-----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, IEO8nyhRzGcfqalvy6y6rtG7bGeJTJtzVFFQNPiWpI/QGkPer6ShcjXk/s6jaVee aZ0m8RumZe5fH4q90eNtpQ== 0000950116-04-003288.txt : 20041108 0000950116-04-003288.hdr.sgml : 20041108 20041108134118 ACCESSION NUMBER: 0000950116-04-003288 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20040930 FILED AS OF DATE: 20041108 DATE AS OF CHANGE: 20041108 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: 041125090 BUSINESS ADDRESS: STREET 1: 400 FEHELEY DR CITY: KING OF PRUSSIA STATE: PA ZIP: 19406 BUSINESS PHONE: 6102778300 MAIL ADDRESS: STREET 1: 400 FEHELEY DR CITY: KING OF PRUSSIA STATE: PA ZIP: 19406 FORMER COMPANY: FORMER CONFORMED NAME: HDS NETWORK SYSTEMS INC DATE OF NAME CHANGE: 19950313 FORMER COMPANY: FORMER CONFORMED NAME: INFORMATION SYSTEMS ACQUISITION CORP DATE OF NAME CHANGE: 19930108 10-Q 1 tenq.txt 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 SEPTEMBER 30, 2004 [ ] 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] As of November 5, 2004, there were 15,721,161 outstanding shares of the Registrant's Common Stock. - -------------------------------------------------------------------------------- NEOWARE SYSTEMS, INC. INDEX
PART I. FINANCIAL INFORMATION PAGE ---- Item 1. Consolidated Financial Statements Condensed Consolidated Balance Sheet as of September 30, 2004 and June 30, 2004................3 Consolidated Statement of Operations for the Three Months Ended September 30, 2004 and 2003............................................................4 Consolidated Statement of Cash Flows for the Three Months Ended September 30, 2004 and 2003............................................................5 Notes to Consolidated Financial Statements.....................................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................................................................11 Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................25 Item 4. Controls and Procedures.......................................................................25 PART II. OTHER INFORMATION Item 6. Exhibits......................................................................................25 Signatures...............................................................................................26
NEOWARE SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share data) (Unaudited)
SEPTEMBER 30, JUNE 30, ASSETS 2004 2004 ------------- ---------- Current assets: Cash and cash equivalents................................. $ 12,473 $ 17,119 Short-term investments..................................... 38,709 38,177 Accounts receivable, net................................... 10,814 10,580 Inventories................................................ 1,708 795 Prepaid expenses and other................................. 1,522 1,628 Deferred income taxes...................................... 643 643 --------- ---------- Total current assets ...................................... 65,869 68,942 Property and equipment, net..................................... 464 509 Goodwill........................................................ 21,202 17,466 Intangibles, net................................................ 3,267 3,545 Deferred income taxes........................................... 145 145 --------- ---------- $ 90,947 $ 90,607 ========= ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 4,050 $ 5,685 Accrued compensation and benefits.......................... 1,237 1,534 Other accrued expenses..................................... 1,475 1,071 Income taxes payable....................................... 1,293 854 Deferred revenue........................................... 656 739 --------- ---------- Total current liabilities............................... 8,711 9,883 Deferred revenue................................................ 266 235 --------- ---------- Total liabilities....................................... 8,977 10,118 --------- ---------- Stockholders' equity: Preferred stock............................................ - - Common stock............................................... 16 16 Additional paid-in capital................................. 71,807 71,718 Treasury stock, 100,000 shares at cost..................... (100) (100) Accumulated other comprehensive income..................... 941 936 Retained earnings.......................................... 9,306 7,919 --------- ---------- Total stockholders' equity.............................. 81,970 80,489 --------- ---------- $ 90,947 $ 90,607 ========= ==========
See accompanying notes to consolidated financial statements. 3 NEOWARE SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (Unaudited)
THREE MONTHS ENDED SEPTEMBER 30, --------------------------- 2004 2003 --------- --------- Net revenues........................................... $ 16,303 $ 15,013 Cost of revenues....................................... 9,213 7,049 --------- --------- Gross profit...................................... 7,090 7,964 --------- --------- Sales and marketing.................................... 3,102 2,965 Research and development............................... 664 721 General and administrative............................. 1,358 1,457 --------- --------- Operating expenses................................ 5,124 5,143 --------- --------- Operating income.................................. 1,966 2,821 Foreign exchange loss.................................. (23) - Interest income, net................................... 159 83 --------- --------- Income before income taxes........................ 2,102 2,904 Income taxes........................................... 715 1,041 --------- --------- Net income............................................. $ 1,387 $ 1,863 ========= ========= Earnings per share: Basic............................................. $ 0.09 $ 0.12 ========= ========= Diluted........................................... $ 0.09 $ 0.12 ========= ========= Weighted average number of common shares outstanding: Basic............................................. 15,799 15,445 ========= ========= Diluted........................................... 16,136 16,200 ========= =========
See accompanying notes to consolidated financial statements. 4 NEOWARE SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, except per share data) (Unaudited)
THREE MONTHS ENDED SEPTEMBER 30, ------------------------------- 2004 2003 ---------- ---------- Cash flows from operating activities: Net income................................................................... $ 1,387 $ 1,863 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation............................................................... 64 72 Amortization of intangibles................................................ 271 187 Stock option benefit on deferred income taxes.............................. 20 - Changes in operating assets and liabilities, net of effect from acquisition: Accounts receivable........................................................ (233) 1,397 Inventories................................................................ (913) (790) Prepaid expenses and other................................................. 107 46 Accounts payable........................................................... (1,636) (2,263) Accrued compensation and benefits.......................................... (297) (292) Other accrued expenses..................................................... 407 216 Income taxes payable....................................................... 439 735 Deferred revenue........................................................... (52) 139 ---------- ---------- Net cash (used in) provided by operating activities...................... (436) 1,310 ---------- ---------- Cash flows from investing activities: Purchase of the Visara thin client business.................................. (3,774) - Purchase of the TeemTalk software business................................... - (9,963) Purchases of short-term investments.......................................... (17,900) (16,209) Sales of short-term investments.............................................. 17,368 982 Purchase of intangible assets................................................ - (125) Purchases of property and equipment.......................................... (19) (80) ---------- ---------- Net cash used in investing activities.................................... (4,325) (25,395) ---------- ---------- Cash flows from financing activities: Repayments of capital leases................................................. (3) (2) Proceeds from issuance of common stock, net of expenses...................... - 24,609 Exercise of stock options and warrants....................................... 69 737 ---------- ---------- Net cash provided by financing activities................................ 66 25,344 ---------- ---------- Effect of foreign exchange rate changes on cash................................. 49 13 ---------- ---------- Increase (decrease) in cash and cash equivalents............................. (4,646) 1,272 Cash and cash equivalents, beginning of period.................................. 17,119 26,014 ---------- ---------- Cash and cash equivalents, end of period..................................... $ 12,473 $ 27,286 ========== ========== Supplemental disclosures: Cash paid for income taxes.................................................. $ 31 $ 264 Cash paid for interest...................................................... 2 4
See accompanying notes to consolidated financial statements. 5 NEOWARE SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENT NOTE 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 for interim financial statements. These statements, while unaudited, reflect all normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the consolidated financial statements. The results for the interim periods presented are not necessarily indicative of the results that may be expected for any future period. Certain information and footnote disclosures included in financial statements have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements. The consolidated financial statements included in this Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended June 30, 2004, filed with the Securities and Exchange Commission on September 13, 2004. NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS In February 2004, the Financial Accounting Standards Board (FASB) issued Emerging Issues Task Force (EITF) Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This EITF was issued to determine the meaning of other-than-temporary impairment and its application to investments in debt and equity securities within the scope of Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. This impairment accounting guidance is effective for reporting periods beginning after June 15, 2004 and the disclosure requirements for annual reporting periods ending after June 15, 2004. The adoption of this Interpretation did not have any impact on the Company's financial statements. NOTE 3. STOCK-BASED COMPENSATION The Company applies Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations for stock options and other stock-based awards while disclosing pro forma net income and earnings per share as if the fair value method had been applied in accordance with SFAS No. 123, "Accounting for Stock-based Compensation" and SFAS No. 148, "Accounting for Stock Based Compensation Transition and Disclosure." Had compensation cost been recognized consistent with SFAS No. 123 and SFAS No. 148, the Company's consolidated net income and earnings per share would have been as follows (in thousands, except share and per share data): THREE MONTHS ENDED SEPTEMBER 30, ------------------ 2004 2003 ------- ------- Net income: As reported............................................ $ 1,387 $ 1,863 Less: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of tax................................... (639) (661) ------- ------- Pro forma.............................................. $ 748 $ 1,202 ======= ======= Basic earnings per share: As reported............................................ $ 0.09 $ 0.12 ------- ------- Pro forma.............................................. $ 0.05 $ 0.08 ------- ------- Diluted earnings per share: As reported............................................ $ 0.09 $ 0.12 ------- ------- Pro forma.............................................. $ 0.05 $ 0.07 ------- ------- The fair value of the Company's stock-based awards to employees was estimated at the date of grant using the Black-Scholes option pricing model, assuming an estimated life of five to ten years, no dividends, volatility of 70% - - 126%, and risk-free interest rates of 2.1% - 6.8%. 6 NOTE 4. BUSINESS COMBINATION On September 22, 2004, the Company acquired the thin client business from Visara International, Inc. (referred to as the "Visara business"), for $3.8 million in cash, including transaction costs. The Company acquired substantially all of the assets of the Visara business, including primarily customer lists, intellectual property and technology, and also entered into reseller, supplier and non-competition agreements. The acquisition was accounted for using the purchase method of accounting. The Company has not completed the allocation of the purchase price for this acquisition. The allocation of the purchase price will be adjusted once the final valuation of assets acquired is completed. The results of operations of the Visara business have been included in the Company's statements of operations from the date of the acquisition. The following unaudited pro forma information presents the results of the Company's operations as though the acquisition had been completed as of July 1, 2003. The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the actual results of operations had the acquisition been completed as of July 1, 2003 or the results that may occur in the future (in thousands, except per share data): THREE MONTHS ENDED SEPTEMBER 30, ------------------------ 2004 2003 --------- --------- Total net revenue..................... $ 17,654 $ 17,098 Net income............................ 1,391 1,864 Basic earnings per share.............. 0.09 0.12 Diluted earnings per share............ 0.09 0.12 NOTE 5. GOODWILL AND INTANGIBLE ASSETS The carrying amount of goodwill was $21.2 million and $17.5 million at September 30, 2004 and June 30, 2004, respectively. The increase in goodwill is due to the acquisition of the Visara business (See Note 4) and the impact of changes in foreign exchange rates. The Company has not yet completed the allocation of the purchase price from the acquisition of the Visara business. Intangible assets with finite useful lives are amortized over their respective estimated useful lives. The following table provides a summary of the Company's intangible assets (in thousands):
