-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, R0Wrh7tXgA/no//A/SQOsYqExzzyADBc3xlHxvrbt4RDzgeLqMnUu3D6qGRdvifu jZ/44Mb8pavw8Pjw/6in6A== 0000950116-02-000235.txt : 20020414 0000950116-02-000235.hdr.sgml : 20020414 ACCESSION NUMBER: 0000950116-02-000235 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020214 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NEOWARE SYSTEMS INC CENTRAL INDEX KEY: 0000894743 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRONIC COMPUTERS [3571] IRS NUMBER: 232705700 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-21240 FILM NUMBER: 02549564 BUSINESS ADDRESS: STREET 1: 400 FEHELEY DR CITY: KING OF PRUSSIA STATE: PA ZIP: 19406 BUSINESS PHONE: 6102778300 MAIL ADDRESS: STREET 1: 400 FEHELEY DR CITY: KING OF PRUSSIA STATE: PA ZIP: 19406 FORMER COMPANY: FORMER CONFORMED NAME: HDS NETWORK SYSTEMS INC DATE OF NAME CHANGE: 19950313 FORMER COMPANY: FORMER CONFORMED NAME: INFORMATION SYSTEMS ACQUISITION CORP DATE OF NAME CHANGE: 19930108 10-Q 1 tenq.txt TENQ.TXT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------- FORM 10-Q -------------------- (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF ----- THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter ended December 31, 2001 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF ----- THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to ________. Commission File Number: 000-21240 ------------------------------- NEOWARE SYSTEMS, INC. (Exact name of registrant as specified in its charter) Delaware 23-2705700 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 400 Feheley Drive King of Prussia, Pennsylvania 19406 (Address of principal executive offices) (610) 277-8300 (Registrant's telephone number including area code) ------------------------------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- As of February 7, 2002, there were 11,251,989 outstanding shares of the Registrant's Common Stock. NEOWARE SYSTEMS, INC. INDEX PART I. FINANCIAL INFORMATION Page Number Item 1. Unaudited Consolidated Financial Statements: Consolidated Balance Sheets: December 31, 2001 and June 30, 2001 3 Consolidated Statements of Operations: Three and Six Months Ended December 31, 2001 and 2000 4 Consolidated Statements of Cash Flows: Six Months Ended December 31, 2001 and 2000 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 PART II. Item 1. Legal Proceedings 17 Item 2. Changes in Securities and Use of Proceeds 17 Item 4. Submission of Matters to a Vote of Security Holders 18 Item 6. Exhibits and Reports on Form 8-K 18 Signatures 19 NEOWARE SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (Unaudited) ASSETS December 31, June 2001 30, 2001 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $ 11,120,344 $ 11,712,535 Marketable securities 336,667 366,667 Accounts receivable, net 4,749,534 3,502,013 Inventories 373,030 458,736 Prepaid expenses and other 304,000 369,529 Notes receivable 26,072 26,072 ------------ ------------ Total current assets 16,909,647 16,435,552 Property and equipment, net 652,015 199,397 Goodwill and other intangibles 5,392,573 2,024,453 Notes receivable 21,549 52,193 Capitalized and purchased software, net 62,513 77,247 ------------ ------------ $ 23,038,297 $ 18,788,842 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,993,471 $ 935,943 Accrued expenses 1,415,179 1,473,718 Capital lease obligations 87,632 -- Deferred revenue 284,506 289,278 ------------ ------------ Total current liabilities 3,780,788 2,698,939 ------------ ------------ Capital lease obligations, non-current portion 293,581 -- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock -- -- Common stock 10,924 10,280 Additional paid-in capital 26,556,384 24,524,567 Treasury stock (100,000) (100,000) Accumulated other comprehensive income 37,990 66,667 Retained earnings (deficit) (7,541,370) (8,411,611) ------------ ------------ Total stockholders' equity 18,963,928 16,089,903 ------------ ------------ $ 23,038,297 $ 18,788,842 ============ ============ The accompanying notes are an integral part of these financial statements. NEOWARE SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended Six Months Ended --------------------------- --------------------------- December 31, December 31, December 31, December 31, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ Net revenues $ 6,595,133 $ 3,389,070 $ 11,859,862 $ 7,422,407 Cost of revenues 3,740,254 2,388,884 6,800,843 5,250,640 ------------ ------------ ------------ ------------ Gross profit 2,854,879 1,000,186 5,059,019 2,171,767 ------------ ------------ ------------ ------------ OPERATING EXPENSES: Sales and marketing 1,315,246 761,500 2,525,354 1,475,776 Research and development 343,985 195,723 674,851 360,550 General and administrative 668,827 529,135 1,184,274 1,048,846 Acquisition costs -- -- -- 161,038 ------------ ------------ ------------ ------------ Total operating expenses 2,328,058 1,486,358 4,384,479 3,046,210 ------------ ------------ ------------ ------------ Operating income (loss) 526,821 (486,172) 674,540 (874,443) Interest income, net 83,747 209,646 195,701 410,371 ------------ ------------ ------------ ------------ Net income (loss) $ 610,568 $ (276,526) $ 870,241 $ (464,072) ============ ============ ============ ============ Basic income (loss) per share $ 0.06 $ (0.03) $ 0.08 $ (0.05) ============ ============ ============ ============ Diluted income (loss) per share $ 0.06 $ (0.03) $ 0.08 $ (0.05) ============ ============ ============ ============ Weighted average number of shares used in basic earnings per share computation 10,376,892 10,275,652 10,275,409 10,279,762 ============ ============ ============ ============ Weighted average number of shares used in diluted earnings per share 10,884,693 10,275,652 10,742,097 10,275,409 computation ============ ============ ============ ============
The accompanying notes are an integral part of these financial statements. NEOWARE SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended Six Months Ended December 31, December 31, 2001 2000 ---------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 870,241 $ (464,072) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities- Depreciation and amortization 161,567 172,544 Changes in operating assets and liabilities- (Increase) decrease in: Accounts receivable (894,266) 387,596 Inventories 89,655 63,393 Prepaid expenses and other 191,159 2,824 Increase (decrease) in: Accounts payable (104,631) (826,288) Accrued expenses (177,523) 132,314 Deferred revenue (181,072) (68,414) ------------ ------------ Net cash used in operating activities (44,870) (600,103) CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (50,413) (40,505) Purchase of ACTIV-e Solutions (146,956) -- Increase in intangible assets (12,421) -- Purchase of treasury stock -- (100,000) Capitalized software -- (36,996) Net cash used in investing activities (209,790) (177,501) CASH FLOWS FROM FINANCING ACTIVITIES: Repayments of assumed bank debt (388,216) -- Decrease (increase) in notes receivable 30,644 (100,314) Repayments of capital leases (6,533) -- Exercise of stock options 26,574 859 ------------ ------------ Net cash used in financing activities (337,531) (99,455) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (592,191) (877,059) ------------ ------------ CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 11,712,535 13,831,792 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 11,120,344 $ 12,954,733 ============ ============ SUPPLEMENTAL DISCLOSURES: Cash paid for interest $ 4,189 $ 4,735 ============ ============
The accompanying notes are an integral part of these financial statements. NEOWARE SYSTEMS, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION --------------------- The accompanying unaudited consolidated financial statements of Neoware Systems, Inc. and Subsidiaries (the "Company") have been prepared in conformity with generally accepted accounting principles. The interim financial information, while unaudited, reflects all normal recurring adjustments which are, in the opinion of management, necessary to present a fair statement of financial position and operating results for the interim periods presented. The results of operations for the six month period ended December 31, 2001 are not necessarily indicative of results expected for the full year. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission. 2. NEW ACCOUNTING PRONOUNCEMENTS ----------------------------- In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations". SFAS No. 141 eliminates the use of the pooling-of-interests method of accounting for business combinations and establishes the purchase method of accounting as the only acceptable method for all business combinations initiated after June 30, 2001. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets." This statement modifies existing generally accepted accounting principles related to the amortization and impairment of goodwill and other intangible assets. Upon adoption of the new standard, goodwill, including goodwill associated with equity method investments, will no longer be amortized. For the six months ended December 31, 2001, there was no goodwill amortization. In addition, goodwill, other than goodwill associated with equity method investments, must be assessed at least annually for impairment using a fair-value based approach. The Company adopted the provisions of this statement effective July 1, 2001. Impairment losses that arise due to the initial application of this statement are to be reported as a cumulative effect of a change in accounting principle. 3. ACQUISITION On December 4, 2001, the Company acquired all of the assets and assumed substantially all of the liabilities of Telcom Assistance Center Corporation, d/b/a ACTIV-e Solutions, a full service Information Technology consulting company in the server-based computing marketplace. The acquisition was accounted for by using the purchase method of accounting. The purchase price was payable in cash of $75,000 and 619,101 shares of the Company's newly issued common stock with a market value of $3.24 per share at the date of acquisition. In addition, the Company assumed net liabilities, exclusive of cash acquired of $9,974, of approximately $1,275,376. Subject to the satisfaction of certain contingencies, an additional 100,000 shares of the Company's common stock were to be issued as additional consideration. Aggregate costs of the acquisition amounted to $3,428,219 (including transaction costs of approximately $81,930) which amount is equal to the excess of the purchase price over the value of net assets acquired. Management is currently in the process of allocating the purchase price to specific intangibles as required under SFAS 141, "Business Combinations". The results of operations of ACTIV-e Solutions have been included in the accompanying statement of operations from the date of the acquisition. 6 The following is a breakdown of the assets and liabilities assumed in connection with the ACTIV-e acquisition: Accounts receivable $ 353,255 Prepaids and other 128,256 Property and equipment 476,518 Bank debt (388,216) Accounts payable (1,162,159) Accrued expenses (118,984) Capital leases (387,746) Deferred revenue (176,300) ----------- Net liabilities assumed $(1,275,376) ----------- Resale of the shares issued in connection with the ACTIV-e transaction is subject to registration or the availability of an exemption from registration. The agreement provides for limitations on the number of shares which may be sold under a registration statement within the first year after effectiveness of the registration statement. It is anticipated that a registration statement will be filed by April 3, 2002. 4. MARKETABLE SECURITIES --------------------- The Company's marketable equity securities have been classified as "available-for-sale" under the provisions of SFAS115, "Accounting for Certain Investments in Debt and Equity Securities" and are reported at estimated fair value, with the accumulated other comprehensive income (unrealized gains and losses), reported as a separate component of stockholders' equity. Accumulated other comprehensive income reported in stockholders' equity was $37,990 at December 31, 2001 and $66,667 at June 30, 2001. The Company owned 333,334 shares of Boundless Corporation common stock at December 31, 2001, which shares have been classified as current, available-for-sale securities. Comprehensive income for the three and six months ended December 31, 2001 was $589,691 and $841,564, respectively, consisting of net income, the change in unrealized gain or loss on marketable securities and the cumulative currency translation gains or losses during the period. 