KEY MANAGEMENT FOR OUR FUTURE SUCCESS, AND FEW OF OUR KEY PERSONNEL ARE OBLIGATED TO STAY WITH US. Our success depends on the efforts and abilities of our senior management and certain other key personnel. Many of our key employees are employed at will. Our business could be harmed if any of these or other key employees left or was seriously injured and unable to work and we were unable to find a qualified replacement. LITIGATION REGARDING INTELLECTUAL PROPERTY RIGHTS EXISTS IN OUR INDUSTRY From time to time, we have received notices of claims of infringement of other parties' proprietary rights and other claims in the ordinary course of our business. We have accrued for estimated losses in the accompanying consolidated financial statements for those matters where we believe the likelihood of an adverse outcome is probable and the amount of the loss is reasonably estimable. The adverse resolution of any one or more of these matters could have a material adverse effect on our business, financial condition or results of operations. Questra Patent Infringement Litigation On June 30, 2004, we announced that we were awarded a patent by the United States Patent and Trademark Office for a key element of our Firewall-Friendly method of communication over the Internet. The patent protects one of our inventions relating to enabling remote "devices" -- machines, appliances, instruments, and computers -- to securely communicate their health and status to enterprise computer systems. On June 30, 2004, we filed a complaint in the United States District Court for the District of Massachusetts against Questra Corporation, one of our competitors, for infringement of this patent. 33 On November 10, 2004, Questra filed a patent infringement lawsuit against us in the United States District Court for the Northern District of California charging us with infringement of U.S. Patent No. 6,377,162 and seeking injunctive relief and unspecified monetary damages. On September 14, 2005 we reached an agreement with Questra to settle all pending patent litigation between Axeda and Questra. Under the terms of the confidential settlement, the parties have agreed, among other things, to cross-license the patents that were involved in the litigation and to dismiss the pending claims with prejudice. The parties have also agreed to a two-year covenant prohibiting the companies from filing against each other any additional patent infringement suits. The parties have agreed to keep the terms of the settlement confidential except to the extent disclosure is required by the securities laws of the United States or any other applicable jurisdiction. AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, OUR BUSINESS IS SUBJECT TO RISKS FROM INTERNATIONAL OPERATIONS SUCH AS LEGAL UNCERTAINTY, TARIFFS AND TRADE BARRIERS AND POLITICAL AND ECONOMIC INSTABILITY. We conduct business in a number of different countries. We sell products in numerous countries outside of the United States, including France, Switzerland, Japan, Germany, the Netherlands and other countries in Europe, Asia and Latin America. Our operations outside the United States include facilities located in France. For the quarter ended September 30, 2005 we derived approximately 42% of our revenues from sales to foreign companies. We anticipate that revenues from international operations will continue to represent a significant portion of our revenues. As a result, we are subject to risks associated with selling and operating in foreign countries. For example, some of our contracts with foreign customers are denominated in foreign currencies. We do not currently hedge against the risk of such transactions and as a result, we face a risk of loss related to possible fluctuations in currency exchange rates. Our geographic diversity requires significant management attention and financial resources in order to develop our international sales, support and distribution channels. We may not be able to maintain international market demand for our products. Our business could be adversely impacted if we are unable to successfully launch our products internationally. Additional risks related to selling and operating in foreign countries include, among others: o legal uncertainty regarding liability; o language barriers in business discussions; o cultural differences in the negotiation of contracts and conflict resolution; o time zone differences; o reduced protection for intellectual property rights in some countries; o differing labor regulations; o tariffs, trade barriers and other regulatory barriers; o problems in collecting accounts receivable; o political and economic instability; o changes in