<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, 2000
Commission File Number: 000-21287
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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 11, 2000 was
14,908,983
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<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 Company disclaims any obligation to update these forward-looking
statements as a result of subsequent events. The risks and uncertainties on
pages 19 through 24, among other things, should be considered in evaluating the
Company's prospects and future financial performance.
The Securities and Exchange Commission encourages companies to disclose forward-
looking information so that investors can better understand a company's future
prospects and make informed investment decisions. This Report on Form 10-Q
contains such forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. 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 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 and storage; 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 financial performance. Words such as
"anticipate," "estimate," "expects," "projects," "intends," "plans," "believes"
and words of similar substance used in connection with any discussion of future
operations or financial performance identify forward-looking statements. In
particular, statements regarding expectations and opportunities, new product
expectations and capabilities, the Company's outlook regarding performance and
growth and comments relating to the projected imaging and storage development
and sales opportunities for the Company are forward-looking statements. These
forward-looking statements are just predictions and involve risks and
uncertainties such that actual results may differ materially from these
statements. Important factors that could cause actual results to differ
materially from those reflected in forward-looking statements made in this
Report on Form 10-Q include the risk factors set forth herein and also, but are
not limited to: a) changes in the marketplace in which Peerless offers its
products; b) the failure of Peerless' business strategy to produce the projected
financial results; c) the failure of Peerless to maintain its margins due to
changes in its business model in reaction to competitive pressures; d) the delay
in or the non-acceptance by the market of new product and technology offerings;
e) the inability of the Company to retain and attract the technical talent to
compete effectively in the marketplace for imaging and storage; f) the failure
of Peerless' markets to achieve expected growth rates; and g) other factors
affecting Peerless' business and these forward-looking statements as set out
from time to time in Peerless' filings with the Securities and Exchange
Commission, including the Company's annual and quarterly reports on Forms 10-K
and 10-Q and the Company's other filings with the SEC. Stockholders are urged
not to place undo reliance on forward-looking statements, which speak only as of
the date hereof. The Company is under no obligation, and expressly disclaims any
obligation, to update or alter any forward-looking statements, whether as a
result of new information, future events or otherwise. All forward-looking
statements contained herein are qualified in their entirety by the foregoing
cautionary statements.
2
<PAGE>
PEERLESS SYSTEMS CORPORATION
INDEX
=====
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
PART I - FINANCIAL INFORMATION
--------------------------------------------------------------------------------
<S> <C> <C>
Item 1: Financial Statements Page No.
--------------------
Consolidated Balance Sheets
October 31, 2000 and January 31, 2000 ...................... 4
Consolidated Statements of Operations
Three and Nine Month Periods Ended October 31,
2000 and October 31, 1999................................... 5
Consolidated Statements of Cash Flows
Nine Month Period Ended October 31, 2000 and
October 31, 1999............................................ 6
Notes to Consolidated Financial Statements................... 8
Item 2: Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operations................................... 13
-------------------------
PART II - OTHER INFORMATION
--------------------------------------------------------------------------------
Item 1: Legal Proceedings............................................ 25
-----------------
Signatures ............................................................. 26
</TABLE>
TRADEMARKS
Memory Reduction Technology(R), PEERLESS SYSTEMS (R), Peerless Powered(R),
WINEXPRESS(R), PeerlessPrint(R), QuickPrint(R) and RedipS(R) are registered
trademarks of Peerless Systems Corporation. CPL(TM), Acceleprint(TM), SPS(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. DirectoryPlus NAS, DirectoryPlus Imaging, Imageworks(TM)
and Webworks(TM) are trademarks of Peerless Systems Corporation. Peerless
Systems (in English and Japanese Katakana), Peerless (in logo), PEERLESSPRINT
and PEERLESSPAGE (all in English and Japanese Katakana), are registered
trademarks and service marks 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
Item 1 - Financial Statements
PEERLESS SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
October 31, January 31,
2000 2000
-------------- --------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 14,093 $ 13,620
Restricted cash 742 -
Short term investments 6,975 12,329
Trade accounts receivable, net 9,672 10,168
Unbilled receivables 105 2,343
Income tax receivable 1,857 21
Deferred tax asset - 682
Prepaid expenses and other current assets 438 682
-------------- --------------
Total current assets 33,882 39,845
Investments 2,371 2,922
Long term receivable 1,500 1,500
Property and equipment, net 6,064 6,565
Deferred tax asset - 1,050
Other assets 604 683
-------------- --------------
Total assets $ 44,421 $ 52,565
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 668 $ 615
Other current liabilities 6,053 4,320
Deferred revenue, current portion 1,207 671
-------------- --------------
Total current liabilities 7,928 5,606
Deferred rent 330 366
Other tax liabilities 2,380 2,799
-------------- --------------
Total liabilities 10,638 8,771
-------------- --------------
Stockholders' equity:
Common stock 15 15
Additional paid-in capital 48,470 47,953
Deferred compensation (74) (123)
Accumulated deficit (14,628) (4,051)
-------------- --------------
Total stockholders' equity 33,783 43,794
-------------- --------------
Total liabilities and stockholders' equity $ 44,421 $ 52,565
============== ==============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
PEERLESS SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 31, October 31,
---------------------- ------------------------
2000 1999 2000 1999
------- ------- -------- -------
<S> <C> <C> <C> <C>
Revenues:
Product licensing $ 6,985 $ 7,476 $ 16,633 $20,681
Engineering services, maintenance, and other 2,480 4,236 7,339 13,171
------- ------- -------- -------
Total revenue 9,465 11,712 23,972 33,852
------- ------- -------- -------
Cost of revenues:
Product licensing 1,954 58 4,481 223
Engineering services, maintenance, and other 2,636 3,163 8,791 9,848
------- ------- -------- -------
Total cost of revenues 4,590 3,221 13,272 10,071
------- ------- -------- -------
Gross margin 4,875 8,491 10,700 23,781
------- ------- -------- -------
Operating expenses:
Research and development 3,122 2,618 9,279 7,150
Sales and marketing 1,504 1,539 4,612 4,626
General and administrative 2,060 1,089 7,313 4,373
Other - non recurring costs - - - 2,014
------- ------- -------- -------
Total operating expenses 6,686 5,246 21,204 18,163
------- ------- -------- -------
Income (loss) from operations (1,811) 3,245 (10,504) 5,618
Interest income, net 242 309 865 923
------- ------- -------- -------
Income (loss) before income taxes (1,569) 3,554 (9,639) 6,541
Provision for income taxes 452 1,260 938 2,328
------- ------- -------- -------
Net income (loss) $(2,021) $ 2,294 $(10,577) $ 4,213
======= ======= ======== =======
Basic earnings per share $ (0.14) $ 0.16 $ (0.71) $ 0.31
======= ======= ======== =======
Diluted earnings per share $ (0.14) $ 0.15 $ (0.71) $ 0.27
======= ======= ======== =======
Weighted average common shares
outstanding - basic 14,899 14,495 14,824 13,637
======= ======= ======== =======
Weighted average common shares
outstanding - diluted 14,899 15,685 14,824 15,380
======= ======= ======== =======
</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,
------------------------
2000 1999
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income $(10,577) $ 4,213
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization 1,444 1,111
Amortization of investment discounts and premiums - (98)
Amortization of deferred compensation 49 49
Compensation expense for option amendment and
common stock issued to employees 245 48
Deferred taxes 1,732 -
Business combination adjustment - 1
Changes in operating assets and liabilities:
Restricted cash (742) -
Trade accounts receivable 496 (3,955)
Unbilled receivables 2,238 (647)
Income tax receivable (1,836) -
Prepaid expenses and other current assets 244 (89)
Other assets 79 528
Accounts payable 53 12
Other current liabilities 1,733 (427)
Other tax liabilities (419) 197
Income tax payable - 188
Deferred rent (36) 43
Deferred revenue 536 (2,227)
-------- -------
Net cash used by operating activities (4,761) (1,512)
-------- -------
Cash flows from investing activities:
Purchases of property and equipment (943) (2,249)
Purchases of software licenses - (380)
Purchases of available-for-sale securities (27,696) (19,596)
Proceed from held-to-maturity securities - 4,000
Proceeds from available-for-sale securities 33,601 18,700
-------- -------
Net cash provided (used) by investing activities (4,962) 934
-------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock 227 800
Proceeds from exercise of common stock options 45 688
Repayment of outstanding note payable to stockholder - (300)
-------- -------
Net cash provided by financing activities 272 1,188
-------- -------
Net increase (decrease) in cash and cash equivalents 473 610
Cash and cash equivalents, beginning of period 13,620 6,132
-------- -------
Cash and cash equivalents, end of period $ 14,093 $ 6,742
======== =======
</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>
<CAPTION>
Nine Months Ended
October 31,
------------------------
2000 1999
--------- --------
<S> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $1,144 $1,550
Interest $ - $ 15
====== ======
Supplemental schedule of noncash investing and financing activities:
Common stock issued to employees $ 48
======
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 (Continued)
(in thousands)
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated 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, 2000,
1999 and 1998 included in the Company's annual report filed on Form 10-K with
the SEC on April 28, 2000. 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.
