<PAGE>
================================================================================
UNITED STATES 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, 1999
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 November 19, 1999 was
13,781,146.
================================================================================
<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 (the "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's 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 risks and uncertainties on pages 16 through 19, among
other things, should be considered in evaluating the Company's prospects and
future financial performance.
2
<PAGE>
PEERLESS SYSTEMS CORPORATION
INDEX
- --------------------------------------------------------------------------------
PART I - FINANCIAL INFORMATION
- --------------------------------------------------------------------------------
Item 1: Financial Statements Page No.
--------------------
Consolidated Balance Sheets
October 31, 1999 and January 31, 1999.......................... 4
Consolidated Statements of Income
Three and Nine Month Periods Ended October 31, 1999 and 1998... 5
Consolidated Statements of Cash Flows
Nine Month Periods Ended October 31, 1999 and 1998............. 6
Notes to Consolidated Financial Statements...................... 8
Item 2: Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations.......................................... 12
---------------------
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 1: Legal Proceedings............................................... 20
-----------------
Item 6: Exhibits and Reports on Form 8-K................................ 20
--------------------------------
Signatures .............................................................. 21
TRADEMARKS
Memory Reduction Technology(R) (MRT), PEERLESS SYSTEMS(R), PeerlessPowered(R),
WINEXPRESS(R), PeerlessPrint(R) and QuickPrint(R) are registered trademarks of
Peerless Systems Corporation. PicturePrint(TM), Acceleprint(TM), Synthesys(TM)
and CPL(TM) are trademarks of Peerless Systems Corporation and are subjects of
applications pending for registration with the United States Patent and
Trademark Office. Imageworks(TM) and Webworks(TM) are trademarks of Peerless
Systems Corporation. Peerless Systems (in English and Japanese Katakana),
Peerless (in logo) and P (in logo) are registered service marks with the
Japanese Patent Office. Peerless(TM) (in logo), P(TM) (in logo), Peerless
Systems(TM), PEERLESSPRINT(TM) and PEERLESSPAGE(TM) (all in English and Japanese
Katakana) are trademarks of Peerless Systems Corporation and are subjects of
applications pending for registration with the Japanese Patent Office. This Form
10-Q also refers to various products and companies by their trademark names. In
most, if not in all cases, their respective companies claim these designations
as trademarks or registered trademarks.
3
<PAGE>
Part I - Financial Information PEERLESS SYSTEMS CORPORATION
Item I - Financial Statements CONSOLIDATED BALANCE SHEETS
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
October 31, January 31,
1999 1999
-------------- --------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 5,815 $ 5,744
Short term investments 16,749 16,158
Trade accounts receivable, net 14,051 9,940
Unbilled receivables 3,641 2,994
Deferred tax asset 2,615 2,615
Prepaid expenses and other current assets 597 632
-------------- --------------
Total current assets 43,468 38,083
Investments 1,008 4,605
Property and equipment, net 6,666 5,374
Other assets 2,690 2,603
-------------- --------------
Total assets $ 53,832 $50,665
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 939 $ 893
Accrued wages 1,064 1,557
Accrued compensated absences 965 784
Other current liabilities 881 867
Income taxes payable 1,169 788
Deferred rent, current portion 96 76
Deferred revenue, current portion 289 1,533
Note payable to stockholder - 350
-------------- --------------
Total current liabilities 5,403 6,848
Deferred rent 378 431
Deferred revenue - 800
Total liabilities 5,781 8,079
-------------- --------------
Commitments and contingencies
Stockholders' equity:
Common stock, $.001 par value, 30,000 shares authorized, 13,737 and 11,948
shares issued and outstanding at October 31, 1999 and January 31, 1999,
respectively 13 12
Additional paid-in capital 47,670 39,348
Convertible preferred stock Series A - 3,217
Convertible preferred stock Series B - 3,520
Deferred compensation (139) (188)
Retained earnings (accumulated deficit) 507 (3,323)
-------------- --------------
Total stockholders' equity 48,051 42,586
-------------- --------------
Total liabilities and stockholders' equity $ 53,832 $ 50,665
============== ==============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
PEERLESS SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 31, October 31,
-------------------------- ---------------------------
1999 1998 1999 1998
--------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $ 10,693 $ 7,774 $ 31,065 $ 26,823
Cost of revenues 2,826 3,226 9,118 10,141
-------- -------- -------- --------
Gross margin 7,867 4,548 21,947 16,682
-------- -------- -------- --------
Operating expenses:
Research and development 2,501 2,114 6,901 6,431
Sales and marketing 1,361 1,315 4,140 3,430
General and administrative 925 1,403 3,906 4,011
Other non-recurring costs (Note 6) - - 2,014 -
-------- -------- -------- --------
Total operating expenses 4,787 4,832 16,961 13,872
-------- -------- -------- --------
Income (loss) from operations 3,080 (284) 4,986 2,810
Interest income, net 301 311 907 999
-------- -------- -------- --------
Income before income taxes 3,381 27 5,893 3,809
Provision for income taxes 1,185 9 2,064 1,272
-------- -------- -------- --------
Net income $ 2,196 $ 18 $ 3,829 $ 2,537
======== ======== ======== ========
Net income per common share $ 0.16 $ 0.00 $ 0.30 $ 0.22
======== ======== ======== ========
Net income per common share -
assuming dilution $ 0.15 $ 0.00 $ 0.26 $ 0.18
======== ======== ======== ========