diplomatic and trade relationships; o seasonal reductions in business activity; o potentially adverse tax consequences; o complexity and unexpected changes in local laws and regulations; o greater difficulty in staffing and managing foreign operations; and o increased financial, accounting, and reporting burdens and complexities. WE ARE SUBJECT TO CONDITIONS ATTACHED TO GOVERNMENTAL GRANTS WE RECEIVED IN ISRAEL. Prior to being acquired by us in December 2001, eMation received grants in Israel from the Office of the Chief Scientist of Israel's Ministry of Industry and Trade, or OCS, in the aggregate amount of $1,800 to fund the development of our Axeda ITA product. As of September 30, 2005 we have paid royalties to the OCS in the aggregate amount of $1,800. As of September 30, 2005, the remaining $200 of principal liability is accrued in accrued expenses. We are obligated to pay royalties of 3.0% to 3.5% of revenues derived from sales of products funded through grants received from the OCS, up to a maximum of the total amount of the grants received. The terms of the OCS grants require that we manufacture our products that are developed with such grants in Israel. In addition, we may not transfer the technology developed pursuant to the terms of these grants to third parties without the prior approval of a governmental committee. Additionally, prior to being acquired by us in December 2001, eMation received grants from the Israeli Government through the Fund for the Encouragement of Marketing Activities, or Marketing Fund, in the aggregate amount of $1,200 and royalties in the aggregate amount of $600 have been repaid. As of September 30, 2005, $300 is accrued in other current liabilities. BECAUSE OF THEIR SIGNIFICANT STOCK OWNERSHIP, OUR OFFICERS AND DIRECTORS CAN EXERT SIGNIFICANT INFLUENCE OVER OUR FUTURE DIRECTION. Assuming the exercise of all stock options exercisable by them within 60 days of September 30, 2005, our officers and directors would have, in the aggregate, beneficially owned approximately 5.7 million shares, or approximately 17%, of our outstanding common stock. These stockholders, if acting together, would be able to significantly influence all matters requiring approval by our stockholders, including the election of directors, the approval of mergers or other business combination transactions or a sale of all or substantially all of our assets. CERTAIN PROVISIONS IN OUR CERTIFICATE OF INCORPORATION AND BY-LAWS MAKE CHANGES OF CONTROL DIFFICULT EVEN IF THEY WOULD BE BENEFICIAL TO OUR STOCKHOLDERS. Our board of directors has the authority without any further vote or action on the part of our stockholders to issue up to 5 million shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions of the preferred stock. This preferred stock, if it is ever issued, may have preference over and harm the rights of the holders of our common stock. Although the issuance of this preferred stock will provide us with flexibility in connection with possible acquisitions and other corporate purposes, this issuance may make it more difficult for a third party to acquire a majority of our outstanding voting stock. We currently have no plans to issue preferred stock. 34 Our certificate of incorporation and by-laws include provisions that may have the effect of deterring an unsolicited offer to purchase our stock. These provisions, coupled with the provisions of the Delaware General Corporation Law, may delay or impede a merger, tender offer or proxy contest involving us. Furthermore, our board of directors is divided into three classes, only one of which is elected each year. Directors are only capable of being removed by the affirmative vote of 66 (2)/3% or greater of all classes of voting stock. These factors may further delay or prevent a change of control. AS OUR BUSINESS IS CURRENTLY CONDUCTED OR IF WE KEEP ANY OF OUR ASSETS, WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY IN THE INTERNET-RELATED PRODUCTS AND SERVICES MARKET. Our products communicate through public and private networks over the Internet. The success of our products may depend, in part, on our ability to continue developing products that are compatible with the Internet. Critical issues concerning the commercial use of the Internet, including security, privacy, demand, reliability, cost, ease of use, accessibility, quality of service and potential tax or other government regulation, remain unresolved and may affect the use of the Internet as a medium to support the functionality of our products. If these critical issues are not favorably resolved, our business, financial condition or results of operations could be adversely affected. 