2. Significant Accounting Policies
Financial results for this year's nine month period ended October 31, 2000
included an additional week due to a change in the Company's reporting cycle,
which should be taken into account when analyzing the Company's results of
operations between fiscal year 2000 and the current fiscal year.
Revenue Recognition: The Company recognizes revenues in accordance with
Statement of Position 97-2 "Software Revenue Recognition" as amended by
Statement of Position 98-4.
Development license revenues from the licensing of source code or software
development kits ("SDKs") 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 revenues are recognized over the course of the
modification work.
The Company also enters into engineering services agreements with certain of its
OEMs to provide a turnkey solution, adapting the Company's software and
supporting electronics to specific OEM requirements. Revenues on such contracts
are recognized over the course of the development work on a percentage-of-
completion basis. Progress-to-completion under the percentage-of-completion
basis is determined based on the direct costs, consisting primarily of labor and
materials, expended on the services under each contract. The Company provides
for any anticipated losses on such contracts in the period in which such losses
are first determinable. During the quarter ended October 31, 2000 the Company
provided $289 thousand for losses on two contracts that had experienced delays
in completion. 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 OEM customers upon manufacturing and subsequent commercial shipment of
products incorporating Peerless technology. These recurring licensing revenues
are recognized on a per unit basis as products are shipped commercially. In
certain cases, the Company may sell a block license, that is, a specific
quantity of licensed units that may be sold in the future, or the Company may
require the customer to pay minimum royalty commitments. Associated payments are
typically made in one lump sum or extend over a period of four or more quarters.
The Company recognizes revenues associated with recurring licensing revenue
commitments on delivery and acceptance of 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)
For fees on multiple element arrangements, values are allocated among the
elements based on vendor specific objective evidence of fair value ("VSOE"). If
VSOE does not exist, all revenue for the arrangement is deferred until the
earliest point at which such VSOE does exist or all elements of the arrangement
have been delivered. If an arrangement includes both software and service
elements, a determination is made as to whether the service element can be
accounted for separately as services are performed.
Deferred revenue consists of prepayments of recurring licensing royalties, and
payments billed to customers in advance of revenue recognized on engineering
services contracts. Unbilled receivables arise when the revenue recognized on a
contract exceeds billings due to timing differences related to billing
milestones as specified in the contract.
The provision for taxes for the three and nine months ended October 31, 2000 are
based on foreign taxes paid, net of the benefit to the Company that will be
realized from the loss carry-back and changes in the valuation reserve. The
provision for income taxes for the three and nine months ended October 31, 1999
were based on the estimated annual effective tax rate and include federal,
state and foreign income taxes.
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 derivative instruments will be
recorded each period in current earnings or other comprehensive income,
depending on whether a derivative instrument 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 Company believes that the adoption of SFAS No. 133 will not have a
material impact on the Company's results of operations, financial position or
cash flows.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 (SAB 101),
"Revenue Recognition in Financial Statements." SAB 101 provides guidance for
revenue recognition under certain circumstances. On March 24, 2000, SAB 101A was
released delaying for one fiscal quarter the implementation date of SAB 101.
Since the issuance of SAB 101 and SAB 101A, the staff of the Securities and
Exchange Commission continued to receive requests from a number of groups asking
for additional time to determine the effects, if any, on registrants revenue
recognition practices. As a result on June 26, 2000, SAB 101B was released
further delaying the effective date of SAB 101. The Company is required to adopt
SAB 101 by the fourth quarter of fiscal year 2001. The Company believes the
adoption of SAB 101 will not have a material impact on the financial statements
and results of operations.
On July 20, 2000, the Financial Accounting Standards Board's Emerging Issues
Task Force (EITF) reached a consensus on Issue 99-19, Reporting Revenue Gross as
a Principal versus Net as an Agent. The Issue interprets SAB 101 and addresses
when a company should report revenue as the gross amount billed to a customer
versus the net amount earned by the company in the transaction. The EITF amended
the consensus to allow the transition to mirror the required implementation of
SAB 101. The Company is currently evaluating the impact of EITF 99-19 on its
financial statements and related disclosures. The Company does not expect the
impact on the financial statements and results of operations to be material.
EITF 99-19 is required to be adopted by the Company by the fourth quarter of
fiscal 2001.
9
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands)
(Unaudited)
3. Investments
Investments consisted of the following:
<TABLE>
<CAPTION>
October 31, January 31,
2000 2000
---- ----
<S> <C> <C>
Available-for-sale securities:
Maturities within one year:
U.S. government debt securities $ - $ 1,500
Commercial paper and equivalents 4,922 -
State and local U.S. government debt securities 1,058 830
Corporate debt securities 995 9,999
---------- ----------
6,975 12,329
---------- ----------
Maturities after one year through five years:
State and local U.S. government debt securities 1,058 500
---------- ----------
1,058 500
---------- ----------
Maturities after five years:
State and local U.S. government debt securities 1,313 2,422
---------- ----------
1,313 2,422
---------- ----------
Total available-for-sale securities 9,346 15,251
---------- ----------
Total Investments $ 9,346 $ 15,251
========== ==========
</TABLE>
The fair value of securities at October 31, 2000 and January 31, 2000
approximated cost.
