UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
FORM 10-Q
--------------------
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
- ---------
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended March 31, 2002
_____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to ________.
Commission File Number: 000-21240
---------------------------------
NEOWARE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 23-2705700
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
400 Feheley Drive
King of Prussia, Pennsylvania 19406
(Address of principal executive offices)
(610) 277-8300
(Registrant's telephone number including area code)
-------------------------------------------------
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
--- ---
As of May 1, 2002, there were 11,230,349 outstanding shares of the Registrant's
Common Stock.
1
NEOWARE SYSTEMS, INC.
---------------------
INDEX
-----
PART I. FINANCIAL INFORMATION Page
Number
Item 1. Unaudited Consolidated Financial Statements:
Consolidated Balance Sheets:
March 31, 2002 and June 30, 2001 3
Consolidated Statements of Operations:
Three and Nine Months Ended March 31, 2002 and 2001 4
Consolidated Statements of Cash Flows:
Nine Months Ended March 31, 2002 and 2001 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II.
Item 1. Legal Proceedings 18
Item 2. Changes in Securities and Use of Proceeds 18
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
2
NEOWARE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS March 31, 2002 June 30, 2001
-------------- --------------
CURRENT ASSETS:
Cash and cash equivalents $7,198,258 $11,712,535
Marketable securities 333,333 366,667
Accounts receivable, net 6,121,645 3,502,013
Inventories 586,257 458,736
Prepaid expenses and other 346,444 369,529
Notes receivable 26,072 26,072
----------- -----------
Total current assets 14,612,009 16,435,552
Property and equipment, net 625,355 199,397
Goodwill and other intangibles 11,636,422 2,024,453
Notes receivable 21,549 52,193
Capitalized and purchased software, net 55,146 77,247
----------- -----------
$26,950,481 $18,788,842
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable 2,695,618 935,943
Accrued expenses 1,643,452 1,473,718
Capital lease obligations 61,335 -
Deferred revenue 368,667 289,278
----------- -----------
Total current liabilities 4,769,072 2,698,939
----------- -----------
Capital lease obligations, non-current portion 220,851 -
----------- -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock - -
Common stock 11,327 10,280
Additional paid-in capital 28,856,626 24,524,567
Treasury stock (100,000) (100,000)
Accumulated other comprehensive income 28,917 66,667
Retained earnings (deficit) (6,836,312) (8,411,611)
----------- -----------
Total stockholders' equity 21,960,558 16,089,903
----------- -----------
$26,950,481 $18,788,842
=========== ===========
The accompanying notes are an integral part of these financial statements.
3
NEOWARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
-------------------------------------------- -------------------------------------------
March 31, March 31, March 31, March 31,
2002 2001 2002 2001
---------------------- ------------------- ----------------------- ----------------
Net revenues $8,368,580 $4,911,167 $20,228,442 $12,333,573
Cost of revenues 5,061,893 3,229,790 11,862,736 8,480,431
---------- ---------- ----------- -----------
Gross profit 3,306,687 1,681,377 8,365,706 3,853,142
---------- ---------- ----------- -----------
OPERATING EXPENSES:
Sales and marketing 1,547,448 740,200 4,072,802 2,215,976
Research and development 352,570 258,293 1,027,421 618,843
General and administrative 761,656 574,561 1,945,930 1,623,406
Acquisition costs - - - 161,038
---------- ---------- ----------- -----------
Total operating expenses 2,661,674 1,573,054 7,046,153 4,619,263
---------- ---------- ----------- -----------
Operating income (loss) 645,013 108,323 1,319,553 (766,121)
Loss on investment - (812,000) - (812,000)
Interest income, net 60,045 207,929 255,746 618,301
---------- ---------- ----------- -----------
Net income (loss) $705,058 $(495,748) $1,575,299 $(959,820)
=========== ========= ========== ==========
Basic income (loss) per share $0.06 $(0.05) $0.15 $(0.09)
=========== ========= ========== ==========
Diluted income (loss) per share $0.06 $(0.05) $0.14 $(0.09)
=========== ========= ========== ==========
Weighted average number of shares
used in basic earnings per share
computation 11,175,240 10,176,060 10,573,863 10,242,657
=========== ========== ========== ==========
Weighted average number of shares
used in diluted earnings per share
computation 12,509,099 10,176,060 11,326,706 10,242,657
=========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
4
NEOWARE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Nine Months
Ended Ended
March 31, March 31,
2002 2001
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 1,575,299 $ (959,820)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities-
Depreciation and amortization 331,405 262,101
Changes in operating assets and liabilities-
(Increase) decrease in:
Accounts receivable (2,271,440) (574,139)
Inventories (127,521) 644,260
Prepaid expenses and other 151,978 73,936
Increase (decrease) in:
Accounts payable 635,305 (533,172)
Accrued expenses 4,790 478,750
Deferred revenue (96,911) (100,756)
------------ ------------
Net cash provided by (used in) operating activities 202,905 (708,840)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (88,744) (61,966)
Purchase of ACTIV-e Solutions (194,986) --
Purchase of NCD ThinSTAR (4,143,236) --
Increase in intangible assets (49,623) --
Purchase of treasury stock -- (100,000)
Capitalized software -- (1,523)
------------ ------------
Net cash used in investing activities (4,476,589) (163,489)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of bank debt assumed in acquisition (388,213) --
Decrease in notes receivable 30,644 711,686
Repayments of capital leases (18,299) --
Exercise of stock options 135,275 1,203
------------ ------------
Net cash used in financing activities (240,593) 712,889
------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (4,514,777) (159,440)
------------ ------------
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 11,712,535 13,831,792
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 7,198,258 $ 13,672,352
============ ============
SUPPLEMENTAL DISCLOSURES:
Cash paid for interest $ 16,190 $ 5,555
============ ============
The accompanying notes are an integral part of these financial statements.
