<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 1998
Commission File Number: 000-21287
================================================================================
PEERLESS SYSTEMS CORPORATION
(Exact name of registrant as specified in its charter)
================================================================================
DELAWARE 95-3732595
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2381 ROSECRANS AVENUE
EL SEGUNDO, CA 90245
(Address of principal executive offices, including zip code)
(310) 536-0908
(Registrant's telephone number, including area code)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
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 [__]
THE NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AS OF DECEMBER 7, 1998 WAS
11,037,314.
================================================================================
<PAGE>
SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
This report on Form 10-Q contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934 which are subject to the "safe harbor" created by those
sections. The forward-looking statements include, but are not limited to,
statements related to industry trends and future growth in the markets for
digital document products, embedded imaging systems and enterprise networks;
Peerless Systems Corporation ("Company") strategies for reducing its customers'
costs and time-to-market; the Company's product development efforts; the effect
of GAAP accounting pronouncements on the Company's recognition of revenues; the
Company's future research and development; business trends; and future quarterly
profitability. Discussions containing such forward-looking statements may be
found in "Management Discussion and Analysis of Financial Condition and Results
of Operations." These forward-looking statements involve certain risks and
uncertainties that could cause actual results to differ materially from those in
such forward-looking statements. The Company disclaims any obligation to update
these forward-looking statements as a result of subsequent events. The business
risks on pages 14 through 16, among other things, should be considered in
evaluating the Company's prospects and future financial performance.
2
<PAGE>
PEERLESS SYSTEMS CORPORATION
INDEX
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PART I - FINANCIAL INFORMATION
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C> <C>
Item 1: FINANCIAL STATEMENTS Page No.
--------------------
Balance Sheets
October 31, 1998 and January 31, 1998...................................4
Statements of Operations
Three and Nine Month Periods Ended October 31, 1998 and 1997............5
Statements of Cash Flows
Nine Month Periods Ended October 31, 1998 and 1997......................6
Notes to Financial Statements.............................................8
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS....................................................12
---------------------
</TABLE>
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C> <C>
Item 6: EXHIBITS AND REPORTS ON FORM 8-K.........................................17
--------------------------------
Signatures...............................................................................18
</TABLE>
TRADEMARKS
PEERLESS SYSTEMS(R) and Memory Reduction Technology(R) (MRT(R)) are registered
trademark of Peerless Systems Corporation. AccelePrint/(TM)/, PEERLESS/(TM)/,
WINEXPRESS/(TM)/, PeerlessPrint/(TM)/, QuickPrint/(TM)/ Multiprint/(TM)/,
PeerlessPowered/(TM)/, PicturePrint/(TM)/, Camera Page Language/(TM)/
(CPL/(TM)/), App-To-Image/(TM)/, and Synthesys/(TM)/ are trademarks of Peerless
Systems Corporation and are subjects of applications pending for registration
with the United States Patent and Trademark Office. Peerless Systems (in English
and Japanese Katakana), PEERLESS (in logo) and P/(TM)/ (in logo) are registered
service marks of Peerless Systems Corporation in Japan and these marks are also
subjects of applications pending for registration as trademarks with the
Japanese Patent Office. This Form 10-Q also refers to various products and
companies by their trademark names. In most, if not all cases, these
designations are claimed as trademarks or registered trademarks by their
respective companies.
