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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, 1999
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 (I.R.S. Employer
of 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; and Redeemable Common Stock
Purchase Warrants each to purchase one share of Common Stock for $5.50 per share
- --------------------------------------------------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. YES _X_ NO ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulations S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ___
The aggregate market value of the voting stock held by non-affiliates of the
registrant is approximately $6,691,530. Such aggregate market value was computed
by reference to the last reported sale price of the Common Stock as reported on
the NASDAQ National Market on September 22, 1999. In making such calculation,
the registrant does not determine whether any director, officer or other holder
of Common Stock is an affiliate for any other purpose.
The number of shares of the registrant's Common Stock outstanding as of
September 22, 1999 was 6,285,782.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on December 9, 1999 are incorporated by
reference into Part III. Those portions of the Proxy Statement included in
response to Item 402(k) and 402(1) of Regulation S-K are not incorporated by
reference into Part III.
TABLE OF CONTENTS
PAGE
PART I....................................................................... 3
Item 1. Business...................................................... 3
Item 2. Properties.................................................... 9
Item 3. Legal Proceedings............................................. 9
Item 4. Submission of Matters to a Vote of Security Holders........... 10
PART II...................................................................... 11
Item 5. Market for Registrant's Common Equity and Related
Shareholder Matters.......................................... 11
Item 6. Selected Financial Data....................................... 11
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 12
Item 8. Financial Statements and Supplementary Data................... 19
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..................................... 19
PART III..................................................................... 19
Item 10. Directors and Executive Officers of the Registrant............ 19
Item 11. Executive Compensation........................................ 21
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................... 21
Item 13. Certain Relationships and Related Transactions................ 21
PART IV...................................................................... 21
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K.......................................... 21
PART I
ITEM 1. BUSINESS.
General
Neoware Systems, Inc. (the "Company") designs, manufactures and markets a
family of Windows-based terminals and thin client computers. The Company's
NeoStationTM family of Windows-based terminals and related software allow users
to access applications and information on multiple platforms, including both
mainframe and mid range computers, as well as the Internet, running a wide
variety of operating systems, including all versions of the Windows(R) operating
system, Citrix WinFrame, UNIX(TM) and Java. Unlike Java network computers, an
alternative type of thin client, Neoware's products do not require customers to
rewrite their applications in the Java language or to use Java emulators to
access their existing systems. Unlike personal computers, the Company's products
are designed primarily to run applications on a server, not on the desktop. This
offers a number of significant advantages compared to an architecture based upon
personal computers. Windows-based terminals and thin clients such as the
Company's NeoStation line of products are designed to be easier to install,
maintain and administer than traditional personal computers. Such lower
administration costs are designed to lower the total cost of ownership of
systems utilizing the Company's products when compared to personal computers.
On March 2, 1995, Human Designed Systems, Inc. ("HDS") was merged into a
wholly-owned subsidiary of the Company (the "Merger"). Pursuant to the Merger,
all of the outstanding shares of HDS were converted into the right to receive a
total of 2,810,000 shares of the Company's Common Stock, 618,200 redeemable
common stock purchase warrants and $5,500,000 in cash, in accordance with the
exchange ratios set forth in the Merger Agreement. Upon completion of the
Merger, the former shareholders of HDS owned approximately 50.1% of the
outstanding Common Stock of the Company. At the time of the Merger, the Company
changed its name to HDS Network Systems, Inc. In April 1996, HDS was merged into
the Company.
In October 1997, the Company merged Information Technology Consulting,
Inc., a wholly-owned subsidiary ("ITC"), with Broadreach Consulting, Inc.
("Broadreach") and Global Consulting Group. As a result of the merger, the
Company, as the sole stockholder of ITC, received stock of the surviving entity
representing approximately 2% ownership of the entity after the merger. The
Company was also reimbursed for the expenses incurred by the Company and ITC in
connection with ITC's efforts to acquire companies in the computer services
field, $300,000 of which was paid in cash. The remainder of the expenses, in the
amount of $700,000, is repayable by Broadreach pursuant to a note upon the
earlier of three years or the consummation of an initial public offering of
Broadreach. The note bears interest at 8% per year. In November 1998, the
Company sold its 2% interest in Broadreach for $406,930.
In February 1997, the Company formed a new subsidiary, Bridging Data
Technology, Inc. ("BDT"). BDT acquired and further developed a software product
for upgrading programs and data for Year 2000 compliance. The Company entered
into an agreement effective January 1, 1998 which reduced the Company's
ownership position in BDT and eliminated the Company's requirement to fund
future operations. In addition, effective March 31, 1998, the Company wrote off
the full amount of its investment in BDT. The write-off reflects the Company's
evaluation that recovery, if any, of its investment in BDT will not occur in the
near future. Future cash distributions, if any, from BDT will be recorded as
income in the period during which the transaction occurs.
3
Product Strategy
The Company's current strategy is to become a leader in the Windows-based
terminal and thin client computer market by focusing on expanding its software
products and its thin client computer hardware. The Company has invested
significant resources in sales and marketing and research and development in the
current and prior years to bring its new product families to market. The
Company's Windows-based terminal and thin client products incorporate the
following elements:
o A choice of operating environments. The Company's products are designed
to run both its netOS operating environment and Microsoft's
Windows(R)CE. The Company offers both environments on its hardware
products in order to give its customers a high level of flexibility.
During the current and prior years, the Company developed and enhanced
netOS and WinCE, both of which are cross-platform software tools for
Windows-based terminals and thin clients based on industry standard
protocols and technologies. The Company's products allow users to access
applications and information on multiple platforms, including both
mainframe and mid range computers, as well as the Internet, running a
wide variety of operating systems, including all versions of the
Windows(R) operating system, Citrix WinFrame, UNIX(TM) and Java.
o Cost-effective, High-Performance Windows-based terminal and thin client
products. The Company's primary products, the NeoStation 2000 Series,
are based upon a highly integrated line of microprocessors from
Motorola. The Company believes that this line of microprocessors offers
it a very cost effective hardware platform, especially compared to
personal computers. The primary microprocessor used in the Company's
products, the Motorola MPC 8XX, includes a number of important
components built into the processor that required additional components
on the Company's older products. This integration reduces the cost of
the Company's products and makes them easier to produce. The NeoStation
family is offered in a very small enclosure that is approximately the
size of a hardcover book. As a result, it takes up significantly less
space than a personal computer, although it offers similar capabilities
when connected to a server. The Company's products are designed to
operate in network environments, and include an Ethernet connection,
serial ports, and connections for printers and monitors. The Company
also produces older products utilizing microprocessors from other
companies.
o Focus on central administration and lower total 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
the desktop as with a personal computer. This makes administration of
networks of the Company's products much simpler than administration of
personal computer networks, since administration takes place at a small
number of servers. Additionally, the Company sells its Remote Manager
software that makes its products easier to update and administer
centrally.
o Diverse Technology Expertise. The Company has significant expertise in a
wide range of technical disciplines, including operating systems,
windowing and networking software, applications software development,
graphics acceleration, multimedia design and compression algorithms.
4
o Low-Cost Design and Manufacturing. The Company plans, implements and
manages the manufacturing of its products to take advantage of
industry-standard components that are widely available in the personal
computer industry. This reduces the Company's risks and costs, and
allows the Company more easily to increase production of products
quickly to meet customer demand. During the quarter ended June 30, 1999,
the Company began outsourcing a significant portion of its manufacturing
requirements to SCI Technology, Inc.
o Modularity and Use of Standard Peripherals. The Company's line of thin
clients and Windows-based terminals are designed to be compatible with a
wide range of standard off-the-shelf peripherals, including keyboards
and monitors, PC card flash and network cards.
Customers
The Company's customers span a wide range of industries, including
aerospace, automotive, education, financial services, government, healthcare,
manufacturing and telecommunications. The Company's products have been adopted
by such customers as 1-800-Flowers, Caesar's Palace, Daughters of Charity, ESPN,
Hollywood Video and Neiman Marcus.
Net revenues from International Business Machines Corporation ("IBM")
represented 15% and 15% of total net revenues for fiscal 1998 and 1997,
respectively. Net revenues from Intel Corporation represented 14% and 25% of
total net revenues for fiscal 1998 and 1997, respectively. Sales to IBM and
Intel declined significantly during the last six months of fiscal 1998, as a
result of completing delivery of product under existing purchase orders. No
single customer represented 10% or more of total net revenues during fiscal
1999.
Product Development
The Company believes that its ability to expand the market for its
Windows-based terminal products will depend in large part upon its ability to
develop enhancements to the Windows CE environment, enhance its own netOS
software, and continue to develop new products which incorporate the latest
improvements in performance, capability and manageability. Accordingly, the
Company is committed to investing significant resources in software and hardware
development activities. During fiscal 1999, 1998 and 1997 the Company's
expenditures for research and development totaled $726,633, $1,443,720 and
$1,071,991, respectively.
The Company's current research and development programs include:
o Continued enhancement of netOS software with an emphasis on
compatibility and interoperability with Microsoft and Citrix enterprise
environments.
o Development of enhancements to the Windows CE environment that make it
more manageable in enterprise environments and allow users to connect to
a variety of enterprise systems.
o Continued development and enhancement of remote management of net OS and
Windows CE clients in an enterprise environment.
o Development of enhanced connectivity to Windows, Linux and other
application servers.
o Continued enhancements of hardware platforms.
5
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 Windows-based terminal
products, maintain the Company's position as a recognized innovator in the
Windows-based terminal industry and differentiate the Company's products from
other thin clients and 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.
The Company's products have won numerous awards in the thin client and
Windows-based terminal market, including "Best Windows-based Terminal" from
Network Computing, "Editor's Choice" from PC Magazine, "Byte Best" from Byte
Magazine, "Editors' Choice" from Network Computing Magazine, "Top of the World"
from SCO World, "Crossroads A-List" from Open Systems Advisors, "Best Buy" from
PC Dealer, "Gold Award for Excellence" from Computing Magazine, "Five Stars for
Features and Overall Performance" from PC Pro, "Best Buy" from PC Week UK,
"5-Star PC Digest Recommends" from PC Digest and "Best Buy" from Network
Solutions.
The Company distributes its products in North America through direct sales
to end user customers, including the use of low-cost telesales channel,
value-added resellers, system integrators, OEMs and the Internet. The timing of
sales to the Company's customers and the continued evolution of the market for
Windows-based terminals will impact the Company's future operating results.
