<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30, 1998
[ ] 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 0-27988
MICROWARE SYSTEMS CORPORATION
(Exact name of registrant as specified in its charter)
IOWA 42-1073916
(State of incorporation) (I.R.S. Employer Identification No.)
1500 N.W. 118TH STREET. DES MOINES, IOWA 50325
(Address of principal executive office)
(515) 223-8000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
COMMON STOCK: 14,639,242 SHARES OUTSTANDING AS OF SEPTEMBER 30, 1998
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MICROWARE SYSTEMS CORPORATION
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying financial information is unaudited but, in the opinion of
management, reflects all adjustments (which include only normally recurring
adjustments) necessary for a fair presentation of the results for the periods
shown. The unaudited consolidated financial statements and analyses should be
read in conjunction with the audited consolidated financial statements and
notes thereto for the year ended March 31, 1998 included in the Annual Report
on Form 10-K previously filed with the Securities and Exchange Commission.
The results for the quarter ended September 30, 1998 are not necessarily
indicative of the results to be expected for the entire year.
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MICROWARE SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
($ in thousands, except per share amounts)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
1998 1997 1998 1997
------------------------- -------------------------
<S> <C> <C> <C> <C>
REVENUES:
Product $ 3,330 $ 2,841 $ 6,930 $ 5,552
Services 868 1,437 2,479 2,805
---------- --------- --------- ---------
4,198 4,278 9,409 8,357
---------- --------- --------- ---------
COST OF REVENUES:
Product 661 577 1,283 1,155
Services 602 925 1,307 1,628
---------- ---------- --------- ---------
1,263 1,502 2,590 2,783
---------- ---------- --------- ---------
GROSS PROFIT 2,935 2,776 6,819 5,574
OPERATING EXPENSES:
Research & development 1,778 1,775 3,516 3,656
Sales & marketing 2,807 2,225 5,572 4,688
General & administrative 1,136 1,388 1,789 2,168
Special charges - 940 - 940
---------- ---------- --------- ---------
TOTAL OPERATING EXPENSES 5,721 6,328 10,877 11,452
---------- ---------- --------- ---------
OPERATING LOSS (2,786) (3,552) (4,058) (5,878)
---------- ---------- --------- ---------
OTHER INCOME (EXPENSE):
Foreign currency gain (loss), net 102 (78) 73 (91)
Interest income 134 200 292 421
Interest expense (134) (130) (268) (160)
---------- ---------- --------- ---------
102 (8) 97 170
---------- ---------- --------- ---------
LOSS BEFORE INCOME TAX EXPENSE (2,684) (3,560) (3,961) (5,708)
Income tax expense 79 26 190 60
---------- ---------- --------- ---------
NET LOSS $ (2,763) $ (3,586) $ (4,151) $ (5,768)
---------- ---------- --------- ---------
---------- ---------- --------- ---------
BASIC LOSS PER SHARE $ (0.19) $ (0.25) $ (0.28) $ (0.40)
---------- ---------- --------- ---------
---------- ---------- --------- ---------
SHARES USED IN PER SHARE CALCULATION - BASIC 14,617 14,422 14,593 14,250
---------- ---------- --------- ---------
---------- ---------- --------- ---------
DILUTED LOSS PER SHARE $ (0.19) $ (0.25) $ (0.28) $ (0.40)
---------- ---------- --------- ---------
---------- ---------- --------- ---------
SHARES USED IN PER SHARE CALCULATION - DILUTED 14,617 14,422 14,593 14,250
---------- ---------- --------- ---------
---------- ---------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
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MICROWARE SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
($ in thousands, except per share amounts)
<TABLE>
<CAPTION>
ASSETS September 30,
1998 (unaudited) March 31, 1998
----------------- ----------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 3,805 $ 2,009
Short-term investments 5,684 11,611
Trade receivables, net of allowance for doubtful
accounts of $387 and $502, respectively 4,372 4,064
Income taxes receivable 3 6
Inventories 67 66
Prepaid royalties 242 370
Prepaid expenses and other current assets 706 780
Deferred tax assets 382 465
----------------- ----------------
TOTAL CURRENT ASSETS 15,261 19,371
PROPERTY AND EQUIPMENT:
Land and improvements 2,529 2,529
Building 8,426 8,426
Furniture, fixtures & equipment 3,604 3,264
Research and development equipment 2,699 2,570
Leasehold improvements 52 50
----------------- ----------------
17,310 16,839
Accumulated depreciation and amortization 3,680 3,176
----------------- ----------------
NET PROPERTY AND EQUIPMENT 13,630 13,663
OTHER ASSETS:
Intangible assets, net of amortization 2,700 3,050
Deposits and other 1,411 1,415
----------------- ----------------
TOTAL OTHER ASSETS 4,111 4,465
----------------- ----------------
$ 33,002 $ 37,499
----------------- ----------------
----------------- ----------------
</TABLE>
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MICROWARE SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(Continued)
<TABLE>
<CAPTION>
LIABILITIES September 30,
1998
(unaudited) March 31, 1998
---------------- -----------------
<S> <C> <C>
CURRENT LIABILITIES:
Notes payable to banks $ 293 $ 300
Current portion of long-term debt 68 66
Accounts payable 851 1,386
Accrued expenses 2,275 2,317
Deferred revenues 824 832
Income taxes payable 125 56
---------------- -----------------
TOTAL CURRENT LIABILITIES 4,436 4,957
Long-term debt, less current installments 6,883 6,918
