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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 2000
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 000-21240
---------
NEOWARE SYSTEMS, INC.
(Exact name of registrant as specified in its charter.)
Delaware 23-2705700
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
400 Feheley Drive, King of Prussia, Pennsylvania 19406
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 277-8300
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None None
------------------- ---------------------------
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed 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
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulations S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
-----
The aggregate market value of the voting stock held by non-affiliates of the
registrant is approximately $34,041,615. Such aggregate market value was
computed by reference to the last reported sale price of the Common Stock as
reported on the NASDAQ SmallCap Market on September 19, 2000. In making such
calculation, the registrant does not determine whether any director, officer or
other holder of Common Stock is an affiliate for any other purpose.
The number of shares of the registrant's Common Stock outstanding as of
September 19, 2000 was 10,275,163.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on December 7, 2000 are incorporated by
reference into Part III. Those portions of the Proxy Statement included in
response to Item 402(k) and 402(1) of Regulation S-K are not incorporated by
reference into Part III.
TABLE OF CONTENTS PAGE
PART I............................................................................................................3
Item 1. Business...............................................................................3
Item 2. Properties.............................................................................8
Item 3. Legal Proceedings......................................................................8
Item 4. Submission of Matters to a Vote of Security Holders....................................9
PART II...........................................................................................................9
Item 5. Market for Registrant's Common Equity and Related Shareholder
Matters................................................................................9
Item 6. Selected Financial Data...............................................................10
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................................11
Item 8. Financial Statements and Supplementary Data...........................................21
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..21
PART III.........................................................................................................22
Item 10. Directors and Executive Officers of the Registrant....................................22
Item 11. Executive Compensation................................................................23
Item 12. Security Ownership of Certain Beneficial Owners and Management. ......................23
Item 13. Certain Relationships and Related Transactions........................................23
PART IV..........................................................................................................23
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......................23
2
PART I
ITEM 1. BUSINESS.
General
Neoware Systems, Inc. (the "Company") provides software and solutions for the
emerging information appliance market. The Company's software and management
tools are designed to power a new generation of smart devices that utilize the
benefits of open, industry-standard technologies to create new alternatives to a
wide variety of proprietary business devices. The Company's products are
designed to run local applications for specific vertical markets, plus allow
access across a network to Linux servers, the Internet and Windows-based
applications running multi-user Windows servers. The Company's infrastructure
software powers and manages information appliances, which are designed as a new
generation of network-connected alternatives to proprietary devices and
general-purpose personal computers, offering the cost benefits of
industry-standard hardware and software, easier installation, as well as lower
up-front and administrative costs. Unlike personal computers, the Company's
products are designed primarily to run applications on a server, not on the
desktop.
The Company was formed in 1995 as the result of a merger between Human Designed
Systems, Inc. (HDS), a privately held technology company, and Information
Systems Acquisition Corporation (ISAC), a publicly held company founded in part
by Safeguard Scientifics, Inc. At the time of the merger, the Company changed
its name to HDS Network Systems, Inc. and, in connection with the license of
certain technology to Hitachi Data Systems in 1997, the name of the Company was
changed to Neoware Systems, Inc.
In June 1998, the Company entered into a joint marketing and development
agreement and an equity purchase agreement with Motorola, Inc., under which
Motorola purchased 396,226 shares of the Company's Common Stock.
During the quarter ended March 31, 2000, the Company announced the reduction in
the exercise price of its Redeemable Common Stock Purchase Warrants from $5.50
to $3.75 per share and extended the expiration date of the warrants to April 14,
2000. A total of approximately $14,000,000 was raised as a result of the
exercise of these warrants. The Company intends to utilize this capital to
pursue a growth strategy in the emerging information appliance marketplace and
intends to seek additional financing, if necessary, as well as strategic
partnerships in order to capitalize upon these new product opportunities.
Product Strategy
The Company's current strategy is to establish itself as the recognized leader
in the market for software to power and manage the wide-scale deployment of
information appliances used by businesses. Information appliances are a new
generation of smart, Internet-connected devices that are alternatives to
traditional personal computers or proprietary business devices. The Company
provides embedded operating system software and proprietary management tools to
power and manage this new generation of devices. The Company intends to
establish a leadership role in its space by partnering with other companies to
build applications with the Company's embedded operating systems and management
infrastructure tools for a wide variety of vertical business markets. Initially,
the Company will seek out partners who have strong market positions in the
server-based computing and Linux markets to expand its existing sales, marketing
and distribution channels and customer relationships to gain access to new
markets and customers. As part of this strategy, the
3
Company intends to leverage its existing technology and marketing relationships
with leading technology companies such as Microsoft, Red Hat and Citrix to build
its business.
The Company has developed and intends to enhance its technology that enables
large numbers of information appliances to be deployed in business environments
as alternatives to proprietary or PC-based systems. The Company intends to add
its proprietary enhancements to open source and other operating systems,
enabling them to be secured and centrally managed. Additionally, Neoware intends
to merge its client-side software with vertical application software to enable
devices to be created for specific vertical markets.
In addition to providing products, the Company intends to develop a revenue
stream from consulting services, assisting enterprise customers as they manage
the large-scale deployment of applications to information appliances. The
Company will support its own Linux-based operating system, as well as existing
operating systems such as Windows CE and Windows NT Embedded. The Company also
intends to bundle its software products with industry-standard hardware to
enable complete hardware, software and management solutions for its customers.
The Company's products incorporate the following elements:
Central Administration and Lower Cost of Ownership. The Company's products are
designed to be centrally administered in order to lower total cost of ownership.
Customers who utilize the Company's products typically run applications and
store files on a server, not on desktop devices as with a personal computer.
This makes administration of networks of the Company's products much simpler
than administration of personal computer networks, since management tasks take
place at a small number of servers. Additionally, the Company sells its Remote
Manager software that makes its products easier to manage, update and administer
centrally.
Use of Open Source Technology. The Company utilizes open source technologies in
a number of its products, including its NeoLinux operating system, which is
based upon Red Hat Linux. The source code to the Linux operating system and to
other open source software is available on the Internet, and is continually
enhanced and developed by a world-wide group of programmers. By using open
source technologies in its products, the Company is able to quickly develop new
products since it can leverage the contributions of large numbers of other
software developers. The Company contributes the technologies that it develops
using open source back to the open source community, and also develops
proprietary technologies for which it does not release its source code.
Diverse Technology Expertise. The Company has significant expertise in a wide
range of technical disciplines, including operating systems, windowing and
networking software, applications software development, graphics acceleration,
multimedia design and compression algorithms. Utilizing more than ten years of
experience designing embedded UNIX operating systems, the Company has developed
a unique version of the Linux operating system which is designed specifically
for information appliance environments.
Use of Industry Standard Components. The Company plans, implements and manages
the manufacturing of its system products to take advantage of industry-standard
components that are widely available in the personal computer industry. This
reduces the Company's risks and costs, and allows the Company more easily to
increase production of products quickly to meet customer demand. During the
latter part of the 2000 fiscal year, the Company began offering its software and
management tools on industry-standard, off-the-shelf platforms and no longer
designs or manufactures proprietary hardware.
4
Customers
The Company's customers span a wide range of industries, including retail,
aerospace, automotive, education, financial services, government, healthcare,
manufacturing and telecommunications. The Company's products have been adopted
by such customers as 1-800-FLOWERS.COM, Burlington Coat Factory, Caesar's
Palace, Circuit City, Daughters of Charity, ESPN, Hollywood Video, Intel,
Motorola, Neiman Marcus, OfficeMax, Target Corporation, VA Connecticut Medical
Center and others.
No single customer represented 10% or more of total net revenues during fiscal
2000 and 1999, respectively. Net revenues from two customers represented 15% and
14%, respectively, of total net revenues during fiscal 1998.
Product Development
The Company believes that its ability to expand the market for its products will
depend in large part upon its ability to develop enhancements to the Linux,
Windows CE and Windows NT Embedded environments, and to continue to develop new
software products which incorporate the latest improvements in performance,
capability and manageability. Accordingly, the Company is committed to investing
significant resources in software development activities. During fiscal 2000,
1999 and 1998, the Company's expenditures for research and development totaled
$648,548, $726,633 and $1,443,720, respectively. It is anticipated that research
and development expenditures will increase significantly during the year ending
June 30, 2001.
The Company's current research and development programs include:
o Development of new versions of its embedded Linux software
targeted at a variety of vertical markets.
o Development of enhancements to Microsoft's Windows CE and NT
Embedded operating systems designed to make them more manageable
and secure.
o Development of server-based remote management software designed to
manage the wide-scale deployments of large numbers of
network-connected devices.
There can be no assurance that any of these development efforts will result in
the introduction of new products or that any such products will be commercially
successful.
Marketing and Sales
The principal objectives of the Company's marketing strategy are to increase
awareness of the benefits of the Company's products, maintain the Company's
position as a recognized innovator in the information appliance industry and
differentiate the Company's products from personal computers and alternative
types of devices. The Company's marketing activities include participation in
trade shows and conferences, advertising and press relations with leading trade
publications and the publication of technical articles.
5
The Company's products have won numerous awards in the information appliance and
Windows-based terminal market, including "Editor's Choice" from PC Magazine,
"Best Windows-based Terminal" and "Editors Choice" from Network Computing, "Best
Buy" from Network Solutions, "Byte Best" from Byte Magazine, "Top of the World"
from SCO World, "Crossroads A-List" from Open Systems Advisors, "Best Buy" from
PC Dealer, "Gold Award for Excellence" from Computing Magazine, "Five Stars for
Features and Overall Performance" from PC Pro, "Best Buy" from PC Week UK,
"5-Star PC Digest Recommends" from PC Digest and "Best Buy" from Network
Solutions.
The Company distributes its products in North America through value-added
resellers as well as via direct sales to end user customers, system integrators,
OEMs and via the Internet. The timing of sales to the Company's customers and
the continued evolution of the market for information appliances and
Windows-based terminals will impact the Company's future operating results.
The Company utilizes distributors for its products throughout the world, and has
relationships with distributors in the United Kingdom, Canada, France,
Scandinavia, Germany, Denmark, Belgium, Austria, Switzerland, Italy, Spain,
Russia, Israel, Australia, India, Egypt, Latvia, Korea, Philippines, New Zealand
and South Africa. Foreign revenues, which accounted for approximately 28%, 29%
and 20% of net revenues, respectively, in fiscal 2000, 1999 and 1998, may be
subject to government controls and other risks, including export licenses,
federal restrictions on the export of technology, changes in demand resulting
from currency exchange fluctuations, political instability, trade restrictions
and changes in tariffs. To date, the Company has experienced no material
difficulties due to these factors.