The Company utilizes distributors for its products throughout the world,
including relationships with distributors in the United Kingdom, France,
Scandinavia, Germany, Switzerland, Italy, Spain, Russia, Israel, Australia, and
India. Foreign revenues, which accounted for approximately 29%, 20% and 22% of
net revenues, respectively, in fiscal 1999, 1998 and 1997, may be subject to
government controls and other risks, including export licenses, federal
restrictions on the export of technology, changes in demand resulting from
currency exchange fluctuations, political instability, trade restrictions and
changes in tariffs. To date, the Company has experienced no material
difficulties due to these factors.
6
Service and Support
The Company believes that its ability to provide service and support is an
important element in the marketing of its products. The Company maintains
in-house repair facilities and also provides telephone and electronic mail
access to its technical support staff. The Company's technical support
specialists not only provide assistance in diagnosing problems but work closely
with customers to address system integration issues and to assist in increasing
the efficiency and productivity of their systems. The Company provides system
level hardware support through its factory-based technical maintenance
organization and through contracted third-party maintenance organizations.
The Company typically warrants its products against defects in materials
and workmanship for one year after purchase by the end user, and offers an
extended warranty of up to an additional two years. To date, the Company has not
encountered any material product maintenance problems.
Competition
The desktop computer market is characterized by rapidly changing technology
and evolving industry standards. The Company experiences significant competition
from suppliers of workstations and personal computers, as well as providers and
prospective providers of Windows-based terminals, thin clients and network
computers.
Competitive thin client products are offered by a number of established
computer manufacturers, including IBM, Sun Microsystems, Inc. ("Sun"), Wyse
Technology, Network Computing Devices, and Boundless Technologies. Each of these
companies has 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 thin
client suppliers include breadth of product line, product price/performance,
capabilities of the products, software features, network expertise, service and
support, and market presence. The Company believes that it competes favorably
with respect to all of these factors except market presence. Workstation and
personal computer manufacturers who also offer thin client products may have
advantages over independent thin client vendors, including the Company, based on
their ability to "bundle" their thin clients, workstations and personal
computers in certain large system sales. The Company anticipates increased
competition from these system suppliers as the thin client market evolves and
also expects that other established domestic and foreign computer equipment
manufacturers may enter the thin client market.
The Company, as well as other manufacturers of thin clients, also faces
competition from established computer manufacturers whose personal computer
products offer alternatives to thin clients for most applications. Thin clients
compete with personal computers offered by such manufacturers as Dell, IBM,
Gateway, Compaq and Hewlett Packard. Personal computers can be configured with
software, such as an ICA client from Citrix Systems, or an RDP client from
Microsoft, that allows them to operate as Windows-based terminals. As the cost
of personal computers declines, the difference in cost between thin clients and
personal computers may continue to decline. Thin clients compete favorably on a
price/performance basis with personal computer networks and offer cost
advantages in initial system installation, as well as subsequent system
upgrading and administration. However, the significant market presence and
reputation of personal computer manufacturers, and customer perceptions
regarding their need for desktop application processing capability, constitute
obstacles to the penetration of this market segment by thin client
manufacturers. Increased competition could result in price reductions, reduced
7
profit margins and loss of market share, which would adversely affect the
Company's operating results. There can be no assurance that the Company will be
able to continue to compete successfully against current and future competitors
as the thin client market evolves and competition increases.
At the low end of the commercial segment of the desktop computer market,
the Company competes with suppliers of lower cost ASCII and 3270 terminals.
These products do not offer the graphics and windowing capabilities offered by
the Company's windows-based computers, but are still appealing to certain price
sensitive customers. The Company believes that thin clients will become
increasingly competitive with ASCII and 3270 terminal systems.
Manufacturing and Suppliers
During the latter part of the 1999 fiscal year, the Company began
transitioning its production activities to SCI Technology, Inc., a leading
contract manufacturer. This process was completed in July 1999. These operations
consist primarily of final assembly, configuration, testing and quality control
of material components, sub-assemblies and systems. Under the Company's
agreement with SCI, products are manufactured and shipped in accordance with the
Company's purchase orders. SCI purchases materials to manufacture the Company's
products according to the quantity and delivery schedule set forth in the
purchase orders. Upon cancellation of a purchase order or termination of the
agreement, the Company would be responsible for finished products,
work-in-process and material purchased to fill a purchase order or authorized to
be purchased by the Company. The Company has maintained a limited in-house
capability to conduct production activities on an as needed basis, and has
retained primary capability for post-manufacturing and installation quality
analysis and control. In addition, the Company maintains an approved vendor list
and control of engineering changes of parts and components. Incoming material is
inspected by SCI for conformance with the Company's specifications. The Company
conducts regular on-site inspection at its vendors' facilities to maintain
quality control.
The components and sub-assemblies used in the Company's products are either
standard, commercially available components or are manufactured to the Company's
specifications by independent suppliers, including foreign suppliers who are
subject to risks associated with foreign operations such as the imposition of
unfavorable governmental controls or other trade restrictions, changes in
tariffs and political instability. A number of components and parts used in the
Company's products, including microprocessors, are currently available only from
single sources. Prolonged or repeated delays in the receipt of these components
could have a material adverse effect on the Company's operations.
The Company has no long-term purchase agreements or other guaranteed supply
arrangements with suppliers of these single or limited source components and
purchases such components, as well as its other parts and components, pursuant
to its standard form of purchase order. The Company has generally been able to
obtain adequate supplies of parts and components in a timely manner from
existing sources under purchase orders and endeavors to maintain inventory
levels adequate to guard against interruptions in supplies. The Company's
inability to develop alternative supply sources in the future, or to obtain
sufficient components from existing suppliers as required, could adversely
affect the Company's operating results.
The Company's products also incorporate memory components, such as DRAMs
and VRAMs, that are available from multiple sources but have been subject to
substantial fluctuations in availability and price. To date, these fluctuations
have not had a material effect on the Company's operating results and the
8
Company has been able to obtain an adequate supply of such components. There can
be no assurance, however, that the Company will be able to obtain adequate
supplies of these components in the future or that price fluctuations will not
adversely affect the Company's operating results.
Proprietary Rights and Licenses
The Company believes that its success will depend primarily on the
innovative skills, technical competence and marketing abilities of its personnel
rather than upon the ownership of patents or other intellectual property
protection methods. In addition, there can be no assurance that any patents
issued to the Company will not be challenged, invalidated or circumvented, or
that any rights granted thereunder will provide adequate protection to the
Company.
Certain technology used in the Company's products is licensed from third
parties on a royalty-bearing basis. Generally, such licenses grant to the
Company non-exclusive, worldwide rights with respect to the subject technology
and terminate upon a material breach by the Company. The Company has licensed
technology from Citrix Systems, Inc., Microsoft, Spyglass, Inc., Liberate
Technologies (formerly Network Computer, Inc.) and Pericom Software PLC. In
addition to these licensing agreements, the Company holds a license agreement
with the Open Software Foundation (OSF), and various other licenses which it
does not consider to be material.
Although the Company has not received any claims that its products infringe
on the proprietary rights of third parties, there can be no assurance that third
parties will not assert infringement claims against the Company in the future
with respect to current or future products or that any such assertion may not
require the Company to enter into royalty arrangements or result in costly
litigation.
Employees
As of June 30, 1999, the Company had 39 employees.
ITEM 2. PROPERTIES.
The Company's principal administrative, marketing, manufacturing and
research and development operations are located in King of Prussia,
Pennsylvania. The facility consists of approximately 22,000 square feet under a
lease which expires in 2001. The annual gross rent for the facility currently
approximates $92,100. The Company believes that its facilities are adequate for
its present requirements, and that suitable additional space will be available
as needed.
ITEM 3. LEGAL PROCEEDINGS.
On March 11, 1998, a complaint entitled Cerrato, Inc. v. Neoware Systems,
Inc., 98 Civ. 1748 (JSM), was filed in the United States District Court for the
Southern District of New York, naming as defendants the Company, its Chairman,
and its former CFO(the "New York action"). The Complaint asserts claims under
ss. 10(b) of the Securities and Exchange Act of 1934 (the "Exchange Act"), Rule
10b-5 promulgated thereunder, and common law. The complaint, which was filed as
a purported class action on behalf of purchasers of the Company's common stock
during the period from June 15, 1996 through August 15, 1997, alleges, among
other things, that the defendants made misrepresentations related to plans for
various potential acquisitions by a subsidiary of the company and a spin-off. A
9
First Amended Complaint ("FAC") was filed on or about May 1, 1998. The FAC adds
claims on behalf of a second purported class -- purchasers of the Company's
stock from November 13, 1997 through May 1, 1998 -- related to the Company's
announcement, on April 30, 1998, that it would be restating certain financial
results previously reported for the first two quarters of fiscal year 1998.
Thereafter four separate purported securities class actions: Galitzer v.
Neoware Systems, Inc., 98CV2582 (BWK), Pollison v. Neoware Systems, Inc.,
98CV2879 (BWK), Tuchman v. Neoware Systems, Inc., 98CV2868 (BWK), and Grubin v.
Neoware Systems, Inc., 98CV3651 (BWK), were filed in the United States District
Court for the Eastern District of Pennsylvania (the "Pennsylvania actions"). The
Pennsylvania actions name some of the same individual defendants as the FAC, as
well as certain additional directors and officers, and alleges violations of
ss.ss. 10(b) and 20(a) of the Exchange Act and Rule 10b-5 based on factual
allegations similar to those added to the New York action in the FAC on behalf
of a purported class of purchasers of the Company's securities between October
30, 1997 and April 30, 1998. In December 1998, the New York action was
transferred to the Eastern District of Pennsylvania and now all actions have
been consolidated under the heading In re Neoware Systems, Inc. Securities
Litigations, Master File No. 98-CV-2582. Lead co-plaintiffs and counsel have
been appointed and a consolidated and amended complaint and an amended motion
for class certification have been filed.
The Company disputes the validity of these claims and intends to defend the
cases vigorously. On August 27,1999, the defendants moved to dismiss the
consolidated and amended complaint in its entirety. Plaintiffs have until
October 22,1999 to respond to the motion.
On May 5, 1998, a complaint was filed in the Court of Common Pleas of
Montgomery County against the Company by Development Concepts, Inc. ("DCI"). The
complaint asserts claims for common law breach of contract, fraud,
misrepresentation, breach of warranty and violations of the federal Lanham Act
arising primarily from the parties' contractual relationships. The complaint
seeks an indeterminate amount of monetary damages in excess of $1,500,000. On
October 29, 1998, the Company filed its Answer and Counterclaim to the complaint
asserting the claims for breach of contract, unjust enrichment, unfair
competition and misappropriation of trade secrets. The Counterclaim demands
injunctive and monetary relief in excess of $180,000. The Company disputes the
validity of DCI's claims and intends to defend these claims and pursue its own
claims vigorously.