Weighted average common shares
outstanding 13,605 11,785 12,747 11,671
======== ======== ======== ========
Weighted average common shares
outstanding and dilutive shares 14,795 14,064 14,490 14,229
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
PEERLESS SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended October 31,
-----------------------------
1999 1998
--------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 3,829 $ 2,537
Adjustments to reconcile net income to net cash (used) provided by
operating activities:
Business combination adjustment (Note 6) 1 -
Depreciation and amortization 1,067 819
Amortization of investment discounts and premiums (98) (75)
Amortization of deferred compensation 49 91
Compensation expense on common stock issued to employees 48 78
Changes in operating assets and liabilities:
Trade accounts receivable (4,111) 29
Unbilled receivables (647) (1,685)
Prepaid expenses and other current assets 35 (384)
Other assets 171 21
Accounts payable 46 (527)
Accrued wages (493) 421
Accrued compensated absences 181 240
Other current liabilities 14 199
Income taxes payable 381 (955)
Deferred rent (33) (41)
Deferred revenue (2,044) (207)
-------- --------
Net cash (used) provided by operating activities (1,604) 561
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (2,237) (1,733)
Purchases of software licenses (380) -
Purchases of available-for-sale securities (19,596) (11,355)
Proceeds from held-to-maturity securities 4,000 10,500
Proceeds from available-for-sale securities 18,700 5,000
-------- --------
Net cash provided by investing activities 487 2,412
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 800 491
Proceeds from exercise of common stock options 688 786
Repayment of outstanding note payable to stockholder (300) -
Proceeds from issuance of Convertible preferred stock Series B - 819
-------- --------
Net cash provided by financing activities 1,188 2,096
-------- --------
Net increase in cash and cash equivalents 71 5,069
Cash and cash equivalents, beginning of period 5,744 3,590
-------- --------
Cash and cash equivalents, end of period $ 5,815 $ 8,659
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
6
<PAGE>
PEERLESS SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(in thousands)
(Unaudited)
<TABLE>
<S> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $1,550 $1,804
====== ======
Interest $ 15 $ 25
====== ======
Supplemental schedule of noncash investing and financing activities:
Common stock issued to employees $ 48 $ 78
====== ======
Conversion of note payable to stockholder to common stock $ 50
======
Conversion of Convertible preferred stock Series A to common stock $3,217
======
Conversion of Convertible preferred stock Series B to common stock $3,520
======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
7
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands)
(Unaudited)
1. Basis of Presentation:
The accompanying unaudited consolidated financial statements of Peerless
Systems Corporation ("Peerless" or 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
consolidated 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, 1999, 1998 and 1997, included in the Company's
annual report filed on Form 10-K with the SEC on April 26, 1999 and the
unaudited pro forma combined balance sheet as of January 31, 1999 and the pro
forma combined statements of operations for the years ended January 31, 1999,
1998, and 1997 included in the registration statement filed on Form S-4 with the
SEC on April 26, 1999 as amended May 7, 1999. 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.
In June 1999, the Company completed its acquisition of Auco, Inc. ("Auco").
Auco, based in Redwood City, California, develops embedded networking technology
and was privately held prior to the acquisition. As a result of the acquisition,
Auco was renamed Peerless Systems Networking and became a wholly owned
subsidiary of the Company. The Company exchanged 2.5 million shares of its
common stock for all outstanding shares of Auco capital stock on a fully diluted
basis, and its convertible note payable. Each share of Auco was exchanged for
.2585 shares of Peerless common stock. The merger qualified as a tax-free
exchange and was accounted for as a "pooling of interests" under Accounting
Principles Board Opinion No. 16. Accordingly, the Company's financial statements
have been restated to include the results of Auco for all periods presented.
2. Significant Accounting Policies
Revenue Recognition:
Development license revenues from the licensing of source code or software
development kits for the Company's standard products are recognized upon
delivery of the software 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,
development license revenue is recognized over the course of the modification
work or deferred until the modification is complete.
The Company also enters into engineering services contracts with certain of
its OEMs to provide a turnkey solution, adapting the Company's software and
supporting technologies to specific OEM requirements. Revenues on such turnkey
contracts are 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.
Recurring licensing revenues are derived from per unit fees paid by the
Company's customers upon manufacturing and subsequent commercial shipment of
products incorporating Peerless technology. In certain cases, the Company
requires customers to pay minimum royalty commitments. These payments are
typically made in one lump sum or extend over a period of four or more quarters.
The Company generally recognizes revenues associated with recurring license fee
commitments on delivery of the software, when collection of the resulting
receivable is probable and when the fee is fixed and determinable. In cases
where the royalty commitments are not fixed and determinable, revenue is
recognized as payments become due. Further, when earned royalties exceed minimum
royalty commitments, revenues are recognized on a per unit basis as products are
shipped commercially.
