UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarter ended March 31, 2007

o 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, INC.

(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization) 23-2705700
(IRS Employer Identification No.)

3200 Horizon 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 þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o      Accelerated Filer þ      Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). (Check one): Yes o No þ

As of May 2, 2007, there were 20,013,341 outstanding shares of the Registrant’s Common Stock.

NEOWARE, INC.

INDEX

	PAGE
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of March 31, 2007 and June 30, 2006	3
Consolidated Statements of Operations for the Three and Nine Months Ended March 31, 2007 and 2006	4
Consolidated Statements of Cash Flows for the Three and Nine Months Ended March 31, 2007 and 2006	5
Notes to Consolidated Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3. Quantitative and Qualitative Disclosures About Market Risk	26
Item 4. Controls and Procedures	26
PART II. OTHER INFORMATION
Item 1A. Risk Factors	26
Item 6. Exhibits	39
Signatures	40
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
CERTIFICATION OF CHIEF FINANCIAL OFFICER
CERTIFICATION OF CEO PURSUANT TO 18 U.S.C. SECTION 1350
CERTIFICATION OF CFO PURSUANT TO 18 U.S.C. SECTION 1350

NEOWARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)

	March 31,			June 30,
	2007			2006
ASSETS
Current assets:
Cash and cash equivalents	$	90,283		$	19,328
Restricted cash		385			—
Short-term investments		29,700			94,798
Accounts receivable, net		16,349			16,877
Inventories		5,903			7,734
Prepaid income taxes		4,503			1,544
Prepaid expenses and other		2,722			1,687
Deferred income taxes		1,866			1,866
Total current assets		151,711			143,834
Property and equipment, net		1,568			1,586
Goodwill		37,223			37,761
Intangibles, net		9,712			12,175
Deferred income taxes		4,026			4,156
Other		81			61
	$	204,321		$	199,573
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	6,464		$	8,989
Accrued compensation and benefits		3,130			2,021
Other accrued expenses		4,587			4,159
Restructuring reserve		419			600
Income taxes payable		167			158
Deferred revenue		1,591			973
Total current liabilities		16,358			16,900
Deferred income taxes		811			755
Deferred revenue		315			316
Total liabilities		17,484			17,971
Stockholders’ equity:
Preferred stock		—			—
Common stock		20			20
Additional paid-in capital		163,803			158,671
Treasury stock, 100,000 shares at cost		(100	)		(100	)
Accumulated other comprehensive income		2,216			556
Retained earnings		20,898			22,455
Total stockholders’ equity		186,837			181,602
	$	204,321		$	199,573

See accompanying notes to consolidated financial statements.

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NEOWARE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

	Three Months Ended						Nine Months Ended
	March 31,						March 31,
	2007			2006			2007			2006
Net revenues	$	22,070		$	27,787		$	67,406		$	83,666
Cost of revenues
Cost of products (includes stock-based compensation expense of $28 and $20 for the three months and $80 and $60 for the nine months ended March 31, 2007 and 2006)		13,513			15,353			41,127			47,051
Amortization of intangibles		343			338			1,018			913
Total cost of revenues		13,856			15,691			42,145			47,964
Gross profit		8,214			12,096			25,261			35,702
Operating expenses
Sales and marketing		4,451			4,295			13,933			12,864
Research and development		1,557			1,645			4,927			4,446
General and administrative		2,710			2,451			10,022			7,614
Amortization of intangibles		491			586			1,670			1,377
Abandoned acquisition costs		12			—			874			—
Total operating expenses (includes stock-based compensation expense of $814 and $760 for the three months and $3,767 and $2,239 for the nine months ended March 31, 2007 and 2006)		9,221			8,977			31,426			26,301
Operating income (loss)		(1,007	)		3,119			(6,165	)		9,401
Foreign exchange gain (loss)		(13	)		(12	)		(57	)		64
Interest income, net		1,044			507			2,979			998
Income (loss) before income taxes		24			3,614			(3,243	)		10,463
Income taxes (benefit)		1,123			1,301			(1,686	)		3,767
Net income (loss)	$	(1,099	)	$	2,313		$	(1,557	)	$	6,696
Earnings (loss) per share:
Basic	$	(0.05	)	$	0.13		$	(0.08	)	$	0.40
Diluted	$	(0.05	)	$	0.12		$	(0.08	)	$	0.38
Weighted average number of common shares outstanding:
Basic		20,000			18,023			19,969			16,931
Diluted		20,000			18,848			19,969			17,474

See accompanying notes to consolidated financial statements.

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NEOWARE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

	Nine Months Ended
	March 31,
	2007			2006
Cash flows from operating activities:
Net income (loss)	$	(1,557	)	$	6,696
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of intangibles		2,688			2,290
Depreciation		410			302
Non-cash share-based compensation		3,847			2,299
Deferred income taxes		138			—
Changes in operating assets and liabilities- net of effect from acquisition:
Restricted cash		(385	)		—
Accounts receivable		613			(4,239	)
Inventories		1,831			465
Prepaid expenses and other		(3,948	)		378
Accounts payable		(2,535	)		3,104
Accrued compensation and benefits		1,102			764
Other accrued expenses		193			(2,413	)
Income taxes payable		1			(2,282	)
Deferred revenue		595			108
Net cash provided by operating activities		2,993			7,472
Cash flows from investing activities:
Purchase of short-term investments		(128,200	)		(74,228	)
Sales of short-term investments		193,274			33,226
Purchases of property and equipment		(418	)		(1,412	)
Purchase of Visara thin client business		—			(2,107	)
Purchase of TeleVideo thin client business		—			(3,520	)
Acquisition of Maxspeed, net of cash acquired		1,674			(12,053	)
Net cash provided by (used in) investing activities		66,330			(60,094	)
Cash flows from financing activities:
Proceeds from issuance of common stock, net of expenses		(3	)		71,236
Exercise of stock options		640			6,014
Excess tax benefit from share-based payment arrangements		648			1,733
Net cash provided by financing activities		1,285			78,983
Effect of foreign exchange rate changes on cash		347			(158	)
Increase in cash and cash equivalents		70,955			26,203
Cash and cash equivalents, beginning of period		19,328			8,285
Cash and cash equivalents, end of period	$	90,283		$	34,488
Supplemental disclosures:
Cash paid for income taxes	$	451		$	5,226

See accompanying notes to consolidated financial statements.

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NEOWARE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1. Basis of Presentation

     The accompanying unaudited consolidated financial statements of Neoware, Inc. and Subsidiaries have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP) for interim financial statements. These statements, while unaudited, reflect all normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the consolidated financial statements. The results for the interim periods presented are not necessarily indicative of the results that may be expected for any future period. Certain information and footnote disclosures included in financial statements have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements. The consolidated financial statements included in this Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended June 30, 2006, filed with the Securities and Exchange Commission on September 13, 2006.

Note 2. Recent Accounting Pronouncements

     In June 2006, the Emerging Issues Task Force (“EITF”) issued EITF 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation), to clarify diversity in practice on the presentation of different types of taxes in the financial statements. The Task Force concluded that, for taxes within the scope of the issue, a company may adopt a policy of presenting taxes either gross within revenue or net. That is, it may include charges to customers for taxes within revenues and the charge for the taxes from the taxing authority within cost of sales, or, alternatively, it may net the charge to the customer and the charge from the taxing authority. If taxes subject to EITF 06-3 are significant, a company is required to disclose its accounting policy for presenting taxes and the amounts of such taxes that are recognized on a gross basis. The guidance in this consensus is effective for the first interim reporting period beginning after December 15, 2006. The Company adopted EITF 06-3 as of January 1, 2007. The adoption of EITF 06-3 did not have a material impact on our consolidated financial statements.

     In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 10).FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with FASB Statement No. 109 and prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, with early adoption permitted. We are currently evaluating the impact Interpretation No. 48 will have on our consolidated financial statements.

     In September 2006 the FASB issued Statement No. 157, Fair Value Measurements. Statement 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. Statement 157 applies under other accounting pronouncements that require or permit fair value measurements and, accordingly, Statement 157 does not require any new fair value measurements. Statement 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We will adopt Statement 157 as of July 1, 2008. The adoption of Statement 157 is not expected to have a significant impact on our consolidated financial statements.

     In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material and therefore must be quantified. SAB 108 is effective for our fiscal year ending June 30, 2007. The adoption of SAB 108 is not expected to have a significant impact on our consolidated financial statements.

6

     In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115. Statement 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities under an instrument-by-instrument election. Subsequent measurements for the financial assets and liabilities an entity elects to fair value will be recognized in earnings. Statement 159 also establishes additional disclosure requirements. Statement 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted provided that the entity also adopts Statement 157 and is required to be adopted by us in the first quarter of fiscal 2009. We are currently evaluating the impact of the adoption of Statement 159 on our consolidated financial statements.

Note 3. Equity-Based Compensation

Accounting for Employee Stock Award Plans

     In July 2005, we adopted SFAS No. 123 (revised 2004), “Share-Based Payment,” (SFAS No. 123R) which was issued in December 2004. SFAS No. 123R revised SFAS No. 123, “Accounting for Stock Based Compensation,” and superseded APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related interpretations. SFAS No. 123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period that the employee is required to perform the services in exchange for the award. SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. SFAS No. 123R also amended SFAS No. 95, “Statement of Cash Flows,” to require that excess tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows. We adopted SFAS No. 123R using the modified prospective method. Accordingly, prior period amounts have not been restated. Under this application, we are required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption.

Classification of Stock-Based Compensation Expense

     Stock-based compensation is as follows (in thousands):

	Three Months Ended				Nine Months Ended
	March 31,				March 31,
	2007		2006		2007		2006
Cost of revenues	$	28	$	20	$	80	$	60
Selling and marketing		351		283		1,061		829
Research and development		102		98		291		306
General and administrative		361		379		2,415		1,104
	$	842	$	780	$	3,847	$	2,299

Tax Effect related to Stock-Based Compensation Expense

     SFAS No. 123R provides that income tax effects of share-based payments are recognized in the financial statements for those awards that will normally result in tax deductions under existing tax law. Under current U.S. federal tax law, we would receive a compensation expense deduction related to non-qualified stock options only when those options are exercised and vested shares are received. Accordingly, the financial statement recognition of compensation cost for non-qualified stock options creates a deductible temporary difference which results in a deferred tax asset and a corresponding deferred tax benefit in the income statement. We do not recognize a tax benefit for compensation expense related to incentive stock options (ISOs) unless the underlying shares are disposed of in a disqualifying disposition. Accordingly, compensation expense related to ISOs is treated as a non-deductible expense for income tax purposes.

Valuation Assumptions for Options Granted during Fiscal 2007

     The fair value of each stock option granted during fiscal 2007 was estimated at the date of grant using Black-Scholes, assuming no dividends and using the valuation assumptions noted in the following table. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated period of time outstanding) of the stock options granted was estimated using the historical exercise behavior of employees.

7

Expected volatility was based on historical volatility for a period equal to the stock option’s expected life, and calculated on a daily basis.

Expected term	5.1 to 5.5 years
Expected volatility	66.8 to 76.7	%
Weighted average volatility	74.0	%
Risk-free rate	4.5 - 5.1	%

     The above assumptions were used to determine the weighted average per share fair value of $8.65 for stock options granted during fiscal 2007.

Equity Compensation Plans

     In December 2004, our stockholders approved the 2004 Equity Incentive Plan (“the 2004 Plan”), and the 1995 Stock Option Plan and the 2002 Non-Qualified Stock Option Plan were terminated as to any shares then available for future grant. On November 30, 2006, our stockholders approved the Amended and Restated 2004 Plan to increase the number of shares available for issuance to our directors, executives and a broad-based category of employees from 1,500,000 to 2,700,000. In addition to the 2,700,000 available for issuance, all outstanding options which terminate, expire or are canceled under the terminated plans on or after December 1, 2004 are available for issuance under the 2004 Plan. Under the terms of the 2004 Plan, the exercise price of options granted cannot be less than the fair market value on the date of grant. Non-employee director options that are automatically granted upon the person first becoming a director vest and become exercisable six months after the date of grant and options granted annually vest and become exercisable for one-half the shares six months from the date of grant and for the balance of the grant one year from the date of grant. All options that have been granted expire ten years from the grant date, although the committee or board may define vesting and expiration dates for all options granted under the 2004 Plan, except for automatic grants of options to non-employee directors and provided that the term does not exceed 10 years, or five years for ISOs granted to optionees who are holders of 10% or more of our stock.

     In May 2005, our Board of Directors approved the acceleration of the vesting of unvested stock options held by employees that had option exercise prices of greater than $14.00 per share. Our stock price had ranged from $6.30 to $12.23 over the previous twelve months. As a result of the acceleration, options to purchase 532,376 shares of our common stock became immediately exercisable. Of these options, approximately seventy percent were scheduled to vest within the next eighteen months. The decision to accelerate vesting of these stock options was made to avoid recognizing compensation cost in the Consolidated Statements of Operations in future financial statements upon our adoption of SFAS No. 123R on July 1, 2005 and because the Board believed that the incentive and retention value of these options was significantly lower than their valuation using the Black-Scholes methodology. We estimate that the accelerated vesting of the stock options reduced stock-based compensation expense on a pre-tax basis by approximately $2.9 million in fiscal 2007, based on valuation calculations using the Black Scholes methodology.

