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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2003
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 (IRS Employer
incorporation or organization) Identification No.)
400 Feheley Drive, King of Prussia, Pennsylvania 19406
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 277-8300
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None None
------------------- -----------------------------------------
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
---------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES _X_ NO __
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulations S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. _X_
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant computed by reference to the last reported sale
price of the Common Stock as reported on the NASDAQ National Market on December
31, 2002 was approximately $199,002,000. 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.
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Exchange Act Rule 12b-2). YES _X_ NO __
The number of shares of the registrant's Common Stock outstanding as of August
26, 2003 was 15,643,650.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the Annual Meeting
of Shareholders to be held on December 3, 2003 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.
2
TABLE OF CONTENTS PAGE
----------------- ----
PART I ...........................................................................................................4
Item 1. Business..................................................................................4
Item 2. Properties................................................................................9
Item 3. Legal Proceedings........................................................................10
Item 4. Submission of Matters to a Vote of Security Holders......................................10
PART II .........................................................................................................10
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters....................10
Item 6. Selected Financial Data..................................................................12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....12
Item 7A Quantitive and Qualitative Disclosures About Market Risk.................................27
Item 8. Financial Statements and Supplementary Data..............................................27
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.....27
Item 9A Controls and Procedures .................................................................28
PART III ........................................................................................................28
Item 10. Directors and Executive Officers of the Registrant.......................................28
Item 11. Executive Compensation...................................................................29
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters..............................................................29
Item 13. Certain Relationships and Related Transactions...........................................29
PART IV .........................................................................................................29
Item 14. Principal Accounting Fees and Services ..................................................30
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K..........................30
3
PART I
ITEM 1. BUSINESS.
Neoware Systems, Inc. (the "Company") provides software, services and solutions
to enable Appliance Computing, a proven Internet-based computing architecture
targeted at business customers that is designed to be easier to manage and more
cost-effective than traditional PC-based computing. The Company's software and
management tools secure, power and manage a new generation of smart thin client
appliances that utilize the benefits of open, industry-standard technologies to
create new alternatives to full-function personal computers used in business and
proprietary business devices including green-screen terminals.
The Company's software runs on thin client appliances and personal computers,
and enables these devices to be secured and centrally managed, as well as to
connect to mainframes, midrange, UNIX, Linux and legacy systems. The Company
generates revenues from sales of its Eon, Capio, ThinSTAR and Voyager thin
client appliances, as well as its ThinPC thin client software for PCs, TeemTalk
host access software for PCs and UNIX workstations, ezRemote Manager central
management software, and services such as training and integration.
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. 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.
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 property and access to the Capio distribution and
customer databases, for $1,600,000, excluding transaction costs.
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
shares of newly issued common stock with a market value of $6.26 per share to
IBM.
On March 26, 2002, the Company acquired the thin client business of Network
Computing Devices, Inc. (NCD), including the ThinSTAR product line. 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 private placement of its common stock
to institutional and other accredited investors. The Company sold 1,600,000
shares of its common stock at a price of $7.50 per share for proceeds of
$12,000,000, excluding transaction costs.
4
On July 1, 2003, the Company acquired from Pericom Holdings PLC the host access
software business operated under the name Pericom Software, including the
TeemTalk host access software product line, for approximately $9,800,000 in
cash, excluding transaction costs. Under the terms of the acquisition, the
Company acquired all assets of the software business, including intellectual
property and technology, customer lists, customer contracts and distribution
channels and a non-competition agreement.
On July 10, 2003, the Company completed a private placement of its common stock
to institutional and other accredited investors. The Company sold 1,500,000
shares of its common stock at a price of $17.50 per share for proceeds of
$26,250,000, excluding transaction costs. Proceeds of 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 and solutions to power and manage the wide-scale
deployment of thin client appliances used by businesses. The Company provides
its software on top of a number of desktop and embedded operating systems,
including Microsoft's Windows 95, 98, ME, NT, 2000, XP, CE .NET, NT Embedded and
XP Embedded, as well as an embedded version of the Linux operating system. The
Company intends to utilize partners who have strong market positions in the
server-based computing market to expand its 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,
which enables large numbers of thin client 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.
The Company offers host access software, which enables customers to connect
their thin client appliances, personal computers and UNIX workstations to a
variety of computer systems, including mainframes, minicomputers, UNIX and
legacy servers.
In addition to providing software and appliance products, the Company offers
consulting services, training services and assistance to enterprise customers as
they manage the large-scale deployment of applications to thin client
appliances. The Company intends to supply its software for use on personal
computers and existing thin clients and to bundle its software with
industry-standard thin client appliance platforms to enable complete hardware,
software and management solutions for its customers.
The Company incorporates the following principal elements of its business
strategy into its products:
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 easier and more
cost-effective than administration of personal computers, since administrative
tasks take place at a small number of servers instead of a much larger number of
desktops.
5
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, host access, 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 desktop and embedded versions of the
Windows and Linux operating systems to develop a unique software product, which
is designed specifically for thin client appliance environments.
Use of Industry Standard Components. The Company plans, implements and manages
the design of its software and appliance products to take advantage of
industry-standard technologies and 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 appliance products
quickly to meet customer demand.
Product Upgrades and Enhancements. The Company sells software upgrades and
enhancements to customers of its thin client appliances, as well as software and
enhancements to customers utilizing personal computers and thin client
appliances sold by other vendors. This allows customers to expand their use of
Appliance Computing, manage all of their appliances through one family of
management tools, ezRemote Manager, and provide the same end-user experience to
all thin client appliances. This provides customers extended use of their
installed personal computers and thin client appliances without changing
hardware, and provides a continued relationship with, and revenue stream from,
the customer.
Thin Client Appliance Computing Technical Support and Consulting Services. The
Company provides technical support services in addition to software and thin
client 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.
Host Access Software Expertise. The Company has significant expertise developing
software that allows customers to connect to thin client appliances, personal
computers and UNIX workstations to mainframes, midrange systems, UNIX servers
and other legacy systems. Additionally, the Company has licensed host access
software from IBM enabling its products to connect to IBM servers with
IBM-branded host access software.
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, Air New Zealand, Ardent
Health Services, Autozone, Bed, Bath and Beyond, Bristol Myers Squibb,
Burlington Coat Factory, Caesar's Palace, California Department of Motor
Vehicles, Circuit City, Comcast Cable, Cook County Circuit Court, Costco,
Discount Tire, ESPN, Federated Department Stores, Harley Davidson, Hollywood
Video, IBM, Ikea, Keystone Automotive, Kilotou, Lee Memorial HealthCare,
Lockheed Martin, MicronPC, Monongehela Valley Hospital, Motorola, National Car
Rental, National City Mortgage, National Semiconductor, Neiman Marcus,
OfficeMax, O'Reilly Auto Parts, Panasonic, Raymour and Flanagan, Safeway, Sears,
Target Corporation, Textron Financial, TJ Maxx Stores, US Veteran's
Administration, Verizon, Wal-Mart and others.
6
For the year ended June 30, 2003, sales to IBM represented 16.6% of net revenues
and sales to a European distributor represented 15.5% of net revenues. These
customers resell the Company's products to individual resellers and/or
end-users, none of which contributed sales of more than 10% of the Company's net
revenues for the year ended June 30, 2003. 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.
The percentage of revenue derived from individual distributors, resellers or
end-users can vary significantly from year to year.
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, 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 host access and the Appliance Computing market. Accordingly, the Company is
committed to investing significant resources in software development activities.
During fiscal 2003, 2002 and 2001, the Company's expenditures for research and
development totaled $1,837,055, $1,441,359 and $955,386, respectively. In
addition, the Company has acquired technology in connection with its
acquisitions and its alliance with IBM Corporation.
The Company's current research and development programs include:
o Development of enhancements to Microsoft's Windows, 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 Development of the Company's host access product line, which provides
connectivity to mainframes, minicomputers, UNIX and legacy servers from
thin clients, personal computers and UNIX workstations.
o Integration of the intellectual property licensed from IBM and NCD into
the Company'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 thin client appliance market and
differentiate the Company's products from alternative types of devices,
including personal computers. 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.
7
The Company's products have won numerous awards in the thin client appliance and
Windows-based terminal market, including "Editor's Choice" from PC Magazine,
"Best Windows-based Terminal" and "Editors Choice" from Network Computing, "Best
Buy" from Network Solutions, "Byte Best" from Byte Magazine, "Top of the World"
from SCO World, "Crossroads A-List" from Open Systems Advisors, "Best Buy" from
PC Dealer, "Gold Award for Excellence" from Computing Magazine, "Five Stars for
Features and Overall Performance" from PC Pro, "Best Buy" from PC Week UK,
"5-Star PC Digest Recommends" from PC Digest, and 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 users 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, South Africa, and elsewhere.
Net revenues from customers in foreign countries accounted for approximately
39%, 30% and 24% of net revenues, respectively, in fiscal 2003, 2002 and 2001.
Service and Support
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 provide assistance in diagnosing
problems and assisting with system integration issues.
The Company typically warrants its thin client 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 thin client segment of the personal computer 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 thin client products.
Competitive thin client products are offered by a number of established computer
manufacturers, including Dell Computer, 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,
investment protection, 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 thin client appliances, faces
competition from established computer manufacturers whose personal computer
products offer alternatives to thin client appliances for most applications.
Thin client 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.
Thin client appliances compete favorably on a price/performance basis with
personal computers 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 the personal computer
portion of the market by thin client appliance suppliers. Increased competition
8
could result in price reductions, reduced profit margins and loss of market
share, which would adversely affect the Company's operating results.
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 thin client 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 designing and 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.
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. Certain technology used in the Company's products is licensed from
third parties, either on a non-royalty-bearing basis or 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 NCD. In addition to these licensing
agreements, the Company holds various other licenses which it does not consider
to be material.