8
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands)
(Unaudited)
Future Developments:
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133
requires that all derivative instruments be recorded on the balance sheet at
their fair value. Changes in the fair value of derivatives are 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 No. 133 is effective for fiscal years beginning after
June 15, 2000, as amended by SFAS No. 137. The adoption of SFAS No. 133 should
not have a material impact on the Company's results of operations, financial
position or cash flows.
3. Investments:
Investment consisted of the following:
<TABLE>
<CAPTION>
October 31, January 31,
1999 1999
--------- ------------
<S> <C> <C>
Held-to-maturity securities:
Maturities within one year:
U.S. government debt securities $ 1,500 $ 5,503
--------- ------------
Total held-to-maturity securities 1,500 5,503
--------- ------------
Available-for-sale securities:
Maturities within one year:
U.S. government debt securities 1,501 979
State and local U.S. government debt securities 1,331 -
Corporate debt securities 8,965 4,976
Other debt securities - 2,000
11,797 7,955
--------- ------------
Maturities after one year through five years:
U.S. government debt securities - 1,503
State and local U.S. government debt securities 752 -
Corporate debt securities 1,008 3,102
--------- ---------
1,760 4,605
--------- ---------
Maturities after ten years:
U.S. government debt securities - 2,700
State and local U.S. government debt securities 2,700 -
--------- ---------
2,700 2,700
--------- ---------
Total available-for-sale securities 16,257 15,260
--------- ---------
Total investments $17,757 $20,763
========= =========
</TABLE>
The fair value of held-to-maturity securities at October 31,1999 and
January 31, 1999 approximated amortized cost. Unrealized gains or losses on
available-for-sale securities were immaterial for all periods presented.
At October 31, 1999 and January 31, 1999, the Company held $3,452 and
$2,700, respectively, in available-for-sale securities with maturities in excess
of one year that were planned to be sold within one year of the respective
balance sheet dates. Accordingly, the securities have been classified as current
in the October 31, 1999 and January 31, 1999 balance sheets. Proceeds from the
sales were invested in short-term, available-for-sale securities.
9
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands)
(Unaudited)
4. Commitments and Contingencies
Legal Proceedings:
The Company is not a party to any pending legal proceedings which
management believes will have a material adverse effect on the financial
position, results of operations and cash flows of the Company. The Company is
currently involved in a dispute with one of its customers over the timing of a
payment due to the Company associated with the sale of a Peerless source code
license to the customer. Refer to Part II "Other Information", Item 1 "Legal
Proceedings" in this Form 10-Q for further discussion of the matter.
5. Net Income Per Common Share:
Net income per common share is calculated as follows:
<TABLE>
<CAPTION>
Three Months Ended October 31,
--------------------------------------------------------------------------
1999 1998
------------------------------------- ---------------------------------
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 $2,196 13,605 $0.16 $ 18 11,785 $0.00
===== =====
Effect of Dilutive Securities
Common stock options - 1,190 - 1,126
Note payable to stockholder - - 1 5
Convertible preferred stock Series A - - - 834
Convertible preferred stock Series B - - - 314
------ ------ ------ ------
Diluted EPS
Net income available to common
stockholders and assumed conversions $2,196 14,795 $0.15 $ 19 14,064 $0.00
====== ====== ===== ====== ====== =====
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended October 31,
--------------------------------------------------------------------------
1999 1998
------------------------------------- ---------------------------------
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 $3,829 12,747 $0.30 $2,537 11,671 $0.22
===== =====
Effect of Dilutive Securities
Common stock options - 1,103 - 1,420
Note payable to stockholder 1 3 3 5
Convertible preferred stock Series A - 443 - 834
Convertible preferred stock series B - 194 - 299
------ ------ ------ ------
Diluted EPS
Net income available to common
stockholders and assumed conversions $3,830 14,490 $0.26 $2,540 14,229 $0.18
====== ====== ===== ====== ====== =====
</TABLE>
10
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands)
(Unaudited)
6. Auco Acquisition
Prior to the June 1999 merger with Auco, Auco's fiscal year ended on
December 31. In recording the business combination, Auco's prior period
financial statements were not restated to conform to the Company's fiscal year.
Accordingly, the consolidated balance sheet at January 31, 1999 combines the
Peerless balance sheet at January 31, 1999 and the Auco balance sheet at
December 31, 1998. The consolidated statements of income for the three and nine
month periods ended October 31, 1998 and for the three month period ended April
30, 1999 consist of Peerless results of operations for the three and nine month
periods ended October 31, 1998 and the three month period ended April 30, 1999
and Auco's results of operations for the three and nine month periods ended
September 30, 1998 and the three month period ended March 30, 1999. Beginning in
the quarter ended July 31, 1999, Auco's fiscal year end was changed to conform
to the Peerless' fiscal year end of January 31. Accordingly, Auco's results of
operations for the month of April 1999 were excluded from the Company's
consolidated operating results. Revenues and net income of Auco for April 1999
were $463 and $1, respectively, with the net income reflected as an adjustment
to retained earnings effective May 1, 1999.