3
<PAGE>
PART I - FINANCIAL INFORMATION
- --------------------------------------------------------------------------------
Item 1: Financial Statements
--------------------
PEERLESS SYSTEMS CORPORATION
BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
OCTOBER 31, JANUARY 31,
1998 1998
---- ----
ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 8,473 $ 3,199
Short term investments 15,416 16,982
Trade accounts receivable, net 5,454 5,577
Unbilled receivables 3,071 1,386
Deferred tax asset 1,544 1,544
Prepaid expenses and other current assets 1,277 892
------- -------
Total current assets 35,235 29,580
Investments 2,997 5,501
Property and equipment, net 5,476 4,426
Deferred tax asset 232 249
Other assets 249 339
------- -------
Total assets $44,189 $40,095
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 593 $ 1,149
Accrued wages 1,486 1,065
Accrued compensated absences 625 501
Other current liabilities 742 468
Income taxes payable - 406
Deferred revenue 1,740 2,278
------- -------
Total current liabilities 5,186 5,867
Deferred rent 373 421
------- -------
Total liabilities 5,559 6,288
------- -------
Stockholders' equity:
Preferred stock, $.001 par value, 5,000 shares authorized, no shares issued
outstanding - -
Common stock, $.001 par value, 30,000 shares authorized, 11,037 and 10,664
shares issued and outstanding at October 31, 1998 and 1997, respectively 11 11
Additional paid-in capital 39,301 37,952
Deferred compensation (184) (275)
Accumulated deficit (498) (3,881)
------- -------
Total stockholders' equity 38,630 33,807
------- -------
Total liabilities and stockholders' equity $44,189 $40,095
======= =======
</TABLE>
The following notes are an integral part of these financial statements.
4
<PAGE>
PEERLESS SYSTEMS CORPORATION
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
------------------------ -------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Product licensing $ 4,532 $ 3,713 $14,998 $10,986
Engineering services and maintenance 2,781 2,710 9,198 6,524
------- ------- ------- -------
Total revenues 7,313 6,423 24,196 17,510
------- ------- ------- -------
Cost of revenues:
Product licensing 35 35 106 105
Engineering services and maintenance 2,540 2,151 8,076 5,543
------- ------- ------- -------
Total cost of revenues 2,575 2,186 8,182 5,648
------- ------- ------- -------
Gross margin 4,738 4,237 16,014 11,862
------- ------- ------- -------
Operating expenses:
Research and development 1,768 1,106 5,314 3,218
Sales and marketing 1,210 936 3,076 2,713
General and administrative 1,222 735 3,425 2,154
------- ------- ------- -------
Total operating expenses 4,200 2,777 11,815 8,085
------- ------- ------- -------
Income from operations 538 1,460 4,199 3,777
Interest income, net 318 387 1,006 1,040
------- ------- ------- -------
Income before income taxes 856 1,847 5,205 4,817
Provision for income taxes 300 702 1,822 1,831
------- ------- ------- -------
Net income $ 556 $ 1,145 $ 3,383 $ 2,986
======= ======= ======= =======
Net income per common share $ 0.05 $ 0.11 $ 0.31 $ 0.28
======= ======= ======= =======
Net income per common share - assuming dilution $ 0.05 $ 0.10 $ 0.29 $ 0.26
======= ======= ======= =======
Weighted average common shares outstanding 10,954 10,628 10,842 10,566
======= ======= ======= =======
Weighted average common shares outstanding and
dilutive shares 11,587 11,644 11,766 11,638
======= ======= ======= =======
</TABLE>
The following notes are an integral part of these financial statements.
5
<PAGE>
PEERLESS SYSTEMS CORPORATION
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
OCTOBER 31,
-------------------------------
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 3,383 $ 2,986
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 670 415
Amortization of deferred compensation 91 91
Compensation expense on common stock issued to employees 160 -
Changes in operating assets and liabilities:
Trade accounts receivable 123 (1,361)
Unbilled receivables (1,685) (1,155)
Prepaid expenses and other current assets (385) (800)
Other assets - (27)
Accounts payable (556) (172)
Accrued wages 421 (31)
Accrued compensated absences 124 227
Other current liabilities 274 425
Income taxes payable (406) 1,383
Deferred rent (48) 165
Deferred revenue (538) (474)
-------- --------
Net cash provided by operating activities 1,628 1,672
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (1,688) (866)
Purchases of held-to-maturity securities - (24,244)
Purchases of available-for-sale securities (11,355) -
Proceeds from held-to-maturity securities 5,000 4,000
Proceeds from available-for-sale securities 10,500 -
-------- --------
Net cash provided (used) by investing activities 2,457 (21,110)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 403 389
Proceeds from exercise of common stock options 786 329
-------- --------
Net cash provided by financing activities 1,189 718
-------- --------
Net increase (decrease) in cash and cash equivalents 5,274 (18,720)
Cash and cash equivalents, beginning of period 3,199 24,162
-------- --------
Cash and cash equivalents, end of period $ 8,473 $ 5,442
======== ========
</TABLE>
The following notes are an integral part of these financial statements.