Deferred income taxes 349 268
---------------- -----------------
TOTAL LIABILITIES 11,668 12,143
---------------- -----------------
SHAREHOLDERS' EQUITY
Series A preferred stock, $14.71 par value; 340,000
shares authorized; none issued or outstanding - -
Series I preferred stock, no par value; 500,000 shares
authorized; none issued or outstanding - -
Common stock, voting, no par value;
50,000,000 shares authorized; 14,864,342 and
14,778,092 shares issued; 14,639,242 and 14,552,992
shares outstanding 36,830 36,735
Accumulated deficit (14,008) (9,857)
Accumulated other comprehensive loss (711) (745)
---------------- -----------------
22,111 26,133
Less cost of common shares acquired for the treasury,
225,100 and 225,100 shares 777 777
---------------- -----------------
TOTAL SHAREHOLDERS' EQUITY 21,334 25,356
---------------- -----------------
$ 33,002 $ 37,499
---------------- -----------------
---------------- -----------------
</TABLE>
See accompanying notes to consolidated financial statements.
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MICROWARE SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED SEPTEMBER 30,
--------------------------------------
1998 1997
---------------- -----------------
<S> <C> <C>
($ in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,151) $ (5,768)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,415 825
Write-off of intangible assets - 940
Deferred income taxes 163 52
Change in assets and liabilities:
Trade receivables, net (204) 2,754
Inventories (1) 77
Prepaid royalties 127 (211)
Other current assets 82 (275)
Income taxes receivable 3 87
Other assets (381) (1,566)
Accounts payable (537) (1,058)
Accrued expenses 118 52
Deferred revenues (204) 89
Income taxes payable 66 21
---------------- -----------------
NET CASH USED IN OPERATING ACTIVITIES (3,504) (3,891)
---------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (646) (4,148)
Purchase of short-term investments (1,008) (11,283)
Maturities of short-term investments 6,935 14,093
---------------- -----------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 5,281 (1,338)
---------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on notes payable to banks and long-term debt
(33) (617)
Proceeds from issuance of notes payable to banks and long-term
debt - 3,710
Proceeds from issuance of common stock 100 570
Cost of issuance of common stock (5) (47)
---------------- -----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 62 3,616
---------------- -----------------
Effect of foreign currency exchange rate changes on cash (43) 74
---------------- -----------------
Net increase (decrease) in cash and cash equivalents 1,796 (1,629)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 2,009 6,758
---------------- -----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,805 $ 5,129
---------------- -----------------
---------------- -----------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $260 $ 359
---------------- -----------------
---------------- -----------------
Cash paid for taxes $26 $ 23
---------------- -----------------
---------------- -----------------
</TABLE>
See accompanying notes to consolidated financial statements.
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MICROWARE SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
In accordance with the rules and regulations of the Securities and Exchange
Commission, the preceding unaudited financial statements omit or condense
certain information and footnote disclosure normally required for complete
financial statements prepared in accordance with generally accepted
accounting principles. In the opinion of management, all adjustments (which
include reclassifications and normal recurring adjustments) necessary to
present fairly the financial position, results of operations and cash flows
at September 30, 1998 and for all periods presented, have been made.
Certain amounts in the fiscal 1998 consolidated financial statements have
been reclassified to conform to the fiscal 1999 presentation.
2. REVENUE RECOGNITION
The Company has adopted the provisions of Statement of Position ("SOP") 97-2,
"Software Revenue Recognition", as amended by SOP 98-4, "Deferral of the
Effective Date of Certain Provisions of SOP 97-2", effective April 1, 1998.
SOP 97-2 and SOP 98-4 provide guidance on recognizing revenue on software
transactions and supercede SOP 91-1. The adoption of SOP 97-2 and SOP 98-4
did not have a significant impact on the Company's current licensing or
revenue recognition practices. However, should the Company adopt new, or
change its existing, licensing practices, the Company's revenue recognition
practices may be subject to change to comply with the accounting guidance
provided in SOP 97-2 and 98-4.
3. COMPUTATION OF NET LOSS PER SHARE
Net loss per share is calculated in accordance with the provisions of
Financial Accounting Standards Board ("FASB") Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings per Share". Basic EPS has
been computed by dividing net loss by the weighted average number of common
shares outstanding during the periods presented. Diluted EPS is computed by
dividing net loss by the weighted average common and, when dilutive, common
equivalent shares outstanding during the periods presented. Dilutive common
equivalent shares are calculated using the treasury stock method and consist
of common stock issuable upon the exercise of options and warrants. Prior
period EPS calculations have been restated.
