<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 June 30, 1999
[ ] 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: 14,944,942 SHARES OUTSTANDING AS OF JUNE 30, 1999
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MICROWARE SYSTEMS CORPORATION
FORM 10-Q
QUARTER ENDED JUNE 30, 1999
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. Financial statements
Consolidated Statements of Operations for the three month
periods ended June 30, 1999 and 1998.
Consolidated Balance Sheets as of June 30, 1999 and March
31, 1999.
Consolidated Statements of Cash Flows for the three month
periods ended June 30, 1999 and 1998.
Notes to Consolidated Financial Statements
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
ITEM 3. Quantitative and Qualitative Disclosures About Market Risks
PART II - OTHER INFORMATION
ITEM 5. Other Information
ITEM 6. Exhibits and Reports of Form 8-K
SIGNATURES
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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 conjuction with the audited consolidated financial statements and notes
thereto for the year ended March 31, 1999 included in the Annual Report on Form
10-K previously filed with the Securities and Exchange Commission.
The results for the quarter ended June 30, 1999 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 JUNE 30,
---------------------------------
1999 1998
--------- -------
<S> <C> <C>
REVENUES:
Product $ 2,380 $ 3,600
Services 437 1,611
--------- -------
2,817 5,211
COST OF REVENUES:
Product 588 622
Services 292 705
--------- -------
880 1,327
--------- -------
GROSS PROFIT 1,937 3,884
OPERATING EXPENSES:
Research & development 1,518 1,738
Sales & marketing 2,283 2,765
General & administrative 741 653
--------- -------
TOTAL OPERATING EXPENSE 4,542 5,156
--------- -------
OPERATING LOSS (2,605) (1,272)
--------- -------
OTHER INCOME AND (EXPENSE):
Foreign currency loss, net (85) (29)
Interest income 68 158
Interest expense (130) (134)
--------- -------
(147) (5)
--------- -------
LOSS BEFORE INCOME TAX EXPENSE (2,752) (1,277)
Income tax expense 77 111
--------- -------
NET LOSS $ (2,829) $ (1,388)
--------- -------
--------- -------
Loss per share $ (0.19) $ (0.10)
--------- -------
--------- -------
Shares used in per share calculation-basic 14,938 14,569
--------- -------
--------- -------
Diluted loss per share $ (0.19) $ (0.10)
--------- -------
--------- -------
Shares used in per share calculation-diluted 14,938 14,569
--------- -------
--------- -------
</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
June 30, 1999 March 31,
(unaudited) 1999
------------- ---------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 2,333 $ 2,840
Short-term investments 3,687 4,687
Trade receivables, net of allowance for doubtful
accounts of $423 and $485 2,403 3,593
Income taxes receivable 120 122
Inventories 73 71
Prepaid expenses and other current assets 481 438
Deferred tax assets 415 473
------------- ---------
TOTAL CURRENT ASSETS 9,512 12,224
PROPERTY AND EQUIPMENT:
Land and improvements 2,004 2,004
Building 8,426 8,426
Furniture, fixtures & equipment 3,567 3,647
Research and development equipment 2,667 2,806
Leasehold improvements 64 49
------------- ---------
16,728 16,932
Accumulated depreciation and amortization 4,496 4,416
------------- ---------
NET PROPERTY AND EQUIPMENT 12,232 12,516
OTHER ASSETS:
Intangible assets, net of amortization 1,732 2,007
Deposits and other 834 787
------------- ---------
TOTAL OTHER ASSETS 2,566 2,794
------------- ---------
$ 24,310 $ 27,534
------------- ---------
------------- ---------
</TABLE>
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MICROWARE SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(Continued)
<TABLE>
<CAPTION>
Liabilities
June 30, 1999 March 31,
(unaudited) 1999
------------- ---------
<S> <C>
CURRENT LIABILITIES:
Notes payable to banks $ - $ 253
Current portion of long-term debt 72 71
Accounts payable 1,110 927
Accrued expenses 1,789 2,140
Deferred revenues 819 812
Income taxes payable 151 113
------------- ---------
TOTAL CURRENT LIABILITIES 3,941 4,316
Long-term debt, less current installments 6,828 6,847
Deferred income taxes 415 428
------------- ---------
TOTAL LIABILTIES 11,184 11,591
SHAREHOLDERS' EQUITY
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; 15,170,042 and
15,154,992 shares issued, 14,944,942 and
14,929,892 shares outstanding 37,081 37,065
Retained earnings (deficit) (22,624) (19,795)
Accumulated other comprehensive loss (554) (550)
------------- ---------
13,903 16,720
Less cost of common shares acquired for the treasury,
225,100 and 225,100 shares 777 777
------------- ---------
TOTAL SHAREHOLDERS' EQUITY 13,126 15,943
------------- ---------
