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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, 1997
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-21240
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NEOWARE SYSTEMS, INC.
(Exact name of registrant as specified in its charter.)
Delaware 23-2705700
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
400 Feheley Drive, King of Prussia, Pennsylvania 19406
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 277-8300
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None NASDAQ
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Securities registered pursuant to Section 12(g) of the Act:
Units consisting of one share of Common Stock and two Redeemable Common Stock
Purchase Warrants; 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. X
-
The aggregate market value of the voting stock held by non-affiliates of the
registrant is approximately $24,778,000. Such aggregate market value was
computed by reference to the last reported sale price of the Common Stock as
reported on the NASDAQ National Market on September 19, 1997. In making such
calculation, the registrant does not determine whether any director, officer or
other holder of Common Stock is an affiliate for any other purpose.
The number of shares of the registrant's Common Stock outstanding as of
September 19 , 1997 was 5,760,820.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on December 10, 1997 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
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PART I...................................................................................................1
ITEM 1. BUSINESS...............................................................................1
ITEM 2. PROPERTIES.............................................................................8
ITEM 3. LEGAL PROCEEDINGS......................................................................9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................................9
PART II..................................................................................................9
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS..................9
ITEM 6. SELECTED FINANCIAL DATA...............................................................10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.11
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...........................................15
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...15
PART III................................................................................................16
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT....................................16
ITEM 11. EXECUTIVE COMPENSATION................................................................17
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. ......................17
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................................17
PART IV.................................................................................................17
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.......................17
PART I
Forward-Looking Statements
Certain statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in Part II, Item 7 and certain
other statements contained in this Form 10-K are forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
These statements are subject to certain risks and uncertainties, including, but
not limited to, quarterly fluctuations in operating results, general economic
conditions affecting the demand for computer products, the timing of significant
orders, the timing and acceptance of new product introductions including the
Company's line of network computers, the mix of distribution channels through
which the Company's products are sold, increased competition, the failure to
reduce product costs or maintain quality, delays in the receipt of key
components, seasonal patterns of spending by customers, continued government
funding of projects for which the Company is a subcontractor, increased
competition in the desktop computer market and the Company's ability to complete
strategic acquisitions.
ITEM 1. BUSINESS.
General
Neoware Systems, Inc., formerly HDS Network Systems, Inc., (the
"Company") designs, manufactures and markets a family of network computers that
are designed to integrate and deliver information to the desktop in network-
centric environments. The Company's @workStation/TM/ and NeoStation/TM/ and
related software combine a variety of windowed-display, graphical user interface
("GUI") and communications industry standards to provide the user seamless and
transparent access to all information, including text, graphics, and audio and
video data, on any type of network. The Company has licensed the Navigator
browser from Navio Communications, Inc. Sun Microsystems, Inc.'s Java/TM/
technology and Spyglass, Inc.'s Web browser technologies to provide cost-
effective access to information and applications within the corporate enterprise
and on the Internet. The functionality of the Company's systems is derived
primarily from netOS/TM/, an operating system software product based on open
systems technologies, owned and developed by the Company. The Company's hardware
products are optimized to run netOS/TM/. The Company's network computers provide
certain advantages over PCs, workstations and traditional terminals,
particularly with respect to lower administrative costs, reduced obsolescence
and improved ease of use.
The Company's network computer product line was introduced in June
1996. Prior to the introduction of the network computer, the Company
manufactured and marketed a family of desktop computing devices, including
multimedia-capable X Window terminals. The X terminal product line was designed
around industry standards and allowed users to access multiple forms of
information simultaneously, using the industry standard X protocol and industry
standard networking interfaces.
The Company was formed in November 1992 as a Specified Purpose
Acquisition Company ("SPAC"), the objective of which was to acquire an operating
business in the information systems industry. During 1993 and 1994, the
Company's efforts were limited to organizational activities, completion of an
initial public offering and evaluation of possible acquisitions. 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 September 1996, the Company entered into an agreement with Hitachi
Data Systems Corporation whereby the Company, among other things, agreed to sell
to Hitachi all of the Company's rights in the mark "HDS" and to cancel certain
petitions filed by the Company in the United States Patent and Trademark Office
to cancel Hitachi's trademark registrations relating to the mark "HDS." At a
Special Meeting of Stockholders held on July 30, 1997, the Company's
stockholders approved the Company's name change to Neoware Systems, Inc.
In August 1996, the Company formed a new subsidiary, Information
Technology Consulting, Inc. ("ITC") for the purpose of acquiring companies in
the network computer services field, including information technology staffing
companies and client-server consulting companies. In January 1997 the Company
announced that ITC entered into a definitive agreement to acquire the business
of Global Consulting Group ("Global"), an information technology staffing and
consulting company, subject to the consummation by ITC of a public offering of
its stock. In March 1997 the Company announced that ITC entered into a
definitive agreement to acquire the business of The Reohr Group, Inc. ("Reohr"),
an information technology staffing and consulting company, subject to the
consummation by ITC of a public offering of its stock.
In August 1997, the Company announced that it had entered into an
agreement under which ITC will merge with Reohr and Global. Under the agreement,
ITC and Global will merge into Reohr, and Neoware, as the sole stockholder of
ITC, will receive stock of the surviving entity that will represent ownership of
approximately 2% of the entity after the merger. The Company will also be
reimbursed for the expenses incurred by the Company and ITC in connection with
ITC's efforts to make these acquisitions.
In February 1997, the Company formed a new subsidiary, Bridging Data
Technology, Inc. (BDT). BDT has acquired and developed a software product,
SmartBridge/TM/, which utilizes the "intelligent bridging" approach to upgrading
programs and data for Year 2000 compliance. Neoware holds a majority ownership
stake in BDT, which is based in Atlanta, GA. The SmartBridge product implements
an on-site automated bridge building "factory" that creates intelligent bridge
modules. These modules allow the uncoupling of applications and data, enabling
conversions to take place quickly and with minimal impact to system performance.
Product Strategy
The Company's objective is to maintain a leadership position in the
evolving market for network computer products. Prior to the introduction of its
network computer product family in June 1996, the Company was a leading provider
of X Window terminals. The Company believes the market potential of the network
computer is significantly larger than that of the X terminal market, and has
invested significant resources in sales and marketing and research and
development in the current and
2
prior years to bring its new product families to market. The Company's network
computer products incorporate the following elements:
. Efficient, standards-based Operating System. During the current
and prior years, the Company developed and enhanced netOS, an
operating system for network computers based on industry standard
protocols and technologies. The operating system allows users to
access applications and information on multiple platforms,
including Windows95(R), WindowsNT(R), Windows 3.1, UNIX/TM/,
mainframe and midrange computers, the Internet and Java/TM/. The
netOS operating system is used within the Company's own product
lines, and the Company has licensed the operating system to other
manufacturers of network-centric computing devices. In July 1997,
the Company introduced three versions of netOS. Its netOS for
WinTerminals/TM/ allows connection to multi-user Windows
application servers. The Company's netOS for the Enterprise/TM/
adds the ability to connect with UNIX computers and enterprise
systems such as mainframes and midrange computers. The Company's
most extensive operating system, netOS for Intranets/TM/,
incorporates the functionality of netOS for the Enterprise/TM/ and
adds support for Java, the Navigator web browser as well as email
and an Internet news reader.
