<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 July 31, 2000
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 August 31, 2000 was
14,898,126.
================================================================================
<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 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. 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 20 through 24, among other things, should be considered
in evaluating the Company's prospects and future financial performance.
2
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PEERLESS SYSTEMS CORPORATION
<TABLE>
<CAPTION>
INDEX
=========================================================================================================
PART I - FINANCIAL INFORMATION
---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Item 1: Financial Statements Page No.
--------------------
Consolidated Balance Sheets
July 31, 2000 and January 31, 2000 ............................. 4
Consolidated Statements of Operations
Three and Six Month Periods Ended July 31, 2000
and July 31, 1999............................................... 5
Consolidated Statements of Cash Flows
Six Month Period Ended July 31, 2000 and July 31, 1999 ......... 6
Notes to Consolidated Financial Statements....................... 8
Item 2: Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations........................................... 14
---------------------
PART II - OTHER INFORMATION
---------------------------------------------------------------------------------------------------------
Item 1: Legal Proceedings................................................ 25
Item 4: Submission of Matters to a Vote of Security Holders.............. 25
---------------------------------------------------
Item 6: Exhibits and Reports on Form 8-K................................. 26
--------------------------------
Signatures ................................................................. 28
</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. 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>
PEERLESS SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
July 31, January 31,
2000 2000
---------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 10,132 $13,620
Restricted cash 742 -
Short term investments 9,967 12,329
Trade accounts receivable, net 7,584 10,168
Unbilled receivables 497 2,343
Income tax receivable 1,945 21
Deferred tax asset - 682
Prepaid expenses and other current assets 623 682
---------- -----------
Total current assets 31,490 39,845
Investments 5,871 2,922
Long term receivable 1,500 1,500
Property and equipment, net 6,315 6,565
Deferred tax asset - 1,050
Other assets 634 683
---------- -----------
Total assets $ 45,810 $52,565
========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 721 $ 615
Other current liabilities 5,621 4,320
Deferred revenue, current portion 938 671
---------- -----------
Total current liabilities 7,280 5,606
Deferred rent 366 366
Other tax liabilities 2,380 2,799
---------- -----------
Total liabilities 10,026 8,771
---------- -----------
Stockholders' equity:
Common stock 15 15
Additional paid-in capital 48,466 47,953
Deferred compensation (90) (123)
Accumulated deficit (12,607) (4,051)
---------- -----------
Total stockholders' equity 35,784 43,794
---------- -----------
Total liabilities and stockholders' equity $ 45,810 $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 Six Months Ended
July 31, July 31,
---------------------- ----------------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenues:
Product licensing $ 7,875 $ 7,264 $ 9,648 $13,205
Engineering services, maintenance, and other 2,245 4,136 4,859 8,935
------- ------- ------- -------
Total revenue 10,120 11,400 14,507 22,140
------- ------- ------- -------
Cost of revenues:
Product licensing 2,497 110 2,527 165
Engineering services, maintenance, and other 2,842 3,376 6,155 6,685
------- ------- ------- -------
Total cost of revenues 5,339 3,486 8,682 6,850
------- ------- ------- -------
Gross margin 4,781 7,914 5,825 15,290
------- ------- ------- -------
Operating expenses:
Research and development 2,594 2,311 6,157 4,532
Sales and marketing 1,542 1,584 3,108 3,087
General and administrative 2,427 1,401 5,253 3,284
Other - non recurring costs - 2,014 - 2,014
------- ------- ------- -------
Total operating expenses 6,563 7,310 14,518 12,917
------- ------- ------- -------
Income (loss) from operations (1,782) 604 (8,693) 2,373
Interest income, net 367 312 623 614
------- ------- ------- -------
Income (loss) before income taxes (1,415) 916 (8,070) 2,987
Provision for income taxes (922) (209) (486) (1,068)
------- ------- ------- -------
Net income (loss) $(2,337) $ 707 $(8,556) $ 1,919
======= ======= ======= =======
Basic earnings per share $ (0.16) $ 0.05 $ (0.58) $ 0.14
======= ======= ======= =======
