-----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, V5sJOUE+rfyfksvSGZdEj56V9Yap3qFToLl2HCUdw5TiyKei35+USjCUqiHl0ppo 1Umd05vWrIrBL31GrwUJlA== 0000950116-03-001637.txt : 20030214 0000950116-03-001637.hdr.sgml : 20030214 20030214124834 ACCESSION NUMBER: 0000950116-03-001637 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030214 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: 03565072 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: INFORMATION SYSTEMS ACQUISITION CORP DATE OF NAME CHANGE: 19930108 FORMER COMPANY: FORMER CONFORMED NAME: HDS NETWORK SYSTEMS INC DATE OF NAME CHANGE: 19950313 10-Q 1 ten-q.txt 10-Q 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, 2002 _____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to ________. Commission File Number: 000-21240 -------------------- NEOWARE SYSTEMS, INC. (Exact name of registrant as specified in its charter) Delaware 23-2705700 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 400 Feheley Drive King of Prussia, Pennsylvania 19406 (Address of principal executive offices) (610) 277-8300 (Registrant's telephone number including area code) -------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No __ As of February 10, 2003, there were 13,534,248 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, 2002 (unaudited) and June 30, 2002 3 Consolidated Statements of Operations: Three and Six Months Ended December 31, 2002 and 2001 (unaudited) 4 Consolidated Statements of Cash Flows: Three and Six Months Ended December 31, 2002 and 2001 (unaudited) 5 Notes to Unaudited Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk 20 Item 4. Controls and Procedures 20 PART II. OTHER INFORMATION Item 1. Legal Proceedings 21 Item 4. Submission of Matters to a Vote of Security Holders 21 Item 6. Exhibits and Reports on Form 8-K 21 Signatures 23 Certifications 24 2
NEOWARE SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS ASSETS December 31, 2002 (Unaudited) June 30, 2002 ------------ ------------ CURRENT ASSETS: Cash and cash equivalents $ 23,995,453 $ 17,031,422 Marketable securities 96,667 183,333 Accounts receivable, net 10,693,809 9,520,558 Inventories, net 793,421 1,040,851 Prepaid expenses and other 552,798 551,598 Deferred income taxes 1,290,916 1,394,864 ------------ ------------ Total current assets 37,423,064 29,722,626 Property and equipment, net 592,594 622,235 Goodwill and other intangibles 11,360,880 11,568,940 Note receivable from officer 254,269 263,732 Deferred income taxes 173,648 173,648 Capitalized and purchased software, net 33,046 47,779 ------------ ------------ $ 49,837,501 $ 42,398,960 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 4,273,397 $ 3,111,164 Accrued expenses 1,825,589 2,136,776 Capital lease obligations 66,951 63,037 Deferred revenue 686,077 582,290 ------------ ------------ Total current liabilities 6,852,014 5,893,267 ------------ ------------ Capital lease obligations, non-current portion 169,495 204,131 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $.001 par value, 1,000,000 shares authorized, none issued and outstanding -- -- Common stock, $.001 par value, 50,000,000 shares authorized, 13,623,351 and 12,935,615 shares issued and outstanding in 2002 and 2002, respectively 13,623 12,936 Additional paid-in capital 43,557,818 40,291,861 Treasury stock (100,000 shares at cost) (100,000) (100,000) Accumulated other comprehensive loss (199,602) (116,672) Accumulated deficit (455,847) (3,786,563) ------------ ------------ Total stockholders' equity 42,815,992 36,301,562 ------------ ------------ $ 49,837,501 $ 42,398,960 ============ ============
The accompanying notes are an integral part of these financial statements 3
NEOWARE SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended Six Months Ended ---------------------------- ---------------------------- December 31, December 31, December 31, December 31, 2002 2001 2002 2001 ------------ ------------ ------------ ------------ Net revenues $ 14,713,778 $ 6,595,133 $ 28,230,456 $ 11,859,862 Cost of revenues 8,167,076 3,740,254 15,989,578 6,800,843 ------------ ------------ ------------ ------------ Gross profit 6,546,702 2,854,879 12,240,878 5,059,019 ------------ ------------ ------------ ------------ Sales and marketing 2,299,087 1,315,246 4,526,420 2,525,354 Research and development 420,686 343,985 808,449 674,851 General and administrative 974,583 668,827 1,882,700 1,184,274 ------------ ------------ ------------ ------------ Operating expenses 3,694,356 2,328,058 7,217,569 4,384,479 ------------ ------------ ------------ ------------ Operating income 2,852,346 526,821 5,023,309 674,540 Interest income, net 90,912 83,747 180,935 195,701 ------------ ------------ ------------ ------------ Income before income taxes 2,943,258 610,568 5,204,244 870,241 Income tax expense (1,059,573) -- (1,873,528) -- ------------ ------------ ------------ ------------ Net income $ 1,883,685 $ 610,568 $ 3,330,716 $ 870,241 ============ ============ ============ ============ Basic income per share $ 0.14 $ 0.06 $ 0.25 $ 0.08 ============ ============ ============ ============ Diluted income per share $ 0.13 $ 0.06 $ 0.23 $ 0.08 ============ ============ ============ ============ Weighted average number of common shares used in basic earnings per share computation 13,573,656 10,376,892 13,368,120 10,275,409 ============ ============ ============ ============ Weighted average number of common shares used in diluted earnings per share computation 14,785,902 10,884,693 14,719,001 10,742,097 ============ ============ ============ ============ The accompanying notes are an integral part of these financial statements.
4
NEOWARE SYSTEMS, INC CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six Months Six Months Ended Ended December 31, December 31, 2002 2001 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 3,330,716 $ 870,241 Adjustments to reconcile net income to net cash provided by (used in) operating activities- Deferred income taxes 1,858,489 -- Depreciation and amortization 375,508 161,567 Changes in operating assets and liabilities- (Increase) decrease in: Accounts receivable (1,173,251) (894,266) Inventories 247,430 89,655 Prepaid expenses and other 2,536 191,159 Increase (decrease) in: Accounts payable 1,162,233 (104,631) Accrued expenses (311,187) (177,523) Deferred revenue 103,787 (181,072) ------------ ------------ Net cash provided by (used in) operating activities 5,596,261 (44,870) CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of intangible assets (44,424) (12,421) Purchase of ACTIV-e Solutions -- (146,956) Purchases of property and equipment, net (78,650) (50,413) ------------ ------------ Net cash used in investing activities (123,074) (209,790) CASH FLOWS FROM FINANCING ACTIVITIES: Repayments of assumed bank debt -- (388,216) Repayments of capital leases (30,722) (6,533) Exercise of stock options and warrants 1,634,512 26,574 Expenses for prior issuance of common stock (122,409) -- Decrease in notes receivable 9,463 30,644 ------------ ------------ Net cash provided by (used in) financing activities 1,490,844 (337,531) ------------ ------------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 6,964,031 (592,191) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 17,031,422 11,712,535 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD $ 23,995,453 $ 11,120,344 ============ ============ SUPPLEMENTAL DISCLOSURES: Cash paid for income taxes $ 79,947 $ 9,000 Cash paid for interest $ 17,189 $ 4,189 Cash received for interest $ 160,976 $ 128,556
The accompanying notes are an integral part of these financial statements. 5 NEOWARE SYSTEMS, INC. --------------------- NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS ---------------------------------------------------- 1. BASIS OF PRESENTATION --------------------- The accompanying unaudited consolidated financial statements of Neoware Systems, Inc. and Subsidiaries (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America. These statements, while unaudited, reflect all normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the consolidated financial statements. The interim results of operations for the three and six month periods ended December 31, 2002 are not necessarily indicative of results expected for the full year or for any other interim period. Certain information and footnote disclosures included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements. The consolidated financial statements included in this Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission. 2. NEW ACCOUNTING PRONOUNCEMENTS ----------------------------- In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections." Generally, SFAS No. 145 is effective for transactions occurring after May 15, 2002. There was no impact on the consolidated financial statements as a result of adopting this statement. In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." Under SFAS No. 146, companies will record exit or disposal costs when they are "incurred" and can be measured at fair value, and they will subsequently adjust the recorded liability for changes in estimated cash flow. SFAS No. 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure". SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation" to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 to require additional disclosure in both annual and interim financial statements on the method of accounting for stock-based employee compensation. The Company plans to adopt the disclosure provisions of SFAS No. 148 in the third quarter of fiscal 2003. In November 2002, the FASB issued Interpretation (FIN) No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". FIN No. 45 requires companies to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. Guarantees in existence at December 31, 2002 are grandfathered for the purposes of recognition and would only need to be disclosed. The Company plans to adopt the initial recognition and measurement provisions of FIN No. 45 for guarantees issued or modified after December 31, 2002. The Company does not expect the provisions of FIN No. 45 to have a material impact on its consolidated financial statements. 3. ACQUISITIONS AND ALLIANCE ------------------------- On December 4, 2001, the Company acquired all of the assets and assumed substantially all of the liabilities of Telcom Assistance Center Corporation, d/b/a ACTIV-e Solutions, a full service Information Technology consulting company in the server-based computing marketplace. The acquisition was accounted for using the purchase method of accounting. The purchase price was payable in cash of $75,000 and, after the adjustments as provided for in the acquisition agreement, an aggregate of 569,727 shares of the Company's newly issued common stock with a market value of $3.24 per share at the date of acquisition. In addition, the Company assumed net liabilities, exclusive of cash acquired of $9,774, of $1,185,693. The aggregate cost of the acquisition was $3,250,913 (including transaction costs of $154,079), which is equal to the excess of the purchase price over the value of the net assets acquired. The entire purchase price has been allocated to goodwill based on management's assessment as required by SFAS No. 141, "Business Combinations". The results of operations subsequent to December 4, 2001 have been included in the accompanying consolidated statement of operations. 