6
<PAGE>
PEERLESS SYSTEMS CORPORATION
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
OCTOBER 31,
-------------------------
1998 1997
---- ----
<S> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $1,804 $ 151
====== =====
Interest $ - $ -
====== =====
Supplemental schedule of noncash investing and financing activities:
Common stock issued to employees $ 160
======
</TABLE>
The following notes are an integral part of these financial statements.
7
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Note 1 BASIS OF PRESENTATION
- ------
The accompanying unaudited financial statements of Peerless Systems
Corporation (the "Company") have been prepared pursuant to the rules of the
Securities and Exchange Commission (the "SEC") for quarterly reports on Form
10-Q and do not include all of the information and note disclosures required by
generally accepted accounting principles. The financial statements and notes
herein are unaudited, but in the opinion of management, include all the
adjustments (consisting only of normal, recurring adjustments) necessary to
present fairly the financial position, results of operations and cash flows of
the Company. These statements should be read in conjunction with the audited
financial statements and notes thereto for the years ended January 31, 1998 and
1997 and the year ended December 31, 1995, included in the Company's annual
report filed on Form 10-K with the SEC on April 24, 1998. The results of
operations for the interim periods shown herein are not necessarily indicative
of the results to be expected for any future interim period or for the entire
year.
Note 2 SIGNIFICANT ACCOUNTING POLICIES
- ------
Revenue Recognition:
In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-2, "Software Revenue Recognition" ("SOP 97-2"),
which supersedes Statement of Position 91-1, "Software Revenue Recognition."
SOP 97-2, and amendments thereto, provides guidance on applying generally
accepted accounting principles in recognizing revenue on software transactions
and is effective for transactions entered into in years beginning after December
15, 1997. The Company adopted SOP 97-2 for all transactions on or after
February 1, 1998.
In accordance with SOP 97-2, the Company recognizes development license
revenue from the licensing of source code for the Company's standard products
upon shipment and customer acceptance of the source code if no significant
modification or customization of the software is required and collection of the
resulting receivable is probable. If modification or customization is essential
to the functionality of the software, revenue is recognized over the course of
the modification work or deferred until the modification is complete. Recurring
licensing revenues are recognized when due from the Company's OEM customers
based on the number of products shipped incorporating the Company's technology.
In certain cases, the fixed or determinable portion of the recurring licensing
fee is recognized as revenue upon delivery and customer acceptance of the
underlying technology.
The Company also enters into engineering services contracts with OEMs to
adapt the Company's software and supporting electronics to specific OEM
requirements. Revenue on such contracts is recognized over the course of the
development work on a percentage-of-completion basis. The Company provides for
any anticipated losses on such contracts in the period in which such losses are
first determinable. Maintenance revenues are recognized ratably over the term
of the maintenance contract.
Future Developments:
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131").
8
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Future Developments (continued):
SFAS 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that such enterprises report selected information about operating
segments in interim financial reports issued to stockholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. SFAS 131 is effective for fiscal years
beginning after December 15, 1997. Management is currently evaluating the
requirements of SFAS 131 and the impact that adoption of SFAS 131 will have on
the financial statements of the Company.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in
the fair value of derivatives will be recorded each period in current earnings
or other comprehensive income, depending on whether a derivative is designated
as part of a hedge transaction and, if it is, the type of hedge transaction.