SEPTEMBER 30, 2004 --------------------------------------------------------- Estimated Gross Carrying Accumulated Net Useful Life Amount Amortization Carrying Amount ----------- -------------- ------------ --------------- Tradenames................. Indefinite $ 259 $ -- $ 259 Customer relationships..... 2 years 543 317 226 Distributor relationships.. 5 years 2,325 1,265 1,060 Acquired technology........ 5-10 years 2,245 523 1,722 ---------- --------- --------- $ 5,372 $ 2,105 $ 3,267 ========== ========= ========= JUNE 30, 2004 --------------------------------------------------------- Estimated Gross Carrying Accumulated Net Useful Life Amount Amortization Carrying Amount ----------- -------------- ------------ --------------- Tradenames................. Indefinite $ 259 $ -- $ 259 Customer relationships..... 2 years 546 273 273 Distributor relationships.. 5 years 2,325 1,149 1,176 Acquired technology........ 5-10 years 2,253 416 1,837 ---------- --------- --------- $ 5,383 $ 1,838 $ 3,545 ========== ========= =========
7 The amortization expense of intangible assets is set forth below (in thousands): THREE MONTHS ENDED SEPTEMBER 30, -------------------- 2004 2003 ------- ------- Customer relationships.......... $ 69 $ -- Distributor relationships....... 116 110 Acquired technologies........... 86 77 ------- ------- $ 271 $ 187 ======= ======= Amortization expense for customer relationships and distributor relationships is included in sales and marketing expenses and amortization expense for acquired technologies is included in cost of revenues. The following table provides estimated future amortization expense related to intangible assets (assuming there is no write down associated with these intangible assets causing an acceleration of expense) (in thousands): FUTURE YEAR ENDING JUNE 30, AMORTIZATION - ------------------------------------------ --------------- Remainder of fiscal 2005................ $ 832 2006.................................... 782 2007.................................... 532 2008.................................... 342 2009.................................... 395 2010 through 2013....................... 125 -------- $ 3,008 ======== NOTE 6. COMPREHENSIVE INCOME Excluding net income, the Company's sources of other comprehensive income (loss) are unrealized income (loss) relating to foreign exchange rate fluctuations. The following summarizes the components of comprehensive income (in thousands): THREE MONTHS ENDED SEPTEMBER 30, -------------------- 2004 2003 -------- ------- Net income........................................ $ 1,387 $ 1,863 Foreign currency translation adjustment........ 5 (13) ------- ------- Comprehensive income.............................. $ 1,392 $ 1,850 ======= ======= NOTE 7. REVENUE RECOGNITION Net revenues included sales of thin client appliance systems, which include the appliance device and related software, and services. The Company follows AICPA Statement of Position No. 97-2, "Software Revenue Recognition" ("SOP 97-2") for revenue recognition because the software component of the thin client appliance systems is more than incidental to the thin client appliance systems as a whole. These products and services are sold either separately or as part of a multiple-element arrangement. Revenue is recognized on product sales when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable and collectibility is probable. Revenue related to post-contract support services is generally recognized with the initial product sale when the fee is included with the initial product fee, post-contract services are for one year or less, the estimated cost of providing such services during the arrangement is insignificant, and unspecified upgrades and enhancements offered during the period historically have been and are expected to continue to be minimal and infrequent. Otherwise, revenue from extended warranty and post-contract support service contracts is recorded as deferred revenue and subsequently recognized over the term of the contract. 8 Revenue from consulting and training services is recognized upon performance. Stock rotation rights and price protection are provided to certain distributors. Stock rotation rights are generally limited to a maximum amount per quarter and require a corresponding order of equal or greater value at the time of the stock rotation. Price protection provides for a rebate in the event the Company reduces the price of products which the distributors have yet to sell to end-users. The Company reserves for these arrangements based on historical experience and the level of inventories in the distribution channel and reduces current period revenue accordingly. Product warranty costs are accrued at the time the related revenues are recognized. NOTE 8. MAJOR CUSTOMERS AND DEPENDENCE ON SUPPLIERS For the three months ended September 30, 2004 and 2003, sales directly to IBM accounted for 15% and 16% of net revenues, respectively. IBM resells the Company's products to individual resellers and/or end-users. Accounts receivable from IBM as of September 30, 2004 and 2003 was $856,000 and $938,000, respectively. The percentage of revenue derived from IBM, individual distributors, resellers or end-users can vary significantly from quarter to quarter. In addition to the Company's direct sales to IBM, IBM can purchase the Company's products through individual distributors and/or resellers. Furthermore, IBM can influence an end-user's decision to purchase the Company's products even though the end-user may not purchase the Company's products through IBM. While it is difficult to quantify the net revenues associated with these purchases the Company believes that these sales could be significant and can vary significantly from quarter to quarter. For the three months ended September 30, 2004 and 2003 revenues from Europe, the Middle East and Africa, based on the location of the Company's primary selling activities with its customers accounted for 31% and 36% of net revenues. Sales to the United Kingdom accounted for 18% of net revenue for the three months ended September 30, 2004. No single international region accounted for more than 10% of net revenue for the three months ended September 30, 2003. The Company depends upon several sole source suppliers for its thin client appliance products and for several of the components in them. One of the Company's suppliers who supplies a sbustantial portion of the company's thin client products has informed the Company that it is experiencing cash liquidity constraints and is evaluating and undertaking financial restructuring actions. As a result, the Company has agreed to accommodate the supplier by purchasing products for inventory in advance of our contractual obligations and the Company anticipates continuing this practice until such time as the supplier's cash liquidity situation is resolved. Accordingly, inventory levels may increase and the Company's cash balances may decrease, although the Company's management does not believe that such changes would have a material adverse impact on its financial condition. In the event that the supplier is unable to resolve its cash liquidity constraints, the Company could face an interruption in the supply of a substantial portion of its products. Although the Company has identified alternative suppliers that could produce comparable products, it is likely there would be an interruption of supply during any transition which would limit the Company's ability to ship product to fully meet customer demand. If this were to happen, the Company's revenue would decline and its profitability would be adversely impacted. The Company also depends on limited sources to supply several other industry standard components and relies on foreign suppliers which subject the Company 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 the Company for its components. NOTE 9. INVENTORIES Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method and consists of the following (in thousands): SEPTEMBER 30, JUNE 30, 2004 2004 ------- ------- Purchased components and subassemblies.... $ 344 $ 234 Finished goods............................ 1,364 561 ------- ------- $ 1,708 $ 795 ======= ======= 9 NOTE 10. 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 on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. NOTE 11. LINE OF CREDIT The Company has a line of credit agreement with a bank, which provides for borrowing up to $2.0 million subject to certain limitations, as defined. The line of credit matures on December 31, 2004. Borrowings under the credit agreement bear interest at the Libor Market Index rate plus 2.5% (4.34% at September 30, 2004). At September 30, 2004 and 2003, $2.0 million was available for borrowing under the line. During the three months ended September 30, 2004 and 2003, there were no borrowings under the line. The line of credit is unsecured and requires the Company to maintain a minimum balance of $3.0 million in cash and cash equivalents with the bank. The Company is in compliance with this condition at September 30, 2004. NOTE 12. EARNINGS PER SHARE The Company applies SFAS No. 128, "Earnings per Share," which 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 net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from the exercise or conversion of securities into common stock, such as stock options and warrants. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except share and per share data): THREE MONTHS ENDED SEPTEMBER 30, ------------------ 2004 2003 -------- -------- Net income...................................... $ 1,387 $ 1,863 ======== ======== Weighted average shares outstanding: Basic........................................ 15,799 15,445 Effect of dilutive employee stock options.... 337 749 Effect of dilutive warrants.................. -- 6 -------- -------- Diluted...................................... 16,136 16,200 ======== ======== Earnings per common share: Basic........................................ $ 0.09 $ 0.12 ======== ======== Diluted...................................... $ 0.09 $ 0.12 ======== ======== For the three months ended September 30, 2004 and 2003, an aggregate of 1,177 and 34, respectively, of stock options and warrants were excluded from the calculation of dilutive earnings per share because their inclusion would have been anti-dilutive. NOTE 13. GUARANTEES INDEMNIFICATIONS In the ordinary course of business, from time-to-time the Company enters into contractual arrangements under which it may agree to indemnify its customer for losses incurred by the customer or supplier arising from certain events as defined within the particular contract, which may include, for example, litigation or intellectual property infringement claims. The Company has not identified any losses that are probable under these provisions and, accordingly, no liability related to these indemnification provisions has been recorded. 10 WARRANTY The Company provides for the estimated cost of product warranties at the time it recognizes revenue. The Company actively monitors and evaluates the quality of its component suppliers; however, ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure, affect the estimated warranty obligation. If actual product failure rates, material usage or service delivery costs differ from estimates, revisions to the estimated warranty liability would be required. The Company's standard warranty service period ranges from one to three years. The changes in the Company's warranty liability during the first quarter of fiscal 2005 is as follows (in thousands): Accrued warranty cost at June 30, 2004 $ 264 Settlements made (39) Provisions for warranties 71 --------- Accrued warranty cost at September 30, 2004 $ 296 ========= NOTE 14. RELATED PARTY TRANSACTIONS For the quarter ended September 30, 2004 and 2003, the Company had sales of $8,000 and $113,000, respectively to a customer of which one of the Company's directors is an executive officer and director. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. OVERVIEW We provide software, services and solutions to enable thin client appliance computing, which is a computing architecture targeted at business customers as an easier to manage, more secure, more reliable, and more cost-effective solution than traditional PC-based, client server computing. Our software and management tools secure, power and manage a new generation of smart thin client appliances that utilize the benefits of open, industry-standard technologies used in the PC industry to create new alternatives to full-function personal computers and green screen terminals used in business. Our software runs on thin client appliances and personal computers, and enables these devices to be secured and centrally managed, as well as to connect to mainframes, midrange, UNIX, Linux and host systems. We generate revenues primarily from sales of thin client appliance systems, which include the appliance device and related software marketed under the brand names Eon and Capio, and to a lesser extent from ThinPC thin client software for PCs, TeemTalk host access software for servers and PCs, ezRemote Manager central management software, and services such as training and integration. We sell our products and services worldwide through our direct sales force, distributors, our alliance with IBM and other indirect channels, such as resellers and systems integrators. Our international sales are primarily made through distributors and resellers and are collectible primarily in US dollars, while the associated operating expenses are payable in foreign currencies. In addition to our headquarters in the United States, we maintain offices in the UK, Germany, France, Austria, Sweden, Australia, and the Netherlands. Revenues from Europe, the Middle East and Africa, based on the location of our primary selling activities with our customers, were as follows: THREE MONTHS ENDED SEPTEMBER 30, (in thousands) ---------------------- 2004 2003 % CHANGE -------- -------- --------- International revenues $ 5,034 $ 5,425 (7)% Percentage of net revenues 31% 36% 11 STRATEGY The market for thin client appliances is part of the enterprise personal computers (PC) market. We market our thin client appliances as alternatives to PCs in certain target markets. Our strategies are to focus on increasing sales to large enterprise customers, primarily through our relationship with IBM, and secondarily through other resellers and directly to end-users, and to execute marketing initiatives designed to grow the thin client segment of the PC industry. We expect that the combination of these actions, including the introduction of new products, will result in increased revenues with overall gross profit margins in approximately the 40% to 45% range in fiscal 2005. We expect to continue to grow the company organically and through acquisitions. Our acquisition strategy is focused on acquiring businesses with products that can be sold through our existing channels to the same end user customers, leveraging our existing organization. In September 2004, we completed the acquisition of Visara International's thin client business, which added products that allow IBM systems, including Linux-based thin client solutions, to connect to mainframes and midrange systems and access to the Visara customer base. We will continue to evaluate strategic acquisitions and partnerships in the future. FINANCIAL HIGHLIGHTS Net revenue, gross profit margin and earnings per share are key measurements of our financial results. For the first quarter of fiscal 2005, net revenue was $16.3 