6 The following is a summary of the net cash paid for the ACTIV-e Solutions transaction: Cash $ 9,774 Accounts receivable 348,192 Prepaids and other 128,893 Property and equipment 469,034 Goodwill 3,250,913 Bank debt (388,213) Accounts payable (1,124,370) Accrued expenses (164,944) Capital leases (300,485) Deferred revenue (153,800) Fair value of stock issued (1,845,915) ----------- Net cash paid $ 229,079 =========== On January 8, 2002, the Company entered into a worldwide alliance with IBM Corporation under which the Company is 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 to IBM 375,000 newly issued shares of common stock with a fair market value of $6.26 per share. The fair value of the shares issued of $2,347,500, plus transaction costs of $58,115, has been allocated to intangible assets. Of the total consideration, $1,900,000 has been allocated to acquired distribution agreements, with the remainder of $505,615 allocated to acquired technology. Amortization of the distribution agreements and technology acquired is being recorded on a straight-line basis over five and ten years, respectively. Amortization of $107,500 and $215,000 respectively, has been recorded in the accompanying consolidated statements of operations for the three and six months ended December 31, 2002. A registration statement covering the shares issued in connection with the ACTIV-e acquisition and the IBM alliance was filed on April 3, 2002, and declared effective on June 24, 2002. The agreements with ACTIV-e and IBM provide for limitations on the number of shares which may be sold within the first twelve months after effectiveness of the registration statement for the shares granted to ACTIV-e and within fifteen months of issuance for the shares granted to IBM. On March 26, 2002, the Company acquired the ThinSTAR product line of Network Computing Devices, Inc. (NCD). In addition, the Company entered into an alliance with NCD to grow the worldwide thin client appliance market. The acquisition was accounted for using the purchase method of accounting. The purchase price was payable in cash of $4,187,476, including transaction costs of $187,476, and was allocated to intangible assets. The entire purchase price was allocated to goodwill based on management's assessment as required by SFAS No. 141, "Business Combinations." The results of operations of the ThinSTAR product line have been included in the accompanying consolidated statement of operations from the date of the acquisition. 4. MARKETABLE SECURITIES --------------------- The Company's marketable equity securities have been classified as "available-for-sale" under the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" and are reported at their estimated fair value. Unrealized gains or losses are included as a component of accumulated other comprehensive loss, which is reported as a separate component of stockholders' equity. Accumulated other comprehensive loss of $199,602 and $116,672 at December 31, 2002 and June 30, 2002 includes an unrealized loss on marketable equity securities for the six months ended December 31, 2002 and 2001 of $86,666 and $66,667, respectively. 7 5. REVENUE RECOGNITION ------------------- 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 should be followed for products or services where a software element exists, unless the software is incidental to the product being sold. The software has been deemed to be essential to the functionality of the hardware and, therefore, SOP 97-2 has been followed for revenue recognition. Revenue is recognized on product sales when a formal arrangement exists, delivery of the product has occurred or title has transferred, the fee is fixed or determinable and collection is probable. Revenue related to post contract services is recognized with the initial sale as the fee is included with the initial licensing fee, post-contract services are typically 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. Post contract services for periods in excess of one year or sold subsequent to the initial sale are recognized as revenues ratably over the contract period. Revenue from consulting services is recognized upon performance. 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. For the three months ended December 31, 2002 and 2001, revenues recognized from "bill and hold" transactions for products which had not shipped by December 31, 2002 and 2001 were zero and $271,600, respectively. Accounts receivable relating to "bill and hold" transactions were zero and $271,600 at December 31, 2002 and 2001, respectively. 6. MAJOR CUSTOMERS --------------- For the three months ended December 31, 2002, sales to IBM and one European distributor constituted 29% of net revenues. Accounts receivable from these two customers as of December 31, 2002 amounted to $4,338,948. Each of these customers resells the Company's products to individual resellers and/or end-users, none of which contributed sales of more than 10% of the Company's net revenues for the three months ended December 31, 2002. No customer contributed sales exceeding 10% of net revenues for the three months ended December 31, 2001. The percentage of revenue derived from individual distributors, resellers or end-users can vary significantly from quarter to quarter. 7. INVENTORIES, NET ---------------- Inventories, net are stated at the lower of cost or market. Cost is determined by the first-in, first-out method and consists of the following: December 31, June 30, 2002 2002 ---------- ---------- Purchased components and subassemblies $ 326,180 $ 211,131 Finished goods 467,241 829,720 ---------- ---------- $ 793,421 $1,040,851 ========== ========== 8 8. LINE OF CREDIT -------------- The Company has a line of credit agreement with a bank, which provides for borrowing up to $2,000,000 subject to certain limitations, as defined. The line of credit matures on March 31, 2003. Borrowings under the credit agreement bear interest at the bank's prime rate plus 1/2% (4.75% at December 31, 2002). At December 31, 2002 and June 30, 2002, there was $2,000,000 available for borrowing under the line. During the three months ended December 31, 2002 and 2001, there were no borrowings under the line. The line of credit is unsecured and requires the Company to maintain a minimum balance of $3,000,000 in cash and cash equivalents with the bank. The Company is in compliance with this condition at December 31, 2002. 9. INCOME TAXES ------------ The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes." Under the asset-and-liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect of deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. During the six months ended December 31, 2002, deferred income taxes included an increase of $1,754,541 as a result of the income tax benefit realized from the exercise of employee and director stock options. This benefit was recorded as an increase in additional paid-in capital in the accompanying consolidated balance sheet. 10. EARNINGS PER SHARE ------------------ The Company applies SFAS No. 128, "Earnings per Share." SFAS No. 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 by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from the exercise or conversion of securities into common stock, such as stock options and warrants. 9 The following table sets forth the computation of basic and diluted earnings per share:
For the three months ended For the six months ended December 31, December 31, ------------------------- ------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ----------- Net income $ 1,883,685 $ 610,568 $ 3,330,716 $ 870,240 =========== =========== =========== =========== Weighted average shares outstanding: Basic 13,573,656 10,376,892 13,368,120 10,275,409 Effect of dilutive employee stock options 1,196,836 507,801 1,335,471 466,688 Effect of dilutive warrants 15,410 -- 15,410 -- ----------- ----------- ----------- ----------- Diluted 14,785,902 10,884,693 14,719,001 10,742,097 Earnings per common share: Basic $ 0.14 $ 0.06 $ 0.25 $ 0..08 =========== =========== =========== =========== Diluted $ 0.13 $ 0.06 $ 0.23 $ 0..08 =========== =========== =========== ===========
For the three and six months ended December 31, 2002 and 2001, an aggregate of 165,500 and 83,500, respectively, compared to 577,250 and 999,506, respectively, of stock options and warrants were excluded from the calculation of dilutive earnings per share because their inclusion would have been anti-dilutive. 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, an 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 Eon, Capio and ThinSTAR 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. The Company has identified critical accounting policies with respect to revenue recognition, accounts receivable, inventories and income taxes. These policies are discussed in the Company's Form 10-K for the year ended June 30, 2002. 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. 10
For the Three Months For the Six Months Ended Ended Ended December 31, 2002 December 31, 2001 ---------------------- ------------------------ 2002 2001 2002 2001 ---- ---- ---- ---- Gross profit 44.5% 43.3% 43.4% 42.7% Operating expenses Sales and marketing 15.6 19.9 16.0 21.3 Research and development 2.9 5.2 2.9 5.7 General and administrative 6.6 10.2 6.7 10.0 ------ ------ ------ ------ Operating income 19.4 8.0 17.8 5.7 Interest income, net 0.6 1.3 0.6 1.6 Income tax expense (7.2) - (6.6) - ------ ------ ------ ------ Net income 12.8% 9.3% 11.8% 7.3% ====== ====== ====== ======
Net revenues for the three and six months ended December 31, 2002 increased to $14,713,778 and $28,230,456, respectively, from $6,595,133 and $11,859,862, respectively, 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, Capio and ThinSTAR products, as well as increased sales of software upgrades and third party products. The Company's gross profit as a percentage of net revenues for the three and six months ended December 31, 2002 increased to 44.5% and 43.4%, respectively, compared to 43.3% and 42.7%, respectively, for the comparable periods of the prior fiscal year. The increase is attributable to reductions in the purchase costs of components and third party license fees, an increase in the number of higher margin units sold, and initial sales of software upgrades primarily to IBM customers. In addition, fixed overhead costs represented a lower percentage of revenue during the three and six months ended December 31, 2002 than in the prior fiscal year. Operating expenses for the three and six months ended December 31, 2002 declined to 25.1% and 25.6% of net revenues, respectively, from 35.3% and 37.0%, respectively, in the comparable periods of the prior fiscal year as a result of increased sales and controlled increases in expenditures. Operating expenses for the three and six months ended December 31, 2002 were $3,694,356 and $7,217,569, respectively, an increase of 58.7% and 64.6% from operating expenses of $2,328,058 and $4,384,479, respectively, in the comparable periods of the prior fiscal year as a result of the Company's execution of its growth strategy. These operating expenses consist of the following: Sales and marketing expenses for the three and six months ended December 31, 2002 were 15.6% and 16.0% of net revenues, respectively, compared to 19.9% and 21.3%, respectively, for the comparable periods in the prior fiscal year. Sales and marketing expenses for the three and six months ended December 31, 2002 were $2,299,087 and $4,526,420, respectively, an increase of 74.8% and 79.2% from $1,315,246 and $2,525,354, respectively, in the comparable periods in the prior fiscal year. This increase reflects 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 ACTIV-e Solutions, ThinSTAR, and IBM transactions, and higher commissions due to increased sales. Research and development expenses for the three and six months ended December 31, 2002 were $420,686 and $808,449, respectively, an increase of 22.3% and 19.8% from $343,985 and $674,851, respectively, 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. 