As a result of the acquisition, Auco's historical financial statements were
restated to adjust the income tax provision (benefit) for certain net operating
loss carryforward benefits which the Company believes will be realizable by the
combined companies. There were no transactions between Peerless and Auco prior
to the combination. Certain reclassifications were made to the Auco financial
statements to conform to Peerless' presentations.
The results of operations for the separate companies and the combined
amounts presented in the consolidated financial statements are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS
------------------------------------- ENDED
APRIL 30, OCTOBER 31, OCTOBER 31,
1999 1998 1998
-------- ---------- -----------------
<S> <C> <C> <C>
Revenues:
Peerless $ 8,194 $ 7,313 $ 24,196
Auco 1,666 461 2,627
--------- ---------- ----------------
Combined $ 9,860 $ 7,774 $ 26,823
========= ========== ================
Net Income (loss):
Peerless $ 1,091 $ 556 $ 3,383
Auco 122 (538) (846)
--------- ---------- ----------------
Combined $ 1,213 $ 18 $ 2,537
========= ========== ================
</TABLE>
In conjunction with the acquisition, the Company incurred transaction
costs, consisting primarily of fees for investment bankers, attorneys,
accountants, consultants, financial printing and other related charges of
$2,014. These costs are included in "Other non-recurring costs" in the
consolidated statements of income for the nine month periods ended October 31,
1999.
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 and networking systems to original equipment manufacturers of
digital document products. Digital document products include monochrome and
color printers, copiers, fax machines, and scanners, as well as multifunction
products 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. Embedded networking systems supply the core software
technologies to digital document products that enable them to communicate over
local area networks and the Internet. The Peerless systems family of products
and engineering services provides advanced embedded imaging and networking
technologies that enable the company's OEM customers to develop networked
digital printers, copiers and multifunction products quickly and cost-
effectively.
In June 1999, the Company acquired Auco, Inc. ("Auco") a supplier of
embedded networking systems. The transaction was accounted for as a pooling of
interests. As a result of the acquisition, Auco became a wholly owned subsidiary
of the Company and was subsequently renamed Peerless Systems Networking.
Peerless Systems Networking provides comprehensive software products and
engineering services to office peripheral OEMs to enable networking support in
their products.
Historically, a limited number of customers have provided a substantial
portion of the Company's revenues. Therefore, new contracts or modifications and
additions to existing contracts with these customers may materially impact the
Company's financial position and results of operations from quarter to quarter.
The Company's product licensing revenues are comprised of both recurring
licensing revenues and one-time licensing fees for source code or software
development kits (SDKs). Recurring licensing revenues are derived from per unit
fees paid quarterly by the Company's OEMs upon manufacturing and subsequent
commercial shipment of products incorporating the Company's technology.
Recurring licensing revenues are derived, to a lesser extent, from arrangements
in which the Company enables third-party technology, such as solutions from
Adobe, to be used with its products. The Company often requires minimum royalty
commitments from certain OEMs. These commitments are generally guaranteed
quarterly minimum royalty payments or block license sales, where the OEM
purchases a fixed number of licenses. Payments associated with royalty
commitments are generally paid in one lump sum or over four or more quarters.
The Company's development licensing fees are paid by OEMs for access to the
Company's SDKs, which in turn generates recurring licensing revenues if the
software is incorporated into OEM products that are subsequently developed and
commercially shipped.
The Company also has engineering services revenues that 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 a turnkey embedded imaging solution for their digital document
products.
12
<PAGE>
The Company's maintenance revenues are derived from software maintenance
agreements. Maintenance revenues currently constitute a small portion of total
revenue.
Over the past several quarters, the Company has experienced a shift in its
business and financial model. The Company generates revenue from its OEMs
through the sale of embedded imaging solutions in either turnkey or software
development kit form. Historically, OEM demand for turnkey solutions has
exceeded demand for SDK solutions. The Company has recently experienced a shift
away from turnkey solutions to the sale of SDKs, particularly for its monochrome
solutions, which incorporate more mature technology. Additionally, the Company
has expanded its solution offering by incorporating related embedded imaging and
networking technologies licensed from third parties, which in future quarters
could result in incremental SDK, services and royalty revenue streams.
As noted above, the shift to SDK sales has resulted in an increase in the
products shipping, as OEMs who utilize Peerless SDKs develop and introduce
multiple products. The Company expects to continue to provide turnkey solutions
in color and MFP where the technology is certain to evolve and where the turnkey
development challenge is more difficult for OEMs to assume.
On July 23, 1999, the Company entered into a distribution license agreement
with Adobe, Inc. for Adobe PostScript 3, PostScript fonts, both roman and
double byte, and certain other Adobe host software applications. This licensing
agreement will allow the Company to directly license Adobe technologies to its
OEMs, resulting in incremental revenues from licensing, recognized both when
the SDKs are delivered and subsequently in the form of recurring licensing
revenues as products utilizing these products are launched. In addition, this
new distribution agreement calls for the Company to remit licensing fees to
Adobe for the first time, which is expected to increase the Company's cost of
goods sold.
