<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, 2000
[ ] 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: 15,861,856 SHARES OUTSTANDING AS OF JUNE 30, 2000
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MICROWARE SYSTEMS CORPORATION
FORM 10-Q
QUARTER ENDED JUNE 30, 2000
<TABLE>
<S> <C>
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. Financial statements
Consolidated Statements of Operations for the three
month periods ended June 30, 2000 and 1999.
Consolidated Balance Sheets as of June 30, 2000 and
March 31, 2000.
Consolidated Statements of Cash Flows for the three
month periods ended June 30, 2000 and 1999.
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 2 Changes in Securities and Use of Proceeds
ITEM 5. Other Information
ITEM 6. Exhibits and Reports on Form 8-K
SIGNATURES
</TABLE>
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<PAGE>
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, 2000 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, 2000 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,
---------------------------
2000 1999
-------- --------
<S> <C> <C>
REVENUES:
Product $ 2,443 $ 2,380
Services 568 437
-------- --------
3,011 2,817
-------- --------
COST OF REVENUES:
Product 657 588
Services 292 292
-------- --------
949 880
-------- --------
GROSS PROFIT 2,062 1,937
-------- --------
OPERATING EXPENSES:
Research & development 1,346 1,518
Sales & marketing 2,156 2,283
General & administrative 775 741
-------- --------
TOTAL OPERATING EXPENSE 4,277 4,542
-------- --------
OPERATING LOSS (2,215) (2,605)
-------- --------
OTHER INCOME AND (EXPENSE):
Foreign currency loss, net (335) (85)
Interest income 48 68
Interest expense (152) (130)
-------- --------
(439) (147)
LOSS BEFORE INCOME TAX EXPENSE (2,654) (2,752)
Income tax expense 7 77
-------- --------
NET LOSS $ (2,661) $ (2,829)
======== ========
Loss per share $ (0.17) $ (0.19)
======== ========
Shares used in per share calculation-basic 15,412 14,938
======== ========
Diluted loss per share $ (0.17) $ (0.19)
======== ========
Shares used in per share calculation-diluted 15,412 14,938
======== ========
</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, 2000 March 31, 2000
(unaudited)
------------- --------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 3,753 $ 1,184
Short-term investments 786 783
Trade receivables, net of allowance for doubtful
accounts of $423 and $434 2,038 2,935
Income taxes receivable 78 78
Inventories 77 77
Prepaid expenses and other current assets 485 413
------- -------
TOTAL CURRENT ASSETS 7,217 5,470
PROPERTY AND EQUIPMENT:
Land and improvements 2,004 2,004
Building 8,426 8,426
Furniture, fixtures & equipment 3,552 3,637
Research and development equipment 2,710 2,677
Leasehold improvements 123 120
------- -------
16,815 16,864
Accumulated depreciation and amortization 5,789 5,514
------- -------
NET PROPERTY AND EQUIPMENT 11,026 11,350
OTHER ASSETS:
Intangible assets, net of amortization 415 753
Deposits and other 837 637
------- -------
TOTAL OTHER ASSETS 1,252 1,390
------- -------
$19,495 $18,210
======= =======
</TABLE>
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MICROWARE SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(Continued)
<TABLE>
<CAPTION>
LIABILITIES
June 30, 2000 March 31, 2000
(unaudited)
------------- --------------
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt $ 70 $ 77
Accounts payable 884 756
Accrued expenses 2,135 2,061
Deferred revenues 820 865
Income taxes payable 205 202
-------- --------
TOTAL CURRENT LIABILITIES 4,114 3,961
Long-term debt, less current installments 6,799 6,770
Deferred income taxes 7 -
-------- --------
TOTAL LIABILITIES 10,920 10,731
PREFERRED STOCK, REDEEMABLE
Series I preferred stock, redeemable, no par value; 500,000
shares authorized; 1,922 shares outstanding
TOTAL PREFERRED STOCK, REDEEMABLE 1,922 -
SHAREHOLDERS' EQUITY
Common stock, voting, no par value;
50,000,000 shares authorized; 16,086,956 and
15,411,900 shares issued, 15,861,856 and 15,186,800
shares outstanding 39,679 37,492
Additional Paid in Capital-Preferred Stock 888 -
Retained earnings (deficit) (32,591) (28,434)
Accumulated other comprehensive loss (546) (802)
-------- --------
7,430 8,256
Less cost of common shares acquired for the treasury,
225,100 and 225,100 shares 777 777
-------- --------
TOTAL SHAREHOLDERS' EQUITY 6,653 7,479
-------- --------
$ 19,495 $ 18,210
======== ========
</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,
---------------------------
2000 1999
------- -------
($ in thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,661) $(2,829)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 670 736
Loss on disposal of assets 3 26
Deferred income taxes 6 45
Change in assets and liabilities:
Trade receivables, net 897 1,111
Inventories (1) (2)
Other current assets (72) (49)
Income taxes receivable - 3
Other assets (200) (160)
Accounts payable 132 195
Accrued expenses 111 (325)
Deferred revenues (45) 22
Income taxes payable 3 31
------- -------