Diluted earnings per share $ (0.16) $ 0.05 $ (0.58) $ 0.13
======= ======= ======= =======
Weighted average common shares
outstanding - basic 14,892 13,565 14,812 13,237
======= ======= ======= =======
Weighted average common shares
outstanding - diluted 14,892 15,365 14,812 15,282
======= ======= ======= =======
</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>
Six Months Ended
July 31,
----------------------------------
2000 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income $ (8,556) $ 1,919
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization 847 640
Amortization of investment discounts and premiums (3) (56)
Amortization of deferred compensation 33 33
Compensation expense for option amendment and 245 48
common stock issued to employees
Deferred taxes 1,732 -
Business combination adjustment - 1
Changes in operating assets and liabilities:
Restricted cash (742) -
Trade accounts receivable 2,584 1,504
Unbilled receivables 1,846 (3,245)
Income tax receivable (1,924) -
Prepaid expenses and other current assets 59 (337)
Other assets 49 (72)
Accounts payable 106 223
Other current liabilities 1,301 1,018
Other tax liabilities (419) 814
Income tax payable - (827)
Deferred rent - (25)
Deferred revenue 267 (1,477)
-------- --------
Net cash used by operating activities (2,575) 161
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (597) (922)
Purchases of leasehold improvements - (625)
Purchases of available-for-sale securities (23,108) (12,815)
Proceed from held-to-maturity securities - 13,200
Proceeds from available-for-sale securities 22,524 3,000
-------- --------
Net cash provided (used) by investing activities (1,181) 1,838
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 227 416
Proceeds from exercise of common stock options 41 704
Repayment of outstanding note payable to stockholder - (300)
- -
-------- --------
Net cash provided by financing activities 268 820
-------- --------
Net increase (decrease) in cash and cash equivalents (3,488) 2,819
Cash and cash equivalents, beginning of period 13,620 6,132
-------- --------
Cash and cash equivalents, end of period $ 10,132 $ 8,951
======== ========
</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>
Six Months Ended
July 31,
----------------------------
2000 1999
-------- -------
<S> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $ 782 $1,377
======== =======
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>
7
<PAGE>
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(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 six month period ended July 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 ("SDK") 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 percentage-of-completion is
determined based on the direct costs, consisting primarily of labor and
materials, expended on the arrangement. 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.
8
<PAGE>
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 which will be sold in the future or 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 fee 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.
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.
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 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 is currently evaluating the impact of SAB 101 on its financial
statements and related disclosures. While the Company does not expect the impact
on the financial statements and results of operations to be material, it is not
known at this time what the ultimate impact will be.
9
<PAGE>
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. While the Company does not expect
the impact on the financial statements and results of operations to be material,
it is not known at this time what the ultimate impact will be. EITF 99-19 is
required to be adopted by the Company by the fourth quarter of fiscal 2001.
10
<PAGE>
3 Investments
Investments consisted of the following:
<TABLE>
<CAPTION>
July 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 3,378 -
State and local U.S. government debt securities 2,460 830
Corporate debt securities 4,129 9,999
------------- -------------
9,967 12,329
------------- -------------
Maturities after one year through five years:
State and local U.S. government debt securities 3,171 500
------------- -------------
3,171 500
------------- -------------
a Maturities after five years:
State and local U.S. government debt securities 2,700 2,422
------------- -------------
2,700 2,422
------------- -------------
Total available-for-sale securities 15,838 15,251
------------- -------------
Total Investments $15,838 $15,251
============= =============
</TABLE>
The fair value of securities at July 31, 2000 and January 31, 2000
approximated cost. Unrealized gains or losses on securities were
immaterial for all periods presented.