SFAS 133 is effective for fiscal years beginning after June 15, 1999. The
Company does not believe that the adoption of SFAS 133 will have a material
impact on the financial statements of the Company.
NOTE 3 INVESTMENTS
- ------
<TABLE>
<CAPTION>
OCTOBER 31, JANUARY 31,
1998 1998
---- ----
<S> <C> <C>
Held-to-maturity securities:
Maturities within one year:
U.S. government debt securities $ 5,511 $ 6,007
Corporate debt securities - 3,979
Certificates of deposit - 2,000
------- -------
5,511 11,986
Maturities after one year through five years:
U.S. government debt securities 1,493 5,501
------- -------
7,004 17,487
------- -------
Available-for-sale securities:
Maturities within one year:
Corporate debt securities 7,941 2,996
U.S. government debt securities 1,964 -
------- -------
9,905 2,996
Maturities after one year through five years:
U.S. government debt securities 1,504 -
Maturities after ten years:
Other debt securities - 2,000
------- -------
11,409 4,996
------- -------
Total investments $18,413 $22,483
------- -------
</TABLE>
The fair value of held-to-maturity securities at October 31, 1998 and
January 31, 1998 approximated amortized cost. Unrealized gains or losses on
available-for-sale securities were immaterial for all periods presented.
9
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
NOTE 4 STOCKHOLDERS' EQUITY
- ------
On October 6, 1998, the Board of Directors of the Company adopted a
stockholder rights plan, as set forth in the Rights Agreement, dated as of
October 7, 1998 by and between the Company and Norwest Bank Minnesota, N.A., as
rights agent. Pursuant to the Rights Agreement, one Right was issued for each
share of the Company's common stock outstanding as of October 15, 1998. Each of
the Rights entitles the registered holder to purchase, from the Company, one
one-thousandth of a share of Series A Junior Participating Preferred Stock at a
price of $35.50 per one one-thousandth of a share. The Rights generally will not
become exercisable unless and until, among other things, any person or group not
approved by the Board of Directors acquires beneficial ownership of 15% or more
of the Company's outstanding common stock or commences a tender offer or
exchange offer which would result in a person or group beneficially owning 15%
or more of the Company's outstanding common stock. Upon the occurrence of
certain events, each holder of a Right would thereafter have the right to
purchase, for the then exercise price of the Right, shares of common stock of
the Company, or a corporation or other entity acquiring the Company, having a
value equal to two times the exercise price of the Right. The Rights are
redeemable by the Company under certain circumstances at $.01 per Right and will
expire, unless earlier redeemed or extended, on October 15, 2008.
NOTE 5 NET INCOME PER COMMON SHARE
- ------
Net income per common share is calculated as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED OCTOBER 31,
-------------------------------------------------------------------------------------------------
1998 1997
-------------------------------------------- --------------------------------------------
NET PER-SHARE NET PER-SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
BASIC EPS
Net income available to the
common stockholders $3,383 10,842 $0.31 $2,986 10,566 $0.28
===== =====
EFFECT OF DILUTIVE SECURITIES
Common stock options - 924 - 1,072
------ ------ ------ ------
DILUTED EPS
Net income available to common
stockholders and assumed
conversions $3,383 11,766 $0.29 $2,986 11,638 $0.26
====== ====== ===== ====== ====== =====
</TABLE>
10
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
NOTE 5 NET INCOME PER COMMON SHARE (CONTINUED)
- ------
<TABLE>
<CAPTION>
THREE MONTHS ENDED OCTOBER 31,
-------------------------------------------------------------------------------------------------
1998 1997
-------------------------------------------- --------------------------------------------
NET PER-SHARE NET PER-SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
BASIC EPS
Net income available to the
common stockholders $ 556 10,954 $0.05 $1,145 10,628 $0.11
===== =====
EFFECT OF DILUTIVE SECURITIES
Common stock options - 633 - 1,016
----- ------ ------ ------
DILUTED EPS
Net income available to common
stockholders and assumed
conversions $ 556 11,587 $0.05 $1,145 11,644 $0.10
===== ====== ===== ====== ====== =====
</TABLE>
11
<PAGE>
PEERLESS SYSTEMS CORPORATION
================================================================================
Item 2: Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
This report on Form 10-Q contains forward-looking statements that involve
risks and uncertainties. The statements contained in this report that are not
purely historical are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934, including, without limitation, statements regarding the Company's
expectations, beliefs, intentions or strategies regarding the future. All
forward-looking statements included in this document are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward-looking statements as a result of certain
factors included in this report.