Employees
As of July 31, 2003, the Company had 119 employees.
Available Information
The Company makes available on its website, www.neoware.com, its annual reports
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
all amendments to those reports, as soon as reasonably practicable after such
material is electronically filed with, or furnished to, the Securities and
Exchange Commission. The information found on the Company's website is not part
of this or any other report that the Company files with or furnishes to the SEC.
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 $230,000. In March 2002 the Company entered
into a two-year lease for approximately 4,800 square feet at an adjacent
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, and a development office in
the UK. The Company believes that its growth will likely require it to lease
additional facilities and that suitable additional space will be available as
needed.
9
ITEM 3. LEGAL PROCEEDINGS.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
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 symbol 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.
Fiscal 2003 High Low
- ----------- ---- -----
First Quarter 18.72 10.50
Second Quarter 20.91 10.94
Third Quarter 17.69 10.76
Fourth Quarter 16.16 8.63
10
Fiscal 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
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 198 holders of record of common stock as of June 30,
2003. 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 July 2003, the Company sold 1.5 million shares of common stock in a private
placement at a price of $17.50 per share. Net proceeds to the Company were
approximately $24.5 million after transaction costs. The shares were issued in
reliance upon the exemption 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 who had access to information
regarding the Company and its business.
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 $11.1 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 who had access to information
regarding 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
exemption 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 who had access to information regarding 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 exemption 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 who had access to information regarding the Company and its
business. A total of 83,910 warrants were exercised in July 2002.
11
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected financial data with respect to the
Company for the periods indicated. The data selected below have been derived
from the consolidated financial statements of Neoware Systems, Inc. and
Subsidiaries, which have been audited by KPMG LLP, independent auditors, for the
years ended June 30, 2003 and 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,
---------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
STATEMENT OF OPERATIONS DATA:
Net revenues $57,522,240 $34,309,667 $17,654,825 $11,044,870 $10,665,753
----------- ----------- ----------- ----------- -----------
Gross profit 25,972,766 13,964,633 5,962,050 2,318,774 1,367,637
Operating expenses 16,133,482 10,982,358 6,430,513 4,430,785 4,163,346
----------- ----------- ----------- ----------- -----------
Operating income (loss) 9,839,284 2,982,275 (468,463) (2,112,011) (2,795,709)
Gain on sale of equity investment -- -- -- -- 406,930
Loss on investment (300,000) -- (812,000) -- --
Interest income, net 322,834 296,045 771,695 291,900 38,317
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes 9,862,118 3,278,320 (508,768) (1,820,111) (2,350,462)
Income taxes (benefit) 3,550,361 (1,346,728) -- -- 430,396
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 6,311,757 $ 4,625,048 $ (508,768) $(1,820,111) $(2,780,858)
=========== =========== =========== =========== ===========
Basic earnings (loss) per share $ 0.46 $ 0.42 $ (0.05) $ (0.25) $ (0.44)
Diluted earnings (loss) per share $ 0.43 $ 0.39 $ (0.05) $ (0.25) $ (0.44)
Weighted average number of shares used in
basic earnings (loss) per share computation 13,601,186 10,904,565 10,226,316 7,374,692 6,278,317
Weighted average number of shares used in
diluted earnings (loss) per share computation 14,695,819 11,851,327 10,226,316 7,374,692 6,278,317
As of June 30,
---------------------------------------------------------------------------
BALANCE SHEET DATA: 2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
Current assets $42,770,331 $29,722,626 $16,435,552 $17,995,134 $ 5,646,345
Current liabilities 7,722,308 5,893,267 2,698,939 2,191,299 3,223,986
Working capital 35,048,023 23,829,359 13,736,613 15,803,835 2,422,359
Total assets 54,376,171 42,398,960 18,788,842 18,668,379 7,325,897
Long-term capital leases excluding current portion 10,252 204,131 -- -- --
Stockholders' equity 46,626,823 36,601,562 16,089,903 16,477,080 4,101,911
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 proven Internet-based computing architecture targeted at business
customers that is designed to be easier to manage and more cost-effective than
traditional PC-based computing. The Company's software and management tools
secure, power and manage a new generation of smart thin client appliances that
utilize the benefits of open, industry-standard technologies to create new
alternatives to full-function personal computers used in business and
proprietary business devices including green-screen terminals.
12
The Company's software runs on thin client appliances and personal computers,
and enables these devices to be secured and centrally managed, as well as to
connect to mainframes, midrange, UNIX, Linux and legacy systems. The Company
generates revenues from sales of its Eon, Capio, ThinSTAR and Voyager thin
client appliances, as well as its ThinPC thin client software for PCs, TeemTalk
host access software for PCs and UNIX workstations, ezRemote Manager central
management software, and services such as training and integration.
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,
-------------------------
2003 2002 2001
-------------------------
Gross profit 45.1% 40.7% 33.7%
Operating expenses:
Sales and Marketing 17.3 18.6 17.3
Research and Development 3.2 4.2 5.4
General and Administrative 7.5 9.2 12.3
Acquisition costs - - 1.4
-------------------------
Operating income (loss) 17.1 8.7 (2.7)
Loss on investment (1.0) - (4.6)
Interest income, net 1.0 0.9 4.4
-------------------------
Income (loss) before taxes 17.1 9.6 (2.9)
Income taxes 6.2 (3.9) -
-------------------------
Net income (loss) 10.9% 13.5% (2.9)%
-------------------------
Year Ended June 30, 2003 Compared to Year Ended June 30, 2002
For the year ended June 30, 2003, net revenues increased by $23,212,573, or
67.7%, to $57,522,240 from $34,309,667 for the prior fiscal year. The increase
in net revenues was primarily attributable to an increase in sales of the
Company's thin client appliance products sold as a result of the increasing
acceptance in the marketplace of thin client technology and the Company's
increased access to customers as a result of its greater market share, its
alliance with IBM, and its larger sales organization. This is an emerging market
gaining mainstream acceptance and has grown in particular in a number of
vertical markets such as retail, healthcare, transportation, hospitality,
education, state and local governments and others. In addition, as discussed
below, the Company significantly increased its investment in sales and marketing
activities during the current fiscal year compared to the prior fiscal year,
which also contributed to the increase in net revenues.
13
The Company's gross profit as a percentage of net revenues increased to 45.1%
for the year ended June 30, 2003, from 40.7% for the prior fiscal year. The
increase in gross profit is attributable primarily to lower component and
license costs (2.4%) and secondarily to increased software sales (1%) and the
spreading of fixed overhead costs over a larger revenue base (1%).
Operating expenses for the year ended June 30, 2002 were $16,133,482, an
increase of $5,151,124, or 46.9%, from operating expenses of $10,982,358 for the
prior fiscal year. As a percentage of revenues, total operating expenses
declined to 28.0% from 32.0% in the prior fiscal year.
Sales and marketing expenses increased by $3,589,819, or 56.2%, to $9,970,943
for the year ended June 30, 2003 compared to $6,381,124 for the prior fiscal
year. The increase is primarily attributable to personnel additions to sales,
marketing and business development staffing and it is anticipated that such
costs will continue to increase as the Company grows. As a percentage of
revenues, sales and marketing expenses declined to 17.3% from 18.6% in the prior
fiscal year.
Research and development expenses for the year ended June 30, 2003 increased by
$395,696, or 27.5%, to $1,837,055 from $1,441,359 in the prior fiscal year
primarily due to increased staffing of professionals dedicated to research and
development activities. The Company is committed to investing in research and
development in order to continue to develop new products and enhance existing
products and it is anticipated that such expenses will continue to increase as
the Company continues to grow. As a percentage of revenues, research and
development expenses declined to 3.2% from 4.2% in the prior fiscal year.
General and administrative expenses for the year ended June 30, 2003 increased
by $1,165,609, or 36.9%, to $4,325,484 from $3,159,875 for the prior fiscal year
primarily due to increased staffing. During the year ended June 30, 2003, the
Company hired a Chief Operating Officer and other management and administrative
personnel to support the Company's continued growth in fiscal 2003 and it is
anticipated that such expenses will continue to increase as the Company
continues to grow. As a percentage of revenues, general and administrative
expenses declined to 7.5% from 9.2%.
During the year ended June 30, 2003, the Company wrote down its investment of
$300,000 in the marketable equity securities of Boundless Corporation to zero as
a result of the bankruptcy filing by Boundless in March 2003.
The Company realized net interest income of $322,834 for the year ended June 30,
2003 compared to net interest income of $296,045 for the prior fiscal year. The
increase was due to the higher levels of cash invested during the current year
primarily as a result of cash provided from operations and the private
placement, offset partially by a decrease in interest rates.
For the year ended June 30, 2003, the Company recorded a provision for income
taxes of $3,550,361 compared to an income tax benefit of $1,346,728 in the prior
year, which reflected the reversal of a previously recorded valuation allowance
against deferred income tax assets. This reversal was the result of the
Company's sustained history of operating profitability and future prospects of
continued profitability. The Company expects its effective income tax rate going
forward will be approximately 36%.
For the year ended June 30, 2003, the Company generated net income of $6,311,757
as compared to $4,625,048 for the prior fiscal year. The improvement in
performance is primarily attributable to higher revenues, higher gross profit
margin and lower operating expenses as a percentage of revenues, offset by the
effect of the variance in the income tax provision/benefit described in the
preceding paragraph resulting from the reversal of a previously recorded
valuation allowance against deferred income tax assets in fiscal 2002.
14
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 increased sales of the Company's thin client
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 thin client business acquired from NCD 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 increase in sales of thin client appliance
products is attributable to the increasing acceptance in the marketplace of thin
client technology and the Company's increased access to customers as a result of
its greater market share, its alliance with IBM, and its larger sales
organization. This is an emerging market gaining mainstream acceptance and has
grown in particular in a number of vertical markets such as retail, healthcare,
transportation, hospitality, education, state and local governments and others.
