August 2002

Compiled and written by
Gary Will

E-mail:
gary@garywill.com

Issue 66 -- September 3, 2002
In this digest:

1. Com Dev gives M/ERGY to Broadband executives
2. Com Dev CEO to step down; jobs cut as sales decline expected
3. Descartes reports big losses in provision-filled quarter
4. MKS' year begins slowly, but big finish expected
5. STOCK REPORT: Dalsa overtakes Descartes in market value

6. CME tries to raise cash through licensing deal
7. ARISE announces intent to merge with capital pool company
8. Onlinetel reports disappointing quarter, faces restructuring
9. Miscellaneous tidbits from Virtek, Dspfactory, RIM, Finline, VideoLocus, Fakespace

Com Dev gives M/ERGY to Broadband executives
August 9, 2002

With no market for the product apparent any time soon, new Com Dev Broadband (CDB) president John O'Connell couldn't find anyone interested in investing in M/ERGY (see May digest). So he offered to take the cash-burning division off Com Dev's hands as an alternative to winding it down and putting the technology in mothballs. Com Dev's board agreed, and what was Com Dev Broadband is now Axio Wireless Inc. with O'Connell as its largest shareholder. Other former CDB managers are minority shareholders in Axio, which is based in California at the former CDB R&D centre.

CEO Keith Ainsworth described the deal as "a pretty unusual transaction" and compared it to a management buyout. Except in this case it was more like a handout. Com Dev didn't receive any money for M/ERGY, and in fact agreed to invest about $3.5 million in Axio for a 13.5% stake in the company. Com Dev said the amount of the investment is comparable to what it would have paid in severance and other costs had it shut CDB down. What it did receive was a release from CDB's liabilities and obligations. It apparently didn't receive any equity in Axio in return for money previously invested in M/ERGY (Com Dev's material change report doesn't specify exactly what the company paid for its stake in Axio beyond the $3.5 million. It mentions equity being given "in satisfaction of outstanding inter-company debts owed from Com Dev Broadband to Com Dev" but doesn't say how much those debts amounted to.)

Com Dev investors who didn't listen to the company's Q2 conference call in May and sit through the Q&A session may have felt blindsided by this announcement, since Com Dev had never said anywhere else that there was a tight deadline to find investors or that it was contemplating shutting down the division. There was nothing about it in the company's news release, and nothing again in Ainsworth's presentation during the Q2 conference call, where O'Connell's mandate was described as reducing costs, refocusing the business plan, restructuring CDB as a separate entity, and seeking outside equity financing.

It was only in the Q&A session of that call when Ainsworth was asked about a timeline for finding investors that he replied that "realistically it's going to be a 10 to 12 week process. I can't see it wrapping up any quicker than that." He later reiterated that there was a 10-12 week window to find investors. Still, nothing was said about the possibility of shutting down the division.

Nine weeks to the day later, Com Dev's board approved the disposition of CDB to Axio and an investment in the new company.

The Ontario Securities Commission has rules in place about disclosing related party transactions to shareholders, but Com Dev avoided or opted-out of those rules. Under OSC rules, Com Dev would have had to ask for shareholder approval of the deal if the value of CDB was greater than 25% of Com Dev's market value. Com Dev's board decided that CDB didn't have that high a value, although it did gave Axio a valuation above that threshold when it invested in the company.

Even if shareholder approval wasn't required, the OSC says companies should let shareholders know about related party transactions three weeks in advance of the expected closing date. Com Dev decided not to do that either and said nothing about it in its news release. The only explanation, provided in the material change report, was that "it was in the best interests of Com Dev to move quickly ... to minimize the further use of cash in this business." And that may be true, but shareholders had no opportunity to see that there was no self-dealing involved before the transaction had closed. Com Dev didn't even think to say in its news release that none of its executives or directors are Axio shareholders, other than the ones from CDB who have joined Axio (it later said this on its Web site). It didn't put the material change report on its Web site or even provide a link to it at SEDAR. Com Dev then complained about retail investors not understanding the deal, but in this case the company needs only to look at itself to see who's to blame.