Management does not anticipate that resolution of the pending litigation,
either separately or in the aggregate, will have a material effect on the
Company's financial position or results of operations. This is a forward-looking
assessment, which may change as the cases develop. While management may reassess
this from time to time, it does not undertake to do so on any regular basis.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders of the Company
during the fourth quarter of fiscal 1999.
10
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
The Common Stock and the Warrants are traded on the NASDAQ National Market.
Prior to August 1, 1997, the Common Stock and the Warrants traded under the
symbols HDSX and HDSXW, respectively. On August 1, 1997, the Company's Common
Stock and the Warrants began trading under the symbols NWRE and NWREW,
respectively. The following table sets forth the high and low closing bid
quotations for the periods indicated.
Common Stock Warrants
--------------------- ---------------------
1999 High Low High Low
- ---- ----- ------ ----- ----
First Quarter 2 5/8 1 1/16 17/32 3/16
Second Quarter 1 5/8 15/16 1/4 1/16
Third Quarter 1 5/8 15/16 3/16 1/16
Fourth Quarter 1 3/8 3/4 5/32 1/16
Common Stock Warrants
--------------------- ------------------------
1998 High Low High Low
- ---- ----- ------ ------- ------
First Quarter 6 13/16 4 1/16 2 5/16 1 9/32
Second Quarter 5 1/16 2 1/8 1 3/4 1/2
Third Quarter 3 2 1/4 3/4 5/16
Fourth Quarter 5 1/16 1 3/4 1 3/16 3/8
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 55 holders of record of Common Stock as of June
30, 1999. The Company has never declared or paid any cash dividends on its
capital stock and does not intend to pay any cash dividends in the foreseeable
future.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected financial data with respect to the
Company for the periods indicated. The data below has been derived from the
Company's consolidated financial statements which have been audited by Arthur
Andersen LLP, independent public accountants. The data set forth below should be
read in conjunction with the Consolidated Financial Statements of the Company
together with the related notes thereto included elsewhere herein and Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations. Upon the consummation of the Merger, the Company changed its fiscal
year for accounting and reporting purposes to June 30.
11
Year Ended June 30,
-------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
Net revenues $10,665,753 $19,976,423 $25,467,487 $20,819,444 $21,841,229
----------- ----------- ----------- ----------- -----------
Gross profit 1,367,637 3,637,368 8,393,642 5,115,850 4,990,123
Operating expenses 4,163,346 9,389,393 7,942,846 4,390,344 2,680,209
----------- ----------- ----------- ----------- -----------
Operating (loss) income (2,795,709) (5,752,025) 450,796 725,506 2,309,914
Gain on sale of equity investment 406,930 -- -- -- --
Interest (expense) income, net 38,317 (338,354) 69,224 220,277 (23,239)
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes (2,350,462) (6,090,379) 520,020 945,783 2,286,675
Income taxes 430,396 (1,121,554) 182,791 322,898 843,405
Net (loss) income $(2,780,858) $(4,968,825) $ 337,229 $ 622,885 $ 1,443,270
=========== =========== =========== =========== ===========
Basic earnings per share $ (0.44) $ (0.86) $ 0.06 $ 0.11 $ 0.42
Diluted earnings per share $ (0.44) $ (0.86) $ 0.05 $ 0.10 $ 0.39
Weighted average number of shares used in
basic earnings per share computation 6,278,317 5,784,366 5,712,309 5,612,386 3,456,990
Weighted average number of shares used in
diluted earnings per share computation 6,278,317 5,784,366 7,132,898 6,069,012 3,747,633
BALANCE SHEET DATA:
Current assets $ 5,646,345 $10,861,643 $16,002,051 $11,165,185 $12,373,592
Current liabilities 3,223,986 6,180,319 7,555,703 2,449,010 4,554,720
Working capital 2,422,359 4,681,324 8,446,348 8,716,175 7,818,872
Total assets 7,325,897 13,021,393 18,327,115 12,023,903 13,161,155
Long-term debt excluding current portion -- -- -- 3,733 9,293
Stockholders' equity 4,101,911 6,841,074 10,771,412 9,481,890 8,494,565
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Introduction
The Company designs, manufactures and markets a family of Windows-based
terminals and thin client computers that allow users to access Windows-based
applications from a multi-user Windows NT server, plus connect to mainframes,
minicomputers and the Internet. The Company's NeoStation family of Windows-based
terminals and related software allows users to utilize substantially all of
their existing computer systems and applications running on Windows platforms,
UNIX, mainframes and minicomputers, and access them across a network.
The Company's current strategy is to become a leader in the Windows-based
terminal and thin client computer market by focusing on expanding its software
products and its thin client computer hardware. The Company plans to continue to
12
develop strategic partnerships on the basis of technology and/or expanding its
sales and distribution channels. The Company has engaged The Platinum Group of
New York to assist in these areas, as well as to identify potential equity
investors and other business combinations. The Company sells its products in
North America directly to end users and through value added resellers, system
integrators, OEMs and the Internet.
In October 1997, the Company merged Information Technology Consulting, Inc.
(`ITC"), a wholly owned subsidiary, with Broadreach Consulting, Inc.
("Broadreach") and Global Consulting Group ("Global"). Under the merger, ITC and
Global merged into Broadreach, and Neoware received stock that represented a 2%
ownership of Broadreach. The Company was also reimbursed for the expenses
incurred by the Company and ITC in connection with ITC's efforts to make these
acquisitions, $300,000 of which was paid in cash. The remainder of the expenses
in the amount of $700,000 is repayable by Broadreach on the earlier of three
years or the consummation of an initial public offering of Broadreach. The note
bears interest at 8% per year. During the year ended June 30, 1999, the Company
sold its 2% stock interest in Broadreach for $406,930, which is included as a
gain on sale of equity investment in the accompanying consolidated statement of
operations included in Item 8.
In February 1997, the Company formed a new subsidiary, Bridging Data
Technology, Inc. ("BDT"). BDT acquired and further developed a software product,
SmartBridge (TM), which utilizes the "intelligent bridging" approach to
upgrading programs and data for Year 2000 compliance. The Company entered into
an agreement effective January 1, 1998 which reduced the Company's ownership
position in BDT and eliminated the Company's requirement to fund future
operations. In addition, effective March 31, 1998, the Company wrote off the
full amount of its investment in BDT. The write-off reflects the Company's
evaluation that recovery, if any, of its investment in BDT will not occur in the
near future. Future cash distributions, if any, from BDT will be recorded as
income in the period during which the transaction occurs.
In June 1998, the Company entered into a joint marketing and development
agreement and an equity purchase agreement with Motorola, Inc., under which
Motorola purchased approximately 6% of the Company's outstanding Common stock.
Under the joint marketing and development agreement, the two companies agreed to
collaborate on technology for the windows-based terminal market, and to jointly
promote this technology to OEM customers. There can be no assurance that the
Company will generate significant revenue from this agreement.
13
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,
-------------------------------------
1999 1998 1997
------ ------ -----
Gross profit 12.8% 18.2% 33.0%
Operating expenses:
Sales and Marketing 14.0 22.4 17.0
Research and Development 6.8 7.2 4.2
General and administrative 18.2 13.3 8.6
Restructuring charge 1.0
Bridging Data Technology venture 3.1 1.4
------ ------ ----
Operating (loss) income (26.2) (28.8) 1.8
Gain on sale of equity investment 3.8
Interest (expense) income 0.4 (1.7) 0.2
(Loss) income before taxes (22.0) (30.5) 2.0
Income tax (benefit) expense 4.0 (5.6) 0.7
------ ------ ---
Net (loss) income (26.1)% (24.9)% 1.3%
====== ====== ===
Year Ended June 30, 1999 Compared to Year Ended June 30, 1998
For the year ended June 30, 1999, net revenues decreased by 46.6% to
$10,665,753 from $19,976,423 for the prior fiscal year. The decrease in net
revenues was attributable to the continued transition to the NeoStation family
of products which have lower selling prices than older products, and the gradual
process associated with the full scale implementation of thin client computers
by corporate customers subsequent to the deployment of Windows NT 4.0 Terminal
Server Edition from Microsoft in August 1998 and the implementation of Year 2000
compliant systems by the Company's customers. In addition, sales to two of the
Company's major customers declined significantly during the 1999 fiscal year, as
compared to the 1998 fiscal year, as a result of completing delivery of product
under existing purchase orders. Revenues to such customers are expected to
remain at this reduced level for the foreseeable future. The Company is subject
to significant variances in its operating results because of the fluctuations in
the timing of the receipt of large orders.
The Company's gross profit as a percentage of net revenues decreased to
12.8% for the year ended June 30, 1999, after the provision for inventory
obsolescence of $800,000, from 18.2% for the prior fiscal year. The decrease was
primarily attributable to fixed overhead representing a higher percentage of
revenues and, to a lesser extent, the impact of reduced average selling prices
which were not offset by lower manufacturing costs. The Company anticipates that
gross margins will vary from quarter to quarter depending on average selling
prices, fixed costs in relation to revenue levels and the mix of the Company's
business, including the percentage of revenues derived from hardware and
software. The gross profit margin also varies in response to competitive market
conditions as well as periodic fluctuations in the cost of memory and other
significant components. The market in which the Company competes remains very
14
competitive, and although the Company intends to continue its efforts to reduce
the cost of its products, there can be no certainty that the Company will not be
required to reduce prices of its products without compensating reductions in the
cost to produce its products in order to increase its market share or to meet
competitors' price reductions.
Operating expenses for the year ended June 30, 1999 were $4,163,346, a
decrease from operating expenses of $9,389,393 in the prior fiscal year. Sales
and marketing expenses decreased by $2,986,346 to $1,497,943 for the year ended
June 30, 1999 as compared to $4,484,289 in fiscal 1998. The decrease reflects
the continued restructuring of the domestic and international sales force and
reduced commissions attributable to lower revenues. During the 1999 fiscal year,
the Company terminated its relationship with its U.S. distributor. The Company
believes that the elimination of a level of distribution will allow it to price
its products more competitively without a negative impact on gross profit. The
Company is using a lower cost telesales channel and the Internet to complement
its current sales efforts and is selling to Value Added Resellers. Research and
development expenses for the year ended June 30, 1999 decreased to $726,633 as
compared to $1,443,720 primarily as a result of the Company's completion of the
introduction of the NeoStation family of products in the 1998 fiscal year. The
decrease in research and development expenses was accomplished primarily through
staffing changes and a substantial reduction in the use of outside consultants
and services. General and administrative expenses for the year ended June 30,
1999 decreased to $1,938,770 from $2,649,800 in the year ended June 30, 1998
primarily due to the Company's cost reduction efforts. The reduction of BDT's
expenses as compared to the 1998 fiscal year reflects the impact of the
agreement which reduced the Company's ownership position and eliminated the
Company's requirement to fund future operations of BDT effective January 1,
1998. The write-off reflects the Company's evaluation that recovery, if any, of
its investment in BDT will not occur. Future cash distributions to the Company
from BDT, if any, will be recorded as income in the period during which the
transaction occurs. Expenses related to BDT including the investment write-off,
have been reclassified as expenses of BDT venture in the Company's Consolidated
Financial Statements included under Item 8. hereof.