$ 24,310 $ 27,534
------------- ---------
------------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
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MICROWARE SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
---------------------------
1999 1998
---------- ---------
($ in thousands)
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (2,829) $ (1,388)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 736 697
Loss on disposal of assets 26 -
Deferred income taxes 45 98
Change in assets and liabilities:
Trade receivables, net 1,111 (378)
Inventories (2) (2)
Prepaid royalties - 24
Other current assets (49) (58)
Income taxes receivable 3 3
Other assets (160) (218)
Accounts payable 195 7
Accrued expenses (325) (550)
Deferred revenues 22 (216)
Income taxes payable 31 8
---------- ---------
NET CASH USED IN OPERATING ACTIVITIES (1,196) (1,973)
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (117) (440)
Purchase of short-term investments (2,975) -
Maturities of short-term investments 3,976 1,951
---------- ---------
NET CASH PROVIDED BY INVESTING ACTIVITIES 884 1,511
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on notes payable to banks and long-term debt (267) (16)
Proceeds from issuance of common stock 16 43
Cost of issuance of common stock - (1)
---------- ---------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (251) 26
---------- ---------
Effect of foreign currency exchange rate changes on cash 56 18
---------- ---------
Net decrease in cash and cash equivalents (507) (418)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 2,840 2,009
---------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,333 $ 1,591
---------- ---------
---------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 129 $ 131
---------- ---------
---------- ---------
Cash paid for income taxes $ 9 $ 27
---------- ---------
---------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
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MICROWARE SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND 1998
(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 June 30, 1999
and for all periods presented, have been made. The consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements and notes thereto for the fiscal year ended March 31, 1999 included
in Microware's Annual Report on Form 10-K.
2. REVENUE RECOGNITION
Microware 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 material impact
on Microware's current licensing or revenue recognition practices. Product
revenues primarily consist of software licenses and development tool products
sold and royalties earned from equipment distributors. Software license fees are
recognized as revenues upon contract signing and shipment of the software master
copy. Sales of development tool products are recognized as revenues upon
shipment. Royalties earned from equipment distributors are recognized as
revenues when reported by the equipment distributors or upon written agreement
for non-refundable prepaid royalties.
Service revenues are derived primarily from custom contract engineering
work, customer support (maintenance) agreements, and training and consulting
services. Revenues from custom contract engineering work are recognized using
the percentage of completion method. Maintenance revenues, including maintenance
bundled with software license fees, are recognized ratably over the term of the
related agreements. Revenues from training and consulting services are
recognized as the services are rendered.
In December 1998, the AICPA released SOP 98-9, " Modification of SOP
97-2, `Software Revenue Recognition with Respect to Certain Transactions." SOP
98-9 amends SOP 97-2 to require that an entity recognize revenue for multiple
element arrangements by means of the "residual method" when (1) there is
vendor-specific objective evidence of the fair values of all the undelivered
elements that are not accounted for by means of long-term contract accounting
(2) vendor-specific objective evidence of fair value does not exist for one or
more of the delivered elements, and (3) all revenue recognition criteria of SOP
97-2 (other than the requirement for vendor-specific objective evidence of the
fair value of each delivered element) are satisfied. The provisions of SOP 98-9
extend the deferral of certain paragraphs of SOP 97-2 and became effective
December 15, 1998. These deferred paragraphs of SOP 97-2 and SOP 98-9 will be
effective for transactions that are entered into in fiscal years beginning after
March 15, 1999. Retroactive application is prohibited. The adoption of this
statement is not expected to have a material impact on Microware's operating
results, financial position or cash flows.
