Back to GetFilings.com
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, 2002
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 (IRS Employer Identification No.)
or organization)
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. ______
The aggregate market value of the voting stock held by non-affiliates of the
registrant is approximately $190,025,000. Such aggregate market value was
computed by reference to the last reported sale price of the Common Stock as
reported on the NASDAQ National Market on September 16, 2002. 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 17, 2002 was 13,378,950.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the Annual Meeting
of Shareholders to be held on December 4, 2002 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....................................8
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...........................................22
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..22
PART III.........................................................................................................23
Item 10. Directors and Executive Officers of the Registrant....................................23
Item 11. Executive Compensation................................................................24
Item 12. Security Ownership of Certain Beneficial Owners and Management. ......................24
Item 13. Certain Relationships and Related Transactions........................................24
PART IV..........................................................................................................25
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......................25
2
PART I
ITEM 1. BUSINESS.
General
Neoware Systems, Inc. (the "Company") provides software, services and solutions
to enable Appliance Computing, a new Internet-based computing architecture
targeted at business customers that is designed to be simpler and easier than
traditional PC-based computing. The Company's software and management tools
power and manage a new generation of smart computing appliances that utilize the
benefits of open, industry-standard technologies to create new alternatives to
personal computers used in business and a wide variety of proprietary business
devices. The Company's Eon, Capio and ThinSTAR products are thin client
computing appliances which are cost-effective alternatives to personal computers
used by businesses and powerful replacements for green-screen terminals. Used in
conjunction with Citrix MetaFrame or Microsoft Terminal Services, the Company's
computing appliances allow users to run computer applications from a server,
plus connect to mainframes, midrange systems and the Internet. Unlike personal
computers, computing appliances can be centrally managed and remotely
configured, which greatly simplifies administration. Because of this, computing
appliances can save up to 80 percent of the total cost of ownership of networked
personal computers, resulting in significant cost savings for enterprise
customers.
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.
During fiscal 2000, the Company raised approximately $14,000,000 in capital as a
result of the exercise of its Redeemable Common Stock Purchase Warrants.
On June 28, 2001, the Company purchased the thin client business of Boundless
Technologies, Inc., which included the Capio product line and associated
software and intellectual properties and access to the Capio distribution and
customer databases, for $1,600,000, excluding transaction costs and assumed
contractual obligations.
On December 4, 2001, the Company acquired all of the assets and assumed
substantially all of the liabilities of Telcom Assistance Center Corporation,
d/b/a ACTIV-e Solutions, a full service Information Technology consulting
company in the server-based computing marketplace. The purchase price was
payable in cash of $75,000, 569,727 shares of the Company's newly issued Common
Stock with a market value of $3.24 per share and the assumption of net
liabilities of approximately $1,178,000, excluding transaction costs.
On January 8, 2002, the Company entered into a worldwide alliance with IBM
Corporation under which the Company is the preferred provider of thin client
appliance products to IBM and its customers. In addition, the Company licensed
from IBM the intellectual property associated with its thin client appliance
products. As consideration for these agreements, the Company issued 375,000
newly issued Common Stock with a market value of $6.26 per share to IBM.
3
On March 26, 2002, the Company acquired the assets of the ThinSTAR product line
from Network Computing Devices, Inc. In addition, the Company entered into an
alliance with NCD to grow the worldwide thin client appliance market. The
purchase price was payable in cash of $4,000,000, excluding transaction costs.
On May 24, 2002, the Company completed a $12,000,000 private placement of its
Common Stock to institutional investors. The Company sold 1,600,000 shares of
its Common Stock at a price of $7.50 per share. Proceeds from the offering will
be used for general corporate purposes and to fund potential future
acquisitions.
Product Strategy
The Company's current strategy is to establish itself as the recognized leader
in the market for software, services and solutions to power and manage the
wide-scale deployment of computing appliances used by businesses. The Company
provides its software on top of a number of embedded operating systems,
including Microsoft's Windows CE .NET, NT Embedded and XP Embedded as well as an
embedded version of the Linux operating system. The Company intends to establish
a leadership role in its space by partnering with other companies to build
applications with the Company's embedded software and management tools for a
wide variety of vertical business markets. The Company intends to seek out
partners who have strong market positions in the server-based computing market
to expand its existing sales, marketing and distribution channels and customer
relationships in order to gain access to new markets and customers. As part of
this strategy, the Company intends to leverage its existing technology and
marketing relationships with leading technology companies to build its business.
The Company has developed and intends to continue to enhance its technology that
enables large numbers of computing appliances to be deployed in business
environments as alternatives to proprietary or PC-based systems. The Company
intends to continue to add its proprietary enhancements to other companies'
operating systems, enabling them to be secured and centrally managed.
Additionally, the Company 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 has begun to develop a revenue
stream from consulting services, training services and assisting enterprise
customers as they manage the large-scale deployment of applications to computing
appliances. The Company intends to continue to bundle its software products with
industry-standard appliance platforms 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 the Company's products much simpler than
administration of personal computers, since administrative tasks take place at a
small number of servers instead of a much larger number of desktops. The
Company's ezRemote Manager software is a core product offering that makes the
Company's products easier to manage, update and administer centrally.
Diverse Technology Expertise. The Company has significant expertise in a wide
range of technical disciplines, including central management, security, embedded
operating systems, windowing and networking software, applications software
development, graphics acceleration, multimedia design and compression
algorithms. Utilizing more than fifteen years of experience designing embedded
UNIX operating systems, the Company has ported its proprietary software
technologies to embedded versions of the Windows and Linux operating systems to
develop a unique software product, which is designed specifically for computing
appliance environments.
4
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 its products quickly to meet customer demand.
Product Upgrades and Enhancements. The Company sells software upgrades and
enhancements to customers of its own appliances, as well as upgrades and
enhancements to customers utilizing appliances sold by other vendors. This
allows customers to expand their use of Appliance Computing, manage all of their
appliances through one management tool, ezRemote Manager, and provide the same
end-user experience to all appliances. This provides customers extended use of
their installed appliances without changing hardware, and provides a continued
relationship with, and revenue stream from, the customer.
Appliance Computing Technical Support and Consulting Services. The Company
provides technical support services in addition to software and appliances. This
support extends from the appliance, through the customer's network
infrastructure, including their server complex, which allows customers to work
with one supplier with the expertise to assist them.
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, Air Canada, Bed, Bath and Beyond,
Bristol Myers Squibb, Burlington Coat Factory, Caesar's Palace, California
Department of Motor Vehicles, Circuit City, Costco, Daughters of Charity, ESPN,
Harley Davidson, Hollywood Video, IBM, Intel, Keystone Automotive, Kilotou, Lee
Memorial HealthCare, Lockheed Martin, MicronPC, Monongehela Valley Hospital,
Motorola, National Car Rental, National Semiconductor, Neiman Marcus, OfficeMax,
O'Reilly Auto Parts, Raymour and Flanagan, Target Corporation, US Veteran's
Administration, Wal-Mart and others.
Revenues from one customer amounted to 10.2% of total net revenues for the year
ended June 30, 2002 and revenues from a different customer amounted to 10.2% for
the year ended June 30, 2001. No single customer represented 10% or more of
total net revenues during the year ended June 30, 2000.
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 cross-platform enhancements to
the Windows CE, NT and XP Embedded and Linux operating systems, and to continue
to develop new software products that incorporate the latest improvements in
performance, capability and manageability targeted specifically at the Appliance
Computing market. Accordingly, the Company is committed to investing significant
resources in software development activities. During fiscal 2002, 2001 and 2000,
the Company's expenditures for research and development totaled $1,441,359,
$955,386 and $648,548, respectively.
5
The Company's current research and development programs include:
o Development of enhancements to Microsoft's Windows CE .NET, NT and XP
Embedded and the Linux operating system designed to make them more
manageable and secure in network environments.
o Development of server-based remote management software designed to
manage the wide-scale deployments of large numbers of network-connected
devices.
o Integration of the intellectual property acquired from IBM and licensed
from NCD into theCompany's software products.
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 Appliance Computing 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.
The Company's products have won numerous awards in the computing 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, "Best Buy" from Network Solutions
and Reader's Choice Award from Windows & .NET Magazine.
The Company distributes its products in North America through IBM, value-added
resellers, system integrators, distributors, direct sales to end user customers
and OEMs, and via the Internet.
The Company utilizes distributors for its products throughout the world, and has
relationships with distributors in the United States, United Kingdom, Canada,
France, Scandinavia, Germany, Denmark, Belgium, Netherlands, Austria,
Switzerland, Italy, Spain, Russia, Israel, India, Egypt, Latvia, Korea,
Philippines, New Zealand, Australia, Malaysia and South Africa. Foreign
revenues, which accounted for approximately 30%, 24% and 28% of net revenues,
respectively, in fiscal 2002, 2001 and 2000, 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.
6
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, and also provides technical support at customers' sites,
as well as via telephone and electronic mail. 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 headquarters-based technical maintenance organization
and through contracted third-party maintenance organizations.
The Company typically warrants its appliance products against defects in
materials and workmanship for three years after purchase by the end user. To
date, the Company has not encountered any material product maintenance problems.
Competition
The Appliance Computing 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 of Windows-based
terminals and thin clients.
Competitive products are offered by a number of established computer
manufacturers, including Hewlett Packard, Sun Microsystems and Wyse Technology.
Some 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.
The Company, as well as other manufacturers of computing appliances, also faces
competition from established computer manufacturers whose personal computer
products offer alternatives to computing appliances for many applications.
Computing appliances compete with personal computers offered by such
manufacturers as Dell, Gateway, 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 thin client appliances.
Computing 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 customers' perceptions regarding their need for desktop
application processing capability, constitute obstacles to the penetration of
this market segment by computing 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 computing 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 computing appliances will become
increasingly competitive with ASCII and 3270 terminal systems.
Manufacturing and Suppliers
The Company provides its software and management tools on hardware platforms
designed and manufactured for it by third parties. These platforms utilize
high-performance, industry-standard components used in high volume in the PC
industry. This lowers the cost of manufacturing the Company's products and
allows the Company to continue to lower the cost of its products as the costs of
personal computers decline. The Company uses this strategy to compete with other
companies that design and manufacture their own proprietary hardware. This
strategy has allowed the Company to significantly lower the cost of its products
and operations, and has allowed the Company to increase sales with higher
margins and lower inventory levels.
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 IBM, Citrix Systems, Inc., Microsoft Corporation, 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 17, 2002, the Company had 101 employees.
ITEM 2. PROPERTIES
The Company's principal administrative, marketing and research and development
operations are located in King of Prussia, Pennsylvania. The primary facility
consists of approximately 22,000 square feet under a lease with an expiration
date of September 30, 2005. The annual gross rent for the facility, including
operating expenses, is approximately $220,000. In March 2002 the Company entered
into a two-year lease for approximately 4,800 square feet at a facility in King
of Prussia. The annual gross rent for this facility, including operating
expenses, is approximately $96,000. The Company also leases a number of sales
offices in the US, Europe and Australia. 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.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
8
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS.
The Company's Common Stock began trading on the NASDAQ National Market on August
7, 2002. Prior to that date, the Company's Common Stock was traded on the NASDAQ
SmallCap Market. Prior to August 1, 1997, the Company's Common Stock traded
under the symbols HDSX and, effective on that date, began trading under the
symbol NWRE. The following table sets forth the high and low closing bid
quotations for the Company's Common Stock for the periods indicated.