. Cost-effective, High-Performance Network Computer Families. The
Company offers a full line of network computers, which are bundled
with the netOS operating system. The Company's @workStation product
family offers a choice of four model lines (@work Basic, Prima,
Supra and Duo) with different levels of performance and capability.
Each model uses an Intel i960 RISC processor, and the @work Supra
models include additional hardware acceleration for faster
performance. The @work Duo models incorporate the capability to
connect two monitors to one network computer base, keyboard and
mouse for applications that require additional screen space. In
July 1997, the Company introduced its new line of thin client
desktops, known as the NeoStation product family. The NeoStation
features a vertical design and simpler administration and setup.
The NeoStation 500 is specifically designed to address the market
for WinTerminals, thin client desktops that allow users to run
Windows applications from central WindowsNT-based servers. Other
products in the NeoStation product family, the NeoStation 520 and
the NeoStation 540, offer access to legacy and Java applications
and the Internet, as well as higher video resolution. The
@workStation and NeoStation models can be paired with monitors
ranging from 14" to 21" color monitors.
. Focus on Multi-vendor Open System Desktop Solutions. The Company
concentrates all of its corporate resources on open system
technologies designed around industry standards. The Company
believes this focus, coupled with its netOS-based vendor-
independent solutions, provides a competitive advantage over its
broader based computer systems competitors and independent
competitors who traditionally have emphasized proprietary
technologies instead of those based on open systems.
. Diverse Technology Expertise. The Company has significant
expertise in a wide range of technical disciplines, including
system, windowing and networking software, applications software
development, monitor design, graphics acceleration, multimedia
3
design and compression algorithms.
. 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. The Company uses a common
hardware architecture and integrated circuits which are common
throughout its product line and employs industry-standard ASICs to
reduce part counts and costs.
. Multimedia. A full range of multimedia options can be added to
certain Neoware network computer models through additional hardware
and software. Through its netVideo technology, the Company lets a
network computer user display full motion video from a camera, VCR
or TV tuner in a window. The Neoware Conference application, which
runs on video-capable network computers, enables users to send
audio and video signals over a local area network or the Internet,
enabling video teleconferencing. Video is converted by the network
computer from analog to digital form so that it can be sent over a
network to other individual users, or to groups via an
industry-standard technology called IP Multicasting.
. Modularity and Use of Standard Peripherals. The Company's lines
of network computers are designed to be compatible with a wide
range of standard off-the-shelf peripherals, ranging from keyboards
and monitors to local hard drives and multimedia options such as
video cameras, microphones and VCRs.
Customers
The Company's customers span a wide range of industries, including
aerospace, automotive, education, financial services, government, healthcare,
manufacturing and telecommunications.
4
Product Development
The Company believes that its ability to expand the market for its
network computer products will depend in large part upon its ability to enhance
its netOS operating system and its existing line of network computers and to
continue developing new products which incorporate the latest improvements in
multimedia, desktop integration and open systems technology. Accordingly, the
Company is committed to investing significant resources in software and hardware
development activities.
The Company's current research and development programs include:
. Development of new versions of its netOS operating system that
will run on a diverse range of microprocessors.
5
. Development of enhanced its connectivity to Windows
application servers.
. Development of enhanced its Java performance.
. Development of lower cost versions of its hardware products.
There can be no assurance that any of these development efforts will
result in the introduction of new products or that any such products will be
commercially successful.
Marketing and Sales
The principal objectives of the Company's marketing strategy are to
increase awareness of the benefits of the Company's network computer products
and netOS operating system, maintain the Company's position as a recognized
innovator in the network computing industry and differentiate the Company's
products from other network computers 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 distributes its products in North America through direct
sales to end user customers, through resellers and through systems integration
partners. The Company's products are currently sold by systems integrators for
several government procurements, including the U.S. Forest Service's Project
615, in which the Company is a subcontractor to IBM. Sales to IBM for this
project are subject to continued government funding, and there is no assurance
that IBM will receive adequate funding to allow it to continue to purchase the
Company's products. Additionally, the timing of sales to the Company's customers
and the continued evolution of the market for network computers will impact
the Company's future operating results.
The Company has distributors for its products throughout the world,
including long-term relationships with distributors in the United Kingdom,
France, Scandinavia, Germany, Switzerland, Italy, Spain, Russia, Israel, Jordan,
Australia, Japan, Hong Kong, China and India. Foreign revenues, which accounted
for approximately 22%, 3% and 6% of net revenues, respectively, in 1997, 1996
and 1995, may be subject to government controls and other risks, including
export licenses, federal restrictions on the export of technology, changes in
demand resulting from currency exchange fluctuations, political instability,
trade restrictions and changes in tariffs. To date, the Company has experienced
no material difficulties due to these factors.
Service and Support
The Company believes that its ability to provide service and support is
and will continue to be 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 primarily through contracted field system
engineers.
6
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 network computers.
Competitive network computer products are offered by a number of
established computer manufacturers, including International Business Machines
Corporation ("IBM"), Sun Microsystems, Inc. ("Sun") and Oracle Corporation. 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 also competes with a number of other
suppliers, including Boundless Technologies, Inc. and Network Computing Devices,
Inc. The Company believes that the principal competitive factors among network
computer suppliers include breadth of product line, product price/performance,
capabilities of the operating system used in the product, software features,
network expertise, service and support, and market presence. The Company
believes that it competes favorably with respect to these factors. Workstation
manufacturers who also offer network computer products may have advantages over
independent network computer vendors, including the Company, based on their
ability to "bundle" their network computers, workstations and personal computers
in certain large system sales. The Company anticipates increased competition
from these system suppliers as the network computer market evolves and also
expects that other established domestic and foreign computer equipment
manufacturers may enter the network computer market.
The Company, as well as other manufacturers of network computers, also
faces competition from established computer manufacturers whose personal
computer and workstation products offer alternatives to network computers for
most applications. In the high-performance, technical segment of the market,
network computers compete with workstation networks offered by such
manufacturers as Digital Equipment Corporation, Hewlett Packard Corporation, IBM
and Sun. Because network-based computing does not require application processing
capability on every desktop, network computers compete favorably on a
price/performance basis with workstation 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 the
larger workstation manufacturers, and customer perceptions regarding their need
for desktop application processing capability, constitute obstacles to the
penetration of this market segment by network computer manufacturers. Increased
competition could result in price reductions, reduced profit margins and loss of
market share, which would adversely affect the Company's operating results.