11 General and administrative expenses for the three and six months ended December 31, 2002 were 6.6% and 6.7% of net revenues, respectively, versus 10.2% and 10.0%, respectively, for the comparable periods of the prior fiscal year. General and administrative expenses for the three and six months ended December 31, 2002 were $974,583 and $1,882,700, respectively, an increase of 45.7% and 59.0% from $668,827 and $1,184,274, respectively, in the comparable periods in the prior fiscal year due to increased staffing and additional costs as a result of the Company's growth strategy. Net interest income for the three and six months ended December 31, 2002 was $90,912 and $180,935, respectively, an increase of 8.6% and a decrease of 7.5% from $83,747 and $195,701, respectively, in the comparable periods in the prior fiscal year. The increase in interest income for the comparable three-month periods is due to the investment of higher cash balances, offset by the effect of lower interest rates. The decrease for the comparable six-month periods was primarily due to lower interest rates. For the three and six months ended December 31, 2002, the Company recorded income tax expense of $1,059,573 and $1,873,528, respectively, or 36% of net income. The Company did not record income tax expense for the comparable periods in the prior year due to the availability of net operating loss carryforwards. For the three and six months ended December 31, 2002, the Company had net income of $1,883,685 and $3,330,716, respectively, as compared to pre-tax net income of $610,568 and $870,241, respectively, for the comparable periods in the prior year primarily as a result of increased revenues and gross margin, offset by increases in operating expenses and income tax expense. Liquidity and Capital Resources As of December 31, 2002, the Company had net working capital of $30,571,050 consisting primarily of cash and cash equivalents and accounts receivable. The Company's principal sources of liquidity include $24,092,120 of cash, cash equivalents and marketable securities and a $2,000,000 bank line of credit facility, all of which was available as of December 31, 2002. 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 March 31, 2003. The Company had no borrowings under the line of credit during the six month period ended December 31, 2002. Cash and cash equivalents increased by $6,964,031 during the six months ended December 31, 2002, primarily as a result of net income and the exercise of stock options and warrants in addition to the utilization of deferred income taxes, offset by changes in other working capital items due to the growth of the Company. The Company generated cash from operations of $5,596,261 for the six months ended December 31, 2002, primarily as a result of higher revenues, improved gross margins and the utilization of deferred income taxes assets. The Company used cash from investing activities of $123,074 for the six months ended December 31, 2002 primarily as a result of $78,650 for the purchase of property plant and equipment. The Company generated cash from financing activities of $1,490,844 during the six months ended December 31, 2002 primarily as a result of the exercise of warrants and employee stock options, offset by the payment of additional transaction costs related to the prior issuance of common stock. 12 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. 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. We may not be able to successfully integrate the acquisitions we have completed and alliance we have entered into as part of our growth strategy, which may materially adversely affect our growth and our operating results. Within the last 21 months, we have made three acquisitions and entered into an alliance with IBM to be the preferred provider of thin client appliance products to IBM and its customers. We have not yet fully integrated some of these acquisitions or fully implemented the alliance. There is no assurance that we will successfully integrate these acquisitions into our business or successfully implement the alliance. In addition, we may be unable to retain key employees or key business relationships of the acquired businesses and integration of the businesses may divert the attention and resources of our management. We cannot assure that we will achieve anticipated revenue and earnings growth as a result of these transactions. Our failure to successfully integrate the acquired businesses into our operations or successfully implement the alliance could have a material adverse effect upon our business, operating results and financial condition. Even if the acquisitions and alliance are successfully integrated, we may not receive the expected benefits of the transactions if we find that the business or alliance does not further our business strategy or that we paid more than what the assets were worth. Managing acquisitions and alliances requires management resources, which may divert our attention from other business operations. As a result, the effects of any completed or future transactions on financial results may differ from our expectations. Although we have generated an operating profit in the past eight reported quarters, we have a prior history of losses and may experience losses in the future, which could result in the market price of our common stock declining. Although we have generated an operating profit in the last eight reported quarters, we have incurred net losses in the past and have an accumulated deficit of $456,000 as of December 31, 2002. We expect to continue to incur significant operating expenses. Our operating expenses increased during the three and six months ended December 31, 2002 reflecting the hiring of additional key personnel as we continue to implement our growth strategy, including the additional personnel we hired in connection with our IBM, ThinSTAR and ACTIV-e Solutions transactions. 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. 13 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 software and 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. We expect our quarterly revenues and operating results to fluctuate for a number of reasons. Future operating results will continue to be subject to quarterly fluctuations based on a wide variety of factors, including: Linearity- Our quarterly sales have historically reflected a pattern in which a disproportionate percentage of sales occur in the last month of the quarter. This pattern makes prediction of revenues, earnings and working capital for each financial period especially difficult and uncertain and increases the risk of unanticipated variations in quarterly results and financial condition. Significant Orders- We are subject to significant variances in our quarterly operating results because of the fluctuations in the timing of our receipt of large orders. If even a small number of large orders are delayed until after a quarter ends, our operating results could vary substantially from quarter to quarter and net income could be substantially less than expected. 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 software and computing appliance products and our operating results may decline as a result. Our gross margins can vary significantly, based upon a variety of factors. If we are unable to sustain adequate gross margins we may be unable to reduce operating expenses in the short term, resulting in losses. Our gross margins can vary significantly from quarter to quarter depending on average selling prices, fixed costs in relation to revenue levels and the mix of our business, including the percentage of revenues derived from hardware, software and consulting services. The gross profit margin also varies in response to competitive market conditions as well as periodic fluctuations in the cost of memory and other significant components. The market in which we compete remains very competitive, and although we intend to continue our efforts to reduce the cost of our products, there can be no certainty that we will not be required to reduce prices of our products without compensating reductions in the cost to produce our products in order to increase our market share or to meet competitors' price reductions. 14 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. Microsoft Corporation provides Windows to us, and we do not have access to the source code for Windows. If Microsoft fails to continue to enhance and develop its embedded operating systems, or if we are unable to license these operating systems on favorable terms, our operations may suffer. Because some of our products use Linux as their operating system, the failure of Linux developers to enhance and develop the Linux kernel could impair our ability to release new products and maintain market share. 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, which could significantly increase our costs. 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. 15 We depend upon single source suppliers for some of 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, political instability and currency fluctuations. A weakening dollar could result in greater costs to us for our components. We have in the past experienced and may in the future experience shortages of, or difficulties in acquiring, these components. A significant portion of our revenues is derived from the sale of computing appliances that are bundled with our software. These computing appliances are produced for us by third parties. If we experience shortages of these products, or of their components, we may not be able to deliver our products to our customers, and our revenues would decline. If we are unable to continue generating substantial revenues from international sales our business could be adversely affected. Currently, approximately 30 to 40 percent of our revenues are derived from international sales. Our ability to sell our products internationally is subject to a number of risks. General economic and political conditions in each country could adversely affect demand for our products and services in these markets. Currency exchange rate fluctuations could result in lower demand for our products or lower pricing resulting in reduced revenue and margins, as well as currency translation losses. Changes to and compliance with a variety of foreign laws and regulations may increase our cost of doing business in these jurisdictions. Trade protection measures and import and export licensing requirements subject us to additional regulation and may prevent us from shipping products to a particular market, and increase our operating costs. Because we rely on channel partners to sell our products, our revenues could be negatively impacted if our existing channel partners do not continue to purchase products from us. We cannot be certain that we will be able to attract channel partners that market our products effectively or provide timely and cost-effective customer support and service. None of our current channel partners is obligated to continue selling our products nor to sell our new products. We cannot be certain that any channel partner will continue to represent our products or that our channel partners will devote a sufficient amount of effort and resources to selling our products in their territories. We need to expand our direct and indirect sales channels, and if we fail to do so, our growth could be limited. As a result of our acquisition of the ThinSTAR product line from NCD, we rely on NCD for the distribution of our ThinSTAR products in Europe. If NCD were to discontinue sales of our products or reduce its sales efforts, it could adversely affect our operating results. In addition, there can be no assurance as to NCD's continued viability and financial condition. As a result of our alliance with IBM, we rely on IBM for distribution of our products to IBM's customers. If IBM were to discontinue sales of our products or reduce its sales efforts, it could adversely affect our operating results. 