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 June 30, 2004

[_] 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)



                                 21 Oxford Road
                         Mansfield, Massachusetts 02048
                           ---------------------------

                    (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 o No

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
                                    Yes No o

                           ---------------------------

              On August 13, 2004, 32,515,227 shares of the Registrant's Common
Stock, $0.001 par value, were outstanding.


<PAGE>

                               AXEDA SYSTEMS INC.
                                    FORM 10-Q
                                      INDEX

<TABLE>
<CAPTION>
                                                                                                               Page
<S>            <C>                                                                                           <C>
Part I           Financial Information

Item 1           Financial Statements

                 Consolidated Balance Sheets as of June 30, 2004 (unaudited) and December 31, 2003             2

                 Consolidated Statements of Operations for the three months ended June 30, 2004 and 2003       3
                 (unaudited)

                 Consolidated Statements of Operations for the six months ended June 30, 2004 and 2003
                 (unaudited)                                                                                   4

                 Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003         5
                 (unaudited)

                 Notes to the Consolidated Financial Statements                                                6


Item 2           Management's Discussion and Analysis of Financial Condition and Results of Operations         15

Item 3           Quantitative and Qualitative Disclosures About Market Risk                                    34

Item 4           Controls and Procedures                                                                       34

Part II          Other Information

Item 1            Legal Proceedings                                                                            35

Item 2            Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities             36

Item 3            Defaults Upon Senior Securities                                                              37

Item 4            Submission of Matters to a Vote of Security Holders                                          37

Item 5            Other Information                                                                            37

Item 6            Exhibits and Reports on Form 8-K                                                             39

                 Signatures                                                                                    40

                 Exhibit Index                                                                                 41

                 Exhibit 10.1
                 Exhibit 31.1
                 Exhibit 31.2
                 Exhibit 32.1
</TABLE>


<PAGE>
PART I  FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS

                               AXEDA SYSTEMS INC.
                           CONSOLIDATED BALANCE SHEETS
                 (In thousands, except share and per share data)
<TABLE>
<CAPTION>


                                                                                           June 30,        December 31,
                                                                                            2004              2003
                                                                                            ----              ----
                                                                                         (unaudited)
ASSETS
Current assets:
<S>                                                                                       <C>               <C>
   Cash and cash equivalents                                                              $   4,001         $   9,617
   Accounts receivable, net                                                                   2,901             3,200
   Prepaid expenses                                                                             249               307
   Other current assets                                                                         114               121
                                                                                                ---               ---
     Total current assets                                                                     7,265            13,245

   Furniture and equipment, net                                                               1,779             2,229
   Goodwill                                                                                   3,640             3,640
   Identified intangible assets, net                                                          1,186             1,423
   Other assets                                                                                 338               349
                                                                                                ---               ---
     Total assets                                                                         $  14,208         $  20,886
                                                                                          =========         =========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Current portion of notes payable                                                         $   300           $   417
   Accounts payable                                                                           1,334             1,253
   Accrued expenses                                                                           4,060             4,866
   Income taxes payable                                                                         635               733
   Deferred revenue                                                                           1,401             1,422
                                                                                              -----             -----
     Total current liabilities                                                                7,730             8,691

Non-current liabilities:
   Other non-current liabilities                                                                850               862
   Financing-related liability                                                                1,824             2,608
                                                                                              -----             -----
     Total liabilities                                                                       10,404            12,161
                                                                                             ------            ------

Commitments and contingencies (note 6)

Stockholders' equity:
   Preferred stock, $0.001 par value; 5,000,000 shares authorized in 2004 and 2003,
     none issued or outstanding                                                                   -                 -
   Common stock, $0.001 par value; 50,000,000 shares authorized; 33,077,237 shares
     issued in 2004 and 32,913,211 shares issued in 2003                                         33                33
   Additional paid-in capital                                                               146,657           146,644
   Deferred stock compensation                                                                (161)             (310)
   Accumulated deficit                                                                    (141,551)         (136,488)
   Accumulated other comprehensive income                                                       206               226
   Treasury stock at cost, 603,800 shares in 2004 and 2003                                  (1,380)           (1,380)
                                                                                            -------           -------
     Total stockholders' equity                                                               3,804             8,725
                                                                                              -----             -----
     Total liabilities and stockholders' equity                                            $ 14,208          $ 20,886
                                                                                           ========          ========
                   See accompanying notes to the consolidated financial statements.
</TABLE>


                                       2
<PAGE>

                               AXEDA SYSTEMS INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (In thousands, except per share data)
                                   (Unaudited)
<TABLE>
<CAPTION>

                                                                     Three Months Ended June 30,
                                                                     ---------------------------
                                                                       2004                 2003
                                                                       ----                 ----
Revenues:
<S>                                                                     <C>                <C>
  License                                                               $1,577             $ 2,158
  Services and maintenance                                               1,252                 570
  Hardware                                                                  66                  46
                                                                            --                  --

    Total revenues                                                       2,895               2,774
                                                                         -----               -----

Cost of revenues:
  License                                                                  236                 314
  Services and maintenance                                                 850               1,025
  Hardware                                                                   -                   1
  Software amortization                                                    112                 159
                                                                           ---                 ---

    Total cost of revenues                                               1,198               1,499
                                                                         -----               -----

    Gross profit                                                         1,697               1,275
                                                                         -----               -----

Research and development (R&D)
  Non-cash compensation                                                      2                  28
  Other R&D expense                                                      1,031               1,407
Sales and marketing (S&M)
  Non-cash compensation                                                    (2)                   6
  Other S&M expense                                                      1,846               2,276
General and administrative (G&A)
  Non-cash compensation                                                     29                 170
  Other G&A expense                                                      1,087               1,956
  Depreciation and amortization                                            255                 262
                                                                           ---                 ---

    Total operating expenses                                             4,248               6,105
                                                                         -----               -----

    Operating loss                                                     (2,551)             (4,830)

Gain on disposal of assets                                                 110                   -
Interest income (expense), net                                            (18)                  22
Other income (expense), net                                                 45                   -
                                                                            --                   -

Loss before provision for income taxes                                 (2,414)             (4,808)

     Provision for income taxes                                             10                  45
                                                                            --                  --
Net loss                                                             $ (2,424)           $ (4,853)
                                                                     =========           =========
Basic and diluted net loss per weighted average common share
  outstanding                                                         $ (0.07)            $ (0.18)
                                                                      ========            ========
Weighted average number of common shares outstanding used in
  calculation of basic and diluted net loss per common share        32,471,541          27,245,700
                                                                    ==========          ==========
</TABLE>

See accompanying notes to the consolidated financial statements.

                                       3
<PAGE>

                               AXEDA SYSTEMS INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (In thousands, except per share data)
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                                      Six Months Ended June 30,
                                                                      -------------------------
                                                                       2004                 2003
                                                                        ----                 ----
Revenues:
<S>                                                                    <C>                <C>
  License                                                              $3,911             $ 4,475
  Services and maintenance                                              2,433               1,533
  Hardware                                                                 86                 183
                                                                           --                 ---

    Total revenues                                                      6,430               6,191
                                                                        -----               -----

Cost of revenues:
  License                                                                 430                 825
  Services and maintenance                                              1,973               2,037

  Hardware                                                                  -                   1
  Software amortization                                                   224                 316
                                                                          ---                 ---

    Total cost of revenues                                              2,627               3,179
                                                                        -----               -----

    Gross profit                                                        3,803               3,012
                                                                        -----               -----

Research and development (R&D)
  Non-cash compensation                                                     2                  56
  Other R&D expense                                                     2,122               3,121
Sales and marketing (S&M)
  Non-cash compensation                                                    43                  17
  Other S&M expense                                                     3,972               4,781
General and administrative (G&A)
  Non-cash compensation                                                    59                 273
  Other G&A expense                                                     2,985               4,517
  Depreciation and amortization                                           518                 570
                                                                          ---                 ---

    Total operating expenses                                            9,701              13,335
                                                                        -----              ------

    Operating loss                                                    (5,898)            (10,323)

Gain on disposal of assets                                                110                 743
Interest income (expense), net                                           (30)                  53
Other income (expense), net                                               785                (18)
                                                                          ---                ----

Loss before provision for income taxes                                (5,033)             (9,545)

     Provision for income taxes                                            30                  95
                                                                           --                  --
Net loss                                                            $ (5,063)           $ (9,640)
                                                                    =========           =========
Basic and diluted net loss per weighted average common share
  outstanding                                                        $ (0.16)            $ (0.35)
                                                                     ========            ========
Weighted average number of common shares outstanding used in
  calculation of basic and diluted net loss per common share       32,442,390          27,212,652
                                                                   ==========          ==========
</TABLE>


See accompanying notes to the consolidated financial statements.

                                       4
<PAGE>


                               AXEDA SYSTEMS INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)
                                   (Unaudited)

<TABLE>
<CAPTION>

                                                                                      Six Months Ended June 30,
                                                                                        2004             2003
                                                                                        ----             ----

Cash flows from operating activities:
<S>                                                                                       <C>              <C>
 Net loss                                                                                 $ (5,063)        $ (9,640)
 Adjustments to reconcile net loss to net cash used in operating activities:
  Depreciation and amortization                                                                 742              886
  Gain on disposals of assets                                                                 (110)            (729)
  Unrealized gain on financing-related liability                                              (784)                -
  Non-cash compensation and other expenses                                                      104              346
  Provision for doubtful accounts                                                                 7             (16)

Changes in items affecting operations:
  Accounts receivable                                                                           292              222
  Prepaid expenses and other current assets                                                      65              265
  Goodwill, intangible assets and other assets                                                   11               19
  Accounts payable                                                                               81            (876)
  Accrued expenses                                                                            (677)          (1,803)
  Income taxes payable                                                                         (98)              102
  Deferred revenue                                                                             (21)            (179)
                                                                                               ----            -----
    Net cash used in operating activities                                                   (5,451)         (11,403)
                                                                                            -------         --------

Cash flows from investing activities:
  Capital expenditures                                                                         (82)            (101)
                                                                                               ----            -----
    Net cash used in investing activities                                                      (82)            (101)
                                                                                               ----            -----

Cash flows from financing activities:
  Net repayment under bank line of credit                                                     (117)              367
  Repayments of long-term debt and other non-current liabilities                                  -            (175)
   Net proceeds from exercise of stock options                                                   27                1
                                                                                                 --                -
    Net cash provided by (used in) financing activities                                        (90)              193
                                                                                               ----              ---

Effect of exchange rate changes on cash and cash equivalents                                      7                6
                                                                                                  -                -

Net decrease in cash and cash equivalents                                                   (5,616)         (11,305)
Cash and cash equivalents:
  Beginning of period                                                                         9,617           19,065
                                                                                              -----           ------
  End of period, including restricted cash of $100 in 2003                                   $4,001           $7,760
                                                                                             ======           ======
</TABLE>

See accompanying notes to the consolidated financial statements.


                                       5
<PAGE>

                               AXEDA SYSTEMS INC.
                 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Information with respect to June 30, 2004 and 2003 is 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 and Liquidity

Axeda  Systems  Inc.,  or we,  our,  us or Axeda,  develops,  markets  and sells
software  products  and  services  used by  multiple  industries  and  customers
worldwide  for Device  Relationship  Management,  or DRM,  to access and exploit
information hidden 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,
Japan 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 2002 our revenues
have been substantially generated from selling DRM products.

We have sustained significant net losses and negative cash flows from operations
since our  inception.  For the six months ended June 30, 2004 and 2003,  our net
losses  were  $5,063 and  $9,640,  respectively,  and  negative  cash flows from
operations  were $5,451 and $11,403,  respectively.  There can be no  assurances
that we will be able to generate sufficient revenues or positive cash flows from
operations  necessary to achieve or sustain  profitability  in the short or long
term.

Based upon our current cash resources and revised financial  projections for the
remainder of the year, we currently anticipate that our available funds and cash
flows  from  operations  should be  sufficient  to meet our cash  needs  through
December 31, 2004.  As such,  we will require  additional  financing to fund our
operations  through December 2005. We intend to obtain  sufficient  financing to
fund our operations, along with cash flows from operations, so that this planned
financing  combined  with  additional   restructuring   efforts  will  allow  us
sufficient cash resources to meet our cash needs through at least December 2005.
However,  due to risks and  uncertainties,  we cannot assure  investors that our
future operating cash flows will be sufficient to meet our requirements. In such
event, our operations and liquidity will be materially  adversely  affected.  We
cannot  assure you that the  additional  financing  will be  available  to us on
favorable terms when required,  or at all. If we raise  additional funds through
the issuance of equity,  equity-linked or debt securities,  those securities may
have rights, preferences or privileges senior to the rights of our common stock,
and our stockholders may experience dilution.

Effective  at the opening of  business on August 5, 2004,  listing of our common
stock was  transferred to The Nasdaq  SmallCap  Market from The Nasdaq  National
Market,  and continues to trade under the symbol XEDA. The transfer  follows the
decision of a Nasdaq Listing  Qualifications  Panel, received on August 3, 2004,
which was based  primarily on our  stockholders'  equity being below the minimum
$10,000  shareholders'  equity  requirement for continued  listing on The Nasdaq
National Market.


b)       Basis of Presentation

The interim  consolidated  financial  statements  of Axeda for the three and six
months ended June 30, 2004 and 2003  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 the financial
position of Axeda at June 30, 2004,  the results of our operations for the three
and six  months  ended  June 30,  2004 and 2003 and our cash  flows  for the six
months  ended  June 30,  2004 and 2003.  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, 2003. The interim  results  presented
are not necessarily  indicative of results for any subsequent quarter or for the
year ending December 31, 2004.

