<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended September 30, 2000, or
[ ] 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: 16,745,082 SHARES OUTSTANDING AS OF SEPTEMBER 30, 2000
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MICROWARE SYSTEMS CORPORATION
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2000
INDEX
PART I - FINANCIAL INFORMATION
ITEM 1. Financial statements
Consolidated Statements of Operations for the six month
periods ended September 30, 2000 and 1999.
Consolidated Balance Sheets as of September 30, 2000 and
March 31, 2000.
Consolidated Statements of Cash Flows for the six month
periods ended September 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 Risk
PART II - OTHER INFORMATION
ITEM 2. Changes in Securities and Use of Proceeds
ITEM 4. Submission of Matters to a Vote of Security Holders
ITEM 6. Exhibits and Reports on 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, 2000 included in the Annual Report on Form
10-K previously filed with the Securities and Exchange Commission.
The results for the quarter ended September 30, 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 SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Product $ 2,633 $ 2,595 $ 5,077 $ 4,975
Services 688 1,065 1,255 1,502
----------- ---------- ----------- ---------
3,321 3,660 6,332 6,477
----------- ---------- ----------- ---------
COST OF REVENUES:
Product 204 479 862 1,067
Services 295 406 586 698
----------- ----------- ----------- ----------
499 885 1,448 1,765
----------- ----------- ---------- ---------
GROSS PROFIT 2,822 2,775 4,884 4,712
OPERATING EXPENSES:
Research and development 1,306 1,500 2,652 3,018
Sales and marketing 2,332 2,621 4,488 4,904
General and administrative 735 800 1,510 1,541
----------- ----------- ----------- ---------
TOTAL OPERATING EXPENSES 4,373 4,921 8,650 9,463
---------- ---------- ---------- ---------
OPERATING LOSS (1,551) (2,146) (3,766) (4,751)
---------- ---------- ---------- ----------
OTHER INCOME (EXPENSE):
Foreign currency (loss) gain, net (50) 338 (383) 253
Interest income 38 54 85 122
Interest expense (132) (129) (284) (259)
----------- ----------- ----------- -----------
(144) 263 (582) 116
----------- ----------- ----------- -----------
LOSS BEFORE INCOME TAX EXPENSE (1,695) (1,883) (4,348) (4,635)
Income tax expense 37 13 44 90
------------ ------------ ----------- -----------
NET LOSS $ (1,732) $ (1,896) $ (4,392) $ (4,725)
========= ========= ========= =========
Loss per share $ (0.11) $ (0.13) $ (0.28) $ (0.32)
========== ========== ========== ==========
Shares used in per share calculation - basic 16,169 14,948 15,790 14,943
========== ========== ========== =========
Diluted loss per share $ (0.11) $ (0.13) $ (0.28) $ (0.32)
========== ========== =========== ===========
Shares used in per share calculation - diluted 16,169 14,948 15,790 14,943
========== ========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
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MICROWARE SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
($ in thousands, except per share amounts)
<TABLE>
<CAPTION>
ASSETS SEPTEMBER 30,
2000 MARCH 31,
(UNAUDITED) 2000
------------------ ----------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 2,126 $ 1,184
Short-term investments 786 783
Trade receivables, net of allowance for doubtful
accounts of $411 and $434, respectively 2,653 2,935
Income taxes receivable 78 78
Inventories 77 77
Prepaid expenses and other current assets 425 413
------------------ ----------------
TOTAL CURRENT ASSETS 6,145 5,470
PROPERTY AND EQUIPMENT:
Land and improvements 2,004 2,004
Building 8,426 8,426
Furniture, fixtures & equipment 3,515 3,637
Research and development equipment 2,715 2,677
Leasehold improvements 130 120
------------------ ----------------
16,790 16,864
Accumulated depreciation and amortization 6,075 5,514
------------------ ----------------
NET PROPERTY AND EQUIPMENT 10,715 11,350
OTHER ASSETS:
Intangible assets, net of amortization 140 753
Deposits and other 904 637
------------------ ----------------
TOTAL OTHER ASSETS 1,044 1,390
------------------ ----------------
$ 17,904 $ 18,210
================== ================
</TABLE>
See accompanying notes to consolidated financial statements.