In addition, as discussed below, the Company significantly increased its
investment in sales and marketing activities during the current and prior fiscal
year which also contributed to the increase in net revenues.
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 primarily to reduced component and
license costs (5%) and secondarily to the spreading of fixed overhead costs over
a larger revenue base (2%).
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 is primarily attributable to personnel additions to sales,
marketing and business development staffing, and it is anticipated that such
costs will continue to increase as the Company grows. As a percentage of
revenues, sales and marketing expenses increased to 18.6% from 17.3% in the
prior fiscal year.
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 of professionals dedicated to research
and development activities. The Company is committed to investing in research
and development in order to continue to develop new products and enhance
existing products, and it is anticipated that such expenses will continue to
increase as the Company continues to grow. As a percentage of revenues, research
and development expenses decreased to 4.2% from 5.4% in the prior fiscal year.
15
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, and it is anticipated
that such expenses will continue to increase as the Company continues to grow.
As a percentage of revenues, general and administrative expenses decreased to
9.2% from 12.3% in the prior fiscal year.
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
available for investment due to 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.
Liquidity and Capital Resources
As of June 30, 2003, the Company had net working capital of $35,048,023 composed
primarily of cash and cash equivalents, short-term investments and accounts
receivable. The Company's principal sources of liquidity include $29,164,875 of
cash and cash equivalents, short-term investments and a $2,000,000 line of
credit facility with Wachovia Bank, formerly First Union National Bank, of which
$2,000,000 was available as of June 30, 2003. The Company had no borrowings
under the line of credit during the year ended June 30, 2003.
Cash and cash equivalents and short-term investments increased by $12,133,453
during the year ended June 30, 2003, primarily as a result of positive cash flow
from operations ($10,154,933) and proceeds received from the exercise of stock
options and warrants ($2,240,933).
The Company generated cash from operating activities of $10,154,933 in fiscal
2003 compared to using cash in operations of $843,661 during fiscal 2002. The
increase in cash provided by operations during fiscal 2003 over cash used in
operations in fiscal 2002 was primarily due to the increase in net income in
fiscal 2003 ($6,311,757) over fiscal 2002 ($4,635,048) and a smaller increase in
accounts receivable in fiscal 2003 ($1,568,436) compared to fiscal 2002
($5,670,353). The increase in accounts receivable in fiscal 2003 is primarily a
result of the increase in revenues of $1,742,442 for the quarter ended June 30,
2003 compared to the quarter ended June 30, 2002. Deferred taxes and current
deductions from the exercise of stock options resulted in reduced income taxes
payable of $2,444,966 in fiscal 2003. The increase in accounts payable and
accrued expenses for fiscal 2003 compared to fiscal 2002 is primarily
attributable to the growth of the Company's business. Cash flow from operations
can vary significantly from quarter to quarter depending on the timing of
payments from, and shipments to, large customers.
16
During fiscal 2003, net cash of $3,304,699 was used in investing activities for
purchases of short-term investments ($3,156,320) and property and equipment
($153,379) compared to net cash used in investing activities of $4,585,959 in
fiscal 2002, which was primarily for the acquisitions of the ACTIV-e Solutions
and the ThinSTAR product line.
During fiscal 2003, net cash of $2,131,897 was provided by financing activities
primarily from the exercise of stock options and warrants compared to net cash
generated by investing activities of $10,748,507 during fiscal 2002 primarily as
a result of the proceeds from a private placement of the Company's common 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.
During July 2003, the Company acquired from Pericom Holdings PLC its host access
software business for approximately $9,800,000 in cash and completed a private
placement of its common stock which resulted in net proceeds to the Company of
approximately $24,500,000.
Contractual Cash Obligations
The following table summarizes the Company's contractual obligations as of June
30, 2003:
Payments Due by Period
- -------------------------------------------------------------------------------------------
Total 2004 2005 2006 After 2006
- -------------------------------------------------------------------------------------------
Contractual Cash Obligations:
Operating Leases $ 775,000 $ 318,329 $228,543 $228,128 -
Capital Leases 16,809 6,557 6,557 3,695 -
Purchase Commitments 2,169,050 2,169,050 - - -
----------------------------------------------------------
Total $2,960,859 $2,493,936 $235,100 $231,823 -
- -------------------------------------------------------------------------------------------
Inflation
The Company believes that inflation has not had a material effect on its costs
and net revenues during the past three years.
Off-Balance Sheet Arrangements
None
Critical Accounting Policies
The Company has identified the following policies as critical to its business
and the understanding of its results of operations. Application of these
policies affects many of the items discussed throughout Management's Discussion
and Analysis of Financial Condition and Results of Operations. 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 because software has been deemed to be essential to the
functionality of the hardware. Generally, the Company recognizes revenue upon
shipment of products. Revenue related to post-contract services on such
shipments is recognized with the initial sale when the fee is included with the
initial license fee, post-contract services are for one year or less, the cost
of providing such services 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.
17
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
customers typically do not provide for product returns except for very limited
circumstances, including certain distributors that have stock rotation rights
which are contractually limited to a maximum amount per quarter and require a
corresponding order of equal or greater value at the time of the stock rotation.
The impact of product returns has not historically been a significant factor in
the Company's results of operations.
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 payment performance and financial condition of its customers. 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 deferred
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.
Asset Impairment
At June 30, 2003, goodwill and intangible assets amount to $11,033,792. Goodwill
and non-amortizable intangible assets are assessed for impairment pursuant to
SFAS No. 142, "Goodwill and Other Intangible Assets," and impairment of other
amortizable intangible amortizable assets is assessed pursuant to SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets". The Company
operates in one reporting unit and is required to perform the SFAS No. 142
impairment test at least annually or more frequently if circumstances indicate
possible impairment. As of June 30, 2003, management believes there has been no
impairment under SFAS No. 142 and no triggering events that would require an
impairment analysis under SFAS No. 144. An adverse change in the business could
result in an impairment charge.
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 experienced significant growth in our business in the past two years due to
internal expansion and business acquisitions, and if we do not appropriately
manage this growth and any future growth, including the integration of our newly
hired employees and executive officers, our business will suffer.
18
Our business has grown during the past two years through both internal
expansion and business acquisitions, and has put pressure on our infrastructure,
internal systems and managerial resources. The number of our employees increased
from 51 employees at June 30, 2001 to 119 employees at July 31, 2003. Our new
employees include a number of senior executive officers and other key
managerial, technical, sales and marketing personnel. To manage our growth
effectively, we must continue to improve and expand our infrastructure,
including operating and administrative systems and controls, and continue
managing and integrating our personnel in an efficient manner. Our business may
be adversely affected if we do not integrate and train our new employees quickly
and effectively and coordinate among our executive, engineering, finance,
marketing, sales, operations and customer support organizations, all of which
add to the complexity of our organization and increase our operating expenses,
which may grow at a faster rate than our sales. In addition, because of the
growth of our foreign operations, we now have facilities located in multiple
locations, and we have limited experience coordinating a geographically
separated organization.
Although we have generated operating profits for the past two years, 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 operating profits in the past two years, we
have incurred net losses in prior periods. We expect to continue to incur
significant operating expenses. Our operating expenses increased during the
three months and year ended June 30,2003 reflecting the hiring of additional key
personnel as we continue to implement our growth strategy. 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 maintain and increase our revenues would likely cause us to incur
losses and negatively impact the price of our common stock.
We may not be able to successfully integrate the acquisitions we have completed,
the alliance we have entered into or future acquisitions we may complete as part
of our growth strategy, which may materially adversely affect our growth and our
operating results.
Within the last two years, we have made four acquisitions and entered
into an alliance with IBM, and we may make additional acquisitions as part of
our growth strategy. We have not yet fully integrated some of these acquisitions
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 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 if we find that the
business or alliance does not further our business strategy or that we paid more
than what the assets were worth. Managing acquisitions 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.
19
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 thin client 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.
We expect our quarterly revenues and operating results to fluctuate for a number
of reasons.
Future operating results will continue to be subject to quarterly
fluctuations based on a wide variety of factors, including:
Linearity- Our quarterly sales have historically reflected a pattern in
which a disproportionate percentage of sales occur in the last month of the
quarter. This pattern makes prediction of revenues, earnings and working capital
for each financial period especially difficult and uncertain and increases the
risk of unanticipated variations in quarterly results and financial condition.
Significant Orders- We are subject to variances in our quarterly
operating results because of the fluctuations in the timing of our receipt of
large orders. If even a small number of large orders are delayed until after a
quarter ends, our operating results could vary substantially from quarter to
quarter and net income could be substantially less than expected. Conversely, if
even a small number of large orders are pulled into a quarter from a future
quarter, our revenues and net income could be substantially higher than
expected, making it possible that sales and net income in future periods may
decline sequentially.
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 thin client 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.
20
We may not succeed in developing and marketing our software and thin
client 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 thin
client 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 thin client appliances to
perform discrete tasks for corporate and Internet-based networks to increase our
revenues. If the role of thin client 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 thin client 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.
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 certain versions of the Windows operating
system. 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.
21
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, which could significantly increase our costs.
Actions taken by the SCO Group ("SCO") could impact the sale of Linux as an
operating system, negatively affecting sales of some of our products.
SCO has taken legal action against IBM and recently sent a letter to
1,500 Linux customers alleging that certain Linux kernels infringe on SCO's Unix
intellectual property and other rights, and that SCO intends to aggressively
protect those rights. While we are not a party to any legal proceeding with SCO,
since some of our products use Linux as their operating system, SCO's
allegations, regardless of merit, could adversely affect sales of such products.
Because we depend on sole source, limited source and foreign source suppliers
for key components in our thin client appliance products, we are susceptible to
supply shortages that could prevent us from shipping customer orders on time, if
at all, and result in lost sales.