NET CASH USED IN OPERATING ACTIVITIES (1,157) (1,196)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (31) (117)
Proceed from sale of property and equipment 2 -
Purchase of short-term investments - (2,975)
Maturities of short-term investments - 3,976
------- -------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (29) 884
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on notes payable to banks and long-term debt (17) (267)
Proceeds from issuance of common stock 17 16
Proceeds from issuance of preferred stock 3,500 -
------- -------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 3,500 (251)
------- -------
Effect of foreign currency exchange rate changes on cash 255 56
------- -------
Net change in cash and cash equivalents 2,569 (507)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,184 2,840
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 3,753 $ 2,333
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 129 $ 129
======= =======
Cash paid for income taxes $ 1 $ 9
======= =======
</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, 2000 AND 1999
(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, 2000 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, 2000 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 became effective for
transactions entered into in fiscal years beginning after March 15, 1999.
Retroactive application is prohibited. The adoption of this statement has not
had 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 or conversion of
preferred shares.
At June 30, 2000, net loss used in computing basic loss per share and diluted
loss per share was $(2,676,000). This is calculated by subtracting dividends
declared on preferred shares of $15,000 from the net loss for the quarter of
$(2,661,000).
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<PAGE>
4. COMPREHENSIVE INCOME
On April 1, 1998, Microware adopted SFAS No. 130, "Reporting Comprehensive
Income". Comprehensive income is defined as the change in equity of a company
during a period from transactions and other events and circumstances,
excluding transactions resulting from investments by owners and distributions
to owners. For Microware, the primary difference between net income and
comprehensive income results from foreign currency translation adjustments.
Comprehensive loss for the three months ended June 30, 2000 and 1999 is as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
2000 1999
----------------- -----------------
($ in thousands)
<S> <C> <C>
Net loss $(2,661) $(2,829)
Foreign currency translation adjustment 255 (4)
----------------- -----------------
TOTAL COMPREHENSIVE LOSS $(2,406) $(2,833)
================= =================
</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 adoption of SOP 98-1 has not had a material
impact on the Company's operating results, financial position or cash flows.
6. REDEEMABLE PREFERRED STOCK
On April 19, 2000 the Company entered into a Securities Purchase Agreement
(the Agreement) with Elliott Associates, L.P. and Westgate International,
L.P. pursuant to which Elliott and Westgate purchased a total of 3,500 shares
of Series I Cumulative Convertible Preferred Stock of the Company for
$3,500,000. In addition, pursuant to the Agreement, Elliott and Westgate
currently hold two separate warrants to purchase an additional 87,500 common
shares in aggregate of stock of the Company at an exercise price of $5.3116
per share, and options to purchase an additional 618,595 shares in aggregate
of common stock at an exercise price of $4.8497 per share. The Series I
Preferred Stock is convertible into common stock at a conversion price of the
lower of (a) $4.8497 or (b) the average of the two lowest closing bid prices
of the common stock, as recorded on Nasdaq, during the fifteen trading days
prior to the conversion date. The warrants are exercisable at any time, and
expire on April 19, 2005. The options are exercisable at any time, and expire
one year from the date the Registration Statement registering such common
shares is declared effective by the SEC. The Agreement contains a mandatory
conversion provision that states that the Preferred Shares will automatically
convert to Common Shares on the two (2) year anniversary of the Closing Date.
If, after such mandatory conversion, the holder of the converted shares holds
more than 9.99% of the Common Shares outstanding, the excess shares shall be
purchased back by the Company at a mandatory redemption price, pursuant to
the mandatory redemption provision outlined in the Agreement. Additionally,
the Preferred Shareholder can require redemption if there is a change in
control transaction (consolidation, merger or any other reorganization), a
"going private" transaction under Rule 13e-3 of the Securities and Exchange
Act of 1934 (the "Exchange Act"), or a tender offer by the Company under Rule
13e-4 of the Exchange Act. Due to these redemption provisions, which are
outside of the control of the Company, the Preferred Shares are considered
redeemable, and are classified outside of the shareholders' equity section.