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MICROWARE SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(Continued)
<TABLE>
<CAPTION>
LIABILITIES SEPTEMBER 30,
2000 MARCH 31,
(UNAUDITED) 2000
---------------- ----------------
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt $ 71 $ 77
Accounts payable 894 756
Accrued expenses 2,224 2,061
Deferred revenues 814 865
Income taxes payable 306 202
---------------- ----------------
TOTAL CURRENT LIABILITIES 4,309 3,961
Long-term debt, less current installments 6,780 6,770
Deferred income taxes 6 -
---------------- ----------------
TOTAL LIABILITIES 11,095 10,731
---------------- ----------------
PREFERRED STOCK, REDEEMABLE
Series I preferred stock, no par value; 500,000 shares
authorized; none issued or outstanding 708 -
---------------- ----------------
TOTAL PREFERRED STOCK, REDEEMABLE 708 -
---------------- ----------------
SHAREHOLDERS' EQUITY
Common stock, voting, no par value;
50,000,000 shares authorized; 16,970,182 and
15,154,992 shares issued; 16,745,082 and
14,929,892 shares outstanding 41,780 37,492
Accumulated deficit (34,318) (28,434)
Accumulated other comprehensive loss (584) (802)
---------------- ----------------
6,878 8,256
Less cost of common shares acquired for the treasury,
225,100 and 225,100 shares 777 777
---------------- ----------------
TOTAL SHAREHOLDERS' EQUITY 6,101 7,479
---------------- ----------------
$ 17,904 $ 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>
SIX MONTHS ENDED SEPTEMBER 30,
--------------------------------------
2000 1999
---------------- ----------------
($ in thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (4,392) $ (4,725)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,260 1,444
Gain on sale of assets 3 11
Deferred income taxes 6 45
Change in assets and liabilities:
Trade receivables, net 282 949
Inventories 1 21
Other current assets (13) (29)
Income taxes receivable - 3
Other assets (268) (245)
Accounts payable 141 179
Accrued expenses 150 79
Deferred revenues (51) 44
Income taxes payable 104 80
---------------- ----------------
NET CASH USED IN OPERATING ACTIVITIES (2,777) (2,144)
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (32) (146)
Purchase of short-term investments - (5,025)
Maturities of short-term investments - 7,000
---------------- ----------------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (32) 1,829
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on notes payable to banks and long-term debt
(33) (295)
Proceeds from issuance of preferred stock 3,500 -
Proceeds from issuance of common stock 16 21
---------------- ----------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 3,484 (274)
---------------- ----------------
Effect of foreign currency exchange rate changes on cash 267 (71)
---------------- ----------------
Net increase (decrease) in cash and cash equivalents 942 (660)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,184 2,840
---------------- ----------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,126 $ 2,180
================ ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 284 $ 258
================ ================
Cash paid for taxes $ 44 $ 9
================ ================
</TABLE>
See accompanying notes to consolidated financial statements.
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MICROWARE SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED SEPTEMBER 30, 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 September 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, as amended.
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 September 30, 2000, net loss used in computing basic loss per share and
diluted loss per share was $(4,405,000). This is calculated by subtracting
dividends declared on preferred shares of $13,000 from the net loss for the six
months ended September 30, 2000 of $(4,392,000).
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4. COMPREHENSIVE INCOME
On April 1, 1998, Microware adopted SFAS No. 130, "Reporting Comprehensive
Income". Comprehensive income is defined as the change in equity of a company
during a period from transactions and other events and circumstances, excluding
transactions resulting from investments by owners and distributions to owners.
For Microware, the primary difference between net income and comprehensive
income results from foreign currency translation adjustments.
Comprehensive loss for the three and six months ended September 30, 2000 and
1999 is as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
September 30, September 30,
------------------------- --------------------------
<S> <C> <C> <C> <C>
2000 1999 2000 1999
---- ---- ---- ----
Net loss $(1,732) $(1,896) $(4,392) $(4,725)
Foreign currency translation adjustment (38) (196) 218 (200)
--------- ---------- --------- --------
Total comprehensive loss $(1,770) $(2,092) $(4,174) $(4,925)
========= ========== ========= ========
</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. On September 8, 2000 Elliott
Associates, L.P. and Westgate International, L.P. converted a total of 1,000
shares of Series I Common Stock plus cumulative dividends accrued at that date,
to 706,628 common shares in aggregate, at a conversion price of $1.4375 per
common share. Additionally, on September 14, 2000 Elliott Associates, L.P. and
Westgate International, L.P.converted a total of 214 shares of Series I Common
Stock plus cumulative dividends accrued at that date, to 151,318 common shares
in aggregate, at a conversion price of $1.4375 per common share.
