<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended December 31,
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: 15,011,704 SHARES OUTSTANDING AS OF DECEMBER 31, 1999
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MICROWARE SYSTEMS CORPORATION
FORM 10-Q
QUARTER ENDED DECEMBER 31, 1999
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. Financial statements
Consolidated Statements of Operations for
the nine month periods ended December 31,
1999 and 1998.
Consolidated Balance Sheets as of December
31, 1999 and March 31, 1999.
Consolidated Statements of Cash Flows for
the nine month periods ended December 31,
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 1. Legal Procedings
ITEM 6. Exhibits and Reports of Form 8-K
SIGNATURES
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MICROWARE SYSTEMS CORPORATION
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The accompanying financial information is unaudited but, in the opinion of
management, reflects all adjustments (which include only normally recurring
adjustments) necessary for a fair presentation of the results for the periods
shown. The unaudited consolidated financial statements and analyses should be
read in conjunction with the audited consolidated financial statements and
notes thereto for the year ended March 31, 1999 included in the Annual Report
on Form 10-K previously filed with the Securities and Exchange Commission.
The results for the quarter ended December 31, 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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------------------- --------------------------
1999 1998 1999 1998
----------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
REVENUES:
Product $ 2,790 $ 2,354 $ 7,765 $ 9,284
Services 874 1,012 2,376 3,491
----------- ----------- ----------- ----------
3,664 3,366 10,141 12,775
COST OF REVENUES: ----------- ----------- ----------- ----------
Product 565 671 1,632 1,954
Services 388 525 1,086 1,832
----------- ----------- ----------- ----------
953 1,196 2,718 3,786
----------- ----------- ----------- ----------
GROSS PROFIT 2,711 2,170 7,423 8,989
OPERATING EXPENSES:
Research and development 1,398 1,615 4,416 5,131
Sales and marketing 2,337 2,990 7,241 8,562
General and administrative 651 936 2,192 2,725
----------- ----------- ----------- ----------
TOTAL OPERATING EXPENSES 4,386 5,541 13,849 16,418
----------- ----------- ----------- ----------
OPERATING LOSS (1,675) (3,371) (6,426) (7,429)
----------- ----------- ----------- ----------
OTHER INCOME (EXPENSE):
Foreign currency gain, net 33 134 286 207
Gain on sale of land, net - 140 - 140
Interest income 42 111 164 403
Interest expense (128) (131) (387) (399)
----------- ----------- ----------- ----------
(53) 254 63 351
----------- ----------- ----------- ----------
LOSS BEFORE INCOME (1,728) (3,117) (6,363) (7,078)
TAX EXPENSE (BENEFIT)
Income tax expense (benefit) 54 (125) 144 65
----------- ----------- ----------- ----------
NET LOSS $ (1,782) $ (2,992) $ (6,507) $ (7,143)
=========== =========== =========== ==========
Basic loss per share $ (0.12) $ (0.20) $ (0.44) $ (0.49)
=========== =========== =========== ==========
Shares used in per share calculation - basic 14,985 14,762 14,957 14,650
=========== =========== =========== ==========
Diluted loss per share $ (0.12) $ (0.20) $ (0.44) $ (0.49)
=========== =========== =========== ==========
Shares used in per share calculation - diluted 14,985 14,762 14,957 14,650
=========== =========== =========== ==========
</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>
December 31, 1999
ASSETS (unaudited) March 31, 1999
-------------------- -------------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 2,061 $ 2,840
Short-term investments 1,492 4,687
Trade receivables, net of allowance for doubtful accounts
of $392 and $485, respectively 2,826 3,593
Income taxes receivable 120 122
Inventories 50 71
Prepaid expenses and other current assets 485 438
Deferred tax assets 393 473
--------- ---------
TOTAL CURRENT ASSETS 7,427 12,224
PROPERTY AND EQUIPMENT:
Land and improvements 2,004 2,004
Building 8,426 8,426
Furniture, fixtures & equipment 3,633 3,647
Research and development equipment 2,678 2,806
Leasehold improvements 136 49
--------- ---------
16,877 16,932
Accumulated depreciation and amortization 5,219 4,416