Service and Support
The Company believes that its ability to provide service and support is an
important element in the marketing of its products. The Company provides systems
integration services, maintains in-house repair facilities and also provides
telephone and electronic mail access to its technical support staff. The
Company's technical support specialists not only provide assistance in
diagnosing problems but work closely with customers to address system
integration issues and to assist in increasing the efficiency and productivity
of their networks. The Company provides system level support through its
factory-based technical maintenance organization and through contracted
third-party maintenance organizations.
The Company typically warrants its products against defects in materials and
workmanship for one year after purchase by the end user, and offers an extended
warranty of up to an additional two years. To date, the Company has not
encountered any material product maintenance problems.
Competition
The information appliance market is characterized by rapidly changing technology
and evolving industry standards. The Company experiences significant competition
from suppliers of personal computers, as well as providers and prospective
providers of Windows-based terminals, information appliances and thin clients.
6
Competitive products are offered by a number of established computer
manufacturers, including IBM, Sun Microsystems, Wyse Technology, Network
Computing Devices, and Boundless Technologies. Most of these companies have
substantially greater name recognition, engineering, manufacturing and marketing
capabilities and greater financial resources than those of the Company. The
Company believes that the principal competitive factors among suppliers include
breadth of product line, product price/performance, capabilities of the
products, software features, network expertise, service and support, and market
presence. The Company believes that it competes favorably with respect to these
factors. Personal computer manufacturers who also offer information appliance
and thin client products may have advantages over independent vendors, including
the Company, based on their ability to "bundle" their appliances with personal
computers in certain large system sales. The Company anticipates increased
competition from these system suppliers as the information appliance market
evolves and also expects that other established domestic and foreign computer
equipment manufacturers may enter the information appliance market.
The Company, as well as other manufacturers of information appliances, also
faces competition from established computer manufacturers whose personal
computer products offer alternatives to information appliances for many
applications. Information appliances compete with personal computers offered by
such manufacturers as Dell, IBM, Gateway, Compaq and Hewlett Packard. Personal
computers can be configured with software, such as an ICA client from Citrix
Systems, or an RDP client from Microsoft, that allows them to operate as
Windows-based terminals. As the cost of personal computers declines, the
difference in cost between information appliances and personal computers may
continue to decline. Information appliances compete favorably on a
price/performance basis with personal computer networks and offer cost
advantages in initial system installation, as well as subsequent system
upgrading and administration. However, the significant market presence and
reputation of personal computer manufacturers, and customer perceptions
regarding their need for desktop application processing capability, constitute
obstacles to the penetration of this market segment by information appliance
suppliers. Increased competition could result in price reductions, reduced
profit margins and loss of market share, which would adversely affect the
Company's operating results. There can be no assurance that the Company will be
able to continue to compete successfully against current and future competitors
as the information appliance market evolves and competition increases.
At the low end of the commercial segment of the desktop computer market, the
Company competes with suppliers of lower cost ASCII and 3270 terminals. These
products do not offer the graphics and windowing capabilities offered by the
Company's products, but are still appealing to certain price sensitive
customers. The Company believes that information appliances will become
increasingly competitive with ASCII and 3270 terminal systems.
Manufacturing and Suppliers
During the latter part of the 2000 fiscal year, the Company terminated designing
and manufacturing its proprietary, customized hardware products and began a
transition to the delivery of its software and management tools on standard
platforms using high performance components manufactured for the Company by
third parties. This is a proven PC manufacturing technique which is intended to
allow the Company to deliver greater capabilities with lower costs.
7
Proprietary Rights and Licenses
The Company believes that its success will depend primarily on the innovative
skills, technical competence and marketing abilities of its personnel rather
than upon the ownership of patents or other intellectual property protection
methods. In addition, there can be no assurance that any patents issued to the
Company will not be challenged, invalidated or circumvented, or that any rights
granted thereunder will provide adequate protection to the Company.
Certain technology used in the Company's products is licensed from third parties
on a royalty-bearing basis. Generally, such licenses grant to the Company
non-exclusive, worldwide rights with respect to the subject technology and
terminate upon a material breach by the Company. The Company has licensed
technology from Citrix Systems, Inc., Microsoft, Liberate Technologies and
Pericom Software PLC. In addition to these licensing agreements, the Company
holds various other licenses which it does not consider to be material.
Although the Company has not received any claims that its products infringe on
the proprietary rights of third parties, there can be no assurance that third
parties will not assert infringement claims against the Company in the future
with respect to current or future products or that any such assertion may not
require the Company to enter into royalty arrangements or result in costly
litigation.
Employees
As of September 19, 2000, the Company had 50 employees.
ITEM 2. PROPERTIES.
The Company's principal administrative, marketing and research and development
operations are located in King of Prussia, Pennsylvania. The facility consists
of approximately 22,000 square feet under a lease with an original expiration
date of September 30, 2000. During July 2000, the Company entered into an
amendment to the lease extending its term to September 30, 2005. Pursuant to the
amendment, the annual gross rent for the facility, including operating expenses,
approximates $220,000. The Company believes that its facilities are adequate for
its present requirements, and that suitable additional space will be available
as needed.
ITEM 3. LEGAL PROCEEDINGS.
On March 11, 1998, a complaint was filed as a purported class action on behalf
of purchasers of the Company's common stock during 1996 and 1997. The complaint
alleged that misrepresentations were made related to plans for various potential
acquisitions by a subsidiary of the Company and a spin-off. An amended complaint
was subsequently filed which added claims on behalf of a second purported class
related to the Company's announcement on April 30, 1998 that it would be
restating certain financial results previously reported. Thereafter, four
separate purported securities class actions were filed.
During October 1999, an agreement in principle to settle all of the foregoing
litigation was reached and the parties subsequently executed and filed with the
Court a definitive settlement agreement. On July 27, 2000 the settlement was
approved by the Court and such settlement had no material adverse effect on the
Company's financial position and results of operations.
8
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On May 16, 2000, the Company held its Annual Meeting of Stockholders. The
Stockholders voted to elect five members to the Board of Directors, to approve
an amendment to the Company's 1995 Stock Option Plan and to ratify the selection
of Arthur Andersen LLP as the Company's independent accountant for the fiscal
year ending June 30, 2000.
Elected to the Board of Directors were Arthur R. Spector (8,846,499 shares voted
for election and 95,175 shares were withheld), Michael G. Kantrowitz (8,866,211
shares voted for election and 75,463 shares were withheld), Christopher G.
McCann (8,867,853 shares voted for election and 73,821 shares were withheld),
John M. Ryan (8,866,511 shares voted for election and 75,163 shares were
withheld), and Carl G. Sempier (8,868,211 shares voted for election and 73,463
shares were withheld).
The amendment to the Company's 1995 Stock Option Plan was approved with
1,872,074 shares voting in favor of the proposal, 171,651 shares voting against
the proposal, 38,190 shares abstaining and 6,859,759 broker non-votes.
The selection of Arthur Andersen LLP as the Company's independent accountant was
ratified with 8,894,578 shares voting in favor of ratification, 28,821 shares
voting against ratification and 18,275 shares abstaining.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
The Company's Common Stock is traded on the NASDAQ SmallCap Market. Prior to
their expiration on April 14, 2000, the Company's Warrants were traded on the
NASDAQ SmallCap Market. Prior to August 1, 1997, the Common Stock and the
Warrants traded under the symbols HDSX and HDSXW, respectively. On August 1,
1997, the Company's Common Stock and the Warrants began trading under the
symbols NWRE and NWREW, respectively. The following table sets forth the high
and low closing bid quotations for the periods indicated.
Common Stock Warrants
------------ --------
2000 High Low High Low
- ---- ---- --- ---- ---
First Quarter 2 3/4 1 1/16 5/16 3/32
Second Quarter 2 3/4 1 5/32 1/16
Third Quarter 9 1/16 1 5/16 5 1/8 1/16
Fourth Quarter 6 1 3/4 2 1/32
Common Stock Warrants
------------ --------
1999 High Low High Low
- ---- ---- --- ---- ---
First Quarter 2 5/8 1 1/16 17/32 3/16
Second Quarter 1 5/8 15/16 1/4 1/16
Third Quarter 1 5/8 15/16 3/16 1/16
Fourth Quarter 1 5/8 3/4 5/32 1/16
9
The above quotations represent prices between dealers and do not include retail
markups or markdowns or commissions. They may not necessarily represent actual
transactions.
There were approximately 64 holders of record of Common Stock as of June 30,
2000. The Company has never declared or paid any cash dividends on its capital
stock and does not intend to pay any cash dividends in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected financial data with respect to the
Company for the periods indicated. The data below has been derived from the
Company's consolidated financial statements which have been audited by Arthur
Andersen LLP, independent public accountants. The data set forth below should be
read in conjunction with the Consolidated Financial Statements of the Company
together with the related notes thereto included elsewhere herein and Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
10
Year Ended June 30,
--------------------------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
Net revenues $ 11,044,870 $ 10,665,753 $ 19,976,423 $ 25,467,487 $ 20,819,444
------------- -------------- -------------- -------------- --------------
Gross profit 2,318,774 1,367,637 3,637,368 8,393,642 5,115,850
Operating expenses 4,430,785 4,163,346 9,389,393 7,942,846 4,390,344
------------- -------------- -------------- -------------- --------------
Operating (loss) income (2,112,011) (2,795,709) (5,752,025) 450,796 725,506
Gain on sale of equity investment -- 406,930 -- -- --
Interest income (expense), net 291,900 38,317 (338,354) 69,224 220,277
------------- -------------- -------------- -------------- --------------
Income (loss) before income taxes (1,820,111) (2,350,462) (6,090,379) 520,020 945,783
Income taxes -- 430,396 (1,121,554) 182,791 322,898
------------- -------------- -------------- -------------- --------------
Net (loss) income $ (1,820,111) $ (2,780,858) $ (4,968,825) $ 337,229 $ 622,885
============= ============== ============== ============== ==============
Basic earnings per share $ (0.25) $ (0.44) $ (0.86) $ 0.06 $ 0.11
Diluted earnings per share $ (0.25) $ (0.44) $ (0.86) $ 0.05 $ 0.10
Weighted average number of shares used in
basic earnings per share computation 7,374,692 6,278,317 5,784,366 5,712,309 5,612,386
Weighted average number of shares used in
diluted earnings per share computation 7,374,692 6,278,317 5,784,366 7,132,898 6,069,012
As of June 30,
--------------------------------------------------------------------------------
2000 1999 1998 1997 1996
BALANCE SHEET DATA: ---- ---- ---- ---- ----
Current assets $ 17,995,134 $ 5,646,345 $ 10,861,643 $ 16,002,051 $ 11,165,185
Current liabilities 2,191,299 3,223,986 6,180,319 7,555,703 2,449,010
Working capital 15,803,835 2,422,359 4,681,324 8,446,348 8,716,175
Total assets 18,668,379 7,325,897 13,021,393 18,327,115 12,023,903
Long-term debt excluding current portion -- -- -- -- 3,733
Stockholders' equity 16,477,080 4,101,911 6,841,074 10,771,412 9,481,890
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Introduction
The Company provides software and solutions for the emerging information
appliance market. Neoware's software and management tools are designed to power
a new generation of smart devices that utilize the benefits of open,
industry-standard technologies to create new alternatives to a wide variety of
proprietary business devices. Neoware's products are designed to run local
applications for specific vertical markets, plus allow access across a network
to Linux servers, the Internet and Windows-based applications running multi-user
Windows servers. Neoware's infrastructure software powers and manages
information appliances, which are designed as a new generation of
network-connected alternatives to proprietary devices and general-purpose
personal computers, offering the cost benefits of industry-standard hardware and
software, easier installation, as well as lower up-front and administrative
costs. Unlike personal computers, the Company's products are designed primarily
to run applications on a server, not on the desktop.