     In October 2006, our former Chief Executive Officer resigned and entered into an agreement to assume the position of Executive Chairman of the Board of Directors. This Agreement was terminated effective January 15, 2007. Under the agreement, he received full vesting of all of his outstanding, unvested stock options and, generally, an additional nine months post vesting exercise period for all outstanding options. In the second quarter of fiscal 2007, we recorded an incremental $1.1 million of stock-based compensation expense as a result of this modification.

     Currently, our primary type of stock-based compensation consists of stock options, generally vesting over four years. We fund shares issued upon exercise out of available authorized shares.

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     A summary of the status of our stock option plans as of March 31, 2007 is presented below:

				Weighted		Remaining		Intrinsic
				Average		Contractual		Value
	Shares			Exercise Price		Term (years)		(in thousands)
Outstanding as of June 30, 2006		1,956,568		$	12.75
Granted		435,000			13.15
Exercised		(78,096	)		8.19
Terminated		(280,250	)		14.12
Outstanding as of March 31, 2007		2,033,222			12.82		6.7	$	635
Options exercisable at March 31, 2007		1,087,577		$	13.63		5.0	$	294
Options expected to vest at March 31, 2007		672,921		$	11.89		8.6	$	243
Options available for future grants at March 31, 2007		1,437,770

     The total intrinsic value of options exercised in fiscal 2007 was $285,000. Upon exercise of stock options, we issue authorized, but unissued shares.

     As of March 31, 2007, there was $6.4 million of total unrecognized compensation cost related to non-vested stock-based compensation arrangements related to stock options granted under our stock option plans. This cost is expected to be recognized over a weighted-average period of 2.1 years.

     The 2004 Plan permits us to grant non-vested awards which may impose conditions, including continued employment or performance conditions. The terms and conditions applicable to a restricted stock issuance, including the vesting periods and conditions, and the form of consideration payable, if any, are determined by the Compensation and Stock Option Committee of the Board of Directors. The plan provides that non-vested awards will not vest in full in less than three years if vesting is based on continued employment or the passage of time, provided that up to 120,000 shares may be granted with vesting based on continued employment or the passage of time over less than one year. Vesting for non-vested awards based on the achievement of performance criteria may not vest in less than one year. Notwithstanding the above, vesting may be otherwise determined by the Committee upon a change in control or upon the participant’s death or termination of service, other than for cause.

     During fiscal 2007 we did not grant any non-vested stock awards. Changes in our non-vested stock awards for fiscal 2007 were as follows:

				Weighted
				Average Grant
	Shares			Date Fair Value
Unvested as of June 30, 2006		11,290		$	13.29
Vested		(5,646	)		13.29
Unvested as of March 31, 2007		5,644			13.29

     As of March 31, 2007, there was $43,000 of total unrecognized compensation cost related to non-vested stock-based compensation arrangements related to restricted stock granted under the Plan. This cost is expected to be recognized over a weighted-average period of 0.3 years.

Note 4. Reclassification and Revision

     The June 30, 2006 and March 31, 2006 consolidated balance sheet has been revised to reflect a reclassification from cash and cash equivalents to short-term investments. This revision did not impact the consolidated statement of operations for the year ended June 30, 2006 or the three and nine months ended March 31, 2007. However, this revision increased cash flows used in investing activities and decreased the increase in cash and cash equivalents in the consolidated statement of cash flows for the year ended June 30, 2006 and nine months ended March 31, 2006. This revision did not impact the consolidated statement of operations or consolidated statement of cash flows for the three and nine months ended March 31, 2007. The impact of this reclassification and revision on the previously issued consolidated balance sheet and statements of cash flows is as follows (in thousands):

9

June 30, 2006	As Reported			Adjustment			As Adjusted
Cash and cash equivalents	$	86,223		$	(66,895	)	$	19,328
Short-term investments		27,903			66,895			94,798
Net cash used in investing activities		(11,257	)		(66,895	)		(78,152	)
Increase in cash and cash equivalents		77,938			(66,895	)		11,043

March 31, 2006	As Reported			Adjustment			As Adjusted
Net cash used in investing activities		(12,154	)		(47,940	)		(60,094	)
Increase in cash and cash equivalents		74,143			(47,940	)		26,203

Note 5. Goodwill and Intangible Assets

     The carrying amount of goodwill was $37.2 million and $37.8 million at March 31, 2007 and June 30, 2006, respectively. Goodwill decreased in fiscal 2007 due to the collection of $1.7 million related to settlement of an escrow claim with the former shareholders of Maxspeed Corporation, offset by the impact of changes in foreign currency exchange rates.

     Intangible assets with finite useful lives are amortized over their respective estimated useful lives. The following table provides a summary of our intangible assets (in thousands):

		March 31, 2007
		Gross
	Estimated	Carrying		Accumulated		Net Carrying
	useful life	Amount		Amortization		Amount
Tradenames	Indefinite	$	369	$	—	$	369
Non-compete agreements	2-5 years		1,690		799		891
Customer relationships	2-5 years		7,384		3,138		4,246
Distributor relationships	5 years		2,325		2,288		37
Acquired technology	5-10 years		7,465		3,296		4,169
		$	19,233	$	9,521	$	9,712

		June 30, 2006
		Gross
	Estimated	Carrying		Accumulated		Net Carrying
	useful life	Amount		Amortization		Amount
Tradenames	Indefinite	$	360	$	—	$	360
Non-compete agreements	2-5 years		1,700		448		1,252
Customer relationships	2-5 years		7,350		2,031		5,319
Distributor relationships	5 years		2,325		2,079		246
Acquired technology	5-10 years		7,506		2,508		4,998
		$	19,241	$	7,066	$	12,175

     The weighted average remaining lives of the intangible assets as of March 31, 2007 are as follows:

Non-compete agreements	2.0 years
Customer relationships	3.2 years
Distributor relationships	1.5 years
Acquired technology	3.2 years

     The amortization expense of intangible assets is set forth below (in thousands):

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	Three Months Ended				Nine Months Ended
	March 31,				March 31,
	2007		2006		2007		2006
Non-compete agreements	$	124	$	127	$	381	$	240
Customer relationships		360		358		1,080		833
Distributor relationships		7		116		209		349
Acquired technologies		343		323		1,018		868
	$	834	$	924	$	2,688	$	2,290

     Amortization expense for customer relationships and distributor relationships is included in sales and marketing expenses and amortization expense for acquired technologies is included in cost of revenues. Amortization expense for non-compete agreements is classified depending on the classification of the related employee. Intangible assets held by foreign subsidiaries whose functional currency is not the U.S. dollar fluctuate based on changes in foreign currency exchange rates.

     The following table provides estimated future amortization expense related to intangible assets (assuming there is no write down associated with these intangible assets causing an acceleration of expense or changes in foreign currency exchange rates) (in thousands):

	Future
Year Ending June 30,	Amortization
Remainder of fiscal 2007	$	830
2008		3,279
2009		2,843
2010		1,873
2011		494
2012		24
	$	9,343

Note 6. Comprehensive Income

     Excluding net income, our sources of other comprehensive income (loss) are unrealized gains and losses relating to foreign exchange rate fluctuations. The following summarizes the components of comprehensive income (loss) (in thousands):

	Three Months Ended					Nine Months Ended
	March 31,					March 31,
	2007			2006		2007			2006
Net income (loss)	$	(1,099	)	$	2,313	$	(1,557	)	$	6,696
Foreign currency translation adjustment		127			306		1,660			(467	)
Comprehensive income (loss)	$	(972	)	$	2,619	$	103		$	6,229

Note 7. Revenue Recognition

     Net revenues include sales of thin client appliance systems, which include the appliance device and related software, and services. We follow AICPA Statement of Position No. 97-2, “Software Revenue Recognition” (“SOP 97-2”) for revenue recognition because the software component of the thin client appliance systems is more than incidental to the thin client appliance systems as a whole. Revenue is recognized on product sales when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable and collectibility is probable. To date, sale of standalone software products and services have not exceeded 10% of our consolidated revenue for any period.

     Beginning in March 2007 our standard products include one year of post-contract support services where the cost to provide these services will not be insignificant and unspecified upgrades and enhancements offered during the period are expected to be more than minimal and infrequent. As a result, in March 2007 we began to defer revenue related to these post-contract support services. Prior to March 2007 revenue related to post-contract support services was generally recognized with the initial product sale when the fee was included with the initial

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product fee, post-contract services were for one year or less, the estimated cost of providing such services during the arrangement was insignificant, and unspecified upgrades and enhancements offered during the period were expected to continue to be minimal and infrequent. Otherwise, revenue from extended warranty and post-contract support service contracts is recorded as deferred revenue and subsequently recognized over the term of the contract. Vendor specific objective evidence of these amounts is determined by the price charged when these elements are sold separately.

     Stock rotation rights and price protection are provided to certain distributors. Stock rotation rights are generally limited to a maximum amount per quarter and require a corresponding order of equal or greater value at the time of the stock rotation. Price protection provides for a rebate in the event we reduce the price of products that our distributors have yet to sell to end-users. We reserve for these arrangements based on a specific review of known issues, historical experience and the level of inventories in the distribution channel and reduce current period revenue accordingly.

     Product warranty costs are accrued at the time the related revenue is recognized. We offer fixed-price support and maintenance contracts, including extended warranties, to customers ranging from one to five years. Revenue from these transactions is recognized over the related term.

     We record sales and value added taxes that are externally imposed on a revenue producing transaction between a seller and a customer on a net basis in the statements of operations.

Note 8. Major Customers and Dependence on Suppliers

     The following table sets forth sales to customers comprising 10% or more of our net revenue and accounts receivable balances:

	Three Months Ended						Nine Months Ended
	March 31,						March 31,
	2007			2006			2007			2006
Net revenues
North American distributor		10	%		*			10	%		*
Lenovo		*			18	%		*			18	%

	March 31,		June 30,
	2007		2006
Accounts receivable
Customer A		*		17	%
Billing agent for Lenovo		*		11	%

(*) Amounts do not exceed 10% for such period

     In April 2005, in connection with the sale of IBM’s Personal Computing Division to Lenovo Group Limited, we entered into a mirror agreement with Lenovo, under which Lenovo can purchase our products under the same terms as IBM. Our agreement with IBM remains in effect.

     Under the IBM and Lenovo agreements, IBM and Lenovo sell our branded products to their customers. During the sales process, our sales and integration personnel work directly with the end customers, along with the support of IBM and Lenovo salespeople, thereby developing ongoing relationships with the customers. The strategy of selling our branded products and developing ongoing relationships with the end customers was designed to mitigate the risk of customer concentration from sales through IBM and Lenovo.

     IBM, Lenovo and our distributors resell our products to individual resellers and end-users. The percentage of revenue derived from IBM, Lenovo, individual distributors, resellers or end-users can vary significantly from period to period. In addition to our direct sales to IBM and Lenovo, IBM, Lenovo and their resellers can purchase our products through distributors. Furthermore, IBM and Lenovo can influence an end-user’s decision to purchase our products even though the end-user may not purchase our products through IBM or Lenovo. While it is difficult to quantify the net revenues associated with these latter purchases, we believe that these sales are significant and can vary significantly from quarter to quarter.

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     Net revenues from sales outside of the United States, primarily in Europe, Middle East and Africa (EMEA) represented approximately 35% and 34% of net revenues for the third quarter for fiscal 2007 and 2006, respectively, and 40% and 29% of net revenues for the first nine months of fiscal 2007 and 2006, respectively. Net revenues from sales to customers located in Germany represented approximately 10% of net revenues for the third quarter of fiscal 2007. Net revenues from sales to customers located in the United Kingdom represented approximately 10% of net revenues for the third quarter of fiscal 2006. No single country outside the United States accounted for more than 10% of net revenue in the first nine months of fiscal 2007 and 2006.

     We depend upon a limited number of single source suppliers for the design and manufacture of our thin client devices and for several of the associated components. A domestic supplier requires advances to fund production of our orders. At March 31, 2007, we advanced $1.1 million to this domestic supplier, which has been classified as part of prepaid expenses and other. Although we have identified alternative suppliers that could produce comparable products, it is likely there would be an interruption of supply during any transition, which would limit our ability to ship product to fully meet customer demand. If this were to happen, our revenue would decline and our profitability would be adversely impacted.

Note 9. Inventories

     Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method and consists of the following (in thousands):

	March 31,		June 30,
	2007		2006
Purchased components and subassemblies	$	1,407	$	3,243
Finished goods		4,496		4,491
	$	5,903	$	7,734

     Cost of product sold in the first nine months of fiscal 2007 includes a $1.5 million write off of unfinished goods inventory and related purchase commitments for certain products acquired in an acquisition.

Note 10. Income Taxes

     We account for income taxes under the asset-and-liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. 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.

Note 11. Short-term Borrowings

     In December 2004, we entered into an Offering Basis Loan Agreement with a bank under which we can request short-term loan advances up to an aggregate principal amount of $10.0 million. Upon such request, the bank would provide us with the interest rate, terms and conditions applicable to the requested loan advance. The funds would be committed upon agreement of such terms by both parties. Unless otherwise agreed to by the bank, the term for any advance cannot exceed 180 days. There were no borrowings under the Offering Basis Loan Agreement in the first nine months of fiscal 2007 and fiscal 2006.