We depend upon single source suppliers for our thin client 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, political instability and currency
fluctuations. A weakening dollar could result in greater costs to us for our
components.
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 thin client appliances that
are bundled with our software. Third parties produce these thin client
appliances for us. 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 39 percent of our revenues are derived 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 or lower pricing resulting in reduced revenue and margins, 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.
22
Because we rely on channel partners, including IBM, 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, including
IBM, 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.
If our channel partners were to discontinue sales of our products or
reduce their sales efforts, it could adversely affect our operating results. In
addition, there can be no assurance as to the continued viability and financial
condition of our channel partners, two of which have accounted for more than
10% of our net sales.
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.
Our business may suffer if it is alleged or found that we have infringed the
intellectual property rights of others.
Although we have not received any claims that our products infringe on
the proprietary rights of third parties, if we were to receive such claims in
the future, responding to such claims, regardless of their merit, could be time
consuming, result in costly litigation, divert management's attention and
resources and cause us to incur significant expenses. There is no assurance, in
the event of such claims, that we would be able to enter into a licensing
arrangement on acceptable terms or that litigation would not occur. In the event
that there were a temporary or permanent injunction entered prohibiting us from
marketing or selling certain of our products, or a successful claim of
infringement against us requiring us to pay royalties to a third party, and we
failed to develop or license a substitute technology, our business, results of
operations or financial condition could be materially adversely affected.
We may not be able to effectively compete against PC and thin client providers
as a result of their greater financial resources and brand awareness.
In the market for thin client appliances, we face significant
competition from makers of personal computers, as well as larger companies that
have greater name recognition than we have. 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,
including PC manufacturers, 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.
23
Thin client 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 thin client appliance market segment of the PC 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 are unable to protect our intellectual property, other vendors could sell
products with features similar to ours, and this could reduce demand for our
products, which would harm our operating results.
We may not be able to attract software developers to bundle their products with
our thin client appliances.
Our thin client appliances include our own software, plus software from
other companies for specific 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 thin client 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.
In order to continue to develop and market our line of thin client
appliances, we may need to hire additional personnel. Competition for employees
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, technologies and operations 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.
24
Errors in our products could harm our business and our operating results.
Because our software and thin client 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.
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.
If our contracts with Citrix and other vendors of software applications were
terminated, our IT services business would be materially adversely affected.
We depend on third-party suppliers to provide us with key software
applications in connection with our IT services business. If such contracts and
relationships were terminated, our revenues would be negatively affected.
Our prior 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 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
25
manager 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.
Our stock price can be volatile.
Our stock price, like that of other technology companies, can be
volatile. For example, our stock price can be affected by many factors such as
quarterly increases or decreases in our revenues or earnings, changes in
revenues or earnings estimates or publication of research reports by analysts;
speculation in the investment community about our financial condition or results
of operations and changes in revenue or earnings estimates, announcement of new
products, technological developments, alliances, acquisitions or divestitures by
us or one of our competitors or the loss of key management personnel. In
addition, general macroeconomic and market conditions unrelated to our financial
performance may also affect our stock price.
Provisions in our charter documents and Delaware law may delay or prevent
acquisition of us, which could decrease the value of your shares.
Our certificate of incorporation and bylaws and Delaware law contain
provisions that could make it harder for a third party to acquire us without the
consent of our board of directors. These provisions include advance notice
procedures with respect to stockholder proposals and the nomination of
candidates for election as directors. Delaware law also imposes some
restrictions on mergers and other business combinations between us and any
holder of 15% or more of our outstanding common stock.
The issuance of additional equity securities may have a dilutive effect on our
existing stockholders and could lead to a decline in the price of our common
stock.
Any additional sale of equity securities may have a dilutive effect on
our existing stockholders. In addition, the perceived risk associated with the
possible sale of a large number of shares could cause some of our stockholders
to sell their stock, thus causing the price of our stock to decline. Subsequent
sales of our common stock in the open market or the private placement of our
common stock or securities convertible into common stock could also have an
adverse effect on the market price of the shares. If our stock price declines,
it may be more difficult or we may be unable to raise additional capital.
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 the increasing acceptance in the marketplace
of thin client technology, anticipated increases in operating expenses, the
Company's expected income tax rate of 36%, 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
26
relationships, the availability of cash or other financing sources to fund
future operations and acquisitions, the Company's commitment to invest in the
development and enhancement of its technology, the investment of significant
resources in software development activities, the growth in the thin client
segment of the PC 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
thin client products, pricing pressures, rapid technological changes in the
industry, growth of the thin client segment of the PC market, increased
competition, the Company's ability to attract and retain qualified personnel,
the economic viability of the Company's channel partners, 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
and short-term investments. This interest income is subject to market risk
related to changes in interest rates which primarily affects the Company's
investment portfolio. The Company invests in instruments that meet high credit
quality standards, as specified in its investment policy.
As of June 30, 2003, cash equivalents and short-term investments 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 cash and cash equivalents and short-term
investments, and the Company does not believe that a sudden change in interest
rates would 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, 2003
would have decreased by less than $200,000 This estimate assumes that the
decrease occurred on July 1, 2002 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 35 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 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 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.
27
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.
ITEM 9A. CONTROLS AND PROCEDURES.
(a) Disclosure Controls and Procedures.
The Company, under the supervision and with the participation of the Company's
Chief Executive Officer and Chief Financial Officer, carried out an evaluation
of the effectiveness of its disclosure controls and procedures, as such term is
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as of June 30, 2003 (the "Evaluation Date"). Based on the evaluation
performed, the Company's Chief Executive Officer and Chief Financial Officer
have concluded that, as of the Evaluation Date, the Company's disclosure
controls and procedures were effective in recording, processing, summarizing and
reporting in the periods specified in the SEC's rules and forms the information
required to be disclosed by the Company in its reports filed or furnished under
the Exchange Act.
(b) Changes in Internal Control Over Financial Reporting
There have not been any changes in the Company's internal control over financial
reporting during the fiscal quarter ended June 30, 2003 that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
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 2003 Annual Meeting of Stockholders.
The following individuals are the current executive officers of the
Company:
Name Age Position
---- --- --------
Michael G. Kantrowitz 43 Chairman, President and Chief
Executive Officer
Eric N. Rubino 44 Chief Operating Officer
Keith D. Schneck 48 Executive Vice President and
Chief Financial Officer
Matthew D. Wrabley 42 Executive Vice President of
Sales
Mr. Kantrowitz has been Chairman of the Company's Board of Directors since
December 2002 and President and Chief Executive Officer of the Company since
February 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
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.
28
Mr. Rubino has been Chief Operating Officer of the Company since December 2002.
Prior to joining the Company, from 1999 to 2002, Mr. Rubino served as the Chief
Operating Officer for SAP America, Inc., where he managed a wide range of
operational departments, including the small and medium business channel,
customer support, new business development, information technology, legal,
contracts, application hosting, strategic alliances, purchasing, facilities, and
risk management. From 1991 to 1999, Mr. Rubino served as Corporate Secretary,
Vice President and General Counsel and Senior Vice President of SAP America,
Inc. In addition, Mr. Rubino has served in a variety of management positions in
contracts and finance with RCA Corporation, General Electric and Bell Atlantic
Business System Services, and holds a J.D., an MBA in Finance, and a B.S. in
Marketing.
Mr. Schneck has been Executive Vice President and Chief Financial Officer since
joining the Company in April 2003. Prior to joining the Company, from December
2000 to April 2003, he served as Chief Financial Officer of T-Networks, a
venture capital-funded start up company that provides next generation fiber
optical components and sub-systems to the telecommunications market. From April
1995 to December 2000, Mr. Schneck served as President and Chief Financial
Officer for AM Communications, Inc., a publicly held company. Prior to that,
from 1987 until 1995, Mr. Schneck held senior management positions at Integrated
Circuit Systems, Inc., a publicly held company, including Chief Operating
Officer and Senior Vice President Finance. Mr. Schneck is a CPA with over 10
years of public accounting experience with KPMG LLP.
Mr. Wrabley has been Executive Vice President of Sales since November 2002 and
was Vice President of Business Development from July 2001. Prior to joining the
Company, Mr. Wrabley, served as Vice President of Business Development at CIDCO
Incorporated, a telecommunications company from 1997 to 2001. Prior to that, Mr.
Wrabley served as Director of Strategic Alliances for Call Technologies, Inc.
and was employed as a Senior Business Development Manager for Voysys
Corporation.
All executive 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 2003 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
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 2003 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 2003 Annual Meeting of Stockholders.
29
PART IV
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The information encouraged to be included in this Annual Report on Form 10-K
under Item 14 will be included in our Proxy Statement under the caption "Audit
Fees" under "Proposal to Ratify Accountants" and is hereby incorporated by
reference.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements
- -----------------------------
See Index to Financial Statements at page 35.
(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.
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. The following is a list of exhibits filed as part of
this annual report on Form 10-K. Where so indicated by footnote, exhibits which
were previously filed are incorporated by reference.
Exhibit
Numbers Description
- ------- -----------
2.1 Asset Purchase Agreement between Neoware Systems, Inc. and Network
Computing Devices, Inc, dated March 22, 2002. (The Schedules and
Exhibits to the Purchase Agreement (a list of which is attached as
Exhibit 99.3 hereto) are not being filed as Exhibits to the Current
Report on Form 8-K. Neoware agrees to furnish supplementally a copy of
any such Schedules and Exhibits to the Securities and Exchange
Commission upon request.) (Exhibit 2.1)(14)
2.2 Agreement for the sale and purchase of the terminal emulation software
business of Pericom Holdings Plc and Pericom Software Plc among Neoware
UK Ltd., as purchaser, Neoware Systems, Inc., as guarantor, Pericom
Holdings Plc and Pericom Software Plc, as sellers, and Ron Cragg, as to
a non-compete, dated July 1, 2003. (Schedule 3 and the Appendices to
the Agreement (a list of which is attached as Exhibit 99.2 hereto) are
not being filed as Exhibits to the Current Report on Form 8-K. Neoware
agrees to furnish supplementally a copy of Schedule 3 and any such
Appendices to the Securities and Exchange Commission upon request.)