                                       6
<PAGE>

c)       Principles of Consolidation

The consolidated  financial  statements include our financial statements and the
financial   statements  of  our  wholly-owned   subsidiaries.   All  significant
intercompany balances and transactions have been eliminated in consolidation.

d)       Cash and Cash Equivalents

For  purposes of the  statement  of cash flows,  we consider  all highly  liquid
instruments  purchased  with a  maturity  of  three  months  or  less to be cash
equivalents.

e)       Revenue Recognition

We recognize  software  revenues in  accordance  with the American  Institute of
Certified Public  Accountants'  Statement of Position,  or SOP, 97-2,  "Software
Revenue Recognition" as amended by SOP 98-9, "Modification of SOP 97-2, Software
Revenue Recognition,  With Respect to Certain  Transactions."  Software 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.

We  recognize  revenue  for  certain  arrangements  where  products  and certain
services are bundled in  accordance  with Emerging  Issues Task Force,  or EITF,
Issue No. 00-21,  "Revenue  Arrangements  with Multiple  Deliverables,"  or EITF
00-21.  In applying the concepts of EITF 00-21,  we must  determine  whether the
deliverables  are separable into multiple  units of accounting.  We allocate the
total fee on such  arrangements to the individual  deliverables  either based on
their  relative  fair  values or using the  residual  method,  as  circumstances
dictate.  We then recognize  revenue on each  deliverable in accordance with our
policies for product and services revenue  recognition.  The application of EITF
00-21 includes judgments whether the delivered item has value to the customer on
a  standalone  basis and  whether we have  established  objective  and  reliable
evidence  of fair value for the  undelivered  items.  Our  ability to  recognize
revenue in the future may be affected if actual selling prices are significantly
less than the fair values.

f)       Financial Instruments

Our  financial  instruments  principally  consist of cash and cash  equivalents,
accounts  receivable,  accounts  payable and notes  payable  that are carried at
cost, which approximates fair value. The  financing-related  liability financial
instrument is recorded at fair value (note 5).

g)       Computation of Earnings Per Share

We compute earnings per share, or EPS, in accordance with Statement of Financial
Accounting Standards,  or 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).
Common  equivalent  shares are excluded from the  calculation if their effect is
anti-dilutive.


The  following  potential  shares of common  stock have been  excluded  from the
computation of diluted net loss per share for all periods  presented because the
effect would have been anti-dilutive:

i) Three Months Ended June 30, 2004

Options to  purchase  5,854,011shares  of common  stock with a  weighted-average
exercise price of $1.43 were outstanding  during the three months ended June 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  3,276,450  options  that are vested,  with a weighted  average
exercise price of $1.48, of which 1,557,222 are vested and in the money,  with a
weighted average  exercise price of $0.20.  The options have various  expiration
dates during the next ten years.

Warrants to purchase  2,683,736  shares of common stock with a  weighted-average
exercise  price of $1.97 were  vested and  outstanding  during the three  months
ended June 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. The  outstanding  warrants  include 8,927 warrants
that are vested and in the money,  with a  weighted  average  exercise  price of
$1.03. The warrants have various expiration dates during the next five years.

                                       7
<PAGE>
ii) Six Months Ended June 30, 2004

Options to purchase  5,854,011  shares of common  stock with a  weighted-average
exercise  price of $1.43 were  outstanding  during the six months ended June 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  3,276,450  options  that are vested,  with a weighted  average
exercise price of $1.48, of which 1,557,222 are vested and in the money,  with a
weighted average  exercise price of $0.20.  The options have various  expiration
dates during the next ten years.

Warrants to purchase  2,701,100  shares of common stock with a  weighted-average
exercise price of $1.97 were vested and outstanding  during the six months ended
June 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. The outstanding  warrants include 14,135 warrants that are vested and in
the money,  with a weighted  average  exercise price of $1.03. The warrants have
various expiration dates during the next five years.


iii) Three Months Ended June 30, 2003

Options to purchase  4,914,669  shares of common  stock with a  weighted-average
exercise price of $1.77 were outstanding  during the three months ended June 30,
2003 but were not included in the computation of diluted EPS because the effects
of assumed conversion or exercise would have an anti-dilutive effect on EPS. The
outstanding  options include 2,503,245 options that are vested,  with a weighted
average  exercise price of $2.33,  of which 848,327 are vested and in the money,
with a weighted  average  exercise  price of $0.01.  The  options  have  various
expiration dates during the next ten years.

Warrants  to purchase  567,060  shares of common  stock with a  weighted-average
exercise  price of $2.70 were  vested and  outstanding  during the three  months
ended June 30,  2003,  but were not included in the  calculation  of diluted EPS
because  the  effects  of  assumed   conversion   or  exercise   would  have  an
anti-dilutive  effect on EPS. The outstanding  warrants include 343,919 warrants
that are vested and in the money,  with a  weighted  average  exercise  price of
$0.33. The warrants have various expiration dates during the next five years.

iv) Six Months Ended June 30, 2003

Options to purchase  4,914,669  shares of common  stock with a  weighted-average
exercise  price of $1.77 were  outstanding  during the six months ended June 30,
2003 but were not included in the computation of diluted EPS because the effects
of assumed conversion or exercise would have an anti-dilutive effect on EPS. The
outstanding  options include 2,503,245 options that are vested,  with a weighted
average  exercise price of $2.33,  of which 848,327 are vested and in the money,
with a weighted  average  exercise  price of $0.01.  The  options  have  various
expiration dates during the next ten years.

Warrants  to purchase  565,625  shares of common  stock with a  weighted-average
exercise price of $2.70 were vested and outstanding  during the six months ended
June 30, 2003,  but were not included in the  calculation of diluted EPS because
the effects of assumed conversion or exercise would have an anti-dilutive effect
on EPS. The outstanding warrants include 287,967 warrants that are vested and in
the money,  with a weighted  average  exercise price of $0.24. The warrants have
various expiration dates during the next five years.

                                       8
<PAGE>
h)       Stock-based Compensation

SFAS No. 123,  "Accounting for Stock-based  Compensation," or SFAS 123, 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.

At June 30, 2004 we have two stock-based employee compensation plans. We account
for those plans 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:

<TABLE>
<CAPTION>

                                                                   Three Months Ended June 30,    Six Months Ended June 30,
                                                                   ---------------------------   --------------------------
                                                                       2004          2003          2004          2003
                                                                     --------      --------      --------      --------
<S>                                                                  <C>           <C>           <C>           <C>
Net loss, as reported ..........................................     $ (2,424)     $ (4,853)     $ (5,063)     $ (9,640)
Add:  Stock-based employee compensation
included in reported net loss, net of
related tax effects ............................................           29           204           104           346
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards ..............................         (447)         (808)         (883)       (1,312)
                                                                     --------      --------      --------      --------
Pro forma net loss .............................................     $ (2,842)     $ (5,457)     $ (5,842)     $(10,606)
                                                                     ========      ========      ========      ========
Net  loss  per  common  share basic and diluted:
     As reported ...............................................     $  (0.07)     $  (0.18)     $  (0.16)     $  (0.35)
                                                                     ========      ========      ========      ========
     Pro forma .................................................     $  (0.09)     $  (0.20)     $  (0.18)     $  (0.39)
                                                                     ========      ========      ========      ========
</TABLE>

We used the following  assumptions  to determine the fair value of stock options
granted using the Black-Scholes option-price model:
                                             June 30,
                                   --------------------------------------
                                          2004                      2003
                                          ----                      ----
  Dividend yield                                0%                      0%
  Expected volatility                   92% - 192%               0% - 192%
  Average expected option life             4 years                 4 years
  Risk-free interest rate            1.02% - 5.71%           1.02% - 5.73%


For the six months  ended June 30, 2004,  we granted  840,000  stock  options to
employees,  including 120,000 to our chief financial  officer,  with an exercise
price per share equal to the fair market  value of our common  stock on the date
of grant and ranging from $1.06 to $1.28.

i)       Guarantees

Our  software  license  agreements  typically  provide  for  indemnification  of
customers for  intellectual  property  infringement  claims.  We also warrant to
customers,  when requested,  that our software products operate substantially in
accordance  with standard  specifications  for a limited period of time. We have
not incurred significant obligations under customer  indemnification or warranty
provisions  historically,  and do not expect to incur significant obligations in
the future.  Accordingly,  we do not maintain  accruals for  potential  customer
indemnification or warranty-related obligations.

We have agreements in place with our directors and officers whereby we indemnify
them for certain events or occurrences while the officer or director is, or was,
serving at our request in such capacity.  The maximum potential amount of future
payments we could be required to make under these indemnification  agreements is
unlimited;  however,  we have a director and officer  insurance  policy that may
enable us to recover a portion of any future amounts paid.

                                       9
<PAGE>
j)       Use of Estimates

The  preparation  of  financial  statements  in  conformity  with GAAP  requires
management to make estimates and assumptions that affect the reported amounts of
assets and  liabilities  and disclosure of contingent  assets and liabilities at
the date of the financial  statements  and the reported  amounts of revenues and
expenses during the reporting period.  Significant items subject to estimates in
these financial statements include the recoverability of goodwill and intangible
assets and valuation allowances for accounts receivable and deferred tax assets.
Actual results could differ from those estimates.

k)       Recent Accounting Pronouncements

On March 31, 2004, the Financial  Accounting  Standards Board, or FASB, issued a
proposed  Statement,  "Share Based Payment,  an Amendment of FASB Statements No.
123 and 95," relating to the  accounting  for  equity-based  compensation.  This
statement  proposes  changes to GAAP that, if  implemented,  would require us to
record a charge to compensation expense for stock option grants to employees. We
currently  account for stock  options  under SFAS 123 (note 1h). As permitted by
SFAS 123, we have elected to use the intrinsic value method prescribed by APB 25
to measure  compensation  expense for  stock-based  awards granted to employees.
Under APB 25 the granting of stock options is not considered compensation if the
option exercise price is not less than the fair market value of the common stock
at the measurement  date, which is generally the grant date. The FASB's proposal
would eliminate our ability, starting in 2005, to account for stock-based awards
granted to employees using the intrinsic value method  prescribed by APB 25, and
would instead require that such awards be accounted for using a fair-value based
method,  which would require us to measure the compensation expense for all such
awards,  including stock options, at fair value at the grant date.  Compensation
expense would then be recognized  over the service or vesting  period.  The FASB
began its  redeliberations  of this  statement  in July 2004,  and set a goal of
completing its  redeliberations and issuing a final statement in the second half
of 2004. We cannot predict whether the proposed  statement will be adopted,  but
if adopted it would have an adverse affect on our results of operations. On July
20, 2004 the U.S. House of Representatives approved a bill (H.R.3574) to replace
the guidance that the FASB set forth in this exposure draft. The bill stipulates
that the fair value of all  options to purchase  the stock of a company  granted
after December 31, 2004, to a named  executive  officer  (defined as the CEO and
the four other most highly  compensated  executive officers of the company) must
be  expensed,  but  only  if  both  the  company's  annual  revenue  and  market
capitalization surpass $25,000. Voluntary expensing is permitted under the bill,
which  additionally  requires  improved  employee stock option  transparency and
reporting disclosures.

In May 2002 the FASB  added a  project  to its  technical  agenda  to  develop a
comprehensive  statement  on  revenue  recognition.  The FASB  plans to issue an
exposure  draft of an  amendment  to FASB  Concepts  Statement 5, and a separate
exposure  draft of a general  standard  on  revenue  recognition  in the  fourth
quarter of 2004.


2)       Supplemental Disclosure of Balance Sheet Information

      Provision for Doubtful Accounts

          Accounts receivable are net of provisions for doubtful accounts of $75
          and $68 as of June 30, 2004 and December 31, 2003, respectively.

      Acquired Identified Intangible Assets

          Accumulated  amortization  at June 30, 2004 and  December 31, 2003 was
          $974 and $737, respectively.

3)       Line of Credit

In May 2004 we renewed our loan and security agreement with Silicon Valley Bank,
or the Bank, that provides us with a line of credit,  or the Line, in the amount
of the  lesser  of  $2,000 or the  borrowing  base,  as  defined  (limited  to a
percentage  of  eligible  accounts  receivable).  The Line also  provides  for a
maximum of $1,000 in the form of letters  of credit or other  services  from the
Bank that reduces the amount of available  borrowings  under the Line.  The Line
matures in June 2005,  bears  interest  at the prime rate plus 1% (5.25% at June
30, 2004),  with a minimum rate of 5.25%, and is collateralized by substantially
all of our assets. We are required to comply with a tangible net worth covenant,
as defined in the loan and  security  agreement,  and a minimum  available  cash
(including  amounts available but undrawn under the Line) covenant.  At June 30,
2004, we were in compliance with our covenants and $452 was available, with $300
outstanding under the terms of the Line.

In connection with renewing the Line, we issued a warrant to the Bank to acquire
19,342  shares of our common  stock at an exercise  price of $1.03 per share and
which expires in May 2009.  The  estimated  fair value of the warrant of $16 was
recorded as debt issuance  costs,  and is being amortized over the one-year term
of the Line and included in interest expense.
                                       10
<PAGE>
At June 30,  2004  there were no  letters  of credit or other  amounts  for bank
services outstanding under the Line.

4)       Accrued Expenses

Accrued expenses consist of the following:

                                                        June 30,   December 31,
                                                           2004       2003
                                                           ----       ----
Legal and professional fees ........................     $  488     $  558
Payroll and related costs ..........................      1,172      1,477
Royalties to Israeli government agencies ...........        875        759
Sales, excise and other taxes ......................        136        266
Severance ..........................................        184         88
Unutilized leased facilities .......................        537        547
Other ..............................................        668      1,171
                                                         ------     ------
                                                         $4,060     $4,866
                                                         ======     ======

5)       Private Placement and Financing-related Liability

On September 23, 2003, we issued 4,918,100 shares of our common stock to certain
accredited  investors  in a  private  investment  in  public  equity,  or  PIPE,
financing.  The shares were sold at $1.22 per share with net proceeds of $5,597.
We also issued to the investors  warrants  exercisable for the purchase of up to
an  aggregate of  2,459,050  shares of our common  stock at an initial  exercise
price of $1.71 per share.