million, an increase of 9% from the same period in fiscal 2004, the result of organic growth plus revenue from the acquisition of the Visara business. Gross profit margins were 43% in the first quarter of fiscal 2005 as compared to 53% in the same period in fiscal 2004. Diluted earnings per share were $0.09 in the first quarter of fiscal 2005, compared to $0.12 in the same period in fiscal 2004, primarily because of lower gross profit margins resulting from our strategy to compete more effectively with personal computers. We have a significant balance of cash and short-term investments. As of September 30, 2004, our cash, cash equivalents and short- term investments were $51.2 million, compared to $55.3 million at June 30, 2004, which represented approximately 77% of tangible assets. We used $3.8 million in the first quarter of fiscal 2005 to acquire the Visara business. We anticipate that in upcoming periods we will have lower cash balances, primarily as a result of lowering our accounts payable to vendors. We utilize cash in ways that our management believes provides an optimal return on investment. Cash has principally been used to acquire businesses. One of our suppliers who provides a substantial portion of our products has informed us that it is experiencing cash liquidity constraints and is evaluating and undertaking financial restructuring actions. As a result, we have agreed to accommodate the supplier by purchasing products for inventory in advance of our contractual obligations and we anticipate continuing this practice until such time as the supplier's cash liquidity situation is resolved. Accordingly, inventory levels may increase and our cash balances may decrease, although management does not believe that such changes would have a material adverse impact on our financial condition. In the event that the supplier is unable to resolve its cash liquidity constraints, we could face an interruption in the supply of a substantial portion of our products. Although we have identified alternative suppliers that could produce comparable products, it is likely there would be an interruption of supply during any transition which would limit our ability to ship product to fully meet customer demand. If this were to happen, our revenue would decline and our profitability would be adversely impacted. CRITICAL ACCOUNTING POLICIES AND ESTIMATES We believe that there are several accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenue and other significant areas that involve management's judgments and estimates. These critical accounting policies and estimates include: o Revenue recognition o Valuation of long-lived and intangible assets and goodwill o Accounting for income taxes These policies and estimates and our procedures related to these policies and estimates are described in detail below and under specific areas within the discussion and analysis of our financial condition and results of operations. Please refer to Note 1, "Organization and Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended June 30, 2004 for further discussion of the Company's accounting policies and estimates. 12 REVENUE RECOGNITION We make significant judgments related to revenue recognition. For each type of arrangement, we make significant judgments regarding the fair value of multiple elements contained in our arrangements, judgments regarding whether fees are fixed or determinable, judgments regarding whether collectibility is probable, and judgments related to accounting for potential distributor stock rotation rights and price protection. These judgments, and their effect on revenue recognition, are discussed below. Multiple Element Arrangements Net revenues include sales of thin client appliance systems, which include the appliance device and related software, maintenance and technical support. We follow AICPA Statement of Position No. 97-2, "Software Revenue Recognition" ("SOP 97-2"), for revenue recognition because the software component of the thin client appliance system is more than incidental to the thin client appliance systems as a whole. These products and services are sold either separately or as part of a multiple-element arrangement. Revenue is recognized on product sales when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable and collectibility is probable. Revenue related to post-contract support services is generally recognized with the initial product sale when the fee is included with the initial product fee, post-contract services are for one year or less, the estimated cost of providing such services during the arrangement is insignificant, and unspecified upgrades and enhancements offered during the period historically have been and are expected to continue to be minimal and infrequent. Otherwise, revenue from extended warranty and post-contract support service contracts is recorded as deferred revenue and subsequently recognized over the term of the contract. The Fee is Fixed or Determinable We make judgments at the outset of an arrangement regarding whether the fees are fixed or determinable. The majority of our payment terms are within 30 to 60 days after invoice date. We review arrangements that have payment terms extending beyond 60 days on a case-by-case basis to determine if the fee is fixed or determinable. If we determine at the outset of an arrangement that the fees are not fixed or determinable, we recognize revenue as the fees become due and payable. Collection is Probable We make judgments at the outset of an arrangement regarding whether collection is probable. Probability of collection is assessed on a customer-by-customer basis. We typically sell to customers with whom we have had a history of successful collections. New customers are subjected to a credit review process to evaluate the customer's financial position and ability to pay. If we determine at the outset of an arrangement that collection is not probable, revenue is recognized upon receipt of payment. Stock Rotation Rights and Price Protection We provide certain distributors with stock rotation rights and price protection. Stock rotation rights are generally limited to a maximum amount per quarter and require a corresponding order of equal or greater value at the time of the stock rotation. We provide price protection as a rebate in the event that we reduce the price of products that our distributors have yet to sell to end-users. We estimate potential stock rotation and price protection claims based on historical experience and the level of inventories in the distribution channel and reduce current period revenue accordingly. If we cannot reasonably estimate claims related to stock rotations and price protection at the outset of an arrangement, we recognize revenue when the claims can be reasonably estimated. VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL In connection with acquisitions, we allocate portions of the purchase price to intangible assets, consisting of acquired technology, distributor and customer relationships and tradenames based on independent appraisals received after each acquisition, with the remainder allocated to goodwill. We assess the realizability of goodwill and intangible assets with indefinite useful lives pursuant to SFAS No. 142, Goodwill and Other Intangible Assets. We are required to perform a SFAS No. 142 impairment test annually, or sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable. We have determined that the reporting unit level is our sole operating segment. The test for goodwill is a two-step process: 13 First, we compare the carrying amount of our reporting unit, which is the book value of the entire Company, to the fair value of our reporting unit. If the carrying amount of our reporting unit exceeds its fair value, we have to perform the second step of the process. If not, no further testing is needed. If the second part of the analysis is required, we allocate the fair value of our reporting unit to all assets and liabilities of our reporting units as if the reporting unit had been acquired in a business combination at the date of the impairment test. We then compare the implied fair value of our reporting unit's goodwill to its carrying amount. If the carrying amount of our reporting unit's goodwill exceeds its fair value, we recognize an impairment loss in an amount equal to that excess. We review our long-lived assets, including amortizable intangibles, for impairment when events indicate that their carrying amount may not be recoverable in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. When we determine that one or more impairment indicators are present for an asset, we compare the carrying amount of the asset to net future undiscounted cash flows that the asset is expected to generate. If the carrying amount of the asset is greater than the net future undiscounted cash flows that the asset is expected to generate, we compare the fair value to the book value of the asset. If the fair value is less than the book value, we recognize an impairment loss. The impairment loss is the excess of the carrying amount of the asset over its fair value. Some of the events that we consider as impairment indicators for our long-lived assets, including goodwill, are: o Significant underperformance of the company relative to expected operating results; o Our net book value compared to our market capitalization; o Significant adverse economic and industry trends; o Significant decrease in the market value of the asset; o The extent that we use an asset or changes in the manner that we use it; and o Significant changes to the asset since we acquired it. We have not recorded an impairment loss on goodwill or other long-lived assets. At September 30, 2004, goodwill and amortizable intangible assets are $21.2 million and $3.3 million, respectively. A decrease in the fair value of our business could trigger an impairment charge related to goodwill. ACCOUNTING FOR INCOME TAXES We are required to estimate our income taxes in each federal, state and international jurisdiction in which we operate. This process requires that we estimate the current tax exposure as well as assess temporary differences between the accounting and tax treatment of assets and liabilities, including items such as accruals and allowances not currently deductible for tax purposes. The income tax effects of the differences we identify are classified as current or long-term deferred tax assets and liabilities in our consolidated balance sheets. Our judgments, assumptions and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of future audits conducted by foreign and domestic tax authorities. Changes in tax laws or our interpretation of tax laws and the resolution of future tax audits could significantly impact the amounts provided for income taxes in our balance sheet and results of operations. We must also assess the likelihood that deferred tax assets will be realized from future taxable income and, based on our assessment, establish a valuation allowance, if required. RESULTS OF OPERATIONS NET REVENUES THREE MONTHS ENDED SEPTEMBER 30, (in thousands) ---------------------- 2004 2003 % CHANGE -------- -------- --------- Net Revenue $ 16,303 15,013 9% We derive revenues primarily from the sale of thin client appliances, which include an appliance device and related software. The increase in net revenues in the first quarter of fiscal 2005 over the same period in fiscal 2004 is primarily the result of increased unit sales of our thin client appliance products. The increase was driven by sales growth from increasing market acceptance of thin client products and our acquisition of the Visara business. 14 We expect total net revenue to increase in fiscal 2005, as a result of increased penetration of the PC market and continued growth of our relationship with IBM, relatively consistent with the growth levels experienced during fiscal 2004. We believe we are seeing positive results from strategies we initiated in fiscal 2004, and believe that if we can successfully implement these initiatives, our revenues may grow at a faster rate. Additionally, we completed only one acquisition in our fiscal 2004. If we complete additional acquisitions in fiscal 2005, our revenues may grow at a faster rate. COST OF REVENUES AND GROSS PROFIT MARGIN THREE MONTHS ENDED SEPTEMBER 30, (in thousands) ---------------------- 2004 2003 % CHANGE -------- -------- --------- Cost of Revenues $ 9,213 $ 7,049 31% Gross Profit Margin 43% 53% Cost of revenues consists primarily of the cost of thin client appliances, which include an appliance device and related software, and, to a lesser extent overhead including salaries and related benefits for personnel who fulfill product orders and deliver services, and distribution costs. The increase in cost of revenues in the first quarter of fiscal 2005 over the same period in fiscal 2004 is primarily the result of sales growth and higher material costs as a percentage of revenues (30%) and amortization of intangibles related to technologies acquired in our acquisition of the TeemTalk software business (1%). Higher material costs as a percentage of revenues are due to changes in product mix and the introduction of new, lower priced products designed to compete more effectively with personal computers. We have benefited from manufacturing efficiencies and component cost reductions achieved through our outsourced offshore manufacturing model. This model depends on high volume production of our thin client appliance products using components commonly used in personal computers. Changes in this model could have a significant impact on our gross profit margins. The change in gross profit margin in the first quarter of fiscal 2005 over the same period in fiscal 2004 is attributable to changes in net revenues and cost of revenues as previously discussed. We expect gross margins to fluctuate or decline in the future, reflecting changes in product mix, the percentage of revenues derived from thin client appliance systems and software, reduction in sales prices due to increased sales to large enterprise customers and increased price competition and changes in the cost of thin client appliances, memory and other components. Accordingly, in fiscal 2005 we expect gross margins to be in the range of 40% to 45%. SELLING AND MARKETING THREE MONTHS ENDED SEPTEMBER 30, (in thousands) ---------------------- 2004 2003 % CHANGE -------- -------- --------- Selling and marketing $ 3,102 $ 2,965 5% As a percentage of net revenues 19% 20% Selling and marketing expenses consist primarily of salaries, related benefits, commissions, amortization of intangibles related to customer and distribution relationships and other costs associated with our sales and marketing efforts. The increase in selling and marketing expense in the first quarter of fiscal 2005 over the same period in fiscal 2004 is primarily due to the increase in our personnel in Europe and the amortization of intangibles related to customer relationships associated with the acquisition of the TeemTalk software business. We expect sales and marketing expenses to increase moderately in absolute dollars during the balance of fiscal 2005. Spending levels in any one quarter will vary depending upon the timing of