Unrealized gains or losses on securities were immaterial for all periods
presented.
10
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands)
(Unaudited)
4. Earnings Per Share
Earnings per share is calculated as follows:
<TABLE>
<CAPTION>
Three Months Ended October 31, Three Months Ended October 31,
2000 1999
------------------------------------ ------------------------------------
Net Per-Share Net Per-Share
Loss Shares Amount Income Shares Amount
---- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Earnings available to common
stockholders $ (2,021) 14,899 $(0.14) $ 2,294 14,495 $ 0.16
Effect of dilutive securities
Common stock options - - - - 1,190 -
Note payable to stockholder - - - - - -
Convertible preferred stock Series A - - - - - -
Convertible preferred stock Series B - - - - - -
---------- ------ ------- ------- ------ --------
Diluted EPS
Earnings available to common
stockholders with assumed - - - - - -
conversions $ (2,021) 14,899 $(0.14) $ 2,294 15,685 $ 0.15
========== ====== ======= ======= ====== ========
<CAPTION>
Nine Months Ended October 31, Nine Months Ended October 31,
2000 1999
----------------------------------- ------------------------------------
Net Per-Share Net Per-Share
Loss Shares Amount Income Shares Amount
---- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Earnings available to common
stockholders $ (10,577) 14,824 $(0.71) $ 4,213 13,637 $ 0.31
Effect of dilutive securities
Common stock options - - - - 1,103 -
Note payable to stockholder - - - 1 3 -
Convertible preferred stock Series A - - - - 443 -
Convertible preferred stock Series B - - - - 194 -
---------- ------ ------- ------- ------ --------
Diluted EPS
Earnings available to common
stockholders with assumed
conversions $ (10,577) 14,824 $(0.71) $ 4,214 15,380 $ 0.27
========== ====== ======= ======= ====== ========
</TABLE>
11
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(in thousands)
(Unaudited)
5. Restricted Cash
On March 16, 2000, Netreon, Inc. entered into an agreement to lease
approximately 12 thousand square feet of office space in Mountain View,
California. The term of the lease agreement is seven years. The Company has
guaranteed the lease commitment of Netreon, Inc. and has secured the first
twelve months of the agreement with a $742 standby letter of credit. This letter
of credit has been secured by a certificate of deposit of a like amount. For the
subsequent four years, the value of the standby letter of credit and the
certificate of deposit shall be reduced to $594, $445, $297 and $148,
respectively. The Company has engaged a real-estate company to attempt to
sublease the premises.
6. Legal Proceedings
Peerless is subject to litigation in the ordinary course of its business. The
Company believes that such litigation has not and will not have material adverse
effects on the financial position, results of operations and the cash flows of
the Company.
Two shareholder class action lawsuits were filed on August 28, 2000 and on
September 19, 2000 against the Company and two former officers of the Company in
the United States District Court for the Southern District of California. These
lawsuits allege a scheme to artificially inflate the Company's stock price
through the dissemination of false and misleading information. The lawsuit seeks
compensatory damages, attorney's fees and expenses. The Company has retained
Wilson, Sonsini, Goodrich & Rosati, LLP, Palo Alto, CA as counsel in this
matter. Peerless believes all of the claims to be without merit.
In July 2000, the Company initiated litigation in the United States District
Court for the Central District of California regarding certain claims arising
out of the acquisition of HDE, Inc. in December 1999. The Company believes that
it has valid claims in this matter. The matter remains in the pleading stage.
The Company filed a lawsuit in January 2000 against Conexant Systems, Inc.,
Newport Beach, CA in the Orange County Superior Court regarding the failure and
refusal of Conexant to pay to the Company a portion of a Source License Fee and
guaranteed royalty payments pursuant to an agreement between the parties.
Conexant has filed a cross complaint alleging misrepresentation of facts
regarding the Company's Intellectual Property. Discovery is continuing. The
Company is confident that it will prevail in this matter. The Company has not
accrued any liability associated with this lawsuit, as management believes that
the reserve for doubtful accounts at January 23, 2000 is adequate. The
receivable has been reclassified as a long-term receivable in that management
does not expect that the lawsuit will be concluded, and the balance outstanding
to Peerless will be collected, within the next fiscal year.
The Company was sued by a major shareholder, the State of Wisconsin Investment
Board ("SWIB") in the Court of Chancery of the State of Delaware in New Castle
County in December 1999. The Company's former Chief Executive Officer, Edward A.
Gavaldon, has also been named as a defendant. The complaint alleges that
Peerless wrongfully influenced the passage of a proposal to increase the number
of shares in the stock option plan at the 1999 Annual Meeting of Shareholders
and provided misleading information to SWIB. Mr. Gavaldon is alleged to have
benefited wrongfully from these actions. SWIB seeks to nullify the shareholder
approved Amendment to the Peerless Equity Incentive Plan and is asking for
unspecified damages.
SWIB and the Company have agreed that Peerless will provide weekly notice to
SWIB and the Court of the number of options returning to the pool of the
available options in the Company's Equity Incentive Plan and will provide
reasonable advance notice to SWIB and the Court before granting any further
options that would reduce the pool of available options in the Equity Incentive
Plan below 1.0 million.
Cross-motions for summary judgment were filed, argued and ruled on by the Court.
The Court granted the Company's summary judgment motion for a determination that
defendants did not omit material information and make false and misleading
statements of material fact about the June 17, 1999 adjournment. The Court
denied the remaining motions of SWIB and the Company.
On December 12, 2000, the lawsuit filed in the Alameda County Superior Court
against the Company and its wholly owned subsidiary, Netreon, Inc. ("Netreon")
by Howard Sidorsky, a current employee of Netreon, Inc. was settled.
7. Concentration of Revenues
During the third quarter of fiscal 2001, four customers generated greater than
10% of the revenues and collectively contribute 60% of revenues. Non-recurring
block license revenues for the same time period were 46% of revenues. During the
third quarter of fiscal 2000, three customers generated greater than 10% of the
revenues and collectively contribute 38% of revenues. Non-recurring block
license revenues for the same period were 9% of revenues.
During the nine month period ending fiscal 2001, two customers generated greater
than 10% of the revenues and collectively contribute 38% of revenues.
Non-recurring block license revenues for the same period were 44% of revenues.
During the nine month period ending fiscal 2000, two customers generated greater
than 10% of revenues and collectively contribute 33% of revenues. Non-recurring
block license revenues for the same period were 3% of revenues.
12
<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 on Form 10-Q 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 report on Form 10-Q are based on
current expectations, estimates, forecasts and projections about the industry in
which Peerless operates, management's beliefs and assumptions made by
management. These statements are not guarantees of future performance and
involve certain risks, uncertainties and assumptions, which are difficult to
predict. Therefore, actual outcomes and results may differ materially from what
is expressed or forecasted in such forward-looking statements. The Company
undertakes no obligation to update publicly any forward-looking statements,
whether as a result of new information, future events or otherwise.