5
NEOWARE SYSTEMS, INC.
---------------------
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
1. BASIS OF PRESENTATION
---------------------
The accompanying unaudited consolidated financial statements of Neoware Systems,
Inc. and Subsidiaries (the "Company") have been prepared in conformity with
generally accepted accounting principles. The interim financial information,
while unaudited, reflects all normal recurring adjustments which are, in the
opinion of management, necessary to present a fair statement of financial
position and operating results for the interim periods presented. The results of
operations for the nine month period ended March 31, 2002 are not necessarily
indicative of results expected for the full year. These financial statements
should be read in conjunction with the audited consolidated financial statements
and notes thereto included in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission.
2. NEW ACCOUNTING PRONOUNCEMENTS
-----------------------------
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations".
SFAS No. 141 eliminates the use of the pooling-of-interests method of accounting
for business combinations and establishes the purchase method of accounting as
the only acceptable method for all business combinations initiated after June
30, 2001.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." This statement modifies existing generally accepted accounting
principles related to the amortization and impairment of goodwill and other
intangible assets. Upon adoption of the new standard, goodwill, including
goodwill associated with equity method investments, will no longer be amortized.
For the nine months ended March 31, 2002 and 2001, there was no goodwill
amortization. In addition, goodwill, other than goodwill associated with equity
method investments, must be assessed at least annually for impairment using a
fair-value based approach. The Company adopted the provisions of this statement
effective July 1, 2001 and there was no impact on the consolidated financial
statements.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations" that applies to legal obligations associated with the retirement of
a tangible long-lived asset that results from the acquisition, construction, or
development and/or the normal operation of a long-lived asset. Companies are
required to adopt the pronouncement in their fiscal year beginning after June
15, 2002. Management believes that adoption of this Statement will not have any
impact on the Company's financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." This statement supersedes FASB Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," and the accounting and reporting provisions of APB
Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" for the disposal of a segment of a business.
This Statement also amends Accounting Research Bulletin No. 51, "Consolidated
Financial Statements," to eliminate the exception to consolidation for a
subsidiary for which control is likely to be temporary. This Statement provides
guidance on financial accounting and reporting for the impairment or disposal of
long-lived assets. Companies are required to adopt the pronouncement in their
fiscal year beginning after December 15, 2001. Management believes that adoption
of this Statement will not have any impact on the Company's financial
statements.
6
3. ACQUISITIONS
------------
On March 26, 2002, the Company acquired the assets of the ThinSTAR product line
of Network Computing Devices, Inc. (NCD) including software, intellectual
property, customer contract rights and other intangibles. In addition, the
Company entered into an alliance with NCD to grow the worldwide thin client
appliance market. The acquisition was accounted for using the purchase method of
accounting. The purchase price was payable in cash of $4,143,236, including
transaction costs of $143,236, and was allocated to intangible assets. The
purchase price includes $300,000 which is being held in escrow subject to the
satisfaction of certain conditions and the purchase agreement provides for the
payment of an additional $250,000 if certain revenue levels are achieved.
Management is currently in the process of allocating the purchase price to
specific intangibles as required by SFAS No. 141, "Business Combinations." The
results of operations of NCD have been included in the accompanying statement of
operations from the date of the acquisition.
On December 4, 2001, the Company acquired all of the assets and assumed
substantially all of the liabilities of Telcom Assistance Center Corporation,
d/b/a ACTIV-e Solutions, a full service Information Technology consulting
company in the server-based computing marketplace. The acquisition was accounted
for using the purchase method of accounting. The purchase price was payable in
cash of $75,000 and, after the adjustments as provided for in the acquisition
agreement, an aggregate of 569,727 shares of the Company's newly issued common
stock with a market value of $3.24 per share at the date of acquisition. In
addition, the Company assumed net liabilities, exclusive of cash acquired of
$9,974, of $1,200,709. Aggregate costs of the acquisition, amounted to
$3,241,610 (including transaction costs of $123,790) which amount is equal to
the excess of the purchase price over the value of the net assets acquired.
Management is currently in the process of allocating the purchase price to
specific intangibles as required by SFAS No. 141, "Business Combinations". The
results of operations of ACTIV-e Solutions have been included in the
accompanying statement of operations from the date of the acquisition.