individual marketing initiatives. RESEARCH AND DEVELOPMENT THREE MONTHS ENDED SEPTEMBER 30, (in thousands) ---------------------- 2004 2003 % CHANGE -------- -------- --------- Research and development $ 664 $ 721 (8)% As a percentage of net revenues 4% 5% 15 Research and development expenses consist primarily of salaries, related benefits, and other engineering related costs. The decrease in research and development expense in the first quarter of fiscal 2005 over the same period in fiscal 2004 is primarily the result of a reduction in the use of outside consultants. We believe that a significant level of research and development investment is required to remain competitive and expect research and development expenses in absolute dollars in the next several quarters to be consistent with the first quarter of fiscal 2005 or to grow moderately. GENERAL AND ADMINISTRATIVE THREE MONTHS ENDED SEPTEMBER 30, (in thousands) ---------------------- 2004 2003 % CHANGE -------- -------- --------- General and administrative $ 1,358 $ 1,457 (7)% As a percentage of net revenues 8% 10% General and administrative expenses consist primarily of salaries, related benefits, corporate insurance, such as director and officer liability insurance and fees related to the obligations of a public company and fees for legal, audit and tax services. The decrease in general and administrative expenses in the first quarter of fiscal 2005 over the same periods in fiscal 2004 is primarily the result of a reduction in the use of outside consultants and a decrease in director and officer liability insurance premiums. In addition, the first quarter of fiscal 2004 included provisions to increase the allowance for doubtful accounts to the present level, while no additional provision was required in the first quarter of fiscal 2005. We expect general and administrative expenses to increase moderately in absolute dollars during the balance of fiscal 2005. INCOME TAXES THREE MONTHS ENDED SEPTEMBER 30, (in thousands) ---------------------- 2004 2003 % CHANGE -------- -------- --------- Income taxes $ 715 $ 1,041 (31)% As a percentage of net revenues 4% 7% Effective tax rate 34% 36% Our effective tax rate in the first quarter of fiscal 2005 differed from the combined federal and state statutory rates due primarily to the tax benefit from the Extraterritorial Income Exclusion ("EIE"). The EIE provides a tax benefit by excluding a portion of income from qualified foreign sales from gross income. The decrease in our effective tax rate in the first quarter of fiscal 2005 over the same period in fiscal 2004 is primarily due to the fact that no EIE tax benefit was recorded in the first quarter of fiscal 2004 because the EIE election had not yet been made. In October 2004 the EIE was repealed and will be phased out through calendar year 2006. Absent other changes that could impact our effective tax rate, such as the implementation of tax strategies that we are currently evaluating, we expect our effective tax rate to be 34% for fiscal 2005 and to increase two percentage points as the EIE is phased out. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2004, we had net working capital of $57.2 million consisting primarily of cash and cash equivalents, short-term investments and accounts receivable. Our principal sources of liquidity include $51.2 million of cash and cash equivalents and short-term investments and a $2.0 million line of credit facility with Wachovia Bank, all of which was available as of September 30, 2004. The credit facility requires us to maintain a minimum cash balance of $3.0 million with the bank. Interest on the line of credit facility accrues at the Libor Market Index rate plus 2.5% and the facility matures on December 31, 2004. We had no borrowings under the line of credit during the three months ended September 30, 2004 or 2003. 16 Cash and cash equivalents and short-term investments decreased by $4.1 million during the quarter ended September 30, 2004, primarily as a result of the acquisition of the Visara business, an increase in inventory, and a decrease in accounts payable. CASH FLOWS PROVIDED BY OPERATING ACTIVITIES: Our largest source of operating cash flows are payments from our customers for the purchase of our products. Our primary uses of cash from operating activities are for the purchase of thin client appliances, software licenses, personnel related expenditures and marketing expenses. Cash flow from operating activities decreased in the first quarter of fiscal 2005 compared to the same period in fiscal 2004 primarily due to lower profits, increased amounts due from customers, and decreased amounts due to vendors. CASH FLOWS USED IN INVESTING ACTIVITIES: The cash out flows from investing activities in the first quarter of fiscal 2005 relate to the acquisition of the Visara business and an increase in the purchase of short-term investments. We typically purchase short-term investments with surplus cash. CASH FLOWS PROVIDED BY FINANCING ACTIVITIES: The cash in flows from financing activities in the first quarter of fiscal 2005 was primarily the result of the exercise of employee stock options. CONTRACTUAL OBLIGATIONS The following is a summary of our contractual obligations as of September 30, 2004: YEAR ENDING JUNE 30, (in thousands) ------------------------------------ 2005 2006 TOTAL --------- ------- --------- Product purchase obligations $ 7,770 $ -- $ 7,770 Operating and capital leases 294 133 427 Other purchase obligations 37 -- 37 --------- ------- --------- $ 8,101 $ 133 $ 8,234 ========= ======= ========= We expect to fund current operations and other cash expenditures through the use of available cash, cash from operations, funds available under our credit facility and, potentially, new debt or equity financings. Management believes that we will have sufficient funds from current cash, operations and available financing to fund operations and cash expenditures for the foreseeable future. However, we may seek additional sources of funding in order to fund acquisitions, including our ability to issue debt and equity securities under our $100 million shelf registration, which was declared effective by the SEC on September 29, 2003. FACTORS AFFECTING THE COMPANY AND FUTURE OPERATING RESULTS Operating results for a particular future period are difficult to predict and, therefore, prior results are not necessarily indicative of results to be expected in future periods. Factors that could have a material adverse effect on our business, results of operations, and financial condition include, but are not limited to, the following: OUR 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. During the past two years, we have increased operating expenses significantly as a foundation for us to stimulate growth in our market, and we expect to continue incurring significant operating expenses. If we do not increase revenues or appropriately manage further increases in operating expenses, our profitability will suffer. Our business has grown during the past three years through both internal expansion and business acquisitions, and this has put pressure on our infrastructure, internal systems and managerial resources. The number of our employees increased from 66 employees at September 30, 2001 to 112 employees at September 30, 2004. Our new employees include a number of senior executive officers and other key managerial, technical, sales and marketing personnel. To manage our growth effectively, we must continue to improve and expand our infrastructure, including operating and administrative systems and controls, and continue managing and integrating our personnel in an efficient manner. Our business may be adversely affected if we do not integrate and train our new employees quickly and effectively and coordinate among our executive, engineering, finance, marketing, sales, operations and customer support organizations. In addition, because of the growth of our foreign operations, we now have facilities located in multiple locations, and we have limited experience coordinating a geographically separated organization. 17 ALTHOUGH WE HAVE GENERATED OPERATING PROFITS FOR THE PAST THREE FISCAL YEARS, WE HAVE A PRIOR HISTORY OF LOSSES AND MAY EXPERIENCE LOSSES IN THE FUTURE, WHICH COULD RESULT IN THE MARKET PRICE OF OUR COMMON STOCK DECLINING. Although we have generated operating profits in the past three fiscal years, we incurred net losses in prior periods. We expect to continue to incur significant operating expenses. Our operating expenses may increase in the future reflecting the hiring of additional key personnel as we continued to implement our growth strategy, including our plan to introduce new products to compete with PC-based solutions and other thin client companies. 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 maintain and increase our revenues would likely cause us to incur losses and negatively impact the price of our common stock. 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 thin client appliances, software, third party products and consulting services. Our gross profit margin also varies in response to competitive market conditions as well as periodic fluctuations in the cost of memory and other significant components. The PC market in which we compete remains very competitive, and although we intend to continue our efforts to reduce the cost of our products, there can be no certainty that we will not be required to reduce prices of our products without compensating reductions in the cost to produce our products in order to maintain or increase our market share or to meet competitors' price reductions. Our new marketing strategy is targeted at increasing the size of the thin client segment of the PC industry, in part by lowering prices to make thin clients more competitive with personal computers, and in addition by selling a larger percentage of products to large enterprise customers, who typically demand lower prices because of their volume purchases. This strategy has resulted in, and is expected to continue to result in a decline in our gross margins. If our sales do not increase as a result of these new strategies, our profitability will decline, and we may experience losses. OUR BUSINESS IS DEPENDENT ON CUSTOMER ADOPTION OF THIN CLIENT APPLIANCES AS AN ALTERNATIVE TO PERSONAL COMPUTERS, AND A DECREASE IN THEIR RATES OF ADOPTION COULD ADVERSELY AFFECT OUR ABILITY TO INCREASE OUR REVENUES. We are dependent on the growing use of thin client appliances to perform discrete tasks for corporate and Internet-based networks to increase our revenues. If thin client appliances are not accepted by corporations as an alternative to personal computers, the result would be slower than anticipated revenue growth or even a decline in our revenues. Thin client appliances have historically represented a very small percentage of the overall PC market, and if sales do not grow as a percentage of the PC market, or if the overall PC market were to decline, our revenues may not grow or may decline. WE MAY NOT BE ABLE TO EFFECTIVELY COMPETE AGAINST PC AND THIN CLIENT PROVIDERS AS A RESULT OF THEIR GREATER FINANCIAL RESOURCES AND BRAND AWARENESS. In the desktop PC market, we face significant competition from makers of traditional personal computers, many of which are larger companies that have greater name recognition than we have. In addition, we face significant competition from thin client providers, including Hewlett Packard, Wyse Technology and other smaller companies. Increased competition may negatively affect our business and future operating results by leading to price reductions, higher selling expenses or a reduction in our market share. Our strategy to seek to increase our share of the overall PC market by targeting our core markets may create increased pressure, including pricing pressure, on certain of our thin client appliance products. 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. 18 If we are unable to offer products and services that compete successfully with the products and services offered by our competitors, including PC manufacturers, 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. WE MAY NOT BE ABLE TO SUCCESSFULLY INTEGRATE FUTURE ACQUISITIONS WE MAY COMPLETE, WHICH MAY MATERIALLY ADVERSELY AFFECT OUR GROWTH AND OUR OPERATING RESULTS. Since June 2001, we have made five acquisitions and entered into an alliance with IBM, and we may make additional acquisitions as part of our growth strategy. There is no assurance that we will successfully integrate future acquisitions into our business. We may be unable to retain key employees or key business relationships of the acquired businesses, consolidate IT infrastructures, combine administrative, research and development and other operations and combine product offerings, and integration of the businesses may divert the attention and resources of our management. Our failure to successfully integrate acquired businesses into our operations could have a material adverse effect on our business, operating results and financial condition. Even if future acquisitions are successfully integrated, we may not receive the expected benefits of the transactions if we find that the acquired business does not further our business strategy or that we paid more than what the 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. During fiscal 2004 we spent approximately $1.6 million pursuing acquisitions that we did not complete. We intend to continue to pursue acquisitions, and if we do not complete them, the cost of pursuing acquisitions will impact our profitability. OUR ABILITY TO ACCURATELY FORECAST OUR QUARTERLY SALES IS LIMITED, ALTHOUGH OUR COSTS ARE RELATIVELY FIXED IN THE SHORT TERM AND WE EXPECT OUR BUSINESS TO BE AFFECTED BY RAPID TECHNOLOGICAL CHANGE, WHICH MAY ADVERSELY AFFECT OUR QUARTERLY OPERATING RESULTS. Our ability to accurately forecast our quarterly sales is limited, which makes it difficult to predict the quarterly revenues that we will recognize. In addition, most of our 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. Future operating results will continue to be subject to quarterly fluctuations based on a wide variety of factors, including: o 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 and earnings for each financial period especially difficult and uncertain and increases the risk of unanticipated variations in quarterly results and financial condition; o Significant Orders - We are subject to variances in our quarterly operating results because of the fluctuations in the timing of our receipt of large orders. If even a small number of large orders are delayed until after a quarter ends, our operating results could vary substantially from quarter to quarter and net income could be substantially less than expected. Conversely, if even a small number of large orders are pulled into a quarter from a future quarter, our revenues and net income could be substantially higher than expected, making it possible that sales and net income in future periods may decline sequentially; and o Seasonality - We have experienced seasonal reductions in business activity in some quarters based upon customer activity and based upon our partners' seasonality. This pattern has generally resulted in lower sales in our first and third quarters than in the prior sequential quarters. 