35 Item 3: Quantitative and Qualitative Disclosures about Market Risk We develop products in the United States and sell such products in North America, Asia and various countries in Europe. We collect a portion of our revenues and pay a portion of our operating expenses in foreign currencies. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Currently, we do not use derivative instruments to hedge our foreign exchange risk, although we may do so in the future. Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in short-term instruments. Due to the nature of our short-term investments, we have concluded that there is no material market risk exposure. Therefore, no quantitative tabular disclosures are required. We are exposed to certain market risks arising from adverse changes in interest rates, primarily due to the potential effect of such changes on the Note held by Laurus, as described under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." We do not use interest rate derivative instruments to manage exposure to interest rate changes. If the interest rate on the Note held by Laurus, which accrues at the prime rate plus 2% per year, were to increase by 1% per year, we would incur additional interest expense of approximately $41,000 in 2005. Item 4: Controls and Procedures Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 as of the end of the period covered by this report, or the Evaluation Date. Based upon the evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the Evaluation Date. Disclosure controls are controls and procedures designed to reasonably ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls include controls and procedures designed to reasonably ensure that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. In connection with this evaluation, our management identified no changes in our internal control over financial reporting that occurred during the most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 36 PART II: OTHER INFORMATION Item 1: Legal Proceedings SECURITIES ALLOCATION CLASS ACTION On November 27, 2001, a putative shareholder class action was filed against us, certain of our officers and directors, and several investment banks that were underwriters of our initial public offering. The action was filed in the United States District Court for the Southern District of New York, purportedly on behalf of investors, who purchased our stock between July 15, 1999 and December 6, 2000. A Consolidated Amended Complaint, which is now the operative complaint, was filed on April 19, 2002. The lawsuit alleges violations of Sections 11 and 15 of the Securities Act of 1933 and Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder against one or both of us and our officers and directors. The claims are based on allegations that the underwriter defendants agreed to allocate stock in our July 15, 1999 initial public offering to certain investors in exchange for excessive and undisclosed commissions and agreements by those investors to make additional purchases in the aftermarket at pre-determined prices. The plaintiffs allege that the prospectus for our initial public offering was false and misleading in violation of the securities laws, because it did not disclose these arrangements. The action seeks damages in an unspecified amount. Similar "IPO allocation" actions have been filed against over 300 other issuers that have had initial public offerings since 1998 and all are included in a single coordinated proceeding in the Southern District of New York. Our board of directors approved a settlement agreement and related agreements which set forth the terms of a settlement among us, our officers and directors, the plaintiff class, the vast majority of the other approximately 300 issuer defendants and the individual defendants currently or formerly associated with these companies. Among other provisions, the settlement agreement provides for a release of us and our officers and directors for the conduct alleged in the action to be wrongful. We would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims we may have against the underwriters. The settlement agreement also provides a guaranteed recovery of $1 billion to plaintiffs for the cases relating to all of the approximately 300 issuers. To the extent that the underwriter defendants settle all of the cases for at least $1 billion, no payment will be required under the issuers' settlement agreement. To the extent that the underwriter defendants settle for less than $1 billion, the issuers are required to make up the difference. It is anticipated that any potential financial obligation we have to plaintiffs pursuant to the terms of