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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 September 30, 2000 total cumulative dividends accrued on the
Preferred Shares equaled $12,901 in aggregate or $18.22 per outstanding
preferred share. This amount is net of $29,116 of accrued dividends utilized in
the Preferred Stock conversions completed as of September 30, 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 and warrants. 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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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.
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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
SECOND QUARTER OF FISCAL 2001 COMPARED TO THE SECOND QUARTER OF FISCAL 2000
REVENUES
Total revenues decreased 9% or $339,000 from $3.7 million in the second quarter
of fiscal 2000 to $3.3 million in the second quarter of fiscal 2001. Product
revenues increased 1% or $38,000 from $2.59 million in the second quarter of
fiscal 2000 to $2.63 million in the second quarter of fiscal 2001. The increase
in product revenues between periods resulted primarily from a slight increase in
distribution royalties. Services revenues decreased 35% or $377,000 from $1.1
million in the second quarter of fiscal 2000 to $688,000 in the second quarter
of fiscal 2001. The decrease in service revenues between periods resulted
primarily from a decrease in support fees for the quarter.
International revenues represented 57% or $2.4 million and 78% or $2.6 million
of total revenues in the second quarter of fiscal 2000 and 2001, respectively.
The increase in international revenues, as a percentage of total sales, resulted
primarily from an overall decrease in North American revenues in the second
quarter of fiscal 2001. 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 44% or $386,000 from $885,000 in the second quarter
of fiscal 2000 to $499,000 in the second quarter of fiscal 2001. Cost of product
revenue decreased 57% or $275,000 from $479,000 to $204,000 in the second
quarters of fiscal 2000 and fiscal 2001, respectively. As a percentage of
product revenues, the cost of product revenues was 19% and 8% for the second
quarters of fiscal 2000 and 2001, respectively. The decrease in cost of product
revenue as well as the increase in cost of product revenue as a percentage of
product revenues was principally due to a reduction in the amortization of
intangible assets between periods. Cost of services revenues decreased 27% or
$111,000 from the second quarter of fiscal 2000 to the second quarter of fiscal
2001, and increased as a percentage of services revenues from 38% in the second
quarter of fiscal 2000 to 42% in the second quarter of fiscal 2001. The
reduction in costs resulted from fewer engineers providing support and custom
engineering.
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RESEARCH AND DEVELOPMENT
Research and development expense includes expenses associated with the
development of new products and the enhancements of existing products, and
consists primarily of employee salaries and related expenses. Research and
development expense decreased 13% or $194,000 from $1.5 million in the second
quarter of fiscal 2000 to $1.3 million in the second quarter of fiscal 2001.
Research and development expense decreased as a result of reductions in
engineering staff and software maintenance expense as well as minimization of
the use of outside consultants. 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 11% or $289,000 from $2.6 million
in the second quarter of fiscal 2000 to $2.3 million in the second quarter of
fiscal 2001. The reduction in sales and marketing expense between periods
primarily resulted from reduced commission expense due to decreased sales, as
well as a reduction in sales personnel. Additionally, cost cutting measures were
implemented relating to trade show expenses, which resulted in substantially
reduced expenditures in the marketing area, for the quarter. 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 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 decreased 8% or $65,000 from $800,000 to $735,000 in the
second quarters of fiscal 2000 and 2001, respectively. The decrease in the
second quarter of fiscal 2001 resulted from the absence of severance costs that
were present during the second quarter of fiscal 2000. This decrease was
partially offset by increased professional and legal fees related to the
required registration of common stock pursuant to the terms of the private
placement of preferred stock.
OTHER INCOME (EXPENSE)
Other income (expense) changed from other income of $263,000 to other (expense)
of ($144,000) in the second quarters of fiscal 2000 and 2001, respectively.