(Exhibit 2.1)(15)
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)
30
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).
4.2 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 December 4, 2002). (Exhibit
10.4)(12)
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 January 27, 1999, between the Registrant and
Vincent T. Dolan. (Exhibit 10.9)(6)
10.7+ Employment Agreement, dated December 4, 2001, between the Registrant
and Anthony J. DePaul (Exhibit 10.1)(8)
10.8+ Termination agreement dated November 1, 2002, between the Registrant
and Anthony J. DePaul. (Exhibit 10.1)(12)
10.9+ Letter Agreement, dated December 9, 2002, between the Registrant and
Eric R. Rubino. (Exhibit 10.2)(12)
10.10+ Letter Agreement, dated November 8, 2002, between the Registrant and
Matthew Wrabley. (Exhibit 10.3)(12)
10.11+ Amended and Restated 2002 Non-Qualified Stock Option Plan (as amended
on June 30, 2003) (Exhibit 4.1)(13)
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* Securities Purchase Agreement dated July 10, 2003 among the Registrant
and the persons listed as Purchasers therein
31
10.16* Registration Rights Agreement dated July 10, 2003 among the Registrant
and the investors named therein.
10.17+ 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. (Exhibit 10.15)(11)
10.18*+ Letter Agreement, dated April 11, 2003, between the Registrant and
Keith D. Schneck
10.19* Separation Agreement, dated June 30, 2003, between the Registrant and
Vincent T. Dolan
21.* Subsidiaries
23.1* Consent of KPMG LLP
23.2* Notice Regarding Consent of Arthur Andersen LLP
31.1* Certification of Michael Kantrowitz as Chairman, President and Chief
Executive Officer of Neoware Systems, Inc. pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2* Certification of Keith D. Schneck as Executive Vice President and Chief
Financial Officer of Neoware Systems, Inc. pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1* Certification of as Chairman, President and Chief Executive Officer of
Neoware Systems, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
32.2* Certification Keith D. Schneck as Executive Vice President and Chief
Financial Officer of Neoware Systems, Inc 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.
(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.
32
(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.
(11) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
year ended June 30, 2002.
(12) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for
the quarter ended December 31, 2002
(13) Filed as an Exhibit to Company's Registration Statement on Form S-8
(No. 333-107970) filed with the Securities and Exchange Commission on
August 14, 2003.
(14) Filed as an Exhibit to the Company's Current Report on Form 8-K filed
on April 2, 2002
(15) Filed as an Exhibit to the Company's Current Report on Form 8-K filed
on July 16, 2003
33
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 15, 2003 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 Keith D. Schneck,
Executive Vice President and Chief Financial Officer, 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/ Michael G. Kantrowitz President, Chief Executive September 15, 2003
- ------------------------------ Officer and Chairman of the Board
Michael G. Kantrowitz (Principal Executive Officer)
/s/ Keith D. Schneck Executive Vice President and Chief September 15, 2003
- ------------------------------ Financial Officer (Principal Financial
Keith D. Schneck Officer and Principal Accounting
Officer)
/s/ John M. Ryan Director September 15, 2003
- ------------------------------
John M. Ryan
/s/ Christopher G. McCann Director September 15, 2003
- ------------------------------
Christopher G. McCann
/s/ David D. Gathman Director September 15, 2003
- ------------------------------
David D. Gathman
/s/ John P. Kirwin Director September 15, 2003
- ------------------------------
John P. Kirwin
34
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
Page
----
Neoware Systems, Inc. and Subsidiaries
Independent Auditors' Report 36
Report of Independent Public Accountants 37
Consolidated Financial Statements: 37
Consolidated Balance Sheets as of June 30, 2003 and 2002 38
Consolidated Statements of Operations for the years ended June 30, 2003, 2002 and 2001 39
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) for the years ended June 30,
2003, 2002 and 2001 40
Consolidated Statements of Cash Flows for the years ended June 30, 2003, 2002 and 2001 41
Notes to Consolidated Financial Statements 42
35
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Neoware Systems, Inc.:
We have audited the 2003 and 2002 consolidated financial statements of Neoware
Systems, Inc. and subsidiaries as listed in the accompanying index. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits. The 2001 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 consolidated financial
statements in their report dated August 17, 2001.
We conducted our audits 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 audits provide a
reasonable basis for our opinion.
In our opinion, the 2003 and 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, 2003 and 2002 and the
results of their operations and their cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of
America.
/s/KPMG LLP
Philadelphia, Pennsylvania
August 21, 2003
36
Below is a copy of the report previously issued by Arthur Andersen LLP in
connection with Neoware Systems, 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 sheets as of June 30, 2000 and 2001 and the
consolidated statements of operations, stockholders' equity and cash flows for
the years ended June 30, 2000 and 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
37
NEOWARE SYSTEMS, INC. AND SUBSIDIARIES
--------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
June 30,
--------------------------------------
ASSETS 2003 2002
- ------ ---------------- ---------------
CURRENT ASSETS:
Cash and cash equivalents $ 26,013,555 $ 17,031,422
Short-term investments 3,151,320 183,333
Accounts receivable, net of allowance for doubtful accounts of $553,329 and
$351,131 11,088,994 9,520,558
Inventories 772,494 1,040,851
Prepaid expenses and other 798,383 551,598
Deferred income taxes 945,585 1,394,864
--------------- ---------------
Total current assets 42,770,331 29,722,626
PROPERTY AND EQUIPMENT, net 572,048 622,235
CAPITALIZED SOFTWARE, net - 47,779
NOTE RECEIVABLE FROM OFFICER - 263,732
DEFERRED INCOME TAXES - 173,648
GOODWILL 8,943,175 8,994,286
INTANGIBLE ASSETS, net 2,090,617 2,574,654
--------------- ---------------
$ 54,376,171 $ 42,398,960
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 4,206,346 $ 3,111,164
Accrued expenses 2,817,791 2,136,776
Capital lease obligations 6,557 63,037
Deferred revenue 691,614 582,290
--------------- ---------------
Total current liabilities 7,722,308 5,893,267
--------------- ---------------
CAPTIAL LEASE OBLIGATIONS 10,252 204,131
DEFERRED INCOME TAXES 16,788 -
COMMITMENTS AND CONTINGENCIES (Note 15)
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, 14,054,800 and
12,935,615 shares issued and 13,954,800 and 12,835,615 shares outstanding 14,056 12,936
Additional paid-in capital 44,214,516 40,291,861
Treasury stock, 100,000 shares at cost (100,000) (100,000)
Other comprehensive income (loss) (26,943) (116,672)
Retained earnings (accumulated deficit) 2,525,194 (3,786,563)
--------------- ---------------
Total stockholders' equity 46,626,823 36,301,562
--------------- ---------------
$54,376,171 $ 42,398,960
=============== ===============
See accompanying notes to consolidated financial statements.
38
NEOWARE SYSTEMS, INC. AND SUBSIDIARIES
--------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
Year Ended June 30,
-----------------------------------------------------
2003 2002 2001
------------ ----------- -----------
NET REVENUES $ 57,522,240 $34,309,667 $17,654,825
COST OF REVENUES 31,549,474 20,345,034 11,692,775
------------ ----------- -----------
Gross profit 25,972,766 13,964,633 5,962,050
------------ ----------- -----------
OPERATING EXPENSES:
Sales and marketing 9,970,943 6,381,124 3,058,008
Research and development 1,837,055 1,441,359 955,386
General and administrative 4,325,484 3,159,875 2,171,280
Acquisition related costs - - 245,839
------------ ----------- -----------
Total operating expenses 16,133,482 10,982,358 6,430,513
------------ ----------- -----------
Operating income (loss) 9,839,284 2,982,275 (468,463)
LOSS ON INVESTMENT (300,000) - (812,000)
INTEREST INCOME, net 322,834 296,045 771,695
------------ ----------- -----------
Income (loss) before income taxes 9,862,118 3,278,320 (508,768)
INCOME TAXES (BENEFIT) 3,550,361 (1,346,728) -
------------ ----------- -----------
NET INCOME (LOSS) $ 6,311,757 $ 4,625,048 $ (508,768)
============ =========== ===========
BASIC EARNINGS (LOSS) PER SHARE $ 0.46 $ 0.42 $ (0.05)
============ =========== ===========
DILUTED EARNINGS (LOSS) PER SHARE $ 0.43 $ 0.39 $ (0.05)
============ =========== ===========
WEIGHTED AVERAGE NUMBER OF SHARES USED IN BASIC
EARNINGS (LOSS) PER SHARE CALCULATION 13,601,186 10,904,565 10,226,316
============ =========== ===========
WEIGHTED AVERAGE NUMBER OF SHARES USED IN
DILUTED EARNINGS (LOSS) PER SHARE CALCULATION 14,695,819 11,851,327 10,226,316
============ =========== ===========
See accompanying notes to consolidated financial statements.