5. REVENUE RECOGNITION AND MAJOR CUSTOMERS --------------------------------------- The Company's products include both a hardware and software component. In accordance with Statement of Position No. 97-2 "Software Revenue Recognition" ("SOP 97-2"), software revenue recognition is followed for products or services where a software element exists, unless the software is incidental to the product being sold. The software has been deemed to be essential to the functionality of the hardware and, therefore, SOP 97-2 has been followed for revenue recognition. Revenue is recognized on product sales when a formal arrangement exists, delivery of the product has occurred or title has transferred, the fee is fixed or determinable and collectibility is probable. Revenue related to post contract services is recognized with the initial sale as the fee is included with the initial licensing fee, post-contract services are for one year or less, the estimated cost of providing such services during the arrangement is deemed insignificant, and unspecified upgrades/enhancements offered during the period historically have been and are expected to continue to be minimal and infrequent. Product warranty costs and an allowance for sales returns are accrued at the time revenues are recognized. From time to time, customers request delayed shipment, usually because of customer scheduling for systems integration and lack of storage space at a customer's facility during the implementation. In such "bill and hold" transactions, the Company recognizes revenues when the following conditions are met: the equipment is complete, ready for shipment and segregated from other inventory; the Company has no further significant performance obligations in connection with the completion of the transaction; the commitment and delivery schedule is fixed; the customer requested the transaction be completed on this basis; and the risks of ownership have passed to the customer. Revenues recognized from "bill and hold" transactions for products which had not shipped by December 31, 2001 and 2000 were $271,600 and $43,000, respectively. Accounts receivable relating to "bill and hold" transactions were $271,600 and $43,000 at December 31, 2001 and 2000, respectively. 7 Net revenues from one customer were 22.6% and 12.6% of total net revenues for the three months and six ended December 31, 2001, respectively. At December 31, 2001, the Company had receivables from this customer of $1,118,443. Net revenues from two other customers were 12.5% and 11.4% of total net revenues for the three months ended December 31, 2000 and net revenues from one of these customers were 16.7% of total net revenues for the six months ended December 31, 2000. 6. INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method and consisted of the following: December 31, June 30, 2001 2001 ------------ -------- Purchased components and subassemblies $132,678 $167,730 Finished goods 240,352 291,006 -------- -------- $373,030 $458,736 -------- -------- 7. LINE OF CREDIT -------------- During fiscal 1999, the Company entered into a line of credit agreement with a bank which provides for borrowing up to $2,000,000 subject to certain limitations, as defined. The line of credit matures on December 31, 2002. Borrowings under the credit agreement bear interest at the bank's prime rate plus 1/2% (5.25% at December 31, 2001). At December 31, 2001 and June 30, 2001, there was $2,000,000 available for borrowing under the line. During the six months ended December 31, 2001, there were no borrowings under the line. The line of credit is collateralized by substantially all of the assets of the Company. The line of credit agreement requires the Company to maintain certain financial ratios and meet other financial conditions, as defined. 8. EARNINGS PER SHARE ------------------ The Company applies SFAS No. 128, "Earnings per Share." SFAS 128 requires dual presentation of basic and diluted earnings per share ("EPS") for complex capital structures on the face of the statement of operations. Basic EPS is computed by dividing income (loss) by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from the exercise or conversion of securities into Common stock, such as stock options. The following table sets forth the computation of basic and diluted earnings per share: 8
For the three months ended For the six months ended December 31, December 31, --------------------------- --------------------------- 2001 2000 2001 2000 ------------ ------------ ------------ ------------ Net income (loss) $ 610,568 $ (276,526) $ 870,241 $ (464,072) ============ ============ ============ ============ Weighted average shares outstanding: Basic 10,376,892 10,275,652 10,279,762 10,275,409 Employee stock options 507,801 -- 462,335 -- ------------ ------------ ------------ ------------ Diluted 10,884,693 10,275,652 10,742,097 10,275,409 Earnings (loss) per common share: Basic $ 0.06 $ (0.03) $ 0.08 $ (0.05) ============ ============ ============ ============ Diluted $ 0.06 $ (0.03) $ 0.08 $ (0.05) ============ ============ ============ ============
For the six months ended December 31, 2001, an aggregate of 999,506 stock options were excluded from the calculation of dilutive earnings per share because their inclusion would have been anti-dilutive. 9. SUBSEQUENT EVENT On January 8, 2002, the Company entered into a worldwide alliance with IBM Corporation under which the Company will be the preferred provider of thin client appliance products to IBM and its customers. In addition, the Company licensed from IBM the intellectual property associated with its thin client appliance products. As consideration for these agreements, the Company issued 375,000 newly issued shares of its common stock with a fair market value of $6.26 per share to IBM. Resale of the shares issued in connection with the IBM transactions is subject to registration or the availability of an exemption from registration. The agreements provide for limitations on the number of shares which may be sold within the first fifteen months of issuance. It is anticipated that a registration statement will be filed by April 3, 2002. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Introduction The Company provides software, services and solutions to enable Appliance Computing, a new Internet-based computing architecture targeted at business customers that is designed to be simpler and easier than traditional PC-based computing. The Company's software and management tools power and manage a new generation of smart computing appliances that utilize the benefits of open, industry-standard technologies to create new alternatives to personal computers used in business and a wide variety of proprietary business devices. The Company's Capio and Eon products are thin client computing appliances, which are cost-effective alternatives to personal computers used by businesses, and powerful replacements for green-screen terminals. Used in conjunction with Citrix MetaFrame or Microsoft Terminal Services, the Company's computing appliances allow users to run Windows-based applications from a server, plus connect to mainframes, midrange systems and the Internet. Unlike personal computers, computing appliances can be centrally managed and remotely configured, which greatly simplifies administration. Because of this, computing appliances can save up to 80 percent of the total cost of ownership of networked personal computers, resulting in significant cost savings for enterprise customers. 9 Results of Operations The following table sets forth, for the periods indicated, certain items from the Company's unaudited consolidated statements of operations as a percentage of net revenues.
For the Three Months Ended For the Six Months Ended December 31, December 31, --------------------------- ------------------------- 2001 2000 2001 2000 -------- ------- --------- -------- Gross profit 43.3% 29.5% 42.7% 29.3% Operating expenses Sales and marketing 19.9 22.5 21.3 19.9 Research and development 5.2 5.8 5.7 4.9 General and administrative 10.2 15.6 10.0 14.1 Acquisition costs - - - 2.2 -------- ------- --------- -------- Operating income (loss) 8.0 (14.4) 5.7 (11.8) Interest income, net 1.3 6.2 1.6 5.5 -------- -------- --------- -------- Net income (loss) 9.3% (8.2)% 7.3% (6.3)% -------- -------- --------- --------
Net revenues for the three and six months ended December 31, 2001 increased to $6,595,133 and $11,859,862 from $3,389,070 and $7,422,407 for the comparable periods in the prior fiscal year. The increase in net revenues was primarily attributable to increased sales of the Company's Eon computing appliance products and from the introduction of the Capio product line acquired in June 2001. Included in net revenues for the three and six months ended December 31, 2001 are net revenues of approximately $428,000 as a result of the acquisition of ACTIV-e Solutions on December 4, 2001. On January 8, 2002, the Company entered into a worldwide alliance with IBM Corporation under which the Company will be the preferred provider of thin client appliance products to IBM and its customers. The Company's gross profit as a percentage of net revenues for the three and six month periods ended December 31, 2001 increased to 43.3% and 42.7% compared to 29.5% and 29.3% for the comparable periods of the prior fiscal year. The increase is primarily attributable to the cost benefits of the operating model adopted by the Company during the latter part of the fiscal year ended June 30, 2000 which eliminated proprietary hardware design and engineering costs. The increase is also attributable to reductions in the purchase costs of components and third party license fees and a favorable mix of products sold. In addition, fixed overhead costs represented a lower percentage of revenue during the three and six month periods ended December 31, 2001 than in the prior fiscal year. Operating expenses for the three and six month periods ended December 31, 2001 declined to 35.3% and 37.0% of net revenues, from 43.9% and 41.1% in the comparable periods of the prior fiscal year as a result of increased sales. Operating expenses for the three and six month periods ended December 31, 2001 were $2,328,058 and $4,384,479, an increase of 56.6% and 43.9% from operating expenses of $1,486,358 and $3,046,210 in the comparable periods of the prior fiscal year as a result of the Company's execution of its growth strategy. These operating expenses are broken down as follows: Sales and marketing expenses for the three and six month periods ended December 31, 2001 were 19.9% and 21.3% of net revenues, compared to 22.5% and 19.9% for the comparable periods in the prior fiscal year. Sales and marketing expenses for the three and six month periods ended December 31, 2001 were $1,315,246 and $2,525,354, an increase of 72.7% and 71.1% from $761,500 and $1,475,776 in the comparable periods in the prior fiscal year. These increases reflect additional sales and marketing personnel, including the opening of additional domestic and international sales offices, additional sales and marketing personnel as a result of the acquisitions of the Capio product line and Activ-e Solutions, increased marketing activities and higher commissions due to increased sales. 