We also entered into a registration  rights  agreement with the investors in the
PIPE  financing  pursuant  to which  we were  obligated  to file a  registration
statement on Form S-3, for the resale of the shares sold in the  transaction and
the  shares  issuable  upon  exercise  of the  warrants,  with the SEC.  The SEC
declared the registration  statement effective on October 23, 2003. In the event
that sales cannot be made because we have not updated the registration statement
to keep it effective and to comply with securities law requirements,  we will be
required to pay  liquidated  damages to each PIPE investor  equal to 1.5% of the
purchase price paid by such investor for each thirty-day  period or pro rata for
any portion thereof after the deadline passes until the  registration  statement
is updated and declared effective by the SEC.

EITF Issue No. 00-19,  "Accounting for Derivative Financial  Instruments Indexed
to, and Potentially Settled in, a Company's Own Stock," or EITF 00-19, 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.  EITF 00-19
provides that the ability to keep SEC filings current is beyond the control of a
registrant.  Therefore,  the potential  liquidated damages we may be required to
pay  pursuant  to the  registration  rights  agreement  if we fail  to keep  our
registration  statement effective is a potential net cash settlement pursuant to
EITF  00-19.  While we view  this  liquidated  damages  contingency  as  neither
probable nor reasonably  estimable,  we recorded the estimated fair value of the
warrant as of September 23, 2003 of $3,410 as a  financing-related  liability in
the consolidated  balance sheet in accordance with EITF 00-19. The fair value of
the financing-related liability is 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.  Upon the earlier of the exercise of the
warrants or the  expiration  of the period for which  liquidated  damages may be
assessed against us, the fair value of the  financing-related  liability will be
reclassified to additional paid-in capital.

The estimated fair value of the financing-related  liability as of June 30, 2004
was $1,824. The change in fair value from December 31, 2003 to March 31, 2004 of
$739, and from March 31, 2004 to June 30, 2004 of $45, totaling $784 for the six
months  ended June 30, 2004,  was  recorded as other income in the  consolidated
statements of operations.

The estimated  fair value of the warrant,  used to determine the estimated  fair
value of the financing-related liability, was calculated using the Black-Scholes
model using the following assumptions:

                                          June 30, 2004      December 31, 2003
                                          ---------------    ------------------
Current market price/share ...............     $     1.07     $     1.36
Exercise price/share .....................     $     1.71     $     1.71
Dividend yield ...........................           0%             0%
Expected volatility ......................         109%           115%
Expected life ............................     4.23 years      4.73 years
Risk-free interest rate ..................           3.63%          3.13%

                                       11
<PAGE>

6)       Commitments and Contingencies

In March 2003 we entered into a confidential  settlement  agreement with Phoenix
Technologies  in connection  with the sale of the assets of our former  Internet
appliance,  or IA, business.  In connection with this settlement  agreement,  we
reversed  accruals of $743 initially  recorded in March 2001 as part of the sale
of the assets of our former IA business.

From  time  to time we are  involved  in  lawsuits,  claims,  investigations  or
proceedings  consisting of  intellectual  property,  commercial,  employment and
other  matters,  which arise in the ordinary  course of business.  In accordance
with SFAS No. 5,  "Accounting  for  Contingencies,"  we make a  provision  for a
liability when it is both probable that a liability has been  incurred,  and the
amount of the loss can be reasonably estimated. These provisions are reviewed at
least   quarterly   and  adjusted  to  reflect  the  impacts  of   negotiations,
settlements,  rulings,  advice of legal counsel and other information and events
pertaining  to a particular  case. It is possible that our cash flows or results
of operations  could be affected in any  particular  period by the resolution of
one or more of these contingencies.

7)       Segment and Major Customer Information

We operate in a single industry segment,  which is the development and licensing
of our technology.

Three  customers  accounted  for 16%,  or $464,  and 25%,  or  $1,588,  of total
revenues  for the three and six months  ended  June 30,  2004.  Three  customers
accounted for 30%, or $828, and 20%, or $1,228,  of total revenues for the three
and six months ended June 30, 2003, respectively.

                                       12
<PAGE>
We sell and license our  technology  to customers  primarily  in North  America,
Europe  and  Asia.  Our  North  American  operations   generated  44%  and  34%,
respectively,  of our  revenues in 2004 and 2003,  and our total  revenues  were
derived from the following  geographic  regions  (based on where the customer is
located):

                                           Three Months Ended June 30,
                                           ---------------------------
Country/ Geographic Region                2004                      2003
--------------------------         -------------------    ---------------------
                                   Amount    % of Total    Amount     % of Total
North America:
     United States ............     $1,107         38%     $  944          34%
     Canada ...................       --         --            10        --
                                    ------     ------      ------      ------
          Total - North America      1,107         38         954          34
                                    ------     ------      ------      ------

Europe:
     Germany ..................        175          6         174           6
     France ...................        355         12         349          13
     Netherlands ..............        134          5         117           4
     Switzerland ..............        320         11         192           7
     United Kingdom ...........         63          2          52           2
     Other ....................        398         14         221           8
                                    ------     ------      ------      ------
          Total - Europe ......      1,445         50       1,105          40
                                    ------     ------      ------      ------

Asia-Pacific:
     Israel ...................        131          5          39           1
     Japan ....................        168          6         587          21
     Other ....................         12       --            74           3
                                    ------     ------      ------      ------
          Total - Asia-Pacific         311         11         700          25
                                    ------     ------      ------      ------

Other .........................         32          1          15           1
                                    ------     ------      ------      ------

         Total ................     $2,895       100%      $2,774        100%
                                     =====     ======      ======      ======

                                           Six Months Ended June 30,
                                           ---------------------------
Country/ Geographic Region                2004                      2003
--------------------------         -------------------    ---------------------
                                   Amount    % of Total    Amount     % of Total
North America:
     United States ............     $2,404         38%     $2,179          35%
     Canada ...................          9       --           260           4
                                    ------     ------      ------      ------
          Total - North America      2,413         38       2,439          39
                                    ------     ------      ------      ------

Europe:
     Germany ..................        296          5         307           5
     France ...................        744         12         752          12
     Netherlands ..............        356          6         230           4
     Switzerland ..............        616         10         405           7
     United Kingdom ...........        209          3          94           2
     Other ....................        748         12         506           8
                                    ------     ------      ------      ------
          Total - Europe ......      2,969         46       2,294          37
                                    ------     ------      ------      ------

Asia-Pacific:
     Israel ...................        149          2         179           3
     Japan ....................        794         12       1,127          18
     Other ....................         47          1          85           1
                                    ------     ------      ------      ------
          Total - Asia-Pacific         990         15       1,391          22
                                    ------     ------      ------      ------

Other .........................         58          1          67           1
                                    ------     ------      ------      ------

         Total ................     $6,430        100%      $6,191        100%
                                    ======      ======      ======      ======


                                       13
<PAGE>

8)       Segment Reporting

Segment  information is presented in accordance with SFAS No. 131,  "Disclosures
About Segments Of An Enterprise And Related Information." This standard requires
segmentation based upon our internal  organization and disclosure of revenue and
operating income based upon internal accounting  methods.  DRM is our reportable
segment.

For 2004,  Other is comprised of our IA business,  the assets of which were sold
in March of 2001. For 2003, Other is comprised of our former personal  computer,
or PC,  business,  which we exited in May 2002,  our former IA business  and our
former consumer electronics,  or CE, business,  the assets of which were sold in
March of 2001.

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.

<TABLE>
<CAPTION>

                          Three Months Ended June 30,  Six Months Ended June 30,
                          ---------------------------  -------------------------
                                  2004       2003           2004       2003
                                ------     ------         ------     ------
Revenues:
<S>                             <C>        <C>            <C>        <C>
  DRM .....................     $2,829     $2,728         $6,344     $5,759
  Other ...................         66         46             86        432
                                ------     ------         ------     ------
          Total ...........     $2,895     $2,774         $6,430     $6,191
                                ======     ======         ======     ======

Gross profit:
       DRM ................     $1,631     $1,230         $3,717     $2,830
       Other ..............         66         45             86        182
                                ------     ------         ------     ------
          Total ...........     $1,697     $1,275         $3,803     $3,012
                                ======     ======         ======     ======
</TABLE>


9)       Consolidated Statements of Cash Flows

         Supplemental disclosure of cash flow information:
                                         Six Months Ended June 30,
                                           2004                2003
                                           ----                ----
Cash paid during the period for:
  Interest                                 $  3             $  22
                                            ====             =====
  Income taxes                               99                 -
                                             ==                ==



10)      Comprehensive Income (Loss)

     The components of comprehensive loss are as follows:
<TABLE>
<CAPTION>

                                     Three Months Ended June 30,          Six Months Ended June 30,
                                     ---------------------------         -------------------------
                                        2004               2003             2004              2003
                                        ----               ----             ----              ----
<S>                                   <C>               <C>               <C>               <C>
Net loss ...................          $(2,424)          $(4,853)          $(5,063)          $(9,640)
Foreign currency translation
adjustment .................              (20)               42                 7                 6
                                      -------           -------           -------           -------
Comprehensive loss .........          $(2,444)          $(4,811)          $(5,056)          $(9,634)
                                      =======           =======           =======           =======
</TABLE>

                                       14
<PAGE>
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  and
adversely  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,"
"will," "should," "seeks," "pro forma," "anticipates,"  "plans," "estimates," or
"intends,"  or the  negative  of any  thereof,  or other  variations  thereon or
comparable terminology, or by discussions of strategy or intentions. Given these
uncertainties,  prospective  investors are cautioned not to place undue reliance
on  such  forward-looking   statements.   Readers  are  referred  to  risks  and
uncertainties  identified  in this  "Management's  Discussion  And  Analysis  Of
Financial  Condition  And  Results Of  Operations,"  under  "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

Axeda is a software  and  services  company  providing  an emerging  category of
business software known as Device Relationship Management,  or DRM. Our flagship
product,  the Axeda DRM System,  is a distributed  software solution designed to
enable businesses to remotely monitor,  manage and service intelligent  devices.
The Axeda DRM System  enables  manufacturers  and service  providers  to use the
Internet to establish and manage continuous connections with devices deployed at
their customers' facilities,  allowing them to stay in touch with their products
throughout their lifecycle,  tapping the value of remote device information with
new, automated e-service, operations monitoring, and e-commerce offerings.

In  recent  years we have  undertaken  several  major  steps to  reposition  our
business and capitalize on the emerging growth opportunities  represented by the
DRM market. This market is also known as M2M, or  machine-to-machine,  autonomic
computing,  remote  monitoring and  management and several other  descriptors in
different  vertical  markets.  On  December  7,  2001,  we  acquired  all of the
outstanding  shares of eMation,  Ltd. The acquisition  gave us an entry into the
DRM market.  During 2002 our revenues were  increasingly  generated from selling
DRM products,  and since 2002,  substantially all of our revenues were generated
from selling DRM products.

In 2003,  we recorded  approximately  $1.4 million in  restructuring  charges to
reduce staffing levels, terminate certain leases and consolidate our operations.
Combined  with our  expected  continued  year  over year  growth in DRM  systems
revenues,  we believe that our future operating losses will continue to be lower
than what we have  historically  experienced.  We will  continue to evaluate our
cost structure and may undertake  additional  measures to reduce expenses in the
future.

On September 23, 2003, we issued 4,918,100 shares of our common stock to certain
accredited  investors  in a  private  investment  in  public  equity,  or  PIPE,
financing.  The shares were sold at a price of $1.22 per share with net proceeds
of $5.6 million.  We also issued to the investors  warrants  exercisable for the
purchase of up to an  aggregate  of  2,459,050  shares of our common stock at an
initial exercise price of $1.71 per share.  Operating  results and our liquidity
position are discussed further, below.

We currently operate in three principal regions:  the United States,  Europe and
Japan.  Total  revenues  increased by $0.1 million in the second quarter of 2004
compared to the second quarter of 2003. Despite the continued  difficult capital
spending climate,  our DRM revenues  increased by $0.6 million in the first half
of 2004  compared to the same period in 2003,  due to  increases  in our service
engagements.  These net increases were driven by an  accelerated  acquisition of
new customer accounts,  as well as additional spending by our increasing base of
existing customers. While recurring sales from existing customers and the timing
of more  widespread  adoption of our product  remains  difficult to predict,  we
believe  overall  revenues will increase in 2004 due to further  orders from our
current customer base, our sales pipeline and improvements in the marketplace.

                                       15
<PAGE>
Despite  the 10%  growth in DRM  revenues  in the first half 2004 over the first
half of 2003,  revenues  were  adversely  affected  by delays in the  purchasing
decision  of certain  prospects  and  customers  near the end of the quarter and
competition  in the DRM space.  This  slowdown in  corporate  spending  has been
observed  industry-wide among CRM and ERP companies,  and has been attributed to
concerns about job growth in the future, uncertainty in the current geopolitical
climate,  and  uncertainty  about the outcome of the upcoming U.S.  presidential
election.  The Company also formally launched its hosted DRM offering during the
second quarter of 2004,  and this resulted in our deferral of licensing  revenue
for these customers into future periods.

For the first half of 2004 our operating expenses decreased by $3.6 million,  or
27%,  compared  to the same  period  for the prior  year.  We  believe  the cost
reductions  combined with an increase in revenues will be sufficient to allow us
to meet our cash needs through December 31, 2004.