There can be no assurance that the Company will be able to continue to compete
successfully against current and future competitors as the network computer
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 network computers, but are still appealing to certain
price sensitive customers. The Company believes that network computers will
become increasingly competitive with ASCII and 3270 terminal systems.
7
In all segments of the Company's market, the Company competes with
personal computers made by companies such as Compaq Computer Corporation, Dell
Computer Corporation and IBM. The Company believes its network computers compete
favorably with personal computers in this environment, primarily because of
their better integration in a network environment, reduced system administration
costs, bundled software features and enhanced ease of use.
Manufacturing and Suppliers
The Company's production activities are conducted at its King of
Prussia, Pennsylvania facility. These operations consist primarily of final
assembly, configuration, testing and quality control of material components,
sub-assemblies and systems. The Company utilizes an automated manufacturing
control system which integrates purchasing, inventory control and cost
accounting. The Company tests each network computer in a network environment
prior to shipment. In addition, the Company maintains an approved vendor list
and control of engineering changes of parts and components. Incoming material is
inspected 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.
Although most of the video monitors used in the Company's products are
available from more than one supplier, monitors used in some of its products are
currently available from a single source. The Company has, from time to time,
experienced delays in the receipt of monitors from certain of these suppliers.
In addition, the Company is required to place orders for some monitors several
months in advance of its anticipated requirements, and its ability to react to
short-term increases or decreases in customer demands of these models is,
therefore, limited. A number of other components and parts used in the Company's
products, including microprocessors, also 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 Company has been able to obtain an adequate supply of such components.
There can be no
8
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 only upon a material breach by the Company. The Company has
licensed technology from Spyglass, Inc., Sun Microsystems, Inc. and Network
Computer, Inc. (formerly Navio Communications, Inc.). 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, 1997, the Company had 76 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 the year 2001. The annual gross rent for the facility
currently approximates $81,500. 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.
There are no material legal proceedings pending against the Company.
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 1997.
9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
Commencing on March 3, 1995, the Company's Common Stock and the
Warrants began trading on the NASDAQ Small Cap Market under the symbols HDSX and
HDSXW, respectively. Commencing on October 3, 1995, the Common Stock and the
Warrants began trading on the NASDAQ National Market. 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
------------------------------------------
High Low High Low
---- --- ---- ---
1997
- ----
First Quarter....................... $9 $6 3/8 $3 5/8 $2 1/4
Second Quarter...................... $8 7/8 $6 7/8 $3 1/2 $2 11/32
Third Quarter....................... $9 1/2 $5 1/2 $3 7/8 $1 3/4
Fourth Quarter...................... $7 7/8 $4 5/16 $2 15/16 $1 3/8
10
Common Stock Warrants
------------------------------------------
High Low High Low
---- --- ---- ---
1997
- ----
First Quarter....................... $5 1/2 $4 5/8 $1 3/8 $7/8
Second Quarter...................... $6 5/8 $4 3/4 $2 $1 3/16
Third Quarter....................... $7 3/8 $5 1/8 $2 1/2 $1 11/16
Fourth Quarter...................... $9 1/4 $5 1/4 $4 $1 5/8
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 84 holders of record of Common Stock as of
September 19, 1997. 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, for each of the four years in the
period ended June 30, 1997 and by William E. Howe & Co., independent public
accountants, for the year ended June 30, 1993. 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.
Year Ended June 30,
-----------------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
Net revenues $25,467,487 $20,819,444 $21,841,229 $19,495,642 $14,790,305
----------- ----------- ----------- ----------- -----------
Gross profit 8,581,619 5,115,850 4,990,123 3,596,141 2,865,098
Operating expenses 8,130,823 4,390,344 2,680,209 2,742,126 2,665,435
--------- --------- --------- --------- ---------
Operating income 450,796 725,506 2,309,914 854,015 199,663
Interest income (expense), net 69,224 220,277 (23,239) (161,012) (163,514)
Income before income taxes,
extraordinary item, and cumulative
effect of change in accounting for
income taxes 520,020 945,783 2,286,675 693,003 36,149
Income taxes 182,791 322,898 843,405 319,561 25,433
Extraordinary item (1) -- -- -- -- 23,517
Cumulative effect of change
11
Year Ended June 30,
-----------------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
in accounting for income taxes (2) -- -- -- 81,023 --
----------- ---------- ----------
Net income $ 337,229 $ 622,885 $ 1,443,270 $ 454,465 $ 34,233
=========== =========== =========== ========== ==========
Earnings per share $.11 $.13 $.39 $.16 $.01
==== ==== ==== ==== ====
Weighted average number
of shares outstanding (3) 9,643,938 8,206,705 3,747,633 2,809,983 2,809,983
========= ========= ========= ========= =========
BALANCE SHEET DATA:
Current assets $16,002,051 $11,165,185 $12,373,592 $6,474,654 $4,757,031
Current liabilities 7,555,703 2,449,010 4,554,720 4,971,611 3,710,685
Working capital 8,446,348 8,716,175 7,818,872 1,503,043 1,046,346
Total assets 18,327,115 12,023,903 13,161,155 6,920,222 5,420,133
Long-term debt, excluding current portion -- 3,733 9,293 388,119 602,827
Stockholders' equity 10,771,412 9,481,890 8,494,565 1,503,190 1,031,850
- ---------------
(1) Relates to the utilization of net operating loss and tax credit
carryforwards.
(2) Effective July 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," and
reported the cumulative effect of the change in accounting in fiscal
1994. Prior to fiscal 1994, the Company accounted for income taxes in
accordance with Accounting Principles Board Opinion No. 11.
(3) Weighted average number of shares reflects the number of equivalent
shares of Common Stock received by the shareholders of HDS in
connection with the Merger with the Company on March 2, 1995.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Introduction
The Company provides network computers and related software that are
designed to integrate and deliver information to the desktop cost in network-
centric environments. The Company's @workStation network computers combine a
variety of windowed-display, GUI and communications industry standards to
provide the user seamless and transparent access to all information, including
text, graphics, audio and video data, on any type of network. The Company has
licensed the Navigator web browser, Sun Microsystems, Inc.'s Java/TM/ technology
and Spyglass, Inc.'s Web browser technologies that it has incorporated into its
products to provide cost-effective access to information and applications within
the corporate enterprise and on the Internet.
The Company's network computer product line was introduced in June
1996. Prior to the introduction of the network computer, the Company
manufactured and marketed a family of desktop computing devices, including
multimedia-capable X Window terminals. The X terminal product line was designed
around industry standards and allowed users to access multiple forms of
information simultaneously, using the industry standard X protocol and industry
standard networking interfaces.