10 Research and development expenses for the three and six month periods ended December 31, 2001 were $343,985 and $674,851, an increase of 75.8% and 87.2% from $195,723 and $360,550 in the comparable periods in the prior year primarily as a result of an increase in personnel dedicated to software development activities resulting from the Company's growth strategy. General and administrative expenses for the three and six month periods ended December 31, 2001 were 10.2% and 15.6% of net revenues, from 10.0% and 14.1% for the comparable periods of the prior fiscal year. General and administrative expenses for the three and six month periods ended December 31, 2001 were $668,827 and $1,184,274, an increase of 26.4% and 12.9% from $529,135 and $1,048,846 in the comparable periods in the prior fiscal year due to increased staffing and personnel costs as a result of the Company's growth strategy. Acquisition costs for the six month period ended December 31, 2000 amounted to $161,038 or 2.2% of net revenues and consisted primarily of professional service fees incurred in connection with a proposed acquisition that was not consummated. Net interest income for the three and six month periods ended December 31, 2001 was $83,747 and $195,701 , a decrease of 60.1% and 52.3% from $209,646 and $410,371 in the comparable periods in the prior fiscal year. The decrease was due primarily to lower interest rates and a slightly lower amount invested primarily as a result of the Company's use of cash for acquisitions. No income tax expense was recognized in the three and six month periods ended December 31, 2001 due to the availability of net operating loss carryforwards. No income tax benefit was recognized in the three and six month periods ended December 31, 2000 as there was no assurance that the benefit of the net operating loss carryforwards would be realized. For the three and six month periods ended December 31, 2001, the Company had net income of $610,568 and $870,241 as compared to net losses of $276,526 and $464,072 for the comparable periods in the prior year primarily as a result of increased revenues and gross margin, offset by an increase in operating expenses and reduced interest income. Liquidity and Capital Resources As of December 31, 2001, the Company had net working capital of $13,128,859 composed primarily of cash and cash equivalents, marketable securities and accounts receivable. The Company's principal sources of liquidity include $11,457,011 of cash, cash equivalents and marketable securities and a $2,000,000 bank line of credit facility with First Union National Bank, all of which was available as of December 31, 2001. The facility is secured by a first lien security interest on all tangible and intangible personal property of the Company and separate pledges of investment property owned by Neoware Investments, Inc. and Neoware Licensing, Inc., each of which is a wholly-owned subsidiary of the Company. The facility agreement requires the Company to maintain certain financial ratios and meet other financial conditions, as defined. Interest on the line of credit facility accrues at the bank's prime rate plus one-half percent with all principal and interest due and payable on December 31, 2002. The Company had no borrowings under the line of credit during the six months ended December 31, 2001. Cash and cash equivalents decreased by $592,191 during the six months ended December 31, 2001 primarily as a result of an increase in accounts receivable and the cash paid for the acquisition of ACTIV-e Solutions offset by net income for the period. 11 The Company used cash in operations of $44,870 and $600,103 for the six months ended December 31, 2001 and 2000, respectively. The decrease is primarily attributable to higher revenues and improved gross margins, offset by increases in operating expenses and accounts receivable. The Company used cash in investing activities of $209,790 and $177,501 for the six months ended December 31, 2001 and 2000, respectively. The decrease was the result of the total amount cash paid for the acquisition of Activ-e Solutions in December 2001 offset by the purchase of treasury stock in December 2000 and a reduction in capitalized software. The Company used cash in financing activities of $337,531 and $99,455 during the six months ended December 31, 2001 and 2000, respectively. The increase was primarily attributable to repayments of debt assumed in connection with the acquisition of ACTIV-e Solutions in December 2001. The Company expects to fund current operations and other cash expenditures through the use of available cash, cash from operations, funds available under its credit facility and possible new debt or equity sources. Management believes that there will be sufficient funds from current cash, operations and available financing to fund operations and cash expenditures for the foreseeable future, however, the Company may seek additional sources of funding, including equity and/or debt financing, in order to fund potential acquisitions. Additionally, the Company must continue to maintain sustained profitability in order to provide adequate funding for the long term. Factors Affecting the Company and Future Operating Results Our future results may be affected by industry trends and specific risks in our business. Some of the factors that could materially affect our future results include those described below. Although the Company has generated an operating profit in the past four quarters, we have a history of losses and may experience losses in the future, which could result in the market price of our common stock declining. Although the Company has generated an operating profit in the last four quarters, we have incurred net losses in the past and have an accumulated deficit of $7.5 million as of December 31, 2001. We expect to continue to incur significant operating expenses. Our operating expenses increased during the three and six months ended December 31, 2001 reflecting the hiring of additional key personnel as we continue to implement our growth strategy. As a result, we will need to generate significant revenues to maintain profitability. If we do not maintain profitability, the market price for our common stock may decline. Our financial resources may not be enough for our capital and corporate development needs, and we may not be able to obtain additional financing. A failure to derive significant revenues would likely cause us to incur losses and negatively impact the price of our common stock. Our ability to accurately forecast our quarterly sales is limited, although our costs are relatively fixed in the short term and we expect our business to be affected by rapid technological change, which may adversely affect our quarterly operating results. Because of the new and rapidly evolving market for our embedded Windows and Linux-based computing appliances, our ability to accurately forecast our quarterly sales is limited, which makes it difficult to predict the quarterly revenues that we will recognize. In addition, most of our costs are for personnel and facilities, which are relatively fixed in the short term. If we have a shortfall in revenues in relation to our expenses, we may be unable to reduce our expenses quickly enough to avoid losses. As a result, our quarterly operating results could fluctuate. 12 There are factors that may affect the market acceptance of our products, some of which are beyond our control, including the following: o the growth and changing requirements of the computing appliance market; o the quality, price, performance and total cost of ownership of our products; o the availability, price, quality and performance of competing products and technologies; and o the successful development of our relationships with software providers, original equipment manufacturers and existing and potential channel partners. We may not succeed in developing and marketing our computing appliance products and our operating results may decline as a result. Our gross margins can vary significantly, based upon a variety of factors. If the Company is unable to sustain adequate gross margins it may be unable to reduce operating expenses in the short term, resulting in losses. The Company's 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 the Company's business, including the percentage of revenues derived from hardware, software and consulting services. The gross profit margin also varies in response to competitive market conditions as well as periodic fluctuations in the cost of memory and other significant components. The market in which the Company competes remains very competitive, and although the Company intends to continue its efforts to reduce the cost of its products, there can be no certainty that the Company will not be required to reduce prices of its products without compensating reductions in the cost to produce its products in order to increase its market share or to meet competitors' price reductions. Our business is dependent on customer adoption of Windows and Linux-based computing appliances to perform discrete tasks for corporate and Internet-based computer networks and a decrease in their rates of adoption could adversely affect our ability to increase our revenues. We are dependent on the growing use of computing appliances to perform discrete tasks for corporate and Internet-based networks to increase our revenues. If the role of computing appliances does not increase as we anticipate, or if it in any way decreases, our revenues would not materialize. If corporate information technology organizations do not accept Windows or Linux-based embedded operating systems, or if there is a wide acceptance of alternative operating systems that provide enhanced capabilities, our operating results could be harmed. The computing appliance market in which we compete is new and unpredictable, and if this market does not develop and expand as we anticipate, our revenues may not grow. Because some of our products use embedded versions of Microsoft Windows as their operating system, an inability to license these operating systems on favorable terms could impair our ability to introduce new products and maintain market share. We may not be able to introduce new products on a timely basis because some of our products use embedded versions of Microsoft Windows as their operating system. Windows is provided to the Company by Microsoft Corporation, and the Company does not have access to the source code for Windows. If Microsoft fails to continue to enhance and develop its embedded operating systems, or if the Company is unable to license these operating systems on favorable terms, our operations may suffer. 13 Because some of our products use Linux as their operating system, the failure of Linux developers to enhance and develop the Linux kernel could impair our ability to release new products and maintain market share. We may not be able to release new products on a timely basis because some of our products use Linux as their operating system. The heart of Linux, the Linux kernel, is maintained by third parties. Linus Torvalds, the original developer of the Linux kernel, and a small group of independent engineers are primarily responsible for the development and evolution of the Linux kernel. If this group of developers fails to further develop the Linux kernel, we would have to either rely on another party to further develop the kernel or develop it ourselves. To date, we have optimized our Linux-based operating system based on a version of Red Hat Linux. If we were unable to access Red Hat Linux, we would be required to spend additional time to obtain a tested, recognized version of the Linux kernel from another source or develop our own operating system internally. We cannot predict whether enhancements to the kernel would be available from reliable alternative sources. We could be forced to rely to a greater extent on our own development efforts, which would increase our development expenses and might delay our product release schedules. In addition, any failure on the part of the kernel developers to further develop and enhance the kernel could stifle the development of additional Linux-based applications for use with our products. Because we depend on sole source, limited source and foreign source suppliers for key components, we are susceptible to supply shortages that could prevent us from shipping customer orders on time, if at all, and result in lost sales. We depend upon single source suppliers for our computing appliance products and for several of the components in them. We also depend on limited sources to supply several other industry standard components. We also rely on foreign suppliers which subject us to risks associated with foreign operations such as the imposition of unfavorable governmental controls or other trade