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. 16 Our future competitive performance depends on a number of factors, including our ability to: o continually develop and introduce new products and services with better prices and performance than offered by our competitors; o offer a wide range of products; and o offer high-quality products and services. If we are unable to offer products and services that compete successfully with the products and services offered by our competitors, our business and our operating results would be harmed. In addition, if in responding to competitive pressures, we are forced to lower the prices of our products and services and we are unable to reduce our costs, our business and operating results would be harmed. Computing appliance products are subject to rapid technological change due to changing operating system software and network hardware and software configurations, and our products could be rendered obsolete by new technologies. The Appliance Computing 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. In order to continue to develop and market our line of computing appliances, we may need to hire additional personnel. Competition for employees is significant and we may experience difficulty in attracting suitably qualified people. 17 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 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 profits and slow our product development processes. Errors in our products could harm our business and our operating results. Because our software and computing appliance products are complex, they could contain errors or bugs that can be detected at any point in a product's life cycle. Although many of these errors may prove to be immaterial, any of these errors could be significant. Detection of any significant errors may result in: o the loss of or delay in market acceptance and sales of our products; o diversion of development resources; o injury to our reputation; or o increased maintenance and warranty costs. These problems could harm our business and future operating results. Occasionally, we have warranted that our products will operate in accordance with specified customer requirements. If our products fail to conform to these specifications, customers could demand a refund for the purchase price or assert claims for damages. Moreover, because our products are used in connection with critical distributed computing systems services, we may receive significant liability claims if our products do not work properly. Our agreements with customers typically contain provisions intended to limit our exposure to liability claims. However, these limitations may not preclude all potential claims. Liability claims could require us to spend significant time and money in litigation or to pay significant damages. Any such claims, whether or not successful, could seriously damage our reputation and our business. Our IT services operations, which we acquired from ACTIV-e Solutions, would suffer and we could lose our customers or fail to attract new customers if we are unable to attract and retain qualified personnel. 18 Our IT services business is labor-intensive, and our success depends in large part upon our ability to attract, develop, motivate and retain highly skilled personnel. Some of these individuals are in great demand and are likely to remain a limited resource for the foreseeable future. We may not be able to engage the services of such personnel or retain our current personnel. If we do not succeed in attracting new, qualified personnel or successfully retaining our current personnel, our IT services business will suffer. If our contracts with Citrix and other vendors of hardware components and software applications and hardware were terminated, our IT services business would be materially adversely affected. We depend on third-party suppliers to provide us with key hardware components and software applications in connection with our IT services business. If such contracts and relationships were terminated, our IT revenues would be negatively affected. Our stock price can be volatile. Our stock price, like that of other technology companies, can be volatile. For example, our stock price can be affected by many factors such as quarterly increases or decreases in our earnings; speculation in the investment community about our financial condition or results of operations and changes in revenue or earnings estimates, announcement of new products, technological developments, alliances, acquisitions or divestitures by us or one of our competitors or the loss of key management personnel. In addition, general macroeconomic and market conditions unrelated to our financial performance may also affect our stock price. Our prior use of Arthur Andersen LLP as our independent auditor may pose risks to us and limit our ability to seek potential recoveries from them related to their work. Our consolidated financial statements as of and for each of the three years in the period ended June 30, 2001 were audited by Arthur Andersen LLP (Andersen). On March 14, 2002, Andersen was indicted on federal obstruction of justice charges arising from the government's investigation of Enron Corporation. On June 15, 2002, a jury convicted Andersen of these charges. On July 23, 2002, we dismissed Andersen and retained KPMG LLP as our independent auditors for our fiscal year ended June 30, 2002. SEC rules require us to present historical audited financial statements in various SEC filings, such as registration statements, along with Andersen's consent to our inclusion of its audit report in those filings. Since our former engagement partner and audit manager have left Andersen and in light of the cessation of Andersen's SEC practice, we will not be able to obtain the consent of Andersen to the inclusion of its audit report in our relevant current and future filings. The SEC has provided regulatory relief designed to allow companies that file reports with the SEC to dispense with the requirement to file a consent of Andersen in certain circumstances, but purchasers of securities sold under our registration statements, which were not filed with the consent of Andersen to the inclusion of its audit report, will not be able to sue Andersen pursuant to Section 11(a)(4) of the Securities Act and, therefore, their right of recovery under that section may be limited as a result of the lack of our ability to obtain Andersen's consent. 19 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 the cost benefits and other advantages of the Company's products, the acquisition of businesses and technologies, and the availability of cash or other financing sources to fund future operations, cash expenditures and acquisitions, the enhancement of the Company's technology, the investment of significant resources in software development activities, the growth in the thin client market, and the development of new products. These forward-looking statements involve risks and uncertainties. The factors set forth below, and those 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, the economic viability of the Company's channel partners, changes in general economic conditions and risks associated with foreign operations and political and economic uncertainties associated with current world events. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Company earns interest income from its balances of cash and cash equivalents. This interest income is subject to market risk related to changes in interest rates which primarily affects the investment portfolio. The Company invests in instruments that meet high credit quality standards, as specified in its investment policy. As of December 31, 2002 and June 30, 2002, cash equivalents consisted primarily of certificates of deposit, commercial paper and money market funds maturing over the following three months. Due to the average maturity and conservative nature of the Company's investment portfolio, a sudden change in interest rates would not have a material effect on the value of the portfolio. Management estimates that if the average yield of the Company's investments decreased by 100 basis points, interest income for the three months ended December 31, 2002 would have decreased by less that $50,000. This estimate assumes that the decrease occurred on July 1, 2002 and reduced the yield of each investment instrument by 100 basis points. Item 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures. On a date that was within 90 days prior to the date of this Quarterly Report on Form 10-Q, the Company carried out an evaluation, under the supervision of the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company's disclosure controls and procedures. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that as of such date the Company's disclosure controls and procedures were effective to ensure that the information required to be disclosed by the Company in the reports it files or submits under the securities Exchange Act of 1934 is recorded, processed, summarized and reported in the periods specified in the SEC's rules and forms. (b) Changes in Internal Controls There have been no significant changes in the Company's internal controls or in other factors that could significantly affect those controls subsequent to the date of their evaluation. 20 PART II. OTHER INFORMATION Item 1. Legal Proceedings None. Item 4. Submission of Matters to a Vote of Security Holders On December 4, 2002, the Company held its Annual Meeting of Stockholders. The Stockholders voted to elect five members to the Board of Directors, to approve an amendment to the Company's 1995 Stock Option Plan to increase the number of shares issuable thereunder and to ratify the selection of KPMG LLP as the Company's independent accountants for the fiscal year ending June 30, 2003. Elected to the Board of Directors were Michael G. Kantrowitz (9,716,450 shares voted for election and 1,778,135 shares were withheld), John M. Ryan (11,440,326 shares voted for election and 54,259 shares were withheld), Christopher G. McCann (11,390,515 shares voted for election and 104,070 shares were withheld), John P. Kirwin, III (11,386,763 shares voted for election and 107,822 shares were withheld) and David D. Gathman (11,388,413 shares voted for election and 106,172 shares were withheld). The amendment of the 1995 Stock option Plan was approved with 8,939,073 shares voting in favor, 2,535,535 shares voting against and 19,977 shares abstaining. The selection of KPMG LLP as the Company's independent accountants was ratified with 11,328,085 shares voting in favor of ratification, 150,660 shares voting against ratification and 15,840 shares abstaining. Item 6. Exhibits and Reports on Form 8-K a. Exhibits The following exhibits are being filed as part of this quarterly report on Form 10-Q: Exhibit No. ----------- 10.1 Termination agreement dated November 1, 2002 between the Company and Anthony J. DePaul. 