4. COMPREHENSIVE INCOME
On April 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income". Comprehensive income is defined as the change in equity of a company
during a period from transactions and other events and circumstances,
excluding transactions resulting from investments by owners and distributions
to owners. For the Company, the primary difference between net income and
comprehensive income results from foreign currency translation adjustments.
Comprehensive loss for the three and six months ended September 30, 1998 and
1997 is as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
-------------------------- ------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss $(2,763) $(3,586) $(4,151) $(5,768)
Foreign currency translation adjustment 21 (57) 34 81
------- ------- ------- -------
TOTAL COMPREHENSIVE LOSS $(2,742) $(3,643) $(4,117) $(5,687)
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
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5. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information". This statement establishes standards for
reporting information about operating segments in annual financial
statements. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. The disclosures
prescribed by SFAS No. 131 will be effective for the Company's consolidated
financial statements for the year ending March 31, 1999.
In April 1998, the American Institute of Certified Public Accountants issued
SOP 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use". SOP 98-1 provides guidance for determining
whether computer software is internal-use software and for accounting for the
proceeds of computer software originally developed or obtained for internal
use and then subsequently sold to the public. It also provides guidance on
capitalization of the costs incurred for computer software developed or
obtained for internal use. The Company has not yet determined the impact, if
any, of adopting this statement. The disclosures prescribed by SOP 98-1 will
be effective for the year ending March 31, 2000 consolidated financial
statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
FORWARD-LOOKING INFORMATION IS SUBJECT TO UNCERTAINTY
This discussion and analysis of the Company's financial condition and results
of operations includes forward-looking statements that involve risk and
uncertainty, including management's expectations for fiscal 1999, issues
relating to Year 2000 disclosure and known trends and uncertainties in the
business. Actual future results and trends may differ materially depending on
a variety of factors, including the volume and timing of orders received
during the quarter, the timing and acceptance of new products and product
enhancements by the Company or its competitors, changes in pricing, product
life cycles, seasonality of customer buying patterns, the existence of
product errors, extraordinary events, such as litigation or acquisition,
including related charges, and economic conditions generally or in various
geographic areas. All of the foregoing factors, and others not mentioned,
make operating results difficult to forecast. The Company's operating results
have varied significantly from quarter to quarter in the past, and the future
operating results of the Company may fluctuate as a result of the above and
other risk factors detailed in the Company's Annual Report on Form 10-K for
the fiscal year ended March 31, 1998 and other documents filed by the Company
with the Securities and Exchange Commission. Due to all of the foregoing
factors, the Company believes that period-to-period comparisons of its
results of operations are not necessarily meaningful and should not be relied
upon as an indication of future performance. In prior years, the Company's
actual financial performance has not always met market expectations. It is
likely that, in some future quarter, the Company's financial performance will
again fall below market expectations.
OVERVIEW
Microware develops, markets and supports sophisticated real-time operating
system software and development tools for the traditional embedded,
communications and consumer products markets. Microware's product line is
built around the OS-9 family of real-time operating systems for advanced
16-bit and 32-bit microprocessors. The Company's OS-9 product family includes
options for programming languages, networking, graphical interfaces and
productivity tools.
The Company has historically derived revenues from development licenses and
run-time license royalty fees along with sales of related software
productivity tools, maintenance support and custom contract engineering work.
Custom contract engineering revenues are typically derived from discrete
software engineering projects porting the OS-9 operating system along with
customized software products to a customer's product. Commonly, license
royalty fees follow the completion of these contracts and the successful
deployment of the customer's product. For financial reporting purposes,
product revenues primarily consist of software licenses and software
development tool products, along with license run-time royalty fees earned,
including non-refundable prepaid royalties. Services revenues principally
consist of revenues from custom contract engineering and maintenance support
agreements, along with consulting and training activity.
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A key element of the Company's long-term strategy is to develop products that
can be embedded into successful, high volume customer products thereby
significantly increasing license run-time royalty fees. Any increase in the
percentage of revenues attributable to license run-time royalties will depend
on the Company's successful negotiation of run-time royalty arrangements and
on the successful commercialization by the Company's customer of the
underlying product. Recently, the Company has been negatively impacted by
target markets, such as cellular phones, two-way paging, personal Internet
devices and digital and interactive television, emerging much slower than
anticipated. In addition, there can be no assurances that the Company will be
successful when the markets, for which the Company's products are targeted,
emerge. In an effort to lessen the variability of its quarterly operating
results and attain profitability, the Company has substantially increased its
emphasis on the traditional embedded and communications markets in the past
year. While the Company believes all these markets present significant
opportunities for growth, this change in market emphasis, along with the
Company's continued involvement in emerging consumer products markets whose
development is uncertain, exposes the Company's business to significant risks
and uncertainties.