restrictions, changes in tariffs and political instability. We have in the past experienced and may in the future experience shortages of, or difficulties in acquiring, these components. If we are unable to buy these components, we will not be able to deliver our products to our customers. Because we rely on channel partners to sell our products, our revenues could be negatively impacted if our existing channel partners do not continue to purchase products from us. We cannot be certain that we will be able to attract channel partners that market our products effectively or provide timely and cost-effective customer support and service. None of our current channel partners is obligated to continue selling our products nor to sell our new products. We cannot be certain that any channel partner will continue to represent our products or that our channel partners will devote a sufficient amount of effort and resources to selling our products in their territories. We need to expand our direct and indirect sales channels, and if we fail to do so, our growth could be limited. We may not be able to effectively compete against other providers as a result of their greater financial resources and brand awareness. In the market for computing appliances, we face significant competition from larger companies which have greater financial resources and name recognition than we do. Increased competition may negatively affect our business and future operating results by leading to price reductions, higher selling expenses or a reduction in our market share. Our future competitive performance depends on a number of factors, including our ability to: 14 o continually develop and introduce new products and services with better prices and performance than offered by our competitors; o offer a wide range of products; and o offer high-quality products and services. If we are unable to offer products and services that compete successfully with the products and services offered by our competitors, our business and our operating results would be harmed. In addition, if in responding to competitive pressures, we are forced to lower the prices of our products and services and we are unable to reduce our costs, our business and operating results would be harmed. Computing appliance products are subject to rapid technological change due to changing operating system software and network hardware and software configurations, and our products could be rendered obsolete by new technologies. The computing appliance market is characterized by rapid technological change, frequent new product introductions, uncertain product life cycles, changes in customer demands and evolving industry standards. Our products could be rendered obsolete if products based on new technologies are introduced or new industry standards emerge. We may not be able to preserve the value of our products' intellectual property because we do not have any patents and other vendors could challenge our other intellectual property rights. Our products will be differentiated from those of our competitors by our internally developed technology that is incorporated into our products. If we fail to protect our intellectual property, other vendors could sell products with features similar to ours, and this could reduce demand for our products, which would harm our operating results. We may not be able to attract software developers to bundle their products with our computing appliances. Our computing appliances include our own software, plus software from other companies for specific vertical markets. If we are unable to attract software developers, and are unable to include their software in our products, we may not be able to offer our computing appliances for certain important target markets, and our financial results will suffer. In order to continue to grow our revenues, we may need to hire additional personnel, including software engineers. In order to continue to develop and market our line of computing appliances, we may need to hire additional software engineers as well as marketing and sales personnel. Competition for employees with these skills is severe and we may experience difficulty in attracting suitably qualified people. Future growth that we may experience will place a significant strain on our management, systems and resources. To manage the anticipated growth of our operations, we may be required to: o improve existing and implement new operational, financial and management information controls, reporting systems and procedures; o hire, train and manage additional qualified personnel; and 15 o establish relationships with additional suppliers and partners while maintaining our existing relationships. We rely on the services of certain key personnel, and those persons' knowledge of our business and technical expertise would be difficult to replace. Our products and technologies are complex and we are substantially dependent upon the continued service of our existing personnel. The loss of any of our key employees could adversely affect our business and slow our product development processes. Errors in our products could harm our business and our operating results. Because our computing appliance products are complex, they could contain errors or bugs that can be detected at any point in a product's life cycle. Although many of these errors may prove to be immaterial, any of these errors could be significant. Detection of any significant errors may result in: o the loss of or delay in market acceptance and sales of our products; o diversion of development resources; o injury to our reputation; or o increased maintenance and warranty costs. These problems could harm our business and future operating results. Product errors or delays could be material, including any product errors or delays associated with the introduction of new products or the versions of our products that support operating systems other than Linux. Occasionally, we have warranted that our products will operate in accordance with specified customer requirements. If our products fail to conform to these specifications, customers could demand a refund for the purchase price or assert claims for damages. Moreover, because our products are used in connection with critical distributed computing systems services, we may receive significant liability claims if our products do not work properly. Our agreements with customers typically contain provisions intended to limit our exposure to liability claims. However, these limitations may not preclude all potential claims. Liability claims could require us to spend significant time and money in litigation or to pay significant damages. Any such claims, whether or not successful, could seriously damage our reputation and our business. Our IT consulting operations, which we acquired from Activ-e Solutions, would suffer and we could lose our customers or fail to attract new customers if we are unable to attract and retain qualified personnel. Our IT consulting business is labor-intensive, and our success depends in large part upon our ability to attract, develop, motivate and retain highly skilled personnel. Some of these individuals are in great demand and are likely to remain a limited resource for the foreseeable future. We may not be able to engage the services of such personnel or retain our current personnel. If we do not succeed in attracting new, qualified personnel or successfully retaining our current personnel, our IT consulting business will suffer. If our contracts with Citrix and other vendors of hardware components and software applications were terminated, our IT consulting business would be materially adversely affected. 16 We depend on third-party suppliers to provide us with key hardware components and software applications in connection with our IT consulting services business. If such contracts and relationships were terminated, our IT revenues would be negatively affected. We may not be able to successfully integrate the acquisitions we have completed as part of our growth strategy, which may materially adversely affect our growth and our operating results. We have made two acquisitions and entered into an alliance with IBM to be the preferred provider of thin client appliance products to IBM and its customers within the last eight months. We have not yet fully integrated these businesses or fully implemented the alliance. There is no assurance that we will successfully integrate these acquisitions into our business or successfully implement the alliance. In addition, we cannot assure you that, we will achieve anticipated revenue and earnings growth as a result of these transactions. Our failure to successfully integrate the acquired businesses into our operations or successfully implement the alliance could have a material adverse effect upon our business, operating results and financial condition. Forward-Looking Statements This quarterly report on Form 10-Q contains statements that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, such as statements regarding future margins and margin trends, future revenues and profitability, increased sales and operating expenses, the Company's competitive position, the reduction in the cost of producing the Company's products, the cost benefits and other advantages of the Company's products and the development of new products and the availability of cash or other financing sources to fund future operations. These forward-looking statements involve risks and uncertainties. The factors contained in "Factors Affecting the Company and Future Operating Results" and set forth elsewhere in this report, could cause actual results to differ materially from those predicted in any such forward-looking statement. Factors that could affect the Company's actual results include the Company's ability to lower its costs, customers' acceptance of Neoware's line of computing appliance products, pricing pressures, rapid technological changes in the industry, growth of the computing appliance market, increased competition, the Company's ability to attract and retain qualified personnel, changes in general economic conditions, risks associated with foreign operations and political and economic uncertainties associated with current world events. PART II. OTHER INFORMATION Item 1. Legal Proceedings None. Item 2. Changes in Securities and Use of Proceeds On December 4, 2001, in connection with the acquisition of substantially all of the assets of Telcom Assistance Center Corporation d/b/a ACTIV-e Solutions, the Company issued 619,101 shares of Neoware's common stock to ACTIV-e. Up to an additional 100,000 shares were to be issued upon the satisfaction of certain conditions. The shares were issued in reliance upon the exception from the registration requirements of the Securities Act under Section 4(2) thereof as a transaction not involving a public offering. The sale was made to a knowledgeable and experienced investor which had access to information respecting the Company and its business. 17 Item 4. Submission of Matters to a Vote of Security Holders On December 7, 2001, the Company held its Annual Meeting of Stockholders. The Stockholders voted to elect five members to the Board of Directors and to ratify the selection of Arthur Andersen LLP as the Company's independent accountant for the fiscal year ending June 30, 2002. Elected to the Board of Directors were Arthur R. Spector (9,188,891 shares voted for election and 56,611 shares were withheld), Michael G. Kantrowitz (9,217,612 shares voted for election and 27,890 shares were withheld), Christopher G. McCann (9,236,782 shares voted for election and 8,720 shares were withheld), John M. Ryan (9,234,882 shares voted for election and 10,620 shares were withheld), and Carl G. Sempier (9,236,682 shares voted for election and 8,820 shares were withheld). The selection of Arthur Andersen LLP as the Company's independent public accountants was ratified with 8,890,353 shares voting in favor of ratification, 29,315 shares voting against ratification and 325,834 shares abstaining. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: 10.1* Employment Agreement dated December 4, 2001 between the Company and Anthony J. DePaul 10.2* 2002 Non-Qualified Stock Option Plan *Management Contract (b) Report on Form 8-K: On January 29, 2002, the Company filed a Form 8-K reporting the acquisition of Substantially all of the assets of ACTIV-e Solutions. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunder duly authorized. NEOWARE SYSTEMS, INC. Date: February 14, 2002 By: /S/ MICHAEL G. KANTROWITZ ----------------------------- Michael G. Kantrowitz President and Chief Executive Officer Date: February 14, 2002 By: /S/ VINCENT T. DOLAN ------------------------ Vincent T. Dolan Vice President-Finance/Administration (Principal Accounting Officer and Principal Financial Officer) 19 EX-10 3 exh10-1.txt EXH10-1.TXT EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (the "Agreement") is made the ___ day of December, 2001 by and between NEOWARE SYSTEMS, INC., a Delaware corporation ("Employer"), and ANTHONY J. DePAUL ("Employee"). W I T N E S S E T H : WHEREAS, Employee has been employed by Telcom Assistance Center Corporation ("Telcom"); and WHEREAS, Employer and Telcom have entered into an asset purchase agreement dated November __, 2001 (the "Purchase Agreement") which provides for the purchase of substantially all of the assets of Telcom by Employer (the "Purchase"); and WHEREAS, the execution of this Agreement by Employee and Employer is a condition to the obligation of Telcom to closing of the Purchase; and WHEREAS, Employer desires to employ Employee and Employee desires to accept such employment, all upon and subject to the terms and conditions contained in this Agreement; NOW, THEREFORE, the parties to this Agreement, for good and valuable consideration and intending to be legally bound, hereby agree as follows: SECTION 1. EMPLOYMENT. (a) Duties. Employer agrees to employ Employee as the Executive Vice President of Employer responsible for North American Marketing, Sales and Business Development. Employee agrees to perform such duties and services consistent with Employee's position and to perform such other duties and to serve in such capacities at such location as may be determined and assigned to him from time to time by the Chief Executive Officer or Board of Directors of Employer, it being expressly provided that the duties of Employee may be enlarged or diminished, as the Chief Executive Officer or the Board of Directors determines. Employee will use his best efforts to perform his duties and discharge his responsibilities pursuant to this Agreement competently, carefully and faithfully. (b) Devotion of Time. Employee will devote his entire time, attention and energies to the affairs of Employer. Employee will not enter the employ of or serve as a consultant to, or in any way perform any services with or without compensation to, any other person, business or organization without the prior written consent of the Board of Directors of Employer, provided that Employee shall be permitted to devote a limited amount of time, without compensation, to charitable or similar activities. (c) Former Employment. Employee represents and warrant that he is a party to an employment agreement with Telcom dated September 29, 2000 (the "Telcom Agreement"), and that his performance under the Agreement shall not, in any way, breach or conflict with the terms of the Telcom Agreement in any manner. Employee and Employer further agrees that Employer has not and does not assume any obligation to Employee under the Telcom Agreement, including but not limited to, payment of any severance or other benefits to Employee. Employee hereby releases and forever discharges Employer from any and all claims, actions, demands or lawsuits of any type that he may have which relate in any manner to the Telcom Agreement and agrees to indemnify and hold Employee harmless from and against any cost, loss or expense (including attorneys' fees) arising out of or relating to any breach of the warranty described in this Section 1(c). 1 SECTION 2. DURATION AND TERMINATION OF EMPLOYMENT. (a) Term. The term of this Agreement shall begin as of the date hereof and shall continue for an initial period of two years unless terminated pursuant to this Section 2 hereof, with or without cause, and shall automatically continue thereafter year-to-year unless terminated pursuant to this Section 2 hereof, with or without cause (collectively, the "Term"). (b) Termination by Employer. Employer may terminate Employee's employment pursuant to this Agreement as follows: (i) If Employee shall die during the Term, Employee's employment shall terminate, except that Employee's legal representatives shall be entitled to receive the base salary provided for under Section 3 hereof prorated to the last day of the month in which Employee's death occurs. (ii) If during the Term, Employee shall become physically or mentally disabled whether totally or partially, so that Employee is unable substantially to perform Employee's services hereunder for a period of four (4) consecutive months, Employer may, by written notice to Employee, terminate Employee's employment hereunder. In the event of Employee's termination pursuant to this Section 2(b)(ii), Employee shall be entitled to receive the payments described in Section 2(c)(i), less any amounts received by Employee from any source for disability-related benefits. (iii) Employer may, by written notice to Employee, terminate Employee's employment hereunder for "cause." For the purposes of this Agreement, "cause" shall mean Employee's termination only upon: (A) Employee's continued neglect of such assigned duties and responsibilities as shall be consistent with the terms of this Agreement or Employee's responsibilities after receipt of a written warning of specific deficiencies and Employee's failure to cure said deficiencies within thirty (30) days; or (B) Employee's engaging in willful misconduct which is demonstrably injurious to Employer; or (C) Employee's committing a felony or an act of fraud against or the misappropriation of property belonging to Employer, or (D) Employee's breaching in any material respect the terms of this Agreement and Employee's failure to cure the breach within thirty (30) days after written notice of the breach from Employer. (iv) Employer may terminate Employee's employment hereunder "without cause" upon thirty (30) days prior written notice. A termination "without cause" shall mean the termination of Employee's employment by Employer under this Agreement other than pursuant to Sections 2(b)(i), (ii) or (iii) above. (c) Severance; Change of Control. (i) If Employer terminates this Agreement during the first twenty four (24) months of the Term for any reason other than pursuant to Section 2(b)(i), (ii) or (iii) above, Employer shall continue Employee's then current annual base salary and health benefits for a period of six (6) months. 2 (ii) If, during the Term, Employee is not offered employment, for any reason other than for "cause," by Employer's successor on the occurrence of a Change in Control (as defined below), (a) Employee will be entitled, under this Section 2(c)(iii), to payment of the amounts specified in Section 2(c)(i), which shall be in lieu of any payments under Section 2(c)(i), and (b) any options to purchase shares of Employer's Common Stock held by Employee shall become fully exercisable. "Change in Control" shall have the meaning set forth in Section 14 of the Company's Stock Option Plan (the "Stock Option Plan"), a copy of which is attached as Exhibit A. (d) Employee Obligations. Notwithstanding the foregoing, no amount will be paid or benefit provided under Section 2(c)(i) or 2(c)(ii) unless and until Employee executes and delivers to Employer a release substantially identical to that attached hereto as Exhibit B and the Revocation Period described therein has expired. In the event that Employee violates any of the provisions of Sections 4 or 6 hereunder, Employer's obligation to make payments under Section 2(c) shall terminate immediately. (e) Termination by Employee. Employee may terminate his employment hereunder upon thirty (30) days prior written notice to Employer. (f) Survival. Notwithstanding any termination of Employee's employment as provided in this Section 2 or otherwise, the provisions of Sections 4, 5, 6 and 7 shall remain in full force and effect. SECTION 3. COMPENSATION. (a) Base Salary. Employee's base salary shall be $175,000 per annum, payable in equal, bi-weekly installments, subject to annual review and adjustments at the discretion of the Chief Executive Officer and the Compensation and Stock Option Committee of the Board of Directors. (b) Bonus; Options. Employee shall be entitled to participate in any employee bonus pool and stock option plans at the discretion of the Compensation and Stock Option Committee or Board of Directors, as applicable. (c) Employee Benefits. Employee shall participate in Employer's standard employee benefit plans (for example, life insurance, disability insurance, health and dental insurance) available to similarly situated employees. 3 SECTION 4. COVENANT NOT TO COMPETE OR SOLICIT. (a) Non-Competition. Employee agrees that he will not directly or indirectly engage in (whether as an employee, consultant, proprietor, partner, director or otherwise), or have any ownership interest in, or participate in the financing, operation, management or control of, any person, firm, corporation or business that engages in or (to Employee's knowledge) intends to engage in a "Restricted Business" (as defined below), during the Term of his employment by Employer and for a period of six (6) months following the later of (i) the termination of this Agreement other than pursuant to Section 2(b)(iv) or (ii) the termination of payments under Section 2(c)(i). Ownership of (i) no more than five percent (5%) of the outstanding voting stock of a publicly traded corporation, or (ii) any stock presently owned by Employee, shall not constitute a violation of this provision. In addition, this provision shall not apply to Employee's employment by a company if: (i) less than ten percent (10%) of the company's revenues during the prior twelve (12) months were generated by the Restricted Business and (ii) Employee is not employed by the division or subsidiary engaged in the Restricted Business. "Restricted Business" shall mean any business that is engaged in or is preparing to engage in the sale or provision of products and/or services comparable to the products and/or services offered by Employer at any time during Employee's employment with Employer. At the time of the execution of this Agreement, upon consummation of the Purchase, "Restricted Business" is defined as any business involved in the creation, marketing and sale of software, services or solutions for the appliance computing, thin client, server-based computing, MSP or ASP markets. (b) Non-Solicitation. With respect to non-solicitation obligations, Employee agrees to be bound by the Non-Solicitation and Confidentiality Agreement between Employer and Employee, the form of which is attached hereto as Exhibit C and incorporated herein, and which shall be executed by Employer and Employee concurrently with this Agreement (the "Non-Solicitation and Confidentiality Agreement"). (c) Worldwide. The parties acknowledge that the market for products of the type sold by Employer is worldwide, and that, in this market, products from any nation compete with products from all other nations. Accordingly, in order to secure to Employer the benefits of this Section 4, the parties agree that the provisions of this Section 4 shall apply to each of the states and counties of the United States and to each nation worldwide. 