Note 12. Earnings per Share

     Basic EPS is computed by dividing net 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 and warrants. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except share and per share data):

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	Three Months Ended					Nine Months Ended
	March 31,					March 31,
	2007			2006		2007			2006
Net income (loss)	$	(1,099	)	$	2,313	$	(1,557	)	$	6,696
Weighted average shares outstanding:
Basic		20,000			18,023		19,969			16,931
Effect of dilutive employee stock options		—			825		—			543
Diluted		20,000			18,848		19,969			17,474
Earnings (loss) per common share:
Basic	$	(0.05	)	$	0.13	$	(0.08	)	$	0.40
Diluted	$	(0.05	)	$	0.12	$	(0.08	)	$	0.38

     The following table sets forth the common shares issuable upon exercise of stock options that were excluded from the dilutive earnings per share computations because the exercise prices were greater than the average market price of the common stock during the period (in thousands):

	Three Months Ended				Nine Months Ended
	March 31,				March 31,
	2007		2006		2007		2006
Common stock equivalents		1,097		23		1,017		115

     In addition, as a result of the net loss for the three and nine months ended March 31, 2007, 25,000 and 48,000 common stock equivalents, respectively, were not included in the computation of diluted earning (loss) per share because we had a net loss and inclusion of these common stock equivalents would have been anti-dilutive.

Note 13. Guarantees

     Indemnifications

     In the ordinary course of business, from time-to-time we enter into contractual arrangements under which we may agree to indemnify our customer for losses incurred by the customer or supplier arising from certain events as defined within the particular contract, which may include, for example, litigation or intellectual property infringement claims. The potential liability related to these indemnification provisions is insignificant.

     Warranty

     We provide for the estimated cost of product warranties at the time we recognize revenue. We actively monitor and evaluate the quality of our component suppliers; however, ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure affect the estimated warranty obligation. If actual product failure rates, material usage or service delivery costs differ from estimates, revisions to the estimated warranty liability would be required. Our standard warranty service period ranges from one to three years.

     The changes in our warranty liability, which is included in other accrued expenses, during fiscal 2007 are as follows (in thousands):

Accrued warranty cost at June 30, 2006	$	1,177
Settlement of warranties		(479	)
Provisions for warranties		332
Accrued warranty cost at March 31, 2007	$	1,030

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

     We are a leading global provider of thin client computing solutions which replace desktop PC’s in enterprises. Thin clients enhance security, improve manageability, increase reliability and lower the up-front and ongoing cost of computing compared to the desktop PC.

     We generate revenue primarily from sales of thin client devices, which includes the device and related software, and to a lesser extent from our software sold on a standalone basis for use on thin client devices, personal computers and servers and complementary services such as integration, training and maintenance utilizing our

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global integration and development centers. Our software powers, secures and manages thin client devices and traditional personal computers, enabling these devices to run Windows^® and web applications across a network, as well as to connect to mainframes, mid-range, UNIX and Linux systems. To date, sales of standalone software products and services have not exceeded 10% of our consolidated revenues for any period.

     We offer a broad range of thin client computing solutions for enterprises of varying sizes and across diverse vertical markets, including the retail, financial services, healthcare, hospitality, transportation, manufacturing, and education industries and multiple levels of government. We sell our products worldwide through our alliances with IBM, Lenovo, NEC, and ClearCube, and other indirect channels such as distributors, resellers and systems integrators, and to a lesser extent through direct sales. Our customers, including those we serve through our alliance and distribution partners, include AutoZone, CVS, Daimler Chrysler, France Telecom, Lockheed Martin, Royal Bank of Canada and the VA Medical Centers. In addition to our principal headquarters in the United States, we maintain offices in Australia, Austria, China, France, Germany, and the United Kingdom. Sales from our international locations are primarily made through distributors and are collectible primarily in US dollars, while the associated operating expenses are payable in foreign currencies.

     In April 2005, in connection with the sale of IBM’s Personal Computing Division to Lenovo Group Limited, we entered into a mirror agreement with Lenovo under which Lenovo can purchase our products under the same terms as IBM. Lenovo sells our products primarily to IBM customers. Our agreement with IBM remains in effect.

     Strategy

     Our objective is to be the leading global provider of thin client solutions for enterprise customers by providing a secure, manageable, and cost-effective alternative to traditional PC architectures. Key elements of our strategy include the following:

• Continue to invest in technology development. We believe that we have developed and acquired the technology to enable a more powerful, secure and cost-effective thin computing architecture. We have more than a 15-year history of developing this technology including those of the companies we have acquired. We believe that the current market interest in thin client computing as a replacement for desktop PCs is due in part to the increase of virtualization technology and that our technical strength and IP in thin client and virtualization technologies will enable us to compete more effectively and take full advantage of the growing opportunity. We will continue to invest in technology development to maintain our competitive position and drive market share growth.

• Focus on the enterprise. We believe the most significant market segment for the thin client solution is the enterprise customer. As a result, we have focused our development, sales and marketing efforts on small, medium and large enterprises across a diverse set of vertical markets. Our access to this highly attractive market is considerably enhanced by our relationships with our alliance and distribution partners. We will continue to make significant investments to attract additional enterprise customers and gain market share. These investments will include additions to the sales teams primarily in the United States and Europe, as well as additional marketing personnel and programs designed to stimulate thin client awareness and lead generation.

• Enhance channel partnerships. To expand our access to customers, we have developed relationships with third parties that we believe have strong market positions and customer relationships. We have developed alliances with IBM, Lenovo, NEC and ClearCube, and other distributors and resellers, all of which sell our products to their customers. We have launched our reseller program to increase sales though our channel partners. We are introducing promotional programs and pricing incentives to expand our customer base in this area and gain market share.

• Expand and deepen our geographic footprint. Our business was historically focused on the U.S. market. In fiscal year 2004, we determined to expand our global footprint as part of a strategic expansion of our development and integration organization through the acquisitions of Maxspeed, Mangrove, Qualystem and ThinTune, as well as through partnerships with global distributors such as NEC, ClearCube and local providers. As a result, we now have a global footprint, with operations primarily in the US and Europe. We believe that international markets will be a significant source of growth and we intend to continue to increase our presence by expanding our reseller relationships and through select acquisitions.

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• Grow our business through strategic acquisitions. Our acquisition strategy has been focused on expanding our geographic reach, acquiring businesses with technologies that increase our ownership of core intellectual property, and with products that can be sold through our existing channels to the same end-user customers, leveraging our existing organization. We have also sought to augment our software development resources and add to our integration capability on a global basis. We intend to continue to pursue select strategic acquisitions in the future.

• Capitalize on the growing adoption of industry-standard and open-source technologies. We believe that many enterprise customers are seeking industry-standard technologies, not proprietary solutions that require them to use a single vendor. As a result, we integrate our products into industry-standard solutions, and utilize open-source and other industry-standard technologies. In our supply chain we leverage the high volumes of the PC industry and PC supply chain techniques to lower our costs. We believe our commitment to open-source, cross-platform and industry-standard software technologies, and our use of the high volume supply chain efficiencies of the PC industry, represent significant differentiators and competitive advantages for us.

     Recent Acquisitions

     In November 2005, we completed the acquisition of Maxspeed Corporation, a provider of thin client solutions, headquartered in the United States, with research, development and sales in China.

     In October 2005, we acquired the thin client business of TeleVideo, Inc., located in the United States, including a trademark license, product brands, customer lists, customer contracts and non-competition agreements.

     In April 2005, we acquired all of the outstanding shares of Qualystem Technology S.A.S., located in France, a provider of software that streams Windows^® operating systems on-demand from a server to other servers, personal computers, and thin clients.

     In March 2005, we acquired the ThinTune thin client business of eSeSIX Computer, located in Germany, which included customer lists, intellectual property and technology, and also entered into reseller, supplier and non-competition agreements, and acquired all of the outstanding shares of eSeSIX Tech, located in Austria, eSeSIX Computer’s development and engineering affiliate. eSeSIX Computer together with eSeSIX Tech are collectively referred to as the ThinTune thin client business.

     In January 2005, we acquired all of the outstanding shares of Mangrove Systems S.A.S., located in France, a provider of Linux software solutions. As a result of the Mangrove acquisition, we acquired customer lists, intellectual property and technology and non-competition agreements.

     In September 2004, we acquired the thin client business of Visara International, Inc, located in the United States, including customer lists, intellectual property and technology, and also entered into reseller, supplier and non-competition agreements.

     Financial Highlights

     Net revenue, gross profit margin, and earnings per share are key measurements of our financial results.

	Three Months Ended						Nine Months Ended
	March 31,						March 31,
	2007			2006			2007			2006
Net revenues (in thousands)	$	22,070		$	27,787		$	67,406		$	83,666
% Change		(21	%)		46	%		(19	%)		50	%
Gross profit margin		37	%		44	%		38	%		43	%
Diluted earnings (loss) per share	$	(0.05	)	$	0.12		$	(0.08	)	$	0.38

     Net revenues decreased in the third quarter of fiscal 2007 primarily due to lower sales of our products to large enterprise customers that contributed $2.6 million in the third quarter of fiscal 2007 compared to sales of $4.0 million to large enterprise customers in the third quarter of fiscal 2006, a decline in several other enterprise accounts of approximately $4.0 million and a $1.4 million decline in EMEA revenues offset by a 23% increase in revenues

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from our small and medium business (SMB) and distributor groups. We define large enterprise customers as those contributing more than $1.0 million of revenue in a quarter. While revenues to these enterprise customers declined in fiscal 2007, they continue to be active customers and we continue to negotiate future purchases, albeit at lower levels.

     Net revenues decreased in the first nine months of fiscal 2007 primarily due to lower sales of our products to large enterprise customers that contributed $9.6 million in the first nine months of fiscal 2007 compared to sales of $26.8 million to large enterprise customers in the first nine months of fiscal 2006. In addition, we experienced declines in other areas of our business offset by a 17% increase in our SMB and distributor groups for the first nine months of fiscal year 2007.

     Our gross profit margin percentage declined seven percentage points in the third quarter of fiscal 2007 of which four percentage points are due to increased sales of Xpe based products, which carry a lower gross profit margin percentage, and lower sales of our higher margin Linux products, due to a decline in revenues to large Linux enterprise customers that had purchased in the third quarter of fiscal 2006. In addition, we incurred higher manufacturing overhead costs in the third quarter of fiscal 2007 quarter as spending levels increased to support higher revenue levels which did not materialize. The gross profit margin percentage decrease in the first nine months of fiscal 2007 was primarily the result of a $1.7 million write off of unfinished goods inventory and related purchase commitments for certain products acquired in an acquisition and excess third party software licenses (collectively approximately three percentage points) and change in the mix of products sold.

     Diluted earnings (loss) per share was ($.05) for the third quarter of fiscal 2007, compared to $0.12 in the third quarter of fiscal 2006, as a result of a decline in revenues and gross profit percentage, increased operating expenses, offset by a larger number of fully diluted shares due to a stock offering completed in February 2006. Stock-based compensation expense included in these results was $28,000 and $20,000 in cost of products and $814,000 and $760,000 in operating expense for the third quarter of fiscal 2007 and fiscal 2006, respectively, and amortization of intangibles was $834,000 and $924,000 for the third quarter of fiscal 2007 and 2006, respectively.

     Diluted earnings (loss) per share was $(0.08) for the first nine months of fiscal 2007, compared to $0.38 in the first nine months of fiscal 2006, as a result of a decline in revenues and gross profit percentage, the impact of a $1.7 million write off to cost of products relating to the write off of inventory and for software purchase commitments, increased operating expenses and $874,000 in abandoned acquisition costs, offset by a larger number of fully diluted shares due to a stock offering completed in February 2006 and a $1.7 million tax benefit. Stock-based compensation expense included in these results was $80,000 and $60,000 in cost of products and $3.8 million and $2.2 million in operating expense for the first nine months of fiscal 2007 and 2006, respectively, and amortization of intangibles was $2.7 million and $2.3 million for the first nine months of fiscal 2007 and 2006, respectively.

     As of March 31, 2007, our cash and cash equivalents and short- term investments were $120.0 million, compared to $114.1 million at June 30, 2006.

Critical Accounting Policies and Estimates

     We believe that there are several accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenue and other significant areas that involve management’s judgments and estimates. These critical accounting policies and estimates include:

• Revenue recognition

• Valuation of long-lived and intangible assets and goodwill

• Accounting for income taxes

• Stock based compensation

     These policies and estimates and our procedures related to these policies and estimates are described in detail below and under specific areas within the discussion and analysis of our financial condition and results of operations. Please refer to Note 1, “Organization and Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements in our annual financial statements as of June 30, 2006 included in our Annual Report on Form 10-K for further discussion of our accounting policies and estimates.

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Revenue Recognition

     For each type of arrangement, we make judgments regarding: the fair value of multiple elements contained in our arrangements, whether fees are fixed or determinable, collectibility is probable, and accounting for potential distributor stock rotation rights and price protection. These judgments, and their effect on revenue recognition, are discussed below.

     Multiple Element Arrangements

     Net revenues include sales of thin client devices, which include the device and related software, maintenance and technical support as well as standalone software products and services. We follow AICPA Statement of Position No. 97-2, “Software Revenue Recognition” (“SOP 97-2”) for revenue recognition. Revenue is recognized on product sales when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable and collectibility is probable.

     Beginning in March 2007 our standard products include one year of free post-contract support services where the cost to provide these services will not be insignificant and unspecified upgrades and enhancements offered during the period are expected to be more than minimal and infrequent. As a result, in March 2007 we began to defer revenue related to these post-contract support services. Prior to March 2007 revenue related to post-contract support services was generally recognized with the initial product sale when the fee was included with the initial product fee, post-contract services were for one year or less, the estimated cost of providing such services during the arrangement was insignificant, and unspecified upgrades and enhancements offered during the period are expected to continue to be minimal and infrequent. Otherwise, revenue from extended warranty and post-contract support service contracts is recorded as deferred revenue and subsequently recognized over the term of the contract. Vendor specific objective evidence of these amounts is determined by the price charged when these elements are sold separately.