Overall, the change is attributable to a foreign exchange loss resulting
primarily from the volatility of foreign currencies against the U.S. Dollar.
SIX MONTHS YEAR-TO-DATE OF FISCAL 2001 COMPARED TO SIX MONTHS YEAR-TO-DATE OF
FISCAL 2000
REVENUES
Total revenues decreased 2% or $145,000 from $6.5 million for the six-month
period ended September 30, 1999 to $6.3 million for the six-month period ended
September 30, 2000. Product revenues increased 2% or $102,000 from $5.0 million
for the six-month period ended September 30, 1999 to $5.1 for the six-month
period ended September 30, 2000. The increase in product revenues came primarily
from increased sales of initial licenses for the period. Services revenues
decreased 16% or $247,000 from $1.5 million for the six-month period ended
September 30, 1999 to $1.3 million for the six-month period ended September 30,
2000. The decrease in services revenues in the first six months of fiscal 2001
as compared to the first six months of fiscal 2000 resulted from a significant
reduction in support fees, but was offset by an increase in training revenue.
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COST OF REVENUES
Total cost of revenues decreased 18% or $317,000 from $1.8 million for the
six-month period ended September 30, 1999 to $1.5 million for the six-month
period ended September 30, 2000. As a percentage of product revenues, cost of
product revenues decreased from 21% for the six-month period ended September 30,
1999 to 17% for the six-month period ended September 30, 2000. This decrease is
a result of the slight increase in product revenues between periods coupled with
the decreasing intangible amortization expense.
RESEARCH AND DEVELOPMENT
Research and development expense decreased 12% or $366,000 from $3.0 million for
the six-month period ended September 30, 1999 to $2.7 million for the six-month
period ended September 30, 2000. Research and development expense fell due to
reductions in engineering staff and decreased utilization of outside consulting
services by the Company between periods.
SALES AND MARKETING
Selling and marketing expense decreased 8% or $416,000 from $4.9 million to $4.5
million in the six months ended September 30, 1999 and 2000, respectively. The
reduction in sales and marketing expense between periods resulted mainly from a
reduction in sales personnel and decreased commission expense. Microware
continues to work towards developing a small, focused and efficient sales and
marketing team. While Microware continues to invest substantial time, expense
and resources in recruiting and training certain sales personnel, many sales and
marketing positions that have been vacated will remain unfilled as the Company
works toward a smaller, more efficient organization.
GENERAL AND ADMINISTRATIVE EXPENSE
General and administrative expenses decreased 2% or $31,000 from $1.54 million
for the six-month period ended September 30, 1999 to $1.51 million for the
six-month period ended September 30, 2000. The decrease between periods resulted
primarily from the absence of severance costs that were present during the
second quarter of fiscal 2000. This decrease was partially offset by increased
professional and legal fees related to the required registration of common stock
pursuant to the terms of the private placement of preferred stock.
OTHER INCOME (EXPENSE)
Other income (expense) changed from income of $116,000 for the six-month period
ended September 30, 1999 to (expense) of ($582,000) for the six-month period
ended September 30, 2000. Overall, the change is attributable to a large swing
from a foreign exchange gain to a foreign exchange loss resulting primarily from
the volatility of foreign currencies against the U.S. Dollar.
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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 September 30, 2000, Microware had approximately $1.8 million in working
capital and $2.9 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 private placement of preferred stock
during the first quarter of fiscal 2001.
Net cash used in operating activities in the first six months of fiscal 2000 and
2001 totaled $2.1 million and $2.7 million, respectively. The net loss of $4.7
million, partially offset by a decrease in trade receivables of $949,000, was
the primary reason for the cash used in operations in the first six months of
fiscal 2000. The net loss of $4.4 million, partially offset by a decrease in
trade receivables of $282,000, was the primary reason for the cash used in
operations in the first six months of fiscal 2001.
Net cash provided by (used in) investing activities in the first six months of
fiscal 2000 and 2001 totaled $1.8 million and ($32,000), respectively. Cash
provided by investing activities during the first two quarters of fiscal 2000
resulted from net maturities of short-term investments and were partially offset
by capital expenditures. Cash used in investing activities for the first six
months of fiscal 2001 was a result of capital expenditures.
