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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 April 30, 2001
Commission File Number: 000-21287
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PEERLESS SYSTEMS CORPORATION
(Exact name of registrant as specified in its charter)
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Delaware 95-3732595
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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 June 7, 2001 was 15,070,788.
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SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
This Report on Form 10-Q contains forward-looking statements within the meaning
of the U.S. Private Securities Litigation Reform Act of 1995. Statements
prompted by, qualified by or made in connection with such words as
"anticipates," "estimates," "expects," "continuing," "projects," "intends,"
"plans," "targets," "believes" and words of similar substance signal forward-
looking statements. Likewise, the use of such words in connection with or
related to any discussion of or reference to the Company's future business
operations, opportunities or financial performance sets apart forward-looking
statements.
In particular, statements regarding the Company's outlook for future business,
financial performance and growth, including projected revenue, profit, spending,
including spending on research and development efforts and investments in
Peerless and Netreon, costs, margins and the Company's cash position through the
fiscal year-end 2002, as well as statements regarding expectations for the
embedded imaging and storage markets, new product development and offerings,
customer demand for the Company's products and services, market demand for
products incorporating the Company's technology, future prospects of Netreon,
and the impact on future performance of organizational and operational changes;
all constitute forward-looking statements.
These forward-looking statements are just predictions and best estimations
consistent with the information available to the Company at this time. Thus they
involve known and unknown risks and uncertainties such that actual results could
differ materially from those projected in the forward-looking statements made in
this Report on Form 10-Q. Risks and uncertainties include, but are not limited
to: a) changes in the marketplace in which the Company 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; g) unfavorable economic
conditions resulting in decreased demand for original equipment manufacturers'
("OEMs") products using Peerless' technology, making it difficult for the
Company to obtain new licensing agreements; h) OEM determinations not to proceed
with development of products using Peerless' technology due to, among other
things, changes in the demand for anticipated OEM products, age of Peerless'
technology, concerns about Peerless' financial position and Peerless'
competitors offering alternative solutions; i) the lack of acceptance of
Peerless' Internet printing technology by users in the hospitality markets; j)
Peerless' competitors coming to market with new products or alternative
solutions that are superior or available at a lower cost or earlier than
anticipated or believed to be possible; k) the anticipated market growth in
imaging, network attached storage ("NAS"), storage area network ("SAN"), and
Internet printing may not grow to anticipated levels; l) the costs associated
with the development of products for imaging, NAS, SAN and Internet printing may
be higher than currently forecasted; m) higher than forecasted legal expenses
and/or an unfavorable outcome to current matters being litigated; n) increases
or decreases in demand for the Company's products and services based on market
conditions and the competitiveness of Peerless' products from both technological
and pricing perspectives; o) the Company's inability to maintain or further
improve operating efficiencies or to further streamline operations; p) the
impact on the Company's financials of any future need to expand the organization
to meet customer or market demands; and q) other factors affecting Peerless'
business and the forward-looking statements set forth herein as set out from
time to time in Peerless' public filings with the Securities and Exchange
Commission, including but not limited to the Company's most recent Annual Report
on Form 10-K dated January 31, 2001, in the Section called Risks and
Uncertainties on pages 31 through 41, inclusive, filed on or about May 1, 2001,
and the Company's most recent prior Quarterly Report on Form 10-Q dated October
31, 2000, in the Section called Risks and Uncertainties on pages 20 through 25,
inclusive, filed on or about December 15, 2000.
Current and prospective stockholders are urged not to place undue 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
PEERLESS SYSTEMS CORPORATION
INDEX
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PART I - FINANCIAL INFORMATION
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Item 1: Financial Statements Page No.
--------------------
Consolidated Balance Sheets
April 30, 2001 and January 31, 2001....................... 4
Consolidated Statements of Operations
Three Month Periods Ended April 30, 2001 and 2000......... 5
Consolidated Statements of Cash Flows
Three Month Periods Ended April 30, 2001 and 2000......... 6
Notes to Consolidated Financial Statements................. 8
Item 2: Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operations................................. 13
-------------------------
Item 3: Quantitative and Qualitative Disclosures About
----------------------------------------------
Market Risk............................................... 18
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PART II - OTHER INFORMATION
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Item 1: Legal Proceedings.......................................... 29
-----------------
Item 6: Exhibits and Reports on Form 8-K........................... 30
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Signatures ........................................................... 31
TRADEMARKS
Memory Reduction Technology(R) (MRT), Peerless Powered(R), WINEXPRESS(R),
PeerlessPrint(R), redipS(R) and QuickPrint(R) are registered trademarks of
Peerless Systems Corporation. Acceleprint(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.
PeerlessPage(TM), Netreon(TM), DirectoryPlus(TM), ImageWorks(TM) and
WebWorks(TM) are trademarks of Peerless Systems Corporation. Peerless Systems
(in English and Japanese Katakana), Peerless (in logo) and P (in logo) are
registered service marks and P (in logo) is a registered trademark, with the
Japanese Patent Office. PEERLESSPRINT in English and Japanese Katakana are
service marks of Peerless Systems Corporation and are subjects of applications
pending for registration with the Japanese Patent Office. This Form 10-Q also
refers to various products and companies by their trademark names. In most, if
not in all cases, their respective companies claim these designations as
trademarks or registered trademarks.
3
Part I - Financial Information
Item 1 - Financial Statements
PEERLESS SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands)
(Unaudited)
April 30, January 31,
2001 2001
--------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 11,325 $ 12,073
Restricted cash 742 742
Short-term investments 5,583 6,358
Trade accounts receivable, net 4,445 6,428
Unbilled receivables 569 159
Income tax receivable 276 19
Prepaid expenses and other current assets 689 474
-------- --------
Total current assets 23,629 26,253
Investments 2,764 3,070
Long-term receivable 1,500 1,500
Property and equipment, net 5,775 5,710
Other assets 548 575
-------- --------
Total assets $ 34,216 $ 37,108
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LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,262 $ 901
Accrued wages 451 2,075
Accrued compensated absences 767 714
Other current liabilities 4,194 3,507
Deferred revenue 1,621 826
-------- --------
Total current liabilities 8,295 8,023
Other tax liabilities 2,260 2,260
Deferred rent 97 97
-------- --------
Total liabilities 10,652 10,380
-------- --------
Common stock subject to put options 321 -
Stockholders' equity:
Common stock 15 15
Additional paid-in capital 48,342 48,471
Deferred compensation (42) (58)
Accumulated deficit (24,959) (21,700)
Treasury stock (113) -
-------- --------
Total stockholders' equity 23,243 26,728
-------- --------
Total liabilities and stockholders'
equity $ 34,216 $ 37,108
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
4
PEERLESS SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
Three Months Ended
April 30,
-------------------------
2001 2000
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Revenues:
Product licensing $ 4,378 $ 1,773
Engineering services and maintenance 1,806 2,373
Other 520 241
------- -------
Total revenue 6,704 4,387
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Cost of revenues:
Product licensing 1,563 30
Engineering services and maintenance 1,448 3,168
Other 315 145
------- -------
Total cost of revenues 3,326 3,343
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Gross margin 3,378 1,044
------- -------
Operating expenses:
Research and development 3,294 3,563
Sales and marketing 1,195 1,566
General and administrative 2,008 2,826
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Total operating expenses 6,497 7,955
------- -------
Loss from operations (3,119) (6,911)
Interest income, net 253 256
------- -------
Loss before income taxes (2,866) (6,655)
Provision for (benefit from) income taxes 393 (436)
------- -------
Net loss $(3,259) $(6,219)
======= =======
Basic and diluted loss per share $ (0.22) $ (0.42)
======= =======
Weighted average common shares
outstanding - basic and diluted 15,007 14,782
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The accompanying notes are an integral part of these consolidated financial
statements.