At June 30, 2004,  our cash balance was $4.0 million  compared with $9.6 million
at year-end  2003.  Operating  results and our liquidity  position are discussed
further below.


                                       16
<PAGE>

Results of Operations

Three and Six Months Ended June 30, 2004  Compared to Three and Six Months Ended
June 30, 2003.

The  following  table sets  forth,  for the  periods  indicated,  the amount and
percentage  of total  revenues  represented  by certain  items  reflected in our
consolidated statements of operations:


                               Axeda Systems Inc.
              Unaudited Consolidated Statements of Operations Data
                                 (In thousands)

<TABLE>
<CAPTION>
                                             Three Months Ended June 30,               Six Months Ended June 30,
                                    ------------------------------------------  ------------------------------------------
                                            2004                   2003                 2004                2003
                                    --------------------  -------------------   --------------------  ----------------------
                                              Percent of           Percent of             Percent of             Percent of
                                      Amount   Revenues   Amount    Revenues      Amount   Revenues    Amount     Revenues
                                      ------   --------   ------   --------       ------   --------    ------     --------
Revenues:
<S>                                  <C>          <C>    <C>          <C>       <C>           <C>      <C>          <C>
   License .......................   $  1,577     54.5%  $  2,158     77.8%     $  3,911      60.8%    $  4,475     72.3%
   Services and maintenance ......      1,252     43.2        570     20.5         2,433      37.8        1,533     24.8
   Hardware ......................         66      2.3         46      1.7            86       1.3          183      2.9
                                     --------    -----     --------    -----     --------    ------    --------    -----
     Total revenues ..............      2,895    100.0      2,774      100.0       6,430     100.0        6,191    100.0
                                     --------    -----     --------    -----     --------    ------    --------    -----
Cost of revenues:
   License .......................        236      8.1        314       11.3         430       6.7          825     13.3
   Services and maintenance ......        850     29.4      1,025       37.0       1,973      30.7        2,037     32.9
   Hardware ......................       --       --            1        --         --         --             1      --
   Software amortization .........        112      3.9        159        5.7         224       3.5          316      5.1
                                     --------    -----     --------    -----     --------    ------    --------     -----
     Total cost of revenues ......      1,198     41.4      1,499       54.0       2,627      40.9        3,179     51.3
                                     --------    -----     --------    -----     --------    ------    --------     -----

   Gross profit ..................      1,697     58.6      1,275       46.0       3,803      59.1        3,012     48.7
                                     --------    -----     --------    -----     --------    ------    --------     -----

Research and development(R&D)
    Non-cash compensation ........          2      0.1         28        1.0           2       0.1           56      0.9
    Other R&D expense ............      1,031     35.6      1,407       50.7       2,122      33.0        3,121     50.4
Sales and marketing (S&M)
    Non-cash compensation ........         (2)    (0.1)         6        0.2          43       0.7           17      0.3
    Other S&M expense ............      1,846     63.8      2,276       82.1       3,972      61.8        4,781     77.2
General and administrative (G&A)
    Non-cash compensation ........         29      1.0        170        6.1          59       0.9          273      4.4
    Other G&A expense ............      1,087     37.6      1,956       70.5       2,985      46.4        4,517     73.0
Depreciation and amortization ....        255      8.8        262        9.5         518       8.0          570      9.2
                                     --------    -----     --------    -----     --------    ------    --------    -----
   Total operating expenses ......      4,248    146.8      6,105      220.1       9,701     150.9       13,335    215.4
                                     --------    -----     --------    -----     --------    ------    --------    -----

   Operating loss ................     (2,551)   (88.2)    (4,830)    (174.1)     (5,898)    (91.7)     (10,323)  (166.7)

Gain on disposal of assets .......        110      3.8       --       --             110       1.7          743      12.0
Interest income (expense), net and
other income (expense), net ......         27      1.0         22        0.8         755      11.7           35       0.5
                                     --------    -----     --------    -----     --------    ------    --------    -----
   Loss before income tax ........     (2,414)   (83.4)    (4,808)    (173.3)     (5,033)    (78.3)      (9,545)   (154.2)
Provision for income taxes .......         10      0.3         45        1.6          30       0.5           95       1.5
                                     --------    -----     --------    -----     --------    ------    --------    -----
   Net loss ......................   $ (2,424)   (83.7)%  $ (4,853)   (174.9)%     (5,063)   (78.8)%   $(9,640)    (155.7)%
                                     ========    =====     ========    =====      ========   ======    ========    =====
</TABLE>

                                       17
<PAGE>
Results of Operations

REVENUES.  Overall revenues  increased by $0.1 million or 4% and $0.2 million or
4%, to $2.9 million and $6.4 million, during the three and six months ended June
30, 2004,  respectively,  compared to the same periods in 2003. Sales of our DRM
solutions  increased  $0.1 million or 4% and $0.6 million or 10%, while hardware
sales were  relatively  flat and decreased $0.1 million during the three and six
months ended June 30, 2004, respectively.

License  revenues for the three and six months ended June 30, 2004  decreased by
approximately $0.6 million in each period, compared to the same periods in 2003.
The decrease in license  revenues for the three months and six months ended June
30, 2004 was due to reduced  sales from our  Japanese and U.S.  subsidiaries  of
$0.5  million and $0.1  million  respectively,  compared to the same  periods in
2003.  For the  balance  of 2004 we expect  DRM  license  revenues  to  increase
compared to 2003 as our DRM software solutions are more widely adopted.

Decreased sales of  fully-reserved,  outdated  components of our former Internet
appliance,  or IA, business  resulted in a decline in hardware  revenues of $0.1
million to $0.1  million  for the six  months  ended  June 30,  2004,  from $0.2
million for the six months  ended June 30,  2003.  In 2004,  we expect  hardware
revenues and related gross profit to be minimal due to the decreasing quantities
available and the uncertainty of any future sales.

Services and maintenance  revenues  increased $0.7 million and $0.9 million,  or
120% and 59%, for the three and six months  ended June 30,  2004,  respectively,
compared to the same periods in 2003. The increases over the three and six-month
periods,  in  comparison  to the same periods in 2003,  are due to a significant
increase in demand for  professional  services in  connection  with existing DRM
installations,  as  well as  additional  maintenance  plans  sold  with  new DRM
systems. We anticipate  services and maintenance  revenues will vary, as work in
this area is subject to our customers' requirement and approval process.

Historically, the majority of our revenues have been derived from a small number
of customers.  However,  since  entering the  enterprise  software  market,  our
revenues are becoming  less  concentrated.  For the three and six month  periods
ended June 30, 2004, our top three customers accounted for $0.5 million, or 16%,
and $1.6 million or 25% of our total revenues,  respectively.  For the three and
six month periods  ended June 30, 2003,  our top three  customers  accounted for
$0.8  million,  or 29%,  and  $1.2  million,  or  20%,  of our  total  revenues,
respectively.  In the future,  we expect our revenues to be less concentrated as
sales of our software and services span a wider  customer  base.  There has also
been a shift in  industry-wide  buying  patterns for enterprise  software,  from
large up-front purchases to smaller, more frequent purchases over time. Finally,
the  introduction  of our hosted  offering is also  expected  to reduce  revenue
concentration in the future.

We sell our DRM system  solutions  primarily to companies in the  industrial and
building  automation,  high technology  devices,  medical  instrumentation,  and
office  automation  industries.  In the quarter  ended June 30, 2004,  customers
based in North America  accounted for 38% of our  revenues.  We anticipate  that
revenues from international  operations will continue to represent a significant
portion of our revenues.

COST OF REVENUES.  Cost of revenues  decreased by $0.3 million and $0.6 million,
or 20% and 17%, respectively, to $1.2 million and $2.6 million for the three and
six months  ended June 30, 2004,  respectively,  compared to the same periods in
2003.

Cost of revenues  for license  fees for the three and six months  ended June 30,
2004  decreased by  approximately  $0.1 million and $0.4 million,  respectively,
compared to the same periods in 2003. While the $0.1 million decrease in cost of
license  revenues  for  the  quarter  ended  June  30,  2004  is due to  reduced
production  costs in our overseas  locations,  the $0.4 million decrease for the
six months ended June 30, 2004, is due to decreased license fees associated with
our  discontinued  PC products of $0.2  million,  and a decrease in DRM costs of
$0.2 million,  resulting from the closure of our Israeli  operations  during the
first quarter of 2003 and decreased  product and packaging costs, as a result of
our ongoing cost management initiatives. We expect our cost of license fees as a
percentage  of license  revenues to decline,  as our  license  revenues  are now
comprised entirely of our DRM products.

Cost of revenues for services and maintenance decreased by $0.2 million and $0.1
million  for the  three  and six  months  ending  June 30,  2004,  respectively,
compared  to the same  periods in 2003.  The $0.2  million  decrease  in cost of
services  and  maintenance  for the three months ended June 30, 2004 is due to a
$0.1 million decrease in travel expense and a $0.1 million decrease in severance
expense  compared  to the  prior  year.  We  expect  our  cost of  services  and
maintenance as a percentage of services and maintenance  revenues to decline, to
reflect  cost  savings from our  restructuring  activities,  but may vary as our
services revenues change.

                                       18
<PAGE>
Software  amortization of our developed and core  technologies for the three and
six months  ending  June 30,  2004  decreased  less than $0.1  million  and $0.1
million,  respectively,  compared to the same  periods in 2003,  due to the full
amortization  of  certain  identified  intangibles.   Non-cash  amortization  of
acquired  technology  will represent  approximately  $0.5 million of our cost of
revenues for the year ending December 31, 2004.

GROSS PROFIT.  Gross profit increased $0.4 million and $0.8 million,  or 33% and
26%, to $1.7  million and $3.8  million for the three and six months  ended June
30, 2004,  respectively,  compared to the same periods in 2003.  The increase in
gross profit is attributable to an increase in services and maintenance revenues
due to increased capacity utilization, the closure of our Israeli operations and
reduced software amortization expense.

For the three and six month periods ended June 30, 2004 and 2003,  substantially
all of our revenues were derived from licenses and services and maintenance.  As
a percentage of total  revenues,  gross profit margin  increased from 46% to 59%
for the quarters ended June 30, 2003 and June 30, 2004,  respectively and 49% to
59% for the six months ended June 30, 2003 and June 30, 2004, respectively.  The
overall  improvement  in gross profit margin is directly due to our services and
maintenance  operations,  which experienced  positive margins for the six months
ended June 30, 2004 versus negative  margins in 2003.  These  improvements  were
accomplished  by  significantly  increasing  the number of  billable  consulting
engagements,  while  simultaneously  decreasing  the cost of operations  through
better capacity utilization.

OTHER RESEARCH AND DEVELOPMENT  ("R&D")  EXPENSE.  Other R&D expense consists of
staff,  staff-related,  professional and other development related support costs
associated with the development of new products,  quality assurance and testing.
R&D expenses  decreased  $0.4 million and $1.0 million,  or 27% and 32%, to $1.0
million  and $2.1  million for the three and six months  ending  June 30,  2004,
respectively, compared to the same periods in 2003.

The  decrease in other R&D expense  during the quarter  ended June 30, 2004 from
the prior year was due to decreases in staff and staff  related  expense of $0.2
million,  severance  expense of $0.1 million and $0.1 million of other  expense.
The decrease in other R&D expense for the six months ended June 30, 2004 was due
to decreases in staff and staff related expense of $0.5 million,  lower expenses
associated  with the closure of our Israeli  operations  and severance  totaling
$0.3 million and $0.2  million of other  expense.  As a percentage  of revenues,
other R&D expenses  decreased  from 51% to 36%, and 50% to 33% for the three and
six months ended June 30, 2004,  compared to the same periods in 2003. We expect
other R&D expense to decrease  slightly in 2004 as we optimize  our  development
teams to meet our current business requirements.  Additionally,  we expect other
R&D  expense  to  decrease  as a  percentage  of  revenues  if and as our future
revenues increase.

OTHER  SALES AND  MARKETING  ("S&M")  EXPENSE.  Other S&M  expense  consists  of
salaries, travel expenses and costs associated with trade shows, advertising and
other sales and marketing efforts, as well as technical support costs. Other S&M
expense decreased  approximately $0.4 million and $0.8 million,  or 19% and 17%,
to $1.8  million and $4.0  million  for the three and six months  ended June 30,
2004, respectively, compared to the same periods in 2003.

Reduced  severance,   staff  and  staff  related  expense,  and  travel  expense
contributed $0.2 million, $0.1 million and $0.1 million to the decrease in other
S&M expense during the quarter ended June 30, 2004 from the prior year.  Reduced
severance,  staff and staff related expense, and travel expense contributed $0.2
million,  $0.4 million and $0.2 million to the decrease in other S&M expense for
the six months  ended June 30,  2004 from the prior  year.  As a  percentage  of
revenues,  other  S&M  expense  decreased  from  82% to  64%,  and  77% to  62%,
respectively,  for the three and six months ended June 30, 2004, compared to the
same periods in 2003.  We expect other S&M expense to decrease  slightly in 2004
as  we  optimize  our  S&M  marketing   teams  to  meet  our  current   business
requirements.  Additionally,  we expect  other S&M  expense as a  percentage  of
revenues to decrease if and as our future revenues increase.

OTHER GENERAL AND ADMINISTRATIVE  ("G&A") EXPENSE. Other G&A expense consists of
staff, staff related, and support costs for our finance, human resources,  legal
and other management departments.  Other G&A expenses decreased $0.9 million and
$1.5 million, or 44% and 34%, to $1.1 million and $3.0 million for the three and
six months  ended June 30, 2004,  respectively,  compared to the same periods in
2003.  As a  percentage  of total  revenues,  other  general and  administrative
expenses  decreased  from 71% to 38%,  and 73% to 46% of total  revenues for the
three and six months ended June 30, 2004.