Traditionally, Peerless provided ASIC (Application Specific Integrated
Circuit) designs to chip foundries that manufactured and distributed the
Company's ASICs to the Company's OEMs. In return, the Company received license
revenue from its chip foundries. As part of the total solution being offered to
its OEMs, the Company is now developing a direct distribution channel for its
ASICs chips. Under this "fabless" model, Peerless will distribute ASIC chips
from the foundry through a third party. The Company will be responsible for
administration, including the billings and collections to and from its OEMs, but
it is expected that the third party will be responsible for the coordination of
production with the foundry, maintenance of necessary inventories and providing
just-in-time delivery to OEMs. The change from licensing ASIC technology to the
distribution of the actual chips will result in higher revenues but lower margin
percentages due to the cost of chips and the costs of distribution and inventory
carry. Peerless is currently finalizing the agreement with a third party
distributor and in the interim, placed its first ASIC order to the foundry in
the third quarter. The Company expects to make its first direct distribution in
the first quarter of next fiscal year.
During the third quarter, the Company established a research and development
center in Seattle, Washington focused on extending the Company's expertise in
NetWare and Directory Services into Windows 2000 and Active Directory
technologies, which is expected to be a major provider of these technologies in
the enterprise space. The Company believes that the combination of its
established network software solutions and its newly acquired expertise in
Windows 2000 and Internet technologies will put it in the forefront of
internetworking and directory integration for networked devices.
13
<PAGE>
Results of Operations
Three and Nine Month Periods Ended October 31, 1999 and 1998
Revenues for the quarter ended October 31, 1999 increased 38% to $10.7
million from the $7.8 million reported for the same quarter in 1998. Revenues
for the current nine month period increased 16% to $31.1 million from the $26.8
million reported for the nine month period ended October 31, 1998. The increase
in revenues was driven by an increase in product licensing revenues for both the
three and nine month periods. Product licensing revenues increased due to an
increase in the number of products shipped into the marketplace incorporating
Peerless' imaging and networking technology, an increase in the market
penetration of existing products, and an increase in sales of SDKs.
Additionally, during the current period, the Company successfully negotiated a
contract modification and extension with a major OEM resulting in the
combination of a new sale and recognition of revenue previously deferred of a
total of $1.2 million in product licensing revenues. Current period product
licensing also benefited from the sales of block licenses to OEMs and an
increase in guaranteed minimum royalty commitments. Engineering services
revenues remained flat in the current three month and nine month periods due to
a shift in OEM demand from turnkey projects to internally developed solutions
based on Peerless standardized software solutions. Revenues in the current
periods further benefited from a one-time cancellation fee of $1.3 million
arising from an OEM project that was cancelled due to external technical
challenges.
The Company's gross margin as a percentage of total revenues increased to
74% for the quarter ended October 31, 1999 from the 59% reported for the same
quarter in 1998. The gross margin as a percentage of total revenues increased to
71% for the nine month period ended October 31, 1999 from the 62% reported for
the comparable period last year. The margin improved as a result of a higher
percentage of licensing fees in the revenue mix in the three and nine month
periods ended October 31, 1999. Licensing revenues have relatively low costs
associated with the revenues being recognized.
Peerless continues to invest heavily in the future by funding the research
and development of new technology solutions. Research and development expenses
increased 18% in the current quarter and 7% in the current nine month period due
to increased spending on technical solutions partially offset by research
efforts expended in the prior year on test tool efforts at Auco that were
subsequently terminated. However, expenses declined as a percentage of revenues.
Research and development expenses decreased to 23% and 22% of total revenues for
the quarter and nine month periods ended October 31, 1999, respectively, from
27% and 24% of revenues for the comparable periods last year. Revenues are
growing at a faster rate than research and development expenses as Peerless is
able to leverage off the existing base of developers and realize economies of
scale. Management anticipates that research and development costs will be
consistent with the quarter ending October 31, 1999 levels for the remainder of
the fiscal year.
Sales and marketing expenses increased 3% in the current quarter and 21% in
the current nine month period. The expense growth was due to an emphasis on
penetrating new OEM customers, a continued emphasis on industry trade shows, and
other opportunities to promote the Company's embedded imaging and network
solutions. As result of this additional effort, the Company added several new
OEMs to its customer list during the past year. Despite the increase in absolute
dollars, sales and marketing expenses remained flat at 13% as a percentage of
total revenues between the two nine month periods and declined in the current
quarter to 13% from 17% in the prior year.
General and administrative expenses for the quarter ended October 31, 1999
decreased $478,000 or 34% over the prior year due to one-time charges. The
decrease in expenses in the current quarter was attributable to the collection
of a $345,000 receivable written off by Auco prior to the merger. The expense
decline in the current nine month period was also attributable to $275,000 of
expenses incurred in the quarter ended July 31, 1998 that were associated with a
proposed transaction that was terminated. Excluding the one time-items, general
and administrative expenses would have been 14% of total revenues for both nine
month periods.
14
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Other non-recurring costs of $2.0 million for the nine month period ended
October 31, 1999 represented transaction costs, consisting primarily of fees for
investment bankers, attorneys, accountants, consultants, financial printing and
other related charges associated with the June 1999 acquisition of Auco.