11
Results of Operations
The following table sets forth, for the periods indicated, certain items from
the Company's consolidated statements of operations as a percentage of net
revenues.
Year Ended June 30,
--------------------------------------------------------------
2000 1999 1998
------------------ ------------------ ---------------
Gross profit 21.0% 12.8% 18.2%
Operating expenses:
Sales and Marketing 14.5 14.0 22.4
Research and Development 5.9 6.8 7.2
General and administrative 15.5 18.2 13.3
Acquisition costs 4.2 -- --
Restructuring charge -- -- 1.0
Bridging Data Technology venture -- -- 3.1
------ ------- -------
Operating loss (19.1) (26.2) (28.8)
Gain on sale of equity investment -- 3.8 --
Interest (expense) income 2.6 0.3 (1.7)
------ ------- -------
Loss before taxes (16.5) (22.1) (30.5)
Income tax (benefit) expense -- 4.0 (5.6)
------ ------- -------
Net loss (16.5)% (26.1)% (24.9)%
====== ======= =======
Year Ended June 30, 2000 Compared to Year Ended June 30, 1999
For the year ended June 30, 2000, net revenues increased by 3.6% to $11,044,870
from $10,665,753 for the prior fiscal year. The increase in net revenues was
attributable to increased acceptance of the NeoStation family of products, as
well as initial sales of the Company's newer Linux-based software products. The
Company is subject to significant variances in its operating results because of
the fluctuations in the timing of the receipt of large orders.
The Company's gross profit as a percentage of net revenues increased to 21.0%
for the year ended June 30, 2000, from 12.8% for the prior fiscal year. Gross
profit for the year ended June 30, 2000 includes the impact of a provision for
inventory and equipment obsolescence of $165,000 in connection with the decision
to terminate the designing and manufacturing of proprietary, custom hardware
products. Gross profit for the year ended June 30, 1999 includes the impact of a
provision for inventory obsolescence of $800,000 in connection with the decision
to outsource manufacturing activities. The increase in gross profit, after the
foregoing adjustments, is primarily attributable to the effects of the Company's
new manufacturing strategy as well as to an increase in software sales and
consulting services. The Company anticipates that gross margins will vary from
quarter to quarter depending on average selling prices, fixed costs in relation
to revenue levels and the mix of the Company's business, including the
percentage of revenues derived from hardware and software. The gross profit
margin also varies in response to competitive market conditions as well as
periodic fluctuations in the cost of memory and other significant components.
The market in which the Company competes remains very competitive, and although
the Company intends to continue its efforts to reduce the cost of its products,
there can be no certainty that the Company will not be required to reduce prices
of its products without compensating reductions in the cost to produce its
products in order to increase its market share or to meet competitors' price
reductions.
12
Operating expenses for the year ended June 30, 2000 were $4,430,785, an increase
from operating expenses of $4,163,346 in the prior fiscal year as a result of
the following:
Sales and marketing expenses increased by $101,266 to $1,599,209
compared to $1,497,943 for the year ended June 30, 1999. The increase reflects
key personnel additions to sales, marketing and business development in the
latter part of the year ended June 30, 2000, as well as higher professional
costs, all associated with the beginning of the Company's implementation of its
growth strategy.
Research and development expenses for the year ended June 30, 2000
decreased to $648,548 as compared to $726,633 primarily due to reductions in
staffing (including the elimination of all hardware engineering staff) and in
the use of outside consultants and services.
General and administrative expenses for the year ended June 30, 2000
decreased to $1,711,918 from $1,938,770 for the year ended June 30, 1999
primarily due to lower professional fees and reduced accruals for uncollectible
receivables.
During the year ended June 30, 2000, the Company incurred costs of
$471,110 in connection with a proposed acquisition which was not consummated.
The Company realized net interest income of $291,900 for the year ended June 30,
2000 compared net interest income of $38,317 for the 1999 fiscal year. The
increase was primarily due to interest earned on the cash generated during the
latter part of the year ended June 30, 2000 as a result of exercise of the
Company's warrants which amounted to approximately $14,000,000.
The effective income tax rate was zero for the year ended June 30, 2000 compared
to approximately 18.3% for the year ended June 30, 1999. No income tax benefit
was recognized in the 2000 and 1999 fiscal years as a result of the net
operating losses incurred as there is no assurance at this time that the benefit
of the net operating loss carryforward will be realized. During the year ended
June 30, 1999, the Company recorded income tax expense of $430,396 to reserve
for a previously recorded deferred tax asset.
For the year ended June 30, 2000, the Company's net loss was $1,820,111 as
compared to a net loss of $2,780,858 for the prior year. The Company's net loss
for the year ended June 30, 1999 includes a provision for inventory obsolescence
of $800,000, an income tax charge of $430,396 and no income tax benefit from the
net operating loss, offset in part by lower operating expenses and the gain of
$406,930 on the sale of the Company's equity investment in Broadreach.
Year Ended June 30, 1999 Compared to Year Ended June 30, 1998
For the year ended June 30, 1999, net revenues decreased by 46.6% to $10,665,753
from $19,976,423 for the prior fiscal year. The decrease in net revenues was
attributable to the continued transition to the NeoStation family of products
which have lower selling prices than the older X-terminal and network computer
products, and the gradual process associated with the full scale implementation
of thin client computers by corporate customers subsequent to the deployment of
Windows NT 4.0 Terminal Server Edition from Microsoft in August 1998 and the
implementation of Year 2000 compliant systems by the Company's customers. In
addition, sales to two of the company's major customers declined significantly
during the 1999 fiscal year, as compared to the 1998 fiscal year, as a result of
completing delivery of product under existing purchase orders. Revenues to such
customers are expected to remain at this reduced level for the foreseeable
future. The Company is subject to significant variances in operating results
because of the fluctuations in the timing of the receipt of large orders.
13
The Company's gross profit percentage of net revenues decreased to 12.8% for the
year ended June 30, 1999, after the provision for inventory obsolescence of
$800,000 in connection with the decision to outsource manufacturing activities,
from 18.2% for the prior fiscal year. The decrease was primarily attributable to
the inventory adjustment described above as well as fixed overhead representing
a higher percentage of revenues in the year ended June 30, 1999 offset by the
accelerated writedown of prepaid royalties in the year ended June 30, 1998. The
Company anticipates that gross margins will vary from quarter to quarter
depending on average selling prices, fixed costs in relation to revenue levels
and the mix of the company's business, including the percentage of revenues
derived from hardware and software. The gross profit margin also varies in
response to competitive market conditions as well as periodic fluctuations in
the cost of memory and other significant components. The market in which the
Company competes remains very competitive, and although the company intends to
continue its efforts to reduce the costs of its products, there can be no
certainty that the Company will not be required to reduce prices of its products
without compensating reductions in the cost to produce its products in order to
increase its market share to meet competitors' price reductions.
Operating expenses for the year ended June 30, 1999 were $4,163,346, a decrease
from operating expenses of $9,389,393 in the prior fiscal year. Sales and
marketing expenses decreased by $2,986,346 to $1,497,943 for the year ended June
30, 1999 as compared to $4,484,289 in fiscal 1998. The decrease reflects the
continued restructuring of the domestic and international sales force and
reduced commissions attributable to lower revenues. During fiscal 1999, the
Company terminated its relationship with its U.S. distributor. Research and
development expenses for the year ended June 30, 1999 decreased to $726,633 as
compared to $1,443,720 primarily as a result of the company's completion of the
introduction of the NeoStation family of products in the 1998 fiscal year. The
decrease in research and development expenses was accomplished primarily through
staffing changes and a substantial reduction in the use of outside consultants
and services. General and administrative expenses for the year ended June 30,
1999 decreased to $1,938,770 from $2,649,800 in the year ended June 30, 1998
primarily due to reductions in personnel and professional fees. The reduction of
BDT's expenses as compared to the 1998 fiscal year reflects the impact of the
agreement which reduced the company's ownership position and eliminated the
company's requirement to fund future operations of BDT effective January 1,
1998. The write-off reflects the company's evaluation that recovery, if any, of
its investments in BDT will not occur. Expenses related to BDT, including the
investment write-off, have been reclassified as expenses of BDT venture in the
company's' Consolidated Financial Statements included under Item 8, hereof.
The Company realized net interest income of $38,317 for the year ended June 30,
1999 as compared to net interest expense of $338,354 for the 1998 fiscal year.
The decline in interest expense was primarily due to decreased borrowings under
the Company's line of credit combined with the collection of recoverable income
taxes of $1,121,554 and the proceeds of $406,930 from the sale of its equity
investment in Broadreach and the investment of such funds in interest bearing
accounts.
14
The effective income tax rates were approximately 18.3% as compared to 18.4% for
the year ended June 30, 1998. During the year ended June 30, 1999, the company
recorded income tax expense of $430,396 to reserve for a previously recorded
deferred tax asset. No income tax benefit was recognized in the 1999 fiscal year
as a result of the net operating losses incurred during the year as there is no
assurance at this time that the benefit of the net operating loss carryforward
will be realized. The tax benefit for the year ended June 30, 1998 reflects
recovery of taxes paid in prior years.
For the year ended June 30, 1999, the company's net loss was $2,780,858 as
compared to a net loss of $4,968,825 for the prior year. The Company's net loss
for the year ended June 30, 1999 includes a provision for inventory obsolescence
of $800,000, an income tax charge of $430,396 and no income tax benefit from the
net operating loss, offset in part by reduced operating and interest expenses
and the gain of $406,930 on the sale of the company's equity investment in
Broadreach.