OVERVIEW
The Company, founded in April 1982, is a leading provider of software-based
embedded imaging systems to original equipment manufacturers ("OEMs") of digital
document products. Digital document products include printers, copiers, fax
machines and scanners, as well as multifunction products ("MFPs") that perform a
combination of these imaging functions. In order to process digital text and
graphics, digital document products rely on a core set of imaging software and
supporting electronics, collectively known as an embedded imaging system.
Peerless' technology and engineering services provide advanced imaging solutions
that enable the Company's OEMs to develop digital printers, copiers and MFPs
quickly and cost effectively.
The Company's customers currently include, among others, Adobe and Rockwell
and OEM customers Canon, IBM, Minolta and Ricoh. A significant portion of the
Company's revenues in recent years has been concentrated with a limited number
of customers, and the Company anticipates that its revenues in the future may be
similarly concentrated.
The Company's product licensing revenues are comprised of both recurring
licensing revenues and one-time licensing fees for source code. Recurring
licensing revenues are derived from per unit fees paid quarterly by the
Company's OEMs upon shipment or manufacture of products incorporating the
Company's technology. Recurring licensing revenues are derived, to a lesser
extent, from arrangements in which the Company enables its products to be used
with third-party technology such as certain arrangements with Adobe. The
Company negotiates minimum recurring license fee requirements from certain OEMs,
generally over four to six quarters, which minimize exposure to OEM products
that may lack market acceptance. The Company's development licensing fees are
paid by OEMs for access to the Company's software, which in turn generates
recurring licensing revenues if the software is incorporated into OEM products
that are subsequently developed and shipped.
The Company's engineering services revenues are derived primarily from
adapting the Company's software and supporting electronics to specific OEM
requirements. The Company provides its engineering services to OEMs seeking an
embedded imaging solution for their digital document products. The Company's
maintenance revenues are derived from software maintenance agreements.
Maintenance revenues constitute a small portion of this revenue category.
The Company recognizes engineering services revenues over the course
of the development work on a percentage-of-completion basis. Maintenance
revenues are recognized ratably over the term of the maintenance contract, which
generally is twelve months. The Company adopted Statement of Position 97-2,
"Software Revenue Recognition" ("SOP 97-2") for all software licensing
transactions entered into on or after February 1, 1998. In accordance with SOP
97-2, the Company recognizes development license revenue from the licensing of
source code for the Company's standard products upon shipment and customer
acceptance of the source
12
<PAGE>
code if no significant modification or customization of the software is required
and collection of the resulting receivable is probable. If modification or
customization is essential to the functionality of the software, revenue is
recognized ratably over the services performed or deferred until the
modification is complete. Recurring licensing revenues are recognized when due
from the Company's OEM customers based on the number of products shipped
incorporating the Company's technology. In certain cases, the fixed or
determinable portion of the recurring licensing fee is recognized as royalty
revenue upon delivery and customer acceptance of the underlying technology.
RESULTS OF OPERATIONS
THREE AND NINE MONTH PERIODS ENDED OCTOBER 31, 1998 AND 1997
REVENUES. Revenues for the quarter ended October 31, 1998 increased 14% to
---------
$7.3 million from the $6.4 million reported for the same quarter in 1997.