Overview
The Company is a provider of software/hardware-based embedded imaging, storage,
and networking systems to original equipment manufacturers of digital document
products. The Company has experienced a decline in demand by OEMs for Peerless'
embedded imaging for digital document product offerings. Initially, this decline
surfaced as a shift in demand from traditional turnkey solutions to Software
Development Kits ("SDKs"). Soon thereafter, there emerged a decline in demand
for SDKs as well as for turnkey solutions.
As discussed below, there has been a general decline in the rates of growth for
the work group printer and copier market segments, in which Peerless is
primarily engaged. While the market for these products has continued to grow in
absolute numbers, the rates of growth have not been as robust as had been
experienced in the past. With the decline in the rates of growth, the OEMs that
produce products in these markets reacted by engaging in internal controller
development and consolidating through mergers and acquisitions. In addition, the
OEMs are now introducing fewer new product platforms than they had in the
past. For those products that do go forward for development and customer
introduction, the OEMs, in most instances, have not selected the Company's
solutions. This occurred in some cases because the OEMs perceived that the
Company's solutions did not meet their technical requirements. In other cases it
occurred because the OEMs judged that the cost of the Company's solution was
higher than what the OEMs wanted to or could afford to pay, whether by the OEM's
developing the technology themselves or by utilizing a lower cost off-shore
embedded software competitor.
The Company has addressed the change in the demand for its solutions by sizing
its organization to manage the current business requirements of embedded imaging
for digital document products, and, as discussed later in the Overview, the
Company is going forward with the assessment of new business opportunities.
The following sections provide a summary of the Company and background of how it
has transitioned to the situation discussed above.
The Company was founded in April 1982. It is a provider of software/hardware-
based embedded imaging, storage, 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
13
<PAGE>
rely on a core set of imaging software, hardware 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
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 (MFPs) quickly
and cost-effectively.
In addition, the company has developed a set of Network Directory software
development kits (SDKs), each of which targets a specific type of device such as
Network Attached Storage, Printer and Scanner. Each SDK provides all of the
networking protocols, security software, and client or server software necessary
for a device to access network directory services. Directory access allows a
device to advertise itself to users and services on the network, to provide and
control access to itself, to authenticate clients, to authenticate itself to
servers, and to be administered over the network.
The Company's product licensing revenues are comprised of both recurring per
unit licensing revenues and development licensing fees for source code or
software development kits (SDKs). Recurring licensing revenues are derived from
per unit fees paid periodically by the Company's OEMs upon manufacturing and
subsequent commercial shipment of products incorporating the Company's
technology. Recurring licensing revenues are also derived from arrangements in
which the Company enables third-party technology, such as solutions from Adobe
or Novell, to be used with its products. In certain cases, the Company may sell
a block license, that is, a specific quantity of licensed units that may be sold
in the future. Associated payments are typically made in one lump sum or extend
over a period of four or more quarters. When the collection of the payments is
probable and the fee is fixed and determinable, revenue is recognized. The
Company's development licensing fees are paid by OEMs for access to the
Company's source code or SDKs, which in turn generate recurring licensing
revenues if the Company's 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. The
Company's maintenance revenues are derived from software maintenance agreements.
Maintenance revenues currently constitute a small portion of total revenue.
Historically, a limited number of customers have provided a substantial portion
of the Company's revenues. Therefore, the availability of and the successful
closing of 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 Peerless embedded imaging solution is based on a combination of software and
imaging Application Specific Integrated Circuits (ASICs), which together form a
system that addresses most sectors of the printing market, from low-end small
office home office (SOHO) inkjets to high end laser digital color copiers and
printers. Low-cost, high-performance printers are increasingly replacing
expensive standalone copiers and printers in corporate offices. The shift to low
cost devices is placing considerable pressure on the Company and its competitors
to provide lower cost solutions while the OEM's themselves look to bring their
development and engineering efforts in-house to reduce their costs.
Traditionally, Peerless provided ASIC 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 these chip foundries. As part
of the total solution being offered to its OEMs, the Company has developed a
direct distribution channel for its ASICs chips. Under this "fabless" model,
Peerless is supplying ASIC chips from the foundry directly to the OEMs through
third party
14
<PAGE>
distributors. The Company is responsible for marketing and sales administration,
including the billings and collections to and from its OEMs and distributors,
and the third party is responsible for the coordination of production with the
foundry, maintenance of necessary inventories and providing just-in-time
delivery to OEMs and distributors. The Company has distribution agreements with
Arrow Electronics and Marubun Corporation. The agreement with Arrow Electronics
requires title to the inventory to remain with the Company until final
acceptance by the OEM. There can be no assurance that the OEM will accept the
delivery in which case the Company is responsible for all costs related to the
delivery and shipment. The agreement with Marubun requires that title to
inventory be transferred to Marubun upon order placement by the Company. As a
result, the Company is not responsible for any costs associated with the
delivery of inventory if not accepted by the OEM. The change in the business
model from licensing ASIC technology to the distribution of the actual chips is
meant to result in higher revenues but lower margin percentages due to the cost
of chips and the costs of distribution and inventory maintenance by the third
party. The Company made its first direct distribution in the first quarter of
fiscal year 2001.
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 had exceeded demand for SDK solutions. However, in
the fiscal year 2001, the Company experienced a shift from an OEM demand of
turnkey solutions to the sale of SDKs, particularly for its mature monochrome
solutions. The Company has attempted to expand its solution offerings by
incorporating related embedded imaging and networking technologies licensed from
third parties. However the Company has nevertheless experienced a continuing
decline in the demand for its SDK solutions in this fiscal year.
The current market in which the Company operates has been consolidating, and the
demand for the technology and products offered by the Company has been
declining. Peerless provides the worldwide market for printers (21-69 PPM) and
MFP (21-110 PPM) unit volume which is projected by International Data
Corporation to grow at a rate of 19% down from previous growth calculations of
26% (1999-2003), 37% (1998-2002), and 40% (1997-2001). Revenue for the same
market segments and periods is expected to grow 17% down from previous growth
projections of 20% (1999-2003), 42% (1998-2002), and 54% (1997-2001). It should
also be noted that there is a good indication that retail prices are declining
in these segments.
The Company has experienced a change in its financial environment as well. It
had been expected that SDK sales would result in an increase in the OEM products
shipping, as OEMs that utilize Peerless SDKs developed and introduced multiple
products. However, last fiscal year's shift to SDKs and this fiscal year's
decline in SDK sales has exacerbated the Company's declining sales and losses.
The engineering services business declined as OEMs have taken technology
development in house. Through the utilization of SDKs, and in situations that
the SDKs did not address the current and particular needs of the OEM, the OEMs
have chosen Peerless' competitors or have elected to develop the needed
technologies themselves.
Thus, the Company is continuing to meet sales resistance from its customers that
have subsequently reduced the number of new products being developed and in some
instances, have preferred to perform in-house development projects for the
projects that they are developing and/or plan to launch. Although there are
fewer opportunities for the Company to sell its turnkey services and SDKs, the
Company continues to support its current OEM controller customers in the digital
printing devices business with its existing technology and has sized the
organization to provide the necessary support and maintenance.