The Company realized net interest income of $38,317 for the year ended June
30, 1999 as compared to net interest expense of $338,354 for the 1998 fiscal
year. The decline in interest expense was primarily due to decreased borrowings
under the Company's line of credit combined with the collection of recoverable
income taxes of $1,121,554 and the proceeds of $406,930 from the sale of its
equity investment in Broadreach and the investment of such funds in interest
bearing accounts.
The effective income tax rates were approximately 18.3% as compared to
35.2% for the year ended June 30, 1998. During the year ended June 30,1999, the
Company recorded income tax expense of $430,396 to reserve for a previously
recorded deferred tax asset. No income tax benefit was recognized in the 1999
fiscal year as a result of the net operating losses incurred during the year as
there is no assurance at this time that the benefit of the net operating loss
carryforward will be realized. The tax benefit for the year ended June 30, 1998
reflects recovery of taxes paid in prior years.
For the year ended June 30, 1999, the Company's net loss was $2,780,858 as
compared to a net loss of $4,968,825 for the prior year. The Company's net loss
for the year ended June 30, 1999 includes a provision for inventory obsolescence
of $800,000, an income tax charge of $430,396 and no income tax benefit from the
net operating loss, offset in part by reduced operating and interest expenses
and the gain of $406,930 on the sale of the Company's equity investment in
Broadreach.
15
Year Ended June 30, 1998 Compared to Year Ended June 30, 1997
For the year ended June 30, 1998, net revenues decreased by 21.6% to
$19,976,423 from $25,467,487 for the prior fiscal year. The Company's net
revenues for the 1998 fiscal year primarily represent a transition from its line
of network computers and X Window terminals to its NeoStation family of
Windows-based terminals which were introduced in December 1997. Net revenues for
the year ended June 30, 1997 represent shipments of the Company's network
computer product line and revenues earned from licensing agreements for its
netOS system software. The decrease in net revenues was attributable to the
aforementioned transition to the NeoStation family of products which have lower
selling prices than older products, and the delay in the full scale
implementation of thin client computers by corporate customers as they awaited
the deployment of Windows Terminal Server from Microsoft. In addition, sales to
two of the Company's major customers declined significantly during the last six
months of fiscal 1998, as a result of completing delivery of product under
existing purchase orders. Revenues to such customers are expected to remain at
this reduced level for the foreseeable future. The Company is subject to
significant variances in its operating results because of the fluctuations in
the timing of the receipt of large orders.
The Company's gross profit as a percentage of net revenues decreased to
18.2% for the year ended June 30, 1998 from 33.0% for the prior fiscal year. The
decrease was primarily attributable to the write-down of certain software
licenses, a charge for a reduction in the carrying value of inventory, higher
fixed overhead as a percentage of sales and the impact of reduced selling
prices. The reduced gross profit was also attributable to the Company deriving
substantially less revenue from software licensing as well as an increase in the
percentage of sales through third party sales channels and reduced sales to two
of its major customers. The Company anticipates that gross margins will vary
from quarter to quarter depending on the source of the Company's business,
including the percentage of revenue derived from hardware and software. The
gross profit margin also varies in response to competitive market conditions as
well as periodic fluctuations in the cost of memory and other significant
components. The market in which the Company competes remains very competitive,
and although the Company intends to continue its efforts to reduce the cost of
its products, there can be no certainty that the Company will not be required to
reduce prices of its products without compensating reductions in the cost to
produce its products in order to increase its market share or to meet
competitors' price reductions.
Operating expenses for the year ended June 30, 1998 were $9,389,393, an
increase from operating expenses of $7,942,846 in the prior fiscal year. Sales
and marketing expenses increased by $151,449 to $4,484,289 for the year ended
June 30, 1998 as compared to $4,332,840 in fiscal 1997. The increase reflects
the cost of additions to the Company's sales and technical staff offset by
reduced expenditures for advertising expense. Research and development expenses
for the year ended June 30, 1998 increased by 34.7%, or $371,729, to $1,443,720
from $1,071,991 in the prior year which reflects the Company's commitment to
developing, adapting or acquiring technologies that will expand the market for
its current and future products. The increase in general and administrative
expenses to $2,649,800 for the year ended June 30, 1998 from $2,172,886 in the
prior year reflects the addition of the Company's Chief Executive Officer and
MIS staff and legal costs incurred in connection with the shareholder suit and
other litigation. These amounts were partially offset by the reimbursement of
expenses related to the Company's former subsidiary, Information Technology
Consulting, Inc. The restructuring charge incurred in fiscal 1998 is primarily
related to a reduction in the Company's workforce in the United States and the
United Kingdom.
16
The increase in net interest expense to $338,354 for the year ended June
30, 1998 from net interest income of $69,224 for the prior year reflects the
increase in average line of credit borrowings during fiscal 1998 needed to
finance the losses from operations and higher inventory and accounts receivable
balances during much of the year.
The effective income tax rates were approximately 18.4% in the 1998 fiscal
year as compared to 35.2% in the prior fiscal year. The reduced rate during the
year ended June 30, 1998 reflects the recording of a valuation reserve of
$679,749 against deferred tax assets.
For the year ended June 30, 1998, the Company incurred a net loss of
$4,968,825 as compared to net income of $337,229 for the prior year. The net
loss resulted from decreased revenues, increased cost of sales and operating
expenses during the period, as well as increased net interest expense, which was
partially offset by the reimbursement of expenses related to the Company's
former subsidiary, Information Technology Consulting, Inc.
Liquidity and Capital Resources
At June 30, 1999, the Company had net working capital of $2,422,359
composed primarily of cash and cash equivalents, accounts receivable and
inventory. The Company's principal sources of liquidity include $1,470,906 of
cash and cash equivalents and a $2,000,000 bank line of credit facility, of
which $1,857,000 was available as of June 30, 1999. The facility is secured by a
first lien security interest on all tangible and intangible personal property of
the Company and separate pledges of investment property owned by Neoware
Investments, Inc. and Neoware Licensing, Inc., each of which is a wholly-owned
subsidiary of the Company. The facility agreement also provides that borrowings
under the line will be based on the amount of eligible accounts receivable, as
defined. Interest on the line of credit facility accrues at the bank's prime
rate plus two percent (2%), with interest payable monthly, and all principal and
interest due and payable on December 31, 1999. At June 30, 1999, the Company was
not in compliance with certain of its financial covenants and the bank has
granted a waiver of such non-compliance. In connection with such waiver, the
Company has agreed to maintain cash collateral equal to the amount outstanding
under the line from time to time but not less than $400,000.
Cash and cash equivalents increased by $167,922 during the year ended June
30, 1999, primarily as a result of the collection of recoverable income taxes,
the proceeds from the sale of its equity investment in Broadreach and a decrease
in accounts receivable and inventories offset by the loss from operations,
repayments under the line of credit and a decrease in accounts payable.
The Company generated $2,963,818 in cash from operating activities in
fiscal 1999 compared to $347,386 during fiscal 1998. The increase in cash
generated from operations during fiscal 1999 is primarily due to the reduction
of the net loss and reductions in accounts receivable, inventories and
recoverable income taxes. Cash flow from operations can vary significantly from
quarter to quarter depending on the timing of payments from, and shipments to,
large customers.
Net cash of $135,104 was generated by investing activities in fiscal 1999
primarily due to the proceeds from the sale of the Company's equity investment
in Broadreach. Net cash of $786,195 was used in investing activities in fiscal
1998 primarily due to the capitalization of development costs related to new
software products and enhancements to existing software products.
17
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 sources. Management believes that
there will be sufficient funds from current cash, operations and available
financing to fund operations and cash expenditures through fiscal 2000. However,
the Company must achieve profitable operations in order to provide adequate
funding for the long term.
Inflation
The Company believes that inflation has not had a material effect on its
sales and net revenues during the past three years.
Year 2000 Compliance
The Company continues to evaluate its Year 2000 exposures. The following
areas were evaluated: internal management information and embedded systems,
products, vendors and customers.
The Company utilizes various computer software programs and systems as part
of its internal management information systems which are primarily off-the-shelf
products purchased from commercial sources with minor customization. Updates to
these products are routinely installed by the Company to upgrade the systems and
correct known defects in the software. All major systems have been reviewed for
Year 2000 issues. The Company's financial accounting software is not Year 2000
compliant. The Company is testing an upgrade to the current software, which is
Year 2000 compliant, and will cost approximately $25,000 for the software and
training. Conversion to the updated software has been substantially completed.
The Company's engineering department utilizes UNIX based systems, which are not
Year 2000 compliant; however, the nature of the utilization is not date
sensitive. The operating systems can be upgraded for less than $5,000. The
Company is in the process of implementing a sales contact management and service
data base software application which is Year 2000 compliant. The total cost of
such software is expected to be less than $15,000. All other significant
internal systems are either compliant or not critical to ongoing operations. The
Company does not utilize any significant systems with embedded technology.
All of the Company's products sold after March 1997 were tested and found
to be Year 2000 compliant.
None of the Company's vendors provides more than 20% of the Company's
annual raw material requirements and alternative sources are generally
available. The Company has substantially completed its evaluation of the Year
2000 readiness of its sole source vendors. Contingency plans have been developed
to ensure continued supply in the event a vendor expects to incur difficulties
achieving Year 2000 compliance. . There can be no assurance that the Company
will not be adversely affected by the failure of distributors, suppliers,
customers and vendors with which it interacts to become Year 2000 compliant. The
Company has not determined the extent to which its business and customers might
be affected in that event.
The Company estimates that the total cost to complete its Year 2000
evaluation and remediation, including normal planned system upgrades, of all
internal systems is less than $50,000, of which approximately $40,000 has been
incurred to date. Funding for these costs is expected to be provided by cash
flows from operations. The Company has not deferred any significant system
projects due to its Year 2000 efforts.