3. COMPUTATION OF NET LOSS PER SHARE
Basic earnings (loss) per share (EPS) has been computed by dividing net earnings
(loss) by the weighted average number of common shares outstanding during the
periods presented. Diluted EPS has been computed by dividing net earnings (loss)
by the weighted average 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.
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4. COMPREHENSIVE INCOME
On April 1, 1998, Microware 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 Microware, the primary difference between net income and comprehensive
income results from foreign currency translation adjustments.
Comprehensive loss for the three months ended June 30, 1999 and 1998 is as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
1999 1998
----------- ----------
($ in thousands)
<S> <C>
Net loss $ (2,829) $ (1,388)
Foreign currency translation adjustment (4) 14
----------- ----------
TOTAL COMPREHENSIVE LOSS $ (2,833) $ (1,374)
----------- ----------
----------- ----------
</TABLE>
5. RECENT ACCOUNTING PRONOUNCEMENTS
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 on 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 losses
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.
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MICROWARE SYSTEMS CORPORATION
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 Microware's financial condition and results of
operations includes forward-looking statements that involve risk and
uncertainty, including management's expectations for fiscal 2000 and known
trends and uncertainties in the business. Words such as "expects",
"anticipates", "intends", "believes", "plans", "seeks", "estimates" and similar
expressions or variations of these words are intended to identify
forward-looking statements, but are not the only means of identifying
forward-looking statements. Additionally, statements that refer to Microware's
estimated or anticipated future results, sales or marketing strategies, new
product development or performance or other non-historical facts are
forward-looking and reflect Microware's current perspective of existing
information. Forward-looking statements are inherently subject to risks and
uncertainties that cannot be predicted or quantified, and actual results and
outcomes may differ materially from the results and outcomes discussed in the
forward-looking statements depending on a variety of factors, including the
volume and timing of orders received during the quarter, the Company's ability
to successfully market its products, the Company's ability to keep pace with its
competition and with rapid technological change, and the Company's ability to
manage turnover in its sales and marketing and other personnel and to attract
and maintain personnel generally, as well as other risk factors mentioned
throughout this Form 10-Q and in Microware's other filings with the Securities
and Exchange Commission. Readers are urged not to place undue reliance on
forward-looking statements and Microware disclaims any obligation to update any
of the forward-looking statements contained in this Form 10-Q to reflect any
future events or developments. Microware's operating results have varied
significantly from quarter to quarter in the past, and the future operating
results of Microware may fluctuate as a result of the above and other risk
factors detailed in this Form 10-Q and other documents filed by Microware with
the Securities and Exchange Commission. Due to all of the foregoing factors,
Microware 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, Microware's actual financial
performance has not always met market expectations and Microware has experienced
significant quarterly losses. It is likely that, in some future quarter,
Microware's financial performance will again fall below market expectations.
OVERVIEW
Microware develops, markets and supports real-time operating system software and
high-level language compilers used in consumer electronics, communications,
process control and factory automation, scientific research, and
government/defense applications. Microware's product line is built around the
OS-9 family of real-time operating systems for advanced microprocessors. The
OS-9 product family includes options for programming languages, networking,
graphical interfaces and productivity tools. Substantially all of Microware's
revenues in the last and current fiscal years have been derived from licenses
and related services from the OS-9 product family.
Microware 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.
A key element of Micrwoare's long-term strategy is to develop products which 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
Microware's successful negotiation of license run-time royalties and on the
successful commercialization by Microware's customer of the underlying product.
To date, Microware 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
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addition, there can be no assurances that Microware will be successful when
the markets, for which its products are targeted, emerge.
RESULTS OF OPERATIONS
FIRST QUARTER OF FISCAL 2000 COMPARED TO THE FIRST QUARTER OF FISCAL 1999
REVENUES
Total revenues decreased 46% or $2.4 million from $5.2 million in the first
quarter of fiscal 1999 to $2.8 million in the first quarter of fiscal 2000.