Revenues for the current nine month period increased 38% to $24.2 million from
the $17.5 million reported for the nine month period ended October 31, 1997. The
increase in revenues was driven by a 22% and 37% increase in product licensing
revenues for the three and nine month periods, respectively, and a 41% increase
in engineering services and maintenance revenues for the current nine month
period. Increases in product licensing revenues were generated by an increase in
the shipments and number of products incorporating Peerless' imaging technology.
Revenues for the current quarter benefited from the launch of seven new color
and monochrome printers into the market and the delivery of an additional five
completed products to OEMs. Revenues for the current nine month period also
benefited from new monochrome and multi-function printers introduced by the
Company's OEMs during fiscal 1998 and an increase in the market penetration of
existing products. Increased outsourcing of digital document products generated
the growth in engineering services and maintenance revenues during the current
nine month period by OEMs as well as a one-time fee paid by an OEM in the second
quarter of this fiscal year to cancel development work on a project.
GROSS MARGIN. The Company's gross margin as a percentage of total revenues
-------------
decreased to 65% for the quarter ended October 31, 1998 from the 66% reported
for the same quarter in 1997. The gross margin as a percentage of total
revenues decreased to 66% for the nine month period ended October 31, 1998 from
the 68% reported for the comparable period last year. Decreases in the
engineering services and maintenance profitability between periods negatively
impacted the overall gross margins. The engineering services and maintenance
gross margins declined to 9% and 12% for the three and nine month periods ended
October 31, 1998, respectively, from the 21% and 15% reported for the comparable
periods in the prior year. The decline in the engineering services and
maintenance gross margins was the result of design changes and increased
technical complexity. Further, the Company put additional resources to work to
complete certain projects in the current quarter. This increased effort
resulted in five project completions, as noted above.
RESEARCH AND DEVELOPMENT EXPENSES. Peerless continues to invest heavily in
----------------------------------
the future by funding the research and development of new technology solutions.
Research and development expenses increased 60% to 24% of total revenues for the
quarter ended October 31, 1998 from 17% of total revenues for the same quarter
last year. Research and development expenditures as a percentage of total
revenues increased to 22% in the current nine month period from 18% in the prior
nine month period. The increased funding was used, among other things, to make
strategic investments in new market sectors such as digital photography and
advanced architectures for high speed color. Management anticipates that
research and development costs will continue to increase in future periods.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased 29%
-----------------------------
between the quarters ended October 31, 1998 and 1997 and increased 13% between
the nine month periods then ended. The expense growth was due to an increase in
the sales and marketing headcount and a continued emphasis on industry trade
shows and other opportunities to promote the Company's embedded imaging
solutions.
13
<PAGE>
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
------------------------------------
for the quarter ended October 31, 1998 increased $487,000 or 66% over the
comparable period last year and increased $1.3 million or 59% between the two
nine month periods ended October 31, 1998 and 1997, respectively. Contributing
to the current year expense growth was a one-time charge of $275,000 in the
second quarter of fiscal 1999 related to a proposed transaction that was
terminated. The balance of the expense growth in both the three and nine month
periods related primarily to an increase in personnel and expenses necessary to
support the growth of the Company's operations.
INTEREST INCOME. The Company earned net interest income of $318,000 and
----------------
$387,000 in the third quarters of fiscal 1999 and 1998, respectively, and $1
million in each of the first nine month periods of fiscals 1999 and 1998.
Interest income was related to interest and investment income earned on cash
equivalents and investments.
INCOME TAX PROVISIONS. The provisions for income taxes for all periods
----------------------
presented are based on the estimated annual effective tax rate and include
current federal, state and foreign income taxes. The effective tax rates for
the periods differ from the federal statutory rate primarily as a result of
foreign and state income tax provisions noted above offset by foreign and
research and experimentation credits. The Company periodically evaluates the
sufficiency of its deferred tax asset valuation allowance, which is adjusted as
deemed appropriate based on operating results.