18
Forward-Looking Statements
Certain statements under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" are forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, and relate to
the development of the Company's products and future operating results that are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those in such forward-looking statements. Forward-looking
statements include anticipated purchases by customers, future margins and margin
trends, future revenues and operating losses, the Company's competitive
position, lower cost of ownership of the Company's systems, expansion of
software products and thin client computer hardware products, statements
regarding Year 2000 compliance and statements regarding the pending litigation.
The words "believe," "expect," intend," "anticipate," variations of such words,
and similar expressions identify forward-looking statements, but their absence
does not mean that the statement is not forward-looking. These statements are
not guarantees of future performance and are subject to certain risks,
uncertainties and assumptions that are difficult to predict. Factors that could
affect the Company's actual results include the Company's ability to lower its
costs, the Company's relationship with SCI, the ability of the Company to market
its products with Motorola to OEM customers, reliance on Microsoft's actions
relating to Windows NT, customers' acceptance of Neoware's line of thin clients
and newly introduced options, pricing pressures, rapid technological changes in
the industry, growth of the thin client computer market, increased competition
and the ability of the Company, its distributors, vendors, suppliers and
customers to effectively address Year 2000 compliance issues. Additional factors
which could affect the Company's actual results include quarterly fluctuations
in operating results, general economic conditions affecting the demand for
computer products, the timing of significant orders, failure to reduce product
costs or maintain quality, delays in the receipt of key components, seasonal
patterns of spending by customers and the outcome of various litigation. The
Company does not undertake to update any forward-looking statements made herein.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements of the Company are filed under this Item 8,
beginning on page F-2 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
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 1999 Annual Meeting of
Stockholders.
19
The following individuals are the current executive officers of the
Company:
Name Age Position
---- --- --------
Edward C. Callahan, Jr. 53 President and Chief Executive Officer
Michael G. Kantrowitz 39 Executive Vice President
Steven B. Ahlbom 49 Vice President of Operations
Edward M. Parks 47 Vice President of Engineering
Vincent T. Dolan 56 Vice President of Finance and Administration
Mr. Callahan has been President and Chief Executive Officer and a Director
of the Company since June 1997. Prior to joining the Company, Mr. Callahan was
President and Chief Operating Officer of Summa Four, Inc. of Manchester, NH, a
provider of telecommunications switches, from June 1995 until November 1996.
Beginning in 1985, Mr. Callahan also held various executive positions during a
ten year tenure at Sun Microsystems Computer Corporation. He was most recently
Vice President of Global Telecom and Cable; previously, he was Vice President of
Strategic Accounts and Vice President of the Northeast Area.
Mr. Kantrowitz has been Executive Vice President and a Director of the
Company since March 2, 1995. Prior to that, he was an employee of HDS from 1983,
holding the positions of Executive Vice President from 1991 until March 1995 and
Vice President of Marketing and Sales from 1987 until 1991. Prior to joining
HDS, Mr. Kantrowitz held positions with Raytheon Company and Adage Corporation.
Mr. Ahlbom has been Vice President of Operations of the Company since March
2, 1995. Prior to that, he held the positions of Vice President of Operations
and Manager of Operations of HDS from 1988. Prior to joining HDS, Mr. Ahlbom was
World-Wide Quality Assurance Manager for Commodore International from 1987 until
1988, and served as Quality Assurance Manager of Burroughs Corporation.
Mr. Parks has been Vice President of Engineering of the Company since March
2, 1995. Prior to that, he held the position of Vice President of Engineering of
HDS from 1987. Prior to joining HDS, Mr. Parks was Corporate Director for
Product and Market Development and Director of Engineering for Commodore
Business Machines from 1984 until 1987, and was employed by Eastman Kodak in
engineering management positions from 1974 to 1984.
Mr. Dolan has been Vice President of Finance and Administration since
January 27, 1999. Prior to joining the Company, he served as Vice
President-Finance and Administration for Superior Tube Company of Collegeville,
Pennsylvania (a subsidiary of Superior Group, Inc.), a manufacturer of
specialty, small diameter tubing, from 1991 through 1998. From 1983 until 1988,
Mr. Dolan also served as Vice President-Finance and Administration and Chief
Financial Officer of General Data Systems, Ltd, a computer services company and,
prior to that, as Executive Vice President-Finance and Administration of Omni
Exploration, Inc.(a Nasdaq Company). Mr. Dolan was also employed by Coopers &
Lybrand and is a certified public accountant.
20
All officers of the Company are appointed annually by the Company's Board
and serve at its discretion.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference to the
section entitled "Executive Compensation" in the Company's definitive proxy
statement for its 1999 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference to the
section entitled "Beneficial Ownership of Common Stock" in the Company's
definitive proxy statement for its 1999 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 1999 Annual Meeting of Stockholders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
Financial Statements
See Index to Financial Statements at page F-1.
Financial Statement Schedules
All schedules have been omitted because they are not applicable, or not
required, or the information is shown in the financial statements or notes
thereto.
Exhibits
The following is a list of exhibits filed as part of this annual report on
Form 10-K. Where so indicated by footnote, exhibits which were previously filed
are incorporated by reference.
21
Exhibit
Numbers Description
- ------- -----------
2.1 Agreement of Merger dated as of December 2, 1994 among the Company, ISAC
Acquisition Co. and HDS (Exhibit 2.1)(3)
3.1 Certificate of Incorporation (Exhibit 3.1(1)
3.2 Amendment to Certificate of Incorporation (Exhibit 3.2)(2)
3.3 By-laws (Exhibit 3.2)(7)
4.1 Form of Warrant Certificate (Exhibit 4.2)(2)
4.2 Warrant Agreement between Continental Stock Transfer & Trust Company and
Registrant (Exhibit 4.4)(3)
4.3 Warrant Agreement, dated March 2, 1995, between Continental Stock
Transfer & Trust Company and the Registrant (Exhibit 4.5)(2)
4.4 Common Stock Purchase Warrants held by Kirlin Holding Corp. and two
related persons (Pursuant to Instruction 2 to Item 601 of Regulation
S-K, the Common Stock Purchase Warrants, which are identical in all
material respects except as to the parties thereto and the number of
Warrants, held by such related persons are not being filed) (Exhibit
4.5)(6)
10.1 Letter Agreement between Safeguard Scientifics, Inc. and Registrant
(Exhibit 10.5)(3)
10.2 Lease between the Registrant and GBF Partners, as amended (Exhibit
10.9)(4)
10.3+ 1995 Stock Option Plan (Exhibit 10.9)(2)
10.4+ 1995 Stock Option Plan (as amended on November 12, 1996)
10.5+ Employment Agreement, dated March 2, 1995, between the Registrant and
Michael G. Kantrowitz (Exhibit 99.2)(5)
10.6+ Letter agreement, dated May 29, 1997, between the Registrant and Edward
C. Callahan, Jr. (Exhibit 10.6)(6)
10.7+* Employment Agreement, dated June 10, 1999, between the Registrant and
Edward M. Parks.
10.8+* Letter agreement, dated October 1, 1999, between the Registrant and
Steven Ahlbom.
21. Subsidiaries (Exhibit 21)(6)
23.* Consent of Arthur Andersen LLP
- ------------
* Filed herewith.
+ Management contract or arrangement.
22
(1) Filed as an Exhibit to the Company's Registration Statement on Form S-1
(File No. 33-56834) filed with the SEC on January 7, 1993.
(2) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1994.
(3) Filed as an Exhibit to Amendment No. 1 to the Company's Registration
Statement on Form S-1 (No. 33-56834) filed with the SEC on February 11,
1993.
(4) Filed as an Exhibit to the Company's Registration Statement on Form S-4
(File No. 33-87036) filed with the SEC on December 6, 1994.
(5) Filed as an Exhibit to the Company's Current Report on Form 8-K dated March
2, 1995. Reports on Form 8-K.
(6) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
year ended June 30, 1998.
(7) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998.
No reports on Form 8-K were filed during the last quarter of fiscal 1999:
23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NEOWARE SYSTEMS, INC.
Date: September 27, 1999 By: /s/ Edward C. Callahan, Jr.
---------------------- --------------------------------------
Edward C. Callahan, Jr.
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 Edward C.
Callahan, President and Chief Executive Officer, Michael G. Kantrowitz,
Executive Vice President and Vincent T. Dolan, Vice President-Finance and
Administration, and each of them severally, his or her true and lawful
attorney-in-fact, in his or her name, place and stead to execute and cause to be
filed with the Securities and Exchange Commission any or all amendments to this
report.
Signature Title Date
--------- ----- ----
/s/ Arthur R. Spector Chairman of the Board September 27, 1999
- -----------------------------
Arthur R. Spector
/s/ Edward C. Callahan, Jr. President, Chief Executive September 27, 1999
- ----------------------------- Officer and Director (Principal
Edward C. Callahan, Jr. Executive Officer)
/s/ Michael G. Kantrowitz Executive Vice President and September 27, 1999
- ----------------------------- Director
Michael G. Kantrowitz
/s/ Vincent T. Dolan Vice President of Finance and September 27, 1999
- ----------------------------- Administration (Principal Financial
Vincent T. Dolan Officer and Principal Accounting
Officer)
/s/ John Ryan Director September 27, 1999
- -----------------------------
John M. Ryan
/s/ Carl G. Sempier Director September 27, 1999
- -----------------------------
Carl G. Sempier
/s/ Christopher G. McCann Director September 27, 1999
- -----------------------------
Christopher G. McCann
24
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Neoware Systems, Inc. and Subsidiaries
Report of Independent Public Accountants F-2
Consolidated Financial Statements--
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Stockholders' Equity F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-7
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Neoware Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Neoware Systems,
Inc. (a Delaware corporation) and subsidiaries as of June 30, 1999 and 1998, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended June 30, 1999. 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 generally accepted auditing
standards. 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, 1999 and 1998, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
1999 in conformity with generally accepted accounting principles.