2002 High Low
- ---- ---- ---
First Quarter 2.81 1.34
Second Quarter 4.90 1.60
Third Quarter 10.03 5.15
Fourth Quarter 11.70 7.49
2001 High Low
- ---- ---- ---
First Quarter 3.69 1.75
Second Quarter 2.88 1.00
Third Quarter 2.28 1.19
Fourth Quarter 2.69 1.18
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 105 holders of record of Common Stock as of June 30,
2002. 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.
In May 2002, the Company sold 1.6 million shares of Common Stock in a private
placement at a price of $7.50 per share. Net proceeds to the Company were
approximately $11.2 million after transaction costs. The shares were issued in
reliance upon the exception from the registration requirements of the Securities
Act under Section 4(2) and Rule 506 thereof as a transaction not involving a
public offering. The shares were acquired for investment and not with a view to
the distribution thereof by accredited investors which had access to information
respecting the Company and its business. In connection with the private
placement, the Company granted to one of the placement agents for the offering
warrants to purchase a total of 48,000 shares of the Company's Common Stock at
an exercise price of $9.375 per share until May 2005, subject to adjustment
under certain conditions. The warrants were issued in reliance upon the
exception from the registration requirements of the Securities Act under Section
4(2) thereof as a transaction not involving a public offering. The warrants were
acquired for investment and not with a view to the distribution thereof by an
accredited investor which had access to information respecting the Company and
its business. A total of 35,000 of these warrants were exercised in September
2002.
In June 2001, in connection with acquisition-related consulting services
provided to the Company by a strategic and financial adviser, the Company
granted to the adviser and two of its affiliates warrants to purchase a total of
86,095 shares of the Company's Common Stock at an exercise price of $2.20 per
share until June 2004, subject to adjustment under certain conditions. The
warrants were issued in reliance upon the exception from the registration
requirements of the Securities Act under Section 4(2) thereof. The warrants were
acquired for investment and not with a view to the distribution thereof by
accredited investors which had access to information respecting the Company and
its business. The warrants were exercised in July 2002.
9
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 have been derived from the
Company's consolidated financial statements, which have been audited by KPMG
LLP, independent auditors, as of and for the year ended June 30, 2002 and by
Arthur Andersen LLP, independent public accountants, for the other years
presented. 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.
Year Ended June 30,
-----------------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
Net revenues $34,309,667 $17,654,825 $11,044,870 $10,665,753 $19,976,423
----------- ----------- ----------- ----------- -----------
Gross profit 13,964,633 5,962,050 2,318,774 1,367,637 3,637,368
Operating expenses 10,982,358 6,430,513 4,430,785 4,163,346 9,389,393
----------- ----------- ----------- ----------- -----------
Operating income (loss) 2,982,275 (468,463) (2,112,011) (2,795,709) (5,752,025)
Gain on sale of equity investment -- -- -- 406,930 --
Loss on investment -- (812,000) -- -- --
Interest income, net 296,045 771,695 291,900 38,317 (338,354)
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 3,278,320 (508,768) (1,820,111) (2,350,462) (6,090,379)
Income taxes (1,346,728) -- -- 430,396 (1,121,554)
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 4,625,048 $ (508,768) $(1,820,111) $(2,780,858) $(4,968,825)
=========== =========== =========== =========== ===========
Basic earnings (loss) per share $ 0.42 $ (0.05) $ (0.25) $ (0.44) $ (0.86)
Diluted earnings (loss) per share $ 0.39 $ (0.05) $ (0.25) $ (0.44) $ (0.86)
Weighted average number of shares used in
Basic earnings (loss) per share
computation 10,904,565 10,226,316 7,374,692 6,278,317 5,784,366
Weighted average number of shares used in
Diluted earnings (loss) per share
computation 11,851,327 10,226,316 7,374,692 6,278,317 5,784,366
As of June 30,
-----------------------------------------------------------------------
BALANCE SHEET DATA: 2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Current assets $29,722,626 $16,435,552 $17,995,134 $ 5,646,345 $10,861,643
Current liabilities 5,893,267 2,698,939 2,191,299 3,223,986 6,180,319
Working capital 23,829,359 13,736,613 15,803,835 2,422,359 4,681,324
Total assets 42,398,960 18,788,842 18,668,379 7,325,897 13,021,393
Long-term debt excluding current portion 204,131 -- -- -- --
Stockholders' equity 36,601,562 16,089,903 16,477,080 4,101,911 6,841,074
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Introduction
The Company provides software, services and solutions to enable Appliance
Computing, a new Internet-based computing architecture targeted at business
customers that is designed to be simpler and easier than traditional PC-based
computing. The Company's software and management tools power and manage a new
generation of smart computing appliances that utilize the benefits of open,
industry-standard technologies to create new alternatives to personal computers
used in business and a wide variety of proprietary business devices. The
Company's Eon, Capio and ThinSTAR products are thin client computing appliances
which are cost-effective alternatives to personal computers used by businesses,
and powerful replacements for green-screen terminals. Used in conjunction with
Citrix MetaFrame or Microsoft Terminal Services, the Company's computing
appliances allow users to run computer applications from a server, plus connect
to mainframes, midrange systems and the Internet. Unlike personal computers,
computing appliances can be centrally managed and remotely configured, which
greatly simplifies administration. Because of this, computing appliances can
save up to 80 percent of the total cost of ownership of networked personal
computers, resulting in significant cost savings for enterprise customers.
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,
--------------------
2002 2001 2000
---- ---- ----
Gross profit 40.7% 33.7% 21.0%
Operating expenses:
Sales and Marketing 18.6 17.3 14.5
Research and Development 4.2 5.4 5.9
General and administrative 9.2 12.3 15.5
Acquisition costs -- 1.4 4.2
---- ---- ----
Operating income (loss) 8.7 (2.7) (19.1)
Loss on investment -- (4.6) --
Interest income, net .9 4.4 2.6
---- ---- ----
Income (loss) before taxes 9.6 (2.9) (16.5)
Income taxes (3.9) -- --
---- ---- ----
Net income (loss) 13.5% (2.9)% (16.5)%
==== ==== ====
Year Ended June 30, 2002 Compared to Year Ended June 30, 2001
For the year ended June 30, 2002, net revenues increased by $16,654,842 or 94.3%
to $34,309,667 from $17,654,825 for the prior fiscal year. The increase in net
revenues was attributable to the shipment of a higher number of units of the
Company's Eon and Capio computing appliance products; net revenues attributable
to ACTIV-e Solutions operations acquired on December 4, 2001 which amounted to
$2,222,176; net revenues generated from the ThinSTAR computing appliance product
line acquired on March 26, 2002 which amounted to $2,892,167; and net revenues
generated from the IBM Alliance which was entered into on January 8, 2002 which
amounted to approximately $2,000,000.
The Company's gross profit as a percentage of net revenues increased to 40.7%
for the year ended June 30, 2002, from 33.7% for the prior fiscal year. The
increase in gross profit is attributable to the Company's software-powered
business model, under which it outsources the design and production of its
appliance products, and to the impact of increased volumes of appliances sold on
component and license costs and the spreading of fixed overhead costs over a
larger revenue base.
11
Operating expenses for the year ended June 30, 2002 were $10,982,358, an
increase of $4,551,845 or 70.8% from operating expenses of $6,430,513 for the
prior fiscal year. As a percentage of revenues, total operating expenses
declined to 32.0% from 36.4% in the prior fiscal year.
Sales and marketing expenses increased by $3,323,116, or 108.7%, to $6,381,124
for the year ended June 30, 2002 compared to $3,058,008 for the prior fiscal
year. The increase reflects personnel additions to sales, marketing and business
development staffing.
Research and development expenses for the year ended June 30, 2002 increased by
$485,973, or 50.9%, to $1,441,359 from $955,386 in the prior fiscal year
primarily due to increases in staffing.
General and administrative expenses for the year ended June 30, 2002 increased
by $988,595, or 45.6%, to $3,159,875 from $2,171,280 for the prior fiscal year
primarily due to increased staffing and personnel costs.
During the year ended June 30, 2001, the Company incurred costs of $245,839 in
connection with proposed acquisitions and/or strategic relationships that were
not consummated.
The Company realized net interest income of $296,045 for the year ended June 30,
2002 compared to net interest income of $771,695 for the prior fiscal year. The
decrease was due to lower interest rates and a reduction in the amount of cash
invested resulting from the Capio, ACTIV-e and ThinSTAR acquisitions.
For the year ended June 30, 2002, the Company recorded a net income tax benefit
of $1,346,728 which reflects the reversal of a previously recorded valuation
allowance against deferred income tax assets. This reversal is the result of the
Company's recent sustained history of operating profitability and future
prospects of continued profitability. The effective income tax rate for the year
ended June 30, 2001 was zero since no income tax benefit was recognized as a
result of the net operating losses incurred as there was no assurance at that
time that the benefit of the net operating loss carryforward would be realized.
For the year ended June 30, 2002, the Company generated net income of $4,625,048
as compared to a net loss of $508,768 for the prior fiscal year. The improvement
in performance is primarily attributable to higher revenues, higher gross profit
margin and the net income tax benefit, offset by increased operating expenses.
Year Ended June 30, 2001 Compared to Year Ended June 30, 2000
For the year ended June 30, 2001, net revenues increased by $6,609,955 or 59.8%
to $17,654,825 from $11,044,870 for the prior fiscal year. The increase in net
revenues was primarily attributable to the shipment of a higher number of units
of the Company's Eon computing appliance products.
The Company's gross profit as a percentage of net revenues increased to 33.7%
for the year ended June 30, 2001, from 21.0% for the prior fiscal year. The
increase in gross profit is primarily attributable to the cost impact of the
operating model adopted by the Company during the latter part of the fiscal year
ended June 30, 2000, which is based upon the utilization of industry-standard,
platforms designed and manufactured for it by third parties. This operating
model eliminates the need for proprietary hardware designs or engineering. The
increase in gross profit is also attributable in part to the spread of fixed
overhead costs over a larger revenue base.
Operating expenses for the year ended June 30, 2001 were $6,430,513, an increase
of $1,999,728 or 45.1% from operating expenses of $4,430,785 for the prior
fiscal year.
12
Sales and marketing expenses increased by $1,458,799 or 91.2% to $3,058,008 for
the year ended June 30, 2001 compared to $1,599,209 for the prior fiscal year.
The increase reflects continued personnel additions to sales, marketing and
business development staffing which began during the latter part of the year
ended June 30, 2000, as well as higher professional costs, all associated with
the implementation of the Company's growth strategy. During the fiscal year the
Company significantly expanded its marketing and sales operations and now
operates with sales offices in Pennsylvania, New Jersey, New York, Florida,
Virginia, Texas, Southern California, Northern California, Canada, the United
Kingdom, France, Germany, and the Netherlands.
Research and development expenses for the year ended June 30, 2001 increased by
$306,838 or 47.3% to $955,386 as compared to $648,548 in the prior fiscal year
primarily due to increases in staffing.
General and administrative expenses for the year ended June 30, 2001 increased
by $459,362 or 26.8% to $2,171,280 for the year ended June 30, 2001 from
$1,711,918 for the prior fiscal year primarily due to increased staffing and
personnel costs.