Liquidity and Capital Resources
As of June 30, 2000, the Company had net working capital of $15,803,835 composed
primarily of cash and cash equivalents, accounts receivable and inventory. The
Company's principal sources of liquidity include $13,831,792 of cash and cash
equivalents and a $2,000,000 line of credit facility with First Union National
Bank, of which $2,000,000 was available as of June 30, 2000. The facility is
secured by a first lien security interest in all tangible and intangible
personal property of the Company and separate pledges of investment property
owned by Neoware Investments, Inc. and Neoware Licensing, Inc., each of which is
a wholly-owned subsidiary of the Company. The facility agreement also provides
that borrowings under the line will be based on the amount of eligible accounts
receivable, as defined. Interest on the line of credit facility accrues at the
bank's prime rate plus 1/2% percent, with interest payable monthly, and all
principal and interest is due and payable on December 31, 2000.
Cash and cash equivalents increased by $12,360,886 during the year ended June
30, 2000, primarily as a result of the exercise of the Company's warrants and
stock options offset by a loss of $1,820,111.
The Company used $1,413,231 in cash from operating activities in fiscal 2000
compared to generating $2,963,818 during fiscal 1999. The decrease in cash
generated from operations during fiscal 2000 is primarily due to the reduction
in accounts receivable and inventories, a provision for inventory obsolescence,
and the collection of recoverable income taxes during fiscal year 1999. Cash
flow from operations can vary significantly from quarter to quarter depending on
the timing of payments from, and shipments to, large customers.
Net cash of $173,875 was used in investing activities in fiscal 2000 for the
purchase of property plant and equipment and capitalized and purchased software.
Net cash of $13,947,992 was generated by the exercise of stock options and
warrants offset by repayment of the Company's line of credit and the issuance of
notes receivable.
The Company expects to fund current operations and other cash expenditures
through the use of available cash, cash from operations, funds available under
its credit facility and possible new debt or equity sources. Management believes
that there will be sufficient funds from current cash, operations and available
financing to fund operations and cash expenditures for the foreseeable future.
However, the Company must achieve profitable operations in order to provide
adequate funding for the long term.
15
Inflation
The Company believes that inflation has not had a material effect on its sales
and net revenues during the past three years.
Factors Affecting the Company and Future Operating Results
Our future results may be affected by industry trends and specific risks in our
business. Some of the factors that could materially affect our future results
include those described below.
We have a history of losses and may experience losses in the future, which could
result in the market price of our common stock declining.
We have recently incurred significant net losses, including net losses of $1.8
million in the year ended June 30,2000. In addition, we had an accumulated
deficit of $7.9 million as of June 30,2000. We expect to continue to incur
significant product development, sales and marketing and administrative
expenses. Our expenses increased during the latter part of the fiscal year ended
June 30, 2000 reflecting the hiring of additional key personnel and it is
anticipated that costs will continue to increase during the year ending June 30,
2001 as we implement our business plan. As a result, we will need to generate
significant revenues to achieve profitability. We cannot be certain that we will
achieve profitability in the future or, if we achieve profitability, whether we
will be able to sustain it. If we do not achieve and maintain profitability, the
market price for our common stock may decline, perhaps substantially.
Our financial resources, even with the proceeds raised from the exercise of our
common stock purchase warrants, may not be enough for our capital needs, and we
may not be able to obtain additional financing. A failure to derive new revenues
from our new business plan would likely increase our losses and negatively
impact the price of our common stock.
Our ability to accurately forecast our quarterly sales is limited, although our
costs are relatively fixed in the short term and we expect our business to be
affected by rapid technological change, which may adversely affect our quarterly
operating results.
Because of the new and rapidly evolving market for our embedded Linux and
Windows-based information appliances, our ability to accurately forecast our
quarterly sales is limited, which makes it difficult to predict the quarterly
revenues that we will recognize. In addition, we cannot forecast operating
expenses based on historical results, and most of our costs are for personnel
and facilities, which are relatively fixed in the short term. If we have a
shortfall in revenues in relation to our expenses, we may be unable to reduce
our expenses quickly enough to avoid significantly greater losses. We do not
know whether our business will grow rapidly enough to absorb the costs of these
employees and facilities. As a result, our quarterly operating results could
fluctuate.
There are factors that may affect the market acceptance of our products, some of
which are beyond our control, including the following:
the growth and changing requirements of the information appliance
market;
the quality, price, performance and total cost of ownership of our
products;
16
the availability, price, quality and performance of competing products
and technologies; and
the successful development of our relationships with software
providers, original equipment manufacturer customers and existing and
potential channel partners.
We may not succeed in developing and marketing our new information appliance
products, and our operating results may decline as a result.
Our business is dependent on customer adoption of Linux and Windows-based
information appliances to perform discrete tasks for corporate and
Internet-based computer networks and a decrease in their rates of adoption could
adversely affect our ability to increase our revenues.
We are dependent on the growing use of information appliances to perform
discrete tasks for corporate and Internet-based networks to increase our
revenues. If the role of information appliances does not increase as we
anticipate, or if it in any way decreases, our revenues would not materialize.
We believe that our expectations for the growth of the information appliance
market may not be fulfilled if customers continue to use general-purpose
personal computers. In addition, if corporate information technology
organizations do not accept Linux-based or Windows-based operating systems, or
if there is a wide acceptance of alternative operating systems that provide
enhanced capabilities, our operating results could be harmed.
The appliance market in which we seek to compete is new and unpredictable, and
if this market does not develop and expand as we anticipate, our revenues may
not grow. In addition, consolidation in this market could result in our clients
being absorbed into larger organizations that might not be as receptive to our
products.
Because some of our products use Linux as their operating system, the failure of
Linux developers to enhance and develop the Linux kernel could impair our
ability to release major product upgrades and maintain market share.
We may not be able to release major upgrades of our new products on a timely
basis because some of our products use Linux as their operating system. The
heart of Linux, the Linux kernel, is maintained by third parties. Linus
Torvalds, the original developer of the Linux kernel, and a small group of
independent engineers are primarily responsible for the development and
evolution of the Linux kernel. If this group of developers fails to further
develop the Linux kernel or if Mr. Torvalds or other prominent Linux developers
were to no longer work on the Linux kernel, we would have to either rely on
another party to further develop the kernel or develop it ourselves. To date, we
have optimized our Linux-based operating system based on a version of Red Hat
Linux. If we were unable to access Red Hat Linux, we would be required to spend
additional time to obtain a tested, recognized version of the Linux kernel from
another source or develop our own operating system internally. We cannot predict
whether enhancements to the kernel would be available from reliable alternative
sources. We could be forced to rely to a greater extent on our own development
efforts, which would increase our development expenses and might delay our
product release and upgrade schedules. In addition, any failure on the part of
the kernel developers to further develop and enhance the kernel could stifle the
development of additional Linux-based applications for use with our products.
17
We may not succeed if Linux fragments, and application developers do not develop
software for our products.
Because we depend on sole source, limited source and foreign source suppliers
for key components, we are susceptible to supply shortages that could prevent us
from shipping customer orders on time, if at all, and result in lost sales.
We depend upon single source suppliers for our information appliance products
and for several of the components in them. We also depend on limited sources to
supply several other industry standard components. We also rely on foreign
suppliers which subject us to risks associated with foreign operations such as
the imposition of unfavorable governmental controls or other trade restrictions,
changes in tariffs and political instability.
We have in the past experienced and may in the future experience shortages of,
or difficulties in acquiring, these components. If we are unable to buy these
components, we will not be able to deliver our products to our customers.
Because we rely on channel partners to sell our products and anticipate using
channel partners to sell our new products, our revenues could be negatively
impacted if our existing channel partners do not continue to purchase products
from us.
We cannot be certain that we will be able to attract channel partners that
market our products effectively or provide timely and cost-effective customer
support and service. None of our current channel partners is obligated to
continue selling our products nor to sell our new products. We cannot be certain
that any channel partner will continue to represent our products or that our
channel partners will devote a sufficient amount of effort and resources to
selling our products in their territories. We need to expand our direct and
indirect sales channels, and if we fail to do so, our growth could be limited.
We do not have a large consulting staff, and our revenues may suffer if
customers demand extensive consulting or other support services.
Many of our competitors offer extensive consulting services in addition to
products. If we introduced a product that required extensive consulting services
for installation and use or if our customers wanted to purchase from a single
vendor a menu of items that included extensive consulting services, we would be
required to change our business model. We would be required to hire and train
consultants, outsource the consulting services or enter into a joint venture
with another company that could provide those services. If these events were to
occur, our future profits would likely suffer because customers would choose
another vendor or we would incur the added expense of hiring and retaining
consulting personnel.
We may not be able to effectively compete against other providers as a result of
their greater financial resources and brand awareness.
In the market for information appliances, we face significant competition from
larger companies who have greater financial resources and name recognition than
we do. Increased competition may negatively affect our business and future
operating results by leading to price reductions, higher selling expenses or a
reduction in our market share.
18
Our future competitive performance depends on a number of factors, including our
ability to:
continually develop and introduce new products and services with better
prices and performance than offered by our competitors;
offer a wide range of products; and
offer high-quality products and services.
If we are unable to offer products and services that compete successfully with
the products and services offered by our competitors, our business and our
operating results would be harmed. In addition, if in responding to competitive
pressures, we are forced to lower the prices of our products and services and we
are unable to reduce our costs, our business and operating results would be
harmed.
Information appliance products are subject to rapid technological change due to
changing operating system software and network hardware and software
configurations, and our products could be rendered obsolete by new technologies.
The information appliance market is characterized by rapid technological change,
frequent new product introductions and enhancements, uncertain product life
cycles, changes in customer demands and evolving industry standards. Our
products could be rendered obsolete if products based on new technologies are
introduced or new industry standards emerge.
We may not be able to preserve the value of our products' intellectual property
because we do not have any patents and other vendors could challenge our other
intellectual property rights.
Our products will be differentiated from those of our competitors by our
internally developed technology that is incorporated into our products. If we
fail to protect our intellectual property, other vendors could sell products
with features similar to ours, and this could reduce demand for our products,
which would harm our operating results.
We may not be able to attract software developers to bundle their products with
our information appliances.
Our information appliances include our own software, plus software from other
companies for specific vertical markets. If we are unable to attract software
developers, and are unable to include their software in our products, we may not
be able to offer our information appliances for certain important target
markets, and our financial results will suffer.