the settlement agreement and related agreements will be covered by existing insurance. We currently are not aware of any material limitations on the expected recovery of any potential financial obligation to plaintiffs from our insurance carriers. Our carriers appear solvent, and we are not aware of any uncertainties as to the legal sufficiency of an insurance claim with respect to any recovery by plaintiffs. Therefore, we do not expect that the settlement will involve any payment by us. If material limitations on the expected recovery of any potential financial obligation to the plaintiffs from our insurance carriers should arise, our maximum financial obligation to the plaintiffs pursuant to the settlement agreement would be less than $3.4 million. On February 15, 2005, the Court granted preliminary approval of the settlement agreement, subject to certain modifications consistent with its opinion. Those modifications have been made and the issuers and the plaintiffs have submitted to the Court a revised settlement agreement for approval. There is no assurance that the Court will grant final approval to the settlement. If the settlement agreement currently before the Court, as revised in accordance with the preliminary approval order, is accepted by the Court, then we anticipate that any potential financial obligation we may have to the plaintiffs pursuant to the terms of the settlement agreement and related agreements will be covered by existing insurance. If the settlement agreement is not approved and we are found liable, we are unable to estimate or predict the potential damages that might be awarded, whether such damages would be greater than the Company's insurance coverage, and whether such damages would have a material impact on our results of operations or financial condition in any future period. If the settlement does not occur, and litigation against us continues, we believe we have meritorious defenses and intend to defend the case vigorously. 37 Questra Patent Infringement Litigation On June 30, 2004, we announced that we were awarded a patent by the United States Patent and Trademark Office for a key element of our Firewall-Friendly method of communication over the Internet. The patent protects one of our inventions relating to enabling remote "devices" -- machines, appliances, instruments, and computers -- to securely communicate their health and status to enterprise computer systems. On June 30, 2004, we filed a complaint in the United States District Court for the District of Massachusetts against Questra Corporation, one of our competitors, for infringement of this patent. On November 10, 2004, Questra filed a patent infringement lawsuit against us in the United States District Court for the Northern District of California charging us with infringement of U.S. Patent No. 6,377,162 and seeking injunctive relief and unspecified monetary damages. On September 14, 2005 we reached an agreement with Questra to settle all pending patent litigation between Axeda and Questra. Under the terms of the confidential settlement, the parties have agreed, among other things, to cross-license the patents that were involved in the litigation and to dismiss the pending claims with prejudice. The parties have also agreed to a two-year covenant prohibiting the companies from filing against each other any additional patent infringement suits. The parties have agreed to keep the terms of the settlement confidential except to the extent disclosure is required by the securities laws of the United States or any other applicable jurisdiction. OTHER From time to time, we have received notices of claims of infringement of other parties' proprietary rights and other claims in the ordinary course of our business. See "Factors That May Affect Future Results - Risk Factors - We have received notices of claims related to our PC products (or digital media products) regarding the alleged infringement of third parties' intellectual property rights that may cause us to pay damages." 