     The Fee is Fixed or Determinable

     We make judgments at the outset of an arrangement regarding whether the fees are fixed or determinable. The majority of our payment terms are within 30 to 60 days after invoice date. We review arrangements that have payment terms extending beyond 60 days on a case-by-case basis to determine if the fee is fixed or determinable. If we determine at the outset of an arrangement that the fees are not fixed or determinable, we recognize revenue as the fees become due and payable.

     Collection is Probable

     We make judgments at the outset of an arrangement regarding whether collection is probable. Probability of collection is assessed on a customer-by-customer basis. We typically sell to customers with whom we have had a history of successful collections. New customers are subjected to a credit review process to evaluate the customer’s financial position and ability to pay. If we determine at the outset of an arrangement that collection is not probable, revenue is recognized upon receipt of payment.

     Stock Rotation Rights and Price Protection

     We provide certain distributors with stock rotation rights and price protection. Stock rotation rights are generally limited to a maximum amount per quarter and require a corresponding order of equal or greater value at the time of the stock rotation. We provide price protection as a rebate in the event that we reduce the price of products that our distributors have yet to sell to end-users. We estimate potential stock rotation and price protection claims based on historical experience and the level of inventories in the distribution channel and reduce current period revenue accordingly. If we cannot reasonably estimate claims related to stock rotations and price protection at the outset of an arrangement, we recognize revenue when the claims can be reasonably estimated.

Valuation of Long-Lived and Intangible Assets and Goodwill

     In connection with acquisitions, we allocate portions of the purchase price to tangible and intangible assets, consisting of acquired technologies, distributor and customer relationships, tradenames and non-compete agreements based on independent appraisals received after each acquisition, with the remainder allocated to goodwill.

     We assess the realizability of goodwill and intangible assets with indefinite useful lives pursuant to SFAS No. 142, “Goodwill and Other Intangible Assets.” We perform a SFAS No. 142 impairment test annually on June 30, or

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sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable. We have determined that the reporting unit level is our sole operating segment. The test for goodwill is a two-step process:

• First, we compare the carrying amount of our reporting unit, which is the book value of the entire company, to the fair value of our reporting unit. If the carrying amount of our reporting unit exceeds its fair value, we have to perform the second step of the process. If not, no further testing is needed.

• If the second part of the analysis is required, we allocate the fair value of our reporting unit to all assets and liabilities as if the reporting unit had been acquired in a business combination at the date of the impairment test. We then compare the implied fair value of our reporting unit’s goodwill to its carrying amount. If the carrying amount of our reporting unit’s goodwill exceeds its fair value, we recognize an impairment loss in an amount equal to that excess.

     We review our long-lived assets, including amortizable intangibles, for impairment when events indicate that their carrying amount may not be recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” When we determine that one or more impairment indicators are present for an asset, we compare the carrying amount of the asset to net future undiscounted cash flows that the asset is expected to generate. If the carrying amount of the asset is greater than the net future undiscounted cash flows that the asset is expected to generate, we compare the fair value to the book value of the asset. If the fair value is less than the book value, we recognize an impairment loss. The impairment loss is the excess of the carrying amount of the asset over its fair value.

     Some of the events that we consider as impairment indicators for our long-lived assets, including goodwill, are:

• Our net book value compared to our market capitalization;

• Significant adverse economic and industry trends;

• Significant decrease in the market value of the asset;

• The extent that we use an asset or changes in the manner that we use it; and

• Significant changes to the asset since we acquired it.

     We have not recorded an impairment loss on goodwill or other long-lived assets. At March 31, 2007, goodwill and intangible assets were $37.2 million and $9.7 million, respectively. A decrease in the value of our business could trigger an impairment charge related to goodwill or amortizable intangible assets.

Accounting for Income Taxes

     We are required to estimate our income taxes in each federal, state and international jurisdiction in which we operate. This process requires that we estimate the current tax expense as well as assess temporary differences between the accounting and tax treatment of assets and liabilities, including items such as accruals and allowances not currently deductible for tax purposes. The income tax effects of the differences we identify are classified as current or long-term deferred tax assets and liabilities in our consolidated balance sheets. Our judgments, assumptions and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of future audits conducted by foreign and domestic tax authorities. Changes in tax laws or our interpretation of tax laws and the resolution of future tax audits could significantly impact the amounts provided for income taxes in our balance sheet and results of operations. We must also assess the likelihood that deferred tax assets will be realized from future taxable income and, based on our assessment, establish a valuation allowance, if required. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating losses. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We have considered ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. In the event we were to determine that we would be able to realize all or a portion of these deferred tax assets, an adjustment to the valuation allowance would increase earnings in the period such determination was made. Likewise, should we determine that we would not be able to realize all or a portion of our remaining deferred tax assets in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination was made. We have forecasted a net operating loss

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for fiscal 2007 and assessed the likelihood that our deferred tax assets will be realized from future taxable income and tax planning and determined that no change in the valuation allowance, was required.

Stock-Based Compensation

     Prior to June 30, 2005, we accounted for employee stock option plans based on the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations and had adopted the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No.123), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (SFAS No. 148). Accordingly, compensation cost for stock options was measured as the excess, if any, of the quoted market price of our stock at the grant date over the amount an employee must pay to acquire the stock. We granted stock options with exercise prices equal to the market price of the underlying stock on the date of grant; therefore, we did not record stock-based compensation expense under APB Opinion No. 25.

     In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R, “Share-Based Payment,” (SFAS No. 123R) to require that compensation cost relating to share-based payment arrangements be recognized in financial statements. As of July 1, 2005, we adopted SFAS No. 123R using the modified prospective method, which requires measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options are determined using the Black-Scholes valuation model, which is consistent with our valuation techniques previously utilized for stock options in footnote disclosures required under SFAS No. 123, as amended by SFAS No. 148. Such fair value is recognized as expense over the service period, net of estimated forfeitures. The adoption of SFAS No.123R resulted in no cumulative change in accounting as of the date of adoption.

     On March 29, 2005, the Securities and Exchange Commission published Staff Accounting Bulletin No. 107 (SAB No. 107), which provides the Staff’s views on a variety of matters relating to stock-based payments. SAB No. 107 requires stock-based compensation to be classified in the same expense line items as cash compensation. Information about stock-based compensation included in the results of operations is as follows (in thousands):

	Three Months Ended				Nine Months Ended
	March 31,				March 31,
	2007		2006		2007		2006
Cost of revenues	$	28	$	20	$	80	$	60
Selling and marketing		351		283		1,061		829
Research and development		102		98		291		306
General and administrative		361		379		2,415		1,104
	$	842	$	780	$	3,847	$	2,299

     We expect stock-based compensation expense to be approximately $4.6 million for fiscal 2007 before income taxes. This amount may increase if we grant options to new executives or grant a significant number of options to other employees. This amount may also change as a result of additional grants to existing employees, forfeitures or differences between actual and estimated forfeitures, modifications to previously granted awards or other factors. SFAS No. 123R provides that income tax effects of share-based payments are recognized in the financial statements for those awards which will normally result in tax deductions under existing tax law. Under current U.S. federal and U.K. tax laws, we would receive a compensation expense deduction related to non-qualified stock options only when those options are exercised and vested shares are received. Accordingly, the financial statement recognition of compensation cost for non-qualified stock options creates a deductible temporary difference which results in a deferred tax asset and a corresponding deferred tax benefit in the income statement. We do not recognize a tax benefit for compensation expense related to incentive stock options (ISOs) unless the underlying shares are disposed of in a disqualifying disposition. Accordingly, compensation expense related to ISOs is treated as a permanent difference for income tax purposes which increases the effective tax rate.

     For stock-based compensation arrangements we make judgments about the fair value of the awards, including the expected term of the award, volatility of the underlying stock and estimated forfeitures, which impact the amount of compensation expense recognized in the financial statements.

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Results of Operations

Net Revenues (in thousands):

	Three Months Ended							Nine Months Ended
	March 31,							March 31,
												%
	2007		2006		% Change			2007		2006		Change
Net revenues	$	22,070	$	27,787		(21	%)	$	67,406	$	83,666		(19	%)

     We derive revenues primarily from the sale of thin client appliances, which include an appliance device and related software. Net revenues decreased in the third quarter of fiscal 2007 primarily due to lower sales of our products to large enterprise customers that contributed $2.6 million in the third quarter of fiscal 2007 compared to sales of $4.0 million to large enterprise customers in the third quarter of fiscal 2006, a decline in several other enterprise accounts of approximately $4.0 million and a $1.4 million decline in EMEA revenues offset by a 23% increase in revenues from our SMB and distributor groups. We define large enterprise customers as those contributing more than $1.0 million of revenue in a quarter. While revenues to enterprise customers declined in fiscal 2007, they continue to be active customers and we continue to negotiate future purchase requirements, albeit at lower levels.

     Unit sales of thin client devices in the third quarter of fiscal 2007 decreased 22% compared to the third quarter of fiscal 2006 primarily due to decreased sales to large enterprise customers. Average selling prices in the third quarter of fiscal 2007 increased 3% compared to those in the third quarter of fiscal 2006. Average selling prices will vary depending on product mix and competitive pricing situations.

     Net revenues decreased in the first nine months of fiscal 2007 primarily due to lower sales of our products to large enterprise customers that contributed $9.6 million in the first nine months of fiscal 2007 compared to sales of $26.8 million to large enterprise customers in the first nine months of fiscal 2006. In addition, we experienced declines in other areas of our business offset by a 17% increase in our SMB and distributor groups for the first nine months of fiscal year 2007 as compared to the first nine months of fiscal year 2006.

     Unit sales of thin client devices in the first nine months of fiscal 2007 decreased 13% compared to the first nine months of fiscal 2006 primarily due to decreased sales to large enterprise customers. Average selling prices in the first nine months of fiscal 2007 decreased 8% compared to the first nine months of fiscal 2006 due to decreased sales of our e900 thin client products, which carry a significantly higher selling prices than our other thin client devices. Average selling prices will vary depending on product mix and competitive pricing situations.

     The following table sets forth sales to customers comprising 10% or more of our net revenue:

	Three Months Ended						Nine Month Ended
	March 31,						March 31,
	2007			2006			2007			2006
Net revenues
North American distributor		10	%		*			10	%		*
Lenovo		*			18	%		*			18	%

(*) Amounts do not exceed 10% for such period

Cost of Revenues and Gross Profit Margin (in thousands):

	Three Months Ended									Nine Months Ended
	March 31,									March 31,
	2007			2006			% Change			2007			2006			% Change
Cost of products	$	13,513		$	15,353			(12	%)	$	41,127		$	47,051			(13	%)
Amortization of intangibles		343			338			1	%		1,018			913			12	%
Total cost of revenues		13,856			15,691			(12	%)		42,145			47,964			(12	%)
Gross profit margin		37	%		44	%					38	%		43	%

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     Cost of revenues consists primarily of the cost of thin client devices, which include a device and related software, and, to a lesser extent, overhead including salaries and related benefits for personnel who fulfill product orders, delivery services, warranty obligations, amortization of intangibles, and distribution costs. The decrease in cost of products in the third quarter of fiscal 2007 was primarily the result of decreased unit sales of our thin client products.

     The decrease in cost of products in the first nine months of fiscal 2007 was primarily the result of decreased unit sales of our e900 thin client products ($4.8 million), which carries a significantly higher unit cost, and decreased unit sales of our other thin client products ($3.8 million), offset by a net $1.7 million write off of acquired unfinished goods inventory and related purchase commitments for certain products acquired in an acquisition due to discontinued sales of this product to new customers and excess third party software licenses.

     Our gross profit margin percentage declined seven percentage points in the third quarter of fiscal 2007 of which four percentage points are due to increased sales of Xpe based products, which carry a lower gross profit margin percentage than our other thin client products, and lower sales of our higher margin Linux products, due to a decline in revenues to large Linux enterprise customers that had purchased in the third quarter of fiscal 2006. In addition, higher manufacturing overhead costs were incurred in the third quarter of fiscal as spending levels increased to support higher revenue levels which did not materialize. The gross profit margin percentage decrease in the first nine months of fiscal 2007 was primarily the result of a net $1.7 million write off of unfinished goods inventory and related purchase commitments for certain products acquired in an acquisition and excess third party software licenses (collectively approximately three percentage points) and change in the mix of products sold.

     Gross margins for the remainder of fiscal 2007 are expected to be approximately 36% to 38%, but will fluctuate due to changes in product mix, promotional and competitive pricing strategies, increased price competition, the percentage of revenues derived from thin client devices and software, and changes in the cost of thin client devices, flash memory, DRAM and other components.

Selling and Marketing (in thousands):

	Three Months Ended									Nine Months Ended
	March 31,									March 31,
																%
	2007			2006			% Change			2007			2006			Change
Selling and marketing	$	4,451		$	4,295			4	%	$	13,933		$	12,864			8	%
As a percentage of revenue		20	%		15	%					21	%		15	%

     Sales and marketing expenses consist primarily of salaries, related benefits, commissions, advertising, direct marketing, the cost of trade shows, stock-based compensation expense, and other costs associated with our sales and marketing efforts.

     The increase in sales and marketing expenses in the third quarter of fiscal 2007 was primarily due to a $68,000 increase in stock-based compensation expense and an $88,000 increase in advertising and tradeshow expenses.