Over $50 million had been spent on M/ERGY and, in the end, Com Dev found no customers for the technology (it boasted of its first-to-market status, which brings up the question of whether you can be first to something that doesn't exist -- there's one for Zeno). The only revenue ever recognized from M/ERGY was for a demonstration system that was essentially sold at cost. Former CFO Tim Zahavich had said there would be CDB revenue recognized in Q3, but none turned up. Apparently the company also never received any revenue from the trial deployment with Monet Mobile Networks announced in April.

So, Com Dev is back to doing what it does best in real (but cyclical and currently sluggish) markets where it is an established top-tier supplier. The cash drain from M/ERGY is over and the company expects to be profitable in the current quarter and throughout the next fiscal year (see below). M/ERGY-related costs for shareholders haven't entirely gone away -- there's still the dilution from the stock that was issued to raise money for development, and Com Dev has to make good on $18 million of convertible debentures that were sold to fund M/ERGY (not due until the end of 2006), but otherwise, the bleeding has stopped. Just a year ago, in its investor FAQ, the company spoke of M/ERGY's "potential to change the nature of Com Dev from generating a few hundred million dollars a year in revenue to one making billions." From the same source a couple weeks ago: "the value of this asset looking forward was less than zero."

Com Dev CEO to step down; jobs cut as sales decline expected
August 28, 2002

Keith Ainsworth will step down as Com Dev's CEO at the end of the company's fiscal year on October 31. His successor is John Keating, Com Dev's COO since April 2001. Keating was previously president of Com Dev Space (1999-2001), president of Com Dev Wireless (1998-1999) and had earlier headed Com Dev's new business initiatives group.

Ainsworth, president of Com Dev since 1990, became CEO in June 1999 and led the company through two strong runs: one from November 1999 to February 2000, and the other from July to November 2000. As has been covered here recently (see March and April digests), he was well-compensated for those successes. Ainsworth turned in a disappointing performance at the last AGM with a haughty dismissal of shareholders who were concerned about a $347,000 bonus he received just as Com Dev's fortunes (on the wireless side, anyway) had seemed to turn for the worse.

With telecom markets grinding to a halt, efforts to diversify Com Dev have ended up being costly flops and the company's shares have been trading at all-time lows over the summer.

Ainsworth, who has been with Com Dev since 1975, will remain on the company's board. In a release, chairman Val O'Donovan said Com Dev "would never have become the great company it is without Keith's engineering skill, dedication and leadership."

Com Dev is also eliminating 45 jobs in Com Dev Space plus additional positions in corporate administration. The company said this restructuring will ensure (yes, it said "ensure") that Com Dev will be profitable "in the fourth quarter and throughout 2003."

In the quarter ended July 31 (Q3 02), Com Dev reported a net loss of $22.5 million ($0.48/share) on revenue of $28.2 million. The loss included an $11.9 million provision for discontinuing Com Dev Broadband, an additional $2.7 million for the disposition of Com Dev Wireless (that's on top of the $57.8 million provision made in Q4), $5.0 million in restructuring charges, and a $5.0 million loss from M/ERGY in the quarter. Sales were down 7% from a year ago and flat sequentially.

The company stepped up collections during the quarter and used a net $2.6 million in cash in Q3. It ended the quarter with $13.5 million in cash. The cash component of all charges recorded in Q3 is about $9.0 million, of which $4.8 million will be paid this year with the remaining $4.2 million to be paid over the next two fiscal years. Total assets were down $20.2 million over the quarter to $104.0 million.