39
NEOWARE SYSTEMS, INC. AND SUBSIDIARIES
--------------------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND
---------------------------------------------------
COMPREHENSIVE INCOME (LOSS)
---------------------------
Accumulated
Additional Other (Deficit)
Common Stock Paid-in Treasury Comprehensive Retained
Shares Amount Capital Stock Income (Loss) Earnings Total
---------- ------- ----------- --------- ------------- ----------- -----------
BALANCE AT JUNE 30, 2000 10,275,163 10,275 24,369,648 -- -- (7,902,843) 16,477,080
Comprehensive 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
Comprehensive 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
Comprehensive income: -- -- -- -- -- 6,311,757 6,311,757
Translation adjustment -- -- -- -- (26,943) -- (26,943)
Reclassification adjustment for
realized loss on marketable
equity securities -- -- -- -- 116,672 -- 116,672
-----------
Total comprehensive income 6,401,496
Costs associated with issuance of
common Stock -- -- (122,409) -- -- -- (122,409)
Exercise of warrants 118,910 119 512,592 -- -- -- 512,711
Exercise of stock options 1,000,275 1,001 1,727,221 -- -- -- 1,728,222
Tax benefits related to stock options -- -- 1,805,251 -- -- -- 1,805,251
-----------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2003 13,954,800 $14,056 $44,214,516 $(100,000) $ (26,943) $ 2,525,194 $46,626,823
- ---------------------------------------- =========================================================================================
See accompanying notes to consolidated financial statements.
40
NEOWARE SYSTEMS, INC. AND SUBSIDIARIES
--------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
Year Ended June 30,
---------------------------------------------
2003 2002 2001
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 6,311,757 $ 4,625,048 $ (508,768)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities-
Depreciation and amortization 786,492 496,233 363,766
Loss on investment 300,000 -- 812,000
Stock option benefit on deferred income taxes 1,805,251 221,031 --
Deferred income tax benefit 639,715 (1,568,512) --
Changes in operating assets and liabilities, net of effect from acquisitions-
(Increase) decrease in:
Accounts receivable (1,568,436) (5,670,353) (1,433,783)
Inventories 268,357 (578,166) 661,108
Prepaid expenses and other (273,723) (57,119) (110,182)
Increase (decrease) in:
Accounts payable 1,095,182 1,050,851 (218,029)
Accrued expenses 681,016 498,114 871,077
Deferred revenue 109,324 139,212 (145,408)
---------------------------------------------
Net cash provided by (used in)
operating activities 10,154,935 (843,661) 291,781
---------------------------------------------
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)
Purchase of Boundless Technologies, Inc. Capio product line -- (12,420) (1,874,453)
Alliance agreement transaction costs -- (52,152) --
Purchases of short-term investments (3,151,320) -- (300,000)
Purchases of property and equipment, net (153,379) (128,324) (100,601)
---------------------------------------------
Net cash used in
investing activities (3,304,699) (4,585,959) (2,341,986)
---------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net of expenses (122,409) 11,192,716 --
Purchase of treasury stock -- -- (100,000)
Exercise of stock options and warrants 2,240,933 162,788 4,925
Repayments of bank debt -- (388,213) --
Repayments of capital leases (250,359) (33,317) --
Repayments (advances) in officer notes receivable 263,732 (185,467) 26,023
---------------------------------------------
Net cash provided by (used in) financing activities 2,131,897 10,748,507 (69,052)
---------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 8,982,133 5,318,887 (2,119,257)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 17,031,422 11,712,535 13,831,792
---------------------------------------------
CASH AND CASH EQUIVALENTS, END OF YEAR $26,013,555 $17,031,422 $11,712,535
=============================================
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid for income taxes $ 976,233 $ 25,000 $ --
Cash paid for interest 32,078 26,422 8,563
See accompanying notes to consolidated financial statements.
41
NEOWARE SYSTEMS, INC. AND SUBSIDIARIES
--------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1. COMPANY BACKGROUND:
-------------------
Neoware Systems, Inc. (the "Company") provides software, services and solutions
to enable Appliance Computing, a proven Internet-based computing architecture
targeted at business customers that is designed to be easier to manage and more
cost-effective than traditional PC-based computing. The Company's software and
management tools secure, power and manage a new generation of smart thin client
appliances that utilize the benefits of open, industry-standard technologies to
create new alternatives to full-function personal computers used in business and
proprietary business devices including green-screen terminals. The Company's
software runs on thin client appliances and personal computers, and enables
these devices to be secured and centrally managed, as well as to connect to
mainframes, midrange, UNIX, Linux and legacy systems. The Company generates
revenues from sales of its Eon, Capio, ThinSTAR and Voyager thin client
appliances, as well as its ThinPC thin client software for PCs, TeemTalk host
access software for PCs and UNIX workstations, ezRemote Manager central
management software, and services such as training and integration.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
-------------------------------------------
Principles of Consolidation and Translation of Foreign Financial Statements
- ---------------------------------------------------------------------------
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. Assets and liabilities
of the Company's foreign subsidiaries are translated at the exchange rate as of
the end of each reporting period. The statement of operations is translated at
the average exchange rate for the period. Gains or losses from translating
foreign currency are accumulated in a separate component of stockholders'
equity.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America 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, reserves for returns and allowances, inventory reserves and
future tax effects of temporary differences between financial reporting and tax
bases of assets and liabilities. 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, 2003 and 2002 consisted
primarily of investments in commercial paper, money market funds and
certificates of deposit.
42
Short-term Investments
- ----------------------
The Company's short-term investments have been classified as
"available-for-sale" securities 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
unrealized gains and losses reported as a separate component of stockholders'
equity. Short-term investments at June 30, 2003 consisted of highly liquid
discount notes. Short-term investments at June 30, 2002 consisted of 300,000
shares of common stock of Boundless Corporation (see Notes 3 and 17).
Inventories
- -----------
Inventories are stated at the lower of cost or market. Cost is determined by the
first-in, first-out method.
Long-Lived Assets
- -----------------
Effective July 1, 2002, the Company adopted SFAS No, 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which supercedes 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, amortizable intangibles or other long-lived assets
may be impaired, an evaluation of recoverability would be performed. If an
evaluation is required, the estimated future undiscounted cash flows associated
with the assets is compared to the carrying amount of the assets to determine if
a write-down to market value or discounted cash flow value is necessary. As of
June 30, 2003, management believes that there are no indications of impairment.
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
- --------
The Company adopted SFAS No. 142, "Goodwill and Other Intangibles" on July 1,
2001. SFAS No. 142 requires that goodwill no longer be amortized but instead be
tested for impairment at least annually. Goodwill represents the excess of the
purchase price over the fair value of net assets acquired. The Company operates
in one reporting segment. At June 30, 2003, management does not believe that
goodwill is impaired. The Company had no goodwill amortization prior to the
adoption of SFAS No. 142 because the Company had no goodwill until the
acquisition of the thin client business of Boundless Technologies, Inc. on
June 28, 2001 (see Note 3). Accordingly, the transitional disclosures required
by SFAS No. 142 are not required. For the year ended June 30, 2003, changes in
goodwill related primarily to minor adjustments to the opening balance sheets of
acquired businesses.
43
Intangible Assets, net
- ----------------------
The Company adopted SFAS No. 142 on July 1, 2001. SFAS No. 142 requires that
intangible assets with indefinite useful lives no longer be amortized but
instead be tested for impairment at least annually. SFAS No. 142 also requires
that intangible assets with finite useful lives be amortized over their
respective estimated useful lives to their estimated residual values (see Note
7). Amortizable intangible assets are reviewed for impairment pursuant to SFAS
No. 144.
Revenue Recognition
- -------------------
The Company's products include both a hardware and software component. Software
has been deemed to be essential to the functionality of the hardware and,
therefore, the Company follows AICPA Statement of Position No. 97-2, "Software
Revenue Recognition" ("SOP 97-2") for revenue recognition. Revenue is recognized
on product sales when persuasive evidence of an arrangement exists, delivery of
the product has occurred, the fee is fixed or determinable and collectibility is
probable. Revenue related to post-contract services is generally recognized with
the initial product sale when the fee is included with the initial product fee,
post-contract services are typically for one year or less, the estimated cost of
providing such services during the arrangement is insignificant, and unspecified
upgrades and 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. In limited circumstances, the Company
provides certain distributors with stock rotation rights, which are
contractually limited to a maximum amount per quarter and require a
corresponding order of equal or greater value at the time of the stock rotation.
The Company reserves for these arrangements based on historical experience and
the level of inventories in the distribution channel. Product warranty costs are
accrued at the time the related revenues are recognized.
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; the
billing and credit terms for the customer have not been modified from the
Company's normal policies; 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 $-0- , $607,980 and $335,119 for
the years ended June 30, 2003, 2002 and 2001, respectively. Accounts receivable
relating to "bill and hold" transactions were $-0- and $233,279 at June 30, 2003
and 2002, 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 $66,932
of software development costs in fiscal 2001 and recorded expense of $47,779,
$29,468 and $230,630 in fiscal 2003, 2002 and 2001, respectively, related to
amortization of capitalized software costs. There were no capitalized software
costs during fiscal 2003 and 2002 since development costs incurred after the
establishment of technological feasibility have not been significant.
44
Prepaid Licenses
- ----------------
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
and are included in prepaid expenses in the accompanying consolidated balance
sheet. The Company continually evaluates whether events and circumstances have
occurred that indicate that the unamortized balances may not be recoverable or
that the amortization period should be revised.
Earnings (Loss) Per Share
- -------------------------
Basic earnings (loss) per share is computed by dividing net income (loss) by the
weighted average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution from the exercise or
conversion of securities into common stock, such as stock options and warrants.
At June 30, 2003, the Company has options and warrants outstanding to purchase
1,633,625 shares of common stock at prices ranging from $0.88 to $18.11. For the
years ended June 30, 2003 and 2002, there were 493,500 and 84,500 options to
purchase shares of common stock which were not included in the computation of
diluted earnings per share as the impact would have been antidilutive. However,
these options may be dilutive in the future. For the year ended June 30, 2001,
there was no dilutive effect of stock options or warrants, as the Company
incurred a net loss.
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
For the year ended June 30,
-----------------------------------------
2003 2002 2001
----------- ----------- -----------
Net income (loss) $ 6,311,757 $ 4,625,048 $ (508,768)
=========== =========== ===========
Weighted average shares outstanding:
Basic 13,601,186 10,904,565 10,226,316
Dilutive effect of stock options and warrants 1,094,633 946,762 -
----------- ----------- -----------
Diluted 14,695,819 11,851,327 10,226,316
=========== =========== ===========
Earnings (loss) per common share:
Basic $0.46 $0.42 $(0.05)
=========== =========== ===========
Diluted $0.43 $0.39 $(0.05)
=========== =========== ===========
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.
