<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 December 31, 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: 14,846,392 SHARES OUTSTANDING AS OF DECEMBER 31, 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 December 31, 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 Nine Months Ended
December 31, December 31,
-------------------- --------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
REVENUES:
Product $ 2,354 $ 2,936 $ 9,284 $ 8,488
Services 1,012 1,229 3,491 4,034
------- ------- ------- -------
3,366 4,165 12,775 12,522
------- ------- ------- -------
COST OF REVENUES:
Product 671 855 1,954 2,010
Services 525 661 1,832 2,289
------- ------- ------- -------
1,196 1,516 3,786 4,299
------- ------- ------- -------
GROSS PROFIT 2,170 2,649 8,989 8,223
OPERATING EXPENSES:
Research & development 1,615 1,849 5,131 5,505
Sales & marketing 2,990 2,527 8,562 7,183
General & administrative 936 1,253 2,725 3,453
Special charges - - - 940
------- ------- ------- -------
TOTAL OPERATING EXPENSES 5,541 5,629 16,418 17,081
------- ------- ------- -------
OPERATING LOSS (3,371) (2,980) (7,429) (8,858)
------- ------- ------- -------
OTHER INCOME (EXPENSE):
Foreign currency gain (loss), net 134 42 207 (49)
Gain on sale of land and building, net 140 215 140 215
Interest income 111 178 403 599
Interest expense (131) (184) (399) (344)
------- ------- ------- -------
254 251 351 421
------- ------- ------- -------
LOSS BEFORE INCOME TAX (BENEFIT) EXPENSE (3,117) (2,729) (7,078) (8,437)
Income tax (benefit) expense (125) 16 65 76
------- ------- ------- -------
NET LOSS $(2,992) $(2,745) $(7,143) $(8,513)
------- ------- ------- -------
------- ------- ------- -------
BASIC LOSS PER SHARE $ (0.20) $ (0.19) $ (0.49) $ (0.59)
------- ------- ------- -------
------- ------- ------- -------
SHARES USED IN PER SHARE CALCULATION - BASIC 14,762 14,508 14,650 14,327
------- ------- ------- -------
------- ------- ------- -------
DILUTED LOSS PER SHARE $ (0.20) $ (0.19) $ (0.49) $ (0.59)
------- ------- ------- -------
------- ------- ------- -------
SHARES USED IN PER SHARE CALCULATION - DILUTED 14,762 14,508 14,650 14,327
------- ------- ------- -------
------- ------- ------- -------
</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 December 31,
1998 March 31,
(unaudited) 1998
------------ ---------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 3,923 $ 2,009
Short-term investments 5,637 11,611
Trade receivables, net of allowance for doubtful
accounts of $308 and $502, respectively 3,042 4,064
Income taxes receivable 3 6
Inventories 48 66
Prepaid royalties 104 370
Prepaid expenses and other current assets 530 780
Deferred tax assets 358 465
------------ ---------
TOTAL CURRENT ASSETS 13,645 19,371
PROPERTY AND EQUIPMENT:
Land and improvements 2,004 2,529
Building 8,426 8,426
Furniture, fixtures & equipment 3,674 3,264
Research and development equipment 2,808 2,570
Leasehold improvements 51 50
------------ ---------
16,963 16,839
Accumulated depreciation and amortization 4,096 3,176
------------ ---------
NET PROPERTY AND EQUIPMENT 12,867 13,663
OTHER ASSETS:
Intangible assets, net of amortization 2,356 3,050
Deposits and other 856 1,415
------------ ---------
TOTAL OTHER ASSETS 3,212 4,465
------------ ---------
$29,724 $37,499
------------ ---------
------------ ---------
</TABLE>
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MICROWARE SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(Continued)
<TABLE>
<CAPTION>
LIABILITIES December 31,
1998 March 31,
(unaudited) 1998
------------ ---------
<S> <C> <C>
CURRENT LIABILITIES:
Notes payable to banks $ 261 $ 300
Current portion of long-term debt 70 66
Accounts payable 908 1,386
Accrued expenses 2,160 2,317
Deferred revenues 830 832
Income taxes payable 143 56
------------ ---------
TOTAL CURRENT LIABILITIES 4,372 4,957
Long-term debt, less current installments 6,865 6,918
Deferred income taxes 173 268
------------ ---------
TOTAL LIABILITIES 11,410 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; 15,071,492 and
14,778,092 shares issued; 14,846,392 and 14,552,992
shares outstanding 36,898 36,735
Accumulated deficit (17,000) (9,857)
Accumulated other comprehensive loss (807) (745)
------------ ---------
29,091 26,133
Less cost of common shares acquired for the treasury,
225,100 and 225,100 shares 777 777
------------ ---------
TOTAL SHAREHOLDERS' EQUITY 18,314 25,356
------------ ---------