LIQUIDITY AND CAPITAL RESOURCES
Compared to January 31, 1998, total assets grew 10% to $44.2 million and
stockholders' equity grew 14% to $38.6 million. The Company's cash and short-
term investment portfolio totaled $26.9 million at October 31, 1998 and the
current ratio was 6.8:1. The Company generated $1.6 million in cash from
operations during the nine month period ended October 31, 1998 and $1.7 million
in cash from operations during the nine month period ended October 31, 1997.
Net cash provided by investing activities during the nine month period
ended October 31, 1998 was $2.5 million and was comprised primarily of purchases
of and proceeds from held-to-maturity and available-for-sale securities.
Additions to property and equipment during the nine months ended October 31,
1998 totaled $1.7 million and related primarily to asset purchases associated
with growth in headcount. Net cash used by investing activities of $21.1
million during the nine months ended October 31, 1997 was comprised primarily of
purchases of held-to-maturity securities.
Net cash provided by financing activities in the nine month periods ended
October 31, 1998 and 1997 was $1.1 million and $718,000, respectively. This
cash resulted from the issuance of shares of common stock as performance awards
and under the Company's employee stock purchase plan, as well as the exercise of
common stock options.
During the current nine month period, the Company had available a $2.0
million revolving line of credit with a bank, which was collateralized by
substantially all assets of the Company. The line expired in May 1998 and has
not been renewed. The Company is currently evaluating proposals for a new line
with additional borrowing capacity.
CERTAIN BUSINESS RISKS
Although the Company has been profitable since the quarter ended December
31, 1995, there can be no assurance that the Company will maintain
profitability, or growth in profitability, on a quarterly basis or achieve
profitability on an annual basis in the future. The success of the Company and
its business strategy is dependent upon, among other things, the ability and
willingness of the Company's OEM customers to timely develop and promote digital
document products that incorporate the Company's technology. The Company's
revenues are
14
<PAGE>
concentrated among a limited number of OEM customers and management believes
that future revenues may be similarly concentrated. Consequently, any
significant decrease in product sales or reduction in licensing or engineering
services with a large OEM customer could have a material adverse effect on the
Company's operating results.
The market for the Company's products is characterized by rapidly changing
technology, evolving industry standards and needs, frequent new product
introductions and diminishing time frames within which to develop new products.
the failure of the Company and its OEM customers to meet these needs on a timely
basis or to anticipate or respond to rapidly changing technology could result in
a loss of competitiveness or revenues, which would have a material adverse
effect on the Company's operating results. Unit shipment reports received after
the end of the current quarter from the Company's OEMs revealed a mixed pattern
of shipments by market segment. Additionally, design changes as well as
technical complexity affected engineering services revenue in the second and
third quarters of fiscal 1999. At present, the Company believes these business
trends are likely to dampen quarterly revenue growth from previous rates for the
remainder of fiscal 1999 and into fiscal 2000. As a result, it is likely that
quarterly profitability will be below prior year results for the remainder of
fiscal year ending January 31,1999 and into fiscal year ending January 31, 2000.
The recurring product licensing revenues reported by the Company are
dependent on the timing and accuracy of product sales reports received from the
Company's OEM customers. These reports are provided only on a calendar quarter
basis and, in any event, are subject to delay and potential revision by the OEM.
The Company, in a few instances, has been required to estimate its quarterly
revenues from an OEM when the report from such OEM is not received in a timely
manner. As a result, the Company may be unable to estimate such revenue
accurately prior to public announcement of the Company's quarterly results. In
such event, the Company subsequently may be required to restate its recognized
revenues or adjust revenues for subsequent periods, which could have a material
adverse effect on the Company's operating results.
During the past year, the Asian economy has experienced a downturn and, as
a result, some companies in the imaging industry have reported negative
financial impacts. Peerless' Asian customers are comprised primarily of
companies headquartered in Japan and sell products containing Peerless'
technology primarily in North American and European marketplaces. Although the
Company's revenues have not been materially impacted by the decline in the Asian
economy, there can be no assurance that revenues from Asian customers will not
be impacted in future quarters.