Certain of our products use embedded versions of the Windows and Linux operating
systems. If we are unable to continue to develop and offer these products to our
customers, our sales may decline.
19
Our embedded Linux software is based upon the open-sourced Linux operating
system, and we do not expect to retain ownership of our enhancements to this
operating system.
The Linux operating system is freely available software that is provided under a
software license requiring that modifications be made freely available to other
software developers. As a result, we do not intend to attempt to protect the
intellectual property related to changes that we make to the Linux operating
system. Providing these changes to other software developers may allow other
companies to offer products which are similar to ours, increasing competition
for our products.
In order to grow our revenues, we will need to hire additional personnel,
including software engineers.
In order to develop and market our line of information appliances, we must hire
additional software engineers as well as marketing and sales personnel.
Competition for employees with these skills is severe and we may experience
difficulty in attracting suitably qualified people.
Any future growth we experience will place a significant strain on our
management, systems and resources. To manage the anticipated growth of our
operations, we may be required to:
improve existing and implement new operational, financial and
management information controls, reporting systems and procedures;
hire, train and manage additional qualified personnel; and
establish relationships with additional suppliers and partners while
maintaining our existing relationships.
We rely on the services of certain key personnel, and those persons' knowledge
of our business and technical expertise would be difficult to replace.
Our products and technologies are complex and we are substantially dependent
upon the continued service of our existing personnel, and especially Michael
Kantrowitz, our President and Chief Executive Officer, and Edward Parks, our
Vice President of Engineering. The loss of any of our key employees could
adversely affect our business and slow our product development processes.
Errors in our products could harm our business and our operating results.
Because our information appliance products are complex, they could contain
errors or bugs that can be detected at any point in a product's life cycle.
Although many of these errors may prove to be immaterial, any of these errors
could be significant. Detection of any significant errors may result in:
the loss of or delay in market acceptance and sales of our products;
diversion of development resources;
injury to our reputation; or
increased maintenance and warranty costs.
20
These problems could harm our business and future operating results. Product
errors or delays could be material, including any product errors or delays
associated with the introduction of new products or the versions of our products
that support operating systems other than Linux. Occasionally, we have warranted
that our products will operate in accordance with specified customer
requirements. If our products fail to conform to these specifications, customers
could demand a refund for the purchase price or assert claims for damages.
Moreover, because our products are used in connection with critical distributed
computing systems services, we may receive significant liability claims if our
products do not work properly. Our agreements with customers typically contain
provisions intended to limit our exposure to liability claims. However, these
limitations may not preclude all potential claims. Liability claims could
require us to spend significant time and money in litigation or to pay
significant damages. Any such claims, whether or not successful, could seriously
damage our reputation and our business.
Forward-Looking Statements
This annual report on Form 10-K contains statements that are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995, such as statements regarding future margins and margin trends, future
revenues and operating losses, the Company's competitive position, the reduction
of the cost of producing the Company's products, the establishment of strategic
partnerships and other relationships, the development of new software products
and the significant increase in investments in software development activities.
These forward-looking statements involve risks and uncertainties. The factors
set forth below, and those contained in "Factors Affecting the Company and
Future Operating Results" and set forth elsewhere in this report, could cause
actual results to differ materially from those predicted in any such
forward-looking statement. Factors that could affect the Company's actual
results include the Company's ability to lower its costs, customers' acceptance
of Neoware's line of information appliance products, pricing pressures, rapid
technological changes in the industry, growth of the information appliance
market and increased competition.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements of the Company are filed under this Item 8, beginning
on page F-2 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
21
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information with respect to directors required by this Item is incorporated
by reference to the Section entitled "Election of Directors" in the Company's
definitive Proxy Statement for its 2000 Annual Meeting of Stockholders.
The following individuals are the current executive officers of the
Company:
Name Age Position
---- --- --------
Michael G. Kantrowitz 40 President and Chief Executive Officer
Steven B. Ahlbom 50 Vice President of Operations
Edward M. Parks 48 Vice President of Engineering
Vincent T. Dolan 57 Vice President of Finance and Administration
Edward F. Golderer 56 Vice President of North American Sales and Marketing
Mr. Kantrowitz has been President and Chief Executive Officer of the Company
since February 14, 2000. Previously, he served as Executive Vice President and a
Director of the Company since March 2, 1995. Prior to that, he was an employee
of HDS from 1983, holding the positions of Executive Vice President from 1991
until March 1995 and Vice President of Marketing and Sales from 1987 until 1991.
Prior to joining HDS, Mr. Kantrowitz held positions with Raytheon Company and
Adage Corporation.
Mr. Ahlbom has been Vice President of Operations of the Company since March 2,
1995. Prior to that, he held the positions of Vice President of Operations and
Manager of Operations of HDS from 1988. Prior to joining HDS, Mr. Ahlbom was
World-Wide Quality Assurance Manager for Commodore International from 1987 until
1988, and served as Quality Assurance Manager of Burroughs Corporation.
Mr. Parks has been Vice President of Engineering of the Company since March 2,
1995. Prior to that, he held the position of Vice President of Engineering of
HDS from 1987. Prior to joining HDS, Mr. Parks was Corporate Director for
Product and Market Development and Director of Engineering for Commodore
Business Machines from 1984 until 1987, and was employed by Eastman Kodak in
engineering management positions from 1974 to 1984.
Mr. Dolan has been Vice President of Finance and Administration since January
27, 1999. Prior to joining the Company, he served as Vice President-Finance and
Administration for Superior Tube Company from 1991 through 1998. From 1983 until
1988, Mr. Dolan also served as Vice President-Finance and Administration of
General Data Systems, Ltd, a computer services company and, prior to that, as
Executive Vice President-Finance and Administration of Omni Exploration, Inc. (a
Nasdaq Company). Mr. Dolan was also employed by PricewaterhouseCoopers and is a
Certified Public Accountant.
22
Mr. Golderer has been Vice President of North American Sales and Marketing since
May 22, 2000. Prior to joining the Company, he served as Executive Vice
President-Sales and General Manager for Decision Data Corporation, a computer
equipment and services company, from 1995 to 2000. Mr. Golderer also served as
Vice President, Sales and Marketing for Robec, Inc. from 1994 to 1995 and for
Computerware Corporation from 1992 to 1994. Prior to that, Mr. Golderer was
employed in sales and marketing positions with Unisys, Okidata and MBI Business
Centers.
All officers of the Company are appointed annually by the Company's Board and
serve at its discretion.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference to the
section entitled "Executive Compensation" in the Company's definitive proxy
statement for its 2000 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference to the
section entitled "Beneficial Ownership of Common Stock" in the Company's
definitive proxy statement for its 2000 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference to the
section entitled "Certain Transactions" in the Company's definitive proxy
statement for its 2000 Annual Meeting of Stockholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
Financial Statements
See Index to Financial Statements at page F-1.
Financial Statement Schedules
All schedules have been omitted because they are not applicable, or not
required, or the information is shown in the financial statements or notes
thereto.
23
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Neoware Systems, Inc. and Subsidiaries
Report of Independent Public Accountants F-2
Consolidated Financial Statements--
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Stockholders' Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Neoware Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Neoware Systems,
Inc. (a Delaware corporation) and subsidiaries as of June 30, 2000 and 1999, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended June 30, 2000. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Neoware Systems, Inc. and
subsidiaries as of June 30, 2000 and 1999, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
2000 in conformity with accounting principles generally accepted in the United
States.
Arthur Andersen LLP
Philadelphia, Pa.,
August 25, 2000
F-2
NEOWARE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
June 30,
------------------------
ASSETS 2000 1999
------ ----------- -----------
CURRENT ASSETS:
Cash and cash equivalents $13,831,792 $ 1,470,906
Accounts receivable, net of allowance for doubtful accounts of
$125,409 and $196,756 2,068,230 2,586,693
Inventories 1,119,844 1,324,424
Prepaid expenses and other 249,196 264,322
Notes receivable 726,072 --
----------- -----------
Total current assets 17,995,134 5,646,345
PROPERTY AND EQUIPMENT, net 231,933 438,367
CAPITALIZED AND PURCHASED SOFTWARE, net 363,096 541,185
NOTES RECEIVABLE 78,216 700,000
----------- -----------
$18,668,379 $ 7,325,897
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Line of credit $ -- $ 143,000
Accounts payable 1,153,972 1,654,926
Accrued expenses 602,641 1,106,388
Deferred revenue 434,686 319,672
----------- -----------
Total current liabilities 2,191,299 3,223,986
----------- -----------
COMMITMENTS AND CONTINGENCIES (Note 10)
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 1,000,000 shares authorized and none
issued and outstanding -- --
Common stock, $.001 par value, 50,000,000 shares
authorized, 10,275,163 and 6,285,782 shares issued and outstanding 10,275 6,286
Additional paid-in capital 24,369,648 10,178,357
Accumulated deficit (7,902,843) (6,082,732)
----------- -----------
Total stockholders' equity 16,477,080 4,101,911
----------- -----------
$18,668,379 $ 7,325,897
============ ===========
The accompanying notes are an integral part of these financial statements.