In response to the decrease in the number of new design wins and the resultant
decrease in turnkey work efforts, the Company has reduced staffing levels at its
El Segundo facility through planned reductions and attrition. During the ten
month period through December 1, 2000, El Segundo staffing decreased 52% (92
employees)
15
<PAGE>
Of this decrease, 38% was engineering, 9% was sales and marketing, which amount
represented a 66% reduction of the sales force, addressing the decline of new
sales opportunities and 30% was general and administrative. The Company also
decreases in staffing levels at Netreon, Inc. of 8% (four employees), primarily
engineers offset by an increase in sales and general and administration staffing
from the beginning of this fiscal year 2001 through December 1, 2000. At
Peerless Systems Imaging Products, Inc., the Company experienced a 25% reduction
(six employees), from engineering and general and administration staffing from
the beginning of this fiscal year 2001 through December 1, 2000.
As a result of the decline in the embedded controller business, the Company is
exploring opportunities to enhance the value of the Company, including new
market opportunities, mergers, acquisitions and/or the sale of all or a portion
of Company assets.
Netreon, Inc. focuses on the development and sale of Directory storage
technology to enterprise storage manufacturers, primarily in NAS and SAN market.
According to market analysts, the combined market for network attached storage
(NAS) and storage area network (SAN) devices is currently $7 billion and growing
60 percent per year. Customers are using NAS and SAN devices to meet the demand
for quickly accessible storage as a storehouse for reproducing data to offload
file storage from application servers and to support increased Web demands. With
network storage doubling every year, managing storage in the enterprise has
become a major issue for enterprise end users. Enterprise end users demand
network storage manufacturers provide better integration of network storage with
existing network directory platforms. Netreon Inc.'s Directory storage
technology supports the two leading directory platforms, Active Directory of
Windows 2000 and Novell Directory Service. Based on the initial indication from
our potential customers and the market demands on Windows 2000, it is expected
that the Company's Directory storage products are positioned to be generally
accepted among the leading storage manufacturers. In addition, this Directory
storage technology may be applicable to Netreon Inc.'s traditional network
printer OEMs for incremental revenue opportunities. Netreon, Inc. is also
developing IPP-FAX for imaging, a technology that enables more effective
communication and printing over the Internet.
There is no assurance that the Company can or will be successful in the pursuit
of these new opportunities meant to result in a return to a growth in revenues,
profitability and an increase in shareholder value.
Results of Operations
Comparison of Three and Nine Month Periods Ended October 31, 2000 and October
31, 1999
Financial results for this year's nine month period ended October 31, 2000
included an additional week due to a change in the Company's reporting cycle,
which should be taken into account when analyzing the Company's results of
operations.
Consolidated revenues for the third quarter ended October 31, 2000 decreased 19%
to $9.5 million compared to $11.7 million reported for the same quarter in
fiscal year 2000. Consolidated revenues for the current nine-month period
decreased 29% to $24.0 million compared to $33.9 million reported for the nine-
month period ended October 31, 1999. The Company reported a net loss for the
third quarter of fiscal year 2001 of $(2.0) million or $(0.14) per share
compared to net income of $2.3 million or $0.15 per share reported for the third
quarter a year ago. The net loss for the nine month period ended October 31,
2000 was $(10.6) million, or $(0.71) per share, compared to net income of $4.2
million or $0.27 per share a year ago. Net income reported for the nine months
ending October 31, 1999 included $2.0 million for transaction expenses
associated with the acquisition of Auco Inc., now Netreon, Inc.
The decrease in revenues resulted from the lower level of engineering services
associated with turnkey efforts performed during the nine months ended October
31, 2000. As had been
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discussed, this was a result of the lower level of turnkey bookings
and the higher proportion as a percentage of total sales of SDK design wins
during fiscal year ended January 31, 2000. In this fiscal year, there has been
both a lower level of turnkey and SDK bookings. As noted above, OEMs have
brought work in house due to industry consolidation and economic pressures and
as the Company's technology offerings did not match the OEM's changing needs.
SDKs are normally accompanied by a significant reduction in engineering fees
versus Turnkey solutions as the OEM's engineers instead perform the OEM
development efforts. In addition to not receiving engineering services revenue
on what would have been an outsourced project, the Company also does not receive
royalty revenue until after OEMs complete their development effort from the SDK
and market their products.
The Company's product licensing revenues for the third quarter ending October
31, 2000 included the sales of $4.0 million of block license sales that are of a
nonrecurring nature. Block licenses are the sale of per unit licenses for units
to be shipped in the future. Block licenses result in bringing forward revenues
to the current period once the fees are determined to be fixed and determinable
and collection of the fees is probable. Peerless anticipates decreases in
revenues for at least the next six months.
The Company's total cost of revenues was $4.6 million and $13.3 million for the
three and nine months ended October 31, 2000, representing increases of 43% and
32%, respectively, from the prior fiscal years levels. Cost of revenues
increased for the three months ended October 31, 2000 due to licensing costs
associated with the block sale of third party licenses.
The Company's gross margin as a percentage of total revenues decreased to 52%
for the quarter ended October 31, 2000 from the 73% reported for the same
quarter in 1999. The gross margin as a percentage of total revenues decreased to
45% for the nine-month period ended October 31, 2000 compared with 70% reported
for the comparable period last year. The decreases were in part a result of the
19% and 29% decreases in revenues for the comparable three and nine month
periods, respectively. In addition, there are lower margins on product licensing
revenues as a result of the cost associated with the sale of third party
licenses that were recorded during the three months ended October 31, 2000. Cost
of revenues for engineering services and maintenance slightly increased to 28%
for the quarter ended October 31, 2000 from the 27% reported for the comparable
quarter in 1999. Cost of revenues for engineering services and maintenance
increased to 37% for the nine-month period ended October 31, 2000 from the 29%
reported for the nine-month period ended October 31, 1999. But as previously
mentioned, a decrease in engineering services revenue occurred due to the change
in the design win mix from fiscal year 2000 and the low level of turnkey
bookings in the nine months of fiscal year 2001.
Total operating expenses for the three and nine months ended October 31, 2000
were $6.7 million and $21.2 million, respectively, compared to $5.2 million and
$16.1 million for the comparable periods a year ago, excluding the $2.0 million
transaction expenses recorded during the nine months ended October 31, 1999
discussed above.
Research and Development expenses increased to 33% of total revenues for the
quarter ended October 31, 2000 compared with 22% of total revenues reported for
the same quarter in 1999. Research and Development expenses increased to 39% of
total revenues in the current nine-month period from 21% of total revenues
reported in the prior nine-month period. The increase was due to lower sales
levels and an increase in research and development costs. The increase of 19%
and 30% in research and development expenses for the three and nine months ended
October 31, 2000, compared to comparable periods last fiscal year, was primarily
due to third party development costs associated with a new ASIC as well as
continued investments in new storage
17
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technologies and imaging development programs.
Sales and Marketing expenses were flat at $4.6 million for the nine months ended
October 31, 2000 compared to the first nine months of last fiscal year.