5
PEERLESS SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Three Months Ended
April 30,
-------------------------------
2001 2000
------------ -------------
Cash flows from operating activities:
Net loss $(3,259) $ (6,219)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization 517 477
Amortization of investment discounts and premiums (6) (3)
Amortization of deferred compensation 16 16
Severance expense for option amendment and common stock
issued to employees - 245
Deferred taxes - 1,732
Changes in operating assets and liabilities:
Restricted cash - (742)
Trade accounts receivable 1,983 2,259
Unbilled receivables (410) 1,255
Income tax receivable (257) (2,283)
Prepaid expenses and other current assets (215) (572)
Other assets (5) (111)
Accounts payable 361 218
Other current liabilities (794) (187)
Deferred tax liability - 40
Deferred revenue 795 1,418
------- -------
Net cash used by operating activities (1,274) (2,457)
------- -------
Cash flows from investing activities:
Purchases of property and equipment (308) (467)
Purchases of leasehold improvements (242) -
Purchases of available-for-sale securities (2,814) (10,121)
Proceeds from sales of available-for-sale securities 3,901 6,750
------- -------
Net cash provided (used) by investing
activities 537 (3,838)
------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock 102 225
Proceeds from exercise of common stock options - 41
Repurchase of common stock (113) -
------- -------
Net cash provided (used) by financing
activities (11) 266
------- -------
Net decrease in cash and cash equivalents (748) (6,029)
Cash and cash equivalents, beginning of period 12,073 13,620
------- -------
Cash and cash equivalents, end of period $11,325 $ 7,591
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
6
PEERLESS SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(in thousands)
(Unaudited)
Three Months Ended
April 30,
------------------
2001 2000
------ ------
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes $ 695 $ 333
===== =====
The accompanying notes are an integral part of these consolidated financial
statements.
7
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands)
(Unaudited)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of Peerless
Systems Corporation (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, 2001,
2000 and 1999 included in the Company's Annual Report on Form 10-K filed with
the SEC on May 1, 2001. 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
Revenue Recognition: The Company recognizes revenues in accordance with
Statement of Position 97-2 "Software Revenue Recognition" as amended by
Statement of Position 98-9. In November 2000, the Company adopted Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" and
Emerging Issues Task Force 99-19, "Reporting Revenue Gross as a Principal
versus Net as an Agent." The adoptions did not impact the Company's revenue
recognition policy.
Development license revenues from the licensing of source code or software
development kits ("SDKs") for the Company's standard products are recognized
upon delivery and acceptance 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 contracts 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 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. At
April 30, 2001, the Company has accrued $165 for losses on two contracts that
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 customers upon manufacturing and subsequent commercial shipment of
products incorporating Peerless and third party 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 generally recognizes revenues associated with block
licenses and minimum royalty commitments
8
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands)
(Unaudited)
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 block licenses or minimum royalty commitments have extended payment terms
and the fees 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
earlier of the point at which such VSOE does exist or all elements of the
arrangement have been delivered. If an arrangement includes 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 licensing fees 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.
9
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands)
(Unaudited)
3. Investments
Investments consisted of the following:
April 30, January 31,
2001 2001
--------- -----------
Available-for-sale securities:
Maturities within one year:
State and local U.S. government debt securities $1,613 $1,417
Corporate debt securities 3,970 4,941
------ ------
5,583 6,358
------ ------
Maturities after one year through five years:
State and local U.S. government debt securities 810 912
------ ------
Maturities after five years:
State and local U.S. government debt securities 1,954 2,158
------ ------
Total Investments $8,347 $9,428
====== ======
The fair value of available-for-sale securities at April 30, 2001 and January
31, 2001 approximated their carrying value (amortized cost).
Unrealized gains or losses on securities were immaterial for all periods
presented.
4. Restricted Cash
On March 16, 2000, Netreon, Inc. entered into an agreement to lease
approximately twelve thousand square feet of office space in Mountain View,
California. The term of the lease agreement is seven years, which commenced on
July 1, 2000. 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.
5. Issuance and Purchase of Shares
On April 11, 2001, the Company issued 579 put options with a strike price
of $0.75. The put options entitle the holder to sell shares of Peerless common
stock to the Company at the strike price on or before September 30, 2001, the
expiration date of the put options. As of April 30, 2001, the Company had 429
put options outstanding. The potential obligation under the outstanding put
options has been transferred from stockholder's equity to "Common stock subject
to put options."
6. Legal Proceedings
The Company engaged in the following litigation matters:
On August 28, 2000, a stockholder class action lawsuit was filed against
the Company and two of the Company's former officers in the United States
District Court for the Southern District of California. A second stockholder
class action lawsuit was filed on September 19, 2000 against the Company and the
same two former officers of the Company in the same United States District
Court. On April 17, 2001, the Company was served with an Amended and
Consolidated Complaint. These lawsuits allege a scheme to artificially inflate
the Company's stock price based on alleged misleading public announcements and
seek compensatory damages with interest and attorneys fees, fees and expenses.
Peerless believes all of the claims to be without merit. A motion has been filed
with the Court to dismiss the amended and consolidated complaint against the
Company and the two former officers.
The Company filed a lawsuit in January 2000 against Conexant Systems Inc.,
Newport Beach, California 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. The parties have been in settlement negotiations and Peerless believes
this lawsuit will be resolved in a manner satisfactory to the Company.
In December 1999, the Company and the Company's former Chief Executive
Officer were sued by the State of Wisconsin Investment Board ("SWIB") in the
Court of Chancery of the State of Delaware in New Castle County. The complaint
alleged that Peerless wrongfully influenced the passage and provided misleading
information in connection with, a proposal to increase the number of shares
available for issuance under the Company's 1996 Equity Incentive Plan by
10
PEERLESS SYSTEMS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands)
(Unaudited)
1,000 at the Company's Annual Meeting of Stockholders in June 1999. The parties
have signed a settlement agreement that, among other things, sets out a payment
of $375 to SWIB for a portion of its legal fees. The lawsuit has been resolved
in a manner satisfactory to the Company.
In July 2000, the Company filed a claim in the United States District Court
for the Central District of California against the former owners of HDE, Inc. in
connection with Peerless' acquisition of that entity. On April 11, 2001, the
Company entered into a settlement agreement with one of the former owners.
Subject to certain limitations, the Company agreed that it will, at the former
owner's option, during the six month period beginning April 11, 2001, purchase
at a price of $0.75 per share, the Company's shares received by the former owner
pursuant to the merger agreement, dated December 7, 1999, under which Peerless
acquired HDE, Inc. The Company also agreed to register, and has filed a
registration statement with respect to the sale of the former owner's shares
under the Securities Exchange Act of 1933, as amended. The settlement agreement
further provides for a release by the former owner and the Company of any claims
that either may have against the other for any event arising on or before April
11, 2001. On April 19, 2001, the lawsuit was dismissed.