4 (d) Severability. The parties intend that the covenants contained in the preceding paragraphs shall be construed as a series of separate covenants, one for each state of the United States, and each nation. If, in any judicial proceeding, a court shall refuse to enforce any of the separate covenants (or any part thereof) deemed included in said paragraphs, then such unenforceable covenant (or such part) shall be deemed eliminated from this Agreement for the purpose of those proceedings to the extent necessary to permit the remaining separate covenants (or portions thereof) to be enforced. In the event that the provisions of this Section 4 should ever be deemed to exceed the time or geographic limitations, permitted by applicable law, then such provisions shall be reformed to the maximum time or geographic limitations, as the case may be, permitted by applicable law. (e) Restrictions Reasonable. Employee acknowledges that the restrictions imposed by this Agreement are reasonable and necessary in order to protect the legitimate business interests of Employer and will not preclude Employee from becoming gainfully employed following his termination of employment with Employer. SECTION 5. EMPLOYEE'S REPRESENTATIONS. Employee represents and warrants to Employer that Employee is familiar with and approves the covenants not to compete and not to solicit set forth in Section 4, including, without limitation, the reasonableness of the length of time, scope and geographic coverage of those covenants. SECTION 6. PROTECTION OF CONFIDENTIAL INFORMATION. In view of the fact that the Employee's work for Employer will bring him into close contact with many confidential affairs of Employer not readily available to the public, Employee agrees to be bound by each of the terms and provisions of the Non-Solicitation and Confidentiality Agreement. SECTION 7. REMEDIES. (a) Employee Violations. If Employee violates any of the provisions of Sections 4 or 6 hereof, Employer shall have the following rights and remedies: (i) In the event of a breach, or a threatened breach, the right and remedy to have the provisions of this Agreement specifically enforced by any court having equity jurisdiction, it being acknowledged and agreed that any such breach or threatened breach will cause irreparable injury to Employer and that money damages will not provide an adequate remedy to Employer; 5 (ii) In the event of an actual breach, the right to recover damages for all losses, actual and contingent, and the right to require the Employee to account for and pay over to Employer all profits or other benefits (collectively "Benefits") derived or received by the Employee as a result of any transactions constituting such a breach, and the Employee hereby agrees to account for and pay over such Benefits to Employer; and (iii) The immediate termination of Employer's obligation to make payments pursuant to Section 2(c). (b) Rights and Remedies Cumulative. Each of the rights and remedies enumerated above shall be independent of the other, and shall be severally enforceable, and all of such rights and remedies shall be in addition to, and not in lieu of, any other rights and remedies available to Employer at law or in equity. SECTION 8. INTELLECTUAL PROPERTY. (a) Owner of Intellectual Property. Employer shall be the sole owner of all the products and proceeds of the Employee's services to Employer, including, but not limited to, all materials, ideas, concepts, formats, designs, suggestions, developments, arrangements, packages, computer programs, inventions, patent applications, patents, copyrights, trademarks and other intellectual properties (collectively, "Intellectual Property") that Employee may acquire, obtain, develop or create in connection with the Employee's employment hereunder, free and clear of any claims by Employee (or anyone claiming under Employee) of any kind or character whatsoever (other than Employee's right to receive payments hereunder). (b) Assistance. Employee shall, at the request of Employer, execute such assignments, certificates or other instruments as Employer may from time to time deem necessary or desirable to evidence, establish, maintain, perfect, protect, enforce or defend its rights, title and interest in or to any such Intellectual Property. SECTION 9. MISCELLANEOUS. (a) Notices. All notices, reports or other communications required or permitted to be given hereunder shall be in writing to both parties and shall be deemed given on the date of delivery, if delivered, or three days after mailing, if mailed first-class mail, postage prepaid, to the following addresses: (i) If to Employee: Anthony J. DePaul 204 Woods Road Glenside, Pennsylvania 19038 (ii) If to Employer: NEOWARE SYSTEMS, INC. 400 Feheley Drive King of Prussia, PA 19406 Attention: President or to such other address as any party hereto may designate by notice given as herein provided. 6 (b) Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the laws of the Commonwealth of Pennsylvania, without regard to its rule or principles relating to conflicts of laws. (c) Amendments. This Agreement shall not be changed or modified in whole or in part except by an instrument in writing signed by each party. (d) Counterparts. This Agreement may be executed in several counterparts, each of which shall be an original, but all of which together shall constitute one and the same agreement. (e) Effect of Headings. The section headings herein are for convenience only and shall not affect the construction or interpretation of this Agreement. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first set forth above. NEOWARE SYSTEMS, INC. By: ------------------------------------ Michael Kantrowitz President and CEO EMPLOYEE ------------------------------------ Anthony J. DePaul 7 EX-10 4 exh10-2.txt EXH10-2.TXT 2002 NON-QUALIFIED STOCK OPTION PLAN PART I DEFINITIONS AND ADMINISTRATIVE MATTERS SECTION 1. Purpose; Definitions. The purpose of the Neoware Systems, Inc. 2002 Non-Qualified Stock Option Plan (the "Plan") is to enable employees, officers, directors and independent contractors of Neoware Systems, Inc. ("the Company") to (i) own shares of stock in the Company, (ii) participate in the stockholder value which has been created, (iii) have a mutuality of interest with other stockholders and (iv) enable the Company to attract, retain and motivate employees, officers, directors and independent contractors of particular merit. For the purposes of the Plan, the following terms shall be defined as set forth below: (a) "Board" means the Board of Directors of the Company. (b) "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto. (c) "Committee" means the Committee designated by the Board to administer the Plan. (d) "Company" means Neoware Systems, Inc., its Subsidiaries or any successor organization. (e) "Director" means any member of the Board. (f) "Disability" means permanent and total disability within the meaning of Section 22(e)(3) of the Code. (g) "Eligible Independent Contractor" means an independent contractor hired by the Company who is neither an Employee or Director of the Company. (h) "Employee" means any person who is employed by the Company and is compensated for such employment by a regular salary. (i) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (j) "Fair Market Value" means the per share value of the Stock as of any given date, as determined by reference to the price of the last traded share of Stock on the over-the-counter market, as reported by the National Association of Securities Dealers, Inc. Automated Quotation ("NASDAQ") System for such date or the next preceding date that Stock was traded on such market, or, in the event the Stock is listed on a stock exchange, the closing price per share of Stock as reported on such exchange for such date. (k) "Insider" means a Participant who is subject to Section 16 of the Exchange Act. (l) "Participant" means an Employee, Director or Eligible Independent Contractor to whom an Option is granted pursuant to the Plan. (m) "Plan" means the Neoware Systems, Inc. 2002 Non-Qualified Stock Option Plan, as hereinafter amended from time to time. (n) "Rules" means Rule 16 b-3 and any successor provisions promulgated by the Securities and Exchange Commission under Section 16 of the Exchange Act. (o) "Securities Act" shall mean the Securities Act of 1933, as amended. (p) "Securities Broker" means the registered securities broker acceptable to the Company who agrees to effect the cashless exercise of an Option pursuant to Section 5(d) hereof. (q) "Stock" means the Common Stock of the Company, par value $.001 per share. (r) "Stock Option" or "Option" means any option to purchase shares of Stock (including Restricted Stock, if the Committee so determines) granted pursuant to Section 5 below. (s) "Subsidiary" means any corporation "controlled," as defined in Rule 405 promulgated under the Securities Act, by the Company. SECTION 2. Administration. 2.1 The Plan shall be administered by a Committee appointed by the Board and who shall serve at the pleasure of the Board. The Committee shall have the authority to grant pursuant to the terms of the Plan: Stock Options to Employees and Directors of the Company, and Eligible Independent Contractors. In particular, the Committee shall, subject to the limitations and terms of the Plan, have the authority: (i) to select the Directors and Employees of the Company, and the Eligible Independent Contractors to whom Stock Options may from time to time be granted hereunder; (ii) to determine the number of shares to be covered by each such award granted hereunder; (iii) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any award granted hereunder, including the option or exercise price and any restrictions or limitations, based upon such factors as the Committee shall determine, in its sole discretion; 2 (iv) to determine whether and under what circumstances a Stock Option may be exercised and settled in cash or Stock or without a payment of cash; (v) to determine whether, to what extent and under what circumstances Stock and other amounts payable with respect to an award under this Plan shall be deferred either automatically or at the election of the Participant; and (vi) to amend the terms of any outstanding award (with the consent of the Participant) to reflect terms not otherwise inconsistent with the Plan, including amendments concerning exercise price changes, vesting acceleration or forfeiture waiver regarding any award or the extension of a Participant's right with respect to awards granted under the Plan, as a result of termination of employment or service or otherwise, based on such factors as the Committee shall determine, in its sole discretion. The Committee shall have the authority to adopt, alter and repeal such administrative rules, guidelines and practices governing the Plan as it shall, from time to time deem advisable; to interpret the terms and provisions of the Plan and any award issued under the Plan (and any agreements relating thereto); and to otherwise supervise the administration of the Plan, provided that the Committee may delegate to the Chief Executive Officer of the Company, or such other officer as may be designated by the Committee, the authority, subject to guidelines prescribed by the Committee, to grant Options to Employees and Eligible Independent Contractors who are not then subject to the provisions of Section 16 of the Exchange Act, and to determine the number of shares to be covered by any such Option, and the Committee may authorize any one or more of such persons to execute and deliver documents on behalf of the Committee, provided that no such delegation may be made that would cause grants of Options to persons subject to Section 16 of the Exchange Act to fail to comply with all applicable conditions of Rule 16b-3 or its successors under the Exchange Act. Determinations, interpretations or other actions made or taken by the Committee pursuant to the provisions of the Plan shall be final and binding and conclusive for all purposes and upon all persons. No member of the Board or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any Stock Option granted under it. Nothing herein shall be deemed to expand the personal liability of a member of the Board or Committee beyond that which may arise under any applicable standards set forth in the Company's by-laws and Delaware law, nor shall anything herein limit any rights to indemnification or advancement of expenses to which any member of the Board or the Committee may be entitled under any by-law, agreement, vote of the stockholders or directors, or otherwise. 2.2 With respect to grants to Directors who are not Employees of the Company, the authority conferred by Section 2.1 shall rest with the Board. 