General and Administrative expenses for the quarter ended October 31, 2000
increased 89% from the same quarter in 1999. General and Administrative
expenses for the nine month period ended October 31, 2000 increased 67% from the
same period in 1999. This increase primarily related to increased legal costs
associated with litigation as well as start-up expenses associated with
professional advisory firms and the use of outside strategy consultants.
Interest income earned in both periods was attributable to interest and
investment income earned on cash and cash equivalents and investment balances.
The provision for taxes for the three and nine months ended October 31, 2000 are
based on foreign taxes paid, net of the benefit to the Company that will be
realized from the loss carry-back and changes in the valuation reserve. The
provision for income taxes for the three and nine months ended October 31, 1999
were based on the estimated annual effective tax rate and include federal, state
and foreign income taxes.
Liquidity and Capital Resources
Compared to January 31, 2000, total assets at October 31, 2000 decreased 15% to
$44.4 million and stockholders' equity decreased 23% to $33.8 million. The
Company's cash and short-term investment portfolio was $21.1 million at October
31, 2000 and the current ratio was 4:1, current assets compared to current
liabilities. The Company used $4.8 million in cash during the nine month period
ended October 31, 2000 to finance operations as compared to $1.1 million in cash
used from operations during the nine month period ended October 31, 1999.
The Company's investment activities during the nine-month period ended October
31, 2000 resulted in a net source of cash of $5.0 million. Proceeds of
investment securities resulted in a net source of cash of $5.9 million. 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. For the nine-month period ended October 31,
2000, the Company invested $0.9 million in property, equipment and leasehold
improvements compared to $2.2 million invested during the nine-month period
ended October 31, 1999.
Net cash provided by financing activities in the nine month period ended October
31, 2000 and October 31, 1999 was $.3 million and $1.2 million, respectively. In
the current nine-month period, cash primarily resulted from the issuance of
common stock under the Company's employee stock purchase plan and the exercise
of common stock options. In the nine month period ended October 31, 1999, 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 $0.3
million repayment of a note payable to an Auco, Inc. stockholder.
During the nine month period ended October 31, 2000, cash and investments
decreased $5.4 million compared to a decrease of $2.4 million for the comparable
period last fiscal year. The Company continues to experience a reduction in
receivables and unbilled receivables, and it collected a $1.0 million block
license that was included in revenues during the quarter ended October 31, 2000.
The Company's principal source of liquidity is its cash and cash equivalents and
investments, which, as of October 31, 2000 were $23.4 million in the aggregate.
For the nine-month period ended October 31, 2000, the Company incurred a loss
and experienced substantial negative
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cash flow. The Company does not have a credit facility and the Company does not
expect to secure a line of credit. Although there can be no assurances, the
Company believes that its current cash and resources will provide sufficient
funds for planned operations for the remainder of the fiscal year ending January
31, 2001. However, if the Company does not generate anticipated cash flow from
sales, or if expenditures are greater than expected, the Company most likely
will reduce discretionary spending, which could require the Company to delay,
scale back or eliminate some or all of its development efforts, any of which
could have a material adverse effect on the Company's business, results of
operations and prospects. Further, if the Company continues to experience
negative cash flows, as is anticipated, and prior to or following the end of
this fiscal year the Company is unable to increase revenues or cut costs so that
revenues generated from operating activities are sufficient to meet the
Company's obligations as a result of which the Company exhausts current capital
resources, the Company will be required to obtain additional capital from other
sources. Such sources might include issuances of debt or equity securities, bank
financings or other means that might be available to the Company to increase its
working capital. Under such circumstances, there is substantial doubt as to
whether the Company would be able to obtain additional capital on commercially
reasonable terms or at all. The inability to obtain such resources on
commercially acceptable terms would have a material adverse effect on the
Company, its operations, liquidity and financial condition, its prospects and
the scope of strategic alternatives and initiatives available to the Company.
Risks and Uncertainties
The following risks and uncertainties, among other things, should be considered
in evaluating the Company's outlook:
Decline in Revenues and Operating Results
-----------------------------------------
The consolidated revenues for fiscal Year 2001 will decline from the level
attained in fiscal year 2000. The Company was unprofitable in the first nine
months of fiscal year 2001 and does not expect to return to profitability in
fiscal year 2001. Furthermore, there can be no assurances that the Company will
be profitable in the future. A continuing loss will deplete the Company's
capital resources. Additionally, the Company anticipates decreases in both
revenues and costs during the last quarter of fiscal year 2001 compared to the
last quarter of fiscal year 2000. The projected decreases in expenses are not
expected to offset the decline in revenues. The factors noted below have had and
will continue to have a material adverse effect on the Company's future revenues
and/or results of operations.
Product Offerings
-----------------
The Company's current technology and products have been in the market place for
an average of 24 months as of October 31, 2000. This represents a 71% increase
from the average of 14 months that the Company's products have been in the
market place as of October 31, 1999. The enlargement in the average age of
current technology and products in the market place is caused by the decline in
demand for the Company's technology and products. Although the Company continues
to sell its current technology and products to certain OEMs, there can be no
assurance that the OEMs will continue to need or utilize the current technology
and products offered by the Company.
Industry and Market
-------------------
Peerless provides the worldwide market for printers (21-69 PPM) and MFP (21-110
PPM) unit volume which is projected by International Data Corporation to grow at
a rate of 19% down from previous growth calculations of 26% (1999-2003), 37%
(1998-2002), and 40% (1997-2001). Revenue for the same market segments and
periods is expected to grow 17% down from previous growth projections of 20%
(1999-2003), 42% (1998-2002), and 54% (1997-2001). It should also be noted that
there is a good indication that retail prices are declining in these
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segments. Both of these segments are key target markets for the Company.
Although the Company currently has some contracts with OEMs, there has been a
decline, and the decline will likely continue, in the demand for the Company's
technology and products presently being offered. Competitors are merging into
larger business units with the resulting strength to acquire and impose a
competitive advantage in the Company's market segments.
Concentration of Revenues
-------------------------
During the third quarter of fiscal 2001, four customers generated greater than
10% of the revenues and collectively contribute 60% of revenues. Non-recurring
block license revenues for the same time period were 46% of revenues. During the
third quarter of fiscal 2000, three customers generated greater than 10% of the
revenues and collectively contribute 38% of revenues. Non-recurring block
license revenues for the same period were 9% of revenues.
During the nine month period ending fiscal 2001, two customers generated greater
than 10% of the revenues and collectively contribute 38% of revenues.
Non-recurring block license revenues for the same period were 44% of revenues.
During the nine month period ending fiscal 2000, two customers generated greater
than 10% of revenues and collectively contribute 33% of revenues. Non-recurring
block license revenues for the same period were 3% of revenues.
Although the acquisitions of Netreon, Inc. and PSIP, as well as on-going sales
efforts have expanded the Company's customer base, a limited number of OEM
customers have provided a substantial portion of Peerless' revenues. There
presently are only a limited number of OEM 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 is severely limited. A
reduction in business from a customer providing a significant portion of the
Company's revenues will have a material adverse effect on the Company's
operating results.