$ 29,724 $ 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>
Nine Months Ended
December 31,
----------------------------
1998 1997
--------- ---------
($ in thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (7,143) $ (8,513)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 2,159 1,657
Write-off of intangible assets - 940
Gain on disposal of assets (140) (204)
Deferred income taxes 10 26
Change in assets and liabilities:
Trade receivables, net 1,165 3,224
Inventories 17 22
Prepaid royalties 267 (135)
Other current assets 263 (367)
Income taxes receivable 3 87
Other assets 262 (2,623)
Accounts payable (528) (1,129)
Accrued expenses (24) (323)
Deferred revenues (230) (217)
Income taxes payable 79 27
--------- ---------
NET CASH USED IN OPERATING ACTIVITIES (3,840) (7,528)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (759) (4,317)
Purchase of short-term investments (5,982) (12,758)
Maturities of short-term investments 11,956 22,434
Proceeds from sale of land and building, net 665 1,641
--------- ---------
NET CASH PROVIDED BY INVESTING ACTIVITIES 5,880 7,000
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on notes payable to banks and long-term debt
(125) (11,782)
Proceeds from issuance of notes payable to banks and long-term
debt - 10,706
Proceeds from issuance of common stock 175 606
Cost of issuance of common stock (13) (49)
--------- ---------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 37 (519)
--------- ---------
Effect of foreign currency exchange rate changes on cash (163) 38
--------- ---------
Net increase (decrease) in cash and cash equivalents 1,914 (1,009)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 2,009 6,758
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,923 $ 5,749
--------- ---------
--------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 395 $ 554
--------- ---------
--------- ---------
Cash paid for taxes $ 41 $ 13
--------- ---------
--------- ---------
</TABLE>
See accompanying notes to consolidated financial statements
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<PAGE>
MICROWARE SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED DECEMBER 31, 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 December 31,
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 will
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 nine months ended December 31, 1998 and
1997 is as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31, December 31,
--------------------- ---------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss $(2,992) $(2,745) $(7,143) $(8,513)
Foreign currency translation adjustment (96) (75) (62) 6
------- ------- ------- -------
Total comprehensive loss $(3,088) $(2,820) $(7,205) $(8,507)
------- ------- ------- -------
------- ------- ------- -------
</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 Company does not anticipate
the disclosures prescribed by SFAS No. 131 to significantly change the reporting
disclosures 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 this document, 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 and the Company recently has experienced
substantial quarterly losses. 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 $220,000 and $1,410,000
resulted from such agreements in the first nine months of fiscal 1998 and 1999,
respectively. Services revenues of approximately $615,000 and $790,000 resulted
from custom contract engineering services for Motorola in the first nine 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
THIRD QUARTER OF FISCAL 1999 COMPARED TO THE THIRD QUARTER OF FISCAL 1998
REVENUES
Total revenues decreased 19% or $799,000 from $4.2 million in the third quarter
of fiscal 1998 to $3.4 million in the third quarter of fiscal 1999. Product
revenues decreased 20% or $582,000 from $2.9 million in the third quarter of
fiscal 1998 to $2.4 million in the third quarter of fiscal 1999. The decrease in
product revenues between periods resulted primarily from a decrease in software
license fees. Services revenues decreased 18% or $217,000 from $1.2 million in
the third quarter of fiscal 1998 to $1.0 million in the third quarter of fiscal
1999. The decrease in services revenue between periods results principally from
a reduction in the number of custom engineering projects.
International revenues represented 63% or $2.7 million and 75% or $2.5 million
of total revenues in the third quarter of fiscal 1998 and 1999, respectively.