The Company has entered into software license and custom contract engineering
agreements with Motorola, Inc. (Motorola) to provide or develop various
software solutions. Motorola has maintained a significant equity position in
the Company since July 1995. Product revenues of approximately $50,000 and
$1,340,000 resulted from such agreements in the first six months of fiscal
1998 and 1999, respectively. Services revenues of approximately $435,000 and
$730,000 resulted from custom contract engineering services for Motorola in
the first six months of fiscal 1998 and 1999, respectively. A portion of
these revenues relates to products under development which Motorola has not
yet begun to distribute. The Company believes that all transactions with
Motorola have been, and the Company's Board of Directors has adopted a policy
stating that any future transactions with significant equity owners will be,
on terms which are considered to be no less favorable to the Company than
those obtained in arm's length transactions with unaffiliated third parties.
RESULTS OF OPERATIONS
SECOND QUARTER OF FISCAL 1999 COMPARED TO THE SECOND QUARTER OF FISCAL 1998
REVENUES
Total revenues decreased 2% or $80,000 from $4.3 million in the second
quarter of fiscal 1998 to $4.2 million in the second quarter of fiscal 1999.
Product revenues increased 17% or $489,000 from $2.8 million in the second
quarter of fiscal 1998 to $3.3 million in the second quarter of fiscal 1999.
The increase in product revenues between periods resulted primarily from an
increase in DAVID distribution license fees received from existing customers.
Services revenues decreased 40% or $569,000 from $1.4 million in the second
quarter of fiscal 1998 to $868,000 in the second quarter of fiscal 1999.
During the second quarter of fiscal 1999 the Company reorganized its
professional services group. The decrease in services revenues resulted from
lower margin work being performed in the second quarter of fiscal 1999 as
compared to the second quarter of fiscal 1998. In addition, during the second
quarter of fiscal 1999 the Company supported certain customer product
launching efforts for which, in some cases, no revenue was recognizable, but
which the Company hopes will lead to future revenues.
International revenues represented 63% or $2.7 million and 57% or $2.4
million of total revenues in the second quarter of fiscal 1998 and 1999,
respectively. The decrease in international revenues as a percentage of total
revenues between periods was due to a decline of $533,000 from the Company's
operations in Japan. The decline in revenues from Japan resulted primarily
from a decrease in funded porting and custom services work, compounded by the
increased strength of the U.S. Dollar against the Japanese Yen. The reduction
in revenues from the Company's operations in Japan was offset, in part, by an
increase of $248,000 in revenues from the Company's operations in Europe. The
increase in revenues from Europe resulted from an increase in OEM license
sales. The Company expects international sales to continue to represent a
significant portion of its revenues, although the percentage may fluctuate
significantly from period to period. In Europe and Japan, revenues and
expenses are primarily denominated in local currencies. The Company's
operating and pricing strategies take into account changes in exchange rates
over time, however, the Company's results of operations may be significantly
affected in the short-term by fluctuations in foreign currency exchange rates.
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COST OF REVENUES
Cost of revenues decreased 16% or $239,000 from $1.5 million in the second
quarter of fiscal 1998 to $1.3 million in the second quarter of fiscal 1999.
As a percentage of product revenues, the cost of product revenues was 20% for
both the second quarters of fiscal 1998 and 1999. The increase in real
dollars was principally due to an increase in the amortization of prepaid
royalties. Cost of services revenues decreased 35% or $323,000 from the
second quarter of fiscal 1998 to the second quarter of fiscal 1999, but
increased as a percentage of services revenues from 64% in the second quarter
of fiscal 1998 to 69% in the second quarter of fiscal 1999. The reduction in
gross margin on services work primarily resulted from reduced volume and
lower margin work being performed in the second quarter of fiscal 1999 as
compared to the second quarter of fiscal 1998. In addition, the Company
supported certain customer product launching efforts for which, in some
cases, no revenue was recognizable, but which the Company hopes will lead to
future revenues
RESEARCH AND DEVELOPMENT
Research and development expense totaled $1.8 million for both the second
quarters of fiscal 1998 and 1999. Research and development expense fell due
to reductions in engineering staff, however these reductions were offset by
increases in software support, depreciation on building and equipment, and
consulting services utilized by the Company between periods.
SALES AND MARKETING
Sales and marketing expense increased 26% or $582,000 from $2.2 million in
the second quarter of fiscal 1998 to $2.8 million in the second quarter of
fiscal 1999. The increase in sales and marketing expense between the periods
was primarily due to an increase in salaries and related costs resulting from
personnel increases in the Company's direct sales force. Commission expense
also increased as a result of the increase in product sales between periods.