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 thin client segment of the PC market; o the quality, price, performance and total cost of ownership of our products compared to personal computers; 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. 19 We may not succeed in developing and marketing our software and thin client appliance products and our operating results may decline as a result. BECAUSE SOME OF OUR PRODUCTS USE EMBEDDED VERSIONS OF MICROSOFT WINDOWS AS THEIR OPERATING SYSTEM, AN INABILITY TO LICENSE THESE OPERATING SYSTEMS ON FAVORABLE TERMS COULD IMPAIR OUR ABILITY TO INTRODUCE NEW PRODUCTS AND MAINTAIN MARKET SHARE. We may not be able to introduce new products on a timely basis because some of our products use embedded versions of Microsoft Windows as their operating system. Microsoft provides Windows to us, and we do not have access to the source code for certain versions of the Windows operating system. If Microsoft fails to continue to enhance and develop its embedded operating systems, or if we are unable to license these operating systems on favorable terms, 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. ACTIONS TAKEN BY THE SCO GROUP (SCO) COULD IMPACT THE SALE OF LINUX AS AN OPERATING SYSTEM, NEGATIVELY AFFECTING SALES OF SOME OF OUR PRODUCTS. SCO has taken legal action against IBM and certain other corporations, and sent letters to Linux customers alleging that certain Linux kernels infringe on SCO's Unix intellectual property and other rights, and that SCO intends to aggressively protect those rights. While we are not a party to any legal proceeding with SCO, since some of our products use Linux as their operating system, SCO's allegations, regardless of merit, could adversely affect sales of such products. SCO has brought claims against certain end user customers of the Linux operating system and threatened to bring claims against other end-users of Linux for copyright violations arising out of the facts alleged in SCO's lawsuit against IBM. Some of these claims could be indemnified under indemnities we have given or may give to certain customers. In the event that claims for indemnification are brought against the customers that we have indemnified, we could incur expenses reimbursing the customers for their costs, and if the claims were successful, for damages. BECAUSE WE DEPEND ON SOLE SOURCE, LIMITED SOURCE AND FOREIGN SOURCE SUPPLIERS FOR THE DESIGN AND MANUFACTURE OF OUR THIN CLIENT PRODUCTS AND FOR KEY COMPONENTS IN OUR THIN CLIENT APPLIANCE PRODUCTS, WE ARE SUSCEPTIBLE TO SUPPLY SHORTAGES THAT COULD PREVENT US FROM SHIPPING CUSTOMER ORDERS ON TIME, IF AT ALL, AND RESULT IN LOST SALES. IN ADDITION, IF WE IMPLEMENT AN OUTSOURCING STRATEGY FOR OTHER FUNCTIONS, WE MAY FAIL TO REDUCE COSTS AND MAY DISRUPT OPERATIONS. We depend upon single source suppliers for the design and manufacture of our thin client appliance products and for several of the components in them. We also depend on limited sources to supply several other industry standard components. The third party designers and manufacturers of our thin client products have access to our intellectual property which increases the risk of infringement or misappropriation of this intellectual property. We primarily rely on foreign suppliers, which subjects us to risks associated with foreign operations such as the imposition of unfavorable governmental controls or other trade restrictions, changes in tariffs, political instability and currency fluctuations. A weakening dollar could result in greater costs to us for our components. Severe Acute Respiratory Syndrome and similar medical crises could also disrupt manufacturing processes and result in quarantines being imposed in the future. 20 We have in the past experienced and may in the future experience shortages of, or difficulties in acquiring, certain components. A significant portion of our revenues is derived from the sale of thin client appliances that are bundled with our software. Third parties design and produce these thin client appliances for us, and we typically do not have long-term supply contracts with them obligating them to continue producing products for us. The absence of such agreements means that, with little or no notice, these suppliers could refuse to continue to manufacture all or some of our products that we require or change the terms under which they manufacture our products. If our suppliers were to stop manufacturing our products, we might be unable to replace the lost manufacturing capacity on a timely basis. If we experience shortages of these products, or of their components, we may not be able to deliver our products to our customers, and our revenues would decline. If these suppliers were to change the terms under which they manufacture for us, our manufacturing costs could increase and our cost of revenues could increase, resulting in a decline in gross margins. In addition, a failure of our suppliers to maintain their viability and financial condition could result in changes in payment and other terms of our relationships and their inability to produce and deliver our products on time and in sufficient quantities. We have accommodated one of our suppliers by purchasing products for inventory in advance of our contractual obligations due to the supplier's cash liquidity constraints which may result in increased inventory levels and decreased cash balances. In addition, if the supplier is unable to resolve its cash liquidity constraints, we could face an interruption of supply of our products, resulting in a decline in our revenues and profits. In addition to using third party suppliers for the manufacture of our products and supply of our components, to achieve additional cost savings or operational benefits, we may expand our outsourcing activities where we believe a third party may be able to provide those services in a more efficient manner. If we are unable to effectively develop and implement our outsourcing strategy, we may not realize cost structure efficiencies and our operating and financial results could be materially adversely affected. In addition, if our third party service providers experience business difficulties or are unable to provide business process services as anticipated, we may need to seek alternative service providers or resume providing such business processes internally which could be costly and time consuming and have an adverse material effect on our operating and financial results. IF WE ARE UNABLE TO CONTINUE GENERATING SUBSTANTIAL REVENUES FROM INTERNATIONAL SALES OUR BUSINESS COULD BE ADVERSELY AFFECTED. We derived a substantial portion of our revenue from international sales during fiscal 2004 and the first quarter of fiscal 2005. 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. Although most of our international sales are denominated in US Dollars, currency exchange rate fluctuations could result in lower demand for our products or lower pricing resulting in reduced revenue and margins, as well as currency translation losses. In addition, a weakening dollar has resulted in increased costs for our international operations, and could result in greater costs for our international operations in the future. 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 DISTRIBUTORS AND IBM TO SELL OUR PRODUCTS, OUR REVENUES COULD BE NEGATIVELY IMPACTED IF THESE COMPANIES DO NOT CONTINUE TO PURCHASE PRODUCTS FROM US. We cannot be certain that we will be able to attract or retain distributors to market our products effectively or provide timely and cost-effective customer support and service. None of our current distributors, including IBM, is obligated to continue selling our products or to sell our new products. We cannot be certain that any distributors will continue to represent our products or that our distributors will devote a sufficient amount of effort and resources to selling our products in their territories. We need to expand our indirect sales channels, and if we fail to do so, our growth could be limited. We derive a substantial portion of our revenue from sales made directly to IBM and through our other distributors. A significant portion of our other revenue was derived from sales to resellers. If our distributors were to discontinue sales of our products or reduce their sales efforts, it could adversely affect our operating results. In addition, there can be no assurance as to the continued viability and financial condition of our distributors, none of which has accounted for more than 10% of our net revenues for fiscal 2004. As a result of our alliance with IBM, we rely on IBM for distribution of our products to IBM's customers. Sales directly to IBM have ranged from 17% to 18% of our net sales during the past two fiscal years. IBM is under no obligation to continue to actively market our products. In addition to our direct sales to IBM, IBM can purchase our products through individual distributors and/or resellers. Furthermore, IBM can influence an end-users decisions to purchase our products even though the end-user may not purchase our products through IBM. While it is difficult to quantify the net revenues associated with these purchases we believe that these sales could be significant and can vary significantly from quarter to quarter. 21 OUR BUSINESS MAY SUFFER IF IT IS ALLEGED OR FOUND THAT WE HAVE INFRINGED THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS. Although we have not received any claims that our products infringe on the proprietary rights of third parties, if we were to receive such claims in the future, responding to such claims, regardless of their merit, could be time consuming, result in costly litigation, divert management's attention and resources and cause us to incur significant expenses. There is no assurance, in the event of such claims, that we would be able to enter into a licensing arrangement on acceptable terms or that litigation would not occur. In the event that there were a temporary or permanent injunction entered prohibiting us from marketing or selling certain of our products, or a successful claim of infringement against us requiring us to pay royalties to a third party, and we failed to develop or license a substitute technology, our business, results of operations or financial condition could be materially adversely affected. THIN CLIENT APPLIANCE PRODUCTS, LIKE PERSONAL COMPUTERS, ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE DUE TO CHANGING OPERATING SYSTEM SOFTWARE AND NETWORK HARDWARE AND SOFTWARE CONFIGURATIONS, AND OUR PRODUCTS COULD BE RENDERED OBSOLETE BY NEW TECHNOLOGIES. The PC market is characterized by rapid technological change, frequent new product introductions, uncertain product life cycles, changes in customer demands and evolving industry standards. Our products could be rendered obsolete if products based on new technologies are introduced or new industry standards emerge. 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 are differentiated from those of our competitors by our internally developed technology that is incorporated into our products. If we are unable to protect our intellectual property, other vendors could sell products with features similar to ours, and this could reduce demand for our products, which would harm our operating results. WE MAY NOT BE ABLE TO ATTRACT SOFTWARE DEVELOPERS TO BUNDLE THEIR PRODUCTS WITH OUR THIN CLIENT APPLIANCES. Our thin client appliances include our own software, plus software from other companies for specific 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 thin client 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 thin client appliances, we may need to hire additional personnel. Competition for employees is significant and we may experience difficulty in attracting qualified people. Future growth that we may experience will place a significant strain on our management, systems and resources. To manage the anticipated growth of our operations, we may be required to: o improve existing and implement new operational, financial and management information controls, reporting systems and procedures; o hire, train and manage additional qualified personnel; and 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, technologies and operations are complex and we are substantially dependent upon the continued service of our existing personnel. The loss of any of our key employees could adversely affect our business and profits and slow our product development processes. Except for our Chairman and CEO, we generally do not have employment agreements with our key employees. Further, we do not maintain key person life insurance on any of our employees. 22 RECENT AND PROPOSED REGULATIONS RELATED TO EQUITY COMPENSATION COULD ADVERSELY AFFECT OUR ABILITY TO ATTRACT AND RETAIN KEY PERSONNEL. We have historically used stock options as a key component of our employee compensation program. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value, and, through the use of vesting, encourage employee retention and allow us to provide competitive compensation packages, although in recent periods many of our employee stock options have had exercise prices in excess of our stock price, which could affect our ability to retain or attract present and prospective employees. The Financial Accounting Standards Board has proposed changes to US GAAP that, if implemented, would require us and other companies to record a charge to earnings for employee stock option grants. This pending regulation would negatively impact our earnings. In addition, new regulations implemented by The Nasdaq National Market requiring stockholder approval for all stock option plans, as well as new regulations implemented by the New York Stock Exchange prohibiting NYSE member organizations from voting on equity-compensation plans unless the beneficial owner of the shares has given voting instructions, could make it more difficult for us to grant options to employees in the future. To the extent that new regulations make it more difficult or expensive to grant options to employees, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business. IN THE EVENT WE ARE UNABLE TO SATISFY REGULATORY REQUIREMENTS RELATING TO INTERNAL CONTROLS OVER FINANCIAL REPORTING, OR IF THESE INTERNAL CONTROLS ARE NOT EFFECTIVE, OUR BUSINESS AND FINANCIAL RESULTS MAY SUFFER. The Sarbanes-Oxley Act of 2002 and newly enacted rules and regulations of the Securities and Exchange Commission and the National Association of Securities Dealers impose new duties on us and our executives, directors, attorneys and independent registered public accountants. In order to comply with the Sarbanes-Oxley Act and such new rules and regulations, we are evaluating our internal controls over financial reporting to allow management to report on, and our independent auditors to attest to, our internal controls over financial reporting as of June 30, 2005. We are currently performing the system and process evaluation and testing (and any necessary remediation) required in an effort to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act. As a result, we expect to incur additional expenses and diversion of management's time, which could materially increase our operating expenses and accordingly reduce our net income. While we anticipate being able to fully implement the requirements relating to internal controls over financial reporting and all other aspects of Section 404 in a timely fashion, we cannot be certain as to the outcome of our testing and resulting remediation. If our independent auditors are not satisfied with our internal controls over financial reporting or the level at which these controls are documented, designed, operated or reviewed, or if the independent auditors' interpretation of the requirements, rules or regulations are different than ours, then they may decline to attest to management's assessment or issue an adverse opinion on management's assessment and/or our internal controls over financial reporting. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact the market price of our shares. WE LICENSE OUR TEEMTALK SOFTWARE TO OTHER THIN CLIENT PROVIDERS WHO MAY CHOOSE TO LICENSE ALTERNATIVE PRODUCTS FROM OTHER SUPPLIERS WHO ARE NOT THEIR COMPETITORS. We license our TeemTalk software, which enables thin clients to connect to legacy systems, to certain of our competitors, including Wyse Technology and Hewlett Packard. Although it is our strategy to continue to generate sales of this software by licensing it to other thin client vendors, these vendors may seek alternative products from suppliers who are not their direct competitors. If we were to lose one or more of these customers, our revenue and profits would decline. ERRORS IN OUR PRODUCTS COULD HARM OUR BUSINESS AND OUR OPERATING RESULTS. Because our software and thin client 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. 23 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. IF OUR CONTRACTS WITH CITRIX AND OTHER VENDORS OF SOFTWARE APPLICATIONS WERE TERMINATED, OUR IT SERVICES BUSINESS WOULD BE MATERIALLY ADVERSELY AFFECTED. We depend on third-party suppliers to provide us with key software applications in connection with our IT services business. If such contracts and relationships were terminated, our 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 revenues or earnings, changes in revenues or earnings estimates or publication of research reports by analysts; 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. PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY DELAY OR PREVENT ACQUISITION OF US, WHICH COULD DECREASE THE VALUE OF YOUR SHARES. Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it harder for a third party to acquire us without the consent of our board of directors. These provisions include advance notice procedures with respect to stockholder proposals and the nomination of candidates for election as directors. Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock. THE ISSUANCE OF ADDITIONAL EQUITY SECURITIES MAY HAVE A DILUTIVE EFFECT ON OUR EXISTING STOCKHOLDERS AND COULD LEAD TO A DECLINE IN THE PRICE OF OUR COMMON STOCK. Any additional issuance of equity securities, including for acquisitions, may have a dilutive effect on our existing stockholders. In addition, the perceived risk associated with the possible sale of a large number of shares could cause some of our stockholders to sell their stock, thus causing the price of our stock to decline. Subsequent sales of our common stock in the open market or the private placement of our common stock or securities convertible into common stock could also have an adverse effect on the market price of the shares. If our stock price declines, it may be more difficult or we may be unable to raise additional capital. FORWARD-LOOKING STATEMENTS This quarterly report on Form 10-Q contains statements that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, such as statements regarding: our expectation to grow the company organically and through acquisitions; anticipated lower cash balances due to our accelerated payments to one of our suppliers; our commitment to investing in software development; our expectations regarding the growth of our revenues as a result of increased penetration of the PC market and our relationship with IBM; our expectations as to gross margins, research and development expenses, sales and marketing expenses, and general and administrative expenses for fiscal 2005; our acquisition of businesses and technologies; the availability of cash or other financing sources to fund future operations; cash expenditures and acquisitions, and our potential issuance of debt and equity securities under our $100 million shelf registration. 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 our actual results include our ability to maintain our relationship with IBM, the timing and receipt of future orders, our timely development and customers' acceptance of our products, pricing pressures, rapid technological changes in the industry, growth of overall thin client sales through the capture of a greater portion of the PC market, increased competition, our ability to attract and retain qualified personnel, the economic viability of our suppliers and channel partners, adverse changes in customer order patterns, our ability to identify and successfully consummate and integrate future acquisitions, adverse changes in general economic conditions in the U. S. and internationally, risks associated with foreign operations and political and economic uncertainties associated with current world events. 24 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We earn interest income from our balances of cash, cash equivalents and short-term investments. This interest income is subject to market risk related to changes in interest rates that primarily affects our investment portfolio. We invest in instruments that meet high credit quality standards, as specified in our investment policy. As of September 30, 2004 and June 30, 2004, cash equivalents and short-term investments consisted primarily of corporate notes and government securities, certificates of deposit, and other specific money market instruments of similar liquidity and credit quality. Due to the conservative nature of our investment portfolio, a sudden change in interest rates would not have a material effect on the value of the portfolio. ITEM 4. CONTROLS AND PROCEDURES Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of our disclosure controls and procedures; as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of September 30, 2004 (the "Evaluation Date"). Based on the evaluation performed, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in recording, processing, summarizing and reporting in the periods specified in the SEC's rules and forms the information required to be disclosed by us in our reports filed or furnished under the Exchange Act. There have not been any changes in our internal control over financial reporting during the quarter ended September 30, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. PART II. OTHER INFORMATION ITEM 6. EXHIBITS The following exhibits are being filed as part of this quarterly report on Form 10-Q: EXHIBIT NUMBERS DESCRIPTION ------- ----------- 10.1 Asset Purchase Agreement between Neoware Systems, Inc. and Visara International, Inc., dated September 22, 2004 31.1 Certification of Michael Kantrowitz as Chairman, President and Chief Executive Officer of Neoware Systems, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Keith D. Schneck as Executive Vice President and Chief Financial Officer of Neoware Systems, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Michael Kantrowitz as Chairman, President and Chief Executive Officer of Neoware Systems, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification Keith D. Schneck as Executive Vice President and Chief Financial Officer of Neoware Systems, Inc pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 25 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: November 8, 2004 By: /s/ MICHAEL KANTROWITZ -------------------------- Michael Kantrowitz Chairman, President and Chief Executive Officer Date:November 8, 2004 By: /s/ KEITH D. SCHNECK ------------------------ Keith D. Schneck Executive Vice President and Chief Financial Officer 26 EX-10 2 ex10-1.txt EXHIBIT 10.1 ================================================================================ ASSET PURCHASE AGREEMENT BETWEEN NEOWARE SYSTEMS, INC. AND VISARA INTERNATIONAL, INC. SEPTEMBER 22, 2004 ================================================================================ TABLE OF CONTENTS ARTICLE I - Definitions........................................................1 ARTICLE II - PURCHASE AND SALE OF ASSETS.......................................4 2.1 Purchase and Sale of Assets...........................................4 (a) Personal Property................................................4 (b) Contract Rights..................................................4 (c) Intellectual Property............................................5 (d) Governmental Licenses, Permits and Approvals.....................5 (e) Books and Records................................................5 (f) Goodwill.........................................................5 2.2 Excluded Assets.......................................................5 (a) Inventory........................................................5 (b) Accounts Receivable..............................................5 (c) Personal Property................................................6 (d) Retained Technology..............................................6 2.3 Purchase Price........................................................6 2.4 Payment of Purchase Price.............................................6 (a) Closing Payment and Escrow.......................................6 (b) Earn-Out.........................................................6 2.5 Closing...............................................................8 2.6 Ad Valorem Tax Adjustment.............................................8 2.7 Allocation of Purchase Price..........................................8 2.8 Assumed Liabilities...................................................9 2.9 Retained Liabilities..................................................9 ARTICLE III - Representations and Warranties of Seller.........................9 3.1 Organization and Good Standing........................................9 3.2 Authorization and Effect of Agreement................................10 3.3 No Restrictions Against Sale of the Assets...........................10 3.4 Financial Statements.................................................10 3.5 Operation of the Business Since December 31, 2003....................11 3.6 Title to Assets; Licenses............................................11 3.7 No Litigation........................................................12 3.8 Income and Other Taxes...............................................12 3.9 Employee Benefit Matters.............................................13 3.10 Governmental Approvals...............................................13 3.11 Assumed Contracts....................................................14 3.12 Employee and Labor Matters...........................................14 3.13 Principal Customers and Suppliers....................................15 3.14 Compliance with Law..................................................15 3.15 Product Warranties...................................................15 3.16 Intellectual Property................................................16 (a) Title...........................................................16 (b) Development.....................................................16 (c) Transfer........................................................16 (d) No Infringement.................................................16 (e) Licensing Arrangements..........................................16 (f) No Intellectual Property Litigation or Disputes.................17 (g) Due Registration, Etc...........................................17 (h) Use of Name and Mark............................................17 (i) Protection of Information.......................................18 (j) Effect of Agreement.............................................18 3.17 Operation of the Business............................................18 3.18 Brokers' Fees........................................................18 3.19 Disclosure...........................................................18 3.20 Transactions with Affiliates.........................................18 3.21 Capitalization of Seller.............................................18 3.22 No Liquidation or Winding-Up; Fairness of Consideration..............19 3.23 Product Returns......................................................19 ARTICLE IV - Representations and Warranties of Purchaser......................19 4.1 Organization and Good Standing.......................................19 4.2 Execution and Delivery...............................................19 4.3 No Conflicts.........................................................20 4.4 Compliance with Law..................................................20 4.5 No restrictions Against Purchase of the Assets.......................20 4.6 Brokers' Fees........................................................20 ARTICLE V - Additional Covenants..............................................20 5.1 Covenants of Seller..................................................20 5.2 Covenants of Purchaser...............................................20 5.3 Expenses.............................................................20 5.4 Further Assurances...................................................21 5.5 Inconsistent Action..................................................21 5.6 Employee Matters.....................................................21 5.7 Assignments; Consents................................................22 5.8 Sufficiency of Assets................................................23 5.9 Waiver...............................................................23 5.10 Tax Assessment and Audits............................................23 ARTICLE VI - Conditions Precedent to Closing..................................23 6.1 Conditions of Purchaser..............................................23 6.2 Conditions of Seller.................................................25 ARTICLE VII - Post-Closing Obligations........................................25 7.1 Seller-Assumed Warranty Obligations..................................25 7.2 Seller-Assumed Support Services Obligations..........................26 ii 7.3 Continued Operations; No Bankruptcy..................................26 7.4 Sales Incentive Program..............................................26 7.5 Use of Seller's Name by Purchaser....................................27 ARTICLE VIII - Indemnification................................................27 8.1 Survival.............................................................27 8.2 Indemnification......................................................28 8.3 Procedures...........................................................28 8.4 Third Party Claims...................................................29 8.5 Indemnification Exclusive............................................29 8.6 