The increase in international revenues as a percentage of total revenues between
periods stemmed primarily from revenues from the Company's North American sales
force falling below expectations. 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 have been and may
continue to be significantly affected in the short-term by fluctuations in
foreign currency exchange rates.
COST OF REVENUES
Cost of revenues decreased 21% or $320,000 from $1.5 million in the third
quarter of fiscal 1998 to $1.2 million in the third quarter of fiscal 1999. As a
percentage of product revenues, the cost of product revenues was 29% for both
the quarters.. The decrease in real dollars was principally due to a reduction
in third party royalty costs. Cost of services revenues decreased 21% or
$136,000 from the third quarter of fiscal 1998 to the third quarter of fiscal
1999, and decreased as a percentage of services revenues from 54% in the third
quarter of fiscal 1998 to 52% in the
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third quarter of fiscal 1999. The improvement in gross margin on services
work primarily resulted from the completion and closeout of a high margin
large custom services contract during the third quarter of fiscal 1999.
RESEARCH AND DEVELOPMENT
Research and development expense decreased 13% or $234,000 from $1.8 million in
the third quarter of fiscal 1998 to $1.6 million in the third quarter of fiscal
1999. Research and development expense fell due to reductions in engineering
staff, however these reductions were partially offset by increases in third
party software and support costs, depreciation on building and equipment, and
consulting services utilized by the Company between periods. During the third
quarter of fiscal 1999 Rebecca Duhaime, Vice President of Engineering, left the
Company.
SALES AND MARKETING
Sales and marketing expense increased 18% or $463,000 from $2.5 million in the
third quarter of fiscal 1998 to $3.0 million in the third quarter of fiscal
1999. The increase in sales and marketing expense between the periods was
primarily due to an increase in third party sales and distribution costs along
with an increase in trade show and promotional activity. 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. During the third quarter of fiscal 1999 Stephen Bashada,
Vice President of Marketing, left the Company.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses decreased 25% or $317,000 from $1.3 million
to $936,000 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 December 31, 1997 was approximately $400,000 of
recruiting and relocation costs associated with the hiring of new executive
management and sales personnel in the U.S. and Japan. Included in general and
administrative charges in the three-month period ended December 31, 1998 were
severance and related benefits of approximately $100,000.
OTHER INCOME (EXPENSE)
Other income increased from $251,000 to $254,000 in the third quarters of
fiscal 1998 and 1999, respectively. Included in other income for the three
month period ended December 31, 1997 was a $215,000 gain from the sale of the
Company's former headquarters facility. Included in other income for the
three month period ended December 31, 1998 was approximately $134,000 of
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. Additionally, the Company sold two lots, which were purchased for the
Company's new headquarters facility, resulting in a gain of $140,000.
Interest income was reduced between periods due to cash used in operations.
NINE MONTHS YEAR-TO-DATE OF FISCAL 1999 COMPARED TO NINE MONTHS YEAR-TO-DATE OF
FISCAL 1998
REVENUES
Total revenues increased 2% or $253,000 from $12.5 million for the nine-month
period ended December 31, 1997 to $12.8 million for the nine-month period ended
December 31, 1998. Product revenues increased 9% or $796,000 from $8.5 million
for the nine-month period ended December 31, 1997 to $9.3 million for the
nine-month period ended December 31, 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 13% or $543,000 from $4.0
million for the nine-month period ended December 31, 1997 to $3.5 million for
the nine-month period ended December 31, 1998. The decrease in services revenues
between periods primarily resulted from a reduction in custom contract work
being performed in the first nine months of fiscal 1999 as compared to the first
nine months of fiscal 1998. In addition, during the first nine months of fiscal
1999, the Company supported certain customer
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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 12% or $513,000 from $4.3 million for the
nine-month period ended December 31, 1997 to $3.5 million for the nine-month
period ended December 31, 1998. As a percentage of product revenues, cost of
product revenues decreased from 24% for the nine-month period ended December 31,
1997 to 21% for the nine-month period ended December 31, 1998. The percentage
decrease resulted from the overall 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 57% for the nine-month period ended December 31, 1997 to 52% for
the nine-month period ended December 31, 1998. The percentage decrease between
periods resulted primarily from high margin custom contract work being performed
during the first three months of fiscal 1999.