--------- ---------
NET PROPERTY AND EQUIPMENT 11,658 12,516
OTHER ASSETS:
Intangible assets, net of amortization 1,093 2,007
Deposits and other 533 787
--------- ---------
TOTAL OTHER ASSETS 1,626 2,794
--------- ---------
$ 20,711 $ 27,534
========= =========
</TABLE>
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MICROWARE SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(Continued)
<TABLE>
<CAPTION>
December 31, 1999
LIABILITIES (unaudited) March 31, 1999
------------------- -----------------
<S> <C> <C>
CURRENT LIABILITIES:
Notes payable to banks $ -- $ 253
Current portion of long-term debt 75 71
Accounts payable 968 927
Accrued expenses 2,117 2,140
Deferred revenues 860 812
Income taxes payable 232 113
--------- ---------
TOTAL CURRENT LIABILITIES 4,252 4,316
Long-term debt, less current installments 6,790 6,847
Deferred income taxes 393 428
--------- ---------
TOTAL LIABILITIES 11,435 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; 15,236,804 and
15,154,992 shares issued; 15,011,704 and 14,929,892
shares outstanding 37,174 37,065
Accumulated deficit (26,302) (19,795)
Accumulated other comprehensive loss (819) (550)
--------- ---------
10,053 16,720
Less cost of common shares acquired for the treasury,
225,100 and 225,100 shares 777 777
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 9,276 15,943
--------- ---------
$ 20,711 $ 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>
NINE MONTHS ENDED
December 31,
----------------------------------------------
1999 1998
--------------- --------------
($ in thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (6,507) $ (7,143)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 2,163 2,159
Loss (gain) on sale of assets 11 (140)
Deferred income taxes 45 10
Change in assets and liabilities:
Trade receivables, net 783 1,165
Inventories 21 17
Prepaid royalties - 267
Other current assets (48) 263
Income taxes receivable 3 3
Other assets 144 262
Accounts payable (6) (528)
Accrued expenses (14) (24)
Deferred revenues 27 (230)
Income taxes payable 117 79
--------------- --------------
NET CASH USED IN OPERATING ACTIVITIES (3,261) (3,840)
--------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (211) (759)
Purchase of short-term investments (5,805) (5,982)
Maturities of short-term investments 9,000 11,956
Proceeds from sale of land, net -- 665
--------------- --------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 2,984 5,880
--------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on notes payable to banks and long-term debt (322) (125)
Proceeds from issuance of common stock 108 175
Cost of issuance of common stock -- (13)
--------------- --------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (214) 37
--------------- --------------
Effect of foreign currency exchange rate changes on cash (288) (163)
--------------- --------------
Net (decrease) increase in cash and cash equivalents (779) 1,914
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 2,840 2,009
--------------- --------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,061 $ 3,923
=============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 386 $ 395
=============== ==============
Cash paid for taxes $ 25 $ 41
=============== ==============
</TABLE>
See accompanying notes to consolidated financial statements.
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MICROWARE SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 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 December 31, 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 effects of these statements are 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
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 and nine months ended December 31, 1999 and
1998 is as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
December 31, December 31,
----------------------------------- ----------------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss $(1,782) $ (2,992) $ (6,507) $ (7,143)
Foreign currency translation adjustment (69) (96) (269) (62)
---------- --------- -------- ---------
Total comprehensive loss $(1,851) $ (3,088) $ (6,776) $ (7,205)
========== ========= ======== =========
</TABLE>
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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 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.