38 Item 2: Unregistered Sales of Equity Securities and Use of Proceeds None. Item 3: Defaults Upon Senior Securities Since July 1, 2005, we have been in default under the Laurus Secured Convertible Term Note, or Note, issued to Laurus Master Fund, Ltd, or Laurus, for failing to pay when due interest under the Note for June, July, August and September 2005, as well as the July, August and September 2005 principal payments. Article IV of the Note defines "Events of Default" as the failure to pay any installment of principal or interest within three days of the due date, and that upon the occurrence and continuance of an Event of Default, Laurus may make all sums of principal, interest and other fees then remaining unpaid immediately due and payable. In the event of such an acceleration, the amount due and owing to Laurus shall be one hundred twenty percent (120%) of the outstanding principal amount, plus accrued and unpaid interest and fees. In addition, the registration rights agreement entered into in connection with the Note states that if our shares are not traded on a "Trading Market", which does not include the "Pink Sheets", where our shares of common stock currently trade, then Axeda is obligated to issue certain warrants to Laurus, and our failure to do so also constitutes a default under the Note. In a Letter Agreement dated July 8, 2005 between Axeda Systems Inc. and Laurus, Laurus agreed to accept payment in full in cash of the outstanding principal and accrued and unpaid interest simultaneously with the closing of the JMI Asset Sale, in full satisfaction of our obligations (see discussion included herein at Part I, Item 2- Management's Discussion and Analysis of Financial Condition and Results of Operations). However, in the event bankruptcy proceedings are initiated by or against us prior to the closing of the JMI Asset Sale, the default penalties described above would resume. Item 4: Submission of Matters To a Vote of Security Holders The DRM Asset Sale cannot be completed unless, among other things, stockholders holding a majority of the outstanding shares of our common stock approve and adopt the transactions contemplated by the Asset Purchase Agreement. Therefore, a special meeting of stockholders of Axeda Systems Inc. will be held at The Holiday Inn, 31 Hampshire Street, Mansfield, MA 02048, on December 2, 2005 at 11:00 a.m., local time. Stockholders will be asked to approve and adopt the sale of substantially all of the assets, including technology, patents and other intellectual property, relating to our device relationship management, or DRM, business to ASOC Acquisition Corp. pursuant to the Asset Purchase Agreement dated as of September 1, 2005 by and among Axeda Systems Inc., Axeda Systems Operating Company, Inc., Axeda IP, Inc. and ASOC Acquisition Corp. More information about the DRM Asset Sale is contained in the Definitive Proxy Statement filed with the SEC on October 31, 2005, which we encourage you to read in its entirety. A copy of the Asset Purchase Agreement is attached as Annex A to the Definitive Proxy Statement. In addition, stockholders will be asked to approve an amendment to our certificate of incorporation to change the name of the company from Axeda Systems Inc. to ITA Holdings, Inc., which is also a requirement of the DRM Asset Purchase Agreement. Item 5: Other Information Not applicable. Item 6: Exhibits The exhibits listed on the Exhibit Index (following the Signatures section of this quarterly report) are included, or incorporated by reference, in this quarterly report. 39 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. November 21, 2005 Axeda Systems Inc. /s/ Robert M. Russell Jr. ---------------------------- Robert M. Russell Jr. Chairman of the Board and Chief Executive Officer /s/ Karen F. Kupferberg ----------------- Karen F. Kupferberg Executive Vice President, Chief Financial Officer and Treasurer 40 EXHIBIT INDEX Pursuant to Item 601(a)(2) of Regulation S-K, this Exhibit Index immediately precedes the exhibits. The following exhibits are included, or incorporated by reference, in this Quarterly Report on Form 10-Q (and are numbered in accordance with Item 601 of Regulation S-K): Exhibit Number Exhibit Title -------------- ------------- 3.1 Amended and Restated Certificate of Incorporation, as amended. (1) 3.2 Bylaws of Axeda Systems Inc., as amended by the Board of Directors on February 22, 2002. (2) 4.1 Agreement, dated as of May 4, 2005, by and between Axeda Systems Inc. and Laurus Master Fund, Ltd. (3) 4.2 Common Stock Purchase Warrant, dated as of May 4, 2005, issued by Axeda Systems Inc. to Laurus Master Fund, Ltd. (3) 10.1 Letter of Intent dated June 29, 2005 between Axeda Systems, Inc. and JMI Equity Fund V, L.P. (4) 10.2 Senior Secured Bridge Note Purchase Agreement dated as of July 8, 2005 by and among Axeda Systems Inc., Axeda Systems Operating Company, Inc., JMI Equity Fund V, L.P. and JMI Equity Fund V (AI), L.P. (4) 10.3 Security Agreement dated as of July 8, 2005 by and among Axeda Systems Inc., Axeda Systems Operating Company, Inc. JMI Equity Fund V, L.P., and JMI Equity Fund V (AI), L.P. (4) 10.4 Subsidiary Guaranty dated July 8, 2005 granted by Axeda Systems Operating Company, Inc. in favor of JMI Equity Fund V, L.P., and JMI Equity Fund V (AI), L.P. (4) 10.5 Grant of Security Interest in Patents and Trademarks dated as of July 8, 2005 made by Axeda Systems Inc., Axeda Systems Operating Company, Inc. and Axeda IP, Inc. to JMI Equity Fund V, L.P. and JMI Equity Fund V (AI), L.P. (4) 10.6 Amendment No. 1 to Security Agreement entered into and effective as of July 13, 2005 by and among Axeda Systems Inc., Axeda Systems Operating Company, Inc., Axeda IP, Inc., JMI Equity Fund V, L.P. and JMI Equity Fund V (AI), L.P. (4) 10.7 Amendment No. 1 to Subsidiary Guaranty entered into and effective as of July 13, 2005 by and among Axeda Systems Operating Company, Inc., Axeda IP, Inc., JMI Equity Fund V, L.P. and JMI Equity Fund V (AI), L.P.