RESEARCH AND DEVELOPMENT
Research and development expense decreased 7% or $374,000 from $5.5 million for
the nine-month period ended December 31, 1997 to $5.1 million for the nine-month
period ended December 31, 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
Sales and marketing expense increased 19% or $1.4 million from $7.2 million to
$8.6 million in the nine-months ended December 31, 1997 and 1998, respectively.
The overall increase in sales and marketing expense was primarily due to an
increase in salaries and related costs resulting from an increase in the
Company's direct sales force. In addition, third party sales and distribution
costs, trade show and promotional activity and commission expense increased
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 21% or $728,000 from $3.5 million
for the nine-month period ended December 31, 1997 to $2.7 million for the
nine-month period ended December 31, 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 nine-month
period ended December 31, 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 and sales personnel in the U.S and Japan of approximately $700,000.
Included in general and administrative charges for the nine-month period ended
December 31, 1998 were severance and related benefits of $290,000 and relocation
costs associated with the hiring of key management personnel of $105,000.
SPECIAL CHARGES
For the nine-month period ended December 31, 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.
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OTHER INCOME (EXPENSE)
Other income decreased $70,000 from $421,000 for the nine-month period ended
December 31, 1997 to $351,000 for the nine-month period ended December 31, 1998.
This decrease is primarily 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. During the first nine-months of fiscal 1998 the Company
sold its former headquarters facility resulting in a gain of $215,000. During
the first nine-months of fiscal 1999 the Company sold two lots, which were
associated with land purchased for the Company's new headquarters facility,
resulting in a gain of $140,000.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had working capital of $9.3 million and
approximately $9.6 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
decrease in working capital, cash, cash equivalents and short-term investments
resulted from the net loss of $7.1 million, partially offset by a collection of
a long-term receivable and proceeds from the sale of two lots, which were
purchased for the Company's new headquarters facility.
Net cash used in operating activities in the first nine-months of fiscal 1998
and 1999 totaled $7.5 million and $3.8 million, respectively. In the first
nine-months of fiscal 1998, the net loss of $8.5 million, and an increase in
other assets of $2.6 million were partially offset by a decrease in trade
receivables of $3.2 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. In the first nine-months of fiscal 1999, the net loss of $7.1
million, and a decrease in accounts payable of $528,000 were partially offset by
a decrease in trade receivables of $1.2 million.
Net cash provided by investing activities in the first nine-months of fiscal
1998 and 1999 totaled $7.0 million and $5.9 million, respectively. In the first
nine-months of fiscal 1998, net maturities of short-term investments and
proceeds from the sale of the Company's former headquarters facility were
partially offset by construction expenditures made on the Company's new
headquarters facility. Cash provided from investing activities during the first
nine-months of fiscal 1999 resulted from net maturaties of short-term
investments of $6.0 million, net proceeds of $665,000 from the sale of two lots,
which were purchased for the Company's new headquarters facility, offset by
capital expenditures of $646,000.
Net cash (used in) provided by financing activities in the first nine-months of
fiscal 1998 and 1999 totaled ($519,000) and $37,000, respectively. The cash used
in financing activities by the Company for the nine-month period ended December
31, 1997 resulted primarily from the payoff of the Company's $10.0 million
construction note offset against the proceeds received on the promissory note
for the Company's 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 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 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
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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.
The foregoing is a Year 2000 readiness disclosure entitled to protection as
provided in the Year 2000 Information and Readiness Disclosure Act.
"EURO" ISSUES
On January 1, 1999, the European Union ("EU") introduced a new currency (the
"Euro"). The Euro is intended to enable the 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 participating
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 believes
that the Euro will not have a material adverse effect on the Company's financial
position, results of operations or cash flows during the transition period,
which began January 1, 1999, and ends December 31, 2001. The significant
requirement of companies during the transitionary period is the ability to
invoice and accept payment in Euro denominated transactions if a customer makes
this request.
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.
MARKET RISKS
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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 lacking in 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
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
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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 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: February 14, 1999 /s/ George E. Leonard
----------------------------------
Goerge E. Leonard
Executive Vice President,
Chief Financial Officer,
Treasurer and Assistant Secretary
Date: February 14, 1999 /s/ Kent E.Thompson
----------------------------------
Kent E. Thompson
Chief Accounting Officer,
Corporate Controller and
Assistant Treasurer
15 of 15
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