45
Comprehensive Income (Loss)
- ---------------------------
The Company follows SFAS No. 130, "Reporting Comprehensive Income," which
requires companies to classify items of other comprehensive income (loss) by
their nature in a financial statement and display the accumulated balance of
other comprehensive income (loss) separately from retained earnings and
additional paid-in-capital in the equity section of a statement of financial
position. Excluding net income (loss), the Company's sources of other
comprehensive income (loss) are unrealized appreciation (depreciation) on its
holdings of short-term investments classified as available-for-sale and
unrealized income (loss) relating to foreign currency exchange rate
fluctuations.
Stock-Based Compensation
- ------------------------
The Company applies Accounting Principles Board Opinion, "Accounting for Stock
Issued to Employees" (APB 25), and related interpretations for stock options and
other stock-based awards while disclosing pro forma net income (loss) and
earnings (loss) per share as if the fair value method had been applied in
accordance with SFAS No. 123, "Accounting for Stock-based Compensation."
In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure."
SFAS No. 148 provides alternative methods of transition for a voluntary change
to the fair value method of accounting for stock-based employee compensation.
SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The transition and disclosure provisions of
SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The
Company has determined that it will not make the voluntary change to the fair
value based method of accounting at this time. Had compensation cost been
recognized consistent with SFAS No. 123, the Company's consolidated net income
(loss) and earnings (loss) per share would have been as follows:
Year ended June 30.
2003 2002 2001
----------- ---------- -----------
Net income (loss) As reported $ 6,311,757 $4,625,048 $ (508,768)
Less total stock-based
compensation
determined under fair
value method for all
awards, net of tax (1,700,748) (964,218) (536,991)
----------- ---------- -----------
Net income (loss) Pro forma $ 4,611,009 $3,660,830 $(1,045,759)
----------- ---------- -----------
Basic and diluted net income (loss) per share:
Basic EPS As reported $ 0.46 $ 0.42 $ (0.05)
Pro forma $ 0.34 $ 0.34 $ (0.10)
Diluted EPS As reported $ 0.43 $ 0.39 $ (0.05)
Pro forma $ 0.33 $ 0.31 $ (0.10)
46
New Accounting Pronouncements
- -----------------------------
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." Under SFAS 146, companies will record exit or
disposal costs when they are incurred and can be measured at fair value, and
they will subsequently adjust the recorded liability for changes in estimated
cash flow. SFAS No. 146 is effective prospectively for exit or disposal
activities initiated after December 31, 2002.
In November 2002, the FASB issued FASB Interpretation (FIN) No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No.
5, 57, and 107 and rescission of FASB Interpretation No. 34". The Interpretation
expands on the disclosure requirements to be made in interim and annual
financial statements. The disclosure requirements are effective for financial
statements of both interim and annual periods that end after December 15, 2002.
The Interpretation also requires that a liability measured at fair value be
recognized for certain guarantees even if the probability of payment on the
guarantee is remote. The provision for initial recognition and measurement
should be applied on a prospective basis to guarantees issued or modified after
December 31, 2002. The adoption of FIN No. 45 did not have a material impact on
the Company's financial statements.
In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on
Issue No. 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables." This issue addresses the appropriate accounting for arrangements
that will result in the delivery of multiple products, services and/or rights to
assets that may occur over a period of time. The Issue is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
Company does not anticipate that the adoption of EITF Issue No. 00-21 will have
a material impact on its financial statements.
In January 2003, the FASB issued Interpretation No. 46, which addresses the
consolidation by business enterprises of variable interest entities as defined
in the Interpretation. The Interpretation applies immediately to variable
interests in variable interest entities created after January 31, 2003, and to
variable interest in variable interest entities obtained after January 31, 2003.
The adoption of this interpretation did not have any impact on the Company's
financial statements.
3. ACQUISITIONS AND ALLIANCE:
--------------------------
On June 28, 2001, the Company acquired 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 $1,874,453, 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 14). 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 Boundless
thin client business have been included in the accompanying statements of
operations from the date of the acquisition. Concurrent with the consummation of
the acquisition, the Company made an equity investment of $300,000 in Boundless,
which was accounted for as an available-for-sale security under SFAS 115. During
the year ended June 30, 2003, the Company wrote off its investment as a result
of the bankruptcy filing by Boundless in March 2003 (See Notes 2 and 17).
47
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 acquisition was accounted
for under SFAS No. 141 using the purchase method of accounting. The purchase
price was payable in cash of $75,000 and 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. The results
of operations of ACTIV-e Solutions have been included in the accompanying
statement of operations from the date of the acquisition.
On January 8, 2002, the Company entered into a worldwide alliance with IBM
Corporation under which the Company became 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.
On March 26, 2002, the Company acquired the thin client business of Network
Computing Devices, Inc. (NCD) which included the ThinSTAR product line. The
acquisition was accounted for under SFAS No. 141 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 goodwill. The results of
operations of the NCD thin client business have been included in the
accompanying statements 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 provided
for limitations on the number of shares which could 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.
4. CONCENTRATIONS AND FOREIGN REVENUES:
-------------------------------------
Sales to IBM accounted for 16.6% of total revenues and sales to a European
distributor accounted for 15.5% of total revenues in fiscal 2003 and accounts
receivable from these customers were $4,799,607 at June 30, 2003. Each of these
customers resells the Company's products to individual resellers and/or
end-users, none of which contributed sales of more than 10% of the Company's net
revenues for the year ended June 30, 2003. One customer provided 10.2% of total
net revenues in fiscal 2002 and accounts receivable from this customer was
$1,879,703 at June 30, 2002. A different customer provided 10.2% of total net
revenues in fiscal 2001. The percentage of revenue derived from individual
distributors, resellers or end-users can vary significantly from year to year.
The Company depends upon single source suppliers its thin client appliance
products and for several of the components in them. The Company also depends on
limited sources to supply several other industry standard components and relies
on foreign suppliers which subject the Company to risks associated with foreign
operations such as the imposition of unfavorable governmental controls or other
trade restrictions, changes in tariffs, political instability and currency
fluctuations. A weakening dollar could result in greater costs to the Company
for its components.
48
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
revenues from customers in foreign countries during fiscal 2003, 2002 and 2001
were approximately 39%, 30% and 24%, respectively, and were transacted in US
dollars.
5. INVENTORIES:
------------
Inventories, net of allowances, consist of the following:
June 30,
--------------------------
2003 2002
---------- -----------
Purchased components and subassemblies $ 172,160 $ 211,131
Finished goods 600,334 829,720
---------- -----------
$ 772,494 $ 1,040,851
========== ===========
6. PROPERTY AND EQUIPMENT:
-----------------------
June 30,
--------------------------
2003 2002
---------- -----------
Computer equipment $1,551,508 $ 1,424,838
Office furniture and equipment 560,317 551,555
Leasehold improvements 457,121 397,949
Other 128,080 130,799
---------- -----------
2,697,026 2,505,141
Less accumulated depreciation and amortization (2,124,978) (1,882,906)
---------- -----------
$ 572,048 $ 622,235
========== ===========
Depreciation and amortization expense was $248,713, $191,767 and $133,136 for
the years ended June 30, 2003, 2002 and 2001, respectively.
7. INTANGIBLE ASSETS:
------------------
June 30, 2003
-----------------------------------------------------------
Estimated Gross carrying Accumulated
useful life value amortization Net
------------- ---------------- ---------------- ----------------
Tradenames Indefinite $ 150,000 $ -- $ 150,000
Distributor relationships 5 years 2,200,000 (690,000) 1,510,000
Acquired technology 10 years 505,615 (74,998) 430,617
---------------- ---------------- ----------------
$ 2,855,615 $ (764,998) $ 2,090,617
================ ================ ================
June 30, 2002
-----------------------------------------------------------
Estimated Gross carrying Accumulated Net
useful life value amortization
------------- ---------------- ---------------- ----------------
Tradenames Indefinite $ 150,000 $ -- $ 150,000
Distributor relationships 5 years 2,200,000 (250,000) 1,950,000
Acquired technology 10 years 499,652 (24,998) 474,654
---------------- ---------------- ----------------
$ 2,849,652 $ (274,998) $ 2,574,654
================ ================ ================
Amortization of intangibles was $490,000 and $274,998 for the years ended June
30, 2003 and 2002, respectively. There was no amortization for the year ended
June 30, 2001.
49
The following table provides estimated future amortization expense related
to intangible assets (assuming there is no write down associated with these
intangible assets causing an acceleration of expense):
Year ending June 30, Total
----------
2004 $ 490,000
2005 490,000
2006 490,000
2007 240,000
2008 50,000
2009 through 2013 180,617
----------
$1,940,617
==========
8. ACCRUED EXPENSES:
-----------------
June 30,
---------------------------------
2003 2002
---------- ----------
Compensation $1,706,780 $1,170,034
Software license fees 184,616 327,703
Marketing costs 294,408 212,175
Professional fees 157,200 91,000
Other 474,787 335,864
---------- ----------
$2,817,791 $2,136,776
========== ==========
9. VALUATION AND QUALIFYING ACCOUNTS:
----------------------------------
A rollforward of the allowance for doubtful accounts is as follows:
Year Ended June 30,
----------------------------------
2003 2002 2001
-------- --------- --------
Beginning balance $351,131 $ 188,151 $125,409
Expense 287,569 282,115 66,137
Write-offs (85,371) (119,135) (3,395)
-------- --------- --------
Ending balance $553,329 $ 351,131 $188,151
======== ========= ========
10. NOTE RECEIVABLE:
----------------
In April 2002, the Company entered into a note agreement with an officer in the
amount of $263,732 in connection with recruiting this individual to the Company
and to provide cash to exercise stock options held in a previous employer, IBM.