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 that similar factors will not
impact future engineering services results. While in the past, the Company has
benefited from the inclusion of cancellation fees in its engineering services
agreements, there is no assurance that the Company will be able to negotiate
these fees into future engineering services arrangements.
Recurring Licensing Revenue
---------------------------
The Company's recurring licensing revenue model has shifted from per unit
royalties paid upon OEM shipment of product and guaranteed quarterly minimum
royalties to a model that results in revenues associated with the sale of SDKs
and sales of block licenses. Block licenses are the sale of licenses for units
to be shipped in the future resulting in bringing forward revenues to the
current period once the fees are determined to be fixed and determinable and
collection of the fees is probable. The reliance on block licenses has occurred
due to aging products in the market place, reduced Adobe product
penetration/rate in OEM products shipping and a design win mix that changed
quickly to being predominately SDKs. Although the present Recurring License
Revenue model benefits the Company's cash flows and minimizes the Company's risk
associated with unexpected decreases in demand for customer products, the
Company's revenues have and could continue to fluctuate significantly from
quarter to quarter as the number and value of design wins vary or if block
licenses are delayed or are lost to competitors.
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 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
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received in a timely manner. In the event the Company is unable to estimate such
revenues accurately prior to reporting of the Company's quarterly results, the
Company may be required to adjust revenues for subsequent periods.
Technological Change
--------------------
The marketplace for the Company's products and services has always been
characterized by rapidly changing technology, evolving industry standards and
needs, and frequent new product introductions, knowledgeable OEMs with financial
strength and negotiating leverage and competitive incursions. Over the past
three quarters, the ability of the Company and its OEM customers to meet
industry changes and market demands in a timely manner with responsive
development projects has been significantly reduced. The Company's success has
always depended on the achievement of new design wins by the Company followed by
the OEMs' deployment of associated new digital document products with attendant
recurring license fees, and the regular and continued introduction of new and
enhanced technology and services by the Company to its OEMs on a timely and
cost-effective basis. The shortfall of the acceptance by the OEMs of the
Company's technology that have been further exacerbated by the less than
projected deliveries of digital document products of the Company's OEM customers
to the marketplace has been the result of fall-off business activity.
There can be no assurance that the product solutions and technology of
competitors of the Company or the OEMs themselves will not render the Company's
technology or its OEMs' products technically and/or cost-wise 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, will result in a loss of competitiveness and/or
revenues. Such actions would have a material adverse effect on the Company's
operating results.
Third Party Licensing
---------------------
The Company currently sublicenses third party technology to its OEM customers.
Such sublicense agreements are non-exclusive. If the Company is not in
compliance with the agreement with the licensor, the Company could lose its
rights to sublicense this technology to its OEM customers. Additionally, the
licensing of this technology has become very competitive with a substantially
larger competitor of the Company pursuing aggressive strategies in the sale of
this third party technology. There is no assurance that the Company can keep
competitive in the market place.
Receivables
-----------
The Company's accounts receivables declined to $11.2 million from $11.7 million
at January 31, 2000 reflecting significant collections from several major
customers, including the conversion of unbilled receivables to accounts
receivable. Included in this amount is a receivable of $1.5 million related to
the Conexant dispute. The Company feels that its accounts receivable reserves
are adequate for the quarter ended October 31, 2000, although there can be no
assurance regarding this assertion.
ASICs
-----
The Company has developed a "fabless" distribution model for the sale of ASICs.
The Company has no direct distribution experience and places reliance on third
party distributors to maintain inventories to address OEM needs, manage
manufacturing logistics, and distribute the product in a timely manner. There
can be no assurance that these distribution agreements will be maintained.
Dependence on Sole Source Providers
-----------------------------------
Currently, the Company is dependent on three independent parties, Motorola, IBM
Microelectronics, and NEC Microelectronics each of which provides unique
application specific integrated circuits ("ASICs") incorporating the Company's
imaging technology for use by the
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Company's OEMs. Additionally, the Company has relationships with Adobe and
Novell that address many critical aspects of the Company's OEM customers' needs.
The Company has licensed from Adobe, for internal development purposes, the
right to use Adobe's PostScript Software to enable the Company's products to
provide Adobe's PostScript printing. The Company has licensed to Adobe several
of the Company's technologies, and has developed technologies for Adobe for
which the Company receives royalties. These sole source providers are subject to
materials shortages, excess demand, reduction in capacity and/or other factors
that may disrupt the flow of goods to the Company's customers and thereby
adversely affect the Company's customer relationships. Any such disruption could
limit or delay production or shipment of the products incorporating the
Company's technology, which could have a material adverse effect on the
Company's operating results.
The Company, through its subsidiary Netreon, Inc., has entered into contracts
with entities and persons located in Hong Kong, a city that is located in a
political district of the People's Republic of China. The Company utilizes the
services of these entities for engineering development and tests. Through these
long-term relationships, the Company operates at favorable cost, schedule and
quality of output advantages.
If the services provided by these entities were to be discontinued, the Company
would have to bring these services in-house, which could increase costs and
delay deliverables. There can be no assurances that the political and business
climates in Hong Kong will remain stable. However, should there be disruption in
the aforesaid relationships, it is not expected to have a materially adverse
affect on the Company, its financial condition or results of financial
operations.
Costs and Expenses
------------------
A substantial portion of the Company's costs and expenses are related to costs
of engineering services and maintenance, product development, other personnel
costs, marketing programs and facilities. The level of spending for such costs
and expenses cannot be adjusted quickly and is based, in significant part, on
the Company's expectations of future revenues and anticipated OEM commitments.
As in the current fiscal year-to-date, if such commitments do not materialize or
are terminated or if revenues are below expectations, the Company's quarterly
and annual operating results will be adversely affected.
Dependence on Key Personnel
---------------------------
The Company is largely dependent upon the skills and efforts of its senior
management and other officers and key employees. The Company has had a turnover
and reduction of senior management and key employees. However the Company
believes that its future success will continue to depend in large part upon its
ability to retain and attract highly skilled managerial, engineering, sales,
marketing and operations personnel, many of whom are in great demand.
Competition for such personnel is intense. The loss of key personnel or the
inability to hire or retain qualified personnel has had and could continue to
have a material adverse effect on the Company's operating results. The Company
maintains a key person life insurance policy for one executive, Mr. Au. The
Company has been restricted in the SWIB lawsuit in its use of the 1.0 million
options approved by the Shareholders in July 1999. Without the ability to grant
stock options to retain or hire key personnel, the Company has been negatively
impacted in the fiercely competitive technical hiring marketplace.
International Activities
------------------------
Peerless is substantially dependent on its international business activities.
The international market for products incorporating the Company's technology is
highly competitive, and the Company expects to face substantial competition in
this market from technologies developed internally by its OEMs. Risks inherent
in the Company's international business activities also include currency
fluctuations, changes in the economic condition of foreign countries, the
imposition of government controls, tailoring of products to local requirements,
trade restrictions, changes in tariffs and taxes, and the burdens of complying
with a wide variety of foreign laws and
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regulations, any of which could have a material adverse effect on the Company's
operating results. Although all of the Company's contracts are, and the Company
expects that its future contracts will be, denominated in U.S. dollars, there
can be no assurance that its contracts with international OEMs in the future
will be denominated in U.S. dollars. In the event that one or more contracts are
denominated in foreign currencies, the Company will be subject to additional
risks associated with currency fluctuations, which could have a material adverse
effect on the Company's operating results.