During the year ended June 30, 2001, the Company incurred costs of $245,839 in
connection with proposed acquisitions and/or strategic relationships which were
not consummated.
During the year ended June 30, 2001, the Company recorded a loss on investment
of $812,000 relating to a note receivable from Broadreach Consulting, Inc. The
note was originally entered into in October 1997 in connection with the merger
of a wholly-owned subsidiary of the Company into Broadreach. (See Note 13 to the
Consolidated Financial Statements.)
The Company realized net interest income of $771,695 for the year ended June 30,
2001 compared to net interest income of $291,900 for the prior fiscal year. The
increase was primarily due to interest earned for the entire year on the cash
generated during the latter part of the prior fiscal year from the exercise of
the Company's Redeemable Stock Purchase Warrants.
The effective income tax rate was zero for the years ended June 30, 2001 and
2000. No income tax benefit was recognized in either fiscal year as a result of
the net operating losses incurred as there was no assurance at the time that the
benefit of the net operating loss carryforward would be realized.
For the year ended June 30, 2001, the Company's net loss was $508,768 as
compared to a net loss of $1,820,111 for the prior fiscal year. The reduction in
the loss is attributable to higher revenues and gross profit margin, offset by
increased operating expenses and the loss on investment.
Liquidity and Capital Resources
As of June 30, 2002, the Company had net working capital of $23,829,359 composed
primarily of cash and cash equivalents and accounts receivable. The Company's
principal sources of liquidity include $17,031,422 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, 2002. 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, 2002. The Company had no borrowings
under the line of credit during the year ended June 30, 2002.
13
Cash and cash equivalents increased by $5,318,887 during the year ended June 30,
2002, primarily as a result of the proceeds from the Company's private placement
of its Common Stock offset by cash utilized in the acquisitions of ACTIV-e
Solutions and the ThinSTAR product line from Network Computing Devices, Inc.
(See Note 3 to the Consolidated Financial Statements under Item 8., Financial
Statements and Supplementary Data.)
The Company used cash from operating activities of $843,661 in fiscal 2002
compared to providing cash of $291,781 during fiscal 2001. The increase in cash
used from operations during fiscal 2002 over cash provided from operations for
fiscal 2001 was primarily due to the increase in accounts receivable resulting
from higher revenues in the fourth quarter of fiscal 2002 as compared to the
fourth quarter of fiscal 2001 offset in part by the higher level of net income
in fiscal 2002 as compared to fiscal 2001. 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 $4,585,959 was used in investing activities in fiscal 2002 primarily
for the acquisitions of the ACTIV-e Solutions and the ThinSTAR product line. Net
cash of $2,341,986 was used in investing activities in fiscal 2001, primarily
for the Capio product line acquired from Boundless Technologies, Inc. Net cash
of $10,748,507 was generated in financing activities during fiscal 2002
primarily as a result of the proceeds from the private placement of the
Company's Common Stock. Net cash of $69,052 was used in financing activities in
fiscal 2001 primarily as a result of the purchase of treasury stock.
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.
Inflation
The Company believes that inflation has not had a material effect on its costs
and net revenues during the past three years.
Critical Accounting Policies
The Company has identified the following policies as critical to its business
and the understanding of its results of operations. The impact of these policies
is discussed throughout Management's Discussion and Analysis of Financial
Condition and Results of Operations where these policies affect reported and
anticipated financial results. For a detailed discussion on the application of
these and other accounting policies see Note 2 in the Notes to the Consolidated
Financial Statements. Preparation of this Annual Report on Form 10-K requires
the Company's use of estimates and assumptions that affect the reported amounts
of assets, liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported revenue and expense amounts
for the periods being reported. There can be no assurance that the Company's
actual results will not differ from these estimates.
Revenue Recognition
The Company's revenue recognition policy is significant as revenue is a key
component of results of operations. The timing of revenues also affects the
timing of various expenses, such as commission and royalty expenses. The Company
recognizes revenues in accordance with Statement of Position No. 97-2, Software
Revenue Recognition, issued by the American Institute of Certified Public
Accountants. Generally, the Company recognizes revenue upon shipment of products
and revenue related to post-contract services on such shipments is recognized
with the initial sale as the fee is included with the initial license fee,
post-contract services are for one year or less, the cost of providing is not
significant and unspecified upgrades/enhancements offered have historically been
and are expected to be minimal and infrequent. Revenue from service obligations
associated with service contracts is generally recognized ratably over the
service period. 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 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.
The Company records a provision for estimated sales returns and allowances in
the same period that related revenues are recorded. These estimates are based on
historical sales returns, analysis of credit memo data and other known factors.
If the historical data used to calculate these estimates do not properly reflect
future returns, additional provisions could be required which would adversely
affect revenues reported in future periods. The Company's agreements with its
customers typically do not provide for product returns except for very limited
circumstances and the impact of product returns has not historically been a
significant factor in the Company's results of operations.
14
Accounts Receivable
The Company sells products and services to a large number of customers in
various industries worldwide. Trade accounts receivable are exposed to normal
credit risks and the Company provides for potential bad debts based upon the
results of management's review of all significant outstanding invoices and the
age of all of its receivables. The Company also performs ongoing credit reviews
of its customers payment performance and financial condition. If the judgments
made as a result of this review are inaccurate, additional provisions for
potential bad debts may be required which would adversely affect the results of
operations of future periods.
Inventories
Inventories are valued at the lower of cost or market, with cost determined on a
first-in first-out (FIFO) basis. Inventories on hand include the cost of
materials, freight, direct labor and other manufacturing overhead. The Company
regularly reviews its inventories on hand and records any provisions needed for
excess and obsolete inventories based on forecasted demand, new product rollouts
and production requirements. In making these judgments, the Company relies on
historical sales data and on projected sales and new product introduction
forecasts. If these estimates do not properly reflect future results, provisions
for excess and obsolete inventories could be required in future periods.
Income Taxes
The Company records the estimated future tax effects of temporary differences
between the financial reporting and tax bases of assets and liabilities and
amounts reported in the accompanying balance sheets, as well as operating loss
and tax credit carryforwards. The Company exercises judgment relating to
projected future taxable income to determine the recoverability of any tax
assets recorded on the balance sheet. If judgments regarding recoverability of
deferred tax assets are not accurate, the Company could be required to record
additional income tax expense in future periods.
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 may not be able to successfully integrate the acquisitions we have completed
and alliance we have entered into as part of our growth strategy, which may
materially adversely affect our growth and our operating results.
15
Within the last 18 months, we have made three acquisitions and entered
into an alliance with IBM to be the preferred provider of thin client appliance
products to IBM and its customers. We have not yet fully integrated these
businesses or fully implemented the alliance. There is no assurance that we will
successfully integrate these acquisitions into our business or successfully
implement the alliance. In addition, we may be unable to retain key employees or
key business relationships of the acquired businesses and integration of the
businesses may divert the attention and resources of our management. We cannot
assure you that we will achieve anticipated revenue and earnings growth as a
result of these transactions. Our failure to successfully integrate the acquired
businesses into our operations or successfully implement the alliance could have
a material adverse effect upon our business, operating results and financial
condition. Even if the acquisitions and alliance are successfully integrated, we
may not receive the expected benefits of the transactions. Managing acquisition
and alliances requires management resources, which may divert our attention from
other business operations. As a result, the effects of any completed or future
transactions on financial results may differ from our expectations.
Although we have generated an operating profit in the past six reported
quarters, we have a prior history of losses and may experience losses in the
future, which could result in the market price of our common stock declining.
Although we have generated an operating profit in the last six reported
quarters, we have incurred net losses in the past and have an accumulated
deficit of $3.8 million as of June 30, 2002. We expect to continue to incur
significant operating expenses. Our operating expenses increased during the
fiscal year ended June 30, 2002 reflecting the hiring of additional key
personnel as we continue to implement our growth strategy, including the
additional personnel we hired in connection with our alliance with IBM and our
acquisition of the ThinSTAR product line from Network Computing Devices, Inc.
and the acquisition of ACTIV-e Solutions. As a result, we will need to generate
significant revenues to maintain profitability. If we do not maintain
profitability, the market price for our common stock may decline.
Our financial resources may not be enough for our capital and corporate
development needs, and we may not be able to obtain additional financing. A
failure to derive significant revenues would likely cause us to incur 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 software and
embedded Windows and Linux-based computing 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, 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 losses. As a result, our quarterly
operating results could fluctuate.
16
There are factors that may affect the market acceptance of our products, some of
which are beyond our control, including the following:
o the growth and changing requirements of the computing appliance market;
o the quality, price, performance and total cost of ownership of our
products;
o the availability, price, quality and performance of competing products and
technologies; and
o the successful development of our relationships with software providers,
original equipment manufacturers and existing and potential channel
partners.
We may not succeed in developing and marketing our software and
computing appliance products and our operating results may decline as a result.
Our gross margins can vary significantly, based upon a variety of factors. If we
are unable to sustain adequate gross margins we may be unable to reduce
operating expenses in the short term, resulting in losses.
Our gross margins can vary significantly from quarter to quarter
depending on average selling prices, fixed costs in relation to revenue levels
and the mix of our business, including the percentage of revenues derived from
hardware, software and consulting services. 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 we
compete remains very competitive, and although we intend to continue our efforts
to reduce the cost of our products, there can be no certainty that we will not
be required to reduce prices of our products without compensating reductions in
the cost to produce our products in order to increase our market share or to
meet competitors' price reductions.
Our business is dependent on customer adoption of Windows and Linux-based
computing 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 computing appliances to perform
discrete tasks for corporate and Internet-based networks to increase our
revenues. If the role of computing appliances does not increase as we
anticipate, or if it in any way decreases, our revenues would not materialize.
If corporate information technology organizations do not accept Windows or
Linux-based embedded operating systems, or if there is a wide acceptance of
alternative operating systems that provide enhanced capabilities, our operating
results could be harmed.
The computing appliance market in which we compete is new and
unpredictable, and if this market does not develop and expand as we anticipate,
our revenues may not grow.
Because some of our products use embedded versions of Microsoft Windows as their
operating system, an inability to license these operating systems on favorable
terms could impair our ability to introduce new products and maintain market
share.
17
We may not be able to introduce new products on a timely basis because
some of our products use embedded versions of Microsoft Windows as their
operating system. Microsoft Corporation provides Windows to us, and we do not
have access to the source code for Windows. If Microsoft fails to continue to
enhance and develop its embedded operating systems, or if we are unable to
license these operating systems on favorable terms, our operations may suffer.
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 new products and maintain market share.
We may not be able to release 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, 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 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.
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 some of our computing
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. A significant
portion of our revenues is derived from the sale of computing appliances that
are bundled with our software. These computing appliances are produced for us by
third parties. If we experience shortages of these products, or of their
components, we may not be able to deliver our products to our customers, and our
revenues would decline.
If we are unable to continue generating substantial revenues from international
sales our business could be adversely affected.
Currently, approximately 30% of our revenues come from international
sales. Our ability to sell our products internationally is subject to a number
of risks. General economic and political conditions in each country could
adversely affect demand for our products and services in these markets. Currency
exchange rate fluctuations could result in lower demand for our products, as
well as currency translation losses. Changes to and compliance with a variety of
foreign laws and regulations may increase our cost of doing business in these
jurisdictions. Trade protection measures and import and export licensing
requirements subject us to additional regulation and may prevent us from
shipping products to a particular market, and increase our operating costs.