7. Concentration of Revenues
During the first quarter of fiscal year 2002, four customers each generated
greater than 10% of the revenues and collectively contributed 66% of revenues.
Block license revenues for the same time period were 53% of revenues. During
the first quarter of fiscal year 2001, one customer generated greater than 10%
of the revenues, which contributed 16% of revenues. There were no block license
revenues during the first quarter of fiscal year 2001.
8. Segment Reporting
Peerless provides software-based embedded imaging and networking technology
for digital document products and provides directory and management software for
networked storage devices and integrates proprietary software into enterprise
networks of original equipment manufacturers.
The Company views its operations as two segments: Imaging and Storage. The
factors that management uses to identify the separate segments include customer
base, products and technology. The factors used to measure the performance of
the two segments include revenues, operating profit and staffing.
A description of the products and services provided by each segment is as
follows:
. Imaging provides to OEM customers imaging systems, page description
languages, drivers, application specific integrated circuits,
engineering services to modify products for specific applications and
maintenance for digital document products. Products can be purchased in
source code form or can be modified using the Company's engineering
services to modify for a specific application. License fees are charged
for the utilization of Imaging technology.
. Storage provides OEM storage customers Network Attached Storage software
development kits that allow NAS OEMs to provide NetWare or Windows 2000
compatibility for their products. Storage is currently developing
comparable products for the Storage Area Networks. Products can be
purchased in source code form or can be
11
modified using the Storage engineering services to modify for a specific
application. License fees are charged for the utilization of the Storage
technology.
The accounting policies used to derive reportable segments results are
generally the same as those described in Form 10-K dated January 31, 2001 Note 1
to the Consolidated Financial Statements. Intersegment transactions are not
material. The Company's selling, general and administrative expenses are not
identified by segments or accumulated in this manner due to, among other things,
shared management and cross-utilization of personnel. Such expenses are
allocated to segments based on the ratio of the segments revenues to total
revenues.
The table below presents segment information for quarter ending April 30:
Total
Imaging Storage Segments
------- ------- --------
April 30, 2001
- --------------
Revenues $ 6,704 $ - $ 6,704
======== ======== ========
Operating loss $ (844) $ (2,275) $ (3,119)
======== ======== ========
Depreciation and amortization $ 464 $ 53 $ 517
======== ======== ========
Assets $ 32,961 $ 1,255 $ 34,216
======== ======== ========
Capital expenditures $ 162 $ 388 $ 550
======== ======== ========
April 30, 2000
- --------------
Revenues $ 4,287 $ 100 $ 4,387
======== ======== ========
Operating loss $ (6,066) $ (845) $ (6,911)
======== ======== ========
Depreciation and amortization $ 443 $ 34 $ 477
======== ======== ========
Assets $ 45,410 $ 2,493 $ 47,903
======== ======== ========
Capital expenditures $ 340 $ 127 $ 467
======== ======== ========
12
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 was founded in April 1982. It is a provider of network attached
storage ("NAS") and storage area network ("SAN") devices and software/hardware-
based embedded imaging, storage, and networking systems to original equipment
manufacturers of digital document products.
The Peerless imaging solution is based on a combination of software and
imaging application specific integrated circuit solutions ("ASICs"), which
together form a cost-effective embedded imaging system that addresses virtually
all sectors of the printing market, from low-end small office/home office
("SOHO") inkjets to high-end laser digital color copiers and printers. The low-
cost, high performance printers and multifunction products ("MFPs") that the
Company's imaging solutions drive are increasingly replacing expensive stand-
alone copiers and printers in corporate offices.
Netreon, Inc., the Company's wholly owned subsidiary, develops software for
centralized, directory-based management of NAS devices and SAN fabrics, and
focuses on the development and sale of directory storage technology to
enterprise storage manufacturers, primarily in the NAS and SAN markets.
Netreon's embedded directory agent technology enables networked devices to use
directory services to authenticate users and administer their access rights, and
is also designed to allow a directory to store and read configuration parameters
and to configure itself automatically.
PSIP, the other of the Company's wholly owned subsidiaries, is a developer
of embedded imaging and Internet printing products.
Historically, a limited number of customers have provided a substantial
portion of the Company's revenues. Therefore, the availability and 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.
During fiscal year ended January 31, 2001, the Company had 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. Because of the slump
in business in general, the printer industry in particular and other factors,
the demand for SDKs and for turnkey solutions had declined.
13
In response to the reduced demand for its products, the Company reduced the
size of its staff at its California Imaging operations. At April 30, 2001, the
staffing level was 86, which represents a 50% reduction from the comparable
level at February 1, 1999. In addition, the Company has adapted its pricing
model to no longer require OEMs commit to minimum levels of royalties prior to
the completion of turnkey efforts.
The Company's product licensing revenues are comprised of recurring
licensing fees (per unit fees), block licenses and development licensing fees
for source code or SDKs. Recurring licensing revenues are derived from per unit
fees paid periodically by the Company's OEM customers 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.
Block licenses are per-unit licenses sold in large volume quantities to an
OEM for products either in or about to enter distribution into the marketplace.
Payment schedules for block licenses are negotiable and payment terms are often
dependent on the size of the block license and other terms and conditions of the
block license being acquired. Typically, payments are made in either one lump
sum or over a period of four or more quarters. The Company generally recognizes
revenues associated with block licenses 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 block licenses have extended payment
terms and the fees are not fixed and determinable, revenue is recognized as
payments become due.
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.
The Peerless embedded imaging solution is based on a combination of
software and imaging ASICs, which together form a system that addresses most
sectors of the printing market, from low-end SOHO inkjets to high-end laser
digital color copiers and printers. Low-cost, high performance printers are
increasingly replacing expensive stand-alone 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 OEMs
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 ASIC chips. Under this "fabless" model,
Peerless can supply 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 agreements with Arrow Electronics and Marubun Corporation
to act as third party distributors. The distribution 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 distribution 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
14
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 and higher gross margin, but lower margin percentages due to the cost
of ASIC 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 2000, the Company experienced a shift in
demand away from turnkey solutions to demand for the Company's 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.
The current market in which the Company operates has been consolidating,
and the demand for the technology and products offered by the Company declined
throughout fiscal year 2001. Peerless provides the worldwide market for printers
(21-69 PPM) and MFP (21-110 PPM) unit volume which is projected by IDC 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
available data indicates 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 utilized Peerless SDKs developed and introduced
multiple products. However, the shift to SDKs did not materialize, aggravating
the decline in the Company's sales and the increase in its operating losses
during fiscal year 2001. The engineering services business had also declined as
OEMs have taken technology development in-house through the utilization of SDKs,
and in situations where 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.
Although sales have increased during the quarter ended April 20, 2001 and
are expected to increase sequentially for the remainder of fiscal year 2002 on a
quarterly basis, the Company is continuing to meet sales resistance from its
customers. These OEMs 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.
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's assets.
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. Failure to realize
success in the marketing of these opportunities could have a material adverse
effect on the Company's operational results.