F-3
NEOWARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended June 30,
---------------------------------------
2000 1999 1998
----------- ----------- -----------
NET REVENUES $11,044,870 $10,665,753 $19,976,423
COST OF REVENUES 8,726,096 9,298,116 16,339,055
----------- ----------- -----------
Gross profit 2,318,774 1,367,637 3,637,368
----------- ----------- -----------
OPERATING EXPENSES:
Sales and marketing 1,599,209 1,497,943 4,484,289
Research and development 648,548 726,633 1,443,720
General and administrative 1,711,918 1,938,770 2,649,800
Acquisition related costs 471,110 -- --
Restructuring charge -- -- 198,105
Bridging Data Technology venture -- -- 613,479
----------- ----------- -----------
Total operating expenses 4,430,785 4,163,346 9,389,393
----------- ----------- -----------
Operating loss (2,112,011) (2,795,709) (5,752,025)
GAIN ON SALE OF EQUITY INVESTMENT -- 406,930 --
INTEREST INCOME (EXPENSE), net 291,900 38,317 (338,354)
----------- ----------- -----------
Loss before income taxes (1,820,111) (2,350,462) (6,090,379)
INCOME TAX EXPENSE (BENEFIT) -- 430,396 (1,121,554)
----------- ----------- -----------
NET LOSS $(1,820,111) $(2,780,858) $(4,968,825)
=========== =========== ===========
BASIC AND DILUTED LOSS PER SHARE $ (.25) $ (.44) $ (.86)
=========== ========== ===========
Weighted average number of shares used in basic and diluted
loss per share computation 7,374,692 6,278,317 5,784,366
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
F-4
NEOWARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- ----------------------------------------------------------------------------------
Common Stock
--------------------------
Shares Amount
---------- -------
BALANCE AT JUNE 30, 1997 5,760,820 $ 5,761
Exercise of stock options 7,112 7
Unit Purchase Options exchanged for Common Stock 100,000 100
Sale of Common Stock, net of expenses 396,226 396
Amortization of deferred compensation -- --
Net loss -- --
---------- -------
BALANCE AT JUNE 30, 1998 6,264,158 6,264
Issuance of Common Stock for services rendered 21,624 22
Amortization of deferred compensation -- --
Net loss -- --
---------- -------
BALANCE AT JUNE 30, 1999 6,285,782 6,286
Exercise of warrants 3,725,853 3,726
Exercise of stock options 263,528 263
Net loss -- --
----------- -------
BALANCE AT JUNE 30, 2000 10,275,163 $10,275
========== =======
[RESTUBBED FOR ABOVE]
- ---------------------------------------------------------------------------------------------------------
Additional Retained
-------------------------------------------------
Paid-in Earnings Deferred
Capital (Deficit) Compensation Total
----------- ----------- ------------ -----------
BALANCE AT JUNE 30, 1997 $ 9,168,171 $ 1,666,951 $(69,471) $10,771,412
Exercise of stock options (7) -- -- --
Unit Purchase Options exchanged for Common Stock (100) -- -- --
Sale of Common Stock, net of expenses 985,988 -- -- 986,384
Amortization of deferred compensation -- -- 52,103 52,103
Net loss -- (4,968,825) -- (4,968,825)
----------- ----------- -------- -----------
BALANCE AT JUNE 30, 1998 10,154,052 (3,301,874) (17,368) 6,841,074
Issuance of Common Stock for services rendered 24,305 -- -- 24,327
Amortization of deferred compensation -- -- 17,368 17,368
Net loss -- (2,780,858) -- (2,780,858)
----------- ----------- -------- -----------
BALANCE AT JUNE 30, 1999 10,178,357 (6,082,732) -- 4,101,911
Exercise of warrants 13,901,036 -- -- 13,904,762
Exercise of stock options 290,255 -- -- 290,518
Net loss -- (1,820,111) -- (1,820,111)
----------- ------------ -------- -----------
BALANCE AT JUNE 30, 2000 $24,369,648 $(7,902,843) $ -- $16,477,080
=========== ============= ======== ===========
The accompanying notes are an integral part of these financial statements.
F-5
NEOWARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended June 30,
---------------------------------------------
2000 1999 1998
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(1,820,111) $(2,780,858) $(4,968,825)
Adjustments to reconcile net (loss) to net cash
provided by (used in) operating activities-
Depreciation and amortization 523,398 738,158 881,295
Amortization of deferred compensation -- 17,368 52,103
Issuance of Common Stock for services rendered -- 24,327 --
Gain on sale of equity investment -- (406,930) --
Write-down of purchased software -- -- 610,984
Write-off investment in Bridging Data Technology -- -- 159,231
Provision for inventory obsolescence 130,000 800,000 --
Write-down of property and equipment 35,000 -- --
Deferred income taxes -- 430,396 --
Changes in operating assets and liabilities- (Increase) decrease in:
Accounts receivable 518,463 2,191,264 4,530,774
Inventories 74,580 994,619 916,159
Recoverable income taxes -- 1,121,554 (1,121,554)
Prepaid expenses and other 15,126 (140,747) 665,603
Increase (decrease) in:
Accounts payable (500,954) (179,474) (1,962,149)
Accrued expenses (503,747) (219) 590,459
Deferred revenue 115,014 154,360 (6,694)
----------- ----------- -----------
Net cash provided by (used in)
operating activities (1,413,231) 2,963,818 347,386
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capitalized and purchased software (139,788) (231,509) (540,736)
Purchases of property and equipment (34,087) (40,317) (245,459)
Proceeds from sale of equity investment -- 406,930 --
----------- ----------- -----------
Net cash provided by
(used in) investing activities (173,875) 135,104 (786,195)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of warrants 13,904,762 -- --
Exercise of stock options 290,518 -- --
Proceeds from (repayment of) line of credit (143,000) (2,931,000) 3,000
Issuance of note receivable (104,288) -- (700,000)
Sale of common stock -- -- 986,384
----------- ----------- -----------
Net cash provided by (used in)
financing activities 13,947,992 (2,931,000) 289,384
----------- ----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 12,360,886 167,922 (149,425)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,470,906 1,302,984 1,452,409
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $13,831,792 $ 1,470,906 $ 1,302,984
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES:
Cash paid for income taxes $ -- $ -- $ 53,032
Cash paid for interest 18,642 65,691 313,112
The accompanying notes are an integral part of these financial statements.
F-6
NEOWARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. COMPANY BACKGROUND:
Neoware Systems, Inc. (the "Company") provides the software and solutions for
the emerging information appliance market. The Company's software and management
tools are designed to power a new generation of smart devices that bring the
benefits of open, industry-standard technologies to a wide variety of
proprietary business devices. The Company's products are designed to run local
applications for specific vertical markets, plus allow access across a network
to Linux servers, the Internet, and Windows-based applications running on
multi-user Windows servers. The Company's infrastructure software powers and
manages information appliances, which are designed as a new generation of
network connected alternatives to proprietary devices and general-purpose
personal computers, offering the cost benefits of industry-standard hardware and
software, easier installation, as well as lower up-front and administrative
costs. Unlike personal computers, the Company's products are designed primarily
to run applications on a server, not on the desktop.
In August 1996, the Company formed a new subsidiary, Information Technology
Consulting, Inc. ("ITC") for the purpose of acquiring companies in the computer
services field, including information technology staffing companies and
client-server consulting companies. In October 1997, ITC merged with Broadreach
Consulting, Inc. ("Broadreach", formerly the Reohr Group, Inc.) and Global
Consulting Group. The Company, as the sole stockholder of ITC, received stock of
the surviving entity representing approximately 2% ownership of the entity after
the merger. The Company was also reimbursed for the expenses incurred by the
Company and ITC in connection with ITC's efforts to complete these transactions
(see Note 5). In November 1998, the Company sold its remaining 2% ownership
interest to Broadreach for $406,930, which is recorded as a gain on sale of
equity investment in the accompanying consolidated statements of operations.
In February 1997, the Company formed a new subsidiary, Bridging Data Technology,
Inc. ("BDT"). BDT acquired and further developed a software product for
upgrading programs and data for Year 2000 compliance. The Company entered into
an agreement effective January 1, 1998 which reduced the Company's ownership
position in BDT and eliminated the Company's requirement to fund future
operations. In addition, effective March 31, 1998, the Company wrote off the
full amount of its investment in BDT. The write-off reflects the Company's
evaluation that recovery, if any, of its investment in BDT will not occur in the
near future.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany profits, accounts
and transactions have been eliminated in consolidation.
F-7
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents for the purpose of
determining cash flows. Cash equivalents at June 30, 2000 and 1999 consist of
money market funds and repurchase agreements.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined by the
first-in, first-out method.
Long-Lived Assets
The Company follows Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." Accordingly, in the event that facts and
circumstances indicate that property and equipment, intangible or other assets
may be impaired, an evaluation of recoverability would be performed. If an
evaluation is required, the estimated future undiscounted cash flows associated
with the assets is compared to the carrying amount of the assets to determine if
a write-down to market value or discounted cash flow value is necessary. As of
June 30, 2000, no write-down was necessary.
Property and Equipment
Property and equipment are stated at cost. Additions and improvements that
significantly extend the useful life of an asset are capitalized. Expenditures
for repairs and maintenance are charged to operations as incurred. Depreciation
and amortization are provided using the straight-line and accelerated methods
over the estimated useful lives of the assets as follows:
Computer equipment 3-5 years
Office furniture and equipment 5-7 years
Leasehold improvements Lease term
Other 3-5 years
Revenue Recognition
Product revenue is recognized at the time of title transfer, which ordinarily
occurs at the time of shipment. From time to time, customers request delayed
shipment, usually because of customer scheduling for systems integration and
lack of storage space at a customer's facility during the implementation. In
such "bill and hold" transactions, the Company recognizes revenues when the
following conditions are met: the equipment is complete, ready for shipment and
segregated from other inventory; the Company has no further significant
performance obligations in connection with the completion of the transaction;
the commitment and delivery schedule is fixed; the customer requested the
transaction be completed on this basis; and the risks of ownership have passed
to the customer. Revenues recognized from "bill and hold" transactions for
products which had not shipped by fiscal year-end were $60,587, $904,265 and
$814,120 for the years ended June 30, 2000, 1999 and 1998, respectively.
Accounts receivable relating to "bill and hold" transactions were $60,587 and
$585,584 at June 30, 2000 and 1999, respectively.
During the year ended June 30, 2000, the Company began to license its software
products to customers for installation on the customers' hardware platforms.
Such license fee revenue is recognized when a formal agreement exists, delivery
of the product has occurred, the license fee is deemed fixed or determinable and
collectibility is probable.
F-8
Product warranty costs and an allowance or sales returns are accrued at the time
revenues are recognized. The Company offers to customers the opportunity to
contract for extended warranty, upgrades and technical support at an additional
cost. The revenue related to these services is recognized ratably over the
service period, generally ranging from one to three years.
Research and Development
Costs incurred in the development of new software products and enhancements to
existing software products are charged to expense as incurred until the
technological feasibility of the product has been established. After
technological feasibility has been established, any additional costs are
capitalized in accordance with SFAS No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed." Capitalized
software costs are amortized to cost of revenues over the expected life of the
product, not to exceed three years. The Company capitalized $139,788, $176,509
and $351,136 of software development cost and amortized $242,377, $264,747 and
$220,877 in fiscal 2000, 1999 and 1998, respectively. Accumulated amortization
was $823,475, and $581,099 at June 30, 2000 and 1999, respectively. The Company
also enters into various licensing agreements which require up front cash
payments and/or royalties based on unit sales. Such amounts are capitalized and
amortized over the term of the license agreement or based on the units sold. The
Company continually evaluates whether events and circumstances have occurred
that indicate that unamortized product development costs may not be recoverable
or that the amortization period should be revised. During fiscal 1998, the
Company wrote down the carrying value of certain prepaid licenses, as such
amounts were not deemed recoverable from future sales. The write-down, which
totaled $610,984 was charged to cost of revenues in the accompanying
consolidated statements of operations.