Looking ahead to fiscal 2003, Com Dev expects that the weak commercial satellite market will cause its sales to decline by as much as 10% ($11 million) in the year. The slide is expected despite growth in the company's new battery and SAW businesses, which are expected to generate about $10 million in revenue next year. It wasn't mentioned in the conference call, but before the end of fiscal 2003, Com Dev will have to pay $20.3 million to Technology Horizons Ltd. (THL) -- the holding company spun off from Com Dev and owned by its pre-IPO shareholders, including O'Donovan and Ainsworth. Payment can be some combination of cash, shares, and a promissory note. This is to pay for Com Dev's membership in the Skybridge partnership, which was funded by THL in 1998 at a cost of $15.55 million. (THL got the money by selling off millions of RIM shares, causing RIM's stock price to fall to what is still its all-time low. THL had been RIM's largest shareholder with O'Donovan serving on RIM's board.)

Also in August, Gary Calhoun became Com Dev's new CFO, replacing Tim Zahavich who is now CFO of Toronto's ViXS Systems (its board includes Celtic House's Brian Antonen and Ron Dizy, who are no strangers to the Waterloo area). Calhoun joined Com Dev last year as finance VP of Com Dev Wireless.

Descartes reports big losses in provision-filled quarter
August 22, 2002

In the quarter ended July 31 (Q2 03), Descartes reported a loss of US$18.5 million on sales of US$18.0 million. Revenue was up 7% from the previous quarter, but down 9% year-over-year.

The loss included US$7.8 million in restructuring costs, US$2.9 million in reported sales that Descartes wasn't able to collect, and a US$2.0 million provision to settle a complaint brought against the company by an unsatisfied customer.

The company recorded its first increase in gross margins in over a year, which created a 13% jump in gross profits sequentially, but a 22% decline from last year. There were 105 "sign-ups" during the quarter, up from 101 in Q1 (a sign-up can be a new customer or an existing customer doing something new).

Expenses (ignoring the legal and bad debt provisions) were about even from the prior quarter. The restructuring announced in June will end up costing Descartes US$11 million -- about US$2 million more than expected. It says there will be a resulting US$16 million savings in annual expenses.

A "collections task force" was formed during the quarter and it succeeded in reducing DSOs to 82 from 97 in the previous quarter. The number drops to 67 after amounts deemed uncollectable are deducted.

Descartes used US$2.5 million in cash over the quarter and ended Q2 with US$187.0 million in cash and marketable securities. Deducting the US$72.0 million payable to debenture holders, Descartes' net cash is US$115.0 million or about CDN$3.43/share. Its closing stock price on Friday was $3.78.

At the end of Q2, Descartes had 538 employees world-wide, down 113 or 17% from 651 at the beginning of the quarter (see June digest). Its accumulated deficit now stands at US$203.3 million.

Co-CEO Manuel Pietra said the company is confident that it will "return to profitability" in the current quarter (Descartes should pay John Denver's estate a royalty whenever it says that, because it always triggers in my head the opening line from Rocky Mountain High about "coming home to a place he'd never been before." Descartes has never had a profitable quarter as a public company. Its last profitable quarter was in 1996. The "profitability" Pietra is referring to is the kind you get when you ignore several real expenses, although the company got closer to cashflow break-even this quarter, which would be a good start.)

Forecast for the rest of this year and beyond is that Q3 revenue will be flat at around US$18 million, with network revenue declining slightly due to a spike in ocean business in Q2. The company is expecting Q4 sales of US$19-19.5 million with a small sequential increase in network revenue. It had previously been looking for quarter-over-quarter gains of 7-10% in network revenue in both Q3 and Q4.

Descartes is offering to buy back up to US$51.4 million principal amount of the 5.5% convertible debentures it sold in June 2000. It's offering US$700 for every US$1,000 in principal amount, and would therefore be spending up to US$36 million in cash to buy back the debentures. It sold US$75 million in convertible debentures in 2000 with a conversion price of US$35/share, which isn't likely to be seen again (although the debentures aren't due for another three years). Since there will almost certainly be no payoff from conversion, the debenture holders would only receive the 5.5% annual interest on their money before getting their principal back in cash or shares. Descartes has already bought back US$3 million in principal amount, at an average price of US$722.53 per US$1,000 principal amount. That leaves US$72 million in debentures outstanding.