The following is a summary of the net cash paid for the purchase of ACTIV-e
Solutions:
Accounts receivable $ 348,192
Prepaids and other 128,893
Property and equipment 476,518
Goodwill 3,241,610
Bank debt (388,213)
Accounts payable (1,124,370)
Accrued expenses (164,944)
Capital leases (300,485)
Deferred revenue (176,300)
Fair value of stock issued (1,845,915)
---------------
Net cash paid $ 194,986
===============
7
On January 8, 2002, the Company entered into a worldwide alliance with IBM
Corporation under which the Company will be the preferred provider of thin
client appliance products to IBM and its customers. In addition, the Company
licensed from IBM the intellectual property associated with its thin client
appliance products. As consideration for these agreements, the Company issued
375,000 newly issued shares of common stock with a fair market value of $6.26
per share to IBM. The fair value of the shares issued of $2,347,500, plus
transaction costs of $37,202 has been allocated to intangible assets. Management
is currently in the process of allocating the purchase price to specific
intangibles as required by SFAS No. 141, "Business Combinations," and an
estimated amount of amortization of $125,000 has been recorded in the
accompanying Statement of Operations for the three months ended March 31, 2002.
A registration statement covering the shares issued in connection with the
ACTIV-e acquisition and the IBM alliance was filed on April 3, 2002. The
agreements with ACTIV-e and IBM provide for limitations on the number of shares
which may be sold within the first twelve months after effectiveness of the
registration statement for the ACTIV-e shares and within fifteen months of
issuance for the IBM shares.
4. MARKETABLE SECURITIES
---------------------
The Company's marketable equity securities have been classified as
"available-for-sale" under the provisions of SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" and are reported at estimated
fair value, with the accumulated other comprehensive income (unrealized gains
and losses) reported as a separate component of stockholders' equity.
Accumulated other comprehensive income reported in stockholders' equity was
$28,917 at March 31, 2002 and $66,667 at June 30, 2001. The Company owns 333,334
shares of Boundless Corporation common stock. Comprehensive income for the three
and nine months ended March 31, 2002 was $695,985 and $1,537,549, respectively,
consisting of net income, the change in unrealized gain or loss on marketable
securities and the cumulative currency translation gains or losses during the
period.
5. REVENUE RECOGNITION AND MAJOR CUSTOMERS
---------------------------------------
The Company's products include both a hardware and software component. In
accordance with Statement of Position No. 97-2, "Software Revenue Recognition"
("SOP 97-2"), software revenue recognition is followed for products or services
where a software element exists, unless the software is incidental to the
product being sold. The software has been deemed to be essential to the
functionality of the hardware and, therefore, SOP 97-2 has been followed for
revenue recognition. Revenue is recognized on product sales when a formal
arrangement exists, delivery of the product has occurred or title has
transferred, the fee is fixed or determinable and collection is probable.
Revenue related to post contract services is recognized with the initial sale as
the fee is included with the initial licensing fee, post-contract services are
for one year or less, the estimated cost of providing such services during the
arrangement is deemed insignificant, and unspecified upgrades/enhancements
offered during the period historically have been and are expected to continue to
be minimal and infrequent. Product warranty costs and an allowance for sales
returns are accrued at the time revenues are recognized.
From time to time, customers request delayed shipment, usually because of
customer scheduling for systems integration and lack of storage space at a
customer's facility during the implementation. In such "bill and hold"
transactions, the Company recognizes revenues when the following conditions are
met: the equipment is complete, ready for shipment and segregated from other
inventory; the Company has no further 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 March 31, 2002 and 2001 were $142,661 and $190,000, respectively. Accounts
receivable relating to "bill and hold" transactions were $142,661 and $190,000
at March 31, 2002 and 2001, respectively.
8
6. INVENTORIES
-----------
Inventories are stated at the lower of cost or market. Cost is determined by the
first-in, first-out method and consist of the following:
March 31, June 30,
2002 2001
------------------------ -----------------------
Purchased components and subassemblies $392,594 $167,730
Finished goods 193,663 291,006
------------------------ -----------------------
$586,257 $458,736
======================== =======================
7. LINE OF CREDIT
--------------
The Company has a line of credit agreement with a bank which provides for
borrowing up to $2,000,000 subject to certain limitations, as defined. The line
of credit matures on December 31, 2002. Borrowings under the credit agreement
bear interest at the bank's prime rate plus 1/2% (5.25% at March 31, 2002). At
March 31, 2002 and June 30, 2001, there was $2,000,000 available for borrowing
under the line. During the nine months ended March 31, 2002 and 2001, there were
no borrowings under the line.
The line of credit is collateralized by substantially all of the assets of the
Company and requires the Company to maintain certain financial ratios and meet
other financial conditions, as defined. The Company is in compliance with these
ratios and conditions at March 31, 2002.
8. EARNINGS PER SHARE
------------------
The Company applies SFAS No. 128, "Earnings per Share." SFAS 128 requires dual
presentation of basic and diluted earnings per share ("EPS") for complex capital
structures on the face of the statement of operations. Basic EPS is computed by
dividing income (loss) by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution from the
exercise or conversion of securities into Common stock, such as stock options.