On June 14, 2000 Elliott Associates, L.P. and Westgate International, L.P.
converted a total of 1,578 shares of Series I Preferred Stock plus cumulative
dividends accrued at that date, to 668,556 common shares in aggregate, at a
conversion price of $2.375 per common share.
The holders of the Preferred Shares are entitled to receive cumulative
dividends at the per share rate of four percent (4%) of each Preferred Share,
per annum accruing daily. At June 30, 2000 total cumulative dividends accrued
on the Preferred Shares equaled $15,376 in aggregate or $8 per outstanding
preferred share. This amount is net of $9,819 of accrued dividends utilized
in the Preferred Stock conversion completed on June 14, 2000.
In accordance with EITF Issue No. 98-5, preferred stock sales proceeds of
$1,312,500 were allocated to additional paid in capital for the preferred
stock beneficial conversion feature using the intrinsic value method. Since
the preferred stock was convertible on the date of issuance, the $1,312,500
preferred stock discount was fully amortized through retained earnings as a
return to preferred shareholders upon issuance of the preferred stock.
Additionally, $166,987 of the preferred stock sales proceeds were allocated
to additional paid in capital for the value of the options. This amount was
calculated using the fair value method of APB Opinion 14. Since the options
and warrants were exercisable on the date of issuance, the $166,987 option
and warrant discount was fully amortized through retained earnings as a
return to preferred shareholders upon issuance of the preferred stock.
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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 2001 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 Microware'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.
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RESULTS OF OPERATIONS
FIRST QUARTER OF FISCAL 2001 COMPARED TO THE FIRST QUARTER OF FISCAL 2000
REVENUES
Total revenues increased 7% or $194,000 from $2.8 million in the first
quarter of fiscal 2000 to $3.0 million in the first quarter of fiscal 2001.
Product revenues increased 3% or $63,000 from $2.38 million in the first
quarter of fiscal 2000 to $2.44 million in the first quarter of fiscal 2001.
Product revenues increased between periods primarily due to the sale of
non-refundable prepaid royalties for existing licenses. Services revenues
increased 30% or $131,000 from $437,000 in the first quarter of fiscal 2000
to $568,000 in the first quarter of fiscal 2001. The increase in service
revenues from the first quarter of fiscal 2000 to the same period in fiscal
2001 resulted from a rededication of resources to custom contract work, and
the appointment of a new director of Consulting Services, in its US
operations. The Company expects to continue its emphasis on increasing its
service revenues in the current fiscal year.
International revenues represented 71% or $2.0 million and 64% or $1.9
million of total revenues in the first quarter of fiscal 2000 and 2001,
respectively. The decrease in international revenues as a percentage of total
revenues between periods was primarily due to the increase in overall
revenues from Microware's North American region. While revenues from the
Company's operations in Japan and Germany increased slightly, these were
offset by decreased revenues from the other areas of European operations. 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 costs, which is comprised of product purchases
and/or royalty expense, and amortization expense of purchased and capitalized
software. Cost of service revenues includes direct and indirect costs for
technical phone support, training and education, and custom engineering.
Cost of revenues increased 8% or $69,000 from $880,000 in the first quarter
of fiscal 2000 to $949,000 in the first quarter of fiscal 2001. As a
percentage of product revenues, cost of product revenues increased from 25%
in the first quarter of fiscal 2000 to 27% in the first quarter of fiscal
2001, primarily as a result of increased third party product costs. As a
percentage of service revenues, cost of service revenues decreased from 67%
in the first quarter of fiscal 2000 to 51% in the first quarter of fiscal
2001. The percentage decrease resulted from a significant increase in service
revenue for the first quarter of fiscal 2001.
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 11% or $172,000 from $1.5 million in the first
quarter of fiscal 2000 to $1.3 million in the first quarter of fiscal 2001.
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.