Product revenues decreased 34% or $1.2 million from $3.6 million in the first
quarter of fiscal 1999 to $2.4 million in the first quarter of fiscal 2000.
Product revenues decreased between periods primarily due to a reduction in OEM
license sales and non-refundable prepaid royalties for Microware's Digital
Television and Java product offerings. Services revenues decreased 73% or $1.2
million from $1.6 million in the first quarter of fiscal 1999 to $437,000 in the
first quarter of fiscal 2000. The decrease in services revenues from the first
quarter of fiscal 1999 to the same period in fiscal 2000 resulted from a
significant quarterly reduction in custom contract work. The Company expects
services revenues to increase in the second quarter of fiscal 2000 as compared
to the first quarter of fiscal 2000.
International revenues represented 46% or $2.4 million and 71% or $2.0 of total
revenues in the first quarter of fiscal 1999 and 2000, respectively. The
increase in international revenues as a percentage of total revenues between
periods was primarily due to the significant decline in revenues from
Microware's North American region. During the first quarter of fiscal 2000,
Microware continued to experience significant turnover in its North American
sales and marketing personnel, including the departure of its Vice President of
Marketing. The significant turnover experienced by the Company has had, and may
continue to have, an adverse effect on Microware's operations, the extent of
which cannot presently be determined. While Microware continues to invest
substantial time, expense and resources in recruiting and training certain sales
personnel, many sales and marketing positions that have been vacated will remain
unfilled as the Company works toward a smaller, more efficient organization.
Revenues from Japan increased approximately $200,000 between periods, partially
due to an increase in local currency revenues, but primarily due to the decrease
of the U.S. dollar against the Japanese yen. The real dollar increase in
revenues from Japan was offset by a decrease in revenues, of approximately
$600,000, from the Company's operations in Europe. The reduction in Europe
resulted from a decrease 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 by fluctuations in foreign currency exchange rates,
particularly in the short term.
COST OF REVENUES
Cost of product revenues includes direct and indirect costs for production
quality, as well as those costs related to the packaging, shipping and delivery
of the product to the customer. Cost of product revenues also includes direct
third party royalty expense and amortization expense of purchased and
capitalized software. Cost of services revenues includes direct and indirect
costs for technical phone support, training and education, and custom
engineering.
Cost of revenues decreased 34% or $447,000 from $1.3 million in the first
quarter of fiscal 1999 to $880,000 in the first quarter of fiscal 2000. As a
percentage of product revenues, cost of product revenues increased from 17% in
the first quarter of fiscal 1999 to 25% in the first quarter of fiscal 2000,
primarily as a result of the reduction in product revenues between periods
combined with a certain level of fixed costs.. As a percentage of services
revenues, cost of services revenues increased from 44% in the first quarter of
fiscal 1999 to 67% in the first quarter of fiscal 2000. The percentage increase
resulted from a significant comparative reduction in lower cost custom contract
work being performed in the first quarter of fiscal 2000 as compared to the
first quarter of fiscal 1999.
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RESEARCH AND DEVELOPMENT
Research and development expense includes expenses associated with the
development of new products and the enhancements of existing products, and
consists primarily of employee salaries and related expenses. Research and
development expense decreased 13% or $220,000 from $1.7 million in the first
quarter of fiscal 1999 to $1.5 million in the first quarter of fiscal 2000. The
reduction in research and development expense between periods is a primary
result of fewer engineers employed by Microware. Microware has made substantial
investments in product development and believes its future success will depend
in large part on its ability to enhance its existing products, to develop new
products and to maintain technological competitiveness. Consequently, Microware
anticipates that it will continue to commit substantial resources to product
development in the future.
SALES AND MARKETING
Sales and Marketing expense consists primarily of sales and marketing personnel
related costs, including sales commissions. Sales and marketing expense also
includes costs of advertising, public relations and attendance at industry trade
shows. Sales and marketing expense decreased 17% or $482,000 from $2.8 million
in the first quarter of fiscal 1999 to $2.3 million in the first quarter of
fiscal 2000. The reduction in expenditure between periods is primarily due to
reduced salaries and commission expense as a result of the reduction in revenue
in the first quarter of fiscal 2000 and the reduction of sales and marketing
personnel. During the quarter, Microware continued to experience significant
turnover in its North American sales and marketing personnel, including the
departure of its Vice President of Marketing. The significant turnover
experienced by the Company has had, and may continue to have, an adverse effect
on Microware's operations, the extent of which cannot presently be determined.