The Company's current strategy is to become a leader in the emerging
market for network computers by focusing on expanding its operating system
software products and its network computer
12
hardware. The Company also plans to continue to seek to acquire strategic
technologies, products or businesses complementary to its current business. The
Company sells its products in North America directly to end users and through
resellers, system integrators and OEMs. International sales are generally made
through distributors.
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
-----------------------------------
1997 1996 1995
---- ---- ----
Gross Profit 33.7% 24.6% 22.8%
Operating expenses:
Sales and Marketing 17.7 11.3 6.4
General and administrative 8.8 7.0 3.6
Research and development 5.4 2.8 2.2
Operating income 1.8 3.5 10.6
Interest income (expense), net 0.2 1.0 (0.1)
Income before taxes
and changes in accounting
for income taxes 2.0 4.5 10.5
---- ---- ----
Income taxes 0.7 1.5 3.9
---- ---- ----
Net Income 1.3% 3.0% 6.6%
==== ==== ====
Year Ended June 30, 1997 Compared to Year Ended June 30, 1996
For the year ended June 30, 1997, net revenues increased by 22.3% to
$25,467,487 from $20,819,444 for the prior fiscal year. The Company's net
revenues for the current year primarily represent shipments of its new line of
network computers, which was introduced at the end of June 1996, and revenues
earned from licensing agreements for its netOS operating system software. Net
revenues for the year ended June 30, 1996 represent shipments of the Company's X
terminal product line, which the Company marketed and manufactured prior to the
introduction of its network computers. The Company is subject to significant
variances in its operating results because of the fluctuations in the timing of
the receipt of large orders.
The Company's gross profit as a percentage of net revenues increased to
33.7% for the year ended June 30, 1997 from 24.6% for the prior fiscal year. The
improvement was a result of achieving higher gross margins on the network
computer product line, despite comparatively lower selling prices, and from the
addition of software licensing revenues. 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
13
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, 1997 were $8,130,823, an
increase from operating expenses of $4,390,344 in the prior fiscal year. Sales
and marketing expenses increased by $2,171,812 to $4,523,910 for the year ended
June 30, 1997 as compared to $2,352,098. These increases were the result of
significantly increasing the Company's sales and marketing staff, including
opening new sales offices in the United States and in Europe, and increased
expenditures for advertising and public relations. The increase also reflects
the results of operations of the Company's Bridging Data Technology subsidiary.
Research and development expenses for the year ended June 30, 1997 increased by
134.6% or $788,257, to $1,374,027 from $585,770 in the prior year as the Company
expanded its investment in engineering resources to develop, adapt or acquire
technologies complementary to its current business that will expand the market
for its current and future products. General and administrative expenses
increased to $2,232,886 for the year ended June 30, 1997 from $1,452,476 in the
prior year due to an increase in corporate staff relating to the formation of
the Company's Information Technology Consulting and Bridging Data Technology
subsidiaries and expenses relating to the recruitment of the Company's new Chief
Executive Officer.
Operating income decreased to $450,796 for the year ended June 30, 1997
from $725,506 in the previous fiscal year. The decrease in operating income for
the period is the result of increased operating expenses relating to the
expansion of the Company's sales and marketing and research and development
staff as well as the expenses relating to its newlt-formed subsidiaries, which
were partially offset by higher net revenues and higher gross profit margins.
Net interest income decreased in the year ended June 30, 1997 due to
lower interest rates and lower investment balances caused by financing of higher
inventory and accounts receivable balances.
The effective income tax rates were approximately 35.2% as compared to
34.1% in the prior fiscal year.
For the year ended June 30, 1997, net income decreased to $337,229 from
$622,885 for the prior year. The decrease in net income resulted from increased
operating expenses during the period, as well as lower net interest income,
which was partially offset by significant increases in revenues and in gross
profit percentages.
Year Ended June 30, 1996 Compared to Year Ended June 30, 1995
For the year ended June 30, 1996, net revenues decreased by $1,021,785
or 4.6% to $20,819,444 from $21,841,229 for the prior year. The decrease in
revenue is attributable to a lack of growth in the Company's X terminal
business, as well as the timing of the introduction of the Company's new network
computer product line, which began too late in the fiscal year to contribute
significant revenue.
Sales to the United States Government, through integration subcontracts
and through direct sales, have historically constituted a significant portion of
the Company's total net revenues. Sales under Government contracts are subject
to continued Government funding, as to which there is no assurance. The Company
is subject to significant variances in its periodic operating results because of
the fluctuations in the timing of the receipt of large orders.
For the year ended June 30, 1996, net income was $622,885 as compared
to $1,443,270 for the
14
prior year. The decrease in net income in 1996 was due to significant increases
in the Company's investment in both sales and marketing and research and
development expenses during the period. These investments, as well as increases
in general and administrative expenses, were partially offset by increased gross
margins and investment income and a lower effective income tax rate.
The Company's gross profit as a percentage of net revenues increased to
24.6% for the year ended June 30, 1996 from 22.8% for the prior fiscal year. The
increase in the Company's gross profit margins was primarily due to the
Company's ability to reduce the cost of acquiring components used in its
products, as well as to its mix of business, as its margins vary within the
Company's product line. 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, 1996 were $4,390,344 as
compared to $2,680,209 in the prior year. Sales and marketing expenses increased
by $947,563 to $2,352,098 for the year ended June 30, 1996 as compared to
$1,404,535 for the prior year as a result of increased expenditures for
advertising and public relations as well as investments in increasing the
Company's sales and marketing staff, in the US, the United Kingdom and Germany.
Research and development expenses for the year ended June 30, 1996 increased by
$97,419 to $585,770 from $488,351 in the prior year as the Company expanded its
investment to develop, adapt or acquire technologies complementary to its
current business that will expand the market for its current and future
products. General and administrative expenses increased to $1,452,476 for the
year ended June 30, 1996 from $787,323 in the prior year due to an increase in
corporate staff, increased expenditures relating to the compliance functions
required of a public company and the Company's purchase of directors' and
officers' liability insurance in the third quarter of the prior fiscal year.
Operating income decreased to $725,506 for the year ended June 30, 1996
from $2,309,914 in the previous fiscal year. The decrease in operating income is
the result of increased investments in the Company's sales and marketing and
research and development expenses as well as increased general and
administrative expenses, which were partially offset by higher gross profit
margins.
Net interest income increased due to the use of the proceeds from the
Merger to repay debt and provide interest income.
The effective income tax rates were approximately 34.1% in the year
ended June 30, 1996 as compared to 36.9% in the prior fiscal year due to the
implementation of tax planning.