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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 6% or $127,000
from $2.3 million in the first quarter of fiscal 2000 to $2.2 million in the
first quarter of fiscal 2001. The reduction in expenditure between periods is
primarily due to a reduction in sales and marketing personnel. While
Microware continues investing strategically in sales and marketing, the
Company is currently experiencing increased operating efficiencies in these
areas. Expenses have been reduced by using internal instead of external
resources, in addition to using certain technologies, such as the Company's
web site, in its sales and marketing strategy. The Company expects to
continue this emphasis for the remainder of fiscal 2001 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 5% or $34,000 from $741,000 to
$775,000 in the first quarters of fiscal 2000 and 2001, respectively. The
increase in general and administrative expenses between periods is
attributable to professional and legal fees related to the issuance of the
Series I Preferred Stock as described in Item 2 of Part II below (the
"Preferred Stock transaction"), and expenses related to the recruiting and
hiring of the President of the Company's subsidiary in Japan.
OTHER INCOME (EXPENSE)
Other income (expense) changed from ($147,000) to ($439,000) in the first
quarters of fiscal 2000 and 2001, respectively. The change between periods is
primarily attributable to losses on foreign currency transactions.
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, 2000, Microware had approximately $3.2 million in working
capital and $4.5 million in cash and short-term investments as compared to
$1.5 million in working capital and $2.0 million in cash and short-term
investments at March 31, 2000. The increase in working capital and cash and
short-term investments resulted principally from the Preferred Stock
transaction during the first quarter of fiscal 2001.
Net cash used in operating activities in the first three months of fiscal
2000 and 2001 totaled $1.2 million and $1.1 million, respectively. The net
loss of $2.8 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. The net loss of $2.7 million, offset by
the collections of trade receivables of $900,000 was the reason for the cash
used in operations in the same period of fiscal year 2001.
Net cash provided by investing activities in the first three months of fiscal
2000 totaled $884,000, which resulted from net maturities of short-term
investments and were partially offset by capital expenditures. Net cash used
in investing activities for the first three months of fiscal year 2001 was
for capital expenditures.
Net cash (used in) provided by financing activities in the first three months
of fiscal 2000 and 2001 totaled $(251,000) and $3.5 million, 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.
Cash provided by financing in the same period of fiscal year 2001 is
attributable to the Preferred Stock transaction.
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As of June 30, 2000, Microware had approximately $6.8 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 $786,000. In order to obtain the irrevocable standby letter of
credit, Microware has pledged a $786,000 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 2001.
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.
"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.
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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:
HISTORY OF OPERATING LOSSES; VARIABILITY OF QUARTERLY OPERATING RESULTS
Microware has experienced significant operating losses for the past four
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 forecast 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.
MARKET RISKS
The Company has invested substantial resources in the development of 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 continued 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.
The communications infrastructure device market is highly fragmented, very
competitive, and technically demanding. While Microware believes the
technological sophistication and openness of its product architecture for the
market will enable it to establish a substantial revenue base in the
communications infrastructure market, there can be no assurance that the
Company will be able to do so.
ABILITY TO KEEP PACE WITH COMPETITION AND RAPID TECHNOLOGY CHANGE
The embedded systems markets are highly diverse and devoid of established
technology standards. A majority of embedded operating systems and
applications are developed in-house by OEMs, and no single processor platform
accounts for a majority or even a substantial minority of the embedded
systems under development. Moreover, the market is increasingly competitive,
with a number of industry-leading companies with substantially greater
financial and technical resources than Microware devoting substantial
resources to the development of significant market share in the embedded
systems business. While the Company tries to support the industry-leading
32-bit microprocessors which it believes represent the best market
opportunities, and to offer the best possible array of incremental software
functionalities, there can be no assurance that the Company's current
products will meet the demands of the market in an environment of increasing
competition and rapid technology change.
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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 through mergers and acquisitions, and in some cases have expanded their
businesses in a manner which competes more directly with the Company.
Microsoft has devoted substantial resources to the development of its Windows
CE product, which is attempting to capture a significant market share in the
handheld computer market and other segments of the embedded market. Sun
Microsystems, Inc. offers an embedded operating system product called JavaOS,
which it markets together with its Java technology. 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.
As a result of consolidation and other transactions involving competitors and
other companies in the Company's markets, the Company occasionally reviews
potential transactions relating to its business, products and technologies.
Such transactions could include mergers, acquisitions, strategic alliances,
joint ventures, licensing agreements, co-promotion agreements or other types
of transactions. The Company may choose to enter into such transactions at
any time, and such transactions could have a material effect on the Company,
its business or operations.