11
<PAGE>
4. Earnings Per Share
Earnings per share is calculated as follows:
<TABLE>
<CAPTION>
Three Months Ended July 31, Three Months Ended July 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 $(2,337) 14,892 $(0.16) $ 707 13,565 $0.05
Effect of dilutive securities
Common stock options 1,085
Note payable to stockholder 3
Convertible preferred stock Series A 495
Convertible preferred stock Series B 217
------
Diluted EPS
Earnings available to common
stockholders with assumed
conversions $(2,337) 14,892 $(0.16) $ 707 15,365 $0.05
======= ====== ====== ====== ====== =====
<CAPTION>
Six Months Ended July 31, Six Months Ended July 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 $(8,556) 14,812 $(0.58) $1,918 13,237 $0.14
Effect of dilutive securities
Common stock options 1,085
Note payable to stockholder 1 4
Convertible preferred stock Series A 665
Convertible preferred stock Series B 291
- - - -
------- ------- ------ -----
Diluted EPS
Earnings available to common
stockholders with assumed
conversions $(8,556) 14,812 $(0.58) $1,919 15,282 $0.13
------- ------- ------ ------ ----- -----
</TABLE>
12
<PAGE>
5. Restricted Cash
On March 16, 2000, PSN 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 PSN 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.
In the matter of State of Wisconsin Investment Board v. Peerless Systems
Corporation, et al. that is filed in the Chancery Court of the State of
Delaware, the parties agreed that Peerless will provide weekly notice to the
Court and to the plaintiff of the number of options returning to the pool of the
available options in the Company's Equity Incentive Plan, will provide
reasonable advance notice to the Court and to plaintiff before granting any
further options, and that Peerless would not grant any options that would reduce
the pool of available options below 782,800.
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.
Additionally, the Company has learned that a shareholder class action lawsuit
has been filed against the Company and two former officers of the Company in the
United States District Court for the Southern District of California. The
lawsuit alleges a scheme to artificially inflate the Company's stock price
through the dissemination of false and misleading information. The lawsuit seeks
compensatory damages, attorneys fees and expenses. Peerless believes all of the
claims to be without merit. If served, the Company will respond appropriately.
13
<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 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
Over the last several quarters, 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 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 began to react by consolidating through mergers and
acquisitions. In addition, the OEMs are now introducing fewer new products than
in the immediate 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 because the OEMs perceived that the Company's
solutions did not meet their technical requirements. It also 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, founded in April 1982, 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 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. Network Directories is a new storage technology, which
operates on any common network operating system. These directory services use
LDAP (Lightweight Directory Access Protocol) for communications between
directory servers and clients. This directory service allows users to store a
vast quantity of information in an array of networked storage devices.
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 will be
sold in the
14
<PAGE>
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 and 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 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 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
15
<PAGE>
exceeded demand for SDK solutions. However, in the last fiscal year, the Company
experienced a shift from an OEM demand of turnkey solutions to the sale of SDKs,
particularly for its mature monochrome solutions. Although the Company had
expanded its solution offerings by incorporating related embedded imaging and
networking technologies licensed from third parties, the Company has experienced
a 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 and trends for the technology and products offered by the Company have
been declining. A recent analysis of industry data has shown that the combined
rate of growth for the work group printer and copier market segments declined
since 1997 at annual rates of 13% for units and 25% for revenue.
The Company has experienced a change in its business and financial environment.
It had been expected that SDK sales would result in an increase in the 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 contributed to the Company's declining sales and
losses. The engineering services business declined as OEMs have taken technology
development in house though the utilization of SDKs, and where the SDKs have not
addressed the current and particular needs of the OEM, they have chosen
competitors or have elected to develop the needed technologies themselves.
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 will continue to support its current OEM controller customers in the
digital printing devices business with its existing technology and an
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. As noted above,
the Company plans to maintain an organization to support and maintain its OEM
customers with its existing technology. During the seven month period through
September 1, 2000, El Segundo staffing decreased 41% (71 employees) since the
beginning of this fiscal year. Of this decrease, 30% was engineering, 7% was
sales and marketing, which represented a 50% reduction of the sales force,
addressing the decline of new sales opportunities and 4% was general and
administrative. The Company also experienced decreases in staffing levels at
Peerless Systems Networking of 15% (eight employees), primarily engineering
offset by an increase in sales and general and administration since the
beginning of this fiscal year 2001 through September 1, 2000. At Peerless
Systems Imaging Products, the Company experienced a 22% reduction (five
employees), from engineering and general and administration since the beginning
of this fiscal year 2001 through September 1, 2000.
As a result of the decline in the embedded controller business, the Company is
exploring all 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.