During the past few years, the Pacific Rim economies have been financially
depressed. As a result, some members of the imaging industry have reported
negative financial impacts attributable to a decrease in demand from Pacific Rim
customers. Peerless' Asian customers are comprised primarily of companies
headquartered in Japan. These Japanese OEMs sell products containing Peerless'
technology primarily in the North American, European, and Asian marketplaces.
These revenues have declined and there can be no assurance that revenues from
Japanese OEMs will not continue to decline in future quarters.
Volatility of Stock Price
-------------------------
The Company's common stock has experienced significant price volatility and has
decreased to less than $1.00 per share at times. Such volatility may occur in
the future. Factors that could affect the trading price of the common stock
include swings in quarterly results of operations, announcements of new products
by the Company or its competitors, developments or disputes with respect to
proprietary rights, general trends in the industry, overall market conditions
and other factors. In addition, the stock market historically has experienced
extreme price and volume fluctuations, which have particularly affected the
market price of securities of many related high technology companies and which
at times have been unrelated or disproportionate to the operating performance of
such companies.
Market Risk
-----------
The Company is exposed to various market risks including changes in interest
rates. Market risk is the potential loss arising from adverse changes in market
rates and prices, such as interest rates. The Company has not been at risk from
adverse changes in foreign currency exchange rates as all transactions have been
denominated in U.S. dollars. The Company has not entered into derivatives or
other financial instruments for trading purposes.
Peerless' exposure to market rate risk for changes in interest rates relates
primarily to the Company's investment portfolio. The Company invests its excess
cash in fixed rate debt instruments of the U.S. Government and high-quality
corporate issuers as well as floating rate money market funds. The Company, by
policy, limits the amount of credit exposure to any one issuer. Investments in
both fixed rate and floating rate interest earning instruments carry a degree of
interest rate risk. Fixed rate securities may have their fair market value
adversely impacted due to a rise in interest rates, while floating rate
securities may produce less income than expected if interest rates fall. Due in
part to these factors, Peerless' future investment income may fall short of
expectations due to changes in interest rates, or Peerless may suffer losses in
principal if forced to sell securities which have declined in market value due
to changes in interest rates.
Year 2000
---------
The Company, its subsidiaries, and to its knowledge the Company's third party
suppliers did not
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experience problems associated with the Company's defined exposure areas of its
Licensed Products, their Key Transaction Processing Applications, the Company's
Equipment and Facilities, and Key Suppliers during the transition to the Year
2000. Additionally, as a result of the work performed previously and experience
in Year 2000 to date, the Company does not foresee any problems in this area.
The Company continues to maintain a discrete observation of these potential
exposure areas through Year 2000 in the ordinary course of business. There can
be no assurances that such problems, should they occur, will not have a
materially adverse effect on the Company, its financial condition, or results of
operations.
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PART II - OTHER INFORMATION
================================================================================
Item 1: Legal Proceedings
Peerless is subject to litigation in the ordinary course of its business. The
Company believes that such litigation has not and will not have material adverse
effects on the financial position, results of operations and the cash flows of
the Company.
Two shareholder class action lawsuits were filed on August 28, 2000 and on
September 19, 2000 against the Company and two former officers of the Company in
the United States District Court for the Southern District of California. These
lawsuits allege a scheme to artificially inflate the Company's stock price
through the dissemination of false and misleading information. The lawsuit seeks
compensatory damages, attorney's fees and expenses. The Company has retained
Wilson, Sonsini, Goodrich & Rosati, LLP, Palo Alto, CA as counsel in this
matter. Peerless believes all of the claims to be without merit.
In July 2000, the Company initiated litigation in the United States District
Court for the Central District of California regarding certain claims arising
out of the acquisition of HDE, Inc. in December 1999. The Company believes that
it has valid claims in this matter. The matter remains in the pleading stage.
The Company filed a lawsuit in January 2000 against Conexant Systems, Inc.,
Newport Beach, CA in the Orange County Superior Court regarding the failure and
refusal of Conexant to pay to the Company a portion of a Source License Fee and
guaranteed royalty payments pursuant to an agreement between the parties.
Conexant has filed a cross complaint alleging misrepresentation of facts
regarding the Company's Intellectual Property. Discovery is continuing. The
Company is confident that it will prevail in this matter. The Company has not
accrued any liability associated with this lawsuit, as management believes that
the reserve for doubtful accounts at January 23, 2000 is adequate. The
receivable has been reclassified as a long-term receivable in that management
does not expect that the lawsuit will be concluded, and the balance outstanding
to Peerless will be collected, within the next fiscal year.
The Company was sued by a major shareholder, the State of Wisconsin Investment
Board ("SWIB") in the Court of Chancery of the State of Delaware in New Castle
County in December 1999. The Company's former Chief Executive Officer, Edward A.
Gavaldon, has also been named as a defendant. The complaint alleges that
Peerless wrongfully influenced the passage of a proposal to increase the number
of shares in the stock option plan at the 1999 Annual Meeting of Shareholders
and provided misleading information to SWIB. Mr. Gavaldon is alleged to have
benefited wrongfully from these actions. SWIB seeks to nullify the shareholder
approved Amendment to the Peerless Equity Incentive Plan and is asking for
unspecified damages.
SWIB and the Company have agreed that Peerless will provide weekly notice to
SWIB and the Court of the number of options returning to the pool of the
available options in the Company's Equity Incentive Plan and will provide
reasonable advance notice to SWIB and the Court before granting any further
options that would reduce the pool of available options in the Equity Incentive
Plan below 1.0 million.
Cross-motions for summary judgment were filed, argued and ruled on by the Court.
The Court granted the Company's summary judgment motion for a determination that
defendants did not omit material information and make false and misleading
statements of material fact about the June 17, 1999 adjournment. The Court
denied the remaining motions of SWIB and the Company.
On December 12, 2000, the lawsuit filed in the Alameda County Superior Court
against the Company and its wholly owned subsidiary, Netreon, Inc. ("Netreon")
by Howard Sidorsky, a current employee of Netreon, Inc. was settled.
Item 2: Changes in Securities
None
Item 3: Defaults Upon Senior Securities
None
Item 5: Other Information
On August 28, 2000, Robert V. Adams resigned from the Board of Directors.
At the Board of Directors meeting held at the Company on November 21, 2000,
Robert G. Barrett resigned as Chairman of the Board of Directors. Mr. Barrett
will remain on the Board. Howard J. Nellor was named President and Chief
Executive Office of the Company and was elected to fill a vacancy on the Board
of Directors.
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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/ Howard J. Nellor Date: December 15, 2000
---------------------------------------
Howard J. Nellor
President and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ William R. Neil Date: December 15, 2000
---------------------------------------
William R. Neil
Vice President of Finance,
Chief Financial Officer
(Principal Financial and Accounting Officer)
26