15
Results of Operations
Comparison of Quarters Ended April 30, 2001 and 2000
The Company's net loss decreased for the first quarter of fiscal year 2002
to $3.3 million, or ($0.22) per share, compared with a net loss of $6.2 million,
or ($0.42) per share, in the first quarter of fiscal year 2001.
Consolidated revenues were $6.7 million for the first quarter of fiscal
year 2002 compared to $4.4 million for the first quarter of fiscal year 2001, an
increase of 53%. The increase in revenues is primarily attributable to increased
licensing of intellectual property. During the current quarter, the Company had
three new design wins and entered into four new block license agreements. These
licensing agreements represent $9.8 million in revenue, of which $3.6 million
was recognized as revenue during the first quarter of fiscal year 2002 with the
remaining amount to be recognized over the next four quarters. There were no
block license revenues during the first fiscal quarter ending April 30, 2000.
Block licenses result in bringing forward revenues to the current period if the
fees are determined to be fixed and determinable and collection of the fees is
probable. As noted below, the sale of these block licenses also resulted in an
increase in cost of revenues.
Total cost of revenues remained flat at $3.3 million; however, the cost of
revenue mix has changed. Product licensing costs were $1.6 million for the
first quarter of fiscal year 2002 as compared to $0.03 million for the first
quarter of fiscal year 2001. The increase was due to licensing costs of third
party technology bundled with Peerless' intellectual property that was
associated with the $3.6 million in sales to OEMs of block licenses.
In the past, OEMs would license Adobe technology directly with Adobe. Adobe
would pay Peerless a portion of the revenues that Adobe derived from Peerless
enabled products. OEMs currently license Adobe technology from Peerless, with
Peerless assuming additional responsibilities (i.e., certification, maintenance,
collections, etc.). Peerless now pays Adobe a portion of the revenues that
Peerless derives from Adobe technology. The change in the Adobe arrangement has
resulted in higher revenues, higher cost of revenues and higher gross margins.
The Company's gross margin improved to 50% in the first quarter of fiscal
year 2002 compared with 24% in the first quarter of fiscal year 2001. The
improvement is primarily attributable to higher revenues and a reduction in the
cost of sales for engineering services resulting from efforts to streamline the
Company's engineering processes.
Total operating expenses for the first quarter of fiscal year 2002
decreased 18% to $6.5 million compared with $8.0 million for the same period one
year ago. Research and development expenses decreased 8% to $3.3 million.
Despite the decline, the Company continues to invest in the future by funding
research and development on technical solutions and continuing investments for
new storage technologies and imaging development programs.
Sales and marketing expenses for the first quarter of fiscal year 2002
decreased to $1.2 million from $1.6 million for the same period a year ago due
to reorganizing actions taken during the past year to streamline the Company's
sales and marketing efforts. Although sales and marketing expenses decreased
24%, the Company is still focused on the penetration of new OEM customers,
attendance at industry trade shows, and other opportunities to promote the
Company's embedded imaging, network and storage solutions.
General and administrative expenses decreased 29% to $2.0 million from $2.8
million due to decreased staffing costs and lower legal, consulting and advisory
fees.
16
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 income taxes for the first quarter of fiscal year 2002
was primarily attributable to foreign taxes paid. The Company has provided a
valuation allowance on its net deferred tax assets because of the uncertainty
with respect to the Company's ability to generate future taxable income to
realize the deferred tax assets. The tax benefit for the quarter ended April 30,
2000 relates to the carry back of losses offset by foreign tax provision and
changes in the valuation reserve.
Liquidity and Capital Resources
Compared to January 31, 2001, total assets at April 30, 2001 decreased 8%
to $34.2 million and stockholders' equity decreased 13% to $23.2 million. The
Company's cash and investment portfolio at April 30, 2001 was $19.7 million and
the ratio of current assets to current liabilities was 3:1. The Company used
$1.3 million in cash during the quarter ended April 30, 2001 to finance
operations as compared to $2.5 million in cash used from operations during the
quarter ended April 30, 2000.
The Company's investing activities during the quarter ended April 30, 2001
provided cash of $0.5 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. During the first quarter of fiscal year 2002, the Company invested
$0.6 million in property, equipment and leasehold improvements compared to $0.5
million invested during the first quarter of fiscal year 2001.
Net cash used by financing activities in the quarter ended April 30, 2001
was $0.01 million. This amount resulted from the issuance of common stock under
the Company's employee stock purchase plan offset by the repurchase of common
stock. In the comparable period ending April 30, 2000, net cash provided by
financing activities was $0.3 million, due primarily to the issuance of common
stock under the Company's employee stock purchase plan and the exercise of
common stock options. As discussed in Note 5, in April 2001, the Company entered
into a settlement agreement with one of the former owners of HDE, Inc. As a
result, the Company has agreed to purchase at a price of $0.75 per share, the
Company's shares received by the former owner pursuant to the merger agreement
dated December 7, 1999 under which Peerless acquired HDE, Inc. Those purchases
will occur at the former owner's option, which expires on September 30, 2001.
During the quarter ended April 30, 2001, the Company repurchased 150,000 shares
of common stock for an aggregate cost of $0.1 million. At April 30, 2001,
428,500 shares remained outstanding under this agreement, representing an
aggregate potential cost of $0.3 million.
During the first quarter of fiscal year 2002, cash and investments
decreased $1.8 million compared to a decrease of $2.7 million in the comparable
quarter ended April 30, 2001.
To offset the Company's decrease in cash, the Company has made a determined
effort to collect its accounts receivable. As a result, the Company had a $2.0
million reduction in net trade receivables during the first quarter of fiscal
year 2002.
The Company's principal source of liquidity is its cash and cash
equivalents and investments, which, as of April 30, 2001 were $19.7 million in
the aggregate. For the first quarter of fiscal year 2002, the Company incurred a
loss and experienced negative cash flow. The Company does not have a credit
facility and the Company does not expect to secure a line of credit.
17
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 would 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 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 issuance of debt or equity securities, bank
financing 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.
Item 3--Quantitative and Qualitative Disclosures About Market Risk.
The Company is exposed to a variety of risks in its investments, mainly a
lowering of interest rates. The primary objectives of the Company's investment
activities are to preserve the principal while at the same time maximizing
yields without significantly increasing risk. To achieve this objective, the
Company from time to time maintains its portfolio of cash equivalents, fixed
rate debt instruments of the U.S. Government and high-quality corporate issuers
and short-term investments in money market funds. Although the Company is
subject to interest rate risks, the Company believes an effective increase or
decrease of 10% in interest rate percentages would not have a material effect on
its results from operations.
The Company has not entered into any derivative financial instruments.
Currently all of the Company's contracts, including those involving foreign
entities, are denominated in U.S. dollars and as a result, the Company has
experienced no foreign exchange gains and losses to date. The Company has not
engaged in foreign currency hedging activities to date and has no intention of
doing so. The Company's international business is subject to risks typical of an
international business including, but not limited to, differing economic
conditions, changes in political climate, differing tax structures, other
regulations and restrictions, and to a lesser extent foreign exchange rate
volatility. Accordingly, the Company's future results could be materially and
adversely affected by changes in these or other factors.
RISKS AND UNCERTAINTIES
An investment in the Company's common stock involves a high degree of risk.