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A key element of Microware's long-term strategy is to develop products that
can be embedded into successful, high volume customer products, thereby
significantly increasing license run-time royalty fees. Any increase in the
percentage of revenues attributable to license run-time royalties will depend
on Microware's successful negotiation of license run-time royalties and on
the successful commercialization by Microware's customer of the underlying
product.
RESULTS OF OPERATIONS
THIRD QUARTER OF FISCAL 2000 COMPARED TO THE THIRD QUARTER OF FISCAL 1999
REVENUES
Total revenues increased 9% or $298,000 from $3.4 million in the third
quarter of fiscal 1999 to $3.7 million in the third quarter of fiscal 2000.
Product revenues increased 19% or $436,000 from $2.4 million in the third
quarter of fiscal 1999 to $2.8 million in the third quarter of fiscal 2000.
The increase in product revenues between periods resulted primarily from an
increase in revenues from design wins in the third quarter of fiscal 2000 as
compared to the third quarter of fiscal 1999. Services revenues decreased 14%
or $138,000 from $1.0 million in the third quarter of fiscal 1999 to $874,000
in the second quarter of fiscal 2000. The decrease in services revenues
between periods resulted primarily from a decline in revenue from custom
contract work, which was partially offset by an increase in revenue from
maintenance support agreements.
International revenues represented 78% or $2.9 million and 75% or $2.5
million of total revenues in the third quarters of fiscal 2000 and 1999,
respectively. The increase in international revenues as a percentage of total
revenues between periods stemmed primarily from sales generated by the
Company's North American sales force falling below expectations. The Company
expects international sales to continue to represent a significant portion of
its revenues, although the percentage may fluctuate significantly from period
to period. In Europe and Japan, revenues and expenses are primarily
denominated in local currencies. The Company's operating and pricing
strategies take into account changes in exchange rates over time, however,
the Company's results of operations may be significantly affected in the
short-term by fluctuations in foreign currency exchange rates.
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 20% or $243,000 from $1.2 million in the third
quarter of fiscal 1999 to $953,000 in the third quarter of fiscal 2000. As a
percentage of product revenues, the cost of product revenues was 29% and 20%
for the third quarters of fiscal 1999 and 2000, respectively. The decrease as
a percentage of product revenues was principally due to a reduction in third
party royalty costs between periods. Cost of services revenues decreased 26%
or $137,000 from the third quarter of fiscal 1999 to the third quarter of
fiscal 2000, and decreased as a percentage of services revenues from 52% in
the third quarter of fiscal 1999 to 44% in the third quarter of fiscal 2000.
The reduction in costs and increase in gross margins on services work
primarily resulted from fewer engineers providing support and custom
engineering for higher margin customers in the third quarter of fiscal 2000
as compared to the third quarter of fiscal 1999.
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 $217,000 from $1.6 million in the third
quarter of fiscal 1999 to $1.4 million in the third quarter of fiscal 2000.
Research and development expense declined as a result of a reduction in
software maintenance support costs associated with certain third party
software utilized by the Company to develop
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new products. 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 22% or
$653,000 from $3.0 million in the third quarter of fiscal 1999 to $2.3
million in the third quarter of fiscal 2000. The reduction in sales and
marketing expense between periods primarily resulted from a reduction in
personnel. Microware continues to work towards developing a small, focused
and efficient sales and marketing team. 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 decreased 30% or $285,000 from $936,000
to $651,000 in the third quarters of fiscal 1999 and 2000, respectively. The
decrease in the second quarter of fiscal 2000 primarily resulted from the
absence of costs incurred from organizational changes made in the Company's
operations during the third quarter of fiscal 1999 and a tax abatement refund
received on the Company's headquarters facility.
OTHER INCOME (EXPENSE)
Other income (expense) decreased from $254,000 to ($53,000) in the third
quarters of fiscal 1999 and 2000, respectively. Overall, the decrease
resulted from the absence of a $140,000 gain related to the sale of two lots
in fiscal 1999 by the Company and a decrease in interest income due to cash
used in operations. Additionally, foreign exchange gains in the third quarter
of fiscal 2000 were not as favorable as in the third quarter of fiscal 1999.