The Company has continued to experience turnover in its sales personnel,
which has had, and may continue to have, an interim adverse affect on the
operations of the Company. While the Company has made significant progress in
filling sales positions as turnover occurs, the costs of training and
recruiting new sales personnel remains substantial.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses decreased 18% or $252,000 from $1.4
million to $1.1 million in the second quarters of fiscal 1998 and 1999,
respectively. The decrease resulted from a reduction in costs stemming from
organizational changes made in the Company's operations. Included in general
and administrative charges for the three month period ended September 30,
1997 were severance and related benefits of $170,000, costs of moving to the
Company's new headquarters facility of $80,000 and recruiting and relocation
costs associated with the hiring of new executive management personnel of
approximately $260,000. Included in general and administrative charges in the
three-month period ended September 30, 1998 were severance and related
benefits of $190,000 and relocation costs associated with the hiring of key
management personnel of $105,000.
OTHER INCOME (EXPENSE)
Other income (expense) increased from ($8,000) to $102,000 in the second
quarters of fiscal 1998 and 1999, respectively. Overall, the increase is
attributable to an increase in foreign exchange gains resulting primarily
from the strengthening of the Japanese Yen against the U.S. Dollar and the
U.S. Dollar against the German Mark. Offsetting the increase in foreign
exchange gains was a reduction in interest income due to cash used in
operations.
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SIX MONTHS YEAR-TO-DATE OF FISCAL 1999 COMPARED TO SIX MONTHS YEAR-TO-DATE OF
FISCAL 1998
REVENUES
Total revenues increased 13% or $1.0 million from $8.4 million for the
six-month period ended September 30, 1997 to $9.4 million for the six-month
period ended September 30, 1998. Product revenues increased 25% or $1.4
million from $5.5 million for the six month period ended September 30, 1997
to $6.9 for the six month period ended September 30, 1998. The increase in
product revenues was due to an increase in DAVID and Java distribution
license and non-refundable prepaid royalty fees. Services revenues decreased
12% or $326,000 from $2.8 million for the six-month period ended September
30, 1997 to $2.5 million for the six-month period ended September 30, 1998.
The decrease in services revenues between periods primarily resulted from
smaller, lower margin work being performed in the second quarter of fiscal
1999 as compared to the second quarter of fiscal 1998. In addition, the
Company supported certain customer product launching efforts for which, in
some cases, no revenue was recognizable, but which the Company hopes will
lead to future revenues
COST OF REVENUES
Total cost of revenues decreased 7% or $193,000 from $2.8 million for the
six-month period ended September 30, 1997 to 2.6 million for the six-month
period ended September 30, 1998. As a percentage of product revenues, cost of
product revenues decreased from 21% for the six month period ended September
30, 1997 to 19% for the six month period ended September 30, 1998. The
percentage decrease resulted from the increase in product revenues partially
offset by increased amortization of purchased software and third party
royalty expense between periods. As a percentage of services revenues, cost
of services revenues decreased from 58% for the six month period ended
September 30, 1997 to 53% for the six month period ended September 30, 1998.
The percentage decrease between periods resulted from high margin custom
contract work being performed during the first three months of fiscal 1999.
RESEARCH AND DEVELOPMENT
Research and development expense decreased 4% or $140,000 from $3.7 million
for the six-month period ended September 30, 1997 to $3.5 million for the
six-month period ended September 30, 1998. Research and development expense
fell due to reductions in engineering staff, however, these reductions were
offset by increases in software support, depreciation on building and
equipment, and consulting services utilized by the Company between periods.
SALES AND MARKETING
Selling and marketing expense increased 19% or $884,000 from $4.7 million to
$5.6 million in the six months ended September 30, 1997 and 1998,
respectively. The overall increase in selling and marketing expense was
primarily due to an increase in salaries and related costs resulting from an
increase in the Company's U.S. direct sales force. Commission expense also
increased as a result of the increase in product sales between periods. The
Company has continued to experience turnover in its sales personnel, which
has had, and may continue to have, an interim adverse affect on the
operations of the Company. While the Company has made significant progress in
filling sales positions as turnover occurs, the costs of training and
recruiting new sales personnel remains substantial.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses decreased 17% or $379,000 from $2.2
million for the six-month period ended September 30, 1997 to $1.8 million for
the six-month period ended September 30, 1998. The decrease resulted from a
reduction in costs stemming from organizational changes made in the Company's
operations. Included in general and administrative charges for the six month
period ended September 30, 1997 were severance and related benefits of
$175,000, costs of moving to the Company's new headquarters facility of
$80,000 and recruiting and relocation costs associated with the hiring of new
executive management personnel of approximately $330,000.
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Included in general and administrative charges in the six-month period ended
September 30, 1998 were severance and related benefits of $190,000 and
relocation costs associated with the hiring of key management personnel of
$105,000.
SPECIAL CHARGES
For the six month period ended September 30, 1997, the Company determined
that due to revised estimates of the marketability of certain products under
development, a special charge of $940,000 was appropriate to more adequately
reflect the residual value of certain intangible assets. Included in this
charge was approximately $566,000 of deferred development costs in the form
of prepaid royalties, approximately $202,000 relating to goodwill associated
with Micromall, Inc., an inactive wholly owned subsidiary of the Company, and
approximately $172,000 relating to the write-off of previously capitalized
purchased technology.