                                       19
<PAGE>
The $0.9  million  decrease in other G&A expense for the quarter  ended June 30,
2004  relates to the  reversal of  estimated  patent and  intellectual  property
accruals  of $0.4  million no longer  considered  necessary,  reduced  severance
expense  of  $0.2  million,  reduced  insurance  expense  of $0.1  million,  and
decreases in other expense of $0.2 million from the prior year. The $1.5 million
decrease in other G&A expense for the six months  ended June 30, 2004 relates to
the  reversal of estimated  patent and  intellectual  property  accruals of $0.4
million no longer  considered  necessary and reduced  severance  expense of $0.4
million. In addition,  we reduced staff and related compensation expense by $0.2
million,  reduced  insurance  expense  by $0.2  million  and  reduced  other and
professional  fees totaling $0.3 million as part of our ongoing cost  management
initiatives.  We expect other G&A expense to decrease in 2004 as we optimize our
general  and  administrative  teams to meet our current  business  requirements.
Additionally,  we expect  other G&A  expense  to  decrease  as a  percentage  of
revenues if and as our future revenues increase.


NON-CASH COMPENSATION G&A EXPENSE. Non-cash G&A expense consists of amortization
of compensation  related to stock options.  Non-cash G&A expense  decreased $0.1
million and $0.2  million for the  quarter and six months  ended June 30,  2004,
respectively,  from $0.2 million and $0.3 million for the quarter and six months
ended June 30,  2003,  respectively.  The  decrease is  attributable  to certain
deferred  compensation  having become fully amortized as a result of the related
stock option awards having fully vested.

DEPRECIATION AND AMORTIZATION. We recorded depreciation and amortization of $0.3
million the three months  ended June 30, 2004 and June 30,  2003,  respectively,
and  depreciation  and amortization of $0.5 million and $0.6 million for the six
months ended June 30, 2004 and June 30, 2003.

GAIN ON DISPOSAL OF ASSETS. During the quarter ended June 30, 2004 we determined
that a $0.1 million  accrual  recorded in connection with the sale of the assets
of our  former  consumer  electronics  business  in  March  2001  was no  longer
considered necessary and thus was reversed. We signed a confidential  settlement
agreement in March 2003 for the escrow relating to the sale of the assets of our
former IA business in March 2001. In connection with this settlement  agreement,
we reversed  accruals of  approximately  $0.7 million  recorded in March 2001 as
part of the sale. No corresponding  gains were recorded for the six months ended
June 30, 2004.

OTHER INCOME  (EXPENSE),  NET. We entered into a registration  rights  agreement
with the investors in the PIPE financing  pursuant to which we were obligated to
file a registration  statement with the SEC for the resale of the shares sold in
the transaction  and the shares issuable upon exercise of the warrants.  The SEC
declared the registration  statement effective on October 23, 2003. In the event
that sales cannot be made because we have not updated the registration statement
to keep it effective, we will be required to pay liquidated damages to each PIPE
investor  equal to 1.5% of the  purchase  price paid by such  investor  for each
thirty-day  period or pro rata for any portion  thereof  after the deadline that
passes before the  registration  statement is updated and declared  effective by
the  SEC.  While we view  the  liquidated  damages  contingency  related  to the
financing-related  liability as neither  probable nor reasonably  estimable,  we
recorded the  estimated  fair value of the warrant as of September 23, 2003 as a
financing-related liability in the consolidated balance sheet in accordance with
EITF Issue No.  00-19.  The fair  value of the  financing-related  liability  is
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.
The related  mark-to-market  non-cash  gain for the three and six month  periods
ended June 30, 2004 was less than $0.1 million and $0.8  million,  respectively.
Due to the uncertainty surrounding the variables required by the valuation model
for the  financing-related  liability and corresponding gain or loss adjustment,
we cannot  estimate  the future  income or expense  resulting  from the periodic
valuations of the liability.

FOREIGN  CURRENCY EFFECTS ON RESULTS OF OPERATIONS.  Foreign currency  movements
for the three and six months ended June 30, 2004 increased revenues and expenses
by $0.1 million and $0.4 million,  respectively,  from the prior year. Increases
in revenues  and  expenses  from foreign  currency  fluctuations  are due to the
weakness  versus  prior year of the U.S.  dollar  against the Euro,  the British
pound and the Japanese  yen.  Although we cannot  predict the future  changes in
foreign currency rates, any strengthening of the U.S. dollar against the foreign
currencies will have an unfavorable impact on our revenues in 2004, and an equal
but opposite favorable impact on our expenses in 2004. We expect that changes in
foreign currencies will not have a material effect on our net loss for 2004.




                                       20
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES

Since March 2001, our operations have largely been financed through the sales of
the assets of our Consumer Electronics and Internet Appliance businesses and the
September 2003 PIPE financing.  As of June 30, 2004, we had $4.0 million in cash
and cash equivalents.

Net cash used in operating activities for the six months ended June 30, 2004 was
$5.5 million,  compared to $11.4 million for the six months ended June 30, 2003.
Cash used in operating activities for the first six months of 2004 was primarily
the result of our net loss of $5.1 million, and other changes in working capital
of approximately  $0.5 million.  The reduction in net cash used in operations is
primarily the result of the lower net loss.

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.  We have  halved the number of global  offices,
reduced  staffing  levels by 46% by  eliminating  or not replacing 96 employees,
engaged partners to provide us with variable staffing  capabilities to meet peak
demand periods and have closely monitored our  infrastructure  costs. In 2002 we
exited the PC  business  and  focused our efforts on several key markets for DRM
Systems products. In 2002 and 2003, we recorded $1.9 million and $1.4 million in
restructuring  charges,  respectively,  to  reduce  staffing  levels,  terminate
certain leases and consolidate our operations.  We continue to evaluate our cost
structure and in the third  quarter,  are taking  additional  measures to reduce
expenses and anticipate  recording $1.0 million to $1.5 million in restructuring
charges  to  reduce  staffing  levels,  terminate  certain  leases  and  further
consolidate our operations.

Net cash used in investing activities for the six months ended June 30, 2004 and
2003 was $0.1 million,  and consisted of purchases of furniture and equipment in
both periods. We have no material commitments for capital  expenditures,  and we
anticipate minimal spending on capital  expenditures as our needs in operations,
infrastructure and personnel arise.

Net cash used in financing  activities was $0.1 million for the six months ended
June 30, 2004, and consisted of principal  payments reducing  indebtedness.  Net
cash provided by financing  activities was $0.2 million for the six months ended
June 30, 2003, and was attributable to borrowings against our line of credit.

In June 2003 we executed a loan and security agreement with Silicon Valley Bank,
that provided us with a line of credit, or the Line, in the amount of the lesser
of $2.0 million or the borrowing  base,  as defined  (limited to a percentage of
eligible  accounts   receivable).   In  May  2004  we  renewed  the  Line  under
substantially the same terms as the prior agreement. As of June 30, 2004, we had
$0.3 million in borrowings under the Line, which were repaid in July 2004. As of
June 30, 2004, we were in compliance with all of our covenants under the Line.

In June 2004 we amended a Software License Agreement,  or the Agreement,  with a
vendor  who  provide  server and client  software  that is bundled  with our DRM
enterprise server products. License fees are due and payable at the rate of 2.5%
of each billable  sale,  as defined.  Under the  Agreement,  we agreed to pay an
additional  minimum,  non-refundable  prepaid license fee of $200,000,  which is
payable in installments.  We paid $100,000 in July 2004, and are required to pay
the remaining $100,000 on December 20, 2004.

As of June 30, 2004, we have $1.1 million of estimated  accrued costs related to
facilities leases that we no longer occupy. We have made significant  efforts to
terminate  these  leases,  but if these leases  cannot be  terminated  or if the
facilities  cannot be sublet, we may be required to make these payments over the
respective lease terms.

We maintain an irrevocable,  cash-secured, standby letter of credit (the "letter
of  credit")  from a bank  for  $0.15  million  as  security  for our  corporate
headquarters lease. The letter of credit expires in August 2004 and provides for
automatic one-year renewals, but not beyond August 2007. The letter of credit is
secured by a certificate  of deposit for $0.15  million from the same bank,  and
also expires in August 2004.  This amount is restricted  for  withdrawal  and is
included in other assets (non-current) in our consolidated balance sheets.

Based upon our current cash resources and revised financial  projections for the
remainder of the year we currently  anticipate that our available funds and cash
flows  from  operations  should be  sufficient  to meet our cash  needs  through
December 31, 2004.  As such,  we will require  additional  financing to fund our
operations  through December 2005. We intend to obtain  sufficient  financing to
fund our operations, along with cash flows from operations, so that this planned
financing  combined  with  additional   restructuring   efforts  will  allow  us
sufficient cash resources to meet our cash needs through at least December 2005.
However,  due to risks and  uncertainties,  we cannot assure  investors that our
future operating cash flows will be sufficient to meet our requirements. In such
event, our operations and liquidity will be materially  adversely  affected.  We
cannot  assure you that the  additional  financing  will be  available  to us on
favorable terms when required,  or at all. If we raise  additional funds through
the issuance of equity,  equity-linked or debt securities,  those securities may
have rights, preferences or privileges senior to the rights of our common stock,
and our stockholders may experience dilution.  See also "Factors That May Affect
Future Results," below.
                                       21
<PAGE>
Employee and Director Stock Options


Option Program Description

Our stock option program is a broad-based,  long-term  retention program that is
intended to attract,  retain and provide  performance  incentives  for  talented
employees,  officers  and  directors,  and to  align  stockholder  and  employee
interests.  Currently,  we grant options from the 1999 Stock  Incentive Plan, as
amended,  or the 1999  Plan.  The 1999 Plan has three  separate  programs  which
include:  the discretionary  option grant program,  under which employees may be
granted options to purchase shares of common stock; the stock issuance  program,
under which eligible  employees may be granted  shares of common stock;  and the
automatic grant program, whereby eligible non-employee board members are granted
options to  purchase  shares of common  stock.  To date,  we have not issued any
shares under the stock issuance program.  In addition,  our stock option program
included the 1995 Stock Option Plan,  or the 1995 Plan,  from which we no longer
grant  options.  During the quarter  ended June 30, 2004,  all of the  remaining
outstanding  options under the 1995 Plan expired and were canceled in accordance
with the design and procedures of the 1995 Plan. In connection  with the eMation
acquisition,  we assumed options issued under eMation,  Ltd.'s 2001 Stock Option
Plan that became  exercisable  for up to 1,428,710  shares of our common  stock,
530,000 of which are exercisable  for $0.01 per share and the remaining  898,710
exercisable  at $2.14 per share.  No options have been or will be granted  under
the  eMation,  Ltd.  2001 Stock Option Plan  subsequent  to our  acquisition  of
eMation,  Ltd.  The plans  listed  above  are  collectively  referred  to in the
following discussion as the "Plans." We consider our option programs critical to
our operation and  productivity;  essentially all of our employees  participate.
Option vesting periods are generally one to four years and expire ten years from
the grant date for the 1999 Plan.

All stock  option  grants to  executive  officers are made after a review by and
with the approval of the Compensation  Committee of the Board of Directors.  All
members of the Compensation Committee are independent  directors,  as defined in
the current and proposed rules  applicable to issuers traded on the NASDAQ Stock
Market.  See the  "Compensation  Committee  Report  in  Executive  Compensation"
appearing in our 2003 Proxy  Statement for further  information  concerning  our
policies  and  procedures,   including  those  of  the  Compensation  Committee,
regarding the use of stock options.

Distribution and Dilutive Effect of Options

The table below  provides  information  about stock options  granted for the six
months  ended June 30,  2004 and the year ended  December  31, 2003 to our Chief
Executive  Officer,  Robert  M.  Russell  Jr.,  and our  three  other  executive
officers,  Dale E. Calder,  Thomas J. Fogarty and John C. Roberts. This group is
referred to as the "Named Executive Officers."

<TABLE>
<CAPTION>
                                                                   Six Months Ended June    Year Ended December 31,
                                                                          30, 2004                  2003
                                                                          --------                  ----
<S>                                                                          <C>                   <C>
Net grants during the period as % of outstanding shares .........            2.59%                 4.11%
Grants to Named Executive Officers during the period as % of
 total options granted ...........................................          14.29%                 11.66%
Grants to Named Executive Officers during the period as % of
 outstanding shares granted ......................................           0.37%                  0.48%
Cumulative options held by Named Executive Officers as % of total
 options outstanding .............................................          37.08%                 34.98%
</TABLE>

                                       22
<PAGE>
General Option Information

         The following table sets forth the summary of activity under the Plans
for the six months ended June 30, 2004 and the year ended December 31, 2003:

<TABLE>
<CAPTION>

                                                        Number of Options Outstanding
                                                   --------------------------------------
                              Number of Shares     Number of Shares      Weighted Average
                                 Available for     Issuable on Exercise   Exercise Price
                                     Options          of Options           (per share)
                                    -------          ----------           -----------
<S>                             <C>                 <C>                    <C>
December 31, 2002 ........           263,424          5,078,819             $   1.95
                                                     ==========                =====
Grants ...................        (1,329,000)         1,329,000                 1.47
Exercises ................              --              (85,645)                0.17
Cancellations* ...........           486,902           (601,533)                2.88
Additional shares reserved         1,100,000                N/A                 N/A
                                                     ----------                 -----
December 31, 2003 ........           521,326          5,720,641             $   1.76
                                                     ==========                =====
Grants ...................          (840,000)           840,000                 1.18
Exercises ................              --             (102,586)                0.26
Cancellations* ...........           571,230           (604,044)                4.38
Additional shares reserved           969,282                N/A                  N/A
                                                     ----------                 -----
June 30, 2004 ............         1,221,838          5,854,011             $   1.43
                                                     ==========                 =====
</TABLE>

* The "Number of Shares  Available for Options"  does not include  options under
assumed  plans  exercisable  for  114,631  shares  and 32,814  shares  that were
cancelled  during  2003 and the first six  months of 2004,  respectively,  as no
options will be granted in the future pursuant to these assumed plans.