Because we rely on channel partners to sell our 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.
18
As a result of our acquisition of the ThinSTAR product line from NCD,
we rely on NCD for the distribution of our ThinSTAR products in Europe. If NCD
were to discontinue sales of our products or reduce its sales efforts, it could
adversely affect our operating results. In addition, there can be no assurance
as to NCD's continued viability and financial condition.
As a result of our alliance with IBM, we rely on IBM for distribution
of our products to IBM's customers. If IBM were to discontinue sales of our
products or reduce its sales efforts, it could adversely affect our operating
results.
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 computing appliances, we face significant competition
from larger companies which 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.
Our future competitive performance depends on a number of factors,
including our ability to:
o continually develop and introduce new products and services with better
prices and performance than offered by our competitors;
o offer a wide range of products; and
o 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.
Computing 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 Appliance Computing market is characterized by rapid technological
change, frequent new product introductions, 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.
19
We may not be able to attract software developers to bundle their products with
our computing appliances.
Our computing 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 computing appliances for certain important
target markets, and our financial results will suffer.
In order to continue to grow our revenues, we may need to hire additional
personnel, including software engineers.
In order to continue to develop and market our line of computing
appliances, we may need to hire additional software engineers as well as
marketing and sales personnel. Competition for employees with these skills is
significant and we may experience difficulty in attracting suitably qualified
people.
Future growth that we may 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:
o improve existing and implement new operational, financial and management
information controls, reporting systems and procedures;
o hire, train and manage additional qualified personnel; and
o 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. The loss of any
of our key employees could adversely affect our business and profits and slow
our product development processes.
Errors in our products could harm our business and our operating results.
Because our software and computing 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:
o the loss of or delay in market acceptance and sales of our products;
o diversion of development resources;
o injury to our reputation; or
o increased maintenance and warranty costs.
20
These problems could harm our business and future operating results.
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.
Our IT services operations, which we acquired from ACTIV-e Solutions, would
suffer and we could lose our customers or fail to attract new customers if we
are unable to attract and retain qualified personnel.
Our IT services business is labor-intensive, and our success depends in
large part upon our ability to attract, develop, motivate and retain highly
skilled personnel. Some of these individuals are in great demand and are likely
to remain a limited resource for the foreseeable future. We may not be able to
engage the services of such personnel or retain our current personnel. If we do
not succeed in attracting new, qualified personnel or successfully retaining our
current personnel, our IT services business will suffer.
If our contracts with Citrix and other vendors of hardware components and
software applications and hardware were terminated, our IT services business
would be materially adversely affected.
We depend on third-party suppliers to provide us with key hardware
components and software applications in connection with our IT services
business. If such contracts and relationships were terminated, our IT revenues
would be negatively affected.
Our use of Arthur Andersen LLP as our independent auditor may pose risks to us
and limit our ability to seek potential recoveries from them related to their
work.
Our consolidated financial statements as of and for each of the three
years in the period ended June 30, 2001 were audited by Arthur Andersen LLP
(Andersen). On March 14, 2002, Andersen was indicted on federal obstruction of
justice charges arising from the government's investigation of Enron
Corporation. On June 15, 2002, a jury convicted Andersen of these charges. On
July 23, 2002, we dismissed Andersen and retained KPMG LLP as our independent
auditors for our current fiscal year ended June 30, 2002. SEC rules require us
to present historical audited financial statements in various SEC filings, such
as registration statements, along with Andersen's consent to our inclusion of
its audit report in those filings. Since our former engagement partner and audit
manager have left Andersen and in light of the cessation of Andersen's SEC
practice, we will not be able to obtain the consent of Andersen to the inclusion
of its audit report in our relevant current and future filings. The SEC has
provided regulatory relief designed to allow companies that file reports with
the SEC to dispense with the requirement to file a consent of Andersen in
certain circumstances, but purchasers of securities sold under our registration
statements, which were not filed with the consent of Andersen to the inclusion
of its audit report, will not be able to sue Andersen pursuant to Section
11(a)(4) of the Securities Act and therefore their right of recovery under that
section may be limited as a result of the lack of our ability to obtain
Andersen's consent.
21
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 results, lower inventory levels, increased sales, the
Company's competitive position, the reduction of the cost of producing the
Company's products, the cost benefits and other advantages of the Company's
products, the acquisition of businesses and technologies, the establishment of
strategic partnerships and other relationships, the availability of cash or
other financing sources to fund future operations and acquisitions, the
enhancement of the Company's technology, the investment of significant resources
in software development activities, the growth in the thin client market, and
the development of new products. 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 computing appliance products, pricing
pressures, rapid technological changes in the industry, growth of the computing
appliance market, increased competition, the Company's ability to attract and
retain qualified personnel, changes in general economic conditions and risks
associated with foreign operations and political and economic uncertainties
associated with current world events.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Risk
The Company earns interest income from its balances of cash and cash
equivalents. This interest income is subject to market risk related to changes
in interest rates which primarily affects the investment portfolio. The Company
invests in instruments that meet high credit quality standards, as specified in
its investment policy.
As of June 30, 2002, cash equivalents consisted primarily of certificates of
deposit, commercial paper and money market funds maturing over the following
three months. Due to the average maturity and conservative nature of the
Company's investment portfolio, a sudden change in interest rates would not have
a material effect on the value of the portfolio.
Management estimates that if the average yield of the Company's investments
decreased by 100 basis points, interest income for the year ended June 30, 2002
would have decreased by less than $150,000. This estimate assumes that the
decrease occurred on July 1, 2001 and reduced the yield of each investment
instrument by 100 basis points.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements of the Company are filed under this Item 8, beginning
on page 30 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
At the direction of the Board of Directors of the Company, acting upon the
recommendation of its Audit Committee, on July 23, 2002, the Company dismissed
Arthur Andersen LLP ("Andersen") as the Company's independent public
accountants.
Andersen's reports on the Company's consolidated financial statements for the
fiscal years ended June 30, 2001 and June 30, 2000 did not contain an adverse
opinion or disclaimer of opinion, nor were they qualified or modified as to
uncertainty, audit scope or accounting principles. During the Company's two most
recent fiscal years ended June 30, 2001 and through July 23, 2002, there were no
disagreements with Andersen on any matter of accounting principle or practice,
financial statement disclosure, or auditing scope or procedure which, if not
resolved to Andersen's satisfaction, would have caused Andersen to make
reference to the subject matter in connection with their reports on the
Company's consolidated financial statements for such fiscal years. There were no
reportable events as defined in Item 304(a)(1)(v) of Regulation S-K during the
period set forth in the preceding sentence.
The Company provided Andersen with a copy of the foregoing disclosures and
requested Andersen to furnish a letter addressed to the Securities and Exchange
Commission stating whether it agrees with the above statements. The Company was
advised that Andersen no longer had the ability to provide such letters, and
therefore the Company relied on the provisions of Item 304T(b)(2) to excuse its
inability to comply with the requirements of Item 304(a)(3).
In addition, at the direction of the Board of Directors of the Company, acting
upon the recommendation of its Audit Committee, on July 23, 2002, the Company
engaged KPMG LLP ("KPMG") to serve as the Company's independent public
accountants for the fiscal year ended June 30, 2002. During the Company's two
most recent fiscal years and through July 23, 2002, the Company did not consult
KPMG with respect to the application of accounting principles to a specified
transaction, either completed or proposed, or the type of audit opinion that
might be rendered on the Company's consolidated financial statements, or any
other matters or reportable events as set forth Items 304(a)(2)(i) and (ii) of
Regulation S-K.
22
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 2002 Annual Meeting of Stockholders.
The following individuals are the current executive officers of the
Company:
Name Age Position
---- --- --------
Michael G. Kantrowitz 42 President and Chief Executive Officer
Steven B. Ahlbom 52 Vice President of Operations
Edward M. Parks 50 Vice President of Engineering
Vincent T. Dolan 59 Vice President of Finance and Administration
Anthony J. DePaul 58 Executive Vice President of Sales
Howard L. Hunger 56 Executive Vice President of Marketing and
Business Development
Mr. Kantrowitz has been President and Chief Executive Officer of the Company
since February 14, 2000. Prior to his appointment as President and CEO, Mr.
Kantrowitz served as Executive Vice President of the Company responsible for
Marketing, Sales and Business Development and as a Director of the Company since
March 2, 1995. Prior to this, Mr. Kantrowitz was a senior executive 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 engineering and technical positions with
Raytheon Company and Adage Corporation. Mr. Kantrowitz holds a BSEE in
Electrical Engineering from the University of Lowell.
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
WorldWide 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.
23
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.
Mr. DePaul has served as Executive Vice President of Sales since the acquisition
of ACTIV-e Solutions on December 4, 2001 where he served as Chairman and Chief
Executive Officer from 1999 to 2001. Prior to that Mr. DePaul was Chief
Executive Officer of Zurich Payroll Solutions, a payroll services company, from
1997 to 1999. Mr. DePaul also served as Vice President of Sales for Decision
One, a national computer services Company from 1995 to 1996. During 1996 and
1997, Mr. DePaul founded Infinity Systems, a computer imaging services company.
Mr. Hunger has been Executive Vice President of Marketing and Business
Development since March 4, 2002. Mr. Hunger joined the Company following a 33
year career at IBM. Most recently, from 1996 to 2002, he was the Director of
Marketing for IBM Net Devices, responsible for the worldwide marketing, and the
key spokesperson for, IBM's thin client product line. Mr. Hunger joined IBM in
1968 and held various executive positions since 1986. He has been a member of
the Board of Directors of the Information Technology Association of America
(ITAA) and the American Software Association, and has been a member of the
national advisory board of the Business Practices Survey of the Massachusetts
Computer Software Council.
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 2002 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" and "Equity Compensation
Plan Information" under "Executive Compensation" in the Company's definitive
proxy statement for its 2002 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 2002 Annual Meeting of Stockholders.
24
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K.
(a)(1) Financial Statements
- -----------------------------
See Index to Financial Statements at page 30.
(a)(2) 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.
(a)(3) 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
- ------- -----------
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)(4)
4.1 Common Stock Purchase Warrants held by GKN Securities Corp. and two
affiliated persons (Pursuant to Instruction 2 to Item 601 of Regulation
S-K, the Warrants, which are identical in all material respects except
as to the parties thereto and the number of Warrants held by the
affiliated persons are not being filed) (Exhibit 4.2)(7).