NINE MONTHS YEAR-TO-DATE OF FISCAL 2000 COMPARED TO NINE MONTHS YEAR-TO-DATE
OF FISCAL 1999
REVENUES
Total revenues decreased 21% or $2.6 million from $12.8 million for the
nine-month period ended December 31, 1998 to $10.1 million for the nine-month
period ended December 31, 1999. Product revenues decreased 16% or $1.5
million from $9.3 million for the nine-month period ended December 31, 1998
to $7.8 million for the nine-month period ended December 31, 1999. The
decrease in product revenues stemmed primarily from a reduction in DAVID and
Java distribution license and non-refundable prepaid royalty fees. Services
revenues decreased 32% or $1.1 million from $3.5 million for the nine-month
period ended December 31, 1998 to $2.4 million for the nine-month period
ended December 31, 1999. The decrease in services revenues in the first nine
months of fiscal 2000 as compared to the first nine months of fiscal 1999
resulted from a significant reduction in custom contract work.
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COST OF REVENUES
Total cost of revenues decreased 28% or $1.1 million from $3.8 million for
the nine-month period ended December 31, 1998 to $2.7 million for the
nine-month period ended December 31, 1999. As a percentage of product
revenues, cost of product revenues remained constant at 21% for the
nine-month periods ended December 31, 1998 and 1999, respectively. As a
percentage of services revenues, cost of services revenues decreased from 53%
for the nine-month period ended December 31, 1998 to 46% for the nine-month
period ended December 31, 1999. The reduction in costs and increase in gross
margins on services work primarily resulted from fewer engineers providing
support and custom engineering for higher margin customers in the first nine
months of fiscal 2000 as compared to the first nine months of fiscal 1999.
RESEARCH AND DEVELOPMENT
Research and development expense decreased 14% or $715,000 from $5.1 million
for the nine-month period ended December 31, 1998 to $4.4 million for the
nine-month period ended December 31, 1999. Research and development expense
fell due to reductions in engineering staff and a decline in software
maintenance support costs associated with certain third party software
utilized by the Company to develop new products.
SALES AND MARKETING
Selling and marketing expense decreased 15% or $1.3 million from $8.6 million
to $7.2 million in the nine-months ended December 31, 1998 and 1999,
respectively. The reduction in sales and marketing expense between periods
primarily resulted from a reduction in personnel. Microware continues to work
towards developing a small, focused and efficient sales and marketing team.
During the first nine months of fiscal 2000 Microware continued to experience
turnover in its sales and marketing personnel, which has had, and may
continue to have, an interim adverse affect on our operations.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses decreased 20% or $533,000 from $2.7
million for the nine-month period ended December 31, 1998 to $2.2 million for
the nine-month period ended December 31, 1999. The decrease between periods
resulted primarily from the absence of costs incurred from organizational
changes made in the Company's operations during the second and third quarters
of fiscal 1999.
OTHER INCOME (EXPENSE)
Other income decreased $288,000 from $351,000 for the nine-month period ended
December 31, 1998 to $63,000 for the nine-month period ended December 31,
1999. Overall, the decrease is attributable to the absence of a $140,000 gain
related to the sale of two lots in fiscal 1999 by the Company and a decrease
in interest income due to cash used in operations.
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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 December 31, 1999, Microware had approximately $3.2 million in
working capital and $3.6 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 three quarters of fiscal 2000 for operating activities.
Net cash used in operating activities in the first nine-months of fiscal 1999
and 2000 totaled $3.8 million and $3.3 million, respectively. The net loss of
$7.1 million, partially offset by the $1.2 million reduction in trade
receivables, was the primary reason for the cash used in operations in the
first nine-months of fiscal 1999. The net loss of $6.5 million, partially
offset by a decrease in trade receivables of $783,000, was the primary reason
for the cash used in operations in the first nine-months of fiscal 2000.