Net cash (used in) provided by financing activities in the first six months of
fiscal 2000 and 2001 totaled ($274,000) and $3.5 million, respectively. Cash
used for financing activities during the first six months of fiscal 2000 stemmed
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 activities for the first two quarters of fiscal 2001 came primarily
from the proceeds of the issuance of preferred stock.
As of September 30, 2000, 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 is reviewing financing transactions and other alternatives to
ensure liquidity needs, and Microware's ability to fund working capital and
other liquidity needs is dependent upon improved future operating performance
as well as the availability of funding sources.
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. There can be no assurance that
Microware's future results of operations will not be adversely affected by
currency fluctuations.
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<PAGE>
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.
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.
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<PAGE>
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.
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.
ATTRACTION AND RETENTION OF QUALIFIED PERSONNEL
The Company's future performance depends to a significant degree upon the
continued contributions of its key management, product development, marketing
and sales personnel, many of whom have joined the Company recently. The Company
has 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.
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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.
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 September 30, 2000, Microware had total
long-term debt of $6,851,000.
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.
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PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITITES AND USE OF PROCEEDS
(c) As disclosed in the Company's Current Report on Form 8-K dated
May 4, 2000, the Company entered into a Securities Purchase
Agreement with Elliott Associates, L.P. ("Elliott") and Westgate
International, L.P. ("Westgate") pursuant to which Elliott and
Westgate purcahsed a total of 3,500 shares of Series I Cumulative
Convertible Preferred Stock of the Company, two separate warrants
to purchase an additional 87,5000 common shares in aggregate, and
options to purchase an additional 618,595 shares in aggregate of
common stock. 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 September 8, 2000 Elliott and Westgate converted a total of
1,000 shares of Series I Common Stock plus cumulative dividends
accrued at that date, to 706,628 common shares in aggregate, at a
conversion price of $1.4375 per common share. Additionally, on
September 14, 2000 Elliott and Westgate converted a total of 214
shares of Series I Common Stock plus cumulative dividends accrued
at that date, to 151,318 common shares in aggregate, at a
conversion price of $1.4375 per common share.
For more information, refer to the Company's Current Report on
Form 8-K filed with the Securities and Exchange Commission on May
4, 2000 and the Company's Quarterly Report filed on Form 10-Q for
the quarter ended June 30, 2000 with the Securities and Exchange
Commission on August 14, 2000.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Annual Meeting of Shareholders of the Company was held on September 12,
2000. More than 91 percent of the holders of the Company's Common Stock were
represented at the meeting. Three issues were presented for consideration at the
meeting and were approved by the shareholders: 1) the election of two Class II
Directors to hold office until the 2003 Annual Meeting; 2) the proposal to amend
the Microware Systems Corporation 1995 Stock Option Plan to increase the number
of shares available for grant by 600,000 shares; and 3) the ratification of the
selection of KPMG LLP as independent public accountants of the Company for the
fiscal year ending March 31, 2001. The results were as follows:
<TABLE>
<CAPTION>
FOR AGAINST WITHHOLD ABSTAIN
<S> <C> <C> <C> <C>
1. ELECTION OF DIRECTORS:
George E. Leonard 13,963,883 592,787
Robert A. Peiser 13,947,953 608,717
2. PROPOSAL TO AMEND THE COMPANY'S 1995
STOCK OPTION PLANT 13,701,283 804,957 50,430
3. PROPOSAL TO RATIFY THE SELECTION OF
KPMG LLP AS INDEPENDENT PUBLIC ACCOUNTANTS 14,470,470 57,920 28,280
</TABLE>
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a.) Exhibits
27 Financial Data Schedule (EDGAR version only).
(b.) Reports on Form 8-K
None.
No other items.
SIGNATURE
Pursuant to the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto authorized.
MICROWARE SYSTEMS CORPORATION
Date: November 14, 2000 /s/ George E. Leonard
---------------------
George E. Leonard
Executive Vice President,
Chief Operating Officer,
Chief Financial Officer
and Secretary
Date: November 14, 2000 /s/ Beth E. Law
---------------
Beth E. Law
Chief Accounting Officer,
Controller, Treasurer
and Assistant Secretary
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