The following table sets forth a comparison,  as of June 30, 2004, of the number
of shares  subject to our  options  whose  exercise  prices were at or below the
closing price of our common stock on June 30, 2004  ("In-the-money"  options) to
the number of shares subject to options whose exercise  prices were greater than
the closing price of our common stock on such date ("Out-of-the-money" options):

<TABLE>
<CAPTION>
                                            Exercisable                        Unexercisable                    Total
                                  ------------------------------     ---------------------------   ------------------------------

                                   Number of    Weighted Average     Number of  Weighted Average    Number of     Weighted Average
                                     Shares      Exercise Price       Shares    Exercise Price        Shares       Exercise Price
                                  ----------   ---------------      ----------  ----------------   -----------     --------------
<S>                               <C>                <C>              <C>              <C>          <C>                 <C>
In-the-money                      1,507,000          $ 0.17           595,936          $ 0.55       2,102,936           $ 0.28
Out-of-the-money (1)              1,769,450          $ 2.60         1,981,625          $ 1.62       3,751,075           $ 2.08
                                  ---------                         ---------                      ---------
Total options outstanding         3,276,450          $ 1.48         2,577,561          $ 1.38       5,854,011           $ 1.43
                                  =========                         =========                       =========
</TABLE>

(1) Out-of-the-money options are those options with an exercise price equal to
or above the closing price of $1.07 as of June 30, 2004, as reported by the
Nasdaq National Market.

                                       23
<PAGE>
Executive Options

The following  table sets forth  information  regarding stock options granted in
2004 to our Named  Executive  Officers  each under our 1999 Plan.  Options  were
granted with an exercise price equal to the closing price of our common stock on
the date of grant.  Potential  realizable  values are net of exercise price, but
before taxes  associated  with exercise.  These amounts  represent  hypothetical
gains that could be  achieved  for the  options if  exercised  at the end of the
option  term  of ten  years.  The  assumed  5% and  10%  rates  of  stock  price
appreciation are provided for purposes of illustration only and do not represent
our estimate or projection of the future price of our common stock.

<TABLE>
<CAPTION>
                                                   Individual Grants
                         ---------------------------------------------------------------------
                              Number of                                                          Potential Realizable Value
                              Securities     Percentage of Total   Exercise                      at Assumed Annual Rates of
                          Underlying Option  Options Granted to   Price (Per      Expiration     Stock Price Appreciation for
Name                          Per Grant          Employees *        Share)           Date                Option Terms
----                          ---------          -----------        ------           ----         ---------------------------
                                                                                                     5%            10%
                                                                                                  --------      ---------
<S>                                  <C>           <C>             <C>             <C>            <C>            <C>
Robert M. Russell Jr.                      -         -               N/A             N/A             N/A           N/A
Dale E. Calder                             -         -               N/A             N/A             N/A           N/A

Thomas J. Fogarty                    120,000       14.29%          $ 1.17       3/23/2014          $99,732       $260,178
</TABLE>

*Based on a total of 840,000  shares  subject to  options  granted to  employees
under our option plans during 2004.

Stock Option Exercises and Option Holdings

The  following  table  shows  stock  options  exercised  by the Named  Executive
Officers  for the six months ended June 30, 2004,  if any,  including  the total
value of gains on the date of  exercise  based on actual  sale  prices or on the
closing  price that day if the shares  were not sold that day, in each case less
the  exercise  price of the stock  options.  In  addition,  the number of shares
covered by both exercisable and  non-exercisable  stock options,  as of June 30,
2004, is shown.  Also reported are the values for  "In-the-Money"  options.  The
dollar amounts shown in the "In-the-Money"  column represent the positive spread
between the exercise  price of any such  existing  stock options and the closing
price as of June 30, 2004 of our common stock.

<TABLE>
<CAPTION>

                            Number of
                             Shares
Named Executive            Acquired on      Value        Number of Securities Underlying               Values of Unexercised
 Officer                    Exercise      Realized            Unexercised Options                       In-the-Money Options*
-------------------         --------      --------       -----------------------------------        -------------------------------
                                                             Exercisable       Unexercisable        Exercisable        Unexercisable
                                                             -----------       -------------        -----------        -------------

<S>                          <C>           <C>                <C>                <C>                 <C>                 <C>
 Robert M. Russell              -            $ -                660,828            220,172             $356,149            $ 58,711
 Dale E. Calder                 -             -                 531,249             43,751              337,999              28,001
 Thomas J. Fogarty              -             -                 367,498            182,502              258,499              28,001
</TABLE>

* Option values based on stock price of $1.07 on June 30, 2004.

                                       24
<PAGE>
                      EQUITY COMPENSATION PLAN INFORMATION

The following table gives information about our common stock that may be issued
upon the exercise of options under all of our Plans as of June 30, 2004:
<TABLE>
<CAPTION>

                                                (1)                    (2)                       (3)
                                                                                         Number of Securities
                                       Number of Securities     Weighted-Average       Remaining Available for
                                         to be Issued upon      Exercise Price of    Future Issuance Under Equity
                                            Exercise of       Outstanding Options,   Compensation Plans (Excluding
                                       Outstanding Options,   Warrants, and Rights    Securities Reflected in
Plan Category                          Warrants, and Rights        (per share)               Column (1) )
-------------                                    ----------             ------               ------------
Equity Compensation Plan Approved by
<S>                                                <C>                      <C>                 <C>
 Shareholders (A) (B)                               5,854,011                 $ 1.43              1,221,838
                                                    ---------                 ======             =========
</TABLE>

(A)       On December 7, 2001, we acquired all of the outstanding shares of
          eMation, Ltd., a private company organized under the laws of the State
          of Israel, pursuant to a share purchase agreement amended and restated
          as of October 5, 2001. In connection with such acquisition, we assumed
          options issued under eMation, Ltd.'s 2001 Stock Option Plan that
          became exercisable for up to 1,428,710 shares of our common stock,
          530,000 of which are exercisable for $0.01 per share and the remaining
          898,710 exercisable at $2.14 per share. No options have been or will
          be granted under the eMation, Ltd. 2001 Stock Option Plan subsequent
          to our acquisition of eMation, Ltd.

(B)       The number of shares reserved for issuance under our 1999 Stock
          Incentive Plan is automatically increased on January 1 of each year by
          an amount equal to 3% of the shares of our common stock outstanding on
          the last trading day of the immediately preceding calendar year, but
          in no event shall such annual increase exceed 1,000,000 shares. On
          January 1, 2004, 969,282 additional shares were reserved for issuance.


Recent Accounting Pronouncements

Information regarding recent accounting pronouncements is provided in note 1k to
the consolidated financial statements included at Part I, Item 1 herein.


                                       25
<PAGE>
FACTORS THAT MAY AFFECT FUTURE RESULTS

RISK FACTORS

Our business and industry are subject to a number of risks. You should carefully
consider  the risks  described  below,  in  addition  to the  other  information
contained  in this Report and in our other  filings  with the SEC. The risks and
uncertainties  described below are not the only ones we face.  Additional  risks
and uncertainties not presently known to us or that we currently deem immaterial
may also affect our business  operations.  If any of these risks actually occur,
our business,  financial  condition or results of operations  could be seriously
harmed.  In that event,  the market price for our common stock could decline and
you may lose part or all of your investment.

WE HAVE NEVER BEEN PROFITABLE AND MAY NEVER ACHIEVE PROFITABILITY IN THE FUTURE

We had a loss before income taxes of approximately $(5.1) million for the six
months ended June 30, 2004. To date, we have not achieved operating
profitability on an annual basis. We have invested and continue to invest
significant resources in product development, selling and marketing, services
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.

OUR COMMON STOCK RECENTLY BEGAN TRADING ON THE NASDAQ SMALLCAP MARKET AND WE
MUST COMPLY WITH CERTAIN LISTING STANDARDS TO MAINTAIN OUR LISTING ON THE NASDAQ
SMALLCAP MARKET; OUR SWITCH TO THE NASDAQ SMALLCAP MARKET COULD HAVE A NEGATIVE
EFFECT ON THE TRADING PRICE AND LIQUIDITY OF OUR COMMON STOCK

On August 5, 2004 our common stock began trading on The Nasdaq SmallCap Market.
Although Nasdaq has indicated that we currently meet the requirements for
listing on The Nasdaq SmallCap Market (other than the $1.00 minimum bid price),
there can be no assurance that we will be able to remain in compliance with all
requirements for continued listing on The Nasdaq SmallCap Market, including the
requirement that the minimum bid price of our common stock not be below $1.00
for 30 consecutive business days (followed by a grace period of up to one year
to regain compliance if other core listing standards, other than minimum bid
price, are met). In addition, the transfer of our common stock to The Nasdaq
SmallCap Market could have a negative effect on the trading price or the
liquidity of our common stock. If we were not able to maintain our listing on
The Nasdaq SmallCap Market, we would likely apply for listing on the OTC
Bulletin Board or another quotation system or exchange for which we could
qualify. We cannot guarantee, however, that if we were unable to maintain our
listing on The Nasdaq SmallCap Market, that we would be eligible for listing on
the OTC Bulletin Board or another quotation system or exchange, or, that if we
do become listed, that there would be no interruption in the trading of our
common stock or that we would be able to maintain eligibility.

WE WILL REQUIRE ADDITIONAL FUNDING TO CONTINUE OUR OPERATIONS AS CURRENTLY
PLANNED BEYOND DECEMBER 31, 2004 AND IT MAY BE DIFFICULT TO RAISE NEEDED CAPITAL
IN THE FUTURE, WHICH COULD SIGNIFICANTLY HARM OUR BUSINESS

Based upon our current cash resources and our revised financial projections for
the remainder of the year we currently anticipate that our available funds and
cash flows from operations will be sufficient to meet our cash needs through
December 31, 2004. Our capital requirements will depend on many factors,
including but not limited to the following:

     o acceptance of and demand for our DRM products;

     o our ability to continue year over year growth in DRM systems revenues;

     o the costs of developing new products;

     o the  extent  to  which we  invest  in new  technology  and  research  and
     development projects;

     o competing technological and market developments; and

     o  the  expansion  of  strategic   alliances  for  the  sales,   marketing,
     manufacturing and distribution of our products.

                                       26
<PAGE>
In order to continue our planned  operations beyond  approximately  December 31,
2004, we will be required to seek additional funds through equity, equity-linked
or debt financing,  strategic  alliances with corporate  partners and others, or
through other sources or strategic transactions.  We intend to obtain sufficient
financing to fund our operations, along with cash flows from operations, through
December 2005.  There can be no assurance that the financial  sources  described
above will be available when needed or on terms commercially acceptable to us or
at all.  In  addition,  our common  stock is now  listed on The Nasdaq  SmallCap
Market and under certain Federal and state securities laws, equity financings we
may enter into in the future may be subject to additional  state securities laws
and  regulations  which we were  exempt  from when we were  listed on The Nasdaq
National Market.  Such additional laws and regulations  could impede or restrict
our ability to raise additional funds from equity financings.  If adequate funds
are not  available  when  needed,  we will likely be required to delay,  further
scale back or eliminate  certain  aspects of our operations or attempt to obtain
funds  through  arrangements  with  collaborative  partners  or others  that may
require us to  relinquish  rights to certain of our  technologies,  products  or
potential markets. If adequate funds are not available, our business,  financial
condition and results of operations  will be materially and adversely  affected.
If we issue additional stock to raise capital,  your percentage  ownership in us
would be reduced.

OUR FUTURE SUCCESS DEPENDS UPON THE ACCEPTANCE OF OUR DRM SYSTEM SOLUTIONS

Our future growth will be driven by sales of Axeda DRM systems and related
services. We acquired eMation, Ltd., or eMation, a private Israeli company, in
December 2001. eMation was founded in 1988 and historically derived its main
source of revenues from its industrial automation products. We offer the Axeda
DRM System and also continue to separately sell the Axeda Supervisor, Axeda
@aGlance/IT, Axeda Web @aGlance and Axeda FactorySoft OPC to support our
industrial automation business.


WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY

Competition in the market for DRM solutions is emerging and expected 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.

WE MAY NOT BE ABLE TO KEEP PACE WITH TECHNOLOGICAL ADVANCES

The process of remotely extracting 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. Although we plan to continue
to spend substantial amounts on research and development in the future, we
cannot assure you that we will develop new products and product enhancements
successfully or that our products will achieve broad market acceptance. Our
failure to respond in a timely and cost-effective manner to new and evolving
technologies and other market changes and developments could have a material
adverse effect on our business.

                                       27
<PAGE>
OUR SALES CYCLE FOR DRM SYSTEMS IS LONG AND MAY BE SEASONAL AND WE MAY RELY ON
LARGE CONTRACTS FROM RELATIVELY FEW DRM CUSTOMERS, WHICH MAY CAUSE OUR OPERATING
RESULTS TO FLUCTUATE

Our sales cycle is lengthy and may be subject to seasonality. Our DRM Systems
sales typically involve significant capital investment decisions by prospective
customers, as well as a significant amount of time to educate them as to the
benefits of our products. As a result, before purchasing our products, companies
spend a substantial amount of time performing internal reviews and obtaining
capital expenditure approvals. It may take up to nine to twelve months or more
from the time we first contact a prospective customer before receiving an
initial order. The length of our DRM Systems 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.