OTHER INCOME (EXPENSE)
Other income decreased $73,000 from $170,000 for the six month period ended
September 30, 1997 to $97,000 for the six month period ended September 30,
1998. This decrease is attributable to a reduction of interest income due to
cash used in operations and an increase in interest expense related to the
Company's new headquarters facility offset by a favorable change in foreign
currency exchange rates.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, the Company had working capital of $10.8 million and
approximately $9.5 million in cash, cash equivalents and short-term
investments as compared to $14.4 million in working capital and $13.6 million
in cash, cash equivalents and short-term investments at March 31, 1998.
Generally, the decreases in working capital, cash, cash equivalents and
short-term investments resulted from the net loss of $4.2 million incurred
during the first six months of fiscal 1999.
Net cash used in operating activities in the first six months of fiscal 1998
and 1999 totaled $3.9 million and $3.5 million, respectively. In the first
six months of fiscal 1998, the net loss of $5.8 million, an increase in other
assets of $1.6 million and a decrease in accounts payable of $1.1 million
were partially offset by a decrease in trade receivables of $2.8 million. The
increase in other assets was due primarily to additional purchases of third
party software to be bundled with the Company's software products. The net
loss of $4.2 million along with the reduction in accounts payable of $537,000
were the primary reasons for the cash being used in operations in the first
six months of fiscal 1999.
Net cash provided by (used in) investing activities in the first six months
of fiscal 1998 and 1999 totaled ($1.3) million and $5.3 million,
respectively. Uses of cash in the first six months of fiscal 1998 resulted
from construction expenditures made on the Company's new headquarters
facility offset by net maturities of short-term investments. Cash provided
from investing activities during the first six months of fiscal 1999 resulted
from net maturaties of short-term investments of $5.9 million offset by
capital expenditures of $646,000.
Net cash provided by financing activities in the first six months of fiscal
1998 and 1999 totaled $3.6 million and $62,000, respectively. The cash
provided by financing activities in the first six months of fiscal 1998
resulted primarily from proceeds received on the Company's construction
loan for it new headquarters facility.
The Company believes its existing cash and short-term investments along with
other working capital will be sufficient to meet its operating and capital
expenditure needs for at least the next 12 months.
"YEAR 2000" ISSUES
The Company is aware of the numerous issues associated with the programming
code in existing computer systems as the year 2000 approaches. The "Year
2000" problem is pervasive and complex, as many computer systems will be
affected in some way by the rollover of the two digit year value to 00.
Systems that do not properly recognize such information may generate
erroneous data or cause a system to fail. The "Year 2000" issue creates risk
for the
12 of 16
<PAGE>
Company from unforeseen problems in its own computer systems and from third
parties with whom the Company deals worldwide. Failures in the Company's
and/or third party's computer systems could have a material adverse impact on
the Company's operations. To address this concern, the Company has evaluated
its products to assess their Year 2000 compliance. The Company believes that
the most current release of all of its products will not cease to perform or
generate incorrect or ambiguous data or results solely due to a change in
date to or after January 1, 2000. The Company believes that the current
versions of its products are in material compliance with Year 2000
requirements. While copies of old versions of the Company's software may be
embedded in deployed products developed by OEM licensees, some of which may
be used in mission critical functions, the Company has made commercially
available Year 2000 upgrades to its past licensees, and believes that the
term of its license agreements preclude any liability for Year 2000 related
failures in such products. The Company is also currently in the process of
evaluating its infrastructure along with its external suppliers for "Year
2000" compliance. Management believes its internal infrastructure and
external suppliers used will be compliant by the year 2000. Management does
not believe the costs related to achieving "Year 2000" compliance will be
material. However, there can be no assurance that the systems of other
companies on which the Company relies have been or will be accurately
converted to be "Year 2000" compliant and will not have an adverse effect on
the Company's operations.
"EURO" ISSUES
The Economic and Monetary Union ("EMU") and the introduction of a new
currency (the "Euro"), will begin in Europe on January 1, 1999. The new
currency intended to enable the European Union ("EU") to blend the economies
of the EU's member states into one large market with unrestricted and
unencumbered trade and commerce across borders. Eleven European countries are
expected to participate in the first membership wave, comprising the
Netherlands, Belgium, Luxembourg, Germany, France, Ireland, Finland, Austria,
Italy, Spain and Portugal. Other member states are expected to join in the
years to come. The Company continues to evaluate the impact of the
introduction of the new currency and currently does not anticipate it will
have a material adverse effect on the Company's financial position, results
of operations or cash flows.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
VARIABILITY OF QUARTERLY OPERATING RESULTS
The Company has experienced significant operating losses for the past two
fiscal years. While the Company has taken a number of measures to increase
its revenues, decrease its operating expenses, and attain profitability,
there can be no assurance that these measures will succeed or that the
Company will become profitable. Furthermore, the Company's revenues and
operating results have varied substantially from quarter to quarter, remain
difficult to foresee due to the nature of the embedded systems market and the
Company's business, and should not be relied upon as an indication of future
performance. The Company believes its revenues may fluctuate from quarter to
quarter depending upon such factors as new product introductions by the
Company or others, seasonality of customer buying patterns, the Company's
sales commission plan, renewals of product licenses by customers, product
development expenses, changes in Company and competitors' pricing policies,
the timing of significant orders, the mix of products sold, the mix of
international versus domestic revenues, currency fluctuations, the existence
of product errors and the hiring and training of additional staff.