16
<PAGE>
As a part of Peerless' active pursuit of new market opportunities, Peerless
Systems Networking is being re-named to Netreon, Inc. in order to provide unique
brand identity for its technology. Netreon will focus on the development and
sale of technology to support Windows 2000 and Novell directory services for
network and enterprise storage products for Windows 2000 and Novell network.
There is no assurance that the Company will be successful in the pursuit of
these new opportunities, resulting in a return to a growth in revenues,
profitable results and an increase in shareholder value.
Results of Operations
Comparison of Three and Six Month Periods Ended July 31, 2000 and July 31, 1999
Financial results for this year's six month period ended July 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 second quarter ended July 31, 2000 decreased 11%
to $10.1 million compared to $11.4 million reported for the same quarter in
fiscal year 2000. Consolidated revenues for the current six month period
decreased 34% to $14.5 million compared to $22.1 million reported for the six
month period ended July 31, 1999. The Company reported a net loss for the second
quarter of fiscal year 2001 of $(2.3) million or $(0.16) per basic and diluted
share compared to net income of $0.7 million or $0.05 per diluted share reported
for the second quarter a year ago. The net loss for the six month period ended
July 31, 2000 was $(8.6) million, or $(0.58) per basic and diluted share,
compared to net income of $1.9 million or $0.13 per diluted share a year ago.
Net income reported in last year's second quarter included $2.0 million for
transaction expenses associated with the acquisition of Auco Inc., now Peerless
Systems Networking.
The decrease in revenues resulted from the lower level of engineering services
associated with turnkey efforts performed during the six months ended July 31,
2000. As had been discussed previously, 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. The shift to SDKs is normally accompanied by the significant
reduction in engineering fees as the OEM development efforts are instead
performed by the OEM's engineers. 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 second quarter ending July 31,
2000 included the sales of $5.2 million of block license sales that are of a
nonrecurring nature. 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. As a result of the low level of turnkey bookings and
the
17
<PAGE>
current level of recurring product licensing revenues, excluding block product
license sales, the Company anticipates decreases in revenues during the second
half of fiscal year 2001 compared to the first half of fiscal year 2001. In
addition, cost of sales and operating expenses are also expected to decrease for
the remainder of the year but will not be sufficient to offset the expected
reduction in revenues.
The Company's total cost of revenues was $5.3 million and $8.7 million for the
three and six months ended July 31, 2000, representing increases of 53% and 27%,
respectively, from prior fiscal years levels. Cost of revenues increased in the
second quarter 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 47%
for the quarter ended July 31, 2000 from the 69% reported for the same quarter
in 1999. The gross margin as a percentage of total revenues decreased to 40% for
the six month period ended July 31, 2000 compared with 69% reported for the
comparable period last year. The decreases were in part a result of the 11% and
34% decreases in revenues for the comparable three and six 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 July 31, 2000. Cost of revenues for
engineering services and maintenance were comparable with the same quarter in
fiscal year 2000. 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 first six months of
fiscal year 2001.
Total operating expenses for the three and six months ended July 31, 2000 were
$6.6 million and $14.5 million, respectively, compared to $5.3 million and $10.9
million for the comparable periods a year ago, excluding the $2.0 million
transaction expenses recorded during the three months ended July 31, 1999
discussed above.
Research and Development expenses increased 12% to 26% of total revenues for the
quarter ended July 31, 2000 compared with 20% of total revenues reported for the
same quarter in 1999. Research and Development expenses increased 42% of total
revenues in the current six month period from 20% of total revenues reported in
the prior six month period. The increase was due to lower sales levels and an
increase in research and development costs. The increase in funding was
primarily due to third party development costs associated with a new ASIC as
well as continued investments in storage technologies and development programs.
Sales and Marketing expenses were flat at $3.1 million compared to the first
half of last fiscal year.
General and Administrative expenses for the quarter ended July 31, 2000
increased 73% from the same quarter in 1999. General and Administrative
expenses for the six month period ended July 31, 2000 increased 60% 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.
Other non-recurring costs of $2.0 million for the quarter and six month periods
ended July 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
Inc., now Peerless Systems Networking.