While Microware continues to invest substantial time, expense and resources in
recruiting and training certain sales personnel, many sales and marketing
positions that have been vacated will remain unfilled as the Company works
toward a smaller, more efficient organization. Microware expects to continue
investing strategically in sales and marketing over the remainder of fiscal 2000
to expand its customer base and to market its products.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses consist primarily of personnel related costs
for administration, finance, human resources and facilities management, as well
as legal, auditing and certain recruiting and relocation expenses. General and
administrative expenses increased 13% or $88,000 from $653,000 to $741,000 in
the first quarters of fiscal 1999 and 2000, respectively. The increase in
general and administrative expenses between periods is attributable to moving
and other related expenses in connection with the relocation of the Company's
offices in Japan.
OTHER INCOME (EXPENSE)
Other income (expense) changed from ($5,000) to ($147,000) in the first quarters
of fiscal 1999 and 2000, respectively. The change between periods is primarily
attributable to a reduction in interest income due to cash used in operations.
LIQUIDITY AND CAPITAL RESOURCES
Microware has historically funded its operations primarily through cash flows
from operations, the sale of common stock and, to a lesser extent, long term
debt. At June 30, 1999, Microware had approximately $5.6 million in working
capital and $6.0 million in cash and short-term investments as compared to $7.9
million in working capital and $7.5 million in cash and short term investments
at March 31, 1999. The reduction in working capital and cash and short term
investments resulted principally from the use of cash during the first quarter
of fiscal 2000 for operating activities.
Net cash used in operating activities in the first three months of fiscal 1999
and 2000 totaled $2.0 million and $1.2 million, respectively. The net loss of
$1.4 million along with the reduction in accrued expenses of $550,000 were the
primary reason for the cash used in operations in the first three months of
fiscal 1999. The net loss of $2.8
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million, partially offset by a decrease in trade receivables of $1.1 million,
was the primary reason for the cash used in operations in the first three
months of fiscal 2000.
Net cash provided by investing activities in the first three months of fiscal
1999 and 2000 totaled $1.5 million and $884,000, respectively. Cash provided by
investing activities during the first quarter of fiscal 1999 and 2000 resulted
from net maturaties of short-term investments and were partially offset by
capital expenditures.
Net cash provided by (used in) financing activities in the first three months of
fiscal 1999 and 2000 totaled $26,000 and ($251,000), respectively. Cash used for
financing activities during the first quarter of fiscal 2000 stemmed primarily
from the retirement of a note payable to a bank associated with Microware's
Japanese subsidiary amounting to approximately $250,000.
As of June 30, 1999, Microware had approximately $6.9 million of long term debt,
including current portion, outstanding relating to its headquarters building.
Monthly payments are $49,000, including interest at 7.46%, with the unpaid
balance due January 1, 2008. In accordance with the loan agreement, Microware
has provided the lender an irrevocable standby letter of credit in the amount of
$724,000. In order to obtain the irrevocable standby letter of credit, Microware
has pledged a $724,000 U.S. Treasury note as collateral.
Management believes current working capital and its $1.0 million bank line of
credit will be adequate to meet Microware's future working capital, new product
development and capital expenditure needs at least through the end of fiscal
2000.
Management does not believe that inflation has historically had a material
effect on Microware's results of operations.
Many of Microware's international contracts are denominated in local currencies,
and an increase in the relative value of the dollar against such currencies
would lead to a reduction in Microware revenues. Microware attempts to minimize
its foreign currency exposure by attempting to keep intercompany balances
current and minimizing assets in any one currency denomination. However, due to
recent losses, intercompany balances have increased and are not specifically
hedged and there can be no assurance that Microware's future results of
operations will not be adversely affected by currency fluctuations.