/s/Arthur Andersen LLP
Philadelphia, Pa.,
August 18, 1999
F-2
NEOWARE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
June 30,
----------------------------
1999 1998
----------- -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,470,906 $ 1,302,984
Accounts receivable, net of
allowance for doubtful accounts of
$196,756 and $168,710 2,586,693 4,777,957
Inventories 1,324,424 3,119,043
Recoverable income taxes -- 1,121,554
Prepaid expenses and other 264,322 123,575
Deferred income taxes -- 416,530
----------- -----------
Total current assets 5,646,345 10,861,643
PROPERTY AND EQUIPMENT, net 438,367 636,414
CAPITALIZED AND PURCHASED SOFTWARE, net 541,185 809,470
NOTE RECEIVABLE 700,000 700,000
DEFERRED INCOME TAXES -- 13,866
----------- -----------
$ 7,325,897 $13,021,393
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit $ 143,000 $ 3,074,000
Accounts payable 1,654,926 1,834,400
Accrued expenses 1,106,388 1,106,607
Deferred revenue 319,672 165,312
----------- -----------
Total current liabilities 3,223,986 6,180,319
----------- -----------
COMMITMENTS AND CONTINGENCIES (Note 10)
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 1,000,000 shares
authorized and none issued and outstanding -- --
Common stock, $.001 par value, 50,000,000 shares
authorized, 6,285,782 and 6,264,158 shares
issued and outstanding 6,286 6,264
Additional paid-in capital 10,178,357 10,154,052
Accumulated deficit (6,082,732) (3,301,874)
Deferred compensation -- (17,368)
----------- -----------
Total stockholders' equity 4,101,911 6,841,074
----------- -----------
$ 7,325,897 13,021,393
=========== ===========
The accompanying notes are an integral part of these financial statements.
F-3
NEOWARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended June 30,
-----------------------------------------------
1999 1998 1997
----------- ----------- -----------
NET REVENUES $10,665,753 $19,976,423 $25,467,487
COST OF REVENUES 9,298,116 16,339,055 17,073,845
----------- ----------- -----------
Gross profit 1,367,637 3,637,368 8,393,642
----------- ----------- -----------
OPERATING EXPENSES:
Sales and marketing 1,497,943 4,484,289 4,332,840
Research and development 726,633 1,443,720 1,071,991
General and administrative 1,938,770 2,649,800 2,172,886
Restructuring charge -- 198,105 --
Bridging Data Technology venture -- 613,479 365,129
----------- ----------- -----------
Total operating expenses 4,163,346 9,389,393 7,942,846
----------- ----------- -----------
Operating (loss) income (2,795,709) (5,752,025) 450,796
GAIN ON SALE OF EQUITY INVESTMENT 406,930 -- --
INTEREST (EXPENSE) INCOME, net 38,317 (338,354) 69,224
----------- ----------- -----------
(Loss) income before income taxes (2,350,462) (6,090,379) 520,020
INCOME TAX (BENEFIT) EXPENSE 430,396 (1,121,554) 182,791
----------- ----------- -----------
NET (LOSS) INCOME $(2,780,858) $(4,968,825) $ 337,229
=========== =========== ===========
BASIC EARNINGS PER SHARE $ (.44) $ (.86) $ .06
=========== =========== ===========
DILUTED EARNINGS PER SHARE $ (.44) $ (.86) $ .05
=========== =========== ===========
Weighted average number of shares used in basic earnings
per share computation 6,278,317 5,784,366 5,712,309
=========== =========== ===========
Weighted average number of shares used in diluted
earnings per share computation 6,278,317 5,784,366 7,132,898
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
F-4
NEOWARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock
--------------------- Additional Retained
Paid-in Earnings
Shares Amount Capital (Deficit)
--------- ------ ------------ ----------
BALANCE AT JUNE 30, 1996 5,619,595 $5,620 $ 8,268,123 $ 1,329,722
Exercise of Common Stock warrants 18,050 18 99,257 --
Exercise of stock options 123,175 123 733,655 --
Tax benefit on options exercised -- -- 67,136 --
Amortization of deferred compensation -- -- -- --
Net income -- -- -- 337,229
--------- ------ ----------- -----------
BALANCE AT JUNE 30, 1997 5,760,820 5,761 9,168,171 1,666,951
Exercise of stock options 7,112 7 (7) --
Unit Purchase Options exchanged for Common Stock 100,000 100 (100) --
Sale of Common Stock, net of expenses 396,226 396 985,988 --
Amortization of deferred compensation -- -- -- --
Net loss -- -- -- (4,968,825)
--------- ------ ----------- -----------
BALANCE AT JUNE 30, 1998 6,264,158 6,264 10,154,052 (3,301,874)
Issuance of Common Stock for services rendered 21,624 22 24,305 --
Amortization of deferred compensation -- -- -- --
Net loss -- -- -- (2,780,858)
--------- ------ ----------- -----------
BALANCE AT JUNE 30, 1999 6,285,782 $6,286 $10,178,357 $(6,082,732)
========= ====== =========== ===========
Deferred
Compensation Total
------------ -----------
BALANCE AT JUNE 30, 1996 $(121,575) $ 9,481,890
Exercise of Common Stock warrants -- 99,275
Exercise of stock options -- 733,778
Tax benefit on options exercised -- 67,136
Amortization of deferred compensation 52,104 52,104
Net income -- 337,229
--------- -----------
BALANCE AT JUNE 30, 1997 (69,471) 10,771,412
Exercise of stock options -- --
Unit Purchase Options exchanged for Common Stock -- --
Sale of Common Stock, net of expenses -- 986,384
Amortization of deferred compensation 52,103 52,103
Net loss -- (4,968,825)
--------- -----------
BALANCE AT JUNE 30, 1998 (17,368) 6,841,074
Issuance of Common Stock for services rendered -- 24,327
Amortization of deferred compensation 17,368 17,368
Net loss -- (2,780,858)
--------- -----------
BALANCE AT JUNE 30, 1999 $ -- $ 4,101,911
========= ===========
The accompanying notes are an integral part of these financial statements.
F-5
NEOWARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended June 30,
-------------------------------------------------------------
1999 1998 1997
------------ ------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(2,780,858) $(4,968,825) $ 337,229
Adjustments to reconcile net (loss) income to net cash
provided by (used in) operating activities-
Depreciation and amortization 738,158 881,295 361,121
Amortization of deferred compensation 17,368 52,103 52,104
Issuance of Common Stock for services rendered 24,327 -- --
Gain on sale of equity investment (406,930) -- --
Write-down of purchased software -- 610,984 --
Write-off investment in Bridging Data Technology -- 159,231 --
Provision for inventory obsolescence 800,000 -- --
Deferred income taxes 430,396 -- (84,196)
Changes in operating assets and liabilities-
(Increase) decrease in:
Accounts receivable 2,191,264 4,530,774 (4,394,724)
Inventories 994,619 916,159 (1,680,948)
Recoverable income taxes 1,121,554 (1,121,554) --
Prepaid expenses and other (140,747) 665,603 (28,023)
Increase (decrease) in:
Accounts payable (179,474) (1,962,149) 1,868,652
Accrued expenses (219) 590,459 199,211
Deferred revenue 154,360 (6,694) (27,938)
------------- ----------- ------------
Net cash provided by (used in)
operating activities 2,963,818 347,386 (3,397,512)
------------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of equity investment 406,930 -- --
Purchases of property and equipment, net (40,317) (245,459) (216,661)
Capitalized and purchased software (231,509) (540,736) (1,596,940)
------------- ----------- ------------
Net cash provided by (used in)
investing activities 135,104 (786,195) (1,813,601)
------------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (repayment of) line of credit (2,931,000) 3,000 3,071,000
Issuance of note receivable -- (700,000) --
Sale of Common Stock -- 986,384 --
Principal payments on long-term debt -- -- (7,965)
Exercise of stock options -- -- 733,778
Tax benefits on options exercised -- -- 67,136
Exercise of warrants -- -- 99,275
------------- ----------- ------------
Net cash provided by (used in)
financing activities (2,931,000) 289,384 3,963,224
-------------- ----------- ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 167,922 (149,425) (1,247,889)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,302,984 1,452,409 2,700,298
------------- ----------- ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,470,906 $ 1,302,984 $ 1,452,409
============= =========== ============
SUPPLEMENTAL DISCLOSURES OF NONCASH
OPERATING ACTIVITIES:
Cash paid for income taxes $ -- $ 53,032 $ 27,213
Cash paid for interest 65,691 313,112 61,560
The accompanying notes are an integral part of these financial statements.
F-6
NEOWARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. COMPANY BACKGROUND:
Neoware Systems, Inc. (the "Company") designs, manufactures and markets a family
of Windows-based terminals and thin client computers. The Company's
NeoStation(TM) family of Windows-based terminals and related software allow
users to access applications and information on multiple platforms, including
both mainframe and mid range computers, as well as the Internet, running a wide
variety of operating systems, including all versions of the Windows(R) operating
system, Citrix WinFrame, UNIX(TM) and Java.
In August 1996, the Company formed a new subsidiary, Information Technology
Consulting, Inc. ("ITC") for the purpose of acquiring companies in the computer
services field, including information technology staffing companies and
client-server consulting companies. In October 1997, ITC merged with Broadreach
Consulting, Inc. ("Broadreach", formerly the Reohr Group, Inc.) and Global
Consulting Group. The Company, as the sole stockholder of ITC, received stock of
the surviving entity representing approximately 2% ownership of the entity after
the merger. The Company was also reimbursed for the expenses incurred by the
Company and ITC in connection with ITC's efforts to complete these transactions
(see Note 5). In November 1998, the Company sold its remaining 2% ownership
interest to Broadreach for $406,930 which is recorded as a gain on sale of
equity investment in the accompanying consolidated statements of operations.
In February 1997, the Company formed a new subsidiary, Bridging Data Technology,
Inc. ("BDT"). BDT acquired and further developed a software product for
upgrading programs and data for Year 2000 compliance. The Company entered into
an agreement effective January 1, 1998 which reduced the Company's ownership
position in BDT and eliminated the Company's requirement to fund future
operations. In addition, effective March 31, 1998, the Company wrote off the
full amount of its investment in BDT. The write-off reflects the Company's
evaluation that recovery, if any, of its investment in BDT will not occur in the
near future. Future cash distributions, if any, from BDT will be recorded as
income in the period during which the transaction occurs.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All significant intercompany profits, accounts
and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
F-7
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, 1999 and 1998 consist of
money market funds.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined by the
first-in, first-out method.
Long-Lived Assets
The Company follows Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." Accordingly, in the event that facts and
circumstances indicate that property and equipment, and intangible or other
assets may be impaired, an evaluation of recoverability would be performed. If
an evaluation is required, the estimated future undiscounted cash flows
associated with the assets is compared to the assets' carrying amount to
determine if a write-down to market value or discounted cash flow value is
necessary. As of June 30, 1999, no write-down was necessary.