Earnings Per Share
The Company applies SFAS No. 128, "Earnings per Share." SFAS 128 requires dual
presentation of basic and diluted earnings per share ("EPS") for complex capital
structures on the face of the statement of operations. Basic EPS is computed by
dividing income (loss) by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution from the
exercise or conversion of securities into Common stock, such as stock options.
At June 30, 2000, the Company has options and warrants outstanding to purchase
1,544,250 shares of common stock at prices ranging from $.84 to $ 7.13. For the
years ended June 30, 2000, 1999 and 1998, there were no dilutive effects of
stock options or warrants as the Company incurred a net loss.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Under the asset-and-liability method of SFAS No.
109, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and the respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Under SFAS No. 109, the
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
F-9
New Accounting Pronouncements
Effective July 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." This statement requires companies to classify items of
other comprehensive income by their nature in a financial statement and display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in-capital in the equity section of a statement of
financial position. For the years ended June 30, 2000, 1999 and 1998, the
Company's comprehensive loss consists only of its net loss.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Financial Instruments and Hedging Activities." SFAS
No. 133, as amended by SFAS No. 137, which must be adopted by the Company in the
year ending June 30, 2001, provides a comprehensive and consistent standard for
the recognition and measurement of derivatives and hedging activities. As the
Company does not currently hold derivative instruments or engage in hedging
activities, the adoption of this pronouncement is expected to have no impact on
the Company's financial statements.
3. MAJOR CUSTOMERS AND FOREIGN REVENUES:
No individual customer provided 10% or more of total net revenues in fiscal 2000
and 1999. Net revenues from two customers represented 15% and 14% of total net
revenues in fiscal 1998.
The Company's products are used in a broad range of industries for a variety of
applications. Sales are made to both domestic and international customers. Net
foreign revenues in fiscal 2000, 1999 and 1998, were approximately 28%, 29% and
20%, respectively, and were transacted in US dollars.
4. CONSOLIDATED BALANCE SHEET COMPONENTS:
Inventories consisted of the following:
June 30,
-------------------------------
2000 1999
------------ ------------
Purchased components and subassemblies $ 584,303 $ 732,026
Work-in-process -- 129,972
Finished goods 535,541 462,426
------------ ------------
$ 1,119,844 $ 1,324,424
============ ============
During the latter part of the year ended June 30, 2000, the Company terminated
the designing and manufacturing its proprietary, customized hardware products
and began a transition to the delivery of its software products and management
tools on standard platforms using high performance components manufactured by
third parties. In connection with the transition, the Company recorded a charge
of $165,000 for the reduction in carrying value of certain inventory to the
lower of cost or market value and for the acceleration of depreciation of
customized test equipment no longer required for manufacturing hardware
platforms.
In fiscal 1999, the Company entered into an agreement to outsource a significant
portion of its manufacturing and fulfillment services. In December 1998, the
Company recorded a charge of $800,000 to reduce the carrying value of certain
inventory to the lower of cost or market value.
F-10
These charges are recorded as a components of cost of revenues in the
accompanying consolidated statements of operations.
Property and equipment consisted of the following:
June 30,
-------------------------------
2000 1999
------------- -------------
Computer equipment $ 933,929 $ 945,712
Office furniture and equipment 369,509 359,434
Leasehold improvements 363,313 362,518
Other 121,921 121,921
------------- -------------
1,788,672 1,789,585
Less- Accumulated depreciation and amortization (1,556,739) (1,351,218)
------------- -------------
$ 231,933 $ 438,367
============= =============
A rollforward of the allowance for doubtful accounts follows:
June 30,
-----------------------------------
2000 1999 1998
--------- -------- --------
Beginning balance $ 196,756 $168,710 $124,086
Expense 29,338 93,848 48,299
Write-off's (100,685) (65,802) (3,675)
--------- -------- --------
Ending balance $ 125,409 $196,756 $168,710
========= ======== ========
5. NOTES RECEIVABLE:
In October 1997, the Company merged ITC, a wholly-owned subsidiary, into
Broadreach in exchange for a 2% stock interest in Broadreach and the
reimbursement of $1,000,000 of expenses incurred by the Company in connection
with its efforts to make certain acquisitions in the information technology
consulting and staffing field. Of the total reimbursement, $300,000 was paid in
cash and the remaining $700,000 under a note which is due on the earlier of
three years or upon the completion of the initial public offering of Broadreach.
The note bears interest at 8% per year. Of the total reimbursement, $292,000 was
offset against general and administrative expenses during fiscal 1998 for costs
previously incurred and charged to expense. During fiscal 1999, the Company sold
its 2% interest in Broadreach for $406,930, which is included as a gain on sale
of equity investment in the accompanying consolidated statements of operations.
During April 2000, the Company entered into note agreements with two of its
officers in the aggregate of $104,288 in order to provide a portion of the funds
required for the exercise by the officers of the warrants to purchase the
Company's common stock which they held. The notes are repayable in equal annual
installments over four years and bear interest at an annual rate of 8%.
6. LINE OF CREDIT:
In March 1999, the Company entered into a line of credit agreement with a bank
which provides for borrowing up to $2,000,000 subject to certain limitations, as
defined. The line of credit matures on December 31, 2000. Borrowings under the
credit agreement bear interest at the bank's prime rate plus 2% (11.5% at June
30, 2000). Subsequent to June 30, 2000 the interest rate on the line of credit
was reduced to 1/2% over prime. At June 30, 2000, there was $2,000,000 available
for borrowing under the line. During fiscal 2000, maximum borrowings under the
line of credit agreement were $750,000 and the weighted average interest rate
was 10.33%. During fiscal 1999 and 1998, the weighted average interest rate was
9.75% and 8.5%, respectively.
The line of credit is collateralized by substantially all of the assets of the
Company. The line of credit agreement requires the Company to maintain certain
financial ratios and meet other financial conditions, as defined.
F-11
7. INCOME TAXES:
The components of income taxes are as follows:
For the Year Ended June 30,
------------------------------------------------
2000 1999 1998
------------- ------------- -------------
Current-
Federal $ -- $ -- $ (1,121,554)
State -- -- --
------------ ------------ ------------
-- -- (1,121,554)
------------ ------------ -------------
Deferred-
Federal -- 406,724 --
State -- 23,672 --
------------ ------------ ------------
-- 430,396 --
------------ ------------ ------------
$ -- $ 430,396 $ (1,121,554)
============ ============ ============
The federal statutory income tax rate is reconciled to the effective tax rate as
follows:
For the Year Ended June 30,
-------------------------------------------------
2000 1999 1998
------------- ------------- --------------
Federal statutory rate (34.0)% (34.0)% (34.0)%
State income taxes, net -- -- --
Expenses not deductible
for tax 0.4 0.4 (0.1)
Valuation allowance 44.1 45.2 11.2
Other (10.5) 6.7 4.5
------ ------ -----
-- 18.3% (18.4)%
------ ------ -----
Deferred taxes are determined based on the estimated future tax effects of
differences between the financial statement and tax basis of assets and
liabilities given the provisions of enacted tax laws. Deferred taxes are
comprised of the following:
June 30,
------------------------------------------
2000 1999
------------------- -------------------
Gross current deferred income tax asset $ 2,176,885 $ 1,514,405
Gross current deferred income tax liability -- --
------------------ -------------------
Total current deferred tax asset 2,176,885 1,514,405
------------------ -------------------
Gross non-current deferred income tax asset 491,242 375,410
Gross non-current deferred income tax liability (95,168) (146,276)
------------------ -------------------
Total non-current deferred tax asset 396,074 229,134
------------------ -------------------
Valuation allowance (2,572,959) (1,743,539)
------------------ -------------------
Net deferred tax asset $ -- $ --
================== ===================
F-12
The tax effect of significant temporary differences representing deferred tax
assets and liabilities are as follows:
June 30,
-----------------------------------------
2000 1999
-------------------
-------------------
Net operating loss carryforwards $ 1,546,387 $ 549,687
Expenses not currently deductible for tax purposes 135,275 339,606
Deferred revenue 171,701 126,270
Basis difference in property and equipment and
capitalized software 396,074 229,134
Basis difference in inventory 323,523 498,842
Valuation allowance (2,572,959) (1,743,539)
------------------ -------------------
Net deferred tax asset $ -- $ --
================== ===================
In fiscal 1999, the Company increased the valuation allowance to the full value
of the net deferred tax asset as management concluded that the net deferred tax
asset no longer met the recognition criteria under SFAS No. 109.
8. STOCK OPTIONS AND WARRANTS:
The Company has a stock option plan (the "Plan") for employees and directors.
The Company is authorized to issue options for the purchase of up to 2,500,000
shares of Common Stock. Under the terms of the Plan, the exercise price of
options granted cannot be less than fair market value on the date of grant.
Employee options generally vest and become exercisable ratably over four years.
Director options generally vest and become exercisable ratably over six months
or one to two years from the date of grant. All options expire five years from
the grant date. As of June 30, 2000, there were 580,771 options available for
grant under the Plan.
Information with respect to the options under the Plan is as follows:
Weighted
Average
Exercise
Shares Price
------ --------
Balance as of June 30, 1997 1,253,349 6.53
Granted 1,197,500 3.22
Exercised (7,112) 1.76
Terminated (1,183,500) 6.57
----------
Balance as of June 30, 1998 1,260,237 3.37
Granted 1,297,000 1.21
Terminated (1,252,750) 3.19
----------
Balance as of June 30, 1999 1,304,487 1.39
Granted 720,500 3.04
Exercised (263,528) 1.21
Terminated (217,209) 1.17
---------
Balance as of June 30, 2000 1,544,250 2.20
=========
On March 3, 1998, the Company modified 955,000 options previously granted. The
effect of this modification was to exchange the original options for 955,000 new
options with an exercise price of $3.00, which was the fair market value of the
Common Stock on the date of the modification. The new options will vest over
four years beginning March 3, 1998. The options are included as granted and
terminated during fiscal 1998 in the table above.
F-13
On August 28,1998, the Company modified 958,500 options previously granted. The
effect of this modification was to exchange the original options for 958,500 new
options with an exercise price of $1.06, which was the fair market value of the
Common Stock on the date of the modification. The new options retained the
vesting period of the original options. The options are included as granted and
terminated during fiscal 1999 in the table above.