Limitation on Amount.................................................30 ARTICLE IX - Rebate and Marketing Programs...................................30 9.1 List of Programs.....................................................30 9.2 Marketing Rights.....................................................30 ARTICLE X - General Provisions................................................30 10.1 Notices..............................................................30 10.2 Severability.........................................................31 10.3 Entire Agreement.....................................................31 10.4 Successors and Assigns...............................................31 10.5 Counterparts.........................................................32 10.6 Recitals, Schedules, Exhibits and Annexes............................32 10.7 Construction.........................................................32 10.8 Governing Law........................................................32 10.9 Passage of Title and Risk of Loss....................................32 10.10 Bulk Sales...........................................................32 iii INDEX OF EXHIBITS Exhibit A Escrow Agreement Exhibit B License Agreement Exhibit C Noncompetition Agreement Exhibit D Reseller Agreement Exhibit E Transitional Supply Agreement Exhibit F Seller's Counsel's Opinion Exhibit G Warranties Exhibit H Transitional Services iv ASSET PURCHASE AGREEMENT THIS ASSET PURCHASE AGREEMENT (the "Agreement") is entered into as of September 22, 2004 between NEOWARE SYSTEMS, INC., a Delaware corporation ("Purchaser"), and VISARA INTERNATIONAL, INC., a Delaware corporation ("Seller"). RECITALS A. Seller is presently engaged in the business of designing, developing, manufacturing, distributing and selling Linux and Windows-based thin client products. B. Seller desires to Transfer (as hereinafter defined) to Purchaser, and Purchaser desires to purchase from Seller, all of the assets owned or held for use by Seller or used by Seller in connection with designing, developing, manufacturing, distributing and selling the Linux and Windows-based thin client products (referred to herein as the "Products" or the "Business"), other than the Excluded Assets (as hereinafter defined), on the terms and subject to the conditions set forth in this Agreement. C. Following the consummation of the transactions contemplated by the terms of this Agreement, Seller will continue to engage in the Retained Business (as hereinafter defined). NOW, THEREFORE, in consideration of the premises and the respective representations, warranties, covenants, agreements and conditions hereinafter set forth, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and intending to be legally bound, the parties hereto hereby agree as follows: ARTICLE I DEFINITIONS Unless otherwise defined herein or the context otherwise requires, the terms defined in this Article I shall have the meanings herein specified for all purposes of this Agreement, applicable to both the singular and plural forms of any of the terms herein defined. Unless otherwise indicated, any reference herein to a Section, Article, Exhibit or Schedule shall mean the applicable section, article, annex or schedule of or to this Agreement. All accounting terms used in this Agreement not defined in this Article I shall, except as otherwise provided for herein, be construed in accordance with generally accepted accounting principles, consistently applied. "ACTION" shall mean any actual or threatened claim, action, suit, arbitration, hearing, inquiry, proceeding, complaint, charge or investigation by or before any Governmental Entity or arbitrator and any appeal from any of the foregoing. "AFFILIATE" of a Person shall mean any Person that directly or indirectly controls, is controlled by, or is under common control with, the indicated Person. "AGREEMENT" shall mean this Asset Purchase Agreement, together with all Schedules and Exhibits hereto. "ANCILLARY AGREEMENTS" shall mean the Escrow Agreement, the Noncompetition Agreements, the Transitional Supply Agreement and the Reseller Agreement. "CODE" shall mean the Internal Revenue Code of 1986, as amended. "DAMAGES" shall mean any and all losses, liabilities, obligations, costs, expenses, damages or judgments of any kind or nature whatsoever (including reasonable attorneys', accountants' and experts' fees, disbursements of counsel, and other costs and expenses incurred pursuing indemnification claims under Article IX hereof). "DELAWARE LAW" shall mean the Delaware General Corporation Law. "ENTERPRISE/CONTROLLER PRODUCTS" shall mean those products that are retained by Seller and are marketed by Visara as of the Closing Date, as well as enhancements to and replacements and derivatives thereof. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time. "ERISA AFFILIATE" shall mean any Person which is (or at any relevant time was) a member of a controlled group of corporations within the meaning of Code Section 414(b), all trades or businesses under common control within the meaning of Code Section 414(c), and all affiliated service groups within the meaning of Code Section 414(m), of which Seller is (or at any relevant time was) a member. "ESCROW AGREEMENT" shall mean the form of Escrow Agreement attached hereto as Exhibit A. "GOVERNMENTAL ENTITY" shall mean any local, state, federal or foreign (i) court, (ii) government or (iii) governmental department, commission, instrumentality, board, agency or authority, including, without limitation, the IRS and other taxing authorities. "KNOWLEDGE" shall mean (a) the actual knowledge of any of the senior management of Seller, including James T. Matthews, Phil Parrish, David Turner, Roger Lucas and William Phelps and (b) the knowledge that any of such persons would be reasonably expected to have after making inquiry of those persons employed by such party who would reasonably be expected to have knowledge of the issue in question. "LEGAL REQUIREMENT" shall mean any statute, law, ordinance, rule, regulation, permit, order, writ, judgment, injunction, decree or award issued, enacted or promulgated by any Governmental Entity or any arbitrator. 2 "LICENSE AGREEMENT" shall mean the License Agreement in the form attached hereto as Exhibit B. "LIEN" shall mean all liens (including judgment and mechanics' liens, regardless of whether liquidated), mortgages, assessments, security interests, easements, claims, pledges, trusts (constructive or other), deeds of trust, options or other charges, encumbrances or restrictions. "MATERIAL ADVERSE EFFECT" shall mean any event, change or effect that is (or could reasonably be expected to be) materially adverse to the Assets or the Business or to Purchaser's ability to continue to operate the Business as operated prior to the Closing. "NONCOMPETITION AGREEMENT" shall mean the Noncompetition Agreement in the form attached hereto as Exhibit C. "ORDINARY COURSE" shall mean, when used with reference to Seller, the ordinary and normal course of the operation of the Business, consistent with past practices. "PERSON" shall mean all natural persons, corporations, business trusts, associations, companies, partnerships and joint ventures. "PLAN" shall mean any employee benefit plan within the meaning of Section 3(3) of ERISA and any other written or oral employee plan (other than arrangements merely involving the payment of wages) which are or at any time have been established, maintained, or contributed to by Seller or any ERISA Affiliate for the benefit of current or former employees, with respect to which Seller or an ERISA Affiliate has or may in the future have any liability or obligation to contribute or make payments of any kind. "RESELLER AGREEMENT" shall mean the Reseller Agreement in the form attached hereto as Exhibit D. "RETAINED BUSINESS" shall mean the business of manufacturing, distributing and selling Enterprise/Controller Products. "RETAINED TECHNOLOGY" shall mean the Licensed Software (as defined in the License Agreement and set forth in Exhibit A of the License Agreement) and any proprietary design techniques and methodologies retained by Seller, including the Visara eManager software, CE Bridge Technology and EOL Systems, that are listed in Schedule 2.2(d) hereof, as they exist as of the date hereof, as well as any updates and enhancements thereto. "SUBSIDIARY OF A PERSON" shall mean any corporation, partnership, limited liability company, association or other business entity at least 50% of the outstanding voting power of which is at the time owned or controlled directly or indirectly by such Person or by one or more of such subsidiary entities, or both. 3 "TAX" shall mean all taxes, including without limitation all Federal, state, local or foreign income, gross receipts, license, payroll, unemployment, excise, severance, stamp, occupation, premium, windfall profits, environmental (including, without limitation, taxes under Code Section 59A), customs duties, capital stock, franchise, profits, withholding, social security (or similar), employment, disability, real property, personal property, ad valorem, sales, use, transfer, registration, value added, alternative or add-on minimum, estimated tax or other tax, assessment or charge of any kind whatsoever, and any interest, fine, penalty or addition thereto, whether disputed or not. "TAX RETURN" shall mean any return, declaration, report, claim for refund or information, or statement relating to Taxes, and any exhibit, schedule, attachment or amendment thereto. "THIN CLIENT CONSOLE PRODUCTS" shall mean any Thin Client Devices used exclusively for the management of Enterprise/Controller Products and mainframe and midrange servers. "THIN CLIENT DEVICES" shall mean devices using embedded operating systems, web browsers, the X Window, Tarantella, RDP or ICA protocols or their successors, or remotely displaying applications from Unix, Linux or Windows computers or from the Internet. "TRANSITIONAL SUPPLY AGREEMENT" shall mean the Transitional Supply Agreement in the form attached hereto as Exhibit E. ARTICLE II PURCHASE AND SALE OF ASSETS 2.1 Purchase and Sale of Assets. On the terms and subject to the conditions hereof, at the Closing (as defined in Section 2.5), Seller will sell, transfer, grant, convey, assign and deliver ("Transfer") to Purchaser, and Purchaser will purchase and accept from Seller, the rights, properties and assets owned, held for use or used by Seller in connection with the operation or conduct of the Business, including any technology under development as of the date hereof, or acquired by Seller in connection with the operation of the Business between the date hereof and the Closing Date (as defined in Section 2.5), or used by Seller in connection with the operation of the Business including, but not limited to, the rights, properties and assets described in this Section 2.1 (collectively the "Assets"): (a) Personal Property. Except as set forth under Section 2.1(c), copies of the software, files, books and records, and all other tangible personal property owned or held by Seller in connection with the operation of the Business, as of the date hereof or acquired by Seller in connection with the operation of the Business between the date hereof and the Closing Date or used by Seller in connection with the operation of the Business, including those items listed or described on Schedule 2.1(a), except for property excluded under Section 2.2 (collectively, the "Owned Tangible Personal Property"); (b) Contract Rights. All rights and incidents of interest of Seller existing as of the date hereof or acquired by Seller between the date hereof and the Closing Date in, to or under all licenses, leases, agreements, 4 customer orders, contracts, written or verbal (including product warranty claims, rebates and indemnity or other rights of action against any person arising out of acts, omissions or occurrences before, at or after the Closing), prepaid items, deposits and refunds relating to the Business, including those items listed on Schedule 2.1(a) (collectively, the "Contracts"); (c) Intellectual Property. Except for the Visara Retained Technology, the entire right, title and interest of Seller existing as of the date hereof or acquired by Seller between the date hereof and the Closing Date in connection with the operation of the Business or used by Seller in connection with the operation of the Business in, to or under (i) all United States, international and foreign patents and applications therefor and all reissues, divisions, renewals, extensions, provisionals, continuations and continuations-in-part thereof, (ii) all software, licenses, inventions (whether patentable or not), invention disclosures, improvements, trade secrets, proprietary information, know how, technology, technical data and customer lists, and all documentation relating to any of the foregoing, (iii) all copyrights, copyrights registrations and applications therefor, and all other rights corresponding thereto throughout the world, (iv) all industrial designs and any registrations and applications therefor, (v) all trade names, logos, common law trademarks and service marks, trademark and service mark registrations and applications therefor, (vi) all databases and data collections and all rights therein, (vii) Seller's list of customer prospects pertaining to the Business, (viii) all moral and economic rights of authors and inventors, however denominated, and (ix) any similar or equivalent rights to any of the foregoing (as applicable), including the items listed on Schedule 2.1(c) (collectively, the "Intellectual Property"); (d) Governmental Licenses, Permits and Approvals. To the extent Transferable, all rights and incidents of interest of Seller existing as of the date hereof or acquired by Seller between the date hereof and the Closing Date in, to or under all licenses, permits and authorizations (collectively, the "Approvals") issued or requested to be issued by any Governmental Entity in connection with the operation of the Business, including the Approvals listed or described on Schedule 2.1(d); (e) Books and Records. Copies of all books, records, ledgers, files, documents, correspondence, studies, reports and other documents of Seller relating to the Business or the Assets. (f) Goodwill. The goodwill of the Business. 2.2 Excluded Assets. Notwithstanding anything contained in this Agreement to the contrary, the following rights, properties and assets (collectively, the "Excluded Assets") will not be included in the Assets: (a) Inventory. All raw material, works-in-progress and finished goods inventories relating to the Business. (b) Accounts Receivable. All accounts receivable arising from the conduct of the Business prior to the Closing. 5 (c) Personal Property. All fixtures, furnishings, furniture, equipment, supplies, computers and printers relating to the Business, including, without limitation, the name "Visara" and all variants thereof, subject to Purchaser's rights under Section 7.5 hereof. (d) Retained Technology. All of the Retained Technology described on Schedule 2.2(d). 2.3 Purchase Price. Purchaser will pay for the Assets a purchase price in the amount of Three Million Seven Hundred Thousand Dollars ($3,700,000), subject to adjustment as provided in Sections 2.4(b) and 2.6 (the "Purchase Price"). 