The new regional general managers were also announced in August, and the Waterloo-based GM for Canada is John Kellett, who had been president of TSX-listed Multiactive Software Inc., based in Vancouver. Kellett held that position for two years before leaving the company in June. At the time he left, Multiactive had a market value of $10 million. Kellett had previously been president of Baan Canada and a VP at Baan Company (Descartes co-CEO Pietra also used to be with Baan).

MKS' year begins slowly, but big finish expected
August 28, 2002

MKS' first quarter is typically its weakest of the year, and it got off to another slow start this year, reporting sales of US$6.5 million and a net loss of US$1.5 million (US$0.04/share) in the quarter ended July 31 (Q1 03). Sales were down 2.5% from a year ago and declined 15% from Q4.

Revenue from the SCM business unit grew 15% from a year ago to $4.4 million, a 5% decline sequentially. The interoperability unit saw sales fall 27% from a year ago and 30% from the previous quarter to US$2.0 million. Expenses climbed 6% from the previous quarter, resulting in a loss from operations of US$2.0 million.

The company used US$2.2 million in cash in the quarter and ended the Q1 with US$5.7 million in cash. It believes its cash on hand is sufficient to see it through to profitability. MKS is expecting break-even EBITDA in the current quarter and break-even EBITDA from its SCM business before the end of the year.

MKS has set some very ambitious revenue growth targets, although it lowered its growth forecast for the current year to 21% from the 30% given a quarter ago. It says the shortfall will be on the interoperability side, while the SCM business unit is expected to meet or exceed original expectations.

To hit its US$34 million revenue target for this year, MKS will have to average 18% sequential growth over the next three quarters. It will require achieving quarterly sales levels that haven't been hit in two and-a-half years. Those are pretty big targets in a sluggish enterprise software market. It did raise its prices 20% on August 1 and is releasing the latest version of its core SCM products soon, which should boost revenue.

STOCK REPORT: Dalsa overtakes Descartes in market value
August 2002

Dalsa's growth and success in the stock market this year has seen it jump from fifth place to third in market value among the locally-based companies followed here. It passed Com Dev in March (and is now worth more than three times as much as Com Dev) and, on Friday, edged by Descartes to trail only RIM and Open Text (it also trails ATS, which I don't cover here).

Dalsa's lead over Descartes may be short-lived -- Descartes has over 50 million shares outstanding, so it doesn't take much of a shift in stock price to have a significant impact on the company's market cap. And Descartes is now trading only slightly above its net cash per share. At Friday's closing prices, Dalsa was worth $206 million compared to Descartes' value of $197 million. Over the first eight months of 2002, the price of Dalsa shares has gone up 80%, while Descartes shares have declined 68%, making them the best and worst performing local tech stocks, respectively. Descartes shares closed the month at $3.78 -- within reach of their all-time low of $3.50 set three years ago.

Looking at a slightly more obscure statistic, Dalsa has just overtaken RIM to take top spot in another list. There were six high-profile IPOs among high-tech companies in the Waterloo area between January 1996 and January 1998 (back when there were IPOs). Among those six companies, Dalsa's shares are now trading the furthest above their IPO price:

Dalsa	+142%
RIM	+130%
Open Text	+72%
================================
Descartes	-46%
Com Dev	-84%
MKS	-87%

For the month of August:

Dalsa [TSX: DSA] +45%
Open Text [TSX: OTC] +17%
MKS [TSX: MKX] +8%
--S&P TSX COMPOSITE +0% [0.1%]
Navtech [OTCBB: NAVH] 0%
Turbosonic [OTCBB: TSTA] 0%
================================
EMJ [TSX: EMJ] -1%
RDM [TSXV: RC] -5%
Finline [TSXV: FIN] -8%
Virtek [TSX: VRK] -9%
RIM [TSX: RIM] -11%
Com Dev [TSX: CDV] -15%
Descartes [TSX: DSG] -24%
CME Telemetrix [TSXV: YME] -29%

RIM stock may be struggling -- down 56% so far this year -- but with a market value of $1.3 billion, RIM is still worth as much as the 12 other companies on that list combined. Open Text is worth more than all the other companies combined excluding RIM.