10.2 Employment Offer Letter dated December 9, 2002 between the Company and Eric Rubino. 10.3 Employment Offer Letter dated November 8, 2002 between the Company and Matthew Wrabley. 10.4 1995 Stock Option Plan, as amended through December 4, 2002 99.1 Certification of Michael Kantrowitz as Chairman, President and Chief Executive Officer of Neoware Systems, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of Vincent T. Dolan, Chief Financial Officer of Neoware Systems, Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 21 b. Reports on Form 8-K On December 9, 2002, the Company filed a Form 8-K relating to the Company's annual meeting of shareholders held on December 4, 2002. On October 31, 2002, the Company filed a Form 8-K relating to a press release announcing earnings for the three months ended September 30, 2002. On October 3, 2002, the Company filed a Form 8-K relating to a press release announcing the appointment of Michael G. Kantrowitz and the resignation of Arthur Spector as chairman of the Company's board of directors. 22 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, 2003 By: /S/ MICHAEL G. KANTROWITZ ----------------------------- Michael G. Kantrowitz Chairman, President and Chief Executive Officer Date: February 14, 2003 By: /S/ VINCENT T. DOLAN ------------------------ Vincent T. Dolan Chief Financial Officer 23 I, Michael G. Kantrowitz, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Neoware Systems, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 14, 2003 /s/Michael G. Kantrowitz ------------------------ Michael G. Kantrowitz Chairman, President and Chief Executive Officer (Principal Executive Officer) 24 I, Vincent T. Dolan, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Neoware Systems, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 14, 2003 /s/ Vincent T. Dolan -------------------- Vincent T. Dolan Chief Financial Officer (Principal Financial Officer) 25 EX-10 3 ex10-1.txt EXHIBIT 10.1 Exhibit 10.1 November 1, 2002 By Hand Delivery - ---------------- Anthony J. DePaul 204 Woods Road Glenside, Pennsylvania Re: Separation Agreement -------------------- Dear Tony: This letter is to confirm your termination of employment from Neoware Systems, Inc. (the "Company") effective December 15, 2002, your voluntary resignation from your position as Executive Vice President of North American Marketing and Sales of the Company effective as of the date hereof, and your agreement to remain as a non-officer employee of the Company for the period from November 1, 2002 until December 15, 2002 (the "Termination Date"). The parties acknowledge that you and the Company are parties to an Employment Agreement dated December 4, 2001 (the "Employment Agreement"), a copy of which is attached hereto. Except as set forth herein, the terms and conditions of the Employment Agreement shall remain in full force and effect. In an effort to provide you with certain benefits in addition to those provided in the Employment Agreement relating to your termination of employment, the Company proposes the following agreement ("Separation Agreement"), which includes a general release: 1. In consideration for your general release and your fulfillment of the various undertakings set forth in this Separation Agreement, the Company agrees as follows: (a) During the period from November 1, 2002 until December 15, 2002, the Company will employ you as a non-officer employee of the Company and will pay you your current base salary and benefits, at regular pay intervals and less taxes and other deductions required by law to be withheld. (b) The Company has previously granted to you options to acquire a total of 140,000 shares of the Company's common stock. Notwithstanding your release under paragraph 2(c) below, the Company acknowledges that the provisions of the Company's 1995 Stock Option Plan and your option agreement (including the vesting schedule until your termination of employment) will continue to apply to your options in accordance with the terms of the Plan and your option agreement. 26 (c) Subject to the terms and conditions of your Employment Agreement and this Separation Agreement, the Company agrees to provide to you the severance benefits pursuant to Sections 2(b)(iii) and 2(c)(i) of the Employment Agreement. 2. In consideration for the Company's promises in paragraph 1, and intending to be legally bound, you represent, warrant and agree as follows: (a) You agree that you hereby voluntarily resign as Executive Vice President of North American Marketing and Sales of the Company effective as of the date hereof. (b) Subject to paragraph 3, you agree that from and after November 1, 2002 until December 15, 2002 you will serve as an employee of the Company and will provide such services as may be reasonably requested by the Company. You agree that in such position, you will no longer be an officer of the Company. (c) By your signature on this Separation Agreement, you hereby fully and forever release and discharge the Company and its parents, affiliates and subsidiaries, including all predecessors and successors, assigns, officers, directors, trustees, employees, agents and attorneys, past and present ("the Released Parties"), from any and all claims, demands, liens, agreements, contracts, covenants, actions, suits, causes of action, obligations, controversies, debts, costs, expenses, damages, judgments, orders and liabilities, of whatever kind or nature, direct or indirect, in law, equity or otherwise, whether known or unknown, arising out of your employment by the Company or the termination thereof, including, but not limited to, any claims for relief or causes of action under Federal, state or local statute, ordinance or regulation regarding discrimination in employment and any claims, demands or actions based upon alleged wrongful or retaliatory discharge or breach or contract under any state or Federal law. This release shall include a release of all claims for attorneys' fees. You agree that this release specifically includes a release of any and all claims arising under the Age Discrimination in Employment Act of 1967, as amended ("ADEA"), and any state or local discrimination laws. You acknowledge that you are being given twenty-one (21) days in which to consider whether you wish to sign this Separation Agreement, including this release. Moreover, you agree that, once you sign the Separation Agreement, including this release, you shall then have seven (7) days in which to change your mind and revoke it (the "Revocation Period"). If you wish to revoke this release, you must send the revocation in writing by overnight mail to Vincent T. Dolan, Vice President-Finance and Administration, 400 Feheley Drive, King of Prussia, Pennsylvania 19406. (d) You acknowledge that your options to purchase 105,000 shares of the Company's common stock will be canceled upon your termination of employment on the Termination Date, or the cancellation of all of your options if you terminate your employment on or before December 9, 2002, and that you will have no further rights to such options. 27 (e) You shall not at any time after the date of this letter disparage or deprecate the Company or its affiliates or any of their officers, directors, employees, stockholders or principals, or any of their operations, assets, services, work product, character, motives or financial standing. Further, you agree to keep the terms and conditions of this Separation Agreement secret and confidential and not to disclose them voluntarily to any third party, except to the extent required by law, to enforce the Separation Agreement or to obtain confidential legal, tax or financial advice. You also agree to comply with each of the provisions of the Employment Agreement that survive the termination of such agreement, including but not limited to, Sections 4, 5, 6, 7 and 8 of the Employment Agreement, including the Non-Solicitation and Confidentiality Agreement attached thereto and incorporated therein. (f) You agree that you will return to the Company on the Termination Date all memoranda, notes, records, reports, manuals, drawings and other documents (and all copies thereof whether in written form or on computer disk or tape) relating to the business of the Company and/or its affiliates and all property associated therewith, which you possess or have under your control on the Termination Date. Without limiting the generality of the foregoing, you agree to return to the Company all copies of all data bases containing information about the Company and/or its affiliates, regardless of whether such information is in hard copy or stored electronically or on tape. You agree that on and after the Termination Date, you will not seek to access the information systems of the Company or its affiliates for any purpose whatsoever. 3. If you terminate your employment with the Company prior to December 15, 2002, your salary and benefits will terminate as of the date of your termination and your right to the payments under paragraph 1(c) above will commence on that date and terminate six months thereafter. In addition, you understand that if you terminate your employment on or before December 9, 2002, you will not be entitled to exercise any of your options to acquire any shares of the Company's common stock. 4. You acknowledge and agree that in order to receive the benefits under Section 2(c)(i) of the Employment Agreement, you are required, among other things, to execute a release substantially in the form of the release in paragraph 2(c) above, and that the benefits you will receive under paragraph 1 above exceed the money and benefits to which you otherwise would be entitled, and that such benefits are sufficient consideration to support the grant of the general release in paragraph 2(c) above and to support your other undertakings set forth in paragraph 2 above. More specifically, if you do not execute this Separation Agreement, which includes a general release, or if you revoke your acceptance, your employment will be deemed to be terminated on December 1, 2002 and you will only be entitled to receive the benefits which you are entitled to receive under Section 2(c)(i) of your Employment Agreement, and you will not be entitled to exercise any of the options to acquire shares of the Company's common stock. Further, if you do not execute this Separation Agreement or revoke your acceptance, and if you do not satisfy the requirements set forth in Section 2(d) of the Employment Agreement, including the execution of the release attached to the Employment Agreement as Exhibit B and expiration of the Revocation Period, you will not be entitled to receive any benefits under Section 2(c)(i) or hereunder. 