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Peerless operates in a dynamic and rapidly changing industry that involves
numerous risks and uncertainties. The risks and uncertainties described below
are not the only ones the Company faces, and other risks and uncertainties,
including those that the Company does not consider material at the time of the
filing of this Report on Form 10-Q, may impair the Company's business or
operations. If any of the risks discussed below actually occur, the Company's
business, financial condition, operating results or cash flows could be
materially adversely affected.
Peerless has a history of losses and anticipate continued losses.
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Peerless was unprofitable in the first fiscal quarter of fiscal year 2002,
which ended on April 30, 2001 and expect to incur operating losses at least
through the first three quarters of fiscal year 2002. There is no assurance
that the Company will be profitable in the future.
18
Continuing losses will deplete the Company's capital resources, and 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.
The future demand for the Company's current products is uncertain.
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Peerless' current technology and products have been in the marketplace for
an average of 17 months as of April 30, 2001. This represents a 13% increase
from the average of 15 months that the Company's products had been in the
marketplace as of April 30, 2000. The growth in the average age of current
technology and products in the marketplace reflects the decline in demand for
the Company's technology and products. Although Peerless continues to license
the Company's 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 the Company offers.
The current market in which Peerless operates has been consolidating and
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demand for the Company's technology and products has been declining.
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Peerless Systems Corporation provides its technology and products to the
worldwide market for printers (21-69 pages per minute) and MFPs (21-110 pages
per minute), unit volume for 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). Available
data indicates that retail prices are declining in these segments. Both of
these segments are key target markets for the Company. There has been a decline
in the number of contracts that the Company has with OEMs under which the
Company is currently performing services and granting licenses and this decline
is likely to continue along with the demand for the technology and products the
Company presently offers. Competitors are merging into larger business units
with the resulting strength to acquire and impose a competitive advantage in the
Company's market segments.
Peerless relies on relationships with certain customers and any change in
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those relationships will harm the Company's business.
-----------------------------------------------------
During the first quarter of fiscal year 2002, four customers each generated
greater than 10% of the Company's revenues and collectively contributed 66% of
the Company's revenues. Block license revenues for the same time period were
53% of revenues. During the first quarter of fiscal year 2001, one customer
generated greater than 10% of the Company's revenues and contributed 16% of
revenues. There were no block license revenues during the first quarter fiscal
year 2001.
Although the acquisitions of Netreon and PSIP and the Company's on-going
sales efforts have expanded the Company's potential 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 can market its technology
and services. Therefore, the Company's ability to replace a lost customer or
offset a significant decrease in the revenues from a particular 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.
The Company's engineering services revenue is subject to significant
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fluctuations.
-------------
In the past, Peerless has experienced significant fluctuations in
engineering services results that have been caused by many factors including:
19
. product development delays (see "PEERLESS MUST ADAPT TO TECHNOLOGY
TRENDS AND EVOLVING INDUSTRY STANDARDS OR THE COMPANY WILL NOT BE
COMPETITIVE" 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 OEMs.
There can be no assurance that similar factors will not adversely impact future
engineering services results, or that the Company will be able to negotiate
cancellation fees into future engineering services arrangements, from which
Peerless has benefited in the past.
Peerless' licensing revenue is subject to significant fluctuations.
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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 block licenses. The reliance on block licenses has occurred due to aging
products in the marketplace, reductions in Adobe product penetration and the
rate of OEM products shipping and a design win mix that changed from object code
licensing arrangements to predominately SDKs. 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.
Any of the factors could have a material adverse effect on the Company's
operating results.
Peerless may be unable to accurately estimate the Company's revenues from
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product licensing and as a result may be required to adjust the Company's
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revenues in the future.
-----------------------
Peerless' recurring product licensing revenues are dependent, in part, on
the timing and accuracy of product sales reports received from 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 must
estimate the entire recurring product licensing revenues for the last month of
each fiscal quarter and to further estimate all quarterly and annual revenues
from an OEM when the report from such OEM is not received in a timely manner.
In the event that the Company is unable to estimate such revenues accurately
prior to reporting quarterly or annual results, the Company may be required to
adjust recorded revenues in subsequent periods.
Peerless must adapt to technology trends and evolving industry standards or
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the Company will not be competitive.
------------------------------------
The marketplace for Peerless' products and services is characterized by
rapidly changing technology, evolving industry standards and needs, frequent new
product introductions, knowledgeable OEMs with financial strength and
negotiating leverage greater than the Company's own and competitive incursions.
Over the past year, the Company's ability and the ability of the Company's OEM
customers to meet industry changes and market demands in a timely manner with
responsive development projects has been significantly reduced. Peerless'
success has always depended on the achievement of new design wins followed by
OEM 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 to the Company's OEMs on a timely and cost-
effective basis. The shortfall of the acceptance by OEMs of the Company's
technology has been further exacerbated by less than projected deliveries of
digital document products by the Company's OEM customers to the marketplace due
to the recent slow down in business and economic activity.
20
There can be no assurance that the product solutions and technology of the
Company's competitors or the OEMs themselves will not render the Company's
technology or the Company's OEMs' products technically or fiscally
noncompetitive or obsolete. If Peerless or its OEMs fail 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, it could result in a loss of
competitiveness and/or revenues. Such actions would have a material adverse
effect on the Company's operating results.
The industry for embedded imaging systems for digital document products
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involves intense competition and rapid technological changes and the Company's
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business may suffer if its competitors develop superior technology.
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The market for embedded imaging systems for digital document products is
highly competitive and characterized by continuous pressure to enhance
performance, to introduce new features and to accelerate the release of new
products. Peerless competes on the basis of technology expertise, product
functionality, development time and price. Peerless' technology and services
primarily compete with solutions developed internally by OEMs. Virtually all of
the Company's OEM customers have significant investments in their existing
solutions and have the substantial resources necessary to enhance existing
products and to develop future products. These OEMs have or may develop
competing embedded imaging systems technologies and may implement these systems
into their products, thereby replacing the Company's current or proposed
technologies, eliminating a need for the Company's services and products and
limiting the Company's future opportunities. Therefore, Peerless is required to
persuade these OEMs to outsource the development of their embedded imaging
systems to us, and to provide products and solutions to these OEMs that cost-
effectively compete with their internally developed products. Peerless also
competes with software and engineering services provided in the digital document
product marketplace by other systems suppliers to OEMs.
As the industry continues to develop, competition and pricing pressures
will increase from OEMs, existing competitors and other companies that may enter
the Company's existing or future markets with similar or substitute solutions
that may be less costly or provide better performance or functionality.
Peerless anticipates increasing competition for the Company's color products
under development, particularly as new competitors develop and enter products in
this market. Some of the Company's existing competitors, many of the Company's
potential competitors and virtually all of the Company's OEM customers have
substantially greater financial, technical, marketing and sales resources than
Peerless does. In the event that price competition increases, competitive
pressures could require the Company to reduce the amount of royalties received
on new licenses and to reduce the cost of the Company's engineering services in
order to maintain existing business and generate additional product licensing
revenues. This could reduce profit margins and result in losses and a decrease
in market share. No assurance can be given as to the Company's ability to
compete favorably with the internal development capabilities of the Company's
current and prospective OEM customers or with other third-party embedded imaging
system suppliers, and the inability to do so would have a material adverse
effect on the Company's operating results.