The following table sets forth the computation of basic and diluted earnings per
share:
For the three months ended For the nine months ended
March 31, March 31,
---------------------------------- ---------------------------------
2002 2001 2002 2001
-------------- --------------- --------------- --------------
Net income (loss) $705,058 $(495,748) $1,575,299 $(959,820)
============== =============== =============== ==============
Weighted average shares outstanding:
Basic 11,175,240 10,176,060 10,573,863 10,242,657
Employee stock options 1,333,859 - 752,843 -
-------------- --------------- --------------- --------------
Diluted 12,509,099 10,176,060 11,326,706 10,242,657
Earnings (loss) per common share:
Basic $0.06 $(0.05) $0.15 $(0.09)
============== =============== =============== ==============
Diluted $0.06 $(0.05) $0.14 $(0.09)
============== =============== =============== ==============
9
For the three and nine month periods ended March 31, 2002, an aggregate of
103,500 stock options were excluded from the calculation of dilutive earnings
per share because their inclusion would have been anti-dilutive. All stock
options outstanding during the three and nine month periods ended March 31, 2001
were excluded from the calculation of dilutive earnings per share because their
inclusion would have been anti-dilutive based on the net losses reported in
these periods.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Introduction
The Company provides software, services and solutions to enable Appliance
Computing, a new Internet-based computing architecture targeted at business
customers that is designed to be simpler and easier than traditional PC-based
computing. The Company's software and management tools power and manage a new
generation of smart computing appliances that utilize the benefits of open,
industry-standard technologies to create new alternatives to personal computers
used in business and a wide variety of proprietary business devices. The
Company's ThinSTAR, Capio and Eon products are thin client computing appliances,
which are cost-effective alternatives to personal computers used by businesses,
and powerful replacements for green-screen terminals. Used in conjunction with
Citrix MetaFrame or Microsoft Terminal Services, the Company's computing
appliances allow users to run Windows-based applications from a server, plus
connect to mainframes, midrange systems and the Internet. Unlike personal
computers, computing appliances can be centrally managed and remotely
configured, which greatly simplifies administration. Because of this, computing
appliances can save up to 80 percent of the total cost of ownership of networked
personal computers, resulting in significant cost savings for enterprise
customers.
Results of Operations
The following table sets forth, for the periods indicated, certain items from
the Company's unaudited consolidated statements of operations as a percentage of
net revenues.
For the Three Months For the Nine Months
Ended Ended
March 31, March 31,
------------------------ -----------------------
2002 2001 2002 2001
---- ---- ---- ----
Gross profit 39.5 % 34.2 % 41.4 % 31.2 %
Operating expenses
Sales and marketing 18.5 15.1 20.1 17.9
Research and development 4.2 5.2 5.1 5.0
General and administrative 9.1 11.7 9.6 13.2
Acquisition costs - - - 1.3
-------- ---- ------- -----
Operating income (loss) 7.7 2.2 6.6 (6.2)
Impairment charge - (16.5) - (6.6)
Interest income, net .7 4.2 1.2 5.0
-------- ---- ------- -----
Net income (loss) 8.4 % (10.1) % 7.8 % (7.8) %
-------- ---- ------- -----
10
Net revenues for the three and nine months ended March 31, 2002 increased to
$8,368,580 and $20,228,442 from $4,911,167 and $12,333,573 for the comparable
periods in the prior fiscal year. The increase in net revenues was primarily
attributable to increased sales of the Company's Eon and Capio computing
appliance products. In addition, net revenues for the three and nine months
ended March 31, 2002 include service revenues of $966,323 and $1,394,627,
respectively, as a result of the acquisition of ACTIV-e Solutions on December 4,
2001.
The Company's gross profit as a percentage of net revenues for the three and
nine month periods ended March 31, 2002 increased to 39.5% and 41.4% compared to
34.2% and 31.2% for the comparable periods of the prior fiscal year. The
increase is primarily attributable to the cost benefits of the operating model
adopted by the Company during the latter part of the fiscal year ended June 30,
2000 which eliminated proprietary hardware design and engineering costs. The
increase is also attributable to reductions in the purchase costs of components
and third party license fees and a favorable mix of products sold, offset by
lower margins on the Company's services business resulting from the acquisition
of Activ-e Solutions. In addition, fixed overhead costs represented a lower
percentage of revenue during the three and nine month periods ended March 31,
2002 than in the prior fiscal year.
Operating expenses for the three and nine month periods ended March 31, 2002
were 31.8% and 34.8% of net revenues, compared to 32.0% and 37.4% in the
comparable periods of the prior fiscal year as a result of increased sales.
Operating expenses for the three and nine month periods ended March 31, 2002
were $2,661,674 and $7,046,153, an increase of 69.2% and 52.5% from operating
expenses of $1,573,054 and $4,619,263 in the comparable periods of the prior
fiscal year as a result of the Company's execution of its growth strategy.