(4) 10.8 Subordination Agreement dated as of July 8, 2005 by and among Axeda Systems Inc., JMI Equity Fund V, L.P., and JMI Equity Fund V (AI), L.P. and Laurus Master Fund, Ltd. (4) 10.9 Letter Agreement dated July 8, 2005 between Axeda Systems Inc. and Laurus Master Fund, Ltd. (5) 10.10 Asset Purchase Agreement dated as of September 1, 2005 among Axeda Systems, Inc., Axeda Systems Operating Company, Inc., Axeda IP, Inc. and ASOC Acquisition Corp. (7) 10.11 Form of Voting Agreement dated September 1, 2005 and executed by ASOC Acquisition Corp. with each of the following stockholders: David Bennett, Paul Vais, Karen Kupfererg, James Hansen, Robert M. Russell, Jr., Richard MacKeen and Dale Calder. (7) 10.12 Senior Subordinated Secured Bridge Note Purchase Agreement dated as of September 1, 2005 by and among Axeda Systems Inc., Axeda Systems Operating Company, Inc., Axeda IP, Inc., JMI Equity Fund V, L.P. and JMI Equity Fund V (AI), L.P. (7) 10.13 Amendment No. 1 to Senior Secured Bridge Note Purchase Agreement entered into effective as of September 1, 2005 by and among Axeda Systems Inc., Axeda Systems Operating Company, Inc., JMI Equity Fund V, L.P. and JMI Equity Fund V (AI), L.P. (7) 10.14 Amended and Restated Security Agreement dated as of September 1, 2005 by and among Axeda Systems Inc., Axeda Systems Operating Company, Inc., Axeda IP, Inc., JMI Equity Fund V, L.P., and JMI Equity Fund V (AI), L.P. (7) 10.15 Amended and Restated Subsidiary Guaranty dated as of September 1, 2005 granted by Axeda Systems Operating Company, Inc. and Axeda IP, Inc. in favor of JMI Equity Fund V, L.P., and JMI Equity Fund V (AI), L.P. (7) 10.16 Amended and Restated Subordination Agreement dated as of September 1, 2005 by and among Axeda Systems Inc., JMI Equity Fund V, L.P., JMI Equity Fund V (AI), L.P. and Laurus Master Fund, Ltd. (7) 10.17 Sublease dated as of September 9, 2005. (8) 16.1 Letter re Change in Certifying Accountant, dated September 7, 2005, from KPMG LLP to the Securities and Exchange Commission. (6) 20.1 Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Amendment 1).(9) 31.1* Certification of the Chief Executive Officer of Axeda Systems Inc. required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2* Certification of the Chief Financial Officer of Axeda Systems Inc. required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1* Certification of the Chief Executive Officer and Chief Financial Officer of Axeda Systems Inc. required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Incorporated by reference to the registrant's Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on April 13, 2005. (2) Incorporated by reference to the registrant's Current Report on Form 8-K, dated February 25, 2002, as filed with the Securities and Exchange Commission on February 27, 2002. (3) Incorporated by reference to the registrant's Current Report on Form 8-K dated May 2, 2005, as filed with the Securities and Exchange Commission on May 6, 2005. (4) Incorporated by reference to the registrant's Current Report on Form 8-K dated July 8, 2005, as filed with the Securities and Exchange Commission on July 14, 2005. 41 (5) Incorporated by reference to the registrant's Current Report on Form 8-K/A dated July 8, 2005, as filed with the Securities and Exchange Commission on July 18, 2005. (6) Incorporated by reference to the registrant's Current Report on Form 8-K as filed with the Securities and Exchange Commission on September 7, 2005. (7) Incorporated by reference to the registrant's Current Report on Form 8-K as filed with the Securities and Exchange Commission on September 8, 2005. (8) Incorporated by reference to the registrant's Current Report on Form 8-K as filed with the Securities and Exchange Commission on October 5, 2005. (9) Incorporated by reference to the registrant's Definitive Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Amendment 1) as filed with the Securities and Exchange Commission on October 31, 2005. --- * Filed herewith 42

AXEDA SYSTEMS INC 10-Q