28 5. Consistent with Company policy, and notwithstanding anything to the contrary in this Separation Agreement, you understand that your final regular paycheck will include payment for all accrued and unused vacation. 6. This Separation Agreement sets forth our complete understanding and agreement and supersedes all prior agreements between us, oral or written, express or implied, except for the Employment Agreement as attached hereto. 7. This Separation Agreement is being offered for the purpose of assisting you in your transition. This Separation Agreement should not be construed as an admission or concession of liability or wrongdoing by the Company or by you. 8. If any provision of this Separation Agreement is deemed unlawful or unenforceable by a court of competent jurisdiction, the remaining provisions shall continue in full force and effect. 9. By your execution of this Separation Agreement, your represent, warrant and agree to the following, each of which is material to the Company's willingness to enter into this Separation Agreement: (a) You have read carefully the terms of this Separation Agreement, including the general release. (b) You have had an opportunity to and have been encouraged to review this Separation Agreement, including the general release, with an attorney. (c) You understand the meaning and effect of the terms of this Separation Agreement, including the general release. (d) You were given sufficient time to determine whether you wished to enter into this Separation Agreement, including the general release. (e) The entry into and execution of this Separation Agreement, including the general release, is your own free and voluntary act without compulsion of any kind. (f) No promise or inducement not expressed herein has been made to you. 29 You have from November 1, 2002 through and including November 22, 2002 to consider this offer. You are encouraged to review this Separation Agreement with an attorney. If you agree with the proposed terms as set forth above, please sign this Separation Agreement indicating your understanding and agreement and the attached Acknowledgment of Rights under the Older Workers Benefit Protection Act and return them to me on or before the close of business on November 22, 2002. The additional copies are for your records. Please note that if you sign this Separation Agreement, you will retain the right to revoke it for seven (7) days. The Separation Agreement will not be effective until the Revocation Period has expired. To revoke the Separation Agreement, you must send a certified letter to my attention. This letter must be post-marked within seven (7) days of you execution of this Separation Agreement. If I do not receive a signed copy of this Separation Agreement by the close of business on November 22, 2002, I will assume that you have rejected this offer. If this offer is rejected, your employment shall nevertheless be deemed to have terminated effective December 1, 2002. 30 We wish you the best in the future. Sincerely, Neoware Systems, Inc By: /S/ Michael Kantrowitz ------------------------------ Name: Michael Kantrowitz Title: Chairman, President and Chief Executive Officer Understood and Agreed, intending to be legally bound: Anthony J. DePaul /S/ Anthony J. DePaul - --------------------- Date: November 1, 2002 Witness: /S/ Vincent T. Dolan 31 ACKNOWLEDGMENT OF RIGHTS UNDER ------------------------------ OLDER WORKERS BENEFIT PROTECTION ACT ------------------------------------ I, ANTHONY J. DEPAUL, acknowledge that I have read and understand the attached separation agreement and general release ("Separation Agreement"). I further understand that this Separation Agreement is revocable by me for a period of seven (7) days following execution thereof, and that this Separation Agreement shall not become effective or enforceable until this seven-day revocation period has ended. I am aware that federal, state and local laws prohibit discrimination against employees because of their race, color, religion, sex, age, national origin, veterans status and disability and that any employee who believes that he has been discharged or otherwise discriminated against for any of these reasons has a right to file a lawsuit in court or initiate other proceedings against the Released Parties and recover damages if it is proved that the Released Parties violated any one of these laws. I acknowledge that I have been encouraged to discuss the release language in the Separation Agreement with an attorney prior to executing the agreement and that I have thoroughly reviewed and understand the effect of the release. I further acknowledge that I have been given twenty-one (21) days in which to consider the Separation Agreement and that, if I sign the Separation Agreement before the end of the twenty-one day period, I am doing so freely, voluntarily and after having had full and fair opportunity to consult with my retained counsel. Anthony J. DePaul /S/ Anthony J. DePaul Date: November 1, 2002 - --------------------- 32 EX-10 4 ex10-2.txt EXHIBIT 10.2 [GRAPHIC OMITTED] Exhibit No. 10.2 November 15, 2002 Mr. Eric N. Rubino 3400 Greene Countrie Drive Newtown Square, PA 19073 Dear Eric: Neoware is pleased to offer you the position of Chief Operating Officer, reporting to me. In your capacity as COO, you will be responsible for Neoware's Operations, Engineering, Human Resources, Administration, and Product Marketing functions. The base salary for this position is $7692.31 payable every two weeks, and you will be eligible for four weeks of vacation annually. Because we believe that all employees should work toward the same goals and benefit from the Company's success, Neoware will grant to you options to purchase 140,000 shares of stock in the Company with an exercise price equal to the closing price on your date of hire, as detailed herein and in your Stock Option Agreement. These will consist of a combination of ISO and non-qualified options, which are ten-year options, and will vest over four years, with twenty-five percent of the options vesting on each of the first four anniversaries subsequent to your start date. As we discussed, we expect your first date of employment to be December 9, 2002. In addition to your base salary, you will be eligible for an executive bonus of up to $100,000 annually based upon the Company meeting its quarterly and annual revenue and profitability goals, as determined by Neoware's CEO and its Compensation Committee. This annual executive bonus amount can be doubled at the option of the Compensation Committee should the Company significantly exceed its goals. These goals may be adjusted from time to time at the discretion of the Company's CEO and Compensation Committee. You understand that this letter is not an employment agreement, and that you are an employee at will. This means that employment and compensation can be terminated with or without "cause," and with or without notice, at any time, at the option of either Neoware or you, except as otherwise provided by law. Should you not be offered employment, for any reason other than for "cause" (as defined below) by the Company's successor upon a "change in control" (as defined below) of the Company, (a) Neoware will continue to pay your base salary for a period of nine months from the date of termination and (b) your options to purchase 140,000 shares of Neoware Common Stock shall become fully exercisable. For the purposes of this offer letter, "cause" shall mean your termination only upon: (A) your continued neglect of such assigned duties and responsibilities as shall be consistent with the terms of this letter or your responsibilities after receipt of a written warning of specific deficiencies and your failure to cure said deficiencies within thirty (30) days; or (B) your engaging in willful misconduct which is demonstrably injurious to Neoware; or (C) your committing a felony or an act of fraud against or the misappropriation of property belonging to Neoware; or (D) your breaching in any material respect the terms of your Non-Solicitation Agreement and Confidentiality Agreement, and "change in control" shall have the meaning set forth in Section 14 of the Company's 1995 Stock Option Plan. A copy of the plan is attached hereto. 33 In connection with this offer of employment, you agree to sign Neoware's standard non-disclosure and non-solicitation agreement at the time of your acceptance of this offer, which is attached. We are very excited about the possibility of you joining Neoware as Chief Operating Officer, and believe that you'll be a great asset to the Company in this position as we continue to build our business Please feel free to contact me with any questions. Very truly yours, /S/Michael Kantrowitz - --------------------- Michael Kantrowitz Chairman, President and CEO Neoware Systems, Inc. Accepted: /S/Eric N. Rubino - ----------------- Eric N. Rubino Date: December 9, 2002 34 EX-10 5 ex10-3.txt EXHIBIT 10.3 [GRAPHIC OMITTED] Exhibit No. 10.3 November 8, 2002 Mr. Matthew D. Wrabley 602 Monticello Lane Kennett Square, PA 19348 Dear Matt: Neoware is pleased to offer you the position of Executive Vice President of Sales, reporting to me as of November 1, 2002. In your capacity as Executive Vice President of Sales, you will be responsible for sales of all Neoware products worldwide excluding EMEA, for business development, and for marketing communications. Your objectives will be to increase Neoware's revenue in order to meet or exceed our sales goals, to meet your expense goals for your department, and to meet or exceed our profitability goals. The base salary for this position is $6153.85 payable every two weeks, and you will be eligible for four weeks of vacation. Because we believe that all employees should work toward the same goals and benefit from the Company's success, on October 21, 2002, Neoware granted to you options to purchase 50,000 shares of stock in the Company with an exercise price equal to the closing price on that date, as detailed in your Stock Option Agreement. These non-qualified options are ten-year options, which will vest over four years, with twenty-five percent of the options vesting on each of your first four anniversaries, commencing on October 21, 2003. In addition to your base salary, you will be eligible for (i) a bonus of up to $20,000 quarterly based on US/ROW sales and based upon meeting your department expense goals, and (ii) an executive bonus of up to $40,000 annually based upon the Company meeting its quarterly and annual revenue and profitability goals, as determined by Neoware's CEO and its Compensation Committee. This annual executive bonus amount can be doubled at the option of the Compensation Committee should the Company significantly exceed its goals. These goals may be adjusted from time to time at the discretion of the Company's CEO and Compensation Committee. You understand that this letter is not an employment agreement, and that you are an employee at will. This means that employment and compensation can be terminated with or without "cause," and with or without notice, at any time, at the option of either Neoware or you, except as otherwise provided by law. Should your employment be terminated by the Company as a result of a "change in control" of the Company, Neoware will agree to continue to pay your base salary for a period of six months from the date of termination. For the purposes of this offer letter, "change in control" shall have the meaning set forth in Section 14 of the Company's 1995 Stock Option Plan. In exchange for this offer, you acknowledge that you have signed Neoware's standard non-disclosure and non-solicitation agreement. We are very excited about your contributions to the Company in your new position of Executive Vice President of Sales of Neoware, and believe that you'll be a great asset to the Company in this position as we build our business. 