Property and Equipment
Property and equipment are stated at cost. Additions and improvements that
significantly extend the useful life of an asset are capitalized. Expenditures
for repairs and maintenance are charged to operations as incurred. Depreciation
and amortization are provided using the straight-line and accelerated methods
over the estimated useful lives of the assets as follows:
Computer equipment 3-5 years
Office furniture and equipment 5-7 years
Leasehold improvements Lease term
Other 3-5 years
Revenue Recognition
Product revenue is recognized at the time of title transfer, which ordinarily
occurs at the time of shipment. From time to time, customers request delayed
shipment, usually because of customer scheduling for systems integration and
lack of storage space at customers' facility during the implementation. In such
"bill and hold" transactions, the Company recognizes revenues when the following
conditions are met: the equipment is complete, ready for shipment and segregated
from other inventory; the Company has no further significant performance
obligations in connection with the completion of the transaction; the commitment
and delivery schedule is fixed; the customer requested the transaction be
completed on this basis; and the risks of ownership have passed to the customer.
Revenues recognized from "bill and hold" transactions for products which had not
shipped by fiscal year-end were $904,265, $814,120 and $7,488,222 for the years
ended June 30, 1999, 1998 and 1997, respectively. Accounts receivable relating
to "bill and hold" transactions were $585,584 and $804,234 at June 30, 1999 and
1998, respectively.
Service contract revenue is recognized ratably over the contract period. Product
warranty costs and an allowance for sales returns are accrued at the time
revenues are recognized.
F-8
Research and Development
Costs incurred in the development of new software products and enhancements to
existing software products are charged to expense as incurred until the
technological feasibility of the product has been established. After
technological feasibility has been established, any additional costs are
capitalized in accordance with SFAS No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed." Capitalized
software costs are amortized to cost of revenues over the expected life of the
product, not to exceed three years. The Company capitalized $176,509, $351,136,
and $285,968 of software development cost and amortized $264,747, $220,877 and
$147,977 in fiscal 1999, 1998 and 1997, respectively. Accumulated amortization
was $581,099 and $316,352 at June 30, 1999 and 1998, respectively. The Company
also enters into various licensing agreements which require up front cash
payments and/or royalties based on unit sales. Such amounts are capitalized and
amortized over the term of the license agreement or based on the units sold. The
Company continually evaluates whether events and circumstances have occurred
that indicate that unamortized product development costs may not be recoverable
or that the amortization period should be revised. During fiscal 1998, the
Company wrote down the carrying value of certain prepaid licenses, as such
amounts were not deemed recoverable from future sales. The write-down which
totaled $610,984 was charged against cost of revenues in the accompanying
consolidated statements of operations.
Earnings Per Share
Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings per
Share," which supersedes Accounting Principles Board Opinion No. 15, "Earnings
per Share." SFAS 128 requires dual presentation of basic and diluted earnings
per share ("EPS") for complex capital structures on the face of the income
statement. Basic EPS is computed by dividing income (loss) by the weighted
average number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution from the exercise or conversion of securities into Common
stock, such as stock options. For fiscal 1997, the weighted average number of
shares outstanding for purposes of calculating diluted earnings per share
included 1,420,589 shares attributable to stock options and warrants. For the
years ended June 30, 1999 and 1998, there were no dilutive effects of stock
options or warrants as the Company incurred a net loss.
Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Under the asset-and-liability method of SFAS No.
109, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their 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.
New Accounting Pronouncements
Effective July 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." This statement requires companies to classify items of
other comprehensive income by their nature in a financial statement and display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in-capital in the equity section of a statement of
financial position. For the years ended June 30, 1999, 1998 and 1997, the
Company's comprehensive income consists only of its net (loss) income.
F-9
Effective July 1, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 superseded SFAS
No. 14, "Financial Reporting for Segments of a Business Enterprise." SFAS No.
131 establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports. SFAS No. 131 also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
The Company operates in one industry segment and, accordingly, the adoption of
SFAS No. 131 had no effect on the Company.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Financial Instruments and Hedging Activities." SFAS
No. 133, as amended by SFAS No. 137, which must be adopted by the Company in the
year ending June 30, 2001, provides a comprehensive and consistent standard for
the recognition and measurement of derivatives and hedging activities. As the
Company does not currently hold derivative instruments or engage in hedging
activities, the adoption of this pronouncement is expected to have no impact on
the Company's financial statements.
In March 1998, the American Institute of Certified Public Accountants ("AICPA")
issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." This statement requires that
certain costs related to the development or purchase of internal-use software be
capitalized and amortized over the estimated useful life of the software, and is
effective for fiscal years beginning after December 15, 1998. The statement also
requires that costs related to the preliminary project stage and post
implementation/operations stage in an internal-use computer software development
project be charged to expense as incurred. As the Company's current policy falls
within the guidelines of SOP 98-1, the adoption of this pronouncement is
expected to have no impact on the Company's financial position or results of
operations.
3. MAJOR CUSTOMERS AND FOREIGN REVENUES:
Net revenues from no individual customer exceeded 10% of total net revenues in
fiscal 1999. Net revenues from two customers represented 15% and 14% of total
net revenues in fiscal 1998 and 15% and 25% of total net revenues in fiscal
1997. Revenues from one significant customer in fiscal 1997 were under
subcontracts for systems integration contracts for major U.S. government
procurements.
The Company's products are used in a broad range of industries for a variety of
applications. Sales are made to both domestic and international customers. Net
foreign revenues in fiscal 1999, 1998 and 1997 were approximately 29%, 20% and
22%, respectively, and were transacted in US dollars.
4. CONSOLIDATED BALANCE SHEET COMPONENTS:
Inventories consist of the following:
June 30,
-----------------------------
1999 1998
---------- ----------
Purchased components and subassemblies $ 732,026 $1,599,136
Work-in-process 129,972 283,587
Finished goods 462,426 1,236,320
---------- ----------
$1,324,424 $3,119,043
========== ==========
F-10
In fiscal 1999, the Company entered into an agreement to outsource a significant
portion of the Company's manufacturing and fulfillment services. In December
1998, the Company recorded a charge of $800,000 to reduce the carrying value of
certain inventory to the lower of cost or market value. The charge is recorded
as a component of cost of revenues in the accompanying consolidated statements
of operations.
Property and equipment consist of the following:
June 30,
-----------------------------
1999 1998
---------- ----------
Computer equipment $ 945,712 $ 922,621
Office furniture and equipment 359,434 342,208
Leasehold improvements 362,518 362,518
Other 121,921 121,921
---------- ----------
1,789,585 1,749,268
Less- Accumulated depreciation
and amortization (1,351,218) (1,112,854)
---------- ----------
$ 438,367 $ 636,414
========== ==========
5. NOTE RECEIVABLE:
In October 1997, the Company merged ITC, a wholly-owned subsidiary, into
Broadreach in exchange for a 2% stock interest in Broadreach and the
reimbursement of $1,000,000 of expenses incurred by the Company in connection
with its efforts to make certain acquisitions in the information technology
consulting and staffing field. Of the total reimbursement, $300,000 was paid in
cash and the remaining $700,000 under a note which is due on the earlier of
three years or upon the completion of the initial public offering of Broadreach.
The note bears interest at 8% per year. Of the total reimbursement, $292,000 was
offset against general and administrative expenses during fiscal 1998 for costs
previously incurred and charged to expense.
During fiscal 1999, the Company sold its 2% interest in Broadreach for $406,930,
which is included as a gain on sale of equity investment in the accompanying
consolidated statements of operations.
6. LINE OF CREDIT:
In March 1999, the Company entered into a line of credit agreement with a bank
which provides for borrowings up to $2,000,000 subject to certain limitations,
as defined. The line of credit matures on December 31, 1999. Borrowings under
the credit agreement bear interest at the bank's prime rate plus 2.00% (9.75% at
June 30, 1999). At June 30, 1999, there was $1,857,000 available for borrowing
under the line. During fiscal 1999, maximum borrowings under the line of credit
agreement were $614,000 and the weighted average interest rate was 9.75%.
The line of credit is collateralized by substantially all of the assets of the
Company. The line of credit agreement requires the Company to maintain certain
financial ratios and meet other financial conditions, as defined. At June 30,
1999, the Company was not in compliance with certain of its financial covenants.
The bank has subsequently agreed to waive such noncompliance.In connection with
such waiver, the Company has agreed to maintain cash collateral equal to the
amount outstanding under the line from time to time but not less than $400,000.
F-11
The Company had a $5,000,000 line of credit with a bank which matured on
November 30, 1998. Effective December 1, 1998, the line of credit was reduced to
$2,000,000 and the maturity was extended through March, 1999. Borrowings under
the line of credit agreement bore interest at the bank's prime rate. In fiscal
1998 and 1997, maximum borrowings under the line of credit agreement were
$5,000,000 and $3,071,000, respectively. The weighted average interest rates
were 8.50% and 6.20% during fiscal 1998 and 1997, respectively.
7. INCOME TAXES:
The components of income taxes are as follows:
For the Year Ended June 30,
------------------------------------------
1999 1998 1997
-------- ----------- --------
Current-
Federal $ -- $(1,121,554) $258,515
State -- -- 8,472
-------- ----------- --------
-- (1,121,554) 266,987
-------- ----------- --------
Deferred-
Federal 406,724 -- (70,725)
State 23,672 -- (13,471)
-------- ----------- --------
430,396 -- (84,196)
-------- ----------- --------
$430,396 $(1,121,554) $182,791
======== =========== ========
F-12
The federal statutory income tax rate is reconciled to the effective tax rate as
follows:
For the Year Ended June 30,
------------------------------------------
1999 1998 1997
-------- ----------- --------
Federal statutory rate (34.0%) (34.0%) 34.0%
State income taxes, net -- -- 0.8
Expenses not deductible
for tax 0.4 (0.1) 0.2
Valuation allowance 45.2 11.2 --
Other 6.7 4.5 0.2
------- ------- -------
18.3% (18.4%) 35.2%
------- ------- -------
Deferred taxes are determined based on the estimated future tax effects of
differences between the financial statement and tax basis of assets and
liabilities given the provisions of enacted tax laws. Deferred taxes are
comprised of the following:
June 30,
-------------------------------
1999 1998
----------- -----------
Gross current deferred income tax asset $ 1,514,405 $ 1,016,787
Gross current deferred income tax liability -- (106,133)
----------- -----------
Total current deferred tax asset 1,514,405 910,654
----------- -----------
Gross non-current deferred income tax asset 375,410 386,657
Gross non-current deferred income tax liability (146,276) (187,166)
----------- -----------
Total non-current deferred tax asset 229,134 199,491
----------- -----------
Valuation allowance (1,743,539) (679,749)
----------- -----------
Net deferred tax asset $ -- $ 430,396
=========== ===========
The tax effect of significant temporary differences representing deferred tax
assets and liabilities are as follows:
June 30,
-------------------------------
1999 1998
----------- -----------
Net operating loss carryforwards $ 549,687 $ 865,533
Expenses not currently deductible for tax
purposes 339,606 318,452
Deferred revenue 126,270 65,298
Basis difference in property and equipment
and capitalized software 229,134 (187,166)
Basis difference in inventory 498,842 48,028
Valuation allowance (1,743,539) (679,749)
----------- -----------
Net deferred tax asset $ -- $ 430,396
=========== ===========
In fiscal 1999, the Company increased the valuation allowance to the full value
of the net deferred tax asset as management concluded that the net deferred tax
asset no longer met the recognition criteria under SFAS No. 109.