Operating expenses are further discussed below.
Sales and marketing expenses for the three and nine month periods ended
March 31, 2002 were 18.5% and 20.1% of net revenues, compared to 15.1% and 17.9%
for the comparable periods in the prior fiscal year. Sales and marketing
expenses for the three and nine month periods ended March 31, 2002 were
$1,547,448 and $4,072,802, an increase of 109.1% and 83.8% from $740,200 and
$2,215,976 in the comparable periods in the prior fiscal year. These increases
reflect additional sales and marketing personnel, including the opening of
additional domestic and international sales offices, additional sales and
marketing personnel as a result of the acquisitions of ACTIV-e Solutions and of
the Capio and ThinSTAR product lines, the alliance with IBM, and higher
commissions due to increased sales.
Research and development expenses for the three and nine month periods
ended March 31, 2002 were $352,570 and $1,027,421, an increase of 36.5% and
66.0% from $258,293 and $618,843 in the comparable periods in the prior year
primarily as a result of an increase in personnel dedicated to software
development activities resulting from the Company's growth strategy.
General and administrative expenses for the three and nine month
periods ended March 31, 2002 were 9.1% and 9.6% of net revenues, versus 11.7%
and 13.2% for the comparable periods of the prior fiscal year. General and
administrative expenses for the three and nine month periods ended March 31,
2002 were $761,656 and $1,945,930, an increase of 32.6% and 19.9% from $574,561
and $1,623,406 in the comparable periods in the prior fiscal year due to
increased staffing and personnel costs as a result of the Company's growth
strategy.
Acquisition costs for the nine month period ended March 31, 2001 were
$161,038 or 1.3% of net revenues and consisted primarily of professional service
fees incurred in connection with a proposed acquisition that was not
consummated.
Net interest income for the three and nine month periods ended March 31, 2002
was $60,045 and $255,746 , a decrease of 71.1% and 58.6% from $207,929 and
$618,301 in the comparable periods in the prior fiscal year. The decrease was
due primarily to lower interest rates and lower amounts invested primarily as a
result of the Company's use of cash for acquisitions.
11
No income tax expense was recognized in the three and nine month periods ended
March 31, 2002 due to the availability of net operating loss carryforwards. No
income tax benefit was recognized in the three and nine month periods ended
March 31, 2001 as there was no assurance that the benefit of the net operating
loss carryforwards would be realized.
For the three and nine month periods ended March 31, 2002, the Company had net
income of $705,058 and $1,575,299 as compared to net losses of $495,748 and
$959,820 for the comparable periods in the prior year primarily as a result of
increased revenues and gross margin, offset by an increase in operating
expenses, reduced interest income, and a loss on investment of $812,000 in the
fiscal 2001 period.
Liquidity and Capital Resources
As of March 31, 2002, the Company had net working capital of $9,842,937
consisting primarily of cash and cash equivalents, marketable securities and
accounts receivable. The Company's principal sources of liquidity include
$7,531,591 of cash, cash equivalents and marketable securities and a $2,000,000
bank line of credit facility, all of which was available as of March 31, 2002.
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
requires the Company to maintain certain financial ratios and meet other
financial conditions, as defined. Interest on the line of credit facility
accrues at the bank's prime rate plus one-half percent with all principal and
interest due and payable on December 31, 2002. The Company had no borrowings
under the line of credit during the nine months ended March 31, 2002 and 2001.
Cash and cash equivalents decreased by $4,514,777 during the nine months ended
March 31, 2002 primarily as a result of the acquisition of the ThinSTAR product
line from NCD and an increase in accounts receivable, offset by net income for
the period.
The Company generated cash from operations of $202,905 for the nine months ended
March 31, 2002 and used cash in operations of $708,840 for the nine months ended
March 31, 2001. The increase in cash generated by operations is primarily
attributable to higher revenues and improved gross margins, offset by increases
in operating expenses and accounts receivable.
The Company used cash in investing activities of $4,476,589 and $163,489 for the
nine months ended March 31, 2002 and 2001, respectively. The increase in cash
used in investing activities was primarily the result of the acquisitions of
ACTIV-e Solutions and the ThinSTAR product line in the nine months ended March
31, 2002.
The Company used cash in financing activities of $240,593 during the nine months
ended March 31, 2002, and generated cash of $712,889 during the nine months
ended March 31, 2001. The use of cash for the nine months ended March 31, 2002
was primarily attributable to repayments of debt assumed in connection with the
acquisition of ACTIV-e Solutions. The increase in cash from financing activities
for the nine months ended March 31, 2001 was attributable primarily to a
decrease in notes receivable.
The Company expects to fund current operations and other cash expenditures
through the use of available cash, cash from operations, funds available under
its credit facility and possible new debt or equity sources. Management believes
that there will be sufficient funds from current cash, operations and available
financing to fund operations and cash expenditures for the foreseeable future,
however, the Company may seek additional sources of funding, including equity
and/or debt financing, in order to fund potential acquisitions. Additionally,
the Company must continue to maintain sustained profitability in order to
provide adequate funding for the long term.