Interest income earned in both periods was attributable to interest and
investment income earned on cash and cash equivalents and investment balances.
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
expected future operating results. Peerless' current effective tax rate is 35%;
however, the Company expects that rate to increase to 37% for the next fiscal
year.
Liquidity and Capital Resources
Compared to January 31, 1999, total assets grew 6% to $53.8 million and
stockholders' equity grew 13% to $48.1 million. The Company's cash and short-
term investment portfolio totaled $22.6 million at October 31, 1999 and the
current ratio was 8:1. The Company used $1.6 million in cash for operations
during the nine month period ended October 31, 1999 as compared to $561,000 in
cash generated from operations during the nine month period ended October 31,
1998. Cash used by operations in the current period was negatively impacted by
a high trade accounts receivable balance at October 31, 1999. Subsequent to
October 31, 1999, the Company collected a $1.3 million cancellation fee that
contributed to the current period receivable balance
The Company's investing activities during the nine-month periods ended
October 31, 1999 and 1998 generated cash of $487,000 and $2.4 million,
respectively. Purchases, sales and maturities of investment securities generated
net cash of $3.1 million in the current period and $4.1 million in the prior
period. It is the Company's policy to invest the majority of its unused cash in
low risk government and commercial debt securities. The Company has not
historically purchased, nor does it expect to purchase in the future, derivative
instruments or enter into hedging transactions. Cash generated by investments
during the nine month periods ended October 31, 1999 and 1998 was offset by
purchases of property, equipment and leasehold improvements. During the second
quarter of the current fiscal year, the Company completed the expansion of its
corporate operating facility from 47,000 square feet to 56,000 square feet in
order to accommodate the current and expected growth in operations. As part of
the expansion, the Company made leasehold improvements in the amount of
$625,000. The remaining additions to property and equipment related to purchases
of furniture, computers, equipment and leasehold improvements associated with
the growth in personnel.
Net cash provided by financing activities in the nine month period ended
October 31, 1999 and 1998 was $1.2 million and $2.1 million, respectively. In
the current nine month period, cash generated from the issuance of shares under
the Company's employee stock purchase plan and the exercise of common stock
options was offset by a $300,000 payment to an Auco stockholder for a note
payable. In the nine month period ended October 31, 1998, cash from investing
activities was generated by cash from the issuance of shares under the Company's
employee stock purchase plan, the exercise of common stock options and the
issuance of Auco Convertible preferred stock Series B.
The Company currently has no material commitments other than those under
operating lease agreements. Over the past several years, the Company has
experienced an increase in capital expenditures and operating lease
arrangements, which is consistent with increased staffing and anticipates
increase may continue in the future due to costs to relocate staff.
Additionally, the Company will continue to evaluate possible acquisitions of, or
investments in businesses, products and technologies that are complimentary to
those of the Company, which may require the use of cash. Management believes
existing cash and investments will be sufficient to meet the
15
<PAGE>
Company's operating requirements for at least the next twelve months; however,
the Company may sell additional equity or debt securities or obtain credit
facilities to further enhance its liquidity position.
RISKS AND UNCERTAINTIES
While Peerless' management is optimistic about the Company's long-term
prospects, the following risks and uncertainties, among other things, should be
considered in evaluating the growth outlook:
Future Growth Rate and Operating Results: The consolidated revenue growth
rate in fiscal 2000 is not expected to approach the 35% level attained in fiscal
1999. Further, although the Company is currently profitable, there can be no
assurance that the Company will maintain profitability on a quarterly or annual
basis in the future. Factors noted below may have a material adverse effect on
the Company's future revenue growth and/or results of operations.
Concentration of Revenues: Peerless generated more than 10% of its revenues
from both Canon and Ricoh during the nine month period ended October 31, 1999.
In the prior nine month period, five customers each generated more than 10% of
the Company's revenues. Historically, a limited number of customers have
provided a substantial portion of Peerless' revenues. There presently are only
a limited number of customers in the digital document product market to which
the Company markets its technology and services. Therefore, the ability of the
Company to replace a lost customer or offset a significant decrease in the
revenues from a customer may be significantly limited. A change in business
from a customer providing a significant portion of the Company's revenues could
have a material adverse effect on the Company's operating results. In
particular, the Company's recurring license fees exert a disproportionate
influence on profitability and are often dependent upon end-user demand for OEM
products that embed the Company's technology. In the third quarter, the Company
derived 13% of its total revenues from recurring license fees associated with
one family of multifunction products. If end user demand for flagship OEM
products were to decline significantly and unexpectedly, the Company's results
of operations would be adversely affected.
Shifting OEM Demand for Software Development Kits vs Turnkey Solutions:
Over the past several quarters, the Company has experienced a shift in OEM
demand from the historically prevailing requirement for a turnkey solution
towards software development kits, or SDKs. Turnkey solutions require the
Company to provide engineering services in order to deliver customized imaging
solutions to an OEM customer, whereas OEMs that opt for an SDK solution choose
to license the Company's embedded imaging technology and perform development
internally using the OEM's in-house engineers. Turnkey design wins result in
engineering services contracts that generate revenue for three to six quarters
prior to product launch. SDK design wins result in development license revenues
that are typically recognized in one quarter and are generally lower in
magnitude than revenue associated with turnkey design wins prior to product
launch but generates higher profitability than engineering services revenues
associated with turnkey design wins. Recurring licensing revenues are generally
the same for both turnkey and SDK products.