ATTRACTIONS 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 continued to experience significant turnover in personnel during
the past fiscal year. Additionally, the Japanese subsidiary's President and
Representative Director, and the Managing Director of European Operations
both resigned and were replaced in calendar year 2000. The Company's ability
to execute its market strategy will depend to a large degree upon its ability
to integrate new personnel into the Company. Competition for qualified
personnel throughout the software industry is intense and there can be no
assurance that the Company will be successful in attracting and retaining
such personnel.
INTERNATIONAL OPERATIONS
In the past four 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 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. The
Company 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. The Company cannot predict whether quotas, duties, taxes
or other charges or restrictions will be implemented on the Company's
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
the Company's business, financial condition and results of 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.
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ISSUANCE OF PREFERRED STOCK, OPTIONS AND WARRANTS
In April 2000, the Company issued 3,500 shares of Series I Preferred Stock
initially convertible into 1,473,684 shares of common stock, stock options to
purchase 618,595 shares of common stock, and warrants to purchase 87,500
shares of common stock. Subsequently, 668,556 shares of common stock were
issued pursuant to the conversion of 1,578 shares of Series I Preferred
Stock. Additionally, the Company has previously issued warrants to acquire
1,803,728 shares of common stock to Motorola, of which warrants to acquire
554,992 shares of common stock have expired and warrants to acquire 554,992
shares of common stock are currently exercisable. In addition, the Company
has issued and will continue to issue substantial stock options to employees.
The holders of these preferred shares, options and warrants have the
opportunity to profit from a rise in the market price of the Company's common
stock, thus resulting in a possible dilution in the interest of other
security holders. The Company's ability to obtain additional capital may be
adversely affected as long as the convertible securities remain unexercised.
Moreover, the holders of the convertible securities may exercise such
securities at a time when the Company may be able to obtain capital by a new
offering of securities on terms more favorable than those under which
existing warrants or options are exercisable.
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.
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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, 2000, Microware had
total long-term debt of $6,800,000.
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 2 CHANGES IN SECURITIES AND USE OF PROCEEDS.
(c) On April 19, 2000 the Company entered into a Securities
Purchase Agreement (the "Agreement") with Elliott Associates,
L.P. ("Elliott") and Westgate International, L.P. ("Westgate")
pursuant to which Elliott and Westgate purchased a total of
3,500 shares of Series I Cumulative Convertible Preferred
Stock of the Company for gross proceeds of $3,500,000.
Additionally, pursuant to the Agreement, Elliott and Westgate
currently hold two separate warrants to purchase an additional
87,500 common shares in aggregate of stock of the Company at
an exercise price of $5.3116 per share, and options to
purchase an additional 618,595 shares in aggregate of common
stock at an exercise price of $4.8497 per share. The Series I
Preferred Stock is convertible into common stock at a
conversion price of the lower of (a) $4.8497 or (b) the
average of the two lowest closing bid prices of the common
stock, as recorded on Nasdaq, during the fifteen trading days
prior to the conversion date. The warrants are exercisable at
any time, and expire on April 19, 2005. The options are
exercisable at any time and expire on August 4, 2001 (one year
from the date the Registration Statement registering such
common shares was declared effective by the SEC). The sale of
the Series I Preferred Stock was exempt from registration
under Section 4(2) of the Securities Act of 1933, as amended.
On June 14, 2000 Elliott and Westgate converted a total of
1,578 shares of Series I Preferred Stock to 668,556 common
shares in aggregate, at a conversion price of $2.375 per
common share.
For more information, refer to the Company's Current Report
filed on Form 8-K with the Securities and Exchange Commission
on May 4, 2000.
ITEM 5. OTHER INFORMATION.
(a) Subsequent to the end of the fiscal quarter ended June 30,
2000, Microware has named Beth E. Law, Microware's Controller
and Chief Accounting Officer, as Treasurer.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a.) Exhibit 27 - Financial Data Schedule (EDGAR version only).
(b.) Reports on Form 8-K
The Company filed a current report on Form 8-K on May 4, 2000
to report under Item 5 the private placement of 3,500 shares
of Series I Preferred Stock.
No other items.
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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 14, 2000 /s/ George E. Leonard
---------------------
George E. Leonard
Executive Vice President,
Chief Financial Officer, Chief
Operating Officer And Secretary
(Principal Financial Officer)
Date: August 14, 2000 /s/ Beth E. Law
---------------
Beth E. Law
Chief Accounting Officer,
Controller, Treasurer
And Assistant Secretary
(Principal Accounting Officer)
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