35 Please feel free to contact with any questions. Very truly yours, /S/Michael Kantrowitz - --------------------- Michael Kantrowitz Chairman, President and CEO Neoware Systems, Inc. Accepted: /S/Matthew D. Wrabley - --------------------- Matthew D. Wrabley Date: December 27, 2002 36 EX-10 6 ex10-4.txt EXHIBIT 10.4 Exhibit 10.4 1995 Stock Option Plan, As Amended (Adopted by the Board of Directors on November 29, 1994, as amended through December 4, 2002) PART I DEFINITIONS AND ADMINISTRATIVE MATTERS -------------------------------------- SECTION 1. Purpose; Definitions. -------------------- The purpose of the Neoware Systems, Inc.1995 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) "Disability" means permanent and total disability within the meaning of Section 22(e)(3) of the Code. (f) "Disinterested Person" shall have the meaning set forth in the Rules. (g) "Eligible Independent Contractor" means an independent contractor hired by the Company who is neither an Employee of the Company nor a Non-Employee Director. (h) "Employee" means any person, including a director, 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) "Incentive Stock Option" means any Stock Option intended to be and designated as an "Incentive Stock Option" within the meaning of Section 422 of the Code. (l) "Insider" means a Participant who is subject to Section 16 of the Exchange Act. 37 (m) "Non-Employee Director" means any member of the Board who is not an Employee of the Company and is not compensated for employment by a regular salary. (n) "Non-Qualified Stock Option" means any Stock Option that is not an Incentive Stock Option. (o) "Participant" means an Employee, officer, Non-Employee Director or Eligible Independent Contractor to whom an Option is granted pursuant to the Plan. (p) "Plan" means the Neoware Systems, Inc. 1995 Stock Option Plan, as hereinafter amended from time to time. (q) "Rules" means Rule 16(b)(3) and any successor provisions promulgated by the Securities and Exchange Commission under Section 16 of the Exchange Act. (r) "Securities Act" shall mean the Securities Act of 1933, as amended. (s) "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. (t) "Stock" means the Common Stock of the Company, par value $.001 per share. (u) "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. (v) "Subsidiary" means any corporation owned, in whole or in part, by the Company. SECTION 2. Administration. -------------- 2.1 Except as provided in Section 2.2, the portion of the Plan with respect to the grant of Options pursuant to Part II shall be administered by a Committee of not less than three Directors who shall be Disinterested Persons appointed by the Board and who shall serve at the pleasure of the Board; provided further, however, that, notwithstanding the foregoing, Part II of the Plan shall be administered by such number of Disinterested Persons as and to the extent required by the Rules. The Committee shall have the authority to grant pursuant to the terms of the Plan: Stock Options to Employees (including directors who are Employees) and officers 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 officers, directors (who are Employees) and other Employees of the Company, and the Eligible Independent Contractors to whom Stock Options may from time to time be granted hereunder; (ii) to determine whether and to what extent incentive Stock Options are to be granted hereunder; (iii) to determine the number of shares to be covered by each such award granted hereunder; (iv) 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; 38 (v) 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; (vi) 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 (vii) 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 The portion of the Plan with respect to the grant of Options to Non-Employee Directors pursuant to Part II shall be administered by the Board. The Board shall have the same authority with respect to the grant of Options to Non-Employee Directors under Part II to as is provided to the Committee pursuant to Section 2.1. 2.3 The portion of the Plan with respect to the grant of Options pursuant to Part III shall be administered by the Board. Grants of Stock Options under Part III of the Plan and the amount, price and timing of the awards to be granted will be automatic, as described in Part III hereof. All questions of interpretation of the Plan with respect to the grant of Options pursuant to Part III will be determined by the Board, and such determination shall, unless otherwise determined by the Board, be final and conclusive on all persons having any interest hereunder. 39 SECTION 3. Stock Subject to the Plan. ------------------------- 3.1 The aggregate number of shares of Stock that may be issued or transferred under the Plan is 3,000,000, subject to adjustment pursuant to Section 14.1 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 (taking into account the share counting requirements established under the Rules) equals the maximum number of shares of Stock authorized under the Plan, no further awards shall be made unless the Plan is amended in accordance with the Rules 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. 3.2 In any fiscal year of the Company, the maximum number of shares of Common Stock with respect to which Options may be granted to any Participant shall not exceed 5% of the Common Stock outstanding, as adjusted for stock splits, stock dividends or other similar changes affecting the Common Stock. SECTION 4. Designation of Participants. --------------------------- 4.1 Except as provided below, Participants under Part II of the Plan shall be selected, from time to time, by the Committee from among those Employees 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 and its Subsidiaries. Participants under Part II may also be selected from among those Non-Employee Directors who, in the opinion of the Board, have the capacity to devote themselves to the Company's success. 4.2 All Non-Employee Directors on the date of grant shall be eligible to receive Options under Part III of the Plan. PART II GRANTS TO EMPLOYEES AND ELIGIBLE INDEPENDENT CONTRACTORS -------------------------------------------------------- SECTION 5. Stock Options. ------------- Any Stock Option granted under Part II of the Plan shall be in such form as the Committee or the Board may from time to time approve. Stock Options granted under Part II of the Plan may be of two types: (i) Incentive Stock Options and (ii) Non-Qualified Stock Options. The Committee shall have the authority to grant Incentive Stock Options, Non-Qualified Stock Options or both types of Stock Options. To the extent that any Stock Option does not qualify as an Incentive Stock Option, it shall constitute a Non-Qualified Stock Option. The Board shall have the authority to grant Non-Qualified Stock Options to Non-Employee Directors under Part II. Anything in the Plan to the contrary notwithstanding, no term of this Plan relating to Incentive Stock Options shall be interpreted, amended or altered, nor shall any discretion or authority granted under the Plan be so exercised, so as to disqualify the Plan under Section 422 of the Code, or, without the consent of the Participant(s) affected, to disqualify any Incentive Stock Option under Section 422. 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: 40 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. Any Incentive Stock Option granted to any Participant who, at the time the Option is granted, owns more than 10% of the voting power of all classes of stock of the Company or of a Parent or Subsidiary corporation (within the meaning of Section 424 of the Code), shall have an exercise price no less than 110% of Fair Market Value per share on the date of the grant. 5.2 Option Term. The term of each Stock Option shall be fixed by the Committee or the Board, but no Stock Option shall be exercisable more than ten years after the date the Stock Option is granted. However, any Incentive Stock Option granted to any Participant who, at the time the Option is granted, owns more than 10% of the voting power of all classes of stock of the Company or of a Parent or Subsidiary corporation may not have a term of more than five years. 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. 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, (i) in the case of an Incentive Stock Option, the right to make a payment in the form of unrestricted Stock already owned by the Participant may be authorized only at the time the Option is granted and (ii) the Company may require that the Stock has been owned by the Participant for a minimum period of time specified by the Committee or the Board. In addition, if such unrestricted Stock was acquired through exercise of an Incentive Stock Option, such Stock shall have been held by the Participant for a period of not less than the holding period described in Section 422(a)(1) of the Code on the date of exercise, or if such Stock was acquired through exercise of a Non-Qualified Stock Option or of an option under a similar plan of the Company, such Stock shall have been held by the Participant for a period of more than one year on the date of exercise, and further provided that the Participant shall not have tendered Stock in payment of the exercise price of any other Option under the Plan or any other stock option plan of the Company within six calendar months of the date of exercise. 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. 41 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 expressly specify whether such Option is an Incentive Stock Option or a Non-Qualified Stock Option and 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 this part of 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. 5.7 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. In the event of termination of employment by reason of Disability, if an Incentive Stock Option is exercised after the expiration of the exercise periods that apply for purposes of Section 422 of the Code, such Stock Option will thereafter be treated as a Non-Qualified Stock Option. 42 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. 5.12 Incentive Stock Option Limitation. The aggregate Fair Market Value (determined as of the time of grant) of the Stock with respect to which Incentive Stock Options are exercisable for the first time by the Participant during any calendar year under the Plan and/or any other stock option plan of the Company shall not exceed $100,000. 5.13 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. 