Net cash provided by investing activities in the first nine-months of fiscal
1999 and 2000 totaled $5.9 million and $3.0 million, respectively. Cash
provided by investing activities during the first three quarters of fiscal
1999 and 2000 resulted from net maturities of short-term investments and were
partially offset by capital expenditures.
Net cash (used in) provided by financing activities in the first nine-months
of fiscal 1999 and 2000 totaled $37,000 and ($214,000), respectively. Cash
used for financing activities during the first nine-months 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 December 31, 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 $786,000. In order to obtain the
irrevocable standby letter of credit, Microware has pledged a $786,000 U.S.
Treasury note, included in short-term investments, 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 while the gains reflected in
the second and third quarters of fiscal 2000 have benefited the Company,
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.
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<PAGE>
"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.
As of the date of filing this report, the Company has not experienced any
significant issues arising from the Year 2000 issue. In addition, the Company
is not aware of any material adverse impact of the Year 2000 on any of its
customers or suppliers. The Company does not expect to expend any material
amount going forward on Year 2000 issues.
The foregoing is a Year 2000 readiness disclosure entitled to protection as
provided in the Year 2000 Information and Readiness Disclosure Act.
"EURO" ISSUES
On January 1, 1999, the European Union ("EU") introduced a new currency (the
"Euro"). The Euro is intended to enable the EU to blend the economies of the
EU's member states into one large market with unrestricted and unencumbered
trade and commerce across borders. Eleven European countries are
participating in the first membership wave, 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. Based on current
information and our current assessments we do not expect that the conversion
to the Euro will have a material adverse effect on our business, financial
condition or results of operations.
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:
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<PAGE>
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.
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 Micrware 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.
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<PAGE>
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'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.
INTERNATIONAL OPERATIONS
In the past three fiscal years, Microware derived at least 50% and as much as
78% 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.
LIMITED PROTECTION OF PROPRIETARY TECHNOLOGY; RISKS OF INFRINGEMENT
Microware depends on its proprietary technology. Despite Microware's efforts
to protect its 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. See Part II - Other Information, Item 1. Legal Proceedings.
Microware's business is therefore dependent on the adequacy of its
intellectual property protection through patents, trademarks, 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.
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<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.
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<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 December 31, 1999, Microware
had total long-term debt of $6,865,000.
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 1. LEGAL PROCEDINGS.
On September 1, 1999, Microware filed suit in the United States District
Court for the Southern District of Iowa ("Court") against Apple Computer,
Inc. ("Apple"). The suit charges Apple with trademark infringement, false
designation of origin, unfair competition, and trademark dilution. Microware
believes that Apple's use of the trademark "MAC OS 9" to identify its
operating system software has, and will continue to, cause confusion in the
marketplace, and dilute the value and goodwill associated with Microware's
trademark and incontestably registration for the mark "OS-9". On October 14,
1999, Microware filed a motion for preliminary injunction, asking the Court
to order Apple to stop all use of the mark "MAC OS 9". On November 26, 1999,
Apple filed a motion for summary judgement based on a fair use defense. The
Court will hear both motions in February 2000. Microware and its counsel
believe the charges brought against Apple are well founded and strongly
supported by the facts and law as presently known and understood.
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<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a.) Exhibits
27 Financial Data Schedule (EDGAR version only).
(b.) None.
No other items.
SIGNATURE
Pursuant to the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto
authorized.
MICROWARE SYSTEMS CORPORATION
Date: February 11, 2000 /s/ George E. Leonard
---------------------
George E. Leonard
Executive Vice President,
Chief Financial Officer,
Treasurer and Secretary
Date: February 11, 2000 /s/ Kent E.Thompson
-------------------
Kent E. Thompson
Chief Accounting Officer,
Controller and Assistant
Treasurer and Assistant Secretary
20 of 20
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