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Factors Affecting the Company and Future Operating Results
Our future results may be affected by industry trends and specific risks in our
business. Some of the factors that could materially affect our future results
include those described below.
We may not be able to successfully integrate the acquisitions we have completed
as part of our growth strategy, which may materially adversely affect our growth
and our operating results.
We have made three acquisitions and entered into an alliance with IBM to be the
preferred provider of thin client appliance products to IBM and its customers
within the last year. We have not yet fully integrated these businesses or fully
implemented the alliance. There is no assurance that we will successfully
integrate these acquisitions into our business or successfully implement the
alliance. In addition, we may be unable to retain key employees or key business
relationships of the acquired businesses and integration of the businesses may
divert the attention and resources of our management. We cannot assure you that
we will achieve anticipated revenue and earnings growth as a result of these
transactions. Our failure to successfully integrate the acquired businesses into
our operations or successfully implement the alliance could have a material
adverse effect upon our business, operating results and financial condition.
Even if the acquisitions and alliance are successfully integrated, we may not
receive the expected benefits of the transactions. Managing acquisitions and
alliances requires management resources, which may divert our attention from
other business operations. As a result, the affects of any completed or future
transactions on financial results may differ from our expectations.
Although we have generated an operating profit in the past five quarters, we
have a prior history of losses and may experience losses in the future, which
could result in the market price of our common stock declining.
Although we have generated an operating profit in the last five
quarters, we have incurred net losses in the past and have an accumulated
deficit of $6.8 million as of March 31, 2002. We expect to continue to incur
significant operating expenses. Our operating expenses increased during the
three and nine months ended March 31, 2002 reflecting the hiring of additional
key personnel as we continue to implement our growth strategy. This includes the
additional personnel we hired in the three month period ended March 31, 2002 in
connection with the alliance with IBM and the acquisition of the ThinSTAR
product line from NCD. As a result, we will need to generate significant
revenues to maintain profitability. If we do not maintain profitability, the
market price for our common stock may decline.
Our financial resources may not be enough for our capital and corporate
development needs, and we may not be able to obtain additional financing. A
failure to derive significant revenues would likely cause us to incur losses and
negatively impact the price of our common stock.
Our ability to accurately forecast our quarterly sales is limited, although our
costs are relatively fixed in the short term and we expect our business to be
affected by rapid technological change, which may adversely affect our quarterly
operating results.
Because of the new and rapidly evolving market for our embedded Windows
and Linux-based computing appliances, our ability to accurately forecast our
quarterly sales is limited, which makes it difficult to predict the quarterly
revenues that we will recognize. In addition, most of our costs are for
personnel and facilities, which are relatively fixed in the short term. If we
have a shortfall in revenues in relation to our expenses, we may be unable to
reduce our expenses quickly enough to avoid losses. As a result, our quarterly
operating results could fluctuate.
There are factors that may affect the market acceptance of our products, some of
which are beyond our control, including the following:
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o the growth and changing requirements of the computing appliance market;
o the quality, price, performance and total cost of ownership of our
products;
o the availability, price, quality and performance of competing products
and technologies; and
o the successful development of our relationships with software
providers, original equipment manufacturers and existing and potential
channel partners.
We may not succeed in developing and marketing our computing appliance
products and our operating results may decline as a result.
Our gross margins can vary significantly, based upon a variety of factors. If we
are unable to sustain adequate gross margins we may be unable to reduce
operating expenses in the short term, resulting in losses.
Our gross margins can vary significantly from quarter to quarter
depending on average selling prices, fixed costs in relation to revenue levels
and the mix of our business, including the percentage of revenues derived from
hardware, software and consulting services. The gross profit margin also varies
in response to competitive market conditions as well as periodic fluctuations in
the cost of memory and other significant components. The market in which we
compete remains very competitive, and although we intend to continue our efforts
to reduce the cost of our products, there can be no certainty that we will not
be required to reduce prices of our products without compensating reductions in
the cost to produce our products in order to increase its market share or to
meet competitors' price reductions.
Our business is dependent on customer adoption of Windows and Linux-based
computing appliances to perform discrete tasks for corporate and Internet-based
computer networks and a decrease in their rates of adoption could adversely
affect our ability to increase our revenues.
We are dependent on the growing use of computing appliances to perform
discrete tasks for corporate and Internet-based networks to increase our
revenues. If the role of computing appliances does not increase as we
anticipate, or if it in any way decreases, our revenues would not materialize.
If corporate information technology organizations do not accept Windows or
Linux-based embedded operating systems, or if there is a wide acceptance of
alternative operating systems that provide enhanced capabilities, our operating
results could be harmed.
The computing appliance market in which we compete is new and
unpredictable, and if this market does not develop and expand as we anticipate,
our revenues may not grow.
Because some of our products use embedded versions of Microsoft Windows as their
operating system, an inability to license these operating systems on favorable
terms could impair our ability to introduce new products and maintain market
share.