Microware anticipates that international sales will continue to account for a
significant portion of net sales in the foreseeable future. This dependence on
international operations subjects Microware to certain risks, including tariffs
and other barriers, difficulty in staffing and managing foreign subsidiary
operations, difficulty in managing distributors and resellers, difficulty in
accounts receivable collection, foreign currency exposure and adverse tax
consequences. Microware is also subject to the risks associated with the
imposition of protective import or export legislation and regulations by the
United States or other countries. Microware cannot predict whether quotas,
duties, taxes or other charges or restrictions will be implemented on its
products in the future. There can be no assurance that these factors or the
adoption of restrictive policies will not have a material adverse effect on
Microware's business, financial condition and results of operations.
"YEAR 2000" ISSUES
Many currently installed computer systems and software products include coding
to accept only two-digit entries in the date code field instead of four digit
entries and therefore cannot distinguish dates prior to January 1, 2000 from
dates on or after January 1, 2000. Systems and software that do not properly
recognize such information may generate erroneous data or fail. Such systems
need to be upgraded or replaced in order to function properly or, in other
words, be Year 2000 compliant. Significant uncertainty exists in the computer
systems and software industry concerning the potential effects associated with
non-compliance.
Microware has conducted Year 2000 compliance reviews of current versions of its
products. The reviews include assessment, implementation, validation, testing
and contingency planning. Microware believes that all of its most current
product releases are Year 2000 compliant. However, there can be no assurance
that all of Microware's customers will implement these compliant releases in a
timely manner. This could lead to failure of customer
<PAGE>
systems and product liability claims against Microware. While copies of old
versions of Microware's software may be embedded in deployed products, some
of which may be used in mission critical functions, Microware has made Year
2000 compliant upgrades commercially available to all of its past licensees,
and believes that the terms of its license agreements preclude any liability
for Year 2000 compliance-related failures in such products. However, even if
Microware products are Year 2000 compliant, Microware may be subject to
claims based on Year 2000 compliance issues in the products of other
companies or issues arising from the integration of multiple products within
a system. The costs of defending and resolving Year 2000 compliance-related
disputes, including consequential damages, could have a material adverse
effect on Microware's business, financial condition and results of operations.
As part of its compliance program, Microware has tested software obtained from
third parties which has been integrated with Microware products and in addition
has sought assurances from respective third parties that their software is Year
2000 compliant. However, despite this testing by Microware and assurances
provided by third party suppliers, third party software may not be Year 2000
compliant. Errors or defects in Microware or third party products may result in
loss of revenue, diversion of product development resources or other damage to
Microware which could have a material adverse effect on Microware's business,
financial condition and results of operations.
Microware has initiated an assessment of its worldwide business systems, which
include, product development, sales and marketing, finance, human resources and
order fulfillment systems. Microware is working with and monitoring critical
suppliers to determine that their products and/or services are year 2000
compliant. Microware believes the software and hardware it uses internally is
presently Year 2000 compliant and is not aware of any material operational
issues or costs that will be incurred in the future. However, Microware provides
no assurance that it will not incur materially adverse consequences caused by
undetected Year 2000 compliant errors or defects in its business systems.
All costs associated with Microware's Year 2000 compliance are expensed as
incurred and have not been accounted for separately. These costs to date have
not been material. Additional costs related to Year 2000 compliance are not
expected to be material. Microware is currently developing contingency plans to
be implemented as part of its Year 2000 compliance efforts. Depending on the
system in question, these plans could include accelerated replacement of
affected equipment, increased work hours for Company personnel or use of
contract personnel or possible manual workarounds, in addition to other similar
approaches. If Microware is required to implement contingency plans, it could
have a materially adverse effect on Microware's business, financial condition
and results of operations.
Microware's ability to achieve Year 2000 compliance, in all areas of its
business, could be adversely effected by, among other things, the availability
and cost of programming and testing resources, vendors' or suppliers' ability to
modify proprietary software and other unanticipated problems identified in Year
2000 compliance reviews and assessments. Such difficulties could have a material
adverse effect on Microware's business, financial condition and results of
operations.
Foregoing is a Year 2000 readiness disclosure entitled to protection as provided
in the Year 2000 Information and Readiness Disclosure Act.