The note bore interest at 5%, was secured by 8,506 shares of IBM common stock,
was full recourse and was repayable upon either the earlier of the sale of the
stock or three years. The note was repaid during May 2003.
50
11. 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, 2004. Borrowings under the credit agreement
bear interest at the Libor Market Index rate plus 2.5% (3.8% at June 30, 2003).
At June 30, 2003 and June 30, 2002, there was $2,000,000 available for borrowing
under the line. During fiscal 2003 and 2002, there were no borrowings under the
line.
The line of credit is unsecured and requires the Company to maintain a minimum
balance of $3,000,000 in cash and cash equivalents with the bank. The Company is
in compliance with this condition at June 30,2003.
12. INCOME TAXES:
------------
Income tax expense (benefit) consists of:
Current Deferred Total
------- -------- -----
Year ended June 30, 2003:
U.S. Federal $2,596,874 $ 548,361 $ 3,145,235
State and local 144,190 91,354 235,544
Foreign jurisdictions 169,582 -- 169,582
---------- ------------- ------------
$2,910,646 $ 639,715 $ 3,550,361
========== ============= ============
Current Deferred Total
------- -------- -----
Year ended June 30, 2002:
U.S. Federal $ -- $ (996,701) $ (996,071)
State and local 753 (351,410) (350,657)
---------- ------------- ------------
$ 753 $ (1,347,481) $ (1,346,728)
========== ============= ============
The federal statutory income tax rate is reconciled to the effective tax rate as
follows:
Year Ended June 30,
---------------------------------------------------------------------------------------------------------
2003 2002 2001
---- ---- ----
Federal statutory rate 34.0% 34.0% (34.0)%
State income taxes, net 1.6 - -
Expenses not deductible for tax .2 1.8 .8
Valuation allowance - (82.2) 59.0
Other .2 5.3 (25.8)
------------------- ----------------- ---------------
36.0% (41.1)% -%
=================== ================= ===============
51
Deferred taxes are comprised of the following:
June 30,
--------------------------
2003 2002
--------- ----------
Current deferred income tax asset $ 945,585 $1,394,864
Current deferred income tax liability - -
--------- ----------
Total current deferred tax asset 945,585 1,394,864
--------- ----------
Gross non-current deferred income tax asset 292,886 292,863
Gross non-current deferred income tax liability (309,674) (119,215)
--------- ----------
Total non-current deferred tax asset (liability) (16,788) 173,648
--------- ----------
Net deferred tax asset $ 928,797 $1,568,512
========= ==========
The tax effect of significant temporary differences representing deferred tax
assets and liabilities are as follows:
June 30,
--------------------------
2003 2002
--------- ----------
Net operating loss carryforwards $ 365,215 $ 951,430
Expenses not currently deductible for tax purposes 501,903 292,223
Deferred revenue 196,610 159,139
Basis difference in property and equipment and
capitalized software 96,094 133,725
Basis difference in inventory 78,649 148,210
Amortization of intangible assets (309,674) (119,215)
--------- ----------
Net deferred tax asset $ 928,797 $1,568,512
========= ==========
As of June 30, 2003, the Company has state net operating loss carryforwards of
approximately $5,300,000 that begin to expire in 2005 and are available to
offset future state taxable income.
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, 2003, 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 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, 2003.
52
13. 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 in
fiscal 2002 were $11,192,716 after transaction costs of $807,284. Additional
transaction costs of $122,409 were incurred in fiscal 2003 related to this
transaction. In addition, warrants to purchase 48,000 shares of common stock
were issued to one of the placement agents at a price of $9.375 per share. The
warrants are exercisable 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. A total of 35,000 warrants
were exercised in fiscal 2003.
14. STOCK OPTIONS AND WARRANTS:
---------------------------
The Company has two stock option plans for employees, directors, and consultants
to the Company. Under the 1995 Stock Option plan (the "1995 Plan"), the Company
is authorized to issue options for the purchase of up to 3,000,000 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 ratably over four years. Director options generally vest
and become exercisable ratably over six months or one to three years from the
date of grant. All options that have been granted expire five or ten years from
the grant date. A committee established for this purpose, or the board of
directors, administers the 1995 Plan. Except for non-discretionary grants of
options to non-employee directors, the committee or board may define vesting and
expiration dates for all options granted under the 1995 Plan. As of June 30,
2003, there were 360,945 options available for future grant under the 1995 Plan.
The Company has a non-qualified stock option plan (the "2002 Plan") for
employees, directors and consultants who perform services for the Company. The
Company is authorized to issue options for the purchase of up to 700,000 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 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, 2003, there were 226,951
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 or may become fully vested and
immediately exercisable upon a "change in control," as defined in the Plan.
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, 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
Granted 680,000 14.34
Exercised (1,000,275) 1.73
Terminated (197,375) 5.27
----------
Balance as of June 30, 2003 1,620,625 8.47
==========
53
The following table summarizes information about stock options outstanding as of
June 30, 2003:
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
------------ --------- -------- ----------- ------- --------
$ .88-2.94 405,250 $ 2.35 2.3 years 224,875 $ 2.39
3.00-5.37 318,000 3.65 2.1 years 185,500 3.87
7.35-10.55 353,875 8.82 4.0 years 61,375 8.07
11.30-15.85 380,500 14.09 4.4 years - -
17.15-18.11 163,000 17.27 4.4 years 20,000 18.11
--------- -------
1,620,625 491,750
========= =======
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 (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 as transaction costs related to
the acquisition. 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. A total of 83,910
warrants were exercised in fiscal 2003.
In May 2002, the Company issued warrants to a placement agent for the purchase
of 48,000 common shares at a price of $9.375 per share and were fully vested at
the date of grant (see Note 13). During the year ended June 30, 2003, 35,000
warrants were exercised and 13,000 warrants remain outstanding as of June 30,
2003 with an expiration date in May 2005.
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 2003, 2002 and 2001: no dividend yield;
expected volatility of approximately 70%-126%; risk-free interest rates of
approximately 2.1%-6.8%; and an expected life of five to ten years.
54
15. COMMITMENTS AND CONTINGENCIES:
------------------------------
The Company leases its principal facilities, an automobile, and furniture and
fixtures under noncancelable operating leases. The remaining terms of these
leases range from three months to three years. Rent expense under these leases
was $482,437, $289,183 and $219,097 in fiscal 2003, 2002 and 2001, respectively.
Future minimum lease payments under operating leases at June 30, 2003 are
$318,329 in fiscal 2004, $228,543 in fiscal 2005 and $228,128 in fiscal 2006.
During fiscal 2002, the Company assumed the liabilities for certain office
equipment, computer hardware and software under capital leases as part of the
ACTIV-e Solutions acquisition. During the year ended June 30, 2003,
substantially all of these obligations were paid off. Interest expense under
these leases was $7,207 and $18,386 in fiscal 2003 and 2002, respectively.
The Company has employment agreements with its executive officers that provide
for certain levels of base compensation, fringe benefits and incentives. One of
the agreements provides for salary continuance of 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, 2003, and all of the executive
officers had been terminated, the severance obligations would have aggregated
approximately $750,000.
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.
16. 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
$131,908, $68,973 and $43,392 in fiscal 2003, 2002 and 2001, respectively.
17. LOSS ON INVESTMENT:
-------------------
In October 1997, the Company merged ITC, a wholly owned subsidiary, into
Broadreach Consulting, Inc. (Broadreach), a software consulting company, 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 fiscal 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.
In fiscal 2003, the Company recorded a loss on investment of $300,000
representing the write-off of an investment in Boundless (See Notes 2 and 3).
18. RELATED PARTY
-------------
For the year ended June 30, 2003, the Company had sales of approximately
$183,000 to a customer of which one of the Company's directors is an executive
officer and director.
19. SUBSEQUENT EVENTS:
------------------
On July 1, 2003, the Company acquired from Pericom Holdings PLC the host access
software business formerly operated under the name Pericom Software for
approximately $9.8 million in cash, excluding transaction costs. The Company
acquired all of the assets of the software business including intellectual
property and technology, customer lists, customer contracts and distribution
channels and also entered into a non-competition agreement. The acquisition will
be accounted for using the purchase method of accounting and the purchase price
will be allocated to intangible assets. The results of operations of the host
access software business will be included in the Company's statements of
operations from the date of the acquisition.
55
On July 10, 2003, the Company sold 1,500,000 shares of common stock at $17.50
per share which represented a premium of 10% on the average closing price for
the 15-day period immediately preceding the sale. Net proceeds to the Company
were approximately $24,500,000 after transaction costs. The Company intends to
use the net proceeds of the financing for general corporate purposes and to fund
potential future acquisitions.
20. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED):
-----------------------------------------------------
The following table sets forth certain unaudited consolidated financial data for
each of the quarters within the fiscal years ended June 30, 2003 and 2002. 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)
(In Thousands Except Share and Per Share Data)
September December March June
Fiscal 2003 Quarter Ended 2002 2002 2003 2003
- ---------------------------------------------- ---- ---- ---- ----
Revenues $ 13,517 $ 14,714 $ 13,468 $ 15,823
Gross profit 5,694 6,547 6,240 7,491
Operating income 2,171 2,852 2,218 2,598
Net income 1,447 1,884 1,281 1,700
Basic net income per share $ 0.11 $ 0.14 $ 0.09 $ 0.12
Diluted net income per share $ 0.10 $ 0.13 $ 0.09 $ 0.12
Shares used in computing
basic net income per share 13,162,589 13,573,656 13,724,625 13,950,356
Shares used in computing
diluted net income per share 14,652,096 14,785,902 14,704,171 14,647,585
- ----------------------------------------------
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
56