If Peerless is not in compliance with the Company's licensing agreements,
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Peerless may lose the Company's rights to sublicense technology; the Company's
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competitors are aggressively pursuing the sale of licensed third party
----------------------------------------------------------------------
technology.
-----------
Peerless currently sublicenses third party technology to the Company's OEM
customers. Such sublicense agreements are non-exclusive. If Peerless is not in
compliance with the Company's agreements with licensors, Peerless could lose the
Company's right to sublicense these technologies. Additionally, the licensing
of this technology has become very competitive with competitors having
substantially greater financial and technical resources and market penetration
than Peerless does. Competitors are pursuing aggressive strategies to purchase
this third party technology. There is no assurance that Peerless can remain
competitive in the marketplace if a competitor purchases this third party
technology.
21
The Company's reserves for accounts receivable may not be adequate.
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The Company's net accounts receivable declined to $5.9 million as of April
30, 2001, down from $7.9 million as of January 31, 2001, reflecting significant
collections from several major customers, including the conversion of unbilled
receivables to accounts receivable. Although Peerless feels that the Company's
reserves for accounts receivable are adequate for fiscal year 2002, there can be
no assurance this is the case. If the Company's reserves for accounts
receivable are not adequate, it could have a material adverse effect on the
Company's results of operations.
The Company's business may suffer if the Company's third party distributors
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are unable to distribute the Company's products and address customer needs
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effectively.
------------
Peerless has developed a "fabless" distribution model for the sale of
ASICs. Peerless has no direct distribution experience and place 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
will prove adequate to meet the Company's needs and contractual requirements.
Peerless is dependent on certain third party providers for applications to
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develop the Company's products. As a result, Peerless is vulnerable to any
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problems experienced by these providers, which may delay product shipments to
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the Company's customers.
------------------------
Currently, Peerless is dependent on three independent parties, Motorola,
IBM Microelectronics, and NEC Microelectronics, each of which provides unique
application specific integrated circuits incorporating the Company's imaging
technology for use by the Company's OEMs. Additionally, Peerless has
relationships with Adobe and Novell that address many critical aspects of the
Company's OEM customers' needs. Peerless 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. Peerless has
licensed to Adobe several of the Company's technologies, and have developed
technologies for Adobe for which Peerless 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 thereby adversely affecting 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.
Through the Company's subsidiary Netreon, Peerless has entered into
contracts with entities and persons located in Hong Kong. Peerless utilizes the
services of these entities for engineering development and tests. Through long-
term relationships, Peerless operates at favorable costs, schedule and quality
of output advantages. If the services provided by these entities were to be
discontinued, Peerless 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 material adverse effect on the Company's financial condition or the
Company's results of financial operations.
Peerless may be unable to respond quickly to changes in demand.
---------------------------------------------------------------
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 fiscal year 2001, 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.
22
Peerless is dependent on key personnel and on employee retention and
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recruiting for the Company's future success.
--------------------------------------------
Peerless is largely dependent upon the skills and efforts of the Company's
senior management and other officers and key employees. Peerless has
experienced significant turnover in, and reduction of, senior management and key
employees. The Company's future success will continue to depend in large part
upon the Company's 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.
Peerless has been restricted in connection with certain litigation in the
use of 1 million options approved by the Company's stockholders in July 1999.
Without the ability to grant stock options, the Company's ability to hire and
retain key personnel has been and could continue to be negatively impacted in
the fiercely competitive technical hiring marketplace.
Peerless maintains a key person life insurance policy for one executive,
Mr. Au, the General Manager of Netreon, Inc.
The Company's international activities may expose the Company to risks
----------------------------------------------------------------------
associated with currency fluctuations.
--------------------------------------
Peerless is substantially dependent on the Company's international business
activities. The international market for products incorporating the Company's
technology is highly competitive, and Peerless faces substantial competition in
this market from technologies developed internally by the Company's OEMs.
Risks inherent in the Company's international business activities also
include:
. major currency rate 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 Peerless expects that the
Company's future contracts will be, denominated in U.S. dollars, there can be no
assurance that the Company's contracts with international OEMs in the future
will be denominated in U.S. dollars. If any of the Company's contracts are
denominated in foreign currencies, Peerless will be subject to major risks
associated with currency fluctuations, which could have a material adverse
effect on the Company's operating results.
Demand from Pacific Rim customers has and may continue to decline.
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During the past several 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. The Company's Pacific Rim customers are comprised
primarily of companies headquartered in Japan. These
23
Japanese OEMs sell products containing the Company's 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.
The Company's stock price may experience extreme price and volume
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fluctuations.
-------------
The Company's common stock has experienced significant price volatility and
over the past 180 days generally has been trading at less than $1.00 per share.
Such price volatility may occur in the future. Factors that could affect the
trading price of the Company's common stock include:
. swings in quarterly results of operations;
. announcements of new products by the Company or the Company's
competitors;
. developments or disputes with respect to proprietary rights;
. general trends in the industry; and
. 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.
Peerless is subject to securities litigation which is expensive and results in
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a diversion of resources. Peerless could be subject to additional litigation
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due to the volatility of the Company's stock price or for other reasons.
------------------------------------------------------------------------
Securities class action litigation has become increasingly common in recent
years. Technology companies are frequently the subjects of such litigation.
Securities class action litigation is particularly common following periods of
market volatility and significant fluctuations in companies' stock prices. In
fiscal year 2000, Peerless and two of the Company's former officers were named
in two separate shareholder class action lawsuits. The first was filed on
August 28, 2000; the second was filed on September 19, 2000. They have since
been consolidated and an Amended and Consolidated Complaint has been filed. The
Amended and Consolidated Complaint alleges that Peerless and the individual
defendants engaged in a scheme to artificially inflate the Company's stock price
through the dissemination of false and misleading information. These lawsuits
seek compensatory damages, attorney's fees and expenses. Litigation is often
expensive and diverts management's attention and resources, which could
materially and adversely affect business, financial conditions and results of
operations.
Future sales of the Company's common stock may affect the market price of the
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Company's common stock.
-----------------------
As of June 7, 2001, Peerless had 15,070,788 shares of common stock
outstanding, which does not include 2,566,872 shares subject to options
outstanding as of such date under stock option plans that are exercisable at
prices ranging from $0.39 to $23.125 per share and 150,000 shares held in
treasury. Management cannot predict the effect, if any, that future sales of
common stock or the availability of shares of common stock for future sale, will
have on the market price of common stock prevailing from time to time. Certain
holders of the Company's common stock have registration rights with respect to
their shares. Sales of substantial amounts of common stock (including shares
issued upon the exercise of stock options), or the perception that such sales
could occur, may materially and adversely affect prevailing market prices for
common stock.
24
The Company's common stock may be removed from listing on the Nasdaq National
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Market and may not provide adequate liquidity.
----------------------------------------------
On February 23, 2001, Peerless received a notice from Nasdaq indicating
that Peerless had failed to maintain a minimum bid price of $1.00 over a 30
trading day period as required by Marketplace Rule 4450(a)(5) and that Peerless
had until May 24, 2001 to regain compliance. On May 21, 2001, Peerless received
notice from Nasdaq that Peerless had regained compliance. There can be no
assurance that compliance with Nasdaq listing requirements will be maintained.