Because the Company has experienced a shift in demand away from turnkey
solutions towards SDKs, engineering services resources were successfully
redeployed to the research and development department in recent quarters. Should
this trend reverse and turnkey design wins were to accelerate, the Company may
need to transfer resources back to engineering services. Accordingly, its
results of operations could be negatively affected in the interim.
Risks in Providing Engineering Services: In the past, the Company has
experienced significant fluctuations in quarterly engineering services results
that have been caused by many factors including: product development delays (see
"Technological Changes" below), third party delays, increases in the estimated
hours to complete particular engineering services projects, delays in the
availability or stability of third-party technology and cancellation or
redirection of engineering services projects by the Company's OEMs. There can be
no assurance
16
<PAGE>
that similar factors will not impact future engineering services results.
Further, in the past, the Company has benefited from the inclusion of
cancellation fees in its engineering services agreements. There can be no
assurance that the Company will continue to be able to negotiate these fees into
future engineering services arrangements.
Shifting of the Recurring License Fee Model: Over the past several
quarters, the Company's recurring licensing fee model has shifted from per unit
royalties paid upon OEM shipment of product to a revenue structure that includes
more revenues associated with guaranteed quarterly minimum royalties and sales
of block licenses. Although the new royalty model benefits the Company's cash
flows and minimize the Company's risk associated with a unexpected decreases in
demand for customer products, the Company's revenues could fluctuate
significantly from quarter to quarter as the number and value of new royalty
commitments changes.
Recurring Product Licensing Reporting: The recurring product licensing
revenues reported by the Company are dependent, in part, 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. Therefore, the Company
is required to estimate all of the recurring product licensing revenues for the
last month of each fiscal quarter and to further estimate all of its quarterly
revenues from an OEM when the report from such OEM is not received in a timely
manner. In the event the Company is unable to estimate such revenues accurately
prior to public announcement of the Company's quarterly results, the Company may
be required to restate its recognized revenues or adjust revenues for subsequent
periods.
Technological Changes: Rapidly changing technology, evolving industry
standards and needs, and frequent new product introductions characterize the
market for the Company's products and services. The Company's success will
depend on, among other things: market acceptance of the Company's technology and
the digital document products of the Company's OEM customers; the ability of the
Company and its OEM customers to meet industry changes and market demands in a
timely manner; achievement of new design wins by the Company followed by the
OEMs' development of associated new digital document products; and the regular
and continued introduction of new and enhanced technology and services by the
Company and its OEMs on a timely and cost-effective basis. There can be no
assurance that the products and technology of competitors of the Company or its
OEMs will not render the Company's technology or its OEMs' products
noncompetitive or obsolete. Any failure by the Company or its OEMs to anticipate
or respond adequately to the rapidly changing technology and evolving industry
standards and needs, or any significant delay in development or introduction of
new and enhanced products and services, could result in a loss of
competitiveness or revenues, which could have a material adverse effect on the
Company's operating results.
Receivables: The Company's net trade accounts receivable balance at October
31, 1999 has increased by $4.1 million, or 41%, over the balance at January 31,
1999. As a result of the increase in trade accounts receivable, the Company's
days-sales-outstanding has also increased. The increase in the current nine
month period was the result of increased recurring licensing revenues, the shift
towards the SDK model and the timing of Japanese collections. Much of the growth
in the Company's revenues has been fostered by strong recurring licensing fees,
which are not contractually possible to collect prior to the end of a quarter.
The shift towards the SDK model has generated lump-sum license fees that are
billed at the time of delivery. Finally, the Company has noted a trend of slow
collections from one of its major Japanese customers. An increase in accounts
receivable has a negative impact on operating cash and poses inherent collection
risks. Although the Company feels that its accounts receivable reserves are
adequate at October 31, 1999, there can be no assurance regarding this
assertion. Subsequent to the quarter end, the Company collected a $1.3 million
cancellation fee, which also contributed to the current period receivable
balance.
Seasonality: The Company believes that its business may be subject to
seasonal trends. In the digital document product industry, it is not unusual for
vendors to experience an increase in demand in the second calendar quarter
followed by a decrease in the third quarter, as well as an increase in demand in
the fourth calendar quarter followed by a significant decrease in the following
quarter. Although the Company has attempted
17
<PAGE>
to manage this risk with the incorporation of guaranteed minimum royalty
commitments, the Company's product licensing revenues may be negatively impacted
by seasonality of unit shipments experienced by its OEMs.
ASIC Chips: The Company is in the process of developing a "fabless"
distribution model for the sale of ASIC chips. The Company has no direct
distribution experience and will place reliance on third parties to maintain
inventories to address OEM needs, manage manufacturing logistics, and distribute
the product in a timely manner. Additionally, there can be no assurance that the
OEMs will elect to purchase from Peerless as its distributor.