5.14 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. If Stock acquired under the exercise of an Incentive Stock Option is used to satisfy such withholding requirement, such Stock must have been held by the Participant for a period of not less than the holding period described in Section 422(a)(1) of the Code on the Determination Date. If Stock acquired through the exercise of a Non-Qualified Stock Option or of an option under a similar plan is delivered by the Participant to the Company to satisfy such withholding requirement, such Stock must have been held by the Participant for a period of more than one year on the Determination Date. For Participants subject to Section 16 of the Exchange Act, to the extent required by Section 16, the election to have Stock withheld by the Corporation hereunder must be either (a) an irrevocable election made six months before the Determination Date; or (b) an irrevocable election where both the election and the Determination Date occur during one of the ten-day periods beginning on the third business day following the date of release of the Company's quarterly or annual summary financial data and ending on the twelfth business day following such release. 43 5.15 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. 5.16 Termination of Non-Employee Directors Options. Section 11 of the Plan shall apply to the termination of Options granted to Non-Employee Directors under Part II. 5.17 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. 44 PART III GRANTS TO NON-EMPLOYEE DIRECTORS -------------------------------- SECTION 6. Grant of Options. ---------------- Options to purchase 10,000 shares of Common Stock, subject to adjustment as provided in Section 14.1 (the "Initial Options") and options to purchase 5,000 shares, subject to adjustments as provided in Section 14.1, (the "Annual Options"), shall be granted to Non-Employee Directors as follows: (a) Each Non-Employee Director on the 30th day after the stockholders of the Company have approved the Plan shall be granted an Initial Option. (b) Each Non-Employee Director who is not granted an Initial Option pursuant to Section 6(a), shall be granted an Initial Option on the first business day immediately following the date that such person is first elected or appointed to serve as a Non-Employee Director. (c) Each year on January 1, each Non-Employee Director on such date shall be granted an Annual Option. SECTION 7. Types of Options. ---------------- All options granted under Part III of the Plan shall be non-qualified Stock Options for purposes of the Code. SECTION 8. Option Price. ------------ The purchase price of each share of Stock issuable upon exercise of an Option will be equal to the Fair Market Value of the Stock on the date of grant. SECTION 9. Option Term and Rights to Exercise. ---------------------------------- 9.1 Period of Option and Rights to Exercise. Except as set forth herein, each Non-Employee Director who receives options under this Plan must continue to hold office as a Non-Employee Director of the Company for six months from the date that the Initial Option is granted and six months from the date each Annual Option is granted before he can exercise any part thereof. Thereafter, subject to the provisions of the Plan, options will vest and be exercisable as follows: (a) Initial Options. (i) Each Initial Option will vest and be exercisable in full six months from the date of grant. (ii) The right to exercise an Initial Option will expire on the fifth anniversary of the date on which the option was granted. (iii) Once an Initial Option has become exercisable, such option may be exercised in whole at any time or in part from time to time until the expiration of the option, whether or not any option granted previously to the Participant remains outstanding at the time of such exercise. 45 (b) Annual Options. (i) Each Annual Option will vest and be exercisable on a cumulative basis as to 2,500 shares beginning six months from the date of grant and 2,500 additional shares beginning on the first anniversary of the date of grant. (ii) The right to exercise an Annual Option will expire on the fifth anniversary of the date on which the Option was granted. (iii) Once each installment of an Annual Option has become exercisable, it may be exercised in whole at any time or in part from time to time until the expiration of the Option, whether or not an Option granted previously to the Participant remains outstanding at the time of such exercise. SECTION 10. Payment of Option Price. ----------------------- Payment or provision for payment of the purchase price shall be made as follows: (i) in cash or check; (ii) by exchange of Stock valued at its Fair Market Value on the date of exercise; (iii) by means of a cashless exercise procedure by the delivery to the Company of an exercise notice and irrevocable instructions to the Securities Broker to sell a sufficient number of shares of Stock to pay the purchase price of the shares of Common Stock as to which such exercise relates and to deliver promptly such amount to the Company; or (iv) by any combination of the foregoing. Where payment of the purchase price is to be made with shares of Stock acquired through exercise of a non-qualified Stock Option or of an option under a similar plan of the Company, such Stock shall have been held by the Participant for a period of more than one year on the date of exercise, and further provided that the Participant shall not have tendered Stock in payment of the exercise price of any other Option under the Plan or any other stock option plan of the Company within six calendar months of the date of exercise. SECTION 11. Termination of Service. ---------------------- Upon cessation of service as a Non-Employee Director (for reasons other than retirement or death), including cessation of service due to physical or mental disability that prevents such person from rendering further services as a Non-Employee Director, only those options exercisable at the date of cessation of service shall be exercisable by the Non-Employee Director. Such options shall be exercisable for a period of three months from cessation of service of the Non-Employee Director or the expiration of the Option, whichever period is shorter. Upon the retirement or death of a Non-Employee Director, options shall be exercisable as follows: (a) Retirement. Upon retirement as a Non-Employee Director after the Non-Employee Director has served for at least six consecutive years as a director, all Options shall continue to be exercisable during their terms as if such person had remained a Non-Employee Director. 46 (b) Death. In the event of the death of a Non-Employee Director while a member of the Board, or within the period after termination of service referred to in the first paragraph of Section 11, the Options granted to him shall be exercisable, to the extent then exercisable, for a period of one year from the date of the Non-Employee Director's death, or until the expiration of the Option, whichever period is shorter. SECTION 12. No Guaranteed Term of Office. ---------------------------- Nothing in this Plan or any modification thereof, and no grant of an option, or any term thereof, shall be deemed an agreement or condition guaranteeing to any Non-Employee Director any particular term of office or limiting the right of the Company, the Board or the stockholders to terminate the term of office of any Non-Employee Director under the circumstances set forth in the Company's Certificate of Incorporation or Bylaws, or as otherwise provided by law. SECTION 13. Other Restrictions. ------------------ Sections 5.5, 5.7 and 5.15 of the Plan shall apply to options granted pursuant to Part III of the Plan. PART IV MISCELLANEOUS ------------- SECTION 14. Adjustments Upon Changes in Capitalization, Merger or Change in Control. --------------------------------------------------------------- 14.1 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. 14.2 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. 14.3 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. 47 14.4 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 (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. At the time of grant of an Option, or if a Change in Control has occurred after the grant, the Committee may, in its discretion, provide on a case by case basis that upon a Change in Control 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. 48 SECTION 15. 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 the Rules. Except for awards made pursuant to Part III, 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. Except for awards made to Non-Employee Directors pursuant to Part III, 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 16. 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. SECTION 17. General Provisions. ------------------ 17.1 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. 17.2 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. 17.3 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 Independent Contractors at any time. 17.4 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. 49 17.5 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. 17.6 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. SECTION 18. Effective Date and Term of Plan. ------------------------------- The Plan shall be effective as of the effective date of the merger of Human Designed Systems, Inc. with and into ISAC Acquisition Co., a wholly-owned subsidiary of the Company (the "Effective Date"), subject to the consent or approval of the Company's stockholders as provided below. 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. If the Plan is not approved by a majority of the votes cast at a duly held meeting at which a quorum representing a majority of all outstanding voting stock of the Company is, either in person or by proxy, present and voting on the Plan, within 12 months after such effective date, any Incentive Stock Options that have been granted shall automatically become Non-Qualified Stock Options. SECTION 19. 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 20. 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 21. Compliance With The Rules. ------------------------- 21.1 Unless an Insider could otherwise transfer shares of Stock issued hereunder without incurring liability under Section 16(b) of the Exchange Act, at least six months must elapse from the date of grant of an Option to the date of disposition of the Stock issued upon exercise of such Option. 21.2 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. 50 21.3 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 and, provided further, such waiver or amendment is carried out in accordance with Section 6 hereof. 51 EX-99 7 ex99-1.txt EXHIBIT 99.1 Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with Quarterly Report of Neoware Systems, Inc. (the "Company") on Form 10-Q for the quarter ended December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Michael Kantrowitz, Chairman, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /S/ Michael Kantrowitz - ---------------------- Michael Kantrowitz Chairman, President and Chief Executive Officer February 14, 2003 52 EX-99 8 ex99-2.txt EXHIBIT 99.2 Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Neoware Systems, Inc. (the "Company") on Form 10-Q for the quarter ended December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Vincent T. Dolan, Vice President - Finance and Administration of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /S/ Vincent T. Dolan - -------------------- Vincent T. Dolan Chief Financial Officer (Principal Financial Officer) February 14, 2003 53 -----END PRIVACY-ENHANCED MESSAGE-----