We may not be able to introduce new products on a timely basis because
some of our products use embedded versions of Microsoft Windows as their
operating system. Windows is provided to the Company by Microsoft Corporation,
and the Company does not have access to the source code for Windows. If
Microsoft fails to continue to enhance and develop its embedded operating
systems, or if the Company is unable to license these operating systems on
favorable terms, our operations may suffer.
Because some of our products use Linux as their operating system, the failure of
Linux developers to enhance and develop the Linux kernel could impair our
ability to release new products and maintain market share.
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We may not be able to release new products on a timely basis because
some of our products use Linux as their operating system. The heart of Linux,
the Linux kernel, is maintained by third parties. Linus Torvalds, the original
developer of the Linux kernel, and a small group of independent engineers are
primarily responsible for the development and evolution of the Linux kernel. If
this group of developers fails to further develop the Linux kernel, we would
have to either rely on another party to further develop the kernel or develop it
ourselves. To date, we have optimized our Linux-based operating system based on
a version of Red Hat Linux. If we were unable to access Red Hat Linux, we would
be required to spend additional time to obtain a tested, recognized version of
the Linux kernel from another source or develop our own operating system
internally. We cannot predict whether enhancements to the kernel would be
available from reliable alternative sources. We could be forced to rely to a
greater extent on our own development efforts, which would increase our
development expenses and might delay our product release schedules. In addition,
any failure on the part of the kernel developers to further develop and enhance
the kernel could stifle the development of additional Linux-based applications
for use with our products.
Because we depend on sole source, limited source and foreign source suppliers
for key components, we are susceptible to supply shortages that could prevent us
from shipping customer orders on time, if at all, and result in lost sales.
We depend upon single source suppliers for our computing appliance
products and for several of the components in them. We also depend on limited
sources to supply several other industry standard components. We also rely on
foreign suppliers which subject us to risks associated with foreign operations
such as the imposition of unfavorable governmental controls or other trade
restrictions, changes in tariffs and political instability.
We have in the past experienced and may in the future experience
shortages of, or difficulties in acquiring, these components. A significant
portion of our revenues is derived from the sale of computing appliances that
are bundled with our software. These computing appliances are produced for us by
third parties. If we experience shortages of these products, or of their
components, we may not be able to deliver our products to our customers, and our
revenues would decline.
Because we rely on channel partners to sell our products, our revenues could be
negatively impacted if our existing channel partners do not continue to purchase
products from us.
We cannot be certain that we will be able to attract channel partners
that market our products effectively or provide timely and cost-effective
customer support and service. None of our current channel partners is obligated
to continue selling our products nor to sell our new products. We cannot be
certain that any channel partner will continue to represent our products or that
our channel partners will devote a sufficient amount of effort and resources to
selling our products in their territories. We need to expand our direct and
indirect sales channels, and if we fail to do so, our growth could be limited.
As a result of our acquisition of the ThinSTAR product line from NCD,
we rely on NCD for the distribution of our ThinSTAR products in Europe. If NCD
were to discontinue sales of our products or reduce its sales efforts, it could
adversely affect our operating results. In addition, there can be no assurance
as to NCD's continued viability and financial condition.
We may not be able to effectively compete against other providers as a result of
their greater financial resources and brand awareness.
15
In the market for computing appliances, we face significant competition
from larger companies which have greater financial resources and name
recognition than we do. Increased competition may negatively affect our business
and future operating results by leading to price reductions, higher selling
expenses or a reduction in our market share.
Our future competitive performance depends on a number of factors,
including our ability to:
o continually develop and introduce new products and services with better
prices and performance than offered by our competitors;
o offer a wide range of products; and
o offer high-quality products and services.
If we are unable to offer products and services that compete
successfully with the products and services offered by our competitors, our
business and our operating results would be harmed. In addition, if in
responding to competitive pressures, we are forced to lower the prices of our
products and services and we are unable to reduce our costs, our business and
operating results would be harmed.
Computing appliance products are subject to rapid technological change due to
changing operating system software and network hardware and software
configurations, and our products could be rendered obsolete by new technologies.
The computing appliance market is characterized by rapid technological
change, frequent new product introductions, uncertain product life cycles,
changes in customer demands and evolving industry standards. Our products could
be rendered obsolete if products based on new technologies are introduced or new
industry standards emerge.
We may not be able to preserve the value of our products' intellectual property
because we do not have any patents and other vendors could challenge our other
intellectual property rights.
Our products will be differentiated from those of our competitors by
our internally developed technology that is incorporated into our products. If
we fail to protect our intellectual property, other vendors could sell products
with features similar to ours, and this could reduce demand for our products,
which would harm our operating results.
We may not be able to attract software developers to bundle their products with
our computing appliances.
Our computing appliances include our own software, plus software from
other companies for specific vertical markets. If we are unable to attract
software developers, and are unable to include their software in our products,
we may not be able to offer our computing appliances for certain important
target markets, and our financial results will suffer.
In order to continue to grow our revenues, we may need to hire additional
personnel, including software engineers.
In order to continue to develop and market our line of computing
appliances, we may need to hire additional software engineers as well as
marketing and sales personnel. Competition for employees with these skills is
significant and we may experience difficulty in attracting suitably qualified
people.