     The increase in sales and marketing expenses in the first nine months of fiscal 2007 was primarily due to an increase in employment resulting in an additional $148,000 of employee compensation cost, increased severance expenses of $565,000, a $232,000 increase in stock-based compensation expense, and a $289,000 increase in advertising and tradeshow expenses, offset by a $165,000 decrease in the expenses related to our annual sales meetings.

     We expect selling and marketing expenses to increase in absolute dollars for the remainder of 2007. Spending levels in any one quarter will vary depending upon the timing of staffing hires and individual marketing initiatives.

Research and Development (in thousands):

	Three Months Ended									Nine Months Ended
	March 31,									March 31,
	2007			2006			% Change			2007			2006			% Change
Research and development	$	1,557		$	1,645			(5	%)	$	4,927		$	4,446			11	%
As a percentage of revenue		7	%		6	%					7	%		5	%

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     Research and development expenses consist primarily of salaries, related benefits, stock-based compensation expense, and other engineering related costs.

     The decrease in research and development in the third quarter of fiscal 2007 is primarily the result of a $230,000 decrease in employee compensation as a result of employment reductions in prior periods, offset by a $142,000 increase in various expenses.

     The increase in research and development in the first nine months of fiscal 2007 is primarily the result of an increase in employment primarily from acquisitions resulting in an additional $187,000 of employee compensation costs, increased severance expenses of $253,000 and a $297,000 increase in various expenses, offset by a $256,000 decrease in outsourced services.

     We believe that a significant level of research and development investment is required to remain competitive and expect research and development expenses to increase in absolute dollars for the balance of fiscal 2007.

General and Administrative (in thousands):

	Three Months Ended									Nine Months Ended
	March 31,									March 31,
																%
	2007			2006			% Change			2007			2006			Change
General and administrative	$	2,710		$	2,451			11	%	$	10,022		$	7,614			32	%
As a percentage of revenue		12	%		9	%					15	%		9	%

     General and administrative expenses consist primarily of salaries, related benefits, corporate insurance, such as director and officer liability insurance, fees related to the cost of being a public company and fees for legal, audit and tax services, and stock-based compensation expense.

     The increase in general and administrative expenses in the third quarter of fiscal 2007 was primarily due to an increase in employment resulting in an additional $185,000 of employee compensation cost, and a $145,000 increase in consulting services, offset by a $71,000 decrease in legal and accounting fees.

     The increase in general and administrative expenses in the first nine months of fiscal 2007 is primarily the result of an increase of $1.3 million in stock-based compensation expense ($1.1 million related to our former CEO’s option modification), increase in severance expenses of $876,000, an increase in employment resulting in an additional $324,000 of employee compensation cost, a $198,000 increase in legal and accounting fees, and a $159,000 increase in franchise and capital stock taxes. These increases are offset by a $449,000 decrease in bonus expenses due to a decrease in the number of employees eligible for bonuses and lower percentage achievement of goals in the first nine months of fiscal 2007 compared to the same period in fiscal 2006.

     We expect general and administrative expenses to decrease in absolute dollars for the remainder of fiscal 2007 as we expect lower stock-based compensation expense and severance charges, if incurred, to be of a lower magnitude than those charges recorded in the third quarter of fiscal 2007.

Amortization of Intangibles (in thousands):

	Three Months Ended									Nine Months Ended
	March 31,									March 31,
																%
	2007			2006			% Change			2007			2006			Change
Amortization of intangibles	$	491		$	586			(16	%)	$	1,670		$	1,377			21	%
As a percentage of revenue		2	%		2	%					3	%		2	%

     The decrease in amortization of intangibles in the third quarter of fiscal 2007 is due to certain intangibles becoming fully amortized in the second quarter of fiscal 2007. The increase in amortization of intangibles in the first nine months of fiscal 2007 is due to additional amortization expense related to intangible assets acquired in fiscal 2006. As of March 31, 2007, we had unamortized intangible assets in the net amount of $9.7 million. We expect amortization of acquired intangible assets to increase slightly in fiscal 2007 compared to fiscal 2006.

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Abandoned Acquisition Costs

     During fiscal 2007, we wrote off $874,000 in acquisition-related expenses which were previously deferred, related to an acquisition that was not consummated. These costs consisted primarily of advisory, legal, third party due diligence and accounting fees. We intend to continue to pursue acquisitions and, if we do not complete them, the cost of pursing acquisitions will impact our profitability.

     Interest Income (in thousands):

	Three Months Ended									Nine Months Ended
	March 31,									March 31,
																%
	2007			2006			% Change			2007			2006			Change
Interest income, net	$	1,044		$	507			106	%	$	2,979		$	998			198	%
As a percentage of revenue		5	%		2	%					4	%		1	%

     Interest income is generated on cash, cash equivalent and short-term investments, primarily invested in tax-free, short-term instruments. Interest income increased in the third quarter and first nine months of fiscal 2007 due to earnings on increased average balances of cash, cash equivalent and short-term investments, generated primarily from the common stock offering completed in February 2006.

Income Tax Expense (Benefit) (in thousands):

	Three Months Ended									Nine Months Ended
	March 31,									March 31,
	2007			2006			% Change			2007			2006			% Change
Income tax expense (benefit)	$	1,123		$	1,301			(14	%)	$	(1,686	)	$	3,767			(145	%)
As a percentage of revenue		5	%		5	%					(3	%)		5	%

     Our effective tax rate in the third quarter and first nine months of fiscal 2007 differed from the combined federal and state statutory rates primarily due to federal tax free investment income, the Extraterritorial Income Exclusion (“EIE”), foreign income taxes in lower tax rate countries, partially offset by the non-deductible portion of stock-based compensation expense associated with incentive stock options. The change in the effective tax rate is primarily due to a decline in forecasted fiscal 2007 pre-tax income and an increase in federal tax free investment income, offset by an increase in non-deductible stock-based compensation expense associated with incentive stock options and a decrease in the EIE.

Liquidity and Capital Resources

     As of March 31, 2007, we had net working capital of $135.4 million compared to $126.9 million at June 30, 2006. Our principal sources of liquidity include $120.0 million of cash and cash equivalents and short-term investments and an Offering Basis Loan Agreement with a bank under which we can request short-term loan advances up to an aggregate principal amount of $10.0 million. Upon such request, the bank would provide us with the interest rate, terms and conditions applicable to the requested loan advance. The funds would be committed upon agreement of such terms by both parties. Unless otherwise agreed to by the bank, the term for any advance cannot exceed 180 days. There were no borrowings under the Offering Basis Loan Agreement during the first nine months of fiscal 2007.

     Cash and cash equivalents increased by $71.0 million during the first nine months of fiscal 2007, primarily as a result of $65.1 million from the net sales of short-term investments, collection of $1.7 million related to settlement of an escrow claim with the former shareholders of Maxspeed Corporation, $1.3 million of cash from the exercise of stock options and related excess tax benefits and $3.0 million provided by operations.

     Cash flows provided by operating activities: Cash flows provided by operating activities in the first nine months of 2007 was $3.0 million primarily as the result of a net loss of $1.6 million, adjusted for, among other items, depreciation of $410,000, amortization of intangibles of $2.7 million, stock-based compensation of $3.8 million, a $3.9 million increase in prepaid expense primarily related to income taxes, a $2.5 million decrease in accounts payable due primarily to payment of obligations for inventory purchases, a $1.8 million decrease in

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inventory, a $613,000 million decrease in accounts receivable, a $1.1 million increase in accrued compensation and benefits, and a net $577,000 increase related to other working capital items.

     Cash flows provided by investing activities: Cash flows from investing activities in the first nine months of fiscal 2007 included the purchases and sales of short-term investments, collection of $1.7 million related to settlement of an escrow claim with the former shareholders of Maxspeed Corporation and purchases of property and equipment.

     Cash flows provided by financing activities: Cash flows from financing activities in the first nine months of fiscal 2007 and fiscal 2006 primarily included proceeds from the exercise of employee stock options and related excess tax benefits.

     Contractual Obligations

     The following is a summary of our contractual obligations as of March 31, 2007 (in thousands):

			Remainder		2008 and		2010 and		2012 and
	Total		of 2007		2009		2011		thereafter
Product purchase obligations	$	9,782	$	9,782	$	—	$	—	$	—
Operating leases		3,187		258		1,462		900		567
Other purchase obligations		579		474		105		—		—
	$	13,548	$	10,514	$	1,567	$	900	$	567

     The above table excludes contingent amounts payable pursuant to arrangements with executive officers that provide for severance obligations of up to an aggregate of $2.7 million.

     In connection with our acquisition of Maxspeed, we recorded a restructuring reserve of $1.4 million as of the acquisition date. The remaining balance will be used to cover agreed upon lease obligations with any residual balance payable to the Maxspeed shareholders after the expiration of the lease.

     We expect to fund current operations and other cash expenditures through the use of available cash, cash from operations, funds that may be available under our Offering Basis Loan Agreement and, potentially, new debt or equity financings. Management believes that we will have sufficient funds from current cash, operations and available financing to fund operations and cash expenditures for the foreseeable future. However, we may seek additional sources of funding in order to fund acquisitions.

     Off Balance Sheet

     Our guaranteed agreements are discussed in Note 13 to the consolidated financial statements.

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: our strength in thin client and virtualization technologies and its ability to improve our competitive advantage; our continued investment in technology development; our focus on enterprises in diverse vertical markets; our future investment in our sales teams and marketing personnel; our international markets as a source of growth; the introduction of promotional programs and pricing initiatives; our commitment to open-source, cross platform and industry-standard software technologies; the expansion of our reseller relationships; continuing sales to our existing large enterprise customers; our expectations regarding gross margins, selling and marketing expenses, research and development expenses, general and administrative expenses and amortization of acquired intangibles for the balance of fiscal 2007; our acquisition of businesses and technologies; future strategic partnerships; our expectation of stock-based compensation in fiscal 2007; the availability of cash or other financing sources to fund future operations; cash expenditures and acquisitions, and our potential issuance of debt and equity securities. These forward-looking statements involve risks and uncertainties. The factors set forth below, and those contained in “Item 1A., Risk Factors”, 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 our actual results include: our success in implementing our expanded marketing, sales and product development initiatives and the rebuilding of our infrastructure within our planned timeframe; insufficient resources to fund our virtualization initiatives; the lack of growth in the virtualization market; higher than expected severance payments; additional write offs of inventory; our success in increasing sales to the targeted customers and our continued dependence on enterprise customers; our inability to manage our expanded organization; our inability to successfully integrate our recent acquisitions; the timing and receipt of future orders; our timely development, release and customers’ acceptance of our products; pricing pressures; rapid technological changes in the industry; growth of overall thin client sales; our

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ability to maintain our partnerships; our dependence on our suppliers and distributors and resellers; increased competition; our continued ability to sell our products through Lenovo to IBM’s customers; our ability to attract and retain qualified personnel; adverse changes in customer order patterns; our ability to identify and successfully consummate and integrate future acquisitions; adverse changes in general economic conditions in the U. S. and internationally; risks associated with foreign operations; and political and economic uncertainties associated with current world events.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     We earn interest income from our balances of cash, cash equivalents and short-term investments. This interest income is subject to market risk related to changes in interest rates that primarily affects our investment portfolio. We invest in instruments that meet high credit quality standards, as specified in our investment policy.

     As of March 31, 2007 and June 30, 2006, cash equivalents and short-term investments consisted primarily of corporate notes and government securities, certificates of deposit, auction rate securities and other specific money market instruments of similar liquidity and credit quality. Due to the conservative nature of our investment portfolio, a sudden change in interest rates would not have a material effect on the value of the portfolio.

     We have operations in the United Kingdom, Germany, France, Austria, Australia and China that are subject to foreign currency fluctuations. As currency rates change, translation of the foreign entities’ statements of operations from local currencies to U.S. dollars affects year-to-year comparability of operating results. Additionally, we have investments in each of these countries for which we recognize unrealized gains and losses through other comprehensive income within stockholders’ equity for foreign currency fluctuations.

Item 4. Controls and Procedures

     Under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of March 31, 2007 (the “Evaluation Date”). Based on the evaluation performed, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures were effective in recording, processing, summarizing and reporting in the periods specified in the SEC’s rules and forms the information required to be disclosed by the Company in its reports filed or furnished under the Exchange Act.

     There have not been any changes in our internal control over financial reporting during the quarter ended March 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II OTHER INFORMATION

Item 1A. Risk Factors

     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. Operating results for a particular future period are difficult to predict and, therefore, prior results are not necessarily indicative of results to be expected in future periods. Factors that could have a material adverse effect on our business, results of operations, and financial condition include, but are not limited to, the following:

Our success depends on our ability to attract, retain and grow our business with large enterprise customers, and the long sales cycle with these customers makes planning and inventory management difficult and future financial results less predictable.

     We must retain and continue to expand our ability to reach and sell to enterprise customers by implementing our sales and marketing initiatives, adding effective channel partners and expanding our integration services. Our inability to attract and retain enterprise customers could have a material adverse effect on our business, results of operations and financial condition. Large enterprise customers usually request special pricing and generally have longer sales cycles, which could negatively impact our revenues, and longer sales cycles could affect our ability to predict our revenues for any particular period. Additionally, as we implement our new sales and marketing initiatives in an attempt to attract and penetrate enterprise customers, we will need to increase our operating expenses. These efforts may not proportionally increase our operating revenues and could reduce our profits.