18
<PAGE>
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 six months ended July 31, 2000 are
based on foreign taxes paid, net of the benefit to the Company will realize from
the loss carry-back and changes in the valuation reserve. The provision for
income taxes for the three and six months ended July 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 July 31, 2000 decreased 13% to
$45.8 million and stockholders' equity decreased 18% to $35.8 million. The
Company's cash and short-term investment portfolio was $20.5 million at July 31,
2000 and the current ratio was 4:1, current assets compared to current
liabilities. The Company used $2.6 million in cash during the six month period
ended July 31, 2000 to finance operations as compared to $0.2 million in cash
generated from operations during the six month period ended July 31, 1999.
The Company's investment activities during the six month period ended July 31,
2000 resulted in a net use of cash of $1.2 million. Purchases of investment
securities resulted in a net use of cash of $0.6 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 six month period ended July 31, 2000, the Company
invested $0.6 million in property, equipment and leasehold improvements compared
to $1.5 million invested during the six month period ended July 31, 1999.
Net cash provided by financing activities in the six month period ended July 31,
2000 and July 31, 1999 was $268 and $820, respectively. In the current six 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 six month period ended July 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 $6.7 million exercise of Auco, now Peerless
Systems Networking , Convertible preferred stock Series B.
During the six month period ended July 31, 2000, cash and investments decreased
$2.9 million compared to a decrease of $0.5 million for the comparable period
last fiscal year. The Company continues to experience a reduction in
receivables and unbilled receivables, and it collected a $3.5 million block
license that was included in revenues during the quarter ended July 31, 2000.
The Company's principal source of liquidity is its cash and cash equivalents and
investments which, as of July 31, 2000 were $26.0 million in the aggregate. For
the six month period ended July 31, 2000, the Company incurred a loss and
experienced substantial negative 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.
19
<PAGE>
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 half 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 and a
continued loss will deplete the Company's capital resources. Additionally, the
Company anticipates decreases in both revenues and costs during the second half
of fiscal year 2001 compared to the first half of fiscal year 2001. The
decreases in costs are not expected to offset the decline in revenues. The
factors noted below have had and may 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 21 months as of July 31, 2000 which
represents a 50% increase from the average of 14 months the products had been in
the market place as of July 31, 1999. The growth in the average age of products
in the market place is a result of 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: A recent analysis of industry data has shown that the
-------------------
combined rates of growth for the work group printer and copier market segments
declined since 1997 at annual rates of 13% for units and 25% for revenue. Both
of these segments are key target markets for the Company. Although the Company
currently has certain contracts with OEMs, there has been a decline, and the
decline may continue, in the demand for the Company's technology and products
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 second quarter of fiscal 2001, Ricoh
-------------------------
Company, Ltd., generated more than 20% of the Company's revenues. For the six
months ended July 31, 1999, four customers each generated more than 20% of the
Company's revenues. Although recent acquisitions and sales efforts have expanded
the Company's customer base, 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 is severely 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.
20
<PAGE>
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. 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.
Recurring Licensing Revenue: Over the past several quarters, the Company's
---------------------------
recurring licensing revenue model has shifted from per unit royalties paid upon
OEM shipment of product to a model that results in revenues associated with the
sale of SDKs and guaranteed quarterly minimum royalties 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. This 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 Recurring License
Revenue model benefited the Company's cash flows and minimized 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.
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
reporting of the Company's quarterly results, the Company may be required to
adjust revenues for subsequent periods.
Technological Changes: The marketplace for the Company's products and services
---------------------
has 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. The
ability of the Company and its OEM customers to meet industry changes and market
demands in a timely manner with timely development projects has been depleted.
The Company's success has always depended on the achievement of new design wins
by the Company followed by the OEMs' development 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. Recent business
activity has indicated a shortfall of the acceptance by the OEMs of the
Company's technology further exacerbated by the less than projected deliveries
of digital document products of the Company's OEM customers to the marketplace.
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.
21
<PAGE>
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 licensee, 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 pursuing 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 $9.1 million from
-----------
$11.7 million reflecting strong 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 July 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 or
that the OEMs will elect to purchase from Peerless' distributor.
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 to certain of
the 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 PSN, has entered into contracts with
entities and persons located in Hong Kong, which city is located in a political
district of the People's Republic of China. Through these long term
relationships, the Company operates at favorable cost, schedule and quality of
output advantages. The Company utilizes the services of these entities for
engineering development and tests.