Future growth that we may experience will place a significant strain on
our management, systems and resources. To manage the anticipated growth of our
operations, we may be required to:
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o improve existing and implement new operational, financial and management
information controls, reporting systems and procedures;
o hire, train and manage additional qualified personnel; and
o establish relationships with additional suppliers and partners while
maintaining our existing relationships.
We rely on the services of certain key personnel, and those persons' knowledge
of our business and technical expertise would be difficult to replace.
Our products and technologies are complex and we are substantially
dependent upon the continued service of our existing personnel. The loss of any
of our key employees could adversely affect our business and slow our product
development processes.
Errors in our products could harm our business and our operating results.
Because our computing appliance products are complex, they could
contain errors or bugs that can be detected at any point in a product's life
cycle. Although many of these errors may prove to be immaterial, any of these
errors could be significant. Detection of any significant errors may result in:
o the loss of or delay in market acceptance and sales of our products;
o diversion of development resources;
o injury to our reputation; or
o increased maintenance and warranty costs.
These problems could harm our business and future operating results.
Occasionally, we have warranted that our products will operate in accordance
with specified customer requirements. If our products fail to conform to these
specifications, customers could demand a refund for the purchase price or assert
claims for damages.
Moreover, because our products are used in connection with critical
distributed computing systems services, we may receive significant liability
claims if our products do not work properly. Our agreements with customers
typically contain provisions intended to limit our exposure to liability claims.
However, these limitations may not preclude all potential claims. Liability
claims could require us to spend significant time and money in litigation or to
pay significant damages. Any such claims, whether or not successful, could
seriously damage our reputation and our business.
Our IT services operations, which we acquired from ACTIV-e Solutions, would
suffer and we could lose our customers or fail to attract new customers if we
are unable to attract and retain qualified personnel.
Our IT services business is labor-intensive, and our success depends in
large part upon our ability to attract, develop, motivate and retain highly
skilled personnel. Some of these individuals are in great demand and are
likely to remain a limited resource for the foreseeable future. We may not be
able to engage the services of such personnel or retain our current personnel.
If we do not succeed in attracting new, qualified personnel or successfully
retaining our current personnel, our IT services business will suffer.
If our contracts with Citrix and other vendors of hardware components and
software applications were terminated, our IT services business would be
materially adversely affected.
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We depend on third-party suppliers to provide us with key hardware
components and software applications in connection with our IT services
business. If such contracts and relationships were terminated, our services
revenues would be negatively affected.
Forward-Looking Statements
This quarterly report on Form 10-Q contains statements that are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995, such as statements regarding future margins and margin trends, future
revenues and profitability, increased sales and operating expenses, the
Company's competitive position, the reduction in the cost of producing the
Company's products, the cost benefits and other advantages of the Company's
products and the development of new products and the availability of cash or
other financing sources to fund future operations. These forward-looking
statements involve risks and uncertainties. The factors contained in "Factors
Affecting the Company and Future Operating Results" and set forth elsewhere in
this report, could cause actual results to differ materially from those
predicted in any such forward-looking statement. Factors that could affect the
Company's actual results include the Company's ability to lower its costs,
customers' acceptance of Neoware's line of computing appliance products, pricing
pressures, rapid technological changes in the industry, growth of the computing
appliance market, increased competition, the Company's ability to attract and
retain qualified personnel, changes in general economic conditions, risks
associated with foreign operations and political and economic uncertainties
associated with current world events.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities and Use of Proceeds
On January 7, 2002, in connection with an alliance entered into by the Company
with International Business Machines Corporation, under which the Company will
supply thin client appliances to IBM and its customers and has licensed IBM
technology to develop next generation thin client appliance products, the
Company issued 375,000 shares of Neoware common stock to IBM. The shares were
issued in reliance upon the exemption from the registration requirements of the
Securities Act of 1933 under Section 4(2) thereof as a transaction not involving
a public offering. The sale was made to a knowledgeable and experienced investor
which had access to information respecting the Company and its business.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
10.1* Employment Agreement dated March 4, 2002 between the
Company and Howard L. Hunger
* Management Contract
(b) Reports on Form 8-K:
On January 8, 2002, the Company filed a Form 8-K relating to the
alliance it entered into with International Business Machines
Corporation.
On January 29, 2002, the Company filed a Form 8-K relating to the
acquisition of substantially all of the assets of ACTIV-e
Solutions.
On February 19, 2002, the Company filed a Form 8-K/A relating to
the acquisition of substantially all of the assets of ACTIV-e
Solutions.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunder duly authorized.
NEOWARE SYSTEMS, INC.
Date: May 15, 2002 By: /S/ MICHAEL G. KANTROWITZ
----------------------------------------------
Michael G. Kantrowitz
President and Chief Executive Officer
Date: May 15, 2002 By: /S/ VINCENT T. DOLAN
------------------------
Vincent T. Dolan
Vice President-Finance/Administration
(Principal Accounting Officer and
Principal Financial Officer)
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