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     Our sales cycle for large-scale deployments to large enterprise customers makes it difficult to predict when these sales will occur, and we may not be able to sustain these sales on a predictable basis. We often have a long sales cycle for these large enterprise sales because:

• our sales personnel generally need to explain and demonstrate the benefits of a large-scale deployment of our products to potential and existing customers prior to sale;

• our technical personnel typically spend a significant amount of time assisting potential customers in their testing and evaluation of our products and services and in integrating the products to suit their needs;

• our large-scale customers are typically large and medium size organizations that carefully research their technology needs and the many potential projects prior to making capital expenditures for IT infrastructure; and

• before making a purchase, our potential customers usually must obtain approvals from various levels of decision makers within their organizations, and this process can be lengthy.

     The long sales cycle and our lack of visibility into when these sales to enterprise customers could occur may make it difficult to predict the timing of sales, or whether they will be completed. Delays in sales could cause significant variability in our revenue and operating results for any particular period. This uneven sales pattern also will affect our inventory management and logistics costs. If predicted demand is substantially greater than orders, as it was in the quarters ended June 30, and September 30, 2006, there will be an increase in inventory, which could make it necessary for us to reduce our prices or write down inventory resulting in lower gross margins and less cash. Alternatively, if orders substantially exceed predicted demand, we may not be able to fulfill all of the orders received.

Our success may depend on our ability to attract, retain and grow our business with small and medium sized customers.

     In order to successfully attract new customer segments and expand our existing relationships with enterprise customers, we must reach and retain small- and medium-sized customers and smaller project initiatives within our large enterprise customers. We have begun a sales and marketing initiative to reach these customers. We cannot guarantee that our small- and medium-sized customer sales and marketing initiatives will be successful. Our failure to attract and retain small and medium-sized customers and smaller project initiatives within our large enterprise customers could have a material adverse effect on our business, results of operations and financial condition. Additionally, as we implement our sales and marketing initiatives in our attempt to attract and retain small and medium-sized customers and smaller project initiatives within our large enterprise customers, we will need to increase our operating expenses. These efforts may not proportionally increase our operating revenues and could reduce our profits.

Because we rely on resellers and distributors, including IBM and Lenovo, to sell our products, our revenues could be negatively impacted if these companies do not continue to purchase products from us.

     Our future success is highly dependent upon maintaining and increasing the number of our relationships with distributors and resellers. By relying on distributors and resellers, we may have little or no contact with the ultimate users of our products, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our products, service ongoing customer requirements, estimate end user demand and respond to evolving customer needs.

     We cannot be certain that we will be able to attract or retain resellers and distributors to market our products effectively. None of our current resellers or distributors, including IBM and Lenovo, are obligated to continue selling our products or to sell our new products, and none are precluded from selling competing products. We cannot be certain that any resellers or distributors will continue to represent our products or that our resellers or distributors will devote a sufficient amount of effort and resources to selling our products. We need to expand our indirect sales channels, and if we fail to do so, our growth could be limited. A number of our distributors resell to their own networks of channel partners with whom we have no direct relationship. Our distribution channel could be affected by disruptions in the relationships of and with our channel partners and their networks. Because many of our indirect channel partners also sell competitive products, our success and revenue growth will depend on our ability to develop and maintain strong cooperative relationships with our channel partners.

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     We cannot assure you that our channel partners will market our products effectively, receive and fulfill customer orders of our products on a timely basis or continue to devote the resources necessary to provide us with effective sales, marketing and technical support. In order to support and develop leads for our distribution channels, we plan to continue to expand our field sales and support staff as needed. We cannot assure you that this internal expansion will be successfully completed, that the cost of this expansion will not exceed the revenues generated or that our expanded sales and support staff will be able to compete successfully against the significantly more extensive and well-funded sales and marketing operations of many of our current or potential competitors. In addition, our channel agreements are generally not exclusive and one or more of our channel partners may compete directly with another channel partner for the sale of our products in a particular region or market. This may cause such channel partners to stop or reduce their efforts in marketing our products. Our inability to effectively establish or manage our distribution channels would harm our sales.

     In addition, our channel partners may provide services to our end user customers that are inadequate or do not meet expectations. Such failures to provide adequate services could result in customer dissatisfaction with us or our products and services due to delays in maintenance and replacement. These occurrences could result in the loss of customers and repeat orders and could delay or limit market acceptance of our products, which would negatively affect our sales and results of operations.

     We derive a significant portion of our revenue from sales made directly to IBM customers through Lenovo and through our other distributors. A significant portion of our other revenue is derived from sales to resellers. If Lenovo or our other distributors were to discontinue sales of our products or reduce their sales efforts, or if IBM salespeople were to reduce their attention to our products, it could adversely affect our operating results. In addition, the continued viability and financial condition of our distributors could deteriorate and may not be able to withstand changes in business conditions, including economic weakness, which could lead to significant delays in their payments to us or defaults on their payment obligations. Additionally, we could experience disruptions in the distribution of our products if our distributors’ financial conditions or operations weaken. Any significant delays, defaults or disruptions could have a material adverse effect on our business, results of operations and financial condition. For example, during the fourth quarter of fiscal 2006, one of our German distributors experienced significant financial difficulties and has since declared insolvency, which caused us to reverse revenues in the amount of $675,000 invoiced in April through June 2006 and to add $385,000 to our reserve for doubtful accounts in the quarter ended June 30, 2006.

     IBM and, more recently Lenovo, have been key strategic channel partners for us, distributing a substantial amount of our products. As a result of our alliances with IBM and Lenovo, we have relied on those parties for distribution of our products to their customers. Sales directly to Lenovo accounted for 7% of our net sales during the quarter ended March 31, 2007, declining from 8% in the quarter ended December 31, 2006 and 17% in the year ended June 30, 2006. IBM and Lenovo are under no obligation to continue to actively market our products. In addition to our direct sales to IBM and Lenovo, IBM and Lenovo can purchase our products through individual distributors and/or resellers.

Our strategy depends on expanding and diversifying our distribution channels and if we fail in these efforts, our business could be adversely affected.

     We are engaged in expanding, and currently intend to continue to expand, our distribution channels by expanding our sales with resellers, distributors and systems integrators. In addition, an integral part of our strategy is to expand and diversify our base of channel relationships by adding more channel partners with abilities to reach large enterprise customers and to sell our newer products. This has required and will continue to require additional resources, as we will need to expand our internal sales and service coverage of these customers and our marketing personnel. If we fail in these efforts and cannot expand or diversify our distribution channels, our revenues and profits could be adversely affected. In addition to this expansion and diversification of our base, we will need to maintain channel partners who cater to smaller customers. We may need to add distribution partners to maintain customer satisfaction and a steady or increasing adoption rate of our products, which could increase our operating expenses. We intend to invest significant resources to develop these channels, which could reduce our profits if our efforts do not result in significant increases in our revenues. Additionally, we have launched a price promotion program for our North American distributors which will provide them with price incentives. While we believe that this strategy will increase revenues through the distribution channel, there are no assurances that we will be successful and it may result in reduced margins.

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If we are unable to continue generating substantial revenues from international sales and effectively managing our international operations our business could be adversely affected.

     We derive a substantial portion of our revenue from international sales primarily in Europe, Middle East and Africa (EMEA). Our international activities, primarily in EMEA, accounted for approximately 35% of revenues during the quarter ended March 31, 2007. In addition, a portion of our operations consists of manufacturing, software and product development, and sales activities outside of the U.S. Our ability to sell our products and conduct our operations internationally is subject to a number of risks. General economic and political conditions and the imposition of governmental controls in each country, including governmental restrictions on the transfer of funds to us from our operations outside the United States, including restrictions in China, could adversely affect our operations and demand for our products and services in these markets. We may also experience reduced intellectual property and contract rights protection as a result of different business practices in certain countries, which could have an adverse effect on our business and financial results. Although most of our international sales are denominated in U.S. Dollars, currency exchange rate fluctuations could result in lower demand for our products or lower pricing resulting in reduced revenue and margins, as well as currency translation losses. In addition, a weakening Dollar has resulted in increased costs for our international operations (which are mostly determined in local currencies), and could result in greater costs for our international operations in the future. In addition, concerns about terrorism or an outbreak of epidemic diseases such as avian influenza or severe acute respiratory syndrome, could have a negative effect on travel and our business operations, and could result in adverse consequences on our international operations.

     Changes to and compliance with a variety of foreign laws and regulations may increase our cost of doing business in these jurisdictions. We incur additional legal compliance costs associated with our international operations and could become subject to legal penalties in foreign countries if we do not comply with local laws and regulations which may be substantially different from those in the United States. In many foreign countries, particularly those with developing economies, it is common to engage in business practices that are prohibited by United States regulations applicable to us, such as the Foreign Corrupt Practices Act, and any violations of such laws by our employees or contractors could have a material adverse effect on our business. Trade protection measures and import and export licensing requirements subject us to additional regulation and may prevent us from shipping products to a particular market, and increase our operating costs. In addition, our future results could be adversely affected by difficulties in staffing, and coordinating communications among and managing our international operations, which have significantly expanded and become more complex as a result of the European acquisitions completed in fiscal 2006 and 2005.

Our business is dependent on customer adoption of thin client devices as an alternative to personal computers, and a decrease in their rates of adoption could adversely affect our ability to increase our revenues.

     We are dependent on the growing use of thin client devices to increase our revenues. If thin client devices are not accepted by corporations as an alternative to personal computers, the result would be slower than anticipated revenue growth or even a decline in our revenues.

     Thin client devices have historically represented a very small percentage of the overall PC market, and, if sales do not grow as a percentage of the PC market, or if the overall PC market were to decline, our revenues might not grow or might decline. Alternatively, if the market were to grow faster than expected, it could attract PC manufacturers to the thin client device segment of the PC market, which would increase competition and could adversely impact our results.

Our acquisition and alliance activities could disrupt our ongoing business, and we may not be able to successfully complete and integrate future acquisitions we may complete, which may materially adversely affect our growth and our operating results.

     As part of our business strategy, we frequently engage in discussions with third parties regarding, and enter into agreements relating to, possible acquisitions, strategic alliances and outsourcing transactions in order to further our business objectives. In order to pursue this strategy successfully, we must identify suitable candidates for these transactions, complete these transactions, some of which may be large and complex, and manage post-closing issues such as the integration of acquired companies or employees. We may, in order to integrate acquired businesses or employees, incur significant integration and restructuring costs, both one-time and on a recurring basis. Integration and other risks of acquisitions, strategic alliances and outsourcing transactions can be more pronounced for larger and more complicated transactions, or if multiple transactions are pursued simultaneously. However, if we fail to identify and successfully complete transactions that further our strategic objectives, we may be required to expend resources to develop products and technology internally, we may be at a competitive disadvantage or we may be

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adversely affected by negative market perceptions, any of which may have a material adverse effect on our revenue and selling, general and administrative expenses.

     Since June 2001, we have completed ten acquisitions and entered into alliances with IBM and Lenovo, and we plan to make additional acquisitions, some of which may be large and complex, or involve technologies that are outside of our core business, as part of our growth strategy. There is no assurance that we will derive benefits from the three European acquisitions we completed in the third and fourth quarters of fiscal 2005, the Visara, TeleVideo or Maxspeed acquisitions we completed in the first half of fiscal 2006 or future acquisitions we pursue. We may be unable to retain key employees or key business relationships of the acquired businesses, consolidate IT infrastructures, integrate accounting controls, policies and procedures, manage supply chain integration, combine administrative, research and development and other operations, eliminate duplicative facilities and personnel, which could result in significant costs and expenses, combine product offerings and successfully commercialize and market acquired technology, and integration of the businesses may divert the attention and resources of our management. Our failure to successfully integrate acquired businesses into our operations could have a material adverse effect on our business, operating results and financial condition. Even if such acquisitions are successfully integrated, we may not receive the expected benefits of the transactions if we find that the acquired business does not further our business strategy or that we paid more than what the business was worth. Managing the completion and integration of acquisitions and alliances requires management resources, which may divert our attention from other business operations. In addition, we may lack experience operating in the geographic or product market of the business acquired. There are also risks associated with the realization of benefits related to commercialization and/or marketing of projects that are in the process of being completed due to the complexity of the technology, competitive pressures and changing customer needs, and therefore there can be no assurances that any such project will be commercially successful. Even when the acquired business has already developed marketable products, there can be no assurance that the products will be successfully marketed in a timely fashion or that pre-acquisition due diligence will have identified all possible issues that might arise with respect to such products. As a result, the effects of any completed or future transactions on financial results may differ from our expectations. These transactions may result in significant costs and expenses, including severance payments and additional compensation to executives and other key personnel, charges related to the elimination of duplicative facilities, assumed liabilities, and legal, accounting and financial advisory fees. Prior acquisitions have resulted in a wide range of outcomes, from successful integration of the business and increased sales and large enterprise customers to an inability to obtain the expected benefits. In connection with completing acquisitions, we may issue shares of our common stock, potentially creating dilution for our existing stockholders. We spent approximately $1.6 million during fiscal 2004 and $857,000 during fiscal 2007 pursuing acquisitions that we did not complete. We intend to continue to pursue acquisitions, and if we do not complete them, the cost of pursuing acquisitions will impact our profitability.

Because we depend on sole source, limited source and foreign source suppliers for the design and manufacture of our thin client products and for key components in our thin client products, we are susceptible to supply shortages that could prevent us from shipping customer orders on time, if at all, and result in lost sales. In addition, our outsourcing activities for other functions may fail to reduce costs and may disrupt operations.