It was a pretty good month for companies with headquarters outside the area:

CVF Technologies [Amex: CNV] +180%
Blue Coat [Nasdaq: BCSI] +40%
Knexa.com [TSXV: KNX] +33%
CheckFree [Nasdaq: CKFR] +24%
Agfa-Gevaert [Brussels: Agfa] +17%
Sybase [NYSE: SY] +15%
Senesco [Amex: SNT] +14%
Network Assoc [NYSE: NET] +7%
Bio-Rad [Amex: BIO] +2%
Engineering.com [TSXV: EGN] 0%
=================================
Siebel [Nasdaq: SEBL] -10%
Adobe [Nasdaq: ADBE] -16%
Eiger Technology [TSX: AXA] -27%

Blue Coat Systems is the new name for CacheFlow. The caching market has been dead for some time and the company has repositioned itself as a provider of Web security systems. It's still being threatened with a Nasdaq delisting, and shareholders are to consider a reverse split soon, but the shift to security (which started long before the name change) got a good response from the market in August -- although not enough to take the company's share price above the US$1 needed to stay on Nasdaq.

The movement in CVF's stock had nothing to do with its portfolio companies in this area. Another of its subsidiaries has developed an insecticide that the company is touting as a non-toxic alternative to combat the risk of West Nile disease. At least one of those penny-stock-pumping e-mail-blasting groups hyped CVF in late August to what was probably its biggest trading week ever. The company's shares were up as much as 340% before falling back to a 180% gain at month-end.

After announcing disappointing results from its Onlinetel subsidiary (see below), Eiger has given back almost all of its gains from earlier this year. Its stock price is now up just 7% in 2002, after being up as much as 314% in the spring.

Cyberplex has left the area and has been taken off the list. Its former offices in Waterloo are going to be used by IBM, which has IT services contracts with Manulife and Sun Life, both of which have large operations in Waterloo.

CME tries to raise cash through licensing deal
August 26, 2002

CME Telemetrix is trying to license the Japanese rights to its new non-invasive glycosylated hemoglobin (HbA1c) measurement technology to raise the money it needs to bring that product and its GlucoNIR glucose monitor to market. It told shareholders that it would be "inappropriate" to raise money through a stock offering now because its current rock-bottom share price would dilute existing investors into oblivion. CME shares closed August at 50 cents -- an all-time low.

In the quarter ended June 30 (Q2 02), CME lost $983,000, with R&D expenses climbing 23% sequentially to $701,000. Operations used $1.2 million in cash in the quarter. The company borrowed $421,000 in Q2, bringing its net cash down to $1.6 million, comprised of $3.0 million in cash and indebtedness of $1.4 million.

CME said that its HBA1c technology has provided "insight into the impediments that have prevented us from achieving our accuracy goal" for its glucose monitor.

ARISE announces intent to merge with capital pool company
August 9, 2002

ARISE Technologies has signed a letter of intent to merge with Intercedent Ventures Ltd., a TSXV-listed capital pool company. Capital pool company (CPCs) are shells listed on the Venture Exchange that search for companies to merge with -- what's called a "qualifying transaction." If no qualifying transaction is closed within 18 months, the Venture Exchange has the option to suspend the CPC's listing.

Intercedent went public in October 2000, so its 18 months ended several months ago. The proposed deal with ARISE is the third letter of intent Intercedent has announced over the last year-and-a-half, and its value keeps dropping with every proposed deal. It announced its intention to merge with UCounsel Corporation in May 2001, valuing Intercedent at 50¢ a share. After that fell through, it announced its intention to merge with VisionMD Inc. in October 2001, valuing Intercedent at 20¢ a share. That also fell through, and the proposed deal with ARISE values Intercedent at 14¢ a share. At the end of March, Intercedent had 11.5¢ a share in cash, or $517,000. Its IPO was priced at 20¢ a share in 2000.