The following table summarizes information about stock options outstanding as of
June 30, 2000:
Outstanding Stock Options Exercisable Stock Options
------------------------------------------------------------------------- -------------------------
Weighted
Range Weighted Average Weighted
of Average Remaining Average
Exercise Exercise Contractual Exercise
Prices Shares Price Life Shares Price
------------- ------------- ------------------- ------------- ---------- ----------
$ .84-.94 21,500 $ .93 3.6 years 16,625 $ .94
1.06 658,500 1.06 3.2 years 507,813 1.06
1.09-3.00 669,250 2.65 4.7 years 36,125 1.68
3.34-7.13 195,000 4.60 4.1 years 60,000 5.75
---------- --------
1,544,250 620,563
========== ========
Options granted under the Plan contain provisions pursuant to which all
outstanding options granted under such Plan shall become fully vested and
immediately exercisable upon a "change in control", as defined in such Plan.
As of July 1, 1999, there were 5,704,842 warrants outstanding to purchase Common
Stock at $5.50 per share. The warrants were exercisable over seven years and
were extended to expire on April 14, 2000. During fiscal 2000, the exercise
price of the warrants was adjusted to $3.75 per share and warrants to purchase
3,725,853 shares of Common Stock were exercised, resulting in net proceeds to
the Company of $13,904,762 and the remaining 1,978,989 warrants expired.
In addition to the aforementioned warrants, during fiscal 1998, the Company
issued 300,000 warrants to purchase Common Stock at prices ranging from $3.00 to
$7.00 in connection with entering into a financial advisory and investment
banking agreement. Warrants for 100,000 shares were exercisable immediately and
200,000 warrants were to vest upon meeting certain provisions, as defined. Such
provisions were not achieved and the 200,000 warrants expired in July 1999. The
exercisable warrants expire in January 2001.
During fiscal 1998, the Company issued 100,000 shares of Common Stock in
exchange for the termination of 540,495 Unit Purchase Options with an exercise
price of $2.44. The Unit Purchase Options had been issued in connection with the
initial public offering of a predecessor company in March 1993 and provided the
holder with the option to acquire Units consisting of one share of Common Stock
and two Common Stock purchase warrants.
F-14
9. ACCOUNTING FOR STOCK-BASED COMPENSATION:
The Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation"
during the year ended June 30, 1997. The Company has elected to adopt the
disclosure requirements of this pronouncement only. The adoption of this
pronouncement, therefore, had no impact on the Company's financial position or
results of operations. Had compensation cost been calculated based on the fair
value at the grant date for awards in fiscal 2000, 1999 and 1998 consistent with
the provisions of SFAS 123, the Company's net loss and net loss per share would
have been changed to the following pro forma amounts:
2000 1999 1998
------------------ ------------------ ------------------
Net loss As reported $ (1,820,111) $ (2,780,858) $ (4,968,825)
Pro forma $ (2,082,463) $ (3,160,219) $ (5,294,614)
Basic EPS As reported $ (.25) $ (.44) $ (.86)
Pro forma $ (.28) $ (.50) $ (.92)
Diluted EPS As reported $ (.25) $ (.44) $ (.86)
Pro forma $ (.28) $ (.50) $ (.92)
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in fiscal 2000, 1999 and 1998; no dividend yield;
expected volatility of approximately 70%-84%; risk-free interest rates of
approximately 4.4%-6.9%; and an expected life of five years. The pro forma
effect on net loss for fiscal 2000, 1999 and 1998 is not representative of the
pro forma effect on net loss in future years because it does not take into
consideration pro forma compensation expense related to grants made prior to
fiscal 1996.
10. COMMITMENTS AND CONTINGENCIES:
The Company leases its principal facility, an automobile and furniture and
fixtures under noncancelable operating leases. The remaining terms of these
leases range from six months to six years. Rent expense under these leases was
$118,373, $112,285 and $108,486 in fiscal 2000, 1999 and 1998, respectively.
Future minimum lease payments under operating leases at June 30, 2000 are
$177,430 in fiscal 2001, $166,369 in 2002, $170,178 in 2003, $164,316 in 2004,
$166,416 in 2005 and $41,859 thereafter.
During July 2000, the Company entered into an amendment to the lease extending
its term from September 30, 2000 to September 30, 2005. Pursuant to the
amendment, the annual gross rent for the facility, including operating expenses,
approximates $220,000.
On March 11, 1998, a complaint was filed as a purported class action on behalf
of purchasers of the Company's Common Stock during 1996 and 1997. The complaint
alleged that misrepresentations were made related to plans for various potential
acquisitions by a subsidiary of the Company and a spin-off. An amended complaint
was subsequently filed which added claims on behalf of a second purported class
related to the Company's announcement on April 30, 1998 that it would be
restating certain financial results previously reported. Thereafter, four
separate purported securities class actions were filed. During October 1999, an
agreement in principle to settle all of the foregoing litigation was reached and
the parties subsequently executed and filed with the Court a definitive
settlement agreement. On July 27, 2000, the settlement was approved by the Court
and such settlement had no material adverse effect on the Company's financial
position and results of operations.
F-15
On October 1, 1999, the Company entered into a settlement agreement with
Development Concepts, Inc. which fully satisfies a complaint filed on May 5,
1998 against the Company by Development Concepts, Inc. The complaint asserted
various claims arising primarily from the parties' contractual relationships.
Under the agreement, the Company agreed to pay Development Concepts, Inc a total
of $300,000, payable in two installments of $75,000 on October 1, 1999 and
January 1, 2000 and three installments of $50,000 payable on April 1, 2000, July
1, 2000 and October 1, 2000.
11. EMPLOYEE BENEFIT PLAN:
The Company sponsors a profit sharing/401(k) plan (the "Plan") for all of its
employees who meet certain age and years of employment requirements.
Participants may make voluntary contributions to the Plan and the Company makes
a matching contribution of 50% of the first 4% of such contributions up to a
maximum of $500 per participant per year. The Company's contributions were
$14,187, $19,458 and $46,501 in fiscal 2000, 1999 and 1998, respectively.
Subsequent to June 30, 2000, the Company amended the Plan to provide for a
matching contribution of 50% of the first 6% of such contributions up to a
maximum of $1,000 per participant per year.
F-16
Exhibits
The following is a list of exhibits filed as part of this annual report on Form
10-K. Where so indicated by footnote, exhibits which were previously filed are
incorporated by reference.
Exhibit
Numbers Description
- ------- -----------
2.1 Agreement of Merger dated as of December 2, 1994 among the Company,
ISAC Acquisition Co. and HDS (Exhibit 2.1)(4)
3.1 Certificate of Incorporation (Exhibit 3.1(1)
3.2 Amendment to Certificate of Incorporation (Exhibit 3.2)(2)
3.3 By-laws (Exhibit 3.2)(7)
4.1 Common Stock Purchase Warrants held by Kirlin Holding Corp. and two
related persons (Pursuant to Instruction 2 to Item 601 of Regulation
S-K, the Common Stock Purchase Warrants, which are identical in all
material respects except as to the parties thereto and the number of
Warrants, held by such related persons are not being filed).
(Exhibit 4.5)(6)
10.1 Letter Agreement between Safeguard Scientifics, Inc. and Registrant.
(Exhibit 10.5)(3)
10.2 Lease between the Registrant and GBF Partners, as amended. (Exhibit
10.9)(4)
10.3* Second Amendment to Commercial Lease, dated July 31, 2000, between
the Registrant and GBF Partners.
10.4+ 1995 Stock Option Plan (as amended on May 16, 2000). (Exhibit
10.2)(8)
10.5+ Employment Agreement, dated February 14, 2000, between the
Registrant and Michael G. Kantrowitz. (Exhibit 10.1)(8)
10.6+ Separation Agreement, dated February 14, 2000, between the
Registrant and Edward C. Callahan, Jr. (Exhibit 10.3 )(8)
10.7+ Employment Agreement, dated June 10, 1999 between the Registrant and
Edward M. Parks. (Exhibit 10.7)(7)
10.8+ Letter agreement, dated October 1, 1998 between the Registrant and
Steven Ahlbom. (Exhibit 10.8)(7)
10.9+* Letter Agreement, dated January 27, 1999, between the Registrant and
Vincent T. Dolan.
10.11+* Note, dated April 14, 2000, of Michael G. Kantrowitz to the
Registrant and Pledge Agreement, dated April 14, 2000, between the
Registrant and Michael G. Kantrowitz
10.12+* Note, dated April 14, 2000, of Edward M. Parks to the Registrant and
Pledge Agreement, dated April 14, 2000, between the Registrant and
Edward M. Parks.
24
21. Subsidiaries (Exhibit 21)(5)
23.* Consent of Arthur Andersen LLP
- -------------------
* Filed herewith.
+ Management contract or arrangement.
(1) Filed as an Exhibit to the Company's Registration Statement on Form
S-1 (File No. 33-56834) filed with the SEC on January 7, 1993.
(2) Filed as an Exhibit to the Company's Annual Report on Form 10-K for
the year ended December 31, 1994.
(3) Filed as an Exhibit to Amendment No. 1 to the Company's Registration
Statement on Form S-1 (No. 33-56834) filed with the SEC on February
11, 1993.
(4) Filed as an Exhibit to the Company's Registration Statement on Form
S-4 (File No. 33-87036) filed with the SEC on December 6, 1994.
(5) Filed as an Exhibit to the Company's Annual Report on Form 10-K for
the year ended June 30, 1998.
(6) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1998.
(7) Filed as an Exhibit to the Company's Annual Report on Form 10-K for
the year ended June 30, 1999.
(8) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2000.
No reports on Form 8-K were filed during the last quarter of fiscal 2000.
25
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NEOWARE SYSTEMS, INC.
Date: September 27, 2000 By: /s/Michael G. Kantrowitz.
---------------------------- --------------------------------
Michael G. Kantrowitz
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated.
Each person in so signing also makes, constitutes and appoints Michael
G. Kantrowitz, President and Chief Executive Officer, and Vincent T. Dolan, Vice
President-Finance and Administration, and each of them severally, his or her
true and lawful attorney-in-fact, in his or her name, place and stead to execute
and cause to be filed with the Securities and Exchange Commission any or all
amendments to this report.
Signature Title Date
--------- ----- ----
/s/ Arthur R. Spector Chairman of the Board September 27, 2000
- -----------------------------------
Arthur R. Spector
/s/ Michael G. Kantrowitz President, Chief Executive September 27, 2000
- ----------------------------------- Officer and Director (Principal
Executive Officer)
/s/ Vincent T. Dolan Vice President of Finance and September 27, 2000
- ----------------------------------- Administration (Principal Financial
Vincent T. Dolan Officer and Principal Accounting
Officer)
/s/ John M. Ryan Director September 27, 2000
- -----------------------------------
John M. Ryan
/s/ Carl G. Sempier Director September 27, 2000
- -----------------------------------
Carl G. Sempier
/s/ Christopher G. McCann Director September 27, 2000
- -----------------------------------
Christopher G. McCann
26