3 SECTION 3. Stock Subject to the Plan. The aggregate number of shares of Stock that may be issued or transferred under the Plan is 500,000, subject to adjustment pursuant to Section 6.1 below. Such shares may be authorized but unissued shares or reacquired shares. If the number of shares of Stock issued under the Plan and the number of shares of Stock subject to outstanding awards equals the maximum number of shares of Stock authorized under the Plan, no further awards shall be made unless the Plan is amended or additional shares of Stock become available for further awards under the Plan. If and to the extent that Options granted under the Plan terminate, expire or are canceled without having been exercised, such shares shall again be available for subsequent awards under the Plan. SECTION 4. Designation of Participants. Except as provided below, Participants shall be selected, from time to time, by the Committee from among those Employees, Directors and Eligible Independent Contractors who, in the opinion of the Committee, occupy responsible positions and who have the capacity to contribute materially to the continued growth, development and long-term success of the Company. PART II GRANTS TO EMPLOYEES AND ELIGIBLE INDEPENDENT CONTRACTORS SECTION 5. Stock Options. Any Stock Option granted under the Plan shall be in such form as the Committee or the Board may from time to time approve. Stock Options granted under the Plan shall be Non-Qualified Stock Options. Options granted hereunder shall be subject to the following terms and conditions and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Committee or the Board shall deem appropriate: 5.1 Option Price. The option price per share of Stock purchasable under a Stock Option shall be determined by the Committee or the Board at the time of grant; provided, however, that the option price per share for any Stock Option shall be not less than 100% of the Fair Market Value of the Stock on the date of grant. 5.2 Option Term. The term of each Stock Option shall be fixed by the Committee or the Board. No Option may be exercised by any person after expiration of the term of the Option. 5.3 Exercisability. Stock Options shall be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Committee or the Board at or after grant. If the Committee or the Board provides, in its discretion, that any Stock Option is exercisable only in installments, the Committee or the Board may waive such installment exercise provisions at any time at or after grant in whole or in part, based on such factors as the Committee or the Board shall determine, in its sole discretion. 4 5.4 Method of Exercise. Subject to whatever installment exercise provisions apply under Section 5.3, Stock Options may be exercised in whole or in part at any time and from time to time during the Option period, by giving written notice of exercise to the Company specifying the number of shares to be purchased. Such notice shall be accompanied by payment in full of the purchase price, either by cash, check, or such other instrument as the Committee or the Board may accept. As determined by the Committee or the Board, in its sole discretion, at or after grant, payment in full or in part may also be made in the form of unrestricted Stock already owned by the Participant (based upon the Fair Market Value of a share of Stock on the business date preceding tender if received prior to the close of the stock market and at the Fair Market Value on the date of tender if received after the stock market closes); provided, however, that the Stock delivered be acceptable to the Committee or the Board. To the extent permitted under the applicable laws and regulations, at the request of the Participant, and with the consent of the Committee or the Board, the Company shall permit payment to be made by means of a "cashless exercise" of an Option. Payment by means of a cashless exercise shall be effected by the Participant delivering to the Securities Broker irrevocable instructions to sell a sufficient number of shares of Stock to cover the cost and expenses associated therewith and to deliver such amount to the Company. No shares of Stock shall be issued until full payment therefor has been made. A Participant shall not have any right to dividends or other rights of a stockholder with respect to shares subject to the Option until such time as Stock is issued in the name of the Participant following exercise of the Option in accordance with the Plan. 5.5 Stock Option Agreement. Each Option granted under this Plan shall be evidenced by an appropriate Stock Option agreement, which agreement shall be executed by the Company and the Participant. The agreement shall contain such terms and provisions, not inconsistent with the Plan, as shall be determined by the Committee or the Board. Such terms and provisions may vary between Participants or as to the same Participant to whom more than one Option may be granted. 5.6 Replacement Options. If an Option granted pursuant to the Plan may be exercised by a Participant by means of a stock-for-stock swap method of exercise as provided in 5.4 above, then the Committee or the Board may, in its sole discretion and at the time of the original Option grant, authorize the Participant to automatically receive a replacement Option pursuant to the Plan. This replacement Option shall cover a number of shares determined by the Committee or the Board, but in no event more than the number of shares equal to the difference between the number of shares of the original Option exercised and the net shares received by the Participant from such exercise. The per share exercise price of the replacement Option shall equal the then current Fair Market Value of a share of Stock, and shall have a term extending to the expiration date of the original Option. The Committee or the Board shall have the right, in its sole discretion and at any time, to discontinue the automatic grant of replacement Options if it determines the continuance of such grants to no longer be in the best interest of the Company. 5 5.7 Non-transferability of Options. No Stock Option shall be transferable by the Participant other than by will, by the laws of descent and distribution, pursuant to a qualified domestic relations order, or as permitted under the Rules, and all Stock Options shall be exercisable, during the Participant's lifetime, only by the Participant. Notwithstanding the foregoing, the Committee or the Board may grant non-qualified Options that are transferable, without payment of consideration, to immediate family members (i.e., spouses, children and grandchildren) of the Participant or to trusts for, or partnerships whose only partners are, such family members. The Committee or the Board may also amend outstanding non-qualified Options to provide for such transferability. 5.8 Termination of Employment by Reason of Death. Unless otherwise determined by the Committee at or after grant, if any Participant dies during the Participant's period of employment by the Company, or during the periods referred to in Sections 5.9, 5.10 or 5.11, any Stock Option held by such Participant may thereafter be exercised, to the extent then exercisable or on such accelerated basis as the Committee may determine at or after grant, by the legal representative of the estate or by the legatee of the Participant under the will of the Participant, for a period of one year (or such shorter period as the Committee may specify at grant) from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is shorter. 5.9 Termination of Employment by Reason of Disability. Unless otherwise determined by the Committee at or after grant, if a Participant's employment by the Company terminates by reason of Disability, any Stock Option held by such Participant may thereafter be exercised by the Participant, to the extent it was exercisable at the time of termination, or on such accelerated basis as the Committee may determine at or after grant, for a period of one year (or such shorter period as the Committee may specify at grant) from the date of such termination of employment or until the expiration of the stated term of such Stock Option, whichever period is shorter. 5.10 Termination of Employment Upon Retirement. Unless otherwise determined by the Committee at or after grant, if an Participant's employment terminates due to retirement (as hereinafter defined), any Stock Option held by such Participant may thereafter be exercised by the Participant, to the extent it was exercisable at the date of retirement, or on such accelerated basis as the Committee may specify at grant, for a period of one-year (or such shorter period as the Committee may specify at grant) from the date of such retirement or until the expiration of the stated term of such Stock Option, whichever period is shorter. For purposes of this Section 5.10, "Retirement" shall mean any Employee retirement under the Company's retirement policy. 5.11 Other Termination of Employment. Unless otherwise determined by the Committee at or after grant, in the event of termination of employment (voluntary or involuntary) for any reason other than death, Disability or retirement, or if an Employee is terminated for cause, any Stock Option held by such Participant may thereafter be exercised by the Participant, to the extent it was exercisable at the time of such termination or on such accelerated basis as the Committee may determine at or after grant, for a period of three months (or such shorter period as the Committee may specify at grant) from the date of such termination of employment or the expiration of the stated term of such Stock Option, whichever period is shorter. If an Employee is terminated for cause, any Stock Option held by such Participant shall terminate immediately. 6 5.12 Termination of Eligible Independent Contractors Options. The termination provisions of Options granted to Eligible Independent Contractors shall be determined by the Committee in its sole discretion. 5.13 Withholding and Use of Shares to Satisfy Tax Obligations. The obligation of the Company to deliver Stock upon the exercise of any Option shall be subject to applicable federal, state and local tax withholding requirements. If the exercise of any Option is subject to the withholding requirements of applicable federal tax laws, the Committee, in its discretion (and subject to such withholding rules ("Withholding Rules") as shall be adopted by the Committee), may permit the Participant to satisfy the federal withholding tax, in whole or in part, by electing to have the Company withhold (or by delivering to the Company) shares of Stock, which Stock shall be valued, for this purpose, at their Fair Market Value on the date the amount of tax required to be withheld is determined (the "Determination Date"). Such election must be made in compliance with and subject to the Withholding Rules, and the Committee may not withhold shares of Stock in excess of the number necessary to satisfy the minimum federal income tax withholding requirements. 5.14 Issuance of Shares and Compliance with Securities Acts. Within a reasonable time after exercise of an Option, the Company shall cause to be delivered to the Participant a certificate for the Stock purchased pursuant to the exercise of the Option. At the time of any exercise of any Option, the Company may, if it shall deem it necessary and desirable for any reason connected with any law or regulation of any governmental authority relative to the regulation of securities, require the Participant to represent in writing to the Company that it is his or her then intention to acquire the Stock for investment and not with a view to distribution thereof and that such Participant will not dispose of such Stock in any manner that would involve a violation of applicable securities laws. In such event, no Stock shall be issued to such holder unless and until the Company is satisfied with such representation. Certificates for shares of Stock issued pursuant to the exercise may bear an appropriate securities law legend. 5.15 Buyout Provision. The Company may at any time offer to buy out, for a payment in cash or stock, an Option previously granted based on such terms and conditions as the Company shall establish and communicate to the Participant at the time that such offer is made. This provision shall not in any way be deemed to create any rights on the part of the Participants to receive buyout offers or payments. PART III MISCELLANEOUS SECTION 6. Adjustments Upon Changes in Capitalization, Merger or Change in Control. 