Furthermore, delays in closing product licensing transactions or in
completion of custom contract engineering work during any quarter could cause
quarterly revenues and net earnings for that quarter to fall below
anticipated levels. The Company derives a significant portion of its revenues
from a relatively small number of large account customers, therefore any
delay in the consummation of business with this small number of customers
could significantly impact the Company's quarterly performance. The majority
of the Company's revenues in a quarter has been historically derived from
orders received in the last month of that quarter, which makes the Company's
financial performance more susceptible to an unexpected downturn in business
and makes quarterly results difficult to forecast. In addition, the Company's
expense levels are based on present expectations of future revenue levels,
and a shortfall in revenues could result in a disproportionate decrease in
the Company's net earnings. As the markets in which the Company competes
mature and as new and existing companies compete for customers, price
competition is likely to intensify and such competition could adversely
affect quarterly operating results. Variations in product mix may also affect
gross profit margin percentages. Therefore, although the Company's revenues
and gross profit in any period may increase in absolute terms, such an
increase may result in lower gross profit margin percentages.
13 of 16
<PAGE>
MARKET RISKS
The Company has invested substantial resources in the development of certain
emerging markets, in particular the digital television and wireless and
Internet communications devices markets. While the Company has achieved a
substantial number of OEM licenses in these markets and a number of the
devices are currently in commercial deployment, these markets remain at an
early stage and are increasingly competitive, and there can be no assurance
that the Company will receive substantial revenues or earnings from products
or services in these markets.
The Company has in the past fiscal year re-emphasized its focus on the
traditional embedded systems business in an effort to lessen the variability
of its quarterly operating results and attain profitability. The traditional
embedded systems business is diverse and increasingly competitive, and there
can be no assurance that the Company will be able to substantially increase
its revenues from that market. Moreover, there is a risk that the shift in
market emphasis will weaken the Company's position in the consumer markets.
The communications infrastructure device market is a new area of emphasis for
the Company, and is highly fragmented, very competitive, and technically
demanding. While Microware believes the technological sophistication and
openness of its product architecture for the market will enable it to
establish a substantial revenue base in the communications infrastructure
market, there can be no assurance that the Company will be able to do so.
ABILITY TO KEEP PACE WITH COMPETITION AND RAPID TECHNOLOGY CHANGE
The embedded systems markets are highly diverse and devoid of established
technology standards. A majority of embedded operating systems and
applications are developed in-house by OEMs, and no single processor platform
accounts for a majority or even a substantial minority of the embedded
systems under development. Moreover, the market is increasingly competitive,
with a number of industry leading companies with substantially greater
financial and technical resources than Microware devoting substantial
resources to the development of significant market share in the embedded
systems business. While the Company tries to support the industry-leading
32-bit microprocessors which it believes represent the best market
opportunities, and to offer the best possible array of incremental software
functionalities, there can be no assurance that the Company's current
products will meet the demands of the market in an environment of increasing
competition and rapid technology change.
RISKS ASSOCIATED WITH PRODUCT DEVELOPMENT AND TRANSITIONS
The Company has in the past experienced delays in software development, and
there can be no assurance that the Company will not experience such delays in
the future. Such delays, which can occur because of resource constraints,
unforeseen technological obstacles within or outside the Company's control,
and changes in market requirements, can have a material adverse effect on the
Company's business.
COMPETITION
The Company has attracted substantial competition in its targeted markets.
Many of the Company's traditional competitors have grown substantially as a
result of successful exploitation of growth in the embedded systems market,
and in some cases have expanded their businesses in a manner which competes
more directly with the Company. Microsoft Corporation has devoted substantial
resources to the development of the embedded operating system business with
its Windows CE product, which is attempting to capture a significant market
share in the handheld computer market. Sun Microsystems, Inc. has developed
an embedded operating system product called JavaOS which it markets together
with its Java technology, and has made a number of business and technology
acquisitions in the past fiscal year related to the development of its
embedded systems business. There can be no assurance the Company will be able
to successfully attain new market share or even maintain its existing market
share in this increasingly competitive market.