4.1.1 Warrant to purchase 48,000 shares of Common Stock dated May 22, 2002 in
favor of Emerging Growth Equities, Ltd.(Exhibit 99.3)(10)
10.1 Lease between the Registrant and GBF Partners, as amended. (Exhibit
10.9)(3)
10.2 Second Amendment to Commercial Lease, dated July 31, 2000, between the
Registrant and GBF Partners.(Exhibit 10.3)(6)
10.3+ 1995 Stock Option Plan (as amended on May 16, 2000). (Exhibit 10.2)(5)
10.4+ Employment Agreement, dated February 14, 2000, between the Registrant
and Michael G. Kantrowitz. (Exhibit 10.1)(5)
10.5+ Employment Agreement, dated June 10, 1999 between the Registrant and
Edward M. Parks. (Exhibit 10.7)(4)
10.6+ Letter agreement, dated October 1, 1998 between the Registrant and
Steven Ahlbom. (Exhibit 10.8)(4)
10.7+ Letter Agreement, dated January 27, 1999, between the Registrant and
Vincent T. Dolan. (Exhibit 10.9)(6)
10.8+ 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. (Exhibit 10.10)(6)
25
10.9+ 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. (Exhibit 10.11)(6)
10.10+ Employment Agreement, dated December 4, 2001 between the Registrant and
Anthony J. DePaul (Exhibit 10.1)(8)
10.11+ 2002 Non-Qualified Stock Option Plan (Exhibit 10.2)(8)
10.12+ Employment Agreement, dated February 12, 2002 between the Registrant
and Howard L. Hunger (Exhibit 10.1)(9)
10.13 Securities Purchase Agreement dated May 22, 2002 among the Registrant
and the persons listed as Purchasers therein(Exhibit 99.1)(10)
10.14 Registration Rights Agreement dated May 22, 2002 among the Registrant,
Emerging Growth Equities, Ltd. and the investors named therein(Exhibit
99.2)(10)
10.15+* Note, dated April 17, 2002, of Howard L. Hunger to the Registrant and
Pledge Agreement dated April 17, 2002, between the Registrant and
Howard L. Hunger
21.* Subsidiaries
23.1* Consent of KPMG LLP
23.2* Notice Regarding Consent of Arthur Andersen LLP
99.1* Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
99.2* Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
* 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 the Company's Registration Statement on Form S-4
(File No. 33-87036) filed with the SEC on December 6, 1994.
(4) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
year ended June 30, 1999.
(5) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2000.
26
(6) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
year ended June 30, 2000.
(7) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
year ended June 30, 2001.
(8) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for
the quarter ended December 31, 2001.
(9) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2002.
(10) Filed as an Exhibit to Amendment No. 1 to the Company's Registration
Statement on Form S-3 (No. 333-85490) filed with the Securities and
Exchange Commission on June 5, 2002.
(b) The Company filed the following reports on Form 8-K during the last
quarter of fiscal 2002:
On April 2, 2002, the Company filed a current report on Form 8-K
pursuant to Item 2, announcing its acquisition of Network Computing Devices,
Inc.'s ThinSTAR thin client appliance product line on March 26, 2002.
On April 9, 2002, the Company filed a current report on Form 8-K
pursuant to Item 5, announcing the issuance of a press release stating a
preliminary estimate of its revenues for the quarter ended March 31, 2002.
On May 30, 2002, the Company filed a current report on Form 8-K
pursuant to Item 5, announcing the completion of a $12 million private placement
of 1.6 million shares its Common Stock to accredited investors.
On June 3, 2002, the Company filed a current report on Form 8-K
pursuant to Item 2, to provide the required financial information in connection
with its acquisition of the ThinSTAR thin client product line from Network
Computing Devices, Inc., a Delaware corporation.
On June 20, 2002, the Company filed a current report on Form 8-K
pursuant to Item 7, amending its current report on Form 8-K/A filed on June 3,
2002 solely to include the independent public accountants' name in the Report of
Independent Certified Public Accountants issued by BDO Seidman, LLP with respect
to the statement of revenues and expenses of the ThinSTAR product line of
Network Computing Devices, Inc.
27
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 30, 2002 By: /s/ Michael G. Kantrowitz.
------------------ --------------------------
Michael G. Kantrowitz
President and Chief
Executive Officer
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 of 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 30, 2002
- -------------------------------
Arthur R. Spector
/s/ Michael G. Kantrowitz President, Chief Executive September 30, 2002
- ------------------------------- Officer and Director (Principal
Michael G. Kantrowitz Executive Officer)
/s/ Vincent T. Dolan Vice President of Finance and September 30, 2002
- ------------------------------- Administration (Principal Financial
Vincent T. Dolan Officer and Principal Accounting
Officer)
/s/ John M. Ryan Director September 30, 2002
- -------------------------------
John M. Ryan
/s/ Carl G. Sempier Director September 30, 2002
- -------------------------------
Carl G. Sempier
/s/ Christopher G. McCann Director September 30, 2002
- -------------------------------
Christopher G. McCann
28
CERTIFICATIONS
I, Michael Kantrowitz, President and Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Neoware Systems, Inc.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
Date: September 30, 2002
/s/ Michael Kantrowitz
Michael Kantrowitz
President and Chief Executive Officer
I, Vincent T. Dolan, Chief Financial Officer and Chief Accounting Officer,
certify that:
1. I have reviewed this annual report on Form 10-K of Neoware Systems, Inc.
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report.
Date: September 30, 2002
/s/ Vincent T. Dolan
Vincent T. Dolan
Chief Financial Officer and Chief Accounting Officer
29
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
Page
----
Neoware Systems, Inc. and Subsidiaries
Independent Auditors' Report 31
Report of Independent Public Accountants 32
Consolidated Financial Statements:
Consolidated Balance Sheets as of June 30, 2002 and 2001 33
Consolidated Statements of Operations for the years ended June 30, 2002, 2001 and 2000 34
Consolidated Statements of Stockholders' Equity for the years ended June 30, 2002, 2001 and 2000 35
Consolidated Statements of Cash Flows for the years ended June 30, 2002, 2001 and 2000 36
Notes to Consolidated Financial Statements 37
30
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Neoware Systems, Inc.:
We have audited the 2002 consolidated financial statements of Neoware Systems,
Inc. and subsidiaries as listed in the accompanying index. 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 audit. The 2001 and 2000 consolidated financial statements of Neoware
Systems, Inc. and subsidiaries as listed in the accompanying index were audited
by other auditors who have ceased operations. Those auditors expressed an
unqualified opinion on those financial statements in their report dated August
17, 2001.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. 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 audit provides a
reasonable basis for our opinion.
In our opinion, the 2002 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Neoware
Systems, Inc. and subsidiaries as of June 30, 2002 and the results of their
operations and their cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
Philadelphia, Pennsylvania
August 23, 2002
31
Below is a copy of the report previously issued by Arthur Andersen LLP in
connection with Neoware System's, Inc.'s filing on Form 10-K for the year ended
June 30, 2001. This audit report has not been reissued by Arthur Andersen LLP in
connection with this filing on Form 10-K. See Exhibit 23.2 for further
discussion. The consolidated balance sheet as of June 30, 2000 and the
consolidated statements of operations, stockholders' equity and cash flows for
the year ended June 30, 1999 have not been included in the accompanying
financial statements.
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, 2001 and 2000, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended June 30, 2001. 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, 2001 and 2000, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
2001 in conformity with accounting principles generally accepted in the United
States.
/s/ Arthur Andersen LLP
Philadelphia, Pa.,
August 17, 2001
32
NEOWARE SYSTEMS, INC.
---------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
June 30
-----------------------------------------
ASSETS 2002 2001
- ------ ---------------- ------------------
CURRENT ASSETS:
Cash and cash equivalents $ 17,031,422 $ 11,712,535
Marketable equity securities 183,333 366,667
Accounts receivable, net of allowance for doubtful accounts of $351,131
and $188,151 9,520,558 3,502,013
Inventories 1,040,851 458,736
Prepaid expenses and other 551,598 369,529
Notes receivable from officers -- 26,072
Deferred income taxes 1,394,864 --
--------------- ---------------
Total current assets 29,722,626 16,435,552
PROPERTY AND EQUIPMENT, net 622,235 199,397
CAPITALIZED AND PURCHASED SOFTWARE, net 47,779 77,247
NOTES RECEIVABLE FROM OFFICERS 263,732 52,193
DEFERRED INCOME TAXES 173,648 --
GOODWILL AND OTHER INTANGIBLES 11,568,940 2,024,453
--------------- ---------------
$ 42,398,960 $ 18,788,842
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 3,111,164 $ 935,943
Accrued expenses 2,136,776 1,473,718
Capital lease obligations 63,037 --
Deferred revenue 582,290 289,278
--------------- ---------------
Total current liabilities 5,893,267 2,698,939
--------------- ---------------
CAPTIAL LEASE OBLIGATIONS 204,131 --
--------------- ---------------
COMMITMENTS AND CONTINGENCIES (Note 11)
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, 12,935,615 and
10,279,663 shares issued and 12,835,615 and 10,179,663 shares outstanding 12,936 10,280
Additional paid-in capital 40,291,861 24,524,567
Treasury stock, 100,000 shares at cost (100,000) (100,000)
Other comprehensive income (loss) (116,672) 66,667
Accumulated deficit (3,786,563) (8,411,611)
--------------- ---------------
Total stockholders' equity 36,301,562 16,089,903
--------------- ---------------
$ 42,398,960 $ 18,788,842
=============== ===============
See accompanying notes to consolidated financial statements.
33
NEOWARE SYSTEMS, INC.
---------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
Year Ended June 30,
-------------------------------------------------------
2002 2001 2000
--------------- --------------- ---------------
NET REVENUES $ 34,309,667 $ 17,654,825 $ 11,044,870
COST OF REVENUES 20,345,034 11,692,775 8,726,096
--------------- --------------- ---------------
Gross profit 13,964,633 5,962,050 2,318,774
--------------- --------------- ---------------
OPERATING EXPENSES:
Sales and marketing 6,381,124 3,058,008 1,599,209
Research and development 1,441,359 955,386 648,548
General and administrative 3,159,875 2,171,280 1,711,918
Acquisition related costs -- 245,839 471,110
--------------- --------------- ---------------
Total operating expenses 10,982,358 6,430,513 4,430,785
--------------- --------------- ---------------
Operating income (loss) 2,982,275 (468,463) (2,112,011)
LOSS ON INVESTMENT -- (812,000) --
INTEREST INCOME, net 296,045 771,695 291,900
--------------- --------------- ---------------
Income (loss) before income taxes 3,278,320 (508,768) (1,820,111)
INCOME TAXES (1,346,728) -- --
--------------- --------------- ---------------
NET INCOME (LOSS) $ 4,625,048 $ (508,768) $ (1,820,111)
=============== =============== ===============
BASIC INCOME (LOSS) PER SHARE $ 0.42 $ (0.05) $ (0.25)
=============== =============== ===============
DILUTED INCOME (LOSS) PER SHARE $ 0.39 $ (0.05) $ (0.25)
=============== =============== ===============
WEIGHTED AVERAGE NUMBER OF SHARES USED IN BASIC
EARNINGS (LOSS) PER SHARE CALCULATION 10,904,565 10,226,316 7,374,692
=============== =============== ===============
WEIGHTED AVERAGE NUMBER OF SHARES USED IN
DILUTED EARNINGS (LOSS) PER SHARE CALCULATION 11,851,327 10,226,316 7,374,692
=============== =============== ===============
See accompanying notes to consolidated financial statements.
34
NEOWARE SYSTEMS, INC.