15
Liquidity and Capital Resources
At June 30, 1997, the Company had net working capital of $8,446,348
composed primarily of cash and cash equivalents, accounts receivable and
inventory. The Company's principal sources of liquidity included approximately
$1,452,000 of cash and cash equivalents and a $5,000,000 bank line of credit
facility, of which $1,929,000 was available as of June 30, 1997.
The Company used $3,397,512 in cash in operating activities in the 1997
fiscal year compared to using cash of approximately $433,000 during the 1996
fiscal year. The decrease in cash generated from operations during the 1997
fiscal year is primarily due to significant increases in accounts receivable and
inventories, which were partially offset by net income and increases in accounts
payable and accrued expenses. 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 $1,596,940 was used in financing activities in the 1997
fiscal year due to the licensing of software from others and prepayment of
royalties on such licensed software. Net cash of $1,530,291 was generated from
investing activities in the 1996 fiscal year from the redemption of
approximately $1,959,000 of short-term investments, which was partially offset
by purchases of equipment and capitalized software.
The Company believes that there will be sufficient funds from current
cash, operations and available financing to fund operations and cash
expenditures for the next 12 months.
Inflation
The Company believes that inflation has not had a material effect on
its sales and net revenues during the past three years.
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.
16
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 1997 Annual Meeting of
Stockholders.
The following individuals are the current executive officers of the
Company:
Name Age Position
---- --- --------
Edward C Callahan, Jr. 51 President and Chief Executive
Officer
Michael G. Kantrowitz 36 Executive Vice President
Steven B. Ahlbom 47 Vice President of Operations
Edward M. Parks 45 Vice President of Engineering
Scott Holland 36 Vice President of Finance and
Administration
17
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 in 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. Holland has served as Vice President-Finance and Administration
since May 30, 1995. Prior to joining the Company, he served as the New Jersey
Area Manager for Lawyers Title Insurance Corporation from 1993 until 1995. From
1988 until 1993, Mr. Holland held financial and operations management positions
with IVT Group, Inc. and Fidelity Bond and Mortgage Company. Prior to that, Mr.
Holland was employed by Laventhol & Horwath from 1982 through 1988 in various
positions, with the latest position being Manager, Accounting and Auditing.
All officers of the Company are appointed annually by the Company's
Board and serve at its discretion.
18
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 1997 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 1997 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 1997 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.
19
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)(1)
3.4 Amendment to By-laws, dated July 20, 1995
4.2 Form of Warrant Certificate (Exhibit 4.2)(2)
4.3 Unit Purchase Option Granted to GKN Securities Corp. (Exhibit 4.4)(2)
4.4 Warrant Agreement between Continental Stock Transfer & Trust Company
and Registrant (Exhibit 4.4)(3)
4.5 Warrant Agreement, dated March 2, 1995, between Continental Stock
Transfer & Trust Company and the Registrant (Exhibit 4.5)(2)
4.6 Loan Agreement between Meridian Bank and the Registrant, dated as of
December 20, 1990, Security Agreement between Meridian Bank and the
Registrant, and Notes, as amended. (Exhibit 4.6)(2)
10.3 Letter Agreement between GKN Securities Corp. and each of the Initial
Stockholders (Exhibit 10.4(1)
10.4 Letter Agreement between Safeguard Scientifics, Inc. and Registrant
(Exhibit 10.5)(3)
10.8 Lease between the Registrant and GBF Partners, as amended
(Exhibit 10.9)(4)
10.9+ 1995 Stock Option Plan (Exhibit 10.9)(2)
10.11+ Employment Agreement, dated March 2, 1995, between the Registrant and
Michael G. Kantrowitz (Exhibit 99.2)(5)
21.* Subsidiaries
23 Consent of Arthur Andersen LLP
- ------------------
* Filed herewith.
+ Management contract or arrangement.
20
(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 Company's Current Report on Form 8-K dated
March 2, 1995.
21
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 29, 1997 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 Scott Holland, Vice President of
Finance and Administration, and each of them severally, his or her true and
lawful attorney-in-fact, in his or her name, place and stead to execute and
cause to be filed with the Securities and Exchange Commission any or all
amendments to this report.
Signature Title Date
--------- ----- ----
/s/ Arthur R. Spector Chairman of the Board September 29, 1997
- -----------------------------
Arthur R. Spector
/s/ Edward C. Callahan, Jr. President, Chief Executive September 29, 1997
- ----------------------------- Officer and Director (Principal
Edward C. Callahan, Jr. Executive Officer)
/s/ Michael G. Kantrowitz Executive Vice President and September 29, 1997
- ----------------------------- Director
Michael G. Kantrowitz
/s/ Scott Holland Vice President-Finance and September 29, 1997
- ----------------------------- Administration (Principal Financial
Scott Holland Officer and Principal Accounting
Officer)
/s/ Howard L. Morgan Director September 29, 1997
- ------------------------------
Howard L. Morgan
/s/ John M. Ryan Director September 29, 1997
- ------------------------------
John M. Ryan
/s/ Carl G. Sempier Director September 29, 1997
- ------------------------------
Carl G. Sempier
/s/ James W. Dixon Director September 29, 1997
- ------------------------------
James W. Dixon
INDEX TO FINANCIAL STATEMENTS
-----------------------------
Page
----
Neoware Systems, Inc.
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, 1997 and 1996, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended June 30, 1997. 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, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
1997 in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Philadelphia, Pa.,
August 27, 1997
NEOWARE SYSTEMS, INC.
---------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
June 30
----------------------------
ASSETS 1997 1996
------ ------------- ------------
CURRENT ASSETS:
Cash and cash equivalents $ 1,452,409 $ 2,700,298
Accounts receivable, net of allowance for doubtful accounts of
$124,086 and $36,762 9,308,731 4,914,007
Inventories 4,035,202 2,354,254
Prepaid expenses and other 789,179 761,156
Deferred income taxes 416,530 435,470
------------- ------------
Total current assets 16,002,051 11,165,185
PROPERTY AND EQUIPMENT, net 680,859 668,420
CAPITALIZED AND PURCHASED SOFTWARE, net 1,630,339 190,298
DEFERRED INCOME TAXES 13,866 -
------------- ------------
$ 18,327,115 $ 12,023,903
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Line of credit $ 3,071,000 $ -
Current portion of long-term debt - 4,232
Accounts payable 3,796,549 1,927,897
Accrued expenses 516,148 316,937
Deferred revenue 172,006 199,944
Income taxes payable - -
Total current liabilities 7,555,703 2,449,010
------------- ------------
LONG-TERM DEBT - 3,733
------------- ------------
DEFERRED INCOME TAXES - 89,270
------------- ------------
COMMITMENTS AND CONTINGENCIES (Note 11)
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 1,000,000 shares authorized and none
issued and outstanding -- --
Common stock, $.001 par value, 50,000,000 shares
authorized, 5,760,820 and 5,619,595 shares issued and outstanding 5,761 5,620
Additional paid-in capital 9,168,171 8,268,123
Retained earnings 1,666,951 1,329,722
Deferred compensation (69,471) (121,575)
------------- ------------
Total stockholders' equity 10,771,412 9,481,890
------------- ------------
$ 18,327,115 $ 12,023,903
============= ============
The accompanying notes are an integral part of these financial statements.