If Peerless is not able to maintain compliance, the Company's common stock may
be subject to being removed from listing on the Nasdaq National Market. Trading
in the Company's common stock after a delisting, if any, would likely be
conducted in the over-the-counter markets in the so-called "pink sheets" or the
National Association of Securities Dealers' Electronic Bulletin Board and could
also be subject to additional restrictions. As a consequence of a delisting,
the Company's stockholders would find it more difficult to dispose of, or to
obtain accurate quotations as to the market value of, the Company's common
stock. In addition, a delisting would make the Company's common stock
substantially less attractive as collateral for margin and purpose loans, for
investment by financial institutions under their internal policies or state
legal investment laws or as consideration in future capital raising
transactions.
The Company's common stock may be subject to the "penny stock" regulations
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which may affect the ability of the holders to sell the Company's common
------------------------------------------------------------------------
stock.
------
If the Company's common stock were to be delisted from the Nasdaq National
Market, it may become subject to regulation as a "penny stock." The Securities
and Exchange Commission has adopted regulations which generally define "penny
stock" to be any equity security that has a market price or exercise price less
than $5.00 per share, subject to certain exceptions, including listing on the
Nasdaq National Market. If the common stock is delisted from the Nasdaq
National Market and no other exception applies, the Company's common stock may
become subject to the Securities and Exchange Commission's Penny Stock Rules,
Rule 15g-1 through Rule 15g-9 under the Exchange Act. For transactions covered
by these rules, the broker-dealer must make a special suitability determination
for the purchase of such securities and have received the purchaser's written
consent to the transaction prior to the purchase. Additionally, a risk
disclosure document mandated by the Securities and Exchange Commission relating
to the penny stock market must be delivered to the purchaser prior to the
transaction, unless the transaction satisfies one of the exemptions under the
rules. The broker-dealer must also disclose the commission payable to both the
broker-dealer and the registered representative, current quotations for the
securities and, if the broker-dealer is the sole market maker, the broker-dealer
must disclose this fact and the broker-dealer's presumed control over the
market. Monthly statements must be sent disclosing recent price information for
the penny stock. Additionally, the rules may restrict the ability of broker-
dealers to sell the Company's common stock and may affect the ability of holders
to sell the Company's common stock in the secondary market.
The Company's future investment income may fall below expectations due to
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adverse market conditions.
--------------------------
Market risk is the potential loss arising from adverse changes in market
rates and prices, such as interest rates. The Company's exposure to market rate
risk for changes in interest rates relates primarily to the Company's investment
portfolio. Peerless invests the Company's 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. Interest rates on these instruments recently
have declined substantially. Peerless, 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, the Company's
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.
25
Effects of anti-takeover provisions could inhibit the Company's acquisition.
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Some of the provisions of the Company's certificate of incorporation, by-
laws and Delaware law could, together or separately:
. discourage potential acquisition proposals;
. delay or prevent a change in control;
. limit the price that investors might be willing to pay in the future for
shares of the Company's common stock.
The Company's existing capital resources may not be sufficient and if Peerless
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is unable to raise additional capital, the Company's business may suffer.
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The Company's cash and short-term investment portfolio was $16.9 million at
April 30, 2001 and the current ratio of assets to current liabilities was 3:1.
Peerless used $1.3 million in cash during the first quarter of fiscal year 2002
to finance operations.
The Company's principal source of liquidity is the Company's cash and cash
equivalents and investments, which, as of April 30, 2001 were $19.7 million in
the aggregate. For the first quarter of fiscal year 2002, Peerless incurred a
loss and experienced negative cash flow. Peerless does not have a credit
facility and Peerless does not expect to secure a line of credit. If Peerless
does not generate anticipated cash flow from licensing, or if expenditures are
greater than expected, Peerless most likely will reduce discretionary spending,
which could require a delay, scaling back or elimination of some or all of the
Company's development efforts, any of which could have a material adverse effect
on the Company's business, results of operations and prospects. Furthermore, if
Peerless continues to experience negative cash flows, as is anticipated, and
Peerless 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 Peerless exhausts current capital resources, Peerless will be
required to obtain additional capital from other sources. Such sources might
include issuances of debt or equity securities, bank financing or other means
that might be available to increase the Company's working capital. Under such
circumstances, there is substantial doubt as to whether Peerless would be able
to obtain additional capital on commercially reasonable terms or at all. The
inability to obtain such resources on commercially acceptable terms could have a
material adverse effect on the Company's operations, liquidity and financial
condition, the Company's prospects and the scope of strategic alternatives and
initiatives available to the Company.
If Peerless fails to adequately protect the Company's intellectual property or
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face a claim of intellectual property infringement by a third party, Peerless
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could lose the Company's intellectual property rights or be liable for
----------------------------------------------------------------------
damages.
--------
The Company's success is heavily dependent upon the Company's proprietary
technology. To protect the Company's proprietary rights, Peerless relies on a
combination of patent, copyright, trade secret and trademark laws as well as
nondisclosure and other contractual restrictions. Peerless holds eight patents
issued in the United States, one of which is also issued in France, Germany and
Great Britain and Hong Kong. The issued patents relate to techniques Peerless
has developed for generating output for continuous synchronous raster output
devices, such as laser printers. Peerless has five patent applications pending
in Japan, four applications each pending in the United States and European
Patent Office and two applications each pending in Hong Kong and Canada. There
can be no assurance that patents Peerless holds will not be challenged or
invalidated, that patents will issue from any of the Company's pending
applications or that any claims allowed from existing or pending patents will be
of sufficient scope or strength (or issue in the countries where products
incorporating the Company's technology may be sold) to provide meaningful
protection or any commercial advantage to the Company. In any event, effective
protection of intellectual property rights may be unavailable or limited in
certain
26
countries. The status of United States patent protection in the software
industry will evolve as the United States Patent and Trademark Office grants
additional patents. Patents have been granted to fundamental technologies in
software after the development of an industry around such technologies and
patents may be issued to third parties that relate to fundamental technologies
related to the Company's technology.
As part of the Company's confidentiality procedures, Peerless enters into
nondisclosure agreements with the Company's employees, consultants, OEMs and
strategic partners and take affirmative steps to limit access to and
distribution of the Company's software and other proprietary information.
Despite these efforts, Peerless may be unable to effectively protect the
Company's proprietary rights and, in any event, enforcement of the Company's
proprietary rights may be very expensive.
The Company's source code also is protected as a trade secret. However,
from time to time Peerless licenses the Company's source code to OEMs, which
subjects the Company to the risk of unauthorized use or misappropriation despite
the contractual terms restricting disclosure and use. In addition, it may be
possible for unauthorized third parties to copy the Company's products or to
reverse engineer or obtain and use the Company's proprietary information.