14 of 19
<PAGE>
"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, namely 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. Legacy currencies will
remain legal tender in the participating countries for a transition period
between January 1999 and January 2002. During the transition period, non-cash
payments can be made in the Euro, and parties can elect to pay for goods and
services and transact business using either the Euro or a legacy currency. The
Company does not presently expect that the introduction and use of the Euro will
have a material adverse effect on the Company's financial position, results of
operations or cash flows during the transition period. 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. The Company will continue to evaluate issues involving the
introduction of the Euro.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
In addition to the other risk factors contained herein and within other filings
with the Securities and Exchange Commission, Microware believes the following
additional risk factors should be taken into consideration in evaluating its
business:
VARIATION OF QUARTERLY OPERATING RESULTS
Microware's revenues and operating results have varied substantially from
quarter to quarter and should not be relied upon as an indication of future
performance. Microware believes its revenues may fluctuate from quarter to
quarter depending upon such factors as new product introductions by itself or
others, seasonality of customer buying patterns, Microware's sales commission
plan, renewals of product licenses by customers, product development and
marketing expenses, changes in Microware's 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. Microware
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 Microware's revenues in a quarter has
been historically derived from orders received in the last month of that
quarter, which makes Microware's financial performance more susceptible to an
unexpected downturn in business and makes quarterly results difficult to
forecast. In addition, Microware's expense levels are based on present
expectations of future revenue levels, and a shortfall in revenues could result
in a disproportionate decrease in net earnings. As the markets in which
Microware 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 Microware's revenues
and gross profit in any period may increase in absolute terms, such an increase
may result in lower gross profit margin percentages.
HISTORY OF OPERATING LOSSES
Microware has experienced significant operating losses for the past three fiscal
years. While Microware 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 Microware will become
profitable.
15 of 19
<PAGE>
MARKET RISKS
Microware has invested substantial resources in the development of emerging
markets, in particular the digital television and wireless and Internet
communications devices markets. While Microware 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 Microware will
receive substantial revenues or earnings from products or services in these
markets.
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 Micrwoare 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 Microware'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
Microware has in the past experienced delays in software development, and there
can be no assurance that Microware will not experience such delays in the
future. Such delays, which can occur because of resource constraints, unforeseen
technological obstacles within or outside Microware's control, and changes in
market requirements, can have a material adverse effect on Microware's business.
COMPETITION
Microware has attracted substantial competition in its targeted markets. Many of
Microware'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 Microware. Microsoft 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
and digital TV 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 years related to the development of its embedded systems business.
There can be no assurance Microware 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
Microware'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 us recently. Microware has
experienced significant turnover in personnel during the past fiscal year
including its Executive Vice President and Chief Operating Officer, Vice
President of Sales, Vice President of Marketing and Vice President of
Engineering. Microware'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 Microware will be successful in attracting
and retaining such personnel.
16 of 19
<PAGE>
INTERNATIONAL OPERATIONS
In the past three fiscal years, Microware 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
Microware to certain risks, including tariffs and other barriers, difficulty in
staffing and managing foreign subsidiary operations, difficulty in managing
distributors and resellers, difficulty in accounts receivable collection,
foreign currency exposure and adverse tax consequences. Microware is also
subject to the risks associated with the imposition of protective import or
export legislation and regulations by the United States or other countries. We
cannot predict whether quotas, duties, taxes or other charges or restrictions
will be implemented on our products in the future. There can be no assurance
that these factors or the adoption of restrictive policies will not have a
material adverse effect on Microware's business, financial condition and results
of operations.
YEAR 2000 ISSUES
Many currently installed computer systems and software products include coding
to accept only two-digit entries in the date code field instead of four digit
entries and therefore cannot distinguish dates prior to January 1, 2000 from
dates on or after January 1, 2000. Systems and software that do not properly
recognize such information may generate erroneous data or fail. Such systems
need to be upgraded or replaced in order to function properly or, in other
words, be Year 2000 compliant. Significant uncertainty exists in the computer
systems and software industry concerning the potential effects associated with
non-compliance.