---------------------
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
----------------------------------------------
Additional Other
Common Stock Paid-in Treasury Comprehensive Accumulated
Shares Amount Capital Stock Income (Loss) Deficit Total
---------- ------- ----------- --------- ------------- ----------- -----------
BALANCE AT JUNE 30, 1999 6,285,782 $ 6,286 $10,178,357 $ -- $ -- $(6,082,732) $ 4,101,911
Net loss -- -- -- -- -- (1,820,111) (1,820,111)
Exercise of warrants 3,725,853 3,726 13,901,036 -- -- -- 13,904,762
Exercise of stock options 263,528 263 290,255 -- -- -- 290,518
---------- ------- ----------- --------- --------- ----------- -----------
BALANCE AT JUNE 30, 2000 10,275,163 10,275 24,369,648 -- -- (7,902,843) 16,477,080
-----------
Net loss -- -- -- -- -- (508,768) (508,768)
Unrealized gain on marketable equity
securities -- -- -- -- 66,667 -- 66,667
-----------
Total comprehensive loss (442,101)
Issuance of warrants -- -- 150,000 -- -- -- 150,000
Purchase of treasury stock (100,000) -- -- (100,000) -- -- (100,000)
Exercise of stock options 4,500 5 4,919 -- -- -- 4,924
---------- ------- ----------- -------- --------- ----------- -----------
BALANCE AT JUNE 30, 2001 10,179,663 10,280 24,524,567 (100,000) 66,667 (8,411,611) 16,089,903
-----------
Net income -- -- -- -- -- 4,625,048 4,625,048
Unrealized loss on marketable equity
securities -- -- -- -- (183,339) -- (183,339)
-----------
Total comprehensive income 4,441,709
Issuance of common stock, net of
expenses 1,600,000 1,600 11,191,116 -- -- -- 11,192,716
Shares issued for acquisition 569,727 570 1,845,345 -- -- -- 1,845,915
Shares issued for alliance 375,000 375 2,347,125 -- -- -- 2,347,500
Exercise of stock options 111,225 111 162,677 -- -- -- 162,788
Tax benefits related to stock options -- -- 221,031 -- -- -- 221,031
---------- ------- ----------- --------- --------- ----------- -----------
BALANCE AT JUNE 30, 2002 12,835,615 $12,936 $40,291,861 $(100,000) $(116,672) $(3,786,563) $36,301,562
========== ======= =========== ========= ========= =========== ===========
See accompanying notes to consolidated financial statements.
35
NEOWARE SYSTEMS, INC.
---------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
For the Year Ended June 30,
----------------------------------------------
2002 2001 2000
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 4,625,048 $ (508,768) $(1,820,111)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities-
Depreciation and amortization 496,233 363,766 523,398
Loss on investment -- 812,000 --
Provision for inventory obsolescence -- -- 130,000
Write-down of property and equipment -- -- 35,000
Deferred income tax benefit (1,347,481) -- --
Changes in operating assets and liabilities-
(Increase) decrease in:
Accounts receivable (5,670,353) (1,433,783) 518,463
Inventories (578,166) 661,108 74,580
Prepaid expenses and other (57,119) (110,182) 15,126
Increase (decrease) in:
Accounts payable 1,050,851 (218,029) (500,954)
Accrued expenses 498,114 871,077 (503,747)
Deferred revenue 139,212 (145,408) 115,014
----------- ----------- -----------
Net cash provided by (used in)
operating activities (843,661) 291,781 (1,413,231)
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of ACTIV-e Solutions, Inc. (220,649) -- --
Purchase of Network Computing Devices ThinSTAR product line (4,172,414) -- --
Capitalized and purchased software -- (66,932) (139,788)
Purchase of Boundless Technologies, Inc. Capio product line (12,420) (1,874,453) --
Alliance agreement transaction costs (52,152) -- --
Purchase of marketable securities -- (300,000) --
Purchases of property and equipment, net (128,324) (100,601) (34,087)
----------- ----------- -----------
Net cash provided by (used in)
investing activities (4,585,959) (2,341,986) (173,875)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net of expenses 11,192,716 -- --
Exercise of warrants -- -- 13,904,762
Purchase of treasury stock -- (100,000) --
Repayments of bank debt (388,213) -- --
Exercise of stock options 162,788 4,925 290,518
Repayments under line of credit -- -- (143,000)
Repayments of capital leases (33,317) -- --
Loan to officer (263,732) -- --
Decrease (increase) in notes receivable 78,265 26,023 (104,288)
----------- ----------- -----------
Net cash provided by (used in)
financing activities 10,748,507 (69,052) 13,947,992
----------- ----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 5,318,887 (2,119,257) 12,360,886
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 11,712,535 13,831,792 1,470,906
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEARD $17,031,422 $11,712,535 $13,831,792
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES:
Cash paid for income taxes $ 25,000 $ -- $ --
Cash paid for interest 26,422 8,563 18,642
Cash received for interest 365,151 828,636 326,278
See accompanying notes to consolidated financial statements.
36
NEOWARE SYSTEMS, INC.
---------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1. COMPANY BACKGROUND:
-------------------
Neoware Systems, Inc. (the "Company") provides software, services and solutions
to enable Appliance Computing, a new Internet-based computing architecture
targeted at business customers that is designed to be simpler and easier than
traditional PC-based computing. The Company's software and management tools
power and manage a new generation of smart computing appliances that utilize the
benefits of open, industry-standard technologies to create new alternatives to
personal computers used in business and a wide variety of proprietary business
devices. The Company's Eon, Capio and ThinSTAR products are thin client
computing appliances which are cost-effective alternatives to personal computers
used by businesses, and are powerful replacements for green-screen terminals.
Used in conjunction with Citrix MetaFrame or Microsoft Terminal Services, the
Company's computing appliances allow users to run computer applications from a
server, plus connect to mainframes, midrange systems and the Internet. Unlike
personal computers, computing appliances can be centrally managed and remotely
configured, which greatly simplifies administration.
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.
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.
Significant estimates include the allowance for doubtful accounts and inventory
reserves. 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, 2002 and 2001 consist of
investments in commercial paper, money market funds and certificates of deposit.
Marketable Securities
- ---------------------
The Company's marketable equity securities have been classified as
"available-for-sale" under the provisions of Statement of Financial Accounting
Standards No. ("SFAS") 115, "Accounting for Certain Investments in Debt and
Equity Securities" and are reported at estimated fair value, with the
accumulated other comprehensive income (unrealized gains and losses) reported as
a separate component of stockholders' equity. Accumulated other comprehensive
income and loss reported in stockholders' equity was a loss of $116,672 at June
30, 2002 and income of $66,667 at June 30, 2001. The Company owned 300,000
shares of Boundless Corporation common stock at June 30, 2002 and June 30, 2001,
which has been classified as current, available-for-sale securities (see Note
3).
37
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 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.
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. Leasehold
improvements are amortized over the lesser of the estimated useful life of the
asset or the lease term. Depreciation and amortization are provided using the
straight-line method over the estimated useful lives of the assets as follows:
Computer equipment 3-5 years
Office furniture and equipment 5-7 years
Leasehold improvements 5 years
Other 3-5 years
Goodwill and Other Intangibles
- ------------------------------
Goodwill represents the excess of the purchase price over the fair value of net
assets acquired. The Company assesses goodwill at least annually for impairment
using a fair value based approach. Other intangible assets are valued at the
lower of amortized cost or fair market value and, except for tradenames, are
amortized on a straight-line basis over the expected periods to be benefited,
which currently is five to ten years.
Revenue Recognition
- -------------------
The Company's products include both a hardware and software component. In
accordance with Statement of Position No. 97-2, "Software Revenue Recognition"
("SOP 97-2"), software revenue recognition should be followed for products or
services where a software element exists, unless the software is incidental to
the product being sold. The software has been deemed to be essential to the
functionality of the hardware and, therefore, SOP 97-2 has been followed for
revenue recognition. Revenue is recognized on product sales when a formal
arrangement exists, delivery of the product has occurred or title has
transferred, the fee is fixed or determinable and collectibility is probable.
Revenue related to post contract services is generally recognized with the
initial sale as the fee is included with the initial licensing fee,
post-contract services are typically for one year or less, the estimated cost of
providing such services during the arrangement is deemed insignificant, and
unspecified upgrades/enhancements offered during the period historically have
been and are expected to continue to be minimal and infrequent. Revenue from
consulting services is recognized upon performance. Product warranty costs and
an allowance for sales returns are accrued at the time revenues are recognized.
38
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 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 $607,980, $335,119 and $60,587 for the years ended June 30, 2002,
2001 and 2000, respectively. Accounts receivable relating to "bill and hold"
transactions were $233,279 and $335,119 at June 30, 2002 and 2001, respectively.
Research and Development
- ------------------------
Costs incurred in the development of new 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 zero,
$66,932 and $139,788 of software development cost and amortized $29,468,
$230,630 and $242,377 in fiscal 2002, 2001 and 2000, respectively. Accumulated
amortization was $1,083,573 and $1,054,105 at June 30, 2002 and 2001,
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.
Earnings Per Share
- ------------------
Basic earnings per share (EPS) is computed by dividing net 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, 2002, the Company has
options and warrants outstanding to purchase 2,272,370 shares of common stock at
prices ranging from $0.84 to $ 10.04. For the year ended June 30, 2002, 84,500
options to purchase shares of common stock and 48,000 warrants to purchase
shares of common stock were not included in the computation of diluted EPS as
the impact would have been antidilutive. However, these options and warrants may
be dilutive in the future. For the years ended 2001 and 2000, there were no
dilutive effects of stock options or warrants as the Company incurred a net
loss.
39
The following table sets forth the computation of basic and diluted earnings per
share:
For the year ended June 30,
---------------------------------------------------------
2002 2001 2000
-------------- ------------------ -----------------
Net income (loss) $4,625,048 $(508,768) $(1,820,111)
============= ================= ================
Weighted average shares outstanding:
Basic 10,904,565 10,226,316 7,374,692
Dilutive effect of stock options and warrants 946,762 - -
------------- ----------------- ----------------
Diluted 11,851,327 10,226,316 7,374,692
============= ================= ================
Earnings (loss) per common share:
Basic $0.42 $(0.05) $(0.25)
============= ================= ================
Diluted $0.39 $(0.05) $(0.25)
============= ================= ================
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.
Comprehensive Income
- --------------------
The Company follows SFAS No. 130, "Reporting Comprehensive Income," which
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 year ended June 30, 2002 and 2001, the Company's comprehensive income (loss)
consisted of net income (loss) and an unrealized (loss) gain of ($183,339) and
$66,667, related to its investment in marketable equity securities,
respectively. There were no sources of other comprehensive income (loss) for the
year ended June 30, 2000.
New Accounting Pronouncements
- -----------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations".
SFAS No. 141 eliminates the use of the pooling-of-interests method of accounting
for business combinations and establishes the purchase method of accounting as
the only acceptable method for all business combinations initiated after June
30, 2001.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." This statement modifies existing generally accepted accounting
principles related to the amortization and impairment of goodwill and other
intangible assets. Upon adoption of the new standard, goodwill, including
goodwill associated with equity method investments, will no longer be amortized.
For the years ended June 30, 2002, 2001 and 1999, there was no goodwill
amortization. In addition, goodwill, other than goodwill associated with equity
method investments, must be assessed at least annually for impairment using a
fair-value based approach. The Company adopted the provisions of this statement
effective July 1, 2001 and there was no impact on the consolidated financial
statements.
40
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations" that applies to legal obligations associated with the retirement of
a tangible long-lived asset that results from the acquisition, construction, or
development and/or the normal operation of a long-lived asset. Companies are
required to adopt the pronouncement in fiscal years beginning after June 15,
2002. Management believes that adoption of this Statement will not have any
impact on the consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long Lived Assets." This statement supercedes FASB Statement No.