NEOWARE SYSTEMS, INC.
---------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
Year Ended June 30
----------------------------------------------------
1997 1996 1995
------------ ------------ ------------
NET REVENUES $ 25,467,487 $ 20,819,444 $ 21,841,229
COST OF REVENUES 16,885,868 15,703,594 16,851,106
------------ ------------ ------------
Gross profit 8,581,619 5,115,850 4,990,123
------------ ------------ ------------
OPERATING EXPENSES:
Sales and marketing 4,523,910 2,352,098 1,404,535
General and administrative 2,232,886 1,452,476 787,323
Research and development 1,374,027 585,770 488,351
------------ ------------ ------------
Total operating expenses 8,130,823 4,390,344 2,680,209
------------ ------------ ------------
Operating income 450,796 725,506 2,309,914
INTEREST INCOME (EXPENSE), net 69,224 220,277 (23,239)
------------ ------------ ------------
Income before income taxes 520,020 945,783 2,286,675
INCOME TAXES 182,791 322,898 843,405
------------ ------------ ------------
NET INCOME $ 337,229 $ 622,885 $ 1,443,270
============ ============ ============
EARNINGS PER SHARE $ .11 $ .13 $ .39
============ ============ ============
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING
9,643,938 8,206,705 3,747,633
============ ============ ============
The accompanying notes are an integral part of these financial statements.
NEOWARE SYSTEMS, INC.
---------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
-----------------------------------------------
Common Stock Common Additional
------------------------------ Stock Paid-in
Shares Amount Warrants Capital
------------ ------------ ------------ ------------
BALANCE AT JUNE 30, 1994 2,479,198 $ 2,479 $ 19,687 $ 768,837
Exercise of stock options 309,378 310 -- 228,534
Tax benefit on options exercised -- -- -- 163,556
Exercise of Common stock warrants 53,341 53 (19,687) 25,259
Retirement of treasury stock (31,934) (32) -- (99,968)
Dividend -- -- -- (3,951,380)
Reverse merger with Information Systems
Acquisition Corporation (Note 1) 2,800,000 2,800 -- 10,629,912
Deferred compensation (Note 8) -- -- -- 191,046
Amortization of deferred compensation -- -- -- --
Net income -- -- -- --
------------ ------------ ------------ ------------
BALANCE AT JUNE 30, 1995 5,609,983 5,610 -- 7,955,796
Tax benefit of acquired net operating
loss carryforward -- -- -- 300,000
Exercise of stock options 9,612 10 -- 12,327
Amortization of deferred compensation -- -- -- --
Net income -- -- -- --
------------ ------------ ------------ ------------
BALANCE AT JUNE 30, 1996 5,619,595 $ 5,620 $ -- $ 8,268,123
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 -- -- -- --
------------ ------------ ------------ ------------
BALANCE AT JUNE 30, 1997 5,760,820 $ 5,761 $ -- $ 9,168,171
============ ============ ============ ============
Retained Treasury Deferred
Earnings Stock Compensation Total
------------ ------------ ------------ ------------
BALANCE AT JUNE 30, 1994 812,187 $ (100,000) -- $ 1,503,190
Exercise of stock options -- -- -- 228,844
Tax benefit on options exercised -- -- -- 163,556
Exercise of Common stock warrants -- -- -- 5,625
Retirement of treasury stock -- 100,000 -- --
Dividend (1,548,620) -- -- (5,500,000)
Reverse merger with Information Systems
Acquisition Corporation (Note 1) -- -- -- 10,632,712
Deferred compensation (Note 8) -- -- (191,046) --
Amortization of deferred compensation -- -- 17,368 17,368
Net income 1,443,270 -- -- 1,443,270
------------ ------------ ------------ ------------
BALANCE AT JUNE 30, 1995 706,837 -- (173,678) 8,494,565
Tax benefit of acquired net operating
loss carryforward -- -- -- 300,000
Exercise of stock options -- -- -- 12,337
Amortization of deferred compensation -- -- 52,103 52,103
Net income 622,885 -- -- 622,885
------------ ------------ ------------ ------------
BALANCE AT JUNE 30, 1996 $ 1,329,722 $ -- $ (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 -- -- 337,229
------------ ------------ ------------ ------------
BALANCE AT JUNE 30, 1997 $ 1,666,951 $ -- $ (69,471) $ 10,771,412
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements.
NEOWARE SYSTEMS, INC.
---------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
For the Year Ended June 30
----------------------------------------------------
1997 1996 1995
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 337,229 $ 622,885 $ 1,443,270
Adjustments to reconcile net income to net cash
provided by (used in) operating activities-
Depreciation and amortization 361,121 357,878 356,347
Amortization of deferred compensation 52,104 52,103 17,368
Deferred income taxes (84,196) (66,860) 82,101
Changes in operating assets and liabilities-
(Increase) decrease in:
Accounts receivable (4,394,724) 850,669 (2,173,044)
Inventories (1,680,948) (138,239) 418,802
Prepaid expenses and other (28,023) (594,479) (67,247)
Increase (decrease) in:
Accounts payable 1,868,652 (869,755) 474,218
Accrued expenses 199,211 (83,637) 3,623
Deferred revenue (27,938) 62,740 21,078
Income taxes payable -- (626,375) 330,558
------------ ------------ ------------
Net cash provided by (used in)
operating activities (3,397,512) (433,070) 907,074
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment, net (216,661) (291,227) (421,864)
Prepaid royalty -- -- (150,000)
Purchase/redemption of short-term investments -- 1,959,324 (1,959,324)
Capitalized and purchased software (1,596,940) (137,806) (126,478)
------------ ------------ ------------
Net cash provided by
(used in) investing activities (1,813,601) 1,530,291 (2,657,666)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (repayment of) line of credit 3,071,000 (589,000) (991,000)
Principal payments on long-term debt (7,965) (5,243) (634,194)
Exercise of stock options 733,778 12,337 228,844
Tax benefits on options exercised 67,136 -- 163,556
Exercise of warrants 99,275 -- 5,625
Payment of dividend -- -- (5,500,000)
Proceeds from reverse merger (Note 1) -- -- 10,632,712
------------ ------------ ------------
Net cash provided by (used in)
financing activities 3,963,224 (581,906) 3,905,543
------------ ------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,247,889) 515,315 2,154,951
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 2,700,298 2,184,983 30,032
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,452,409 $ 2,700,298 $ 2,184,983
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF NONCASH
OPERATING ACTIVITIES:
Cash paid for income taxes $ 27,213 $ 1,026,500 $ 267,190
Cash paid for interest 61,560 10,069 124,706
The accompanying notes are an integral part of these financial statements.