Microware believes its most current releases of its products, including third
party software integrated into certain products, are Year 2000 compliant and
will neither cease to perform nor generate incorrect or ambiguous data or
results when processing dates on or after January 1, 2000. Microware believes
that its products will calculate any information dependent on such dates in the
same manner and with the same functionality, data integrity and performance.
However, Microware provides no assurance that its software products contain all
the necessary software routines and programs for the accurate calculation,
display, storage and manipulation of data involving dates on or after January 1,
2000. Any non-compliance of Microware's software products could have a material
adverse effect on its business, financial condition and results of operations.
Additionally, the majority of Microware's software products are combined by its
customers with non-Microware software programs or hardware devices. Such
non-Microware products could be non-compliant, causing Year 2000 compliance
issues for Microware's customers. Any such Year 2000 issues could affect
customers' demand for Microware products, which could have a material adverse
effect on Microware's business, financial condition and results of operations.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations, Year 2000 Issues"
LIMITED PROTECTION OF PROPRIETARY TECHNOLOGY; RISKS OF INFRINGEMENT
Microware depends on its proprietary technology. Despite Microware's efforts
to protect it proprietary rights, it may be possible for unauthorized third
parties to copy Microware's products or to reverse engineer or obtain and use
information that Microware regards as proprietary. Policing and enforcing
unauthorized use of Microware's products is difficult and can be expected to
be a persistent problem, particularly as many countries have only limited or
evolving protection of intellectual property rights. Because substantially
all of Microware'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. Microware's business is therefore dependent on the adequacy of its
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 its products.
17 of 19
<PAGE>
VOLATILITY OF STOCK PRICE
The market price of Microware's common stock has fluctuated considerably in the
past, and is likely to fluctuate considerably in the future. Microware believes
that various factors, including quarterly fluctuations in results of operations,
announcements of new products or partners by Microware or by its competitors,
changes in the software industry in general, or general economic, political and
market conditions may significantly affect the market price of its common stock.
Following periods of significant volatility, securities class action litigation
may be initiated against Microware. Such litigation, if initiated, could result
in substantial costs and diversion of management attention and resources, which
could have a material adverse effect on Microware's business.
FINANCIAL STATEMENTS ARE BASED ON ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the recorded amounts of assets and liabilities at the date of the
financial statements and the recorded amounts of revenues and expenses during
the reporting period. A change in the facts and circumstances surrounding these
estimates could result in a change to the estimates and impact future operating
results.
18 of 19
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
INTEREST RATE SENSITIVITY
Microware's exposure to market risk associated with changes in interest rates
relates primarily to debt obligations as all financial assets are short term in
nature. Microware is exposed to changes in fair value of its long-term debt,
which carries a fixed interest rate. At June 30, 1999, Microware had total
long-term debt of $6,900,000.
FOREIGN CURRENCY RISK
Microware transacts business in various foreign currencies, primarily Japanese
yen and certain European currencies, as discussed within this Form 10-Q as well
as the Annual Report on Form 10-K, and accordingly is exposed to fluctuations in
foreign currency markets. The Company does not enter into foreign currency
hedging transactions.
PART II - OTHER INFORMATION
ITEM 5. OTHER INFORMATION.
a) Subsequent to the end of the fiscal quarter ended June 30,
1999, Microware accepted the resignation of a class II
director and executive vice president, M. Denis Connaghan, who
had been serving as Microware's Chief Operating Officer and
Secretary. Microware does not anticipate replacing its Chief
Operating Officer in the near future and has named George E.
Leonard, Microware's Chief Financial Officer, as Secretary.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a.) Exhibit 27 - Financial Data Schedule (EDGAR version only).
(b.) Reports on Form 8-K - 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: August 13, 1999 /s/ George E. Leonard
---------------------
George E. Leonard
Executive Vice President,
Chief Financial Officer, Treasurer
And Secretary
(Principal Financial Officer)
Date: August 13, 1999 /s/ Kent E. Thompson
--------------------
Kent E. Thompson
Chief Accounting Officer,
Controller, Assistant Treasurer
And Assistant Secretary
(Principal Accounting Officer)
19 of 19
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