6.1 Changes in Capitalization. If any change is made to the Stock (whether by reason of merger, consolidation, reorganization, recapitalization, stock dividend, stock split, combination of shares, or exchange of shares or any other change in capital structure, where such changes are made without receipt of consideration), then unless such event or change results in the termination of all outstanding awards under the Plan, the Board or the Committee shall preserve the value of the outstanding awards by adjusting the maximum number and class of shares issuable under the Plan to reflect the effect of such event or change in the Company's capital structure, and by making appropriate adjustments to the number and class of shares subject to an outstanding award and/or the option price of each outstanding Option, except that any fractional shares resulting from such adjustments shall be eliminated by rounding any portion of a share equal to .500 or greater up, and any portion of a share equal to less than .500 down, in each case to the nearest whole number. 7 6.2 Dissolution or Liquidation. In the event of a proposed dissolution or liquidation of the Company, the Committee, or its designee, shall notify each Participant as soon as practicable prior to the effective date of such proposed transaction. The Committee or the Board in its discretion may provide for a Participant to have the right to exercise his or her Option during such period prior to such transaction as the Committee in its sole discretion shall determine as to all of the Stock covered thereby, including shares of Stock as to which the Option would not otherwise be exercisable. To the extent it has not been previously exercised, an Option will terminate immediately prior to the consummation of such proposed action. 6.3 Merger or Asset Sale. In the event of a merger of the Company with or into another corporation, or the sale of all or substantially all of the assets of the Company, each outstanding Option shall either (a) be assumed or an equivalent option substituted by the successor corporation or a parent or subsidiary of the successor corporation or (b) the Committee or its designee shall notify the Participant in writing or electronically that the Option may be exercised, as to the extent then exercisable, during such period of time from the date of such notice, as shall be determined by the Committee, and the Option shall terminate upon the expiration of such period. The Committee may, in its discretion, provide on a case by case basis that Options may be immediately exercisable for the total remaining number of shares covered by the Option. 6.4 Change in Control. A "Change in Control" for purposes of this Plan shall mean any one of the events described below: (a) at any time during a period of two (2) consecutive years, at least a majority of the Board shall not consist of Continuing Directors. "Continuing Directors" shall mean directors of the Company at the beginning of such two-year period and directors who subsequently became such and whose selection or nomination for election by the Company's shareholders was approved by a majority of the then Continuing Directors; or (b) any person or "group" (as determined for purposes of Regulation 13D-G promulgated by the Commission under the Exchange Act or under any successor regulation), but excluding any majority-owned subsidiary or any employee benefit plan sponsored by the Company or any subsidiary or any trust or investment manager for the account of such a plan, shall have acquired "beneficial ownership" (as determined for purposes of such regulation) of the Company's securities representing fifty percent (50%) or more of the combined voting power of the Company's then outstanding securities unless such acquisition is approved in advance by a majority of the directors of the Company who were in office immediately preceding such acquisition and any individual selected to fill any vacancy created by reason of the death or disability of any such director; or 8 (c) the Company becomes a party to a merger, consolidation or share exchange in which either (i) the Company will not be the surviving corporation or (ii) the Company will be the surviving corporation and any outstanding shares of Common Stock will be converted into shares of any other company (other than a reincorporation or the establishment of a holding company involving no change in ownership of the Company or other securities or cash or other property (excluding payments made solely for fractional shares); or (d) the Company's stockholders (i) approve any plan or proposal for the disposition or other transfer of all, or substantially all, of the assets of the Company, whether by means of a merger, reorganization, liquidation or dissolution or otherwise or (ii) dispose of, or become obligated to dispose of, 50% or more of the outstanding capital stock of the Company by tender offer or otherwise. If a Change in Control has occurred, the Committee may, in its discretion, provide on a case by case basis that Options may be immediately exercisable for the total remaining number of Shares covered by the Option and/or that the Options shall terminate, provided that the Participant shall have the right to exercise such Option during such period prior to the Change in Control as shall be determined by the Committee. SECTION 7. Amendments and Termination. The Board may amend, alter or discontinue the Plan at any time and from time to time, but no amendment, alteration or discontinuation shall be made which would impair the rights of a Participant under a Stock Option award theretofore granted, without the Participant's consent, or which, without the approval of the Company's stockholders, would require stockholder approval under applicable laws, regulations and NASDAQ requirements. The Committee or the Board may amend the terms of any Stock Option theretofore granted, prospectively or retroactively, but no such amendment shall impair the rights of any holder without the holder's consent. The Committee may also substitute new Stock Options for previously granted Stock Options, including previously granted Stock Options having higher option prices. Subject to the above provisions, the Board shall have broad authority to amend the Plan to take into account changes in applicable tax laws, securities laws and accounting rules, as well as other developments. SECTION 8. Unfunded Status of Plan. The Plan is intended to constitute an "unfunded" plan of incentive and deferred compensation. With respect to any payments not yet made to a Participant by the Company, nothing contained herein shall give any such Participant any rights that are greater than those of a general creditor of the Company. In its sole discretion, the Committee may authorize the creation of trusts or other arrangements to meet the obligations created under the Plan to deliver Stock or payments in lieu of or with respect to awards hereunder; provided, however, that, unless the Committee otherwise determines with the consent of the affected Participant, the existence of such trusts or other arrangements is consistent with the "unfunded" status of the Plan. 9 SECTION 9. General Provisions. 9.1 All certificates for shares of Stock or other securities delivered under the Plan shall be subject to such stock-transfer orders and other restrictions as the Committee or the Board may deem advisable under the rules, regulations and other requirements of the Securities Act, the Exchange Act, any stock exchange or over-the-counter market upon which the Stock is then listed, and any applicable federal or state securities law, and the Committee or the Board may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. 9.2 Nothing contained in this Plan shall prevent the Board from adopting other or additional compensation arrangements, subject to stockholder approval if such approval is required, and such arrangements may be either generally applicable or applicable only in specific cases. 9.3 The adoption of the Plan shall not confer upon any Participant any right to continued employment with the Company nor shall it interfere in any way with the right of the Company to terminate its relationship with any of its Employees, Directors or Eligible Independent Contractors at any time. 9.4 No later than the date as of which an amount first becomes includable in the gross income of the Participant for federal income tax purposes with respect to any award under the Plan, the Participant who is an Employee of the Company shall pay to the Company, or make arrangements satisfactory to the Committee regarding the payment of, any federal, state, or local taxes of any kind required by law to be withheld with respect to such amount. To the extent permitted by the Committee, in its sole discretion, the minimum required withholding obligations may be settled with Stock, including Stock that is part of the award that gives rise to the withholding requirement. The obligations of the Company under the Plan shall be conditional on such payment or arrangements and the Company shall, to the extent permitted by law, have the right to deduct any such taxes from any payment of any kind otherwise due to the Participant. 9.5 The Committee shall establish such procedures as it deems appropriate for a Participant to designate a beneficiary to whom any amounts payable in the event of the Participant's death are to be paid. 9.6 The Plan shall be governed by and subject to all applicable laws and to the approvals by any governmental or regulatory agency as may be required. 10 SECTION 10. Effective Date and Term of Plan. The Plan shall be effective as of January __, 2002 (the "Effective Date"). No Stock Option award shall be granted pursuant to the Plan on or after ten years from the Effective Date, but Stock Options granted prior to such tenth anniversary may be exercised after such date. SECTION 11. Interpretation. A determination of the Committee or the Board as to any question which may arise with respect to the interpretation of the provisions of this Plan or any Options shall be final and conclusive, and nothing in this Plan, or in any regulation hereunder, shall be deemed to give any Participant, his legal representatives, assigns or any other person any right to participate herein except to such extent, if any, as the Committee or the Board may have determined or approved pursuant to this Plan. The Committee or the Board may consult with legal counsel who may be counsel to the Company and shall not incur any liability for any action taken in good faith in reliance upon the advice of such counsel. SECTION 12. Governing Law. With respect to any Incentive Stock Options granted pursuant to the Plan and the agreements thereunder, the Plan, such agreements and any Incentive Stock Options granted pursuant thereto shall be governed by the applicable Code provisions to the maximum extent possible. Otherwise, the laws of the State of Delaware shall govern the operation of, and the rights of Participants under, the Plan, the agreements and any Options granted thereunder. SECTION 13. Compliance With The Rules. 13.1 It is the intent of the Company that this Plan comply in all respects with the Rules in connection with any grant of Options to, or other transaction by, an Insider. Accordingly, if any provision of this Plan or any agreement relating to an Option does not comply with the Rules as then applicable to any such Insider, such provision will be construed or deemed amended to the extent necessary to conform to such requirements with respect to such person. In addition, neither the Committee nor the Board shall have authority to make any amendment, alteration, suspension, discontinuation, or termination of the Plan or any agreement hereunder, or take other action if such authority would cause an Insider's transactions under the Plan not to be exempt under the Rules. 13.2 Certain restrictive provisions of the Plan have been implemented to facilitate the Company's and Insiders' compliance with the Rules. The Committee or the Board, in its discretion, may waive certain of these restrictions, provided the waiver does not relate in any way to an Insider. 11 -----END PRIVACY-ENHANCED MESSAGE-----