NEOWARE SYSTEMS, INC.
---------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1. COMPANY BACKGROUND:
-------------------
Neoware Systems, Inc. (the Company) is a leading international supplier of
network computers and related software which are cost-effective solutions for
the integration and delivery of information and applications to the desktop. The
Company's network computers are based on an open architecture, incorporating
industry standards to enable seamless access to multiple forms of information,
including text, graphics, audio and video data, on any type of network.
On March 2, 1995, Human Designed Systems, Inc. (HDS) merged with and into ISAC
Acquisition Co., a wholly owned subsidiary of Information Systems Acquisition
Corporation (ISAC). ISAC issued 2,810,000 shares of Common stock, cash of
$5,500,000 and warrants to purchase 618,200 shares of ISAC Common stock at $5.50
per share to the shareholders of HDS. ISAC then changed its name to HDS Network
Systems, Inc. On July 30, 1997, the Company changed its name to Neoware Systems,
Inc.
The merger resulted in HDS's stockholders having majority ownership of the
merged entity. The merger was treated as an issuance of shares by HDS for the
net assets of ISAC, which is primarily cash. The consolidated statements of
operations and cash flows of HDS are presented as the historical operating
results and cash flows of the merged entity. The historical stockholders equity
of HDS prior to the merger has been retroactively restated for the equivalent
number of shares received in the merger after giving effect to the difference in
par value of ISAC's and HDS's stock with an offset to paid-in capital. Pro forma
information is not presented since the combination is not considered a business
combination for financial reporting purposes.
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 January 1997, the Company announced that ITC
entered into a definitive agreement to acquire Global Consulting Group (Global)
and in March 1997 an agreement was entered into to acquire The Reohr Group, Inc.
(Reohr). In August 1997, the proposed transactions were revised whereby ITC will
merge with Reohr and Global. The Company, as the sole stockholder of ITC, will
receive stock of the surviving entity representing approximately 2% ownership of
the entity after the merger. The Company will also be reimbursed for the
expenses incurred by the Company and ITC in connection with ITC's efforts to
complete these transactions. The fiscal 1997 statement of operations reflects
approximately $291,000 of internal costs incurred and charged to expense related
to these efforts. The transaction is expected to close prior to December 31,
1997. The reimbursement of costs previously charged to expense will be recorded
as income at that time.
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.
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, 1997 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.
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
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.
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. If the
Company's substantial performance obligations otherwise have been fulfilled,
revenue on such delayed shipment transactions generally is recognized. 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.
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 $285,968, $137,806,
and $126,478 of software development cost and amortized $147,977 $134,795, and
$118,292 in fiscal 1997, 1996 and 1995, respectively. Accumulated amortization
was $753,280 and $605,303 at June 30, 1997 and 1996, respectively. In addition,
the Company entered into various licensing agreements in Fiscal 1997 which
required upfront cash payments of $1,600,000 in the aggregate and royalties
based on unit sales. The Company continually evaluates whether events and
circumstances have occurred that indicate that unamortized product development
costs may not be recoverable or that the amortization period should be revised.
Earnings Per Share
- ------------------
The Company utilized the modified treasury stock method for the years ended June
30, 1997 and 1996 to compute earnings per share since common share equivalents
at the end of the year exceeded 20 percent of the number of common shares
outstanding. Earnings per common and common equivalent share (primary earnings
per share) is computed using the weighted average number of common shares and
common share equivalents (stock options and warrants, using the treasury stock
method) outstanding. If the inclusion of common stock equivalents has an
anti-dilutive effect in the aggregate, it is excluded from the earnings per
share calculation. Fully diluted earnings per share is not materially different
from the primary earnings per share indicated.
All share and per share amounts have been adjusted retroactively to give effect
to the equivalent number of shares received by the HDS stockholders in the
merger discussed in Note 1.
Income Taxes
- ------------
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," effective July 1, 1993. 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
- -----------------------------
SFAS No. 129, "Disclosure of Information About Capital Structure", was issued in
February 1997. SFAS 129 will not result in any substantive changes in the
Company's disclosures.
3. MAJOR CUSTOMERS AND FOREIGN REVENUES:
-------------------------------------
Net revenues from two customers represented 25% and 15%of total net revenues in
fiscal 1997 and 16% and 27% of total net revenues in fiscal 1996, while net
revenues from three customers represented 25%, 12% and 11% of total net revenues
in fiscal 1995. Revenues from one of the significant customers in fiscal 1996
and two of the significant customers in fiscal 1995 were under subcontracts for
systems integration contracts for major US government procurements. The
procurement projects are subject to funding by the US government and there are
no assurances that such funding will continue. At June 30, 1997 and 1996, the
Company had receivables from these customers of approximately $5,937,000 and
$1,923,000, respectively.
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 1997, 1996 and 1995 were approximately 22%, 3% and
6%, respectively, and were transacted in US dollars.
4. CONSOLIDATED BALANCE SHEET COMPONENTS:
--------------------------------------
Inventories consisted of the following:
June 30
------------------------
1997 1996
---------- ----------
Purchased components and subassemblies $1,566,161 $ 942,210
Work-in-process 301,565 173,792
Finished goods 2,167,476 1,238,252
---------- ----------
$4,035,202 $2,354,254
========== ==========
Property and equipment consisted of the following:
June 30
---------------------------
1997 1996
----------- -----------
Computer equipment $ 749,082 $ 695,200
Office furniture and equipment 318,989 216,462
Leasehold improvements 357,053 344,039
Other 127,712 95,156
----------- -----------
1,552,836 1,350,857
Less- Accumulated depreciation and
amortization (871,977) (682,437)
----------- -----------
$ 680,859 $ 668,420
=========== ===========
5. LINE OF CREDIT:
---------------
The Company has a $5,000,000 revolving line of credit with a bank which expires
on December 31, 1997, subject to annual renewal. Borrowings under the line bear
interest at the bank's prime rate (8.5% at June 30, 1997). At June 30, 1997
there was $1,929,000 available for borrowing under the line. Under the line, the
Company is required to maintain specified ratios of working capital and debt to
net worth, as defined. The maximum amount borrowed under the line of credit was
$3,071,000 in fiscal 1997, $1,206,000 in fiscal 1996 and $2,046,000 in fiscal
1995. The average amounts outstanding were $997,269, $247,917 and $1,085,000 in
fiscal 1997, 1996 and 1995, respectively, and the weighted average interest rate
during such years was 6.2%, 8.69% and 9%, respectively.