     We depend upon single source suppliers for the design and manufacture of our thin client device products and for several of the associated components. We also depend on limited sources to supply several other industry standard components. The third party designers and manufacturers of our thin client products have access to our intellectual property which increases the risk of infringement or misappropriation of this intellectual property.

     We primarily rely on foreign suppliers, which subjects us to risks associated with foreign operations such as the imposition of unfavorable governmental controls or other trade restrictions, changes in tariffs, political instability and currency fluctuations. A weakening dollar could result in greater costs to us for our components. Severe acute respiratory syndrome, avian influenza and similar medical crises could also disrupt manufacturing processes and result in quarantines being imposed in the future.

     We have in the past experienced and may in the future experience shortages of, or difficulties in acquiring, certain components. A significant portion of our revenues is derived from the sale of thin client devices that are bundled with our software. Third parties design and produce these thin client devices for us, and we typically do not have long-term supply contracts with them obligating them to continue producing products for us. The absence of such agreements means that, with little or no notice, these suppliers could refuse to continue to manufacture all or some of our products that we require or change the terms under which they manufacture our products. If our suppliers were to stop manufacturing our products, we might be unable to replace the lost manufacturing capacity on

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a timely basis. If we experience shortages of these products, or of their components, we may not be able to deliver our products to our customers, and our revenues would decline. If these suppliers were to change the terms under which they manufacture for us, our manufacturing costs could increase and our cost of revenues could increase, resulting in a decline in gross margins. If we were unable to adequately address the supply issues, we might have to reengineer some products resulting in further costs and delays. In addition, a failure of our suppliers to maintain their viability and financial condition could result in changes in payment and other terms of our relationships and their inability to produce and deliver our products on time and in sufficient quantities. A domestic supplier that we added in fiscal 2005 required an advance payment of $1.1 million at June 30, 2006 and March 31, 2007, which were recorded as prepaid expenses, to fund a portion of the initial and continued production of our orders. In the event of increased inventory levels, as at September 30, 2006, we would reduce our purchase of inventory in the short term, which could adversely affect the financial condition of our suppliers and jeopardize the continued supply of our products. Finally, if one of our suppliers failed to maintain viability, we would likely be required to honor warranties granted by them to our customers for products sold by us, which would increase our costs.

     In addition to using third party suppliers for the manufacture of our products and supply of our components, to achieve additional cost savings or operational benefits, we have expanded, and may in the future expand, our outsourcing activities where we believe a third party may be able to provide those services in a more efficient manner. In fiscal 2006, we entered into a relationship with a third-party company that provides CRM software and services to us on an outsourced basis. To the extent that we rely on partners or third party service providers for the provision of software development services and key business process functions, we may incur increased business continuity risks. We may no longer be able to exercise control over some aspects of software development and the development, support or maintenance of operations and processes, including the internal controls associated with our business operations and processes, which could adversely affect our business. If we are unable to effectively develop and implement our outsourcing strategy, we may not realize cost structure efficiencies and our operating and financial results could be materially adversely affected. In addition, if our third party service providers experience business difficulties or are unable to provide the services as anticipated, we may need to seek alternative service providers or resume providing such services internally which could be costly and time consuming and have an adverse material effect on our operating and financial results.

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.

     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 operating expenses 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 operating expenses quickly enough to avoid losses. As a result, our quarterly operating results could fluctuate.

     Future operating results will continue to be subject to quarterly fluctuations based on a wide variety of factors, including:

• Linearity — Our quarterly sales have historically reflected a pattern in which a disproportionate percentage of sales occur in the last month of the quarter due to typical customer buying patterns in the IT industry. This pattern makes prediction of revenues and earnings for each financial period especially difficult and uncertain and increases the risk of unanticipated variations in quarterly results and financial condition;

• Significant Orders — We are subject to variances in our quarterly operating results because of the fluctuations in the timing of our receipt of large orders. If even a small number of large orders are delayed until after a quarter ends, or do not materialize, our operating results could vary substantially from quarter to quarter and net income could be substantially less than expected. Conversely, if even a small number of large orders are completed in an earlier quarter than that which was anticipated, our revenues and net income could be substantially higher than expected, making it possible that sales and net income in future periods may decline sequentially. Further, if orders substantially exceed predicted demand, we may not be able to fulfill all of the orders received in the last few weeks of the quarter;

• Seasonality – We have experienced seasonal reductions in business activity in some quarters based upon customer activity and based upon our partners’ seasonality. This pattern has generally resulted in lower sales in our first and third quarters than in the prior sequential quarters; and

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• Stock-based compensation expense — Starting in the quarter ended September 30, 2005, we began recording stock-based compensation expense as calculated under SFAS No. 123R. The non-cash impact of stock-based compensation expense during fiscal 2006 was $3.4 million and is expected to be $4.7 million in fiscal 2007. Such amounts may change as a result of additional grants, forfeitures, modifications in assumptions and other factors.

     There are factors that may affect the market acceptance of our products, some of which are beyond our control, including the following:

• the growth and changing requirements of the thin client segment of the PC market;

• the quality, price, performance and total cost of ownership of our products compared to personal computers;

• the availability, price, quality and performance of competing products and technologies;

• the timely development and introduction of new and enhanced products; and

• the successful development of our relationships with software providers, original equipment manufacturers and existing and potential channel partners.

     We may not succeed in developing and marketing our software and thin client device products and our operating results may decline as a result. Additionally, we plan to increase our sales and marketing expenses for our products and these efforts may not proportionately increase our sales, resulting in reduced profitability.

Our inventory management is complex as we sell a significant mix of products and our revenues and gross margins could suffer if we fail to manage the issues properly.

     We must manage inventory effectively, which involves forecasting demand and pricing issues. Demand is difficult to forecast since it depends on many factors, including pricing, changes in customer buying patterns and changes in competition. Significant unanticipated fluctuations in demand, the timing and disclosure of new product releases or the timing of key sales orders could result in costly excess inventories or the inability to secure sufficient quantities of our products to satisfy customer demand. To the extent we manufacture products in anticipation of future demand that does not materialize, or in the event a customer cancels or reduces outstanding orders, we could experience an unanticipated increase in our inventory, as occurred in the past several quarters. This could adversely impact our revenues, gross margins and financial condition. Our use of indirect distribution methods may reduce visibility to demand and pricing issues, and therefore make forecasting more difficult. If we have excess or obsolete inventory, we may have to reduce our prices or write down inventory to market value.

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 various thin client device models, software, third party products and consulting services. Our 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 PC 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 maintain or increase our market share or to meet competitors’ price reductions. Our marketing strategy is targeted at increasing the size of the thin client segment of the PC industry, in part by lowering prices to make thin clients more competitive with personal computers, by selling a larger percentage of products to large enterprise customers, who typically demand lower prices because of their volume purchases, and by focusing on sales through our distribution channel. This strategy has resulted in, and the implementation of our new sales and marketing initiatives may in the future result in, a decline in our gross margins. Additionally, we have certain products, including our e900 thin client product line, which has higher average selling prices and higher gross profit dollars, but lower gross margin percentages than our traditional products. If our sales do not continue to increase as a result of these strategies, our profitability will decline, and we may experience losses. Finally, our gross margins may decline if it is necessary for us to reduce the prices of our products as a result of excess inventory.

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During the past several years, we have increased operating expenses significantly as a foundation for us to stimulate our growth and growth in our market, and we expect to increase our operating expenses during fiscal 2007, including increases needed to implement our new sales and marketing and product development initiatives. If we do not increase revenues or appropriately manage further increases in operating expenses, our profitability will suffer.

     Our business has grown through both internal expansion and business acquisitions, and, as a result, we have significantly increased our operating expenses. If our revenues fail to increase as we increase our operating expenses, our profits may decline. Additionally, this growth has put pressure on our infrastructure, internal systems and managerial resources. The number of our employees increased from 176 full-time employees at March 31, 2006 to 184 full-time employees at March 31, 2007 and we expect to add a significant number of new employees through June 2007. Our new employees include key managerial, technical, sales and marketing personnel, as well as international employees, and we intend to hire a significant number of additional sales and marketing personnel during fiscal 2007. To manage our growth effectively, we must continue to improve and expand our infrastructure, including operating and administrative systems and controls, and continue managing and integrating our personnel in an efficient manner. Our business may be adversely affected if we do not integrate and train our new employees quickly and effectively and coordinate among our executive, engineering, finance, marketing, sales, operations and customer support organizations. In addition, because of the growth of our international operations, we now have facilities located in multiple countries, and we have limited experience coordinating a geographically separated organization. If we are unable to effectively manage our growth, our business and operating results could be adversely affected.

We may not generate sufficient future taxable income to allow us to realize our deferred tax assets.

     We have a significant amount of U.S. Federal, state and other tax loss carryforwards that will be available to reduce the taxes we would otherwise owe in the future. We have recognized the value of these future tax deductions in our consolidated balance sheets. The realization of our deferred tax assets is dependent upon our generation of future taxable income during the periods in which we are permitted, by law, to use those assets. We exercise judgment in evaluating our ability to realize the recorded value of these assets, and consider a variety of factors, including the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Our evaluation of the realizability of deferred tax assets must consider both positive and negative evidence, and the weight given to the potential effects of positive and negative evidence is based on the extent to which the evidence can be verified objectively. While we believe that sufficient positive evidence exists to support our determination that the realization of our deferred tax assets is more likely than not, we cannot guarantee profitable U.S operations in the future that will allow us to fully realize those assets.

Our business may suffer if it is alleged or found that we have infringed the intellectual property rights of others.

     In the course of our business, we receive notices from third parties claiming that we are infringing upon their intellectual property rights. We evaluate the validity of the claims and determine whether we will negotiate licenses to use the technology. Even if we believe that the claims are without merit, responding to such claims can be time consuming, result in costly litigation, divert management’s attention and resources and cause us to incur significant expenses. There is no assurance, in the event of such claims, that we would be able to enter into a licensing arrangement on acceptable terms or that litigation would not occur. In the event that there were a temporary or permanent injunction entered prohibiting us from marketing or selling certain of our products, or a successful claim of infringement against us requiring us to pay royalties to a third party, and we failed to develop or license a substitute technology, our business, results of operations or financial condition could be materially adversely affected.

     In addition, certain products or technologies developed by us, including for example the Linux-based products, may incorporate so-called “open source” software. Open source software is typically licensed for use at no initial charge, but certain open source software licenses impose on the licensee of the applicable open source software certain requirements to license or make available to others both the open source software as well as the software that relates to, or interacts with, the open source software. Our ability to commercialize products or technologies incorporating open source software may be restricted as a result of using such open source software because, among other reasons:

• open source license terms may be ambiguous and may result in being subject to unanticipated obligations regarding our products and technologies;

• competitors may have improved access to information that may help them develop competitive products;

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• open source software cannot be protected under trade secret law; and

• it may be difficult for us to accurately determine the origin of the open source code and whether the open source software in fact infringes third party intellectual property rights.

Thin client device products, like personal computers, 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 PC market is characterized by rapid technological change, frequent new product introductions, uncertain product life cycles, changes in customer demands and evolving industry standards. Our products could be rendered obsolete if products based on new technologies are introduced or new industry standards emerge.

If we are unable to rapidly and successfully develop and introduce new products and manage our inventory, we will not be able to satisfy customer demand.

     We operate in a highly competitive, quickly changing environment, and our future success depends on our ability to develop and introduce new products, such as virtualization products and solutions, that our customers choose to buy. If we are unable to develop new products, our business and operating results could be adversely affected. We must quickly develop, introduce and deliver new software and hardware products. These include our Neoware Device Manager, Image Manager and Linux operating system, among others. If we fail to accurately anticipate our customers’ needs and technological trends, or are otherwise unable to complete the development of a product on a timely basis, we will be unable to introduce new products into the market on a timely basis, if at all, and our business and operating results would be materially and adversely affected.

     Once we have developed a new product, we must be able to manufacture new products in sufficient volumes so that we can have an adequate supply of new products to meet customer demand. Forecasting demand requires us to predict order volumes, the correct mix of our products and the correct configurations of these products. We must manage new product introductions and transitions to minimize the impact of customer-delayed purchases of existing products in anticipation of new product releases. We must also try to reduce the levels of older product and component inventories to minimize inventory write-offs. If we have excess inventory due to discontinued sales of specific products to new customers, as we had at September 30, 2006, it may be necessary to reduce our prices or write down inventory, which could result in lower gross margins. Additionally, our customers may delay orders for existing products in anticipation of new product introductions, such as may be the case with the introduction of Microsoft’s Vista operation system. As a result, we may decide to adjust prices of our existing products during this process to try to increase customer demand for these products. Our future operating results would be materially and adversely affected if such pricing adjustments were to occur and we were unable to mitigate the resulting margin pressure by maintaining a favorable mix of hardware, software and services, or if we were unsuccessful in achieving cost reductions, operating efficiencies and increasing sales volumes.

The virtualization products and solutions we are developing are based on an emerging technology and the potential market remains uncertain and may cause delays in our sales cycles.

     The virtualization products and solutions we are developing are based on an emerging technology and our success depends on customers perceiving technological and operational benefits and cost savings associated with adopting virtualization solutions. The relatively limited extent to which virtualization solutions have been currently adopted may make it difficult to evaluate the potential market for our virtualization solutions, and slower than expected growth of the market would adversely affect our growth in this area.

     The interest in virtualization in the PC market may result in longer sales cycles for us as customers attempt to resolve their virtualization strategy and delay purchasing decisions pending a final decision on their approach. The longer sales cycle could cause significant variability in our revenues and our operating results in any particular period.