F-13
8. STOCK OPTIONS AND WARRANTS:
The Company has a stock option plan (the "Plan") for employees and directors.
The Company is authorized to issue options for the purchase of up to 1,500,000
shares of Common Stock. Under the terms of the Plan, the exercise price of
options granted cannot be less than fair market value on the date of grant.
Employee options generally vest and become exercisable ratably over four years.
Director options vest and become exercisable ratably over six months or one year
from the date of grant. All options expire five years from the grant date. As of
June 30, 1999, there were 84,062 options available for grant under the Plan.
In November 1994, a stock option to purchase 20,000 shares of Common stock of
HDS at $2.50 per share was granted, which was exchanged in connection with the
prior merger of HDS and ISAC into an option to purchase 28,448 shares of Common
Stock of the Company at $1.76 per share. Deferred compensation of $191,046 was
recorded for the difference between the exercise price and merger consideration,
and was being amortized over the option vesting period. The deferred
compensation was fully amortized during fiscal 1999. As of June 30, 1999, the
remaining options outstanding under this grant were for 7,112 shares, which are
fully vested.
Information with respect to the options under the Plan and the options issued in
connection with the HDS and ISAC merger is as follows:
Weighted
Average
Exercise
Shares Price
--------- -----------
Balance as of July 1, 1996 813,024 $5.82
Granted 584,500 7.37
Exercised (123,175) 6.07
Terminated (21,000) 5.36
---------
Balance as of June 30, 1997 1,253,349 6.53
Granted 1,197,500 3.22
Exercised (7,112) 1.76
Terminated (1,183,500) 6.57
---------
Balance as of June 30, 1998 1,260,237 3.37
Granted 1,297,000 1.21
Terminated (1,252,750) 3.19
---------
Balance as of June 30, 1999 1,304,487 1.39
=========
On March 3, 1998, the Company modified 955,000 options previously granted. The
effect of this modification was to exchange the original options for 955,000 new
options with an exercise price of $3.00, which was the fair market value of the
Common Stock on the date of the modification. The new options will vest over
four years beginning March 3, 1998. The options are included as granted and
terminated during fiscal 1998 in the table above.
On August 28, 1998, the Company modified 958,500 options previously granted. The
effect of this modification was to exchange the original options for 958,000 new
options with an exercise price of $1.06, which was the fair market value of the
Common Stock on the date of the modification. The new options retained the
vesting period of the original options. The options are included as granted and
terminated during fiscal 1999 in the table above.
The following table summarizes information about stock options as of June 30,
1999:
Outstanding Stock Options Exercisable Stock Options
- ---------------------------------------------------------------------- -------------------------
Weighted
Range Weighted Average Weighted
of Average Remaining Average
Exercise Exercise Contractual Exercise
Prices Shares Price Life Shares Price
- --------------- ------------- ------------------- ---------------- ---------- -------------
$ .84-.94 22,500 $ .93 4.7 years 75,000 $ .94
1.06 1,088,000 1.06 4.2 years 476,922 1.06
1.09-3.00 133,987 1.95 3.8 years 34,362 2.50
5.13-7.13 60,000 5.75 1.4 years 60,000 5.75
----------- --------
1,304,487 578,784
=========== ========
Options granted under the Company's Plan contain provisions pursuant to which
all outstanding options granted under such plan shall become fully vested and
immediately exercisable upon a "change in control" as defined in such plan.
After giving effect to the prior merger of HDS and ISAC, there are 5,704,842
warrants outstanding to purchase Common Stock at $5.50 per share. The warrants
are exercisable over seven years and expire in March 2000. The warrants will be
redeemable at a price of $.01 per warrant upon 30 days notice at any time, only
in the event that the last price of the Common Stock is at least $10 per share
for 20 consecutive trading days ending on the third day prior to the one on
which notice of redemption is given.
F-14
During fiscal 1998, the Company issued 300,000 warrants to purchase Common Stock
at prices ranging from $3.00 to $7.00 in connection with entering into a
financial advisory and investment banking agreement. Warrants for 100,000 shares
were exercisable immediately and 200,000 warrants were to vest upon meeting
certain provisions, as defined. Such provisions were not achieved and the
200,000 warrants expired in July 1999. The exercisable warrants expire in
January 2001.
During fiscal 1998, the Company issued 100,000 shares of Common Stock in
exchange for the termination of 540,495 Unit Purchase Options with an exercise
price of $2.44. The Unit Purchase Options had been issued in connection with the
initial public offering of ISAC in March 1993 and provided the holder with the
option to acquire Units consisting of one share of Common Stock and two Common
Stock purchase warrants.
9. ACCOUNTING FOR STOCK-BASED COMPENSATION:
The Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation"
during the year ended June 30, 1997. The Company has elected to adopt the
disclosure requirement of this pronouncement only. The adoption of this
pronouncement, therefore, had no impact on the Company's financial position or
results of operations. Had compensation cost been calculated based on the fair
value at the grant date for awards in 1999, 1998 and 1997 consistent with the
provisions of SFAS 123, the Company's net income (loss) and net income (loss)
per share would have been changed to the following pro forma amounts:
1999 1998 1997
------------ ------------ --------
Net income (loss) As reported $(2,780,858) $(4,968,825) $337,229
Pro forma $(3,160,219) $(5,294,614) $ 69,953
Basic EPS As reported $ (.44) $ (.86) $ .06
Pro forma $ (.50) $ (.92) $ .01
Diluted EPS As reported $ (.44) $ (.86) $ .05
Pro forma $ (.50) $ (.92) $ .01
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 1999, 1998 and 1997; no dividend yield; expected
volatility of 70.0%; risk-free interest rates of approximately 4.42%-6.94%; and
an expected life of 5 years. The pro forma effect on net income (loss) for 1999,
1998 and 1997 is not representative of the pro forma effect on net income (loss)
in future years because it does not take into consideration pro forma
compensation expense related to grants made prior to fiscal 1996.
10. COMMITMENTS AND CONTINGENCIES:
The Company leases its principal facility, an automobile and furniture and
fixtures under noncancelable operating leases. The remaining terms of these
leases range from six months to two years. Rent expense under these leases was
$112,285, $108,486 and $73,168 in fiscal 1999, 1998 and 1997, respectively.
Future minimum lease payments under operating leases at June 30, 1999 are
$104,660 in 2000 and $24,043 in 2001.
F-15
On March 11, 1998, a complaint entitled Cerrato, Inc. v. Neoware Systems, Inc.,
98 Civ. 1748 (JSM), was filed in the United States District Court for the
Southern District of New York, naming as defendants the Company, its Chairman,
and its former CFO (the "New York" action). The Complaint asserts claims under
ss. 10(b) of the Securities and Exchange Act of 1934 (the "Exchange Act"), Rule
10b-5 promulgated thereunder, and common law. The complaint, which was filed as
a purported class action on behalf of purchasers of the Company's common stock
during the period from June 15, 1996 through August 15, 1997, alleges, among
other things, that the defendants made misrepresentations related to plans for
various potential acquisitions by a subsidiary of the Company and a spin-off. A
First Amended Complaint ("FAC") was filed on or about May 1, 1998. The FAC adds
claims on behalf of a second purported class -- purchasers of the Company's
stock from November 13, 1997 through May 1, 1998 -- related to the Company's
announcement, on April 30, 1998, that it would be restating certain financial
results previously reported for the first two quarters of fiscal year 1998.
Thereafter four separate purported securities class actions: Galitzer v. Neoware
Systems, Inc., 98CV2582 (BWK), Pollison v. Neoware Systems, Inc., 98CV2879
(BWK), Tuchman v. Neoware Systems, Inc., 98CV2868 (BWK), and Grubin v. Neoware
Systems, Inc., 98CV3651 (BWK), were filed in the United States District Court
for the Eastern District of Pennsylvania (the "Pennsylvania actions"). The
Pennsylvania actions name some of the same individual defendants as the FAC, as
well as certain additional directors and officers, and alleges violations of
ss.ss. 10(b) and 20(a) of the Exchange Act and Rule 10b-5 based on factual
allegations similar to those added to the New York action in the FAC on behalf
of a purported class of purchasers of the Company's securities between October
30, 1997 and April 30, 1998. In December 1998, the New York action was
transferred to the Eastern District of Pennsylvania and all actions have been
consolidated under the heading In re Neoware Systems, Inc. Securities
Litigations, Master File No. 98-CV-2582. Lead co-plaintiffs and counsel have
been appointed and a consolidated and amended complaint and an amended motion
for class certification have been filed.
On May 5, 1998, a complaint was filed in the Court of Common Pleas of Montgomery
County against the Company by Development Concepts, Inc. The complaint asserts
claims for common law breach of contract, fraud, misrepresentation, breach of
warranty and violations of the federal Lanham Act arising primarily from the
parties' contractual relationships. The complaint seeks an indeterminate amount
of monetary damages in excess of $1,500,000. On October 29, 1998, the Company
filed its Answer and Counterclaim to the complaint asserting the claims for
breach of contract, unjust enrichment, unfair competition and misappropriation
of trade secrets. The Counterclaim demands injunctive and monetary relief in
excess of $180,000.
The Company disputes the validity of these cases and intends to defend the
claims vigorously. Management does not anticipate that resolution of the pending
litigation, either separately or in the aggregate, will have a material adverse
effect on the Company's financial position or results of operations.
11. EMPLOYEE BENEFIT PLAN:
The Company sponsors a profit sharing/401(k) plan (the "Plan") for all of its
employees who meet certain age and years of employment requirements.
Participants may make voluntary contributions to the Plan and the Company makes
a matching contribution of 50% of the first 4% of such contributions. Effective
January 1, 1998, the Company's matching contribution is limited to $500 per
participant per year. The Company's contributions were $19,458, $46,501 and
$47,600 in fiscal 1999, 1998 and 1997, respectively.
F-16