There are some pretty big names behind Intercedent, including the co-founder of MacDonald Dettwiler and a former president of Simon Fraser University (SFU is the home of former Waterloo business figure Mike Volker, who has been a leading proponent of capital pool companies).

It isn't the first capital pool company ARISE has looked at merging with. In June 2001, Sunshine Capital said there was "a high probability" that it would merge with ARISE. The deal fell through not long after.

In the quarter ended June 30 (Q2 02), ARISE lost $283,000 on sales of $364,000. Sales were up 177% from the previous quarter. Operations used $152,000 in cash. It ended the quarter with working capital of just $46,000 which includes $346,000 in inventory. ARISE has since received a $25,000 deposit and a $75,000 loan from Intercedent. ARISE is continuing with its planned IPO.

Suncor Energy -- the Sunoco people -- announced early in the month that it has installed a solar heating system at a car wash in Markham that was designed by Kitchener's Enermodal Engineering and delivered and installed by ARISE. The system uses solar energy to heat water used in the car wash and is expected to save 16,000 cubic metres of natural gas and reduce CO2 emissions by 30 tonnes a year. Suncor says the payback period ranges from 3-15 years, and it may install the technology at other sites following a one-year assessment.

Onlinetel reports disappointing quarter, faces restructuring
August 21, 2002

Onlinetel's Q3 numbers were a big disappointment, and Eiger Technology, its parent company, is now considering restructuring its Kitchener-based subsidiary. In its quarterly results, Eiger said the possible restructuring is in response to "Onlinetel's inability to produce satisfactory operating and profitability results on a more timely basis."

In the quarter ended June 30, Onlinetel lost $486,000 on sales of $324,000. Sales fell 13% from the prior quarter, which was a shock since Eiger had announced new termination agreements and Onlinetel had launched new services in the quarter, but revenue ended up being lower than in both of the previous two quarters. Eiger now says Onlinetel will continue to operate at a loss until its network utilization doubles from current levels.

Near the end of the quarter, Eiger issued a news release stating it was "seeing positive trend-line growth from all divisions of Onlinetel," but the quarterly results tell a very different story.

Miscellaneous Tidbits

• Virtek received a $1.2 grant from the Ontario Ministry of Agriculture and Food's Healthy Futures for Ontario Agriculture Program. The money will be used to apply Virtek's FONA biosensor technology to recreational water quality testing and, later, to the testing of wastewater and drinking water. London's GAP EnviroMicrobial Services, which is part of Conestoga Rovers & Associates, is also participating in the project.

• Dspfactory ranked second on Profit Magazine's listing of "Canada's Hottest Startups" -- a ranking of self-nominated private companies by two-year revenue growth (similar to the Profit 100, which is five-year growth). Dspfactory's sales went from about a quarter-million dollars in its 2000 year to $16.3 million in fiscal 2002, a 6,509% increase.

• RIM announced that it was adding an application for viewing email attachments to the BlackBerry. The sentence from the news release reads: "The new application, developed using the AirDoc platform from Arizan Corporation which was acquired by RIM," which can be interpreted in a couple of ways. Arizan is based in Atlanta. The release went on to mention other companies RIM is working with to develop document handling applications. PrinterOn was conspicuously absent from the list.

• Finline says it had sales of $589,000 in the quarter ended June 30. That would be about $27,000 more than it has reported in the last two fiscal years combined. It says the revenue came from sales to Brazil and the Ivory Coast. This probably includes the $300,000 order from Richardson Electronics announced in December. Reported net income for the quarter was $78,000. Working capital deficiency is $1.2 million. Even with the increased sales, operations used $28,000 in cash, which -- after an additional $5,000 in loans from shareholders -- took Finline down to just $2,700 in cash at quarter-end.

• VideoLocus made its first product announcement -- a real-time H.264 standard definition video encoder, which it bills as the first to deliver DVD quality video at under 1 Mbps.

• Fakespace Systems reported revenue of $4.2 million in the quarter ended June 30 -- up 52% from the previous quarter and 61% from a year ago. Operating loss was down to $123,000.