Furthermore, our software license revenues may result from a relatively small
number of sales, some of which may generate disproportionately large revenues.

VARIATIONS  IN THE  LENGTH OF OUR  SALES  CYCLES  COULD  CAUSE  OUR  REVENUE  TO
FLUCTUATE WIDELY FROM PERIOD TO PERIOD

Because we have typically recognized a substantial portion of our software
revenue in the last month of a quarter, any delay in the license of our products
could cause significant variations in our revenue from quarter to quarter. These
fluctuations could cause our operating results to suffer in some future periods
because our operating expenses are relatively fixed over the short term and we
devote significant time and resources to prospective clients.

A VARIATION  IN THE  CONVERSION  OF OUR  REVENUE  PIPELINE  TO  CONTRACTS  COULD
ADVERSELY AFFECT OUR REVENUES AND ABILITY TO FORECAST OPERATIONS

Our revenue pipeline estimates may not consistently correlate to actual revenues
in a particular quarter or over a longer period of time. There has been a shift
in industry-wide buying patterns for enterprise software, from large up-front
purchases to smaller, more frequent purchases over time. A variation in the
revenue pipeline or in the conversion of the revenue pipeline into contracts
could cause us to plan or budget inaccurately and thereby could adversely affect
our business, financial condition or results of operations.

IT MAY BE DIFFICULT, TIME-CONSUMING AND EXPENSIVE FOR OUR CUSTOMERS TO INTEGRATE
OUR DRM SOLUTIONS WITH THEIR PRODUCTS AND THEY MAY BE UNABLE TO DEPLOY THEIR
PRODUCTS SUCCESSFULLY OR OTHERWISE ACHIEVE THE BENEFITS ATTRIBUTABLE TO OUR DRM
SOLUTIONS

Our customers often desire to integrate our DRM 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 DRM
solutions may limit our ability to expand our revenues, and may result in
customer dissatisfaction, causing harm to our reputation.

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 50%, reduced staffing levels by 46%, eliminating or not replacing 96
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 in the third quarter of 2004, are taking
additional measures to reduce expenses for the third quarter and beyond.

                                       28
<PAGE>
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.

OUR FUTURE  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 we anticipate that we will continue to derive, a significant
portion of our revenues from these relationships.

Our future growth will be limited if:

     o we fail to work effectively with indirect distribution channels;

     o we fail to increase  the number of indirect  distribution  channels  with
     which we have relationships;

     o the business of one or more of our indirect  distribution channels fails;
     or

     o there is a  decrease  in the  willingness  and  ability  of our  indirect
     distribution  channels  to  devote  sufficient  resources  and  efforts  to
     marketing and supporting our products.

If any of these circumstances occurs, we will have to devote substantially more
resources to the sales, marketing, distribution, implementation and support of
our products than we otherwise would, and our own efforts may not be as
effective as those of our indirect distribution channels.

INCREASED  SALES THROUGH  INDIRECT  CHANNELS MAY ADVERSELY  AFFECT OUR OPERATING
PERFORMANCE

Even if our marketing efforts through indirect channels are successful and
result in increased sales, our average selling prices and operating margins
could be adversely affected because of the lower unit prices that we receive
when selling through indirect channels.

WE 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

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.

OUR BUSINESS MODEL DEPENDS UPON LICENSING OUR INTELLECTUAL  PROPERTY,  AND IF WE
FAIL TO 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 important to our business. We currently have one United States Patent and
eleven United States patent applications pending relating to our DRM business
and ten patent applications pending internationally. 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:
                                       29
<PAGE>
     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," are likely be expensive to
resolve and may not be successful, and will require management's time and
resources and, therefore, could harm our business.

WE MAY BE SUBJECT TO PRODUCT  LIABILITY  CLAIMS  AND  REDUCED  SALES  BECAUSE OF
DEFECTS IN OUR PRODUCTS

Our products are very complex and may contain undetected errors that could harm
our reputation, result in product liability or decrease market acceptance of our
products. The likelihood of errors is higher when a new product is introduced or
when new versions or enhancements are released. Our products are integrated with
our customers' networks and software applications. Errors may also arise as a
result of defects in the products and systems into which our products are
incorporated. We are unable to test our products in each of the applications in
which they are designed to work. It is possible that defects could cause our
customers to experience 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 it is foreseeable that a customer could cancel a contract due to defects;

     o diversion of development resources;

     o increased product development costs;

     o damage to our reputation;

     o delay or diminish market acceptance of our products;

     o increased service and warranty costs; and

     o litigation costs.

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.

                                       30
<PAGE>
SUBSTANTIAL  LITIGATION  REGARDING  INTELLECTUAL  PROPERTY  RIGHTS EXISTS IN OUR
INDUSTRY

There is a risk that third-parties, including current and potential competitors
and current developers of our intellectual property, will claim that our
products, or our customers' products, infringe on their intellectual property
rights or that we have misappropriated their intellectual property. Software,
business processes and other property rights in our industry might be
increasingly subject to third-party infringement claims as the number of
competitors grows and the functionality of products in different industry
segments overlaps. Other parties might currently have, or might eventually be
issued, patents that infringe on the proprietary rights we use. Any of these
third parties might make a claim of infringement against us.

We may be required to pay substantial damages and may be restricted or
prohibited from selling our products if it is proven that we violate the
intellectual property rights of others. The defense of infringement claims and
lawsuits, regardless of their outcome, would likely be expensive to resolve and
could require a significant portion of management's time. We cannot assume that
we will prevail in intellectual property disputes regarding infringement,
misappropriation or other disputes. Litigation in which we are accused of
infringement or misappropriation might cause a delay in the introduction of new
products, require us to develop non-infringing technology, require us to enter
into royalty or license agreements, which might not be available on acceptable
terms, or at all, or require us to pay substantial damages, including triple
damages if we are held to have willfully infringed a third party's intellectual
property. If a successful claim of infringement was made against us and we could
not develop non-infringing technology or license the infringed or similar
technology on a timely and cost-effective basis, our business could be
significantly harmed.

In addition, rather than litigating an infringement matter, we may determine
that it is in our best interests to settle the matter. The terms of a settlement
may include the payment of damages and our agreement to license technology in
exchange for a license fee and ongoing royalties. These fees may be substantial.
If we are forced to take any of the actions described above, defend against any
claims from third parties or pay any license fees or damages, our business could
be harmed.

WE HAVE RECEIVED NOTICES OF CLAIMS RELATED TO OUR FORMER PC PRODUCTS (OR DIGITAL
MEDIA PRODUCTS) REGARDING THE ALLEGED INFRINGEMENT OF THIRD PARTIES'
INTELLECTUAL PROPERTY RIGHTS THAT MAY CAUSE US TO PAY DAMAGES.

Some third parties claim to hold patents covering various aspects of digital
television, or DTV, high-definition television, or HDTV, and digital versatile
disk, or DVD technology incorporated into our former and our former PC
customers' digital media products and have claimed that various aspects of DTV,
HDTV and DVD technology incorporated into our and our customers' digital media
products infringe upon patents held by them, including the following:

A group of companies formed a consortium known as MPEG-LA to enforce the
proprietary rights of other holders of patents covering essential aspects of
MPEG-2 technology that were incorporated into our former PC products.

Another group of companies formed a consortium known as DVD6C (formerly DVD
Patent License Program) to enforce the proprietary rights of other holders of
patents covering essential aspects of DVD technology that were incorporated into
our former PC products.

Another consortium of companies, commonly known as 3C, notified a number of DVD
product manufacturers that the members of the consortium hold patents that are
essential to DVD technology, and have requested that such companies pay license
royalties for the use of the technology covered by the 3C patents.

If MPEG LA, DVD6C, 3C, or any other third party proves that our former digital
media products infringe their proprietary rights, we may be required to pay
substantial damages for such past infringement.

We may also be liable to some of our former customers for damages that they
incur in connection with intellectual property claims. Some of our license
agreements with former customers contain warranties of non-infringement and/or
commitments to indemnify our former customers against liability arising from
infringement of third-party intellectual property, which may include third-party
intellectual property such as the patents held by members of MPEG LA, DVD6C, 3C
and others. These commitments may require us to indemnify or pay damages to our
former customers for all or a portion of any license fees or other damages,
including attorneys' fees, they are required to pay or agree to pay these or
other third parties. We have received notices of up to an aggregate of $6.5
million asserting rights under the indemnification provisions and warranty
provisions of our license agreements from several of our former digital media
products customers. We may be required to pay substantial damages with respect
to such indemnification assertions, which could have a material adverse effect
on our business, financial condition or results of operations.

                                       31
<PAGE>
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 Japan, France,
Switzerland, Germany, the Netherlands, Germany and other countries in Europe,
Asia and Latin America. Our operations outside the United States include
facilities located in France and Japan. For both the three and six months ended
June 30, 2004, we derived approximately 62% 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. Significant management attention and financial resources are needed
to develop our international sales, support and distribution channels. We may
not be able to maintain international market demand for our products. Our
business could be adversely impacted if we are unable to successfully launch our
DRM products into our international operations.

Additional risks related to selling and operating in foreign countries include,
among others:

     o legal uncertainty regarding liability;

     o language barriers in business discussions;

     o  cultural  differences  in the  negotiation  of  contracts  and  conflict
     resolution;

     o time zone differences;

     o reduced protection for intellectual property rights in some countries;

     o differing labor regulations;

     o tariffs, trade barriers and other regulatory barriers;

     o problems in collecting accounts receivable;

     o political and economic instability;

     o changes in diplomatic and trade relationships;

     o seasonal reductions in business activity;

     o potentially adverse tax consequences;

     o 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 HAVE 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 $1.8 million to fund the
development of our Axeda Supervisor product. We have paid royalties to the OCS
in the aggregate amount of $1.4 million. As of June 30, 2004, the remaining $0.4
million 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.

                                       32
<PAGE>
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 $1.2 million
and royalties in the aggregate amount of $0.6 million have been repaid. As of
June 30, 2004, $0.4 million of the remaining potential $0.6 million of principal
liability is accrued in other current liabilities. We are obligated to pay
royalties of 4.0% of revenues derived from sales of products that result from
grants received through the Marketing Fund, up to a maximum of the total amount
of the grants received.

BECAUSE OF THEIR  SIGNIFICANT  STOCK  OWNERSHIP,  OUR OFFICERS AND DIRECTORS CAN
EXERT SIGNIFICANT INFLUENCE OVER OUR FUTURE DIRECTION

As of June 30, 2004, our executive officers, directors and entities affiliated
with them, in the aggregate, beneficially owned approximately 4.1 million
shares, or approximately 13%, of our outstanding common stock. These
stockholders, if acting together, would be able to significantly influence all
matters requiring approval by our stockholders, including the election of
directors, the approval of mergers or other business combination transactions or
a sale of all or substantially all of our assets.

CERTAIN  PROVISIONS OF OUR CERTIFICATE OF INCORPORATION AND BY-LAWS MAKE CHANGES
OF CONTROL DIFFICULT EVEN IF THEY WOULD BE BENEFICIAL TO OUR STOCKHOLDERS

The board of directors has the authority without any further vote or action on
the part of our stockholders to issue up to 5 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.

Our certificate of incorporation and by-laws include provisions that may have
the effect of deterring an unsolicited offer to purchase our stock. These
provisions, coupled with the provisions of the Delaware General Corporation Law,
may delay or impede a merger, tender offer or proxy contest involving us.
Furthermore, our board of directors is divided into three classes, only one of
which is elected each year. Directors are only capable of being removed by the
affirmative vote of 66 2/3% or greater of all classes of voting stock. These
factors may further delay or prevent a change of control.

WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY IN THE  INTERNET-RELATED  PRODUCTS AND
SERVICES MARKET

Our DRM solutions communicate through public and private networks over the
Internet. The success of our products may depend, in part, on our ability to
continue developing products that are compatible with the Internet.

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.

OUR BUSINESS IS SUBJECT TO CHANGES IN FINANCIAL ACCOUNTING STANDARDS,  WHICH MAY
AFFECT OUR REPORTED REVENUE, OR THE WAY WE CONDUCT BUSINESS

We prepare our financial statements in conformity with accounting principles
generally accepted in the United States of America, or GAAP. GAAP are subject to
interpretation by the Financial Accounting Standards Board, the American
Institute of Certified Public Accountants, or AICPA, the Securities and Exchange
Commission, or SEC, and various bodies appointed by these organizations to
interpret existing rules and create new accounting policies. In particular, a
task force of the Accounting Standards Executive Committee, a subgroup of the
AICPA, meets periodically to review various issues arising under the existing
software revenue recognition rules, and interpretations of these rules.
Additional interpretations issued by the task force may have an adverse effect
on how we report revenue or on the way we conduct our business in the future.


                                       33
<PAGE>

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.

ITEM 4: CONTROLS AND PROCEDURES

As of the end of the quarter ended June 30, 2004, under the supervision and with
the participation of our management, including our chief executive officer and
chief financial officer, we conducted an evaluation of the effectiveness of the
design and operation of our disclosure controls and procedures, as such term is
defined in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities
Exchange Act of 1934, as amended. Based on that evaluation, our chief executive
officer and chief financial officer concluded that our disclosure controls and
procedures were effective as of June 30, 2004 to ensure that information we are
required to disclose in reports that we file or submit under the Securities
Exchange Act of 1934 is (i) recorded, processed, summarized and reported within
the time periods specified in Securities and Exchange Commission rules and
forms, and (ii) accumulated and communicated to our management, including our
chief executive officer and chief financial officer, as appropriate to allow
timely decisions regarding required disclosure.