121, "Accounting for the Impairment of Long Lived assets and for Long Lived
Assets to be Disposed Of," and the accounting and reporting provisions of APB
Opinion No. 30, "Reporting the Results of Operations Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" for the disposal of a segment of a business.
This statement also amends Accounting Research Bulletin No. 51, "Consolidated
Financial Statements," to eliminate the exception to consolidation for a
subsidiary for which control is likely to be temporary. This statement provides
guidance on financial accounting and reporting for the impairment or disposal of
long lived assets. Companies are required to adopt the pronouncement in fiscal
years beginning after December 15, 2001. Management believes that adoption of
this statement will not have any impact on the consolidated financial
statements.
3. ACQUISITIONS AND ALLIANCE:
--------------------------
On June 28, 2001, the Company acquired the assets of the thin client business of
Boundless Technologies, Inc. (Boundless), which included the Capio product line
and associated software, intellectual property, customer contract rights and
other intangibles. The acquisition was accounted for using the purchase method
of accounting. The purchase price was payable in cash of $1,805,074, including
transaction costs of $205,074. In addition, the Company issued warrants to
purchase 86,095 common shares in the aggregate to a financial advisor and two of
its affiliates for providing acquisition related services (see Note 10). The
fair value of the warrants of $150,000 was also included as part of the purchase
price. The Company also accrued $81,799 of future contractual obligations in
connection with the acquisition. The aggregate purchase price of $2,036,873 has
been recorded as intangible assets, of which $300,000 was allocated to acquired
distribution agreements, $150,000 was allocated to the Capio trade name, and
$1,586,873 was allocated to goodwill. The results of operations of the Capio
product line have been included in the accompanying statement of operations from
the date of the acquisition. For the year ended June 30, 2002, amortization
expense of $60,000 was recorded on the intangible assets relating on the
acquired distribution agreements. Concurrent with the consummation of the
acquisition, the Company made an equity investment of $300,000 in Boundless
which is accounted for as a cost method investment under SFAS 115.
41
On December 4, 2001, the Company acquired all of the assets and assumed
substantially all of the liabilities of Telecom Assistance Center Corporation,
d/b/a ACTIV-e Solutions, a full service Information Technology consulting
company in the server-based computing marketplace. The acquisition was accounted
for using the purchase method of accounting. The purchase price was payable in
cash of $75,000 and, after adjustments as provided for in the acquisition
agreement, an aggregate of 569,727 shares of the Company's newly issued Common
stock with a market value of $3.24 per share at the date of acquisition. In
addition, the Company assumed net liabilities, exclusive of cash acquired of
$9,774, of $1,178,209. The aggregate cost of the acquisition was $3,234,999
(including transaction costs of $145,649), which amount is equal to the excess
purchase price over the value of the net assets acquired. The entire purchase
price has been allocated to goodwill based on management's assessment as
required by SFAS No. 141, "Business Combinations." The results of operations of
ACTIV-e Solutions have been included in the accompanying statement of operations
from the date of the acquisition. The following is a summary of the cash paid
for the purchase of ACTIV-e Solutions:
Cash $ 9,774
Accounts receivable 348,192
Prepaids and other 128,893
Property and equipment 476,518
Goodwill 3,234,999
Bank debt (388,213)
Accounts payable (1,124,370)
Accrued expenses (164,944)
Capital leases (300,485)
Deferred revenue (153,800)
Fair value of stock issued (1,845,915)
-----------
Cash paid $ 220,649
===========
On January 8, 2002, the Company entered into a worldwide alliance with IBM
Corporation under which the Company will be the preferred provider of thin
client appliance products to IBM and its customers. In addition, the Company
licensed from IBM the intellectual property associated with its thin client
appliance products. As consideration for these agreements, the Company issued to
IBM 375,000 newly issued shares of common stock with a fair market value of
$6.26 per share. The fair value of the shares issued of $2,347,500, plus
transaction costs of $52,152 has been allocated to intangible assets. Of the
total consideration, $1,900,000 has been allocated to acquired distribution
agreements with the remainder of $499,652 allocated to acquired technology.
Amortization of the distribution agreements and technology acquired is being
recorded on a straight-line basis over five and ten years, respectively.
Amortization of $214,998 was recorded in the accompanying statement of
operations for the year ended June 30, 2002.
On March 26, 2002, the Company acquired the ThinSTAR product line of Network
Computing Devices, Inc. (NCD). In addition, the Company entered into an alliance
with NCD to grow the worldwide thin client appliance market. The acquisition was
accounted for using the purchase method of accounting. The purchase price was
payable in cash of $4,172,414, including transaction costs of $172,414, and was
allocated to intangible assets. The purchase price includes $300,000 which is
being held in escrow subject to the satisfaction of certain conditions and the
purchase agreement provides for the payment of an additional $250,000 if certain
revenue levels are achieved. The entire purchase price was allocated to goodwill
based on management's assessment as required by SFAS No. 141, "Business
Combinations." The results of operations of NCD have been included in the
accompanying statement of operations from the date of the acquisition.
A registration statement covering the shares issued in connection with the
ACTIV-e acquisition and the IBM alliance was filed on April 3, 2002, and
subsequently declared effective. The agreements with ACTIV-e and IBM provide for
limitations on the number of shares which may be sold within the first twelve
months after effectiveness of the registration statement for the shares granted
to ACTIV-e and within fifteen months of issuance for the shares granted to IBM.
42
The following unaudited pro forma information presents the results of the
Company's operations for the years ended June 30, 2002 and 2001 as though each
of the acquisitions had been completed as of July 1, 2000:
June 30,
2002 2001
---- ----
Total revenue $46,666,157 $ 41,874,919
=========== ============
Net loss $(1,495,844) $(10,033,049)
=========== ============
Basic net loss per share $(0.13) $(0.93)
=========== ============
Diluted net loss per share $(0.13) $(0.93)
=========== ============
The pro forma results have been prepared for comparative purposes only and are
not necessarily indicative of the actual results of operations had the
acquisitions been completed as of July 1, 2000 or the results that may occur in
the future. Shares used to calculate basic and diluted net loss per share
includes the effect of 245,061 and 569,727 additional common shares that would
have been considered outstanding for the year ended June 30, 2002 and 2001,
respectively, had the acquisition of ACTIV-e Solutions been completed as of July
1, 2000.
4. MAJOR CUSTOMERS AND FOREIGN REVENUES:
-------------------------------------
One customer provided 10.2% of total net revenues in fiscal 2002. The accounts
receivable from this customer were $1,879,703 at June 30, 2002. A different
customer provided 10.2% of total net revenues in fiscal 2001. The accounts
receivable for this customer were $5,616 at June 30, 2001. No individual
customer provided more than 10% of revenues in fiscal 2000.
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 2002, 2001 and 2000, were approximately 30%, 24% and
28%, respectively, and were transacted in US dollars.
5. CONSOLIDATED BALANCE SHEET COMPONENTS AND VALUATION ALLOWANCE:
--------------------------------------------------------------
Inventories, net of allowances, consist of the following:
June 30,
-------------------------------
2002 2001
--------------- -------------
Purchased components and subassemblies $ 211,131 $ 167,730
Finished goods 829,720 291,006
------------- -------------
$ 1,040,851 $ 458,736
============= =============
43
Property and equipment consist of the following:
June 30,
--------------------------
2002 2001
----------- -----------
Computer equipment $ 1,424,838 $ 1,010,747
Office furniture and equipment 551,555 382,368
Leasehold improvements 397,949 374,236
Other 130,799 121,921
----------- -----------
2,505,141 1,889,272
Less accumulated depreciation and amortization (1,882,906) (1,689,875)
----------- -----------
$ 622,235 $ 199,397
=========== ===========
Depreciation and amortization expense was $191,767, $133,136 and $208,929 for
the years ended June 30, 2002, 2001 and 2000.
Goodwill and other intangibles consist of the following:
June 30,
-------------------------
2002 2001
----------- ----------
Goodwill $ 8,994,286 $1,574,453
Tradenames 150,000 150,000
Other intangibles:
Distributor relationships 2,200,000 300,000
Acquired technology 499,652 -
----------- ----------
2,699,652 300,000
Accumulated amortization (274,998) -
----------- ----------
Total other intangibles 2,424,654 300,000
----------- ----------
Total intangibles $11,568,940 $2,024,453
=========== ==========
Amortization of intangibles was $274,998 for the year ended June 30, 2002. There
was no amortization for the years ended June 30, 2001 and 2000.
Accrued expenses consist of the following:
June 30,
-------------------------
2002 2001
----------- ----------
Compensation $ 1,170,034 $ 574,324
Software license fees 327,703 302,024
Marketing costs 212,175 206,799
Professional fees 91,000 172,698
Other 335,864 217,873
----------- ----------
$ 2,136,776 $1,473,718
=========== ==========
A rollforward of the allowance for doubtful accounts is as follows:
Year Ended June 30,
---------------------------------
2002 2001 2000
-------- -------- ---------
Beginning balance $188,151 $125,409 $ 196,756
Expense 282,115 66,137 29,338
Write-offs (119,135) (3,395) (100,685)
-------- -------- ---------
Ending balance $351,131 $188,151 $ 125,409
======== ======== =========
44
6. NOTES RECEIVABLE:
-----------------
In April 2002, the Company entered into a note agreement with one officer for
$263,732 in connection with recruiting this individual to provide the officer
with cash to exercise stock options held in a previous employer. The note is
full recourse and is repayable either the earlier of the sale of the related
stock or three years. The note is secured by 8,506 shares on the common stock of
IBM Corporation, which are worth approximately $612,000 at June 30, 2002. The
note bears interest at an annual rate of 5%.
In June 2002, two officers repaid the outstanding balance on notes receivable.
7. LINE OF CREDIT:
---------------
The Company has 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, 2002. Borrowings under the credit agreement
bear interest at the bank's prime rate plus 1/2% (5.25% at June 30, 2002). At
June 30, 2002, there was $2,000,000 available for borrowing under the line.
During fiscal 2002 and 2001, there were no borrowings under the line. During
fiscal 2000, maximum borrowings under the line of credit agreement were
$750,000, the weighted average interest rate was 10.33% and interest thereon
was $13,815.
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. The Company
was in compliance with these requirements.
8. INCOME TAXES:
-------------
The components of income taxes are as follows:
For the Year Ended June 30,
---------------------------------------------
2002 2001 2000
------------- ------------- ----------
Current-
Federal $ -- $ -- $ --
State 753 -- --
-------------- ------------- ------------
753 -- --
-------------- ------------- ------------
Deferred-
Federal (996,071) -- --
State (351,410) -- --
-------------- ------------- ------------
(1,347,481) -- --
-------------- ------------- ------------
$ (1,346,728) $ -- $ --
============== ============= ============
The federal statutory income tax rate is reconciled to the effective tax rate as
follows:
For the Year Ended June 30,
----------------------------------------------
2002 2001 2000
------------- ------------- ----------
Federal statutory rate 34.0 % (34.0)% (34.0)%
State income taxes, net -- -- --
Expenses not deductible
for tax 1.8 0.8 0.4
Valuation allowance (82.2) 59.0 44.1
Other 5.3 (25.8) (10.5)
----- ----- -----
(41.1)% -- % -- %
===== ===== =====
45
In fiscal 2002, the Company recorded a deferred tax asset and additional paid in
capital of $221,031 related to the tax benefits of stock options.