ATTRACTION AND RETENTION OF QUALIFIED PERSONNEL
14 of 16
<PAGE>
The Company's future performance depends to a significant degree upon the
continued contributions of its key management, product development, marketing
and sales personnel, many of whom have joined the Company recently. The
Company has experienced significant turnover in personnel during the past 18
months, much of which was initiated by the Company. The Company's ability to
execute its market strategy will depend to a large degree upon its ability to
integrate new personnel into the Company. Competition for qualified personnel
throughout the software industry is intense and there can be no assurance
that the Company will be successful in attracting and retaining such
personnel.
INTERNATIONAL OPERATIONS
In the past three fiscal years, the Company derived at least 50% of its total
revenue from sales outside North America, and this trend is anticipated to
continue in the future. This dependence on international operations subjects
the Company to certain risks, including difficulty in staffing and managing
foreign subsidiary operations, difficulty in managing distributors and
resellers, foreign currency exchange exposure, and other risks inherent in
international business operations.
DEPENDENCE ON PROPRIETARY TECHNOLOGY AND RISK OF TECHNOLOGY LITIGATION
Because substantially all of the Company's revenues are derived from OS-9 and
related products, any impairment of OS-9 could have a material adverse impact
on Microware's business. The Company's business is therefore dependent on the
adequacy of the Company's intellectual property protection through patents,
copyrights, trade secrets, and license agreements; the adequacy and continued
availability of its licenses of integrated technology from third parties; and
the absence of any material technology litigation related to the Company's
products.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Annual Meeting of Shareholders of the Company was held on September 8,
1998. More than 91 percent of the holders of the Company's Common Stock were
represented at the meeting. Three issues were presented for consideration at
the meeting and were approved by the shareholders; 1) the election of three
Class III Directors to hold office until the 2001 Annual Meeting; 2) the
amendment of the Company's 1995 Stock Option Plan to authorize the issuance
of an additional 350,000 shares under the plan; and 3) the ratification of
the selection of KPMG Peat Marwick LLP as independent public accountants of
the Company for the fiscal year ending March 31, 1999. The results were as
follows:
<TABLE>
<CAPTION>
1. Election of Class III Directors
Shares Entitled to Vote Votes at Meeting
----------------------- ----------------
<S> <C>
14,584,692 13,276,988
<CAPTION>
Name For Withhold Authority
---- ---------- ------------------
<S> <C> <C>
Arthur Don 13,143,856 133,132
Dennis E. Young 13,155,179 121,809
<CAPTION>
2. Proposal to Amend the Company's 1995 Stock Option Plan
For Against Abstain Broker Non-vote
----------------- ---------- ------- ---------------
<S> <C> <C> <C>
12,506,662 734,139 36,187 -0-
15 of 16
<PAGE>
<CAPTION>
3. Ratification of Selection of KPMG Peat Marwick LLP as Independent
Public Accountants
For Against Abstain Broker Non-vote
------------ ------- ------- ---------------
<S> <C> <C> <C>
13,222,152 39,369 17,467 -0-
</TABLE>
ITEM 5. OTHER INFORMATION
(a.) On August 31, 1998, the Company announced that George E. Leonard
has been appointed chief financial officer effective August 31,
1998. Mr. Leonard most recently served as vice president of
finance and chief financial officer of Western Pacific Airlines,
Inc. where he was responsible for leading all financial aspects of
the $300 million organization. He directed the efforts of general
and revenue accounting, aircraft acquisition and financing
projects, risk management, treasury and investment functions,
financial reporting and contract negotiation.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a.) Exhibit 27 - Financial Data Schedule (EDGAR version only).
(b.) None.
No other items.
SIGNATURE
Pursuant to the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto
authorized.
MICROWARE SYSTEMS CORPORATION
Date: November 14, 1998 /s/ George E. Leonard
---------------------
Goerge E. Leonard
Executive Vice President,
Chief Financial Officer,
Treasurer and Assistant Secretary
Date: November 14, 1998 /s/ Kent E. Thompson
-------------------
Kent E. Thompson
Chief Accounting Officer,
Corporate Controller and
Assistant Treasurer
16 of 16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1998 AND CONSOLIDATED STATEMENT
OF OPERATIONS FOR THE SIX-MONTH PERIOD ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-START> APR-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 3,805
<SECURITIES> 5,684
<RECEIVABLES> 4,759
<ALLOWANCES> 387
<INVENTORY> 67
<CURRENT-ASSETS> 15,261
<PP&E> 17,310
<DEPRECIATION> 3,680
<TOTAL-ASSETS> 33,002
<CURRENT-LIABILITIES> 4,436
<BONDS> 6,883
0
0
<COMMON> 36,830
<OTHER-SE> (15,496)
<TOTAL-LIABILITY-AND-EQUITY> 33,002
<SALES> 6,930
<TOTAL-REVENUES> 9,409
<CGS> 1,283
<TOTAL-COSTS> 2,590
<OTHER-EXPENSES> 10,877
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 268
<INCOME-PRETAX> (3,961)
<INCOME-TAX> 190
<INCOME-CONTINUING> (4,151)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,151)
<EPS-PRIMARY> (.28)
<EPS-DILUTED> (.28)
</TABLE>