                                       34
<PAGE>
PART II: OTHER INFORMATION

ITEM 1:  LEGAL PROCEEDINGS

SECURITIES CLASS ACTION
Between February and April 2000, eleven class action lawsuits were filed against
us and certain of our officers and directors in the United States District Court
for the Eastern District of Pennsylvania. On May 25, 2000, the cases were
consolidated under Civil Action No. 00-CV-1014, and entitled "In re RAVISENT
Technologies, Inc. Securities Litigation." Pursuant to the court's consolidation
order, a consolidated and amended class action complaint was filed on June 14,
2000 with an alleged class period of July 15, 1999 through April 27, 2000. This
complaint alleges violations of the federal securities laws, specifically
Sections 11 and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder. On
July 3, 2000, we and the other defendants filed a motion to dismiss the
consolidated and amended class action complaint. On July 13, 2004, the Court
denied the motion and the discovery stay has been lifted. We will answer the
consolidated and amended class action complaint in September 2004 and the case
is now in discovery. No trial date has been set.

SECURITIES ALLOCATION CLASS ACTION
On November 27, 2001, a putative shareholder class action was filed against us,
certain of our officers and directors (the "Individual Defendants"), 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 the Individual
Defendants. 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. 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. The Company
has approved a settlement agreement and related agreements which set forth the
terms of a settlement between the Company, the Individual Defendants, the
plaintiff class and the vast majority of the other approximately 300 issuer
defendants and the individual defendants currently or formerly associated with
those companies. Among other provisions, the settlement provides for a release
of the Company and the individual defendants for the conduct alleged in the
action to be wrongful. The Company would agree to undertake certain
responsibilities, including agreeing to assign away, not assert, or release
certain potential claims the Company may have against its underwriters. It is
anticipated that any potential financial obligation of the Company to plaintiffs
pursuant to the terms of the settlement agreement and related agreements will be
covered by existing insurance. The settlement agreement has not yet been
executed. The agreement will be subject to approval by the court, which cannot
be assured. A motion for preliminary approval by the court of the proposed
settlement was filed on June 25, 2004. On July 14, 2004, the underwriter
defendants filed a memorandum in Opposition to Plaintiffs' Motion for
Preliminary Approval of Settlement with Defendant Issuers' and Individuals.
Plaintiffs and issuer defendants filed replies on August 4, 2004.

If the settlement does not occur, and litigation against us continues, we
believe we have meritorious defenses and intend to defend the case vigorously.
The Company cannot predict whether or when a settlement will occur or be
finalized and are unable at this time to determine whether the outcome of the
litigation will have a material impact on its results of operations or financial
condition in any future period. However, failure to successfully defend this
action could harm our results of operations, liquidity and financial condition.

                                       35
<PAGE>
IPM
On March 20, 2003, Industria Politecnica Meridionale Spa., or IPM, an Italian
corporation, filed a complaint against us in the United States District Court
for the Northern District of California. The lawsuit alleges breach of an
agreement between IPM and our wholly-owned subsidiary Ravisent Technologies
Internet Appliance Group, Inc., or RTIAG, and fraud in connection with the
delivery of circuit boards to IPM that were not in compliance with the
agreement, and claims damages of $15 million for breach of contract and fraud,
and unspecified punitive damages and attorney's fees. On May 2, 2003, we moved
to dismiss all claims against RTIAG. On or about June 23, 2003, IPM filed an
amended complaint adding RTIAG as a party in the action and providing further
specificity on the fraud allegation. We withdrew our motion to dismiss shortly
thereafter. We filed an answer to the amended complaint on July 3, 2003 denying
the breach of contract and fraud claims. RTIAG filed a counterclaim on July 3,
2003 for breach of contract against IPM, seeking damages of $2.7 million, plus
interest, fees and costs. IPM filed an answer to the amended complaint on July
22, 2003 denying the breach of contract claims. IPM filed a motion to amend
their complaint on February 19, 2004, which was granted, and which withdrew
their fraud complaint and modified their breach of contract claim to specify
that the defendants breached the contract by providing circuit boards, which
were underpowered, and to an unacceptable extent, incapable of operating in
IPM's products. We filed a motion seeking summary judgment on March 9, 2004. On
March 30, 2004, IPM's motion to amend their complaint was granted. On April 13,
2004, Axeda filed a supplement to its motion for summary judgment. On April 27,
2004, IPM filed a supplemental opposition to our summary judgment motion. We
filed a response on May 4, 2004 and our motion for summary judgment was heard on
May 18, 2004.

On June 22, 2004, the court issued an order granting our motion for summary
judgment and dismissing IPM's claims against us. IPM filed a Motion for Entry
and Certification of Final Judgment on August 2, 2004 so as to permit an appeal
of the summary judgment ruling before trial on Axeda's counterclaim. The motion
is scheduled to be heard on September 7, 2004. A case settlement hearing on our
counterclaim is also scheduled for September 2004.

QUESTRA
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(TM) method of communication over the Internet. Our U.S. patent
(#6,757,714) is titled "Reporting The State Of An Apparatus To A Remote
Computer." 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 U.S Federal District Court in Massachusetts
against Questra Corporation, one of our competitors, for infringement of this
patent. We have one hundred and twenty days to serve the complaint from the date
of filing.

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." 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.

ITEM 2: CHANGES IN  SECURITIES,  USE OF PROCEEDS AND ISSUER  PURCHASES OF EQUITY
SECURITIES


(c) Recent sales of unregistered securities
         On May 13, 2004, we issued a warrant to purchase 19,342 shares of our
         common stock to Silicon Valley Bank, with an exercise price of $1.03
         and expiring in May 2009, in connection with the modification of the
         2003 loan and security agreement with Silicon Valley Bank. The warrant
         was issued in a private placement exempt from registration under the
         Securities Act of 1933 pursuant to Section 4(2) of the Act.


ITEM 3: DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.
                                       36
<PAGE>
ITEM 5: OTHER INFORMATION

  (b) Adoption of Procedures by which Stockholders may Recommend Nominees to Our
Board of Directors

         Stockholder Nominees

         In August 2004, our Board of Directors formed a Nominating and
Governance Committee and adopted procedures by which our stockholders may
recommend nominees to our Board of Directors. The policy of the Nominating and
Governance Committee is to consider properly submitted stockholder nominations
for candidates for membership on the Board as described below under "Identifying
and Evaluating Nominees for Directors." In evaluating such nominations, the
Nominating and Governance Committee seeks to achieve a balance of knowledge,
experience and capability on the Board and to address the membership criteria
set forth under "Director Qualifications."

         The Nominating and Governance Committee will consider suggestions of
nominees from stockholders. Stockholders may recommend individuals for
consideration by submitting the materials set forth below to the Company
addressed to the Chairman of the Nominating and Governance Committee at the
Company's address. To be timely, the written materials must be submitted within
the time permitted for submission of a stockholder proposal for inclusion in the
Company's proxy statement for the subject annual meeting.

         The written materials must include: (1) all information to relating the
individual recommended that is required to be disclosed pursuant to Regulation
14A under the Securities Exchange Act of 1934 (including such person's written
consent to being named in the proxy statement as a nominee and to serving as a
director if elected); (2) the name(s) and address(es) of the stockholders making
the nomination and the amount of the Company's securities which are owned
beneficially and of record by such Stockholder(s); (3) appropriate biographical
information (including a business address and a telephone number) and a
statement as to the individual's qualifications, with a focus on the criteria
described below; (4) a representation that the stockholder of record is a holder
of record of stock of the Company entitled to vote on the date of submission of
such written materials and (5) any material interest of the stockholder in the
nomination.

         Any stockholder nominations proposed for consideration by the
Nominating and Governance Committee should be addressed to:

         Chairman of the Nominating and Corporate Governance Committee
         Axeda Systems Inc.
         21 Oxford Road
         Mansfield, MA 02048

         Director Qualifications

         The Nominating and Governance Committee has established the following
minimum criteria for evaluating prospective board candidates:


     o Reputation  for integrity,  strong moral  character and adherence to high
     ethical standards.

     o Holds or has held a generally  recognized  position of  leadership in the
     community and/or chosen field of endeavor, and has demonstrated high levels
     of accomplishment.

     o  Demonstrated  business  acumen and  experience,  and ability to exercise
     sound  business  judgments  and common  sense in matters that relate to the
     current and long-term objectives of the Company.

     o Ability  to read and  understand  basic  financial  statements  and other
     financial information pertaining to the Company.

     o  Commitment  to  understand  the Company and its  business,  industry and
     strategic objectives.

     o Commitment and ability to regularly attend and participate in meetings of
     the Board of Directors, Board Committees and stockholders,  number of other
     company  Boards on which the  candidate  serves and  ability  to  generally
     fulfill all responsibilities as a director of the Company.

     o Willingness to represent and act in the interests of all  stockholders of
     the Company rather than the interests of a particular group.

     o Good health, and ability to serve.

     o For  prospective  non-employee  directors,  independence  under  SEC  and
     applicable  stock  exchange  rules,  and the  absence  of any  conflict  of
     interest  (whether  due to a business  or personal  relationship)  or legal
     impediment to, or restriction on, the nominee serving as a director.

     o  Willingness  to accept  the  nomination  to serve as a  director  of the
     Company.

                                       37
<PAGE>
         Other Factors for Potential Consideration

         The Nominating and Governance Committee will also consider the
following factors in connection with its evaluation of each prospective nominee:

     o Whether the  prospective  nominee  will foster a diversity  of skills and
     experiences.

     o For potential Audit Committee members,  whether the nominee possesses the
     requisite  education,  training and  experience to qualify as  "financially
     literate" or as an audit committee  "financial expert" under applicable SEC
     and stock exchange rules.

     o For incumbent  directors  standing for  re-election,  the  Nominating and
     Governance  Committee  will  assess the  incumbent  director's  performance
     during his or her term, including the number of meetings attended, level of
     participation, and overall contribution to the Company.

     o Composition of Board and whether the  prospective  nominee will add to or
     complement the Board's existing strengths


         Identifying and Evaluating Nominees for Directors

         The Nominating and Governance Committee initiates the process by
preparing a slate of potential candidates who, based on their biographical
information and other information available to the Nominating and Corporate
Governance Committee, appear to meet the criteria specified above and/or who
have specific qualities, skills or experience being sought (based on input from
the full Board).

     o Outside  Advisors.  The Nominating and Governance  Committee may engage a
     third-party  search  firm  or  other  advisors  to  assist  in  identifying
     prospective nominees.

     o  Nomination  of  Incumbent  Directors.   The  re-nomination  of  existing
     directors  should  not be  viewed  as  automatic,  but  should  be based on
     continuing qualification under the criteria set forth above.

     o For incumbent  directors  standing for  re-election,  the  Nominating and
     Governance  Committee  will  assess the  incumbent  director's  performance
     during his or her term, including the number of meetings attended, level of
     participation, and overall contribution to the Company; the number of other
     company Boards on which the individual serves,  composition of the Board at
     that time, and any changed circumstances  affecting the individual director
     which may bear on his or her ability to continue to serve on the Board.

     o Management Directors.  The number of officers or employees of the Company
     serving at any time on the Board should be limited such that, at all times,
     a majority of the directors is  "independent"  under  applicable SEC, stock
     exchange rules, or over-the-counter market rules.

After  reviewing  appropriate   biographical   information  and  qualifications,
first-time  candidates  will  be  interviewed  by at  least  one  member  of the
Nominating and Governance  Committee and by the Chief  Executive  Officer.  Upon
completion of the above  procedures,  the Nominating  and  Governance  Committee
shall  determine the list of potential  candidates to be recommended to the full
Board for nomination at the annual  meeting.  The Board of Directors will select
the slate of nominees only from candidates identified,  screened and approved by
the Nominating and Governance Committee.

                                       38
<PAGE>

ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

   (a) Exhibits

The exhibits listed on the Exhibit Index (following the Signatures section of
this report) are included, or incorporated by reference, in this quarterly
report.

   (b) The following reports were filed on Form 8-K during the quarter ended
June 30, 2004:

On April 28, 2004 the Company filed a Current Report on Form 8-K relating to its
April 28, 2004 press release announcing its financial results for the first
quarter ended March 31, 2004. Under the Form 8-K, the Company furnished, (not
filed) pursuant to Item 12, the press release entitled "Axeda Systems Inc.
Reports 2004 First Quarter Financial Results."

On June 30, 2004 the Company filed a Current Report on Form 8-K relating to its
June 30, 2004 press release announcing that it has been awarded a patent from
the United States Patent and Trademark Office for a key element of its
Firewall-Friendly(TM) method of communication over the Internet.





                                       39
<PAGE>


                               AXEDA SYSTEMS INC.


SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act
of 1934, as amended, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

August 16, 2004
Axeda Systems Inc.


       /s/ Thomas J. Fogarty
           -----------------
           Thomas J. Fogarty
           Executive Vice President and Chief Financial Officer





                                       40
<PAGE>


                                  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):
<TABLE>
<CAPTION>

                                    EXHIBITS
     Exhibit Number       Exhibit Title
     --------------       --------------------------------------------------------------------------------------------------

<S>                    <C>
          10.1            Loan Modification Agreement dated May 12, 2004 by and between Axeda Systems Operating Company, Inc. and
                           Silicon Valley Bank
          31.1            Certification of the Chief Executive Officer of Axeda Systems Inc. required pursuant to Rule
                           13a-14(a)/15d-14(a)
          31.2            Certification of the Chief Financial Officer of Axeda Systems Inc. required pursuant to Rule
                           13a-14(a)/15d-14(a)
          32.1            Certification of the Chief Executive Officer and Chief Financial Officer of Axeda Systems Inc. required
                           pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

</TABLE>

                                       41