As the number of patents, copyrights, trademarks and other intellectual
property rights in the Company's industry increases, products based on the
Company's technologies increasingly may become the subjects of infringement
claims. There can be no assurance that third parties will not assert
infringement claims against the Company in the future. Any such claims,
regardless of merit, could be time consuming, result in costly litigation, cause
product shipment delays or require the Company to enter into royalty or
licensing agreements. Such royalty or licensing agreements, if required, may not
be available on terms acceptable to the Company, or at all, which could have a
material adverse affect on the Company's operating results. In addition,
Peerless may initiate claims or litigation against third parties for
infringement of the Company's proprietary rights or to establish the validity of
the Company's proprietary rights. Litigation to determine the validity of any
claims, whether or not such litigation is determined in the Company's favor,
could result in significant expenses and divert the efforts of the Company's
technical and management personnel from productive tasks. In addition, Peerless
may lack sufficient resources to initiate a meritorious claim. In the event of
an adverse ruling in any litigation regarding intellectual property, Peerless
may be required to pay substantial damages, discontinue the use and sale of
infringing products, and expend significant resources to develop non-infringing
technology or obtain licenses to infringing or substituted technology. The
Company's failure to develop, or license on acceptable terms, a substitute
technology if required could have a material adverse effect on the Company's
operating results.
Peerless cannot guarantee the success of the Company's new Internet printing
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systems.
--------
Peerless has installed the Company's first two Internet printing systems in
the hospitality market and have just recently begun to implement the business
model. Although Peerless has been able to demonstrate that the Company's
Internet printing system works, there is no assurance that this new business
model will generate revenues and become profitable.
Peerless may not be able to manage expansion and growth effectively.
--------------------------------------------------------------------
The Company's ability to implement the Company's business plan, develop and
offer products and manage expansion in rapidly developing and disparate market
places requires comprehensive and effective planning and management. The growth
in business, relationships with current and potential customers and third
parties has placed, and will continue to place, a significant strain on
management systems and resources. The Company's failure to continue to improve
upon the Company's operational, managerial and financial controls, reporting
systems and procedures or the Company's failure to expand and manage the
Company's workforce, could have a material adverse affect on the Company's
business and financial results.
27
Peerless may not be able to deploy the Company's employees effectively in
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connection with changing demands from the Company's OEM customers.
------------------------------------------------------------------
The industry in which Peerless operates has experienced significant
downturns, both in the United States and abroad often in connection with, or in
anticipation of, maturing product cycles and declines in general economic
conditions. Over the past two years, Peerless has experienced a shift in OEM
demand from the historically prevailing requirement for turnkey solutions toward
software development kits. Because Peerless has experienced a general decrease
in demand for engineering services, engineering services resources have been re-
deployed to research and development. Should this trend abruptly change,
Peerless may not be able to reassess and re-deploy labor effectively, which
inability could have material adverse effect on the Company's operational
results.
Peerless may not be able to develop new and enhanced products that achieve
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widespread market acceptance.
-----------------------------
Peerless currently derives substantially all of the Company's revenues from
licensing and sales of the Company's embedded imaging software and products.
Peerless expects that revenue from the embedded imaging products will continue
to account for a substantial portion of revenues for fiscal year 2002. The
Company's future success depends on the Company's ability to address the rapidly
changing needs of potential customers in the storage marketplace and the
introduction of high-quality, cost-effective products, product enhancements and
services on a timely basis, and by keeping pace with technological developments
and emerging storage industry standards. The Company's failure to develop and
successfully introduce new products and product enhancements in the Company's
prime market places could adversely affect the Company's business and financial
results.
Peerless may not achieve success in the development or marketing of Netreon's
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NAS and SAN technologies.
-------------------------
Peerless expects to be substantially dependent on revenues generated by
sales and licenses of Netreon's NAS and SAN technologies in the future. There
can be no assurance that Peerless or Netreon will complete the development of,
or achieve market success for, Netreon's NAS and SAN technologies. Failure to
realize success in the market of these technologies could have a material
adverse effect on the Company's operational results.
28
PART II - OTHER INFORMATION
================================================================================
Item 1: Legal Proceedings
The Company engaged in the following litigation matters:
On August 28, 2000, a stockholder class action lawsuit was filed against
the Company and two of the Company's former officers in the United States
District Court for the Southern District of California. A second stockholder
class action lawsuit was filed on September 19, 2000 against the Company and the
same two former officers of the Company in the same United States District
Court. On April 17, 2001, the Company was served with an Amended and
Consolidated Complaint. These lawsuits allege a scheme to artificially inflate
the Company's stock price based on alleged misleading public announcements and
seek compensatory damages with interest and attorneys fees, fees and expenses.
Peerless believes all of the claims to be without merit. A motion has been filed
with the Court to dismiss the amended and consolidated complaint against the
Company and the two former officers.
The Company filed a lawsuit in January 2000 against Conexant Systems Inc.,
Newport Beach, California 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. The parties have been in settlement negotiations and Peerless believes
this lawsuit will be resolved in a manner satisfactory to the Company.
In December 1999, the Company and the Company's former Chief Executive
Officer were sued by the State of Wisconsin Investment Board (``SWIB'') in the
Court of Chancery of the State of Delaware in New Castle County. The complaint
alleged that Peerless wrongfully influenced the passage and provided misleading
information in connection with, a proposal to increase the number of shares
available for issuance under the Company's 1996 Equity Incentive Plan by
1,000,000 at the Company's Annual Meeting of Stockholders in June 1999.
The Company determined that it was in the best interests of the Company to
conclude the litigation with SWIB in order to free up 750,000 stock options
approved by its stockholders at the 1999 Stockholders Meeting, but restricted
because of the lawsuit by SWIB, and to eliminate the costs of proceeding to
trial. Pursuant to the Settlement Agreement, the Company agreed to amend its
bylaws and formalize certain internal procedures that had been generally
followed by the Company in the past, such as, but not limited to, not re-pricing
options outstanding or issuing options at below fair market value. The Company
also agreed to pay SWIB $375,000 for a portion of its legal fees.
In accordance with the Settlement Agreement, on May 23, 2001 the Board of
Directors of the Company adopted amended and restated bylaws, a copy of which is
attached hereto as Exhibit B, in which the following sections of the Company's
bylaws were amended: Sections 5(c), 15(b), 15(c), 17, 18, 23, 24(b), 24(c)(i),
24(c)(ii), 24(e), 24(f), 44(a) and 44(b).
In July 2000, the Company filed a claim in the United States District Court
for the Central District of California against the former owners of HDE, Inc. in
connection with Peerless' acquisition of that entity. On April 11, 2001, the
Company entered into a settlement agreement with one of the former owners.
Subject to certain limitations, the Company agreed that it will, at the former
owner's option, during the six month period beginning April 11, 2001, purchase
at a price of $0.75 per share, the Company's shares received by the former owner
pursuant to the merger agreement, dated December 7, 1999, under which Peerless
acquired HDE, Inc. The Company also agreed to register, and has filed a
registration statement with respect to the sale of the former owner's shares
under the Securities Exchange Act of 1933, as amended.
29
The settlement agreement further provides for a release by the former owner
and the Company of any claims that either may have against the other for any
event arising on or before April 11, 2001. On April 19, 2001, the lawsuit was
dismissed.
Item 2: Changes in Securities
None
Item 3: Defaults Upon Senior Securities
None
Item 4: Submission of Matters to a Vote of Security Holders
None
Item 5: Other Information
None
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
Form 8-K filed as of April 27, 2001.
Form 8-K filed as of June 12, 2001.
30
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: June 14, 2001
--------------------------------
Howard J. Nellor
President and
Chief Executive Officer
(Principal Executive Officer)
By: /s/ William R. Neil Date: June 14, 2001
--------------------------------
William R. Neil
Vice President of Finance and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
31