The Year 2000 Issue: As is true for most companies, Peerless faces risks
arising from the year 2000 issue. Peerless faces risks primarily in the
following areas: 1) systems used by Peerless to run its business including
information systems, equipment and facilities; 2) systems used by Peerless'
suppliers; 3) potential warranty or other claims from Peerless' OEMs; and 4)
potential for reduced spending by businesses as a result of significant
information systems spending on year 2000 remediation. Peerless continues to
evaluate and mitigate its exposure in these areas where appropriate.
Equipment and Facilities: Peerless' operations are conducted predominantly
in El Segundo, CA and Redwood City, CA and to a significantly lesser extent in
Tokyo, Japan. Contingency plans for critical business operations are in place at
all locations. Additionally, Peerless has evaluated year 2000 readiness of its
mission-critical equipment and facilities. The Company is in the final stages of
contacting its key suppliers to ascertain year 2000 compliance of the products
and services used by the company. The Company does not anticipate any internal
disruption that could adversely affect its results of operations or financial
condition. Currently, the Company believes all internal systems and facilities
are compliant, but will continue assurance testing through the end of year.
Key Suppliers: Peerless has contacted its mission-critical suppliers of
products and services to determine that the suppliers' operations, and the
products and services they provide are year 2000 ready. Since Peerless has not
received notice of full compliance from all of its suppliers, confirmation of
the year 2000 readiness of these key suppliers will continue throughout the
remainder of 1999. If one or more key suppliers fails to address the year 2000
issue adequately for the products or services they provide to Peerless, some
critical material, products or services may not be delivered in a timely manner,
which could adversely affect Peerless' results of operations or financial
condition. Because of the quality and size of Peerless' OEM and strategic
partner base, Peerless expects each will be ready for year 2000 by the end of
the calendar year.
Customers: From the information received to date, Peerless believes that
the products currently offered by its OEMs are year 2000 ready. However,
Peerless is uncertain that its overseas customers are sufficiently compliant to
minimize disruptions to their and consequently to Peerless' business. Despite
Peerless' confidence in its OEMs, severe disruptions overseas because of year
2000 unpreparedness on the parts of OEMs, could cause sales disruptions,
administrative hurdles and consequently difficulties in both the sales and
reporting of Peerless' segment of their businesses. Contingency plans will
continue to be refined as Peerless learns more about the preparations and
potential exposure of its customers to year 2000 disruptions.
Costs to Address Year 2000 Issues: Costs to be applied to year 2000 include
hardware, software, and implementation costs for internal work and are not
expected to exceed $400,000. Through November 30, 1999, Peerless has incurred
approximately $300,000 in costs associated with the Y2K issue, of which,
$200,000 related to internal costs and $100,000 related to fixed asset upgrades
and have been capitalized. The remainder of its projected year 2000 costs
include: i) hardware and software upgrades or replacements primarily related to
desktop systems and networking equipment; ii) consultant and contractor fees to
assist in assessments and to perform remediation and integration testing; iii) a
contingency for potential product upgrades or replacements; iv) a contingency
for potential disruption in supplier product or service delivery or in
manufacturing operations; and v) a contingency for potential unexpected costs
associated with replacing or repairing systems previously considered to be year
2000 ready. Peerless has not included in the total cost estimate, any costs
associated with potential year 2000 litigation exposure since these costs are
not estimable. Peerless has adequate funds to pay for the expected
18
<PAGE>
costs of year 2000 programs. As of the end of fiscal 1999, Peerless has not
deferred any significant internal information technology projects due to its
year 2000 efforts.
Other Risks: Also inherent in the Company's business are additional risks,
which include but are not limited to: competition in the market for 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.
19
<PAGE>
PART II - OTHER INFORMATION
_____________________________________________________________________________
Item 1: Legal Proceedings
-----------------
In the prior quarter, Peerless gave notice that it intended to seek binding
arbitration in a dispute regarding the payment of fees and cost for the services
provided to that customer. The related fees have been subsequently collected.
Refer to "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for discussion of the financial impact of this matter on
current period general and administrative expenses.
The Company is currently involved in a dispute with one of its customers
over the timing of a payment due to the Company associated with the sale of a
Peerless source code license to the customer. The matter is currently scheduled
for arbitration in December 1999. However, pending the outcome of the
arbitration, this matter may require litigation for resolution. The Company has
not accrued any liability associated with this dispute as management believes
that the reserve for doubtful accounts at October 31, 1999 is adequate. Further,
the Company has provided adequate reserves to cover the cost of resolving this
matter.
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
None
20
<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
By: /s/Edward A. Gavaldon
------------------------------------------- Date: November 24, 1999
Edward A. Gavaldon
Chairman of the Board, President and Chief
Executive Officer
By: /s/Carolyn M. Maduza
------------------------------------------------ Date: November 24, 1999
Carolyn M. Maduza
Senior Vice President of Finance and Administration,
Chief Financial Officer, Secretary and Treasurer
(Principal Financial and Accounting Officer)
21
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REFERENCE TO SUCH FINANCIAL STATEMENTS.
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