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
Based on a recent assessment, the Company will be required to modify
certain support software so that its computer systems will properly utilize
dates beyond December 31, 1999. Management believes that the Company's
engineering and development tools will not be impacted by the Year 2000 Issue as
they are not date sensitive. The Company believes that the exposure, if any, to
contingencies related to the Year 2000 Issue for products developed for OEMs is
not material.
To date, the Company has spent approximately $50,000 for Year 2000 software
upgrades. Management is currently developing a plan that would include
independent validation of the Company's Year 2000 assessment procedures,
initiating formal communications with all of its significant vendors, large
customers and development partners to determine the extent to which the Company
is vulnerable to those third parties' failure to remediate their own Year 2000
Issues. The estimated cost to complete the project is not expected to have a
material effect on the financial position or results of operations of the
Company. The Company will utilize both internal and external resources for Year
2000 software modifications.
15
<PAGE>
The Company presently believes that with the identified modifications, the
Year 2000 Issue can be mitigated. However, if the modifications are not made,
or are not completed timely, the Year 2000 Issue could have a material impact on
the operations of the Company. Further, there can be no guarantee that the
systems of other companies on which the Company's systems rely will be timely
converted, or that a failure to convert by another company, or a conversion that
is incompatible with the Company's systems, would not have a material adverse
effect on the Company. The Company intends to, but has not yet, established a
contingency plan detailing actions that will be taken in the event that its
assessment of the Year 2000 Issue is not completed on a timely basis.
Also inherent in the Company's business are additional risks, which include
but are not limited to: competition in the market of embedded imaging systems
for digital document products, including internal development by OEMs; potential
fluctuation in quarterly results, including factors such as the duration of
contractual arrangements and product life-cycles; the Company's dependence on
the success of its OEMs; risks associated with the development of products,
whether such delays are within the control of the Company or not; risks
associated in developing products for new and rapidly developing markets, to
which the Company has directed a substantial portion of its recent development
efforts; dependence on sole source providers; uncertainties regarding protection
of intellectual property rights, including the potential for trademark and
patent infringement litigation; dependence on key personnel; and risks
associated with the Company's international business activities, which account
for a substantial portion of revenues.
16
<PAGE>
PART II - OTHER INFORMATION
================================================================================
Item 1: LEGAL PROCEEDINGS
-----------------
None
Item 2: CHANGES IN SECURITIES
---------------------
None
Item 3: DEFAULTS UPON SENIOR SECURITIES
-------------------------------
None
Item 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
None
Item 5: OTHER INFORMATION
-----------------
None
Item 6: EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
A Report on form 8-K was filed on October 13, 1998, pursuant to "Item 5.
Other Events", whereby the Company disclosed it had adopted a
stockholder rights plan.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized:
PEERLESS SYSTEMS CORPORATION
<TABLE>
<S> <C>
By: /s/Edward Gavaldon Date: December 14, 1998
----------------------------------------------------------------
Edward Gavaldon
Chairman of the Board, President and Chief Executive Officer
By: /s/Hoshi Printer Date: December 14, 1998
----------------------------------------------------------------
Hoshi Printer
Chief Financial Officer and Secretary
(Principal Financial and Accounting Officer)
</TABLE>
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORM
10-Q FOR THE PERIOD ENDED OCTOBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> OCT-31-1998
<CASH> 8,473
<SECURITIES> 18,413
<RECEIVABLES> 5,554
<ALLOWANCES> (100)
<INVENTORY> 0
<CURRENT-ASSETS> 35,235
<PP&E> 7,339
<DEPRECIATION> (1,863)
<TOTAL-ASSETS> 44,189
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<BONDS> 0
0
0
<COMMON> 11
<OTHER-SE> 38,619
<TOTAL-LIABILITY-AND-EQUITY> 44,189
<SALES> 24,196
<TOTAL-REVENUES> 24,196
<CGS> 8,182
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<OTHER-EXPENSES> 11,815
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</TABLE>