6. LONG-TERM DEBT:
---------------
The Company had a term loan payable in monthly installments of approximately
$400, including interest at 7.8%, with final payment due in July 1998. The loan
was paid off in November 1996.
7. INCOME TAXES:
-------------
The components of income taxes are as follows:
For the Year Ended June 30
-------------------------------------------
1997 1996 1995
--------- --------- ---------
Current-
Federal $ 258,515 $ 377,528 $ 606,313
State 8,472 12,230 154,991
--------- --------- ---------
266,987 389,758 761,304
--------- --------- ---------
Deferred-
Federal (70,725) (57,551) 71,014
State (13,471) (9,309) 11,087
--------- --------- ---------
(84,196) (66,860) 82,101
--------- --------- ---------
$ 182,791 $ 322,898 $ 843,405
========= ========= =========
The federal statutory income tax rate is reconciled to the effective tax rate as
follows:
For the Year Ended June 30
-------------------------------
1997 1996 1995
------ ------ ------
Federal statutory rate 34.0% 34.0% 34.0%
State income taxes, net 0.8 0.8 5.5
Expenses not deductible
for tax 0.2 0.4 --
Other 0.2 (1.1) (2.6)
------ ------ ------
35.2% 34.1% 36.9%
------ ------ ------
Income tax expense differs from the amount currently payable as certain
transactions are reported in different periods for financial reporting and tax
purposes. The principal differences relate to depreciation and amortization, the
capitalization of software development costs, service contract revenue and
accrued expenses.
The tax effect of temporary differences that gave rise to the deferred tax
assets and liabilities are as follows:
June 30
-----------------------
1997 1996
--------- ---------
Net deferred tax asset, current-
Accruals, allowances and reserves $ 175,710 $ 109,487
Operating loss carryforwards 300,200 300,200
Deferred revenue 67,942 78,978
Capitalized inventory costs (127,322) (53,195)
--------- ---------
$ 416,530 $ 435,470
========= =========
Net deferred tax asset (liability), long
term-Losses of subsidiary $ 144,226 $ --
Capitalized software costs (129,678) (75,164)
Differences in book/tax depreciation (682) (14,106)
--------- ---------
$ 13,866 $ 89,270
========= =========
The Company has recorded no valuation allowances against deferred tax assets at
June 30, 1997 and 1996.
In fiscal 1996, the Company recognized a $300,000 income tax benefit from a net
operating loss carryforward of ISAC (see Note 1) and recorded this benefit as a
deferred tax asset and an increase in additional paid-in capital.
8. STOCK OPTIONS AND WARRANTS:
---------------------------
The Company has an incentive stock option plan (the "Plan") for employees and
directors. The Company is authorized to issue options for the purchase of up to
1,100,000 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 six months and one year from the date of grant. All options expire five
years from the grant date. As of June 30, 1997, the Company had options
outstanding under the Plan for the purchase of 697,349 shares of Common Stock at
prices ranging from $5.125 to $7.875 per share. Options to purchase 422,750
shares of Common Stock were vested at June 30, 1997.
In November 1994, a stock option to purchase 20,000 shares of Common stock of
HDS at $2.50 per share was granted, which has been exchanged in connection with
the merger 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 is being
amortized over the option vesting period. As of June 30, 1997, the options
outstanding under this grant were for 14,224 shares, none of which were vested.
HDS issued other stock options and warrants in earlier years and all such
outstanding options and warrants were exercised prior to the merger
(see Note 1).
After giving effect to the merger of ISAC and HDS discussed in Note 1, there are
5,700,510 warrants outstanding to purchase Common Stock at $5.50 per share. The
warrants are exercisable over seven years and expire in March 2000 through March
2002. 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.
9. EARNINGS PER SHARE
------------------
Earnings per share for the years ended June 30, 1997 and 1996 are
calculated as follows:
1997 1996
---- ----
Net income as reported $ 337,229 $ 622,885
Imputed interest income, net of income taxes 687,996 443,986
---------- ----------
Adjusted net income $1,025,225 $1,066,871
========== ==========
Actual number of shares outstanding 5,760,820 5,607,850
Net additional shares arising from exercise of
warrants and options 3,883,118 2,598,855
---------- ----------
Weighted average number of shares outstanding 9,643,938 8,206,705
========== ==========
Earnings per share $ .11 $ .13
====== ======
SFAS No. 128, "Earnings per Share", which supersedes APB Opinion No.
15, "Earnings per Share", was issued in February 1997. 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 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. SFAS 128 is
required to be adopted for the Company's fiscal year ending June 30, 1998 and,
when adopted, will require restatement of prior periods' EPS.
10. ACCOUNTING FOR STOCK-BASED COMPENSATION
---------------------------------------
In October 1995, the Financial Accounting Standards Board adopted SFAS
No. 123, "Accounting for Stock-Based Compensation". The Company adopted this
standard during 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 1997 and 1996 consistent with the
provisions of SFAS 123, the Company's net income and net income per share would
have been changed to the following pro forma amounts:
1997 1996
---- ----
Net income As reported $ 337,229 $ 622,885
Proforma $ 167,446 $ 606,798
Earnings per share As reported $ .11 $ .13
Proforma $ .09 $ .13
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 1997 and 1996 no dividend yield; expected
volatility of 62.10% - 75.58%; risk-free interest rates of approximately 5.40% -
6.76%; and an expected life of 5 years. The pro forma effect on net income
for 1997 and 1996 is not representative of the pro forma effect on net
income and in future years because it does not take into consideration
pro forma compensation expense related to grants made prior to fiscal 1996.
11. COMMITMENTS AND CONTINGENCIES:
------------------------------
The Company leases its principal facility and an automobile under noncancelable
operating leases. The facility lease expires in 2001 and the auto lease expires
in fiscal 2000. Rent expense under these leases was $73,168, $72,929 and
$142,039 in fiscal 1997, 1996 and 1995,
respectively. Minimum required lease payments are $112,324 in 1998, $112,324 in
1999, $100,527 in 2000 and $15,350 in 2001.
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 $1,000 of such contributions. The
Company's contributions were $47,600, $20,139 and $18,901 in fiscal 1997, 1996
and 1995, respectively.
Upon consummation of the merger transaction discussed in Note 1, an employment
agreement with an officer was executed. The agreement is for a three-year term
and provides for base compensation of $125,000 per year.
The Company has entered into various licensing agreements which required upfront
cash payments in the aggregate of $1,600,000 and royalties based on unit sales.
The Company is from time to time involved in certain legal actions arising in
the ordinary course of business. In the Company's opinion, the outcome of any
such actions will not have a material adverse effect on the Company's financial
position or results of operations.