We may not be able to preserve the value of our products’ intellectual property because other vendors could challenge our intellectual property rights.

     Our products are differentiated from those of our competitors by our internally developed technology that is incorporated into our products. We rely upon patent, copyright, trademark and trade secret laws in the United States

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and similar laws in other countries, and agreements with our employees, customers, suppliers and other parties, to establish and maintain our intellectual property rights. However, any of our intellectual property rights could be challenged, invalidated or circumvented, which could result in costly product redesign efforts, discontinuance of certain product offerings or other competitive harm. Further, the laws of certain countries do not protect our proprietary rights to the same extent as do the laws of the United States. Therefore, in certain jurisdictions in which we operate or in which we have outsourced operations we may be unable to protect our proprietary technology adequately against unauthorized third-party copying or use, which could adversely affect our competitive position and cause us to incur substantial legal fees. If we are unable to protect our intellectual property, other vendors could sell products with features similar to ours, and this could reduce demand for our products, which would harm our operating results.

We may not be able to effectively compete against PC and thin client providers as a result of their greater financial resources and brand awareness.

     In the desktop PC market, we face significant competition from makers of traditional personal computers, many of which are larger companies that have greater name recognition than we have. In addition, we face significant competition from thin client providers, including Hewlett Packard, Wyse Technology and other, smaller companies. 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 strategy to seek to increase our share of the overall PC market by targeting our core markets may create increased pressure, including pricing pressure, on certain of our thin client device products. While we believe that this will enable us to increase our revenues, there is no assurance that we will be successful in this approach. In fact, our implementation of this strategy may result in reductions in gross and operating margins as we compete to attract business. Our inability to successfully implement this strategy could have an adverse impact on our revenues.

     Our future competitive performance depends on a number of factors, including our ability to:

• continually develop and introduce new products and services with better prices and performance than offered by our competitors in the PC market;

• offer a wide range of products; and

• 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 in the PC market, 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.

     As the market for our products and services continues to develop, additional companies, including companies with significant market presence in the computer software, hardware and networking industries, could enter the market in which we compete and further intensify competition. In addition, we believe that price competition could become a more significant competitive factor in the future. As a result, we may not be able to maintain our historic prices and margins, which could adversely affect our business, results of operations and financial condition.

Actions taken by the SCO Group (SCO) could impact the sale of our Linux products, negatively affecting sales of some of our products.

     SCO has taken legal action against IBM and certain other corporations, and sent letters to Linux customers alleging that certain Linux kernels infringe on SCO’s Unix intellectual property and other rights, and that SCO intends to aggressively protect those rights. While we are not a party to any legal proceeding with SCO, since some of our products use Linux as their operating system, SCO’s allegations, regardless of merit, could adversely affect sales of such products. SCO has brought claims against certain end user customers of the Linux operating system and threatened to bring claims against other end-users of Linux for copyright violations arising out of the facts alleged in SCO’s lawsuit against IBM. Some of these claims could be indemnified under indemnities we have given or may give to certain customers. In the event that claims for indemnification are brought against the customers that we have indemnified, we could incur expenses reimbursing the customers for their costs, and if the claims were successful, for damages.

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In order to continue to grow our revenues, we may need to hire additional executives and personnel and update our IT infrastructure.

     In order to continue to develop and market our line of thin client devices, we may need to hire additional executives and other personnel, including the additional sales and marketing employees we plan to hire to help implement our sales and marketing initiatives. Competition for employees is significant and we may experience difficulty in attracting qualified people. Additionally, to meet our increased requirements for capacity and efficiency, we are continuing to update our information technology infrastructure. In the event that the updated systems do not meet our needs or are not deployed in a timely manner, our business may suffer.

     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:

• improve existing and implement new operational, financial and management information controls, reporting systems and procedures;

• hire, train and manage additional qualified personnel; and

• establish relationships with additional suppliers and partners while maintaining our existing relationships.

We rely on the services of certain key personnel, and those persons’ knowledge of our business and technical expertise would be difficult to replace.

     Our products, technologies and operations are complex and we are substantially dependent upon the continued service of our existing personnel. The loss of any of our key employees could adversely affect our business and profits and slow our product development processes. We generally do not have employment contracts, including non-competition agreements, with our key employees. Further, we do not maintain key person life insurance on any of our employees.

If we determine that any of our goodwill or intangible assets, including technology purchased in acquisitions, are impaired, we would be required to take a charge to earnings, which could have a material adverse effect on our results of operations.

     As a result of our completed and potential future acquisitions, we anticipate that we may have a significant amount of goodwill and other intangible assets, such as product and core technology, related to these acquisitions. We periodically evaluate our intangible assets, including goodwill, for impairment. As of March 31, 2007, we had $37.2 million of goodwill and $9.7 million of intangible assets. We review for impairment annually, or sooner if events or changes in circumstances indicate that the carrying amount could exceed fair value. Fair values are based on discounted cash flows using a discount rate determined by our management to be consistent with industry discount rates and the risks inherent in our current business model. Due to uncertain market conditions and potential changes in our strategy and product portfolio, it is possible that the forecasts we use to support our goodwill could change in the future, which could result in non-cash charges that would adversely affect our results of operations and financial condition. If impairment is deemed to exist, we would write down the recorded value of these intangible assets to their fair values and our stock price and operating results could be materially adversely affected.

We might repatriate cash from our foreign subsidiaries, which could result in additional income taxes that could negatively impact our results of operations and financial position. In addition, if foreign countries’ currency policies limit our ability to repatriate the needed funds, our business and results of operations could be adversely impacted.

     One or more of our foreign subsidiaries may hold a portion of our cash and cash equivalents. Although our intention is to reinvest the earnings of our international subsidiaries permanently, if we need additional cash to acquire assets or technology, or to support our operations in the United States, and if the currency policies of these foreign countries allow us, we might repatriate some of our cash from these foreign subsidiaries to the United States. Depending on our financial results and the financial results of our subsidiaries at the time that the cash is repatriated, we may incur additional income taxes from the repatriation, which could negatively affect our results of operations and financial position. In addition, if the currency policies of these foreign countries prohibit or limit our ability to repatriate the needed funds, our business and results of operations could be adversely impacted.

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Although we have generated operating profits for the past five fiscal years, we have a prior history of losses and may experience losses in the future, which could result in the market price of our common stock declining.

     Although we have generated operating profits in the past five fiscal years, we incurred net operating losses in prior periods and in the first three quarters of fiscal 2007. We expect to continue to incur significant operating expenses. Our operating expenses are expected to increase in the future reflecting the hiring of additional key personnel as we continue to implement our growth strategy and develop new products and enhance existing products. As a result, we will need to generate significant revenues and gross profit margin to maintain profitability. If we do not maintain profitability, the market price for our common stock may decline.

     Our financial resources may not be enough for our capital and corporate development needs, and we may not be able to obtain additional financing. A failure to maintain and increase our revenues would likely cause us to incur losses and negatively impact the price of our common stock.

Because some of our products use embedded versions of Microsoft Windows as their operating system, an inability to license these operating systems on favorable terms could impair our ability to introduce new products and maintain market share.

     We may not be able to introduce new products on a timely basis because some of our products use embedded versions of Microsoft Windows as their operating system. Microsoft provides Windows to us, and we do not have access to the source code for certain versions of the Windows operating system. If Microsoft fails to continue to enhance and develop its embedded operating systems, or if we are unable to license these operating systems on favorable terms, or at all, our operations may suffer.

Because some of our products use Linux as their operating system as well as other open source technologies, the failure of open source developers to enhance and develop open source software that we use could impair our ability to release new products and maintain market share.

     We may not be able to release new products on a timely basis because some of our products use Linux as their operating system and include other open source software. Much of the open source software we use is maintained by third parties. If this group of developers fails to further develop the software, we would have to either rely on other parties to further develop this software or develop it ourselves, which would increase our costs and slow our development efforts.

If our contracts with Citrix and other vendors of software applications were terminated, our business would be materially adversely affected.

     Our thin client devices include our own software, plus software from other companies. We depend on third-party suppliers to provide us with key software applications in connection with our business. If such contracts and relationships were terminated, our revenues would be negatively affected.

Unforeseen environmental costs could impact our future earnings.

     The European Union (“EU”) has adopted a directive to facilitate the recycling of electrical and electronic equipment sold in the EU. The Waste Electrical and Electronic Equipment (“WEEE”) directive directs EU member states to enact laws, regulations and administrative provisions to ensure that producers of electrical and electronic equipment are financially responsible for specified collection, recycling, treatment, and environmentally sound disposal of products placed on the market after August 13, 2005, and from products in use prior to that date that are being replaced. The EU has also adopted the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (“RoHS”) directive. The RoHS directive restricts the use of lead, mercury, and certain other substances in electrical and electronic products placed on the market in the European Union after July 1, 2006. As a result of these obligations, our product distribution costs may increase and may adversely impact our financial condition. We have implemented these directives during fiscal 2006. Similar legislation has been or may be proposed or enacted in other areas, including in the United States and China, the cumulative impact of which could be significant if we are unable to recover our costs to comply with these laws in the price of our products.

Recent regulations related to equity compensation could adversely affect our ability to attract and retain key personnel and affect our operating results.

     We have historically used stock options as a key component of our employee compensation program. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-

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term stockholder value, and, through the use of vesting, encourage employee retention and allow us to provide competitive compensation packages, although in recent periods many of our employee stock options have had exercise prices in excess of our stock price, which could affect our ability to retain or attract present and prospective employees. The adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R) requires all share-based payments to employees, including grants of stock options, to be recognized in the financial statements based on their fair values beginning with the first annual period beginning after June 15, 2005. We adopted SFAS No. 123R in the first quarter of fiscal 2006 and it has had a material impact on our financial statements. In addition, rules implemented by The NASDAQ Global Market requiring stockholder approval for all stock option plans, as well as regulations implemented by the New York Stock Exchange prohibiting NYSE member organizations from voting on equity-compensation plans unless the beneficial owner of the shares has given voting instructions, could make it more difficult for us to grant options to employees in the future. As a result of these regulations, we may change our equity compensation strategy, which may make it more difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business.

In the event we are unable to satisfy regulatory requirements relating to internal controls over financial reporting, or if these internal controls are not effective, our business and financial results may suffer.

     The Sarbanes-Oxley Act of 2002 and newly enacted rules and regulations of the Securities and Exchange Commission and the National Association of Securities Dealers impose new duties on us and our executives, directors, attorneys and independent registered public accountants. In order to comply with the Sarbanes-Oxley Act and such new rules and regulations, we have recently completed our evaluation of our internal control over financial reporting to allow management to report on, and our independent registered public accounting firm to attest to, our internal control over financial reporting. As a result, we have incurred additional expenses and diversion of management’s time, which increased our operating expenses and accordingly reduced our net income. While our evaluation resulted in our conclusion that as of June 30, 2006 our internal control over financial reporting was effective, we cannot be certain as to the outcome of our testing in future periods. If we do not maintain effective internal control over financial reporting, it could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact the market price of our shares.

Errors in our products could harm our business and our operating results.

     Because our software and thin client device 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:

• the loss of or delay in market acceptance and sales of our products;

• diversion of development resources;

• injury to our reputation;

• unsaleable inventory; or

• 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 and, from time-to-time, we enter into contractual arrangements under which we agree to indemnify a customer for certain losses it may incur. 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.

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Our stock price can be volatile.

     Our stock price, like that of other technology companies, can be volatile. For example, our stock price can be affected by many factors such as: quarterly increases or decreases in our revenues or earnings, changes in revenues or earnings estimates or publication of research reports by analysts; speculation in the investment community about, or actual changes in, our executive team, our financial condition or results of operations and changes in revenue or earnings estimates; the announcement of new products, technological developments, alliances, acquisitions or divestitures by us or one of our competitors. In addition, general macroeconomic and market conditions unrelated to our financial performance may also affect our stock price.

The issuance of additional equity securities may have a dilutive effect on our existing stockholders and could lead to a decline in the price of our common stock.

     Any additional issuance of equity securities, including for acquisitions, may have a dilutive effect on our existing stockholders. In addition, the perceived risk associated with the possible sale of a large number of shares could cause some of our stockholders to sell their stock, thus causing the price of our stock to decline. Subsequent sales of our common stock in the open market or the private placement of our common stock or securities convertible into common stock could also have an adverse effect on the market price of the shares. If our stock price declines, it may be more difficult or we may be unable to raise additional capital.

Provisions in our charter documents and Delaware law may delay or prevent acquisition of us, which could decrease the value of your shares.

     Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it harder for a third party to acquire us without the consent of our board of directors. These provisions include advance notice procedures with respect to stockholder proposals and the nomination of candidates for election as directors. Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock.

Item 6. Exhibits

     The following exhibits are being filed as part of this quarterly report on Form 10-Q:

Exhibit
Number	Description
31.1	Certification of Klaus Besier as President and Chief Executive Officer of Neoware, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Keith D. Schneck as Executive Vice President and Chief Financial Officer of Neoware, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Klaus Besier as President and Chief Executive Officer of Neoware, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification Keith D. Schneck as Executive Vice President and Chief Financial Officer of Neoware, Inc pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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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, INC.
Date: May 10, 2007	By:	/s/ KLAUS BESIER
	Klaus Besier
	President and Chief Executive Officer
Date: May 10, 2007	By:	/s/ KEITH D. SCHNECK
	Keith D. Schneck
	Executive Vice President and Chief Financial Officer

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