22
<PAGE>
If the services provided by these entities were to discontinue, 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. While
the Company has had a turnover and reduction of senior management and employees,
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 recently has increased
significantly. 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 only maintains key person life
insurance policies for one executive, Mr. Au.
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 established
companies and 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 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.
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
23
<PAGE>
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 experience any problems associated with its
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 will 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.
24
<PAGE>
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.
In the matter of State of Wisconsin Investment Board v. Peerless Systems
Corporation, et al. that is filed in the Chancery Court of the State of
Delaware, the parties agreed that Peerless will provide weekly notice to
the Court and to the plaintiff of the number of options returning to the
pool of the available options in the Company's Equity Incentive Plan, will
provide reasonable advance notice to the Court and to plaintiff before
granting any further options, and that Peerless would not grant any options
that would reduce the pool of available options below 782,800.
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.
Additionally, the Company has learned that a shareholder class action
lawsuit has been filed against the Company and two former officers of the
Company in the United States District Court for the Southern District of
California. The lawsuit alleges a scheme to artificially inflate the
Company's stock price through the dissemination of false and misleading
information. The lawsuit seeks compensatory damages, attorneys fees and
expenses. Peerless believes all of the claims to be without merit. If
served, the Company will respond appropriately.
Item 2: Changes in Securities
None
Item 3: Defaults Upon Senior Securities
None
Item 4: Submission of Matters to a Vote of Security Holders
The Company held its annual shareholders meeting on June 20,2000. A
copy of the certified list of shareholders was presented at the
meeting.
The Inspector of Election, Wells Fargo Shareowner Services, Inc., St.
Paul, Minnesota, reported that 12,381,469 shares out of a total of the
14,894,543 issued and outstanding shares on the date of record, May
15, 2000 of Common Stock were represented in person or by proxy at the
meeting. Each share of Common Stock was entitled to one vote.
The shareholders voted on the following matters:
1) Election of directors: Robert V. Adams, Adam Au, Robert G.
Barrett, and Robert L. North were nominated and elected as
directors, representing the Board of Directors in its entirety.
The votes were counted as follows:
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<PAGE>
Votes Votes
For Withheld
--- --------
Robert V. Adams 11,983,466 398,003
Adam Au 11,985,466 396,003
Robert G. Barrett 11,984,539 396,930
Robert L. North 11,982,466 399,003
2) Ratification of Selection of Independent Auditors: The selection
of Ernst & Young LLP as the independent auditors was ratified by
a vote of 12,339,215 votes for and 19,750 votes against with
22,504 votes abstaining.
3) Approval of the 1996 Employee Stock Purchase Plan, As Amended:
The amendment increases the number of shares authorized for
issuance under the Plan by 500,000 shares. The 1996 Employee
Stock Purchase Plan, as amended, was approved by a vote of
9,961,792 votes for and 2,078,317 votes against with 341,360
votes abstaining.
Item 5: Other Information
None
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
A Report on Form 8-K was filed on July 5, 2000, pursuant to "Item
6" whereby the Company announced the resignation of Margaret
Turner as Vice President of Engineering for Peerless Systems
Corporation effective June 23, 2000.
26
<PAGE>
A Report on Form 8-K was filed on July 14, 2000, pursuant to
"Item 6" whereby the Company announced the resignation of Gordon
L. Hanson as Vice President and General Manager for Peerless
Systems Imaging Products, Inc. effective July 11, 2000.
A Report on Form 8-K was filed on August 1, 2000, pursuant to
"Item 6" whereby the Company announced the resignation of Carolyn
M. Maduza as Senior Vice President, Finance and Administration
and Chief Financial Officer for Peerless Systems Corporation
effective July 28, 2000.
27
<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
/s/ Howard J. Nellor
By: ----------------------------------------- Date: September 14, 2000
Howard J. Nellor
Interim President and
Chief Executive Officer
(Principal Executive Officer)
/s/ William R. Neil
By: ---------------------------------------- Date: September 14, 2000
William R. Neil
Vice President of Finance,
Chief Financial Officer
(Principal Financial and Accounting Officer)
28