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,
-------------------------
2002 2001
---------- -----------
Gross current deferred income tax asset $1,394,864 $ 2,205,736
Gross current deferred income tax liability -- --
---------- -----------
Total current deferred tax asset 1,394,864 2,205,736
---------- -----------
Gross non-current deferred income tax asset 292,863 521,065
Gross non-current deferred income tax liability (119,215) (30,513)
---------- -----------
Total non-current deferred tax asset 173,648 490,552
---------- -----------
Valuation allowance -- (2,696,288)
---------- -----------
Net deferred tax asset $1,568,512 $ --
========== ===========
The tax effect of significant temporary differences representing deferred tax
assets and liabilities are as follows:
June 30,
-------------------------
2002 2001
---------- -----------
Net operating loss carryforwards $ 951,430 $ 1,874,532
Expenses not currently deductible for tax purposes 295,223 124,528
Deferred revenue 159,139 114,264
Basis difference in property and equipment and
capitalized software 133,725 490,552
Basis difference in inventory 148,210 92,412
Amortization of intangible assets (119,215) --
Valuation allowance -- (2,696,288)
---------- -----------
Net deferred tax asset $1,568,512 $ --
========== ===========
The valuation allowance for deferred tax assets as of June 30, 2001 was
$2,696,288. The net change in the total valuation allowance for the year ended
June 30, 2002 was a decrease of $2,696,288. As of June 30, 2002, the Company
does not have a valuation allowance against the deferred tax assets. In
assessing the realizability of deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities and projected future taxable
income in making this assessment. Based upon the level of historical taxable
income and projections for future taxable income over the periods which the
deferred tax assets are deductible, along with reasonable and prudent tax
planning strategies and the expiration dates of carryforwards, management
believes it is more likely than not the Company will realize the benefits of
these deductible differences at June 30, 2002.
As of June 30, 2002, the Company has net operating loss carryforwards for
federal and state income tax purposes of approximately $1,869,000 and $513,000,
that begin to expire in 2018 and 2005, respectively, and are available to offset
future federal and state taxable income.
9. SALE OF COMMON STOCK:
---------------------
In May 2002, the Company sold 1,600,000 shares of common stock at $7.50 per
share. The price represented an 8% discount from the average closing price for
the 15-day period immediately preceding the sale. Net proceeds to the Company
were $11,192,716 after transaction costs of $807,284. In addition, 48,000
warrants to purchase Common stock were issued to one of the placement agents at
a price of $9.375 per share. The warrants are exerciseable until May 2005. The
Company valued the warrants at $272,941 using the Black-Scholes option pricing
model with the following assumptions: no dividend yield; expected volatility of
114%; risk-free interest rate of 4.9%; and an expected life of three years.
46
10. STOCK OPTIONS AND WARRANTS:
----------------------------
The Company has two stock option plans for employees, directors, and consultants
of the Company. Under the 1995 Stock Option plan (the "1995 Plan"), 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 1995 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 that have been granted expire five
years from the grant date. As of June 30, 2002, there were 92,601 options
available for grant under the 1995 Plan.
The Company has a non-qualified stock option plan (the "2002 Plan") for
employees, directors and consultants who do work for the company. The Company is
authorized to issue options for the purchase of up to 500,000 shares of common
stock, subject to adjustment. Under the terms of the 2002 Plan, the exercise
price of options granted cannot be less than fair market value on the date of
grant. Options generally vest and become exercisable ratably over four years. A
committee established for this purpose, or the board of directors, administers
the 2002 plan. The committee or board may define vesting and expiration dates
for all options granted under the 2002 plan. As of June 30, 2002, there were
278,420 options available for grant under the 2002 Plan.
Options granted under the 1995 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 the Plan.
Options granted under the 2002 Plan contain provisions pursuant to which
outstanding options granted under such Plan may become fully vested and
immediately exercisable upon a "change in control," as defined in the Plan,
subject to the discretion of the committee or the board of directors.
Information with respect to the options under the Company's stock option plans
is as follows:
Weighted
Average
Exercise
Shares Price
--------- -------
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
Granted 220,750 1.90
Exercised (4,500) 1.09
Terminated (83,750) 2.96
---------
Balance as of June 30, 2001 1,676,750 2.12
Granted 655,500 5.10
Exercised (111,225) 1.46
Terminated (82,750) 3.66
---------
Balance as of June 30, 2002 2,138,275 3.01
=========
The following table summarizes information about stock options outstanding as of
June 30, 2002:
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- 1.18 652,500 $ 1.06 1.3 years 618,125 $ 1.06
1.31- 1.96 156,375 1.65 2.7 years 95,531 1.56
2.00- 3.00 631,400 2.73 3.1 years 236,400 2.84
3.12- 4.18 372,000 3.48 3.8 years 67,000 4.10
5.13- 7.25 221,000 6.83 4.4 years 40,000 5.19
7.94-10.04 105,000 9.05 4.7 years --
--------- ---------
2,138,275 1,057,056
========= =========
47
During fiscal 2000, the exercise price on 5,704,842 outstanding warrants was
adjusted from $5.50 to $3.75 per share and were extended to April 14, 2000.
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 June 2001, the Company issued warrants to purchase 86,095 common shares at a
price of $2.20 per share to a financial advisor and two of its affiliates in
connection with acquisition related services provided (see Note 3). The warrants
vested immediately and expire in June 2004. In accordance with SFAS No. 123, the
fair value of the warrants of $150,000 was recorded. The fair value of the
warrants was determined using the Black-Scholes options pricing model using the
following assumptions: dividend yield of zero, weighted average risk free
interest rate of 4.6%, and expected volatility of 114% over the contractual term
of the warrant. The warrants were outstanding at June 30, 2002 and were
exercised in July 2002.
In May 2002, the Company issued warrants to a placement agent for the purchase
of 48,000 common shares at a price of $7.50 per share and were fully vested at
the date of grant (see Note 9). The warrants are outstanding at June 30, 2002
and expire in May 2005.
The Company follows the disclosure requirements of SFAS No. 123, "Accounting for
Stock-Based Compensation". Had compensation cost been calculated based on the
fair value at the grant date for awards in fiscal 2002, 2001 and 2000 consistent
with the provisions of SFAS 123, the Company's net income (loss) per share would
have been changed to the following pro forma amounts:
2002 2001 2000
------------------ ------------------ ------------------
Net income (loss) As reported $ 4,625,048 $ (508,768) $ (1,820,111)
Pro forma $ 3,660,830 $ (1,045,759) $ (2,082,463)
Basic EPS As reported $ 0.42 $ (0.05) $ (0.25)
Pro forma $ 0.34 $ (0.10) $ (0.28)
Diluted EPS As reported $ 0.39 $ (0.05) $ (0.25)
Pro forma $ 0.31 $ (0.10) $ (0.28)
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 2002, 2001 and 2000: no dividend yield;
expected volatility of approximately 70%-120%; risk-free interest rates of
approximately 4.1%-6.8%; and an expected life of five years. The pro forma
effect on net income (loss) for fiscal 2002, 2001 and 2000 is not representative
of the pro forma effect in future years because it does not take into
consideration pro forma compensation expense related to grants made prior to
fiscal 1996.
48
11. 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 two months to four years. Rent expense under these leases was
$289,183, $219,097 and $118,373 in fiscal 2002, 2001 and 2000, respectively.
Future minimum lease payments under operating leases at June 30, 2002 are
$348,583 in fiscal 2003, $325,305 in fiscal 2004, $313,131 in fiscal 2005 and
$151,770 in fiscal 2006.
The Company assumed the liabilities for certain office equipment, computer
hardware and software under capital leases as part of the ACTIV-e Solutions
acquisition. The remaining terms of the leases range from one to four years.
Interest expense under these leases was $18,386 in fiscal 2002. Future minimum
lease payments under capital leases at June 30, 2002 are $63,037 in fiscal 2003,
$68,364 in fiscal 2004, $75,860 in fiscal 2005 and $59,907 in fiscal 2006.
The Company has employment agreements with its six executive officers that
provide for certain levels of base compensation, fringe benefits and incentives.
Three of the agreements provide for salary continuance of six months or one year
of employment if terminated upon certain conditions. In addition, all of the
agreements provide for severance payments in the event of a change in control
and the executive officer is not extended a similar position after the change in
control. If a change of control had occurred on June 30, 2002, and all of the
executive officers had been terminated, severance obligations would have
aggregated approximately $780,000.
The Company, in the normal course of business, may be party to various claims.
Management believes that the ultimate resolution of any such claims would not
have a material impact on the Company's financial position or operating results.
12. 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 6% of such contributions up to a
maximum of $1,000 per participant per year. The Company's contributions were
$68,973, $43,392 and $14,187 in fiscal 2002, 2001 and 2000, respectively.
13. LOSS ON INVESTMENT:
-------------------
In October 1997, the Company merged ITC, a wholly owned subsidiary, into
Broadreach Consulting, Inc. in exchange for a 2% stock interest in Broadreach
and the reimbursement of $1,000,000 of expenses incurred by the Company. Of the
total reimbursement, $300,000 was paid in cash and the remaining $700,000 was
due under a note. During fiscal 1999, the Company sold its 2% interest in
Broadreach for $406,930, which was included as a gain on the sale of an equity
investment in the consolidated statements of operations. In March 2001, the
Company recorded a loss on investment of $812,000, representing the balance due
on the note receivable and accrued interest thereon. Broadreach has subsequently
discontinued operations.
14. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
-----------------------------------------------------
The following table sets forth certain unaudited financial data for each of the
quarters within the fiscal years ended June 30, 2002 and 2001. This information
has been derived from the Company's Consolidated Financial Statements, and in
management's opinion, reflects all adjustments (consisting only of normal
recurring adjustments) necessary for a fair presentation of the information for
the quarters presented. The operating results for any quarter are not
necessarily indicative of results for any future periods
(Unaudited-See accompanying accountants' report)
(In Thousands Except Share and Per Share Data)
September December March June
Fiscal 2002 Quarter Ended 2001 2001 2002 2002
- ------------------------------------------- ---- ---- ---- ----
Revenues $ 5,265 $ 6,595 $ 8,369 $ 14,081
Gross profit 2,204 2,855 3,307 5,599
Operating income 148 527 645 1,662
Net income 260 611 705 3,049
----------- ----------- ----------- -----------
Basic net income per share $ 0.03 $ 0.06 $ 0.06 $ 0.26
Diluted net income per share $ 0.02 $ 0.06 $ 0.06 $ 0.23
Shares used in computing
Basic net income per share 10,179,851 10,376,892 11,175,240 11,916,044
Shares used in computing
diluted net income per share 10,596,720 10,884,693 12,509,099 13,417,597
49
September December March June
Fiscal 2001 Quarter Ended 2000 2000 2001 2001
- ----------------------------------------- ---- ---- ---- ----
Revenues $ 4,033 $ 3,390 $ 4,911 $ 5,321
Gross profit 1,172 1,000 1,681 2,109
Operating income(loss) (388) (486) 108 298
Net income(loss) (188) (277) (496) 452
----------- ----------- ----------- -----------
Basic and diluted net income
(loss) per share $ (0.02) $ (0.03) $ (0.05) $ 0.04
Shares used in computing
basic and diluted net income
(loss) per share 10,275,163 10,275,652 10,176,060 10,177,806
50