2.4 Payment of Purchase Price. (a) Closing Payment and Escrow. At the Closing (as defined in Section 2.5): (i) Purchaser shall pay to Seller an amount equal to Three Million Three Hundred Thirty Thousand Dollars ($3,330,000), subject to adjustment, as provided in Sections 2.4(b) and 2.6 (the "Closing Payment"); and (ii) Purchaser shall deposit into an escrow account (the "Escrow Account") Three Hundred Seventy Thousand Dollars ($370,000) (the "Escrow Amount"), to be held and disbursed by Wachovia Bank (or if Wachovia Bank is unable to serve, by another party appointed by the parties), as escrow agent (the "Escrow Agent"). The Escrow Amount shall be held by the Escrow Agent pursuant to the Escrow Agreement. The Escrow Amount will be subject to set-off for any indemnification claims arising during the six-month period commencing on the Closing Date (the "Escrow Period"), and as otherwise provided herein and in the Escrow Agreement. The Escrow Agreement shall terminate at the close of business on the last day of the Escrow Period (the "Escrow Termination Date"), unless there are any unresolved indemnification or other claims or disputes on such date pursuant to which Purchaser may be entitled to all or a portion of the Escrow Amount. In the event of any such unresolved claims or disputes, the Escrow Agreement will continue in force, but any portion of the Escrow Amount which exceeds the amount for which a claim has been made or a dispute exists shall be released to Seller, except as provided in the Escrow Agreement. Seller's liability for the claims identified in this Section 2.4(b), or any other claims of Purchaser hereunder, shall not be limited to the Escrow Amount. (b) Earn-Out. (i) Purchaser shall pay to Seller additional cash consideration (the "Contingent Consideration") equal to the sum of the following: (1) $500,000, if revenues to Purchaser from the sum of (x) the sale of Purchaser's thin client products with coax or twinax connections or containing proprietary Linux software developed by Seller, (y) 6 the resale by Purchaser to IBM of Seller's retained products not acquired by Purchaser as part of the Business in accordance with this Agreement and (z) sales to Seller's Customers (as defined below) (revenues under (x), (y) and (z) collectively, the "Earn-Out Revenues") exceed $8,000,000 for the 12-month period commencing on the Closing Date (the "Earn-Out Period"), including open unshipped orders existing on the last day of the Earn-Out Period, provided that such orders are shipped and billed within 60 days after the last day of the Earn-Out Period); and (2) $500,000, if the Earn-Out Revenues exceed $9,000,000 for the Earn-Out Period; and (3) an amount equal to 0.25 multiplied by the excess of the Earn-Out Revenues over $10,000,000 for the Earn-Out Period. "Seller's Customers" shall be those customers listed on Schedule 2.4(b), except that revenues derived from Seller's Customers that are noted as "mutual" on Schedule 2.4(b) shall consist only of revenues generated from specific applications using Products or Neoware products substituted for the same application. (ii) The amount of Contingent Consideration payable to Seller under this Section 2.4(b) shall be subject to adjustment for credits related to product returns, price adjustments and non-payment of invoices. (iii) Subject to adjustment under Section 2.4(b)(ii), Contingent Consideration, if any, payable under Section 2.4(b)(i) shall be payable to Seller within 45 days after the end of the Earn-Out Period. Seller shall have the right, at its sole expense, to audit Purchaser's records related and limited to Purchaser's performance under Section 2.4(b)(i) as is necessary to verify the amount of Contingent Consideration payable, upon at least three days prior notice, in a manner not disruptive of Purchaser's business during Purchaser's normal business hours. (iv) In the event that Purchaser and Seller are unable to agree on the determination of any matter under this Section 2.4(b), either Purchaser or Seller may deliver to the other notice in writing setting forth the disputed items and a proposed resolution of such disputed items (a "Dispute Notice"). The parties shall endeavor in good faith to resolve any disputed items within thirty (30) days of the receipt of a Dispute Notice. If the parties are unable to resolve all disputed items within such thirty (30) day period, the parties shall mutually select, within ten (10) days following the expiration of such thirty (30) day period, a public accounting firm independent of each party (the "Accounting Arbitrator") to resolve the items remaining in dispute (the "Disputed Items"), and the determination of the Accounting Arbitrator in respect of the correctness of each of the Disputed Items shall be conclusive and binding on the parties absent manifest error. The Accounting Arbitrator shall use all reasonable efforts to resolve all Disputed Items within thirty (30) days following its appointment. The scope of the Accounting Arbitrator's review shall be limited to only the Disputed Items. All fees and expenses of any Accounting Arbitrator selected in accordance with this Section 2.4(b) shall be borne equally by Purchaser and Seller. 7 (v) Each party shall provide the other party promptly with copies of any information requested by the party which is reasonably necessary to confirm or verify the Earn-Out Revenues or any other information or matters addressed in this Section 2.4(b) which are related to the calculation of the Contingent Consideration. 2.5 Closing. The purchase and sale of the Assets and the consummation of the other transactions contemplated by this Agreement (the "Closing") shall occur at 10:00 a.m., local time, on September 22, 2004 at the offices of the Company or at such other time or on such other date as shall be agreed by Seller and Purchaser upon fulfillment of all conditions precedent to the Closing, such hour and date being herein generally referred to as the "Closing Date." At the Closing: (a) Seller shall deliver or cause to be delivered to Purchaser, against payment by Purchaser to Seller of the Closing Payment: (i) all of the agreements, documents, certificates and instruments required to be delivered by Seller pursuant to Section 6.1 hereof. (b) Purchaser shall deliver or cause to be delivered to Seller against delivery of the agreements, documents, certificates and instruments required to be delivered by Seller pursuant to Section 6.1: (i) a wire transfer of immediately available funds to an account designated in writing by Seller in an amount representing the Closing Payment; and (ii) all of the documents, if any, required to be delivered by Purchaser pursuant to Section 6.2 hereof. 2.6 Ad Valorem Tax Adjustment. All ad valorem Taxes imposed by any taxing authority upon the Assets will be prorated between Seller and Purchaser as of the Closing Date based on the most current available tax rates and assessed values (such prorations to be adjusted when final rates and assessed values are established). All such Taxes attributable to the period up to the Closing Date and which remain unpaid as of the Closing Date shall be deducted from the Purchase Price. All such Taxes, if any, attributable to the period following the Closing Date and which have been paid by Seller prior to the Closing Date shall be added to the Purchase Price. All adjustments to the Purchase Price will be calculated as of 11:59 p.m. on the Closing Date. 2.7 Allocation of Purchase Price. The Purchase Price represents the amount agreed upon by Purchaser and Seller to be the aggregate fair market value of the Assets. Purchaser and Seller have agreed that the Purchase Price will be allocated based upon an appraisal to be obtained by Purchaser within sixty (60) days following the Closing Date. Purchaser and Seller will allocate the Purchase 8 Price to the Assets in such manner consistently for all purposes, including in connection with all federal, foreign, state, local and other Tax Returns and reports prepared and filed by or for either of Purchaser or Seller. 2.8 Assumed Liabilities. On the terms and subject to the conditions hereof, as of the Closing, Purchaser will assume only and thereafter in due course pay, perform and discharge the following, and only the following, liabilities and obligations of Seller (the "Assumed Liabilities") (a) all liabilities and obligations of Seller arising under the terms of the Contracts that are included in the Assets and listed or described on Schedule 3.11(a) (the "Assumed Contracts"), but only to the extent such liabilities and obligations arise after the Closing Date (and are not based on events occurring on or prior to the Closing Date) under the terms of such Assumed Contracts, provided, however, that Purchaser will not assume or be responsible for any such liabilities or obligations which arise under or in relation to any Plan or from any breach or default by Seller under any Contract, all of which liabilities and obligations will constitute Retained Liabilities (as defined in Section 2.9); and (b) such liabilities and obligations as are listed on Schedule 2.8(b). 2.9 Retained Liabilities. Except as provided in Section 2.8, Seller will retain, and Purchaser will not assume or be responsible or liable with respect to, any liabilities or obligations of Seller or its Affiliates or their respective predecessors-in-interest, whether or not arising out of or relating to the operation of the Business or associated with or arising from any of the Assets or any other rights, properties or assets used in or associated with the Business at any time, and whether fixed or contingent, direct or indirect, or known or unknown, including, but not limited to, liabilities relating to warranties and service obligations relating to the operation of the Business by the Seller, liabilities for Taxes relating to the sale of the Assets and liabilities with respect to any of Seller's employees (collectively the "Retained Liabilities"). Except for the Assumed Liabilities, Seller agrees to pay or discharge when due any and all liabilities of Seller. ARTICLE III REPRESENTATIONS AND WARRANTIES OF SELLER Seller hereby represents and warrants to, and covenants and agrees with, Purchaser that as of the date hereof and as of the Closing Date: 3.1 Organization and Good Standing. (a) Seller has been duly organized and is existing as a corporation in good standing under the laws of the jurisdiction of its incorporation with full power and authority (corporate and other) to own and lease its assets and properties and to conduct its business and the operation of the Business as currently conducted. Seller has been duly qualified as a foreign corporation for the transaction of business and is in good standing under the laws of each jurisdiction set forth on Schedule 3.1(a), such jurisdictions comprising all jurisdictions in which Seller owns or leases any property, or conducts any business, so as to require such qualification, except where any failure to qualify would not have a Material Adverse Effect, as defined in Article I. 9 (b) Except as set forth in Schedule 3.1(b), Seller has no Subsidiary nor owns or controls, or has any other equity investment or other interest in, directly or indirectly, any corporation, joint venture, partnership, association or other entity. 3.2 Authorization and Effect of Agreement. Seller has the requisite corporate power to execute and deliver this Agreement and to perform the transactions contemplated hereby to be performed by Seller. The execution and delivery by Seller of this Agreement and the performance by Seller of the transactions contemplated hereby to be performed by Seller has been duly authorized by all necessary action on the part of Seller's board of directors and, if applicable, holders of the Seller's indebtedness. This Agreement has been duly executed and delivered by Seller and, assuming the due execution and delivery of this Agreement by Purchaser, constitutes a valid and binding obligation of Seller enforceable in accordance with its terms. 3.3 No Restrictions Against Sale of the Assets. Except as listed or described on Schedule 3.3, the execution and delivery of this Agreement by Seller does not, and the performance by Seller of the transactions contemplated hereby to be performed by it will not, conflict with, or result in any violation of, or constitute a default (with or without notice or lapse of time, or both) under, or give rise to a right of termination, cancellation or acceleration of any obligation or to loss of a material benefit under, (a) the certificate of incorporation or bylaws of Seller, (b) any Legal Requirement to which Seller or any of the Assets is subject, (c) any Contract or other material agreement, instrument or obligation of Seller, or (d) any licenses of Seller. No consent, approval, order or authorization of, or registration, declaration or filing with, any Governmental Entity is required to be obtained or made by or with respect to Seller under any Legal Requirement in connection with the execution and delivery of this Agreement by Seller or the performance by Seller of the transactions contemplated hereby to be performed by it. 3.4 Financial Statements. (a) Schedule 3.4 hereto contains true and complete copies of (i) the audited balance sheets of Seller at December 31, 2002 and 2003, and the related audited income statement for the years then ended (the "Audited Financial Statements"), and (ii) the unaudited balance sheet of Seller at June 30, 2004, (the "Interim Balance Sheet") and the related income statement for the six months then ended, including, except for the six-month period, the notes thereto (the financial statements described in clause (i) and (ii) above are collectively referred to as the "Financial Statements"). (b) The Financial Statements fairly present, in all material respects, the financial condition of the Seller, the Business and Seller's retained business as of the dates indicated therein and the results of operations and changes in financial position of the Seller and the Business for the periods specified therein, have been prepared in conformity with generally accepted accounting principles ("GAAP") applied on a consistent basis during the periods covered thereby and prior periods (except in each case as stated in the applicable footnotes or auditor's report and except, in the case of interim financial statements, for year end adjustments). 10 (c) The Seller has no liabilities or obligations which would be required under GAAP to be reflected on a balance sheet of the Seller as of the date of this Agreement, except for liabilities and obligations (i) reflected or reserved against in the Interim Balance Sheet, (ii) incurred or arising in the ordinary course of business since June 30, 2004, (iii) incurred or arising other than in the ordinary course of business since June 30, 2004 and not, individually or in the aggregate, material, or (iv) described on Schedule 3.4(c). (d) Schedule 3.4(d) contains true and complete schedules of (i) Seller's revenues by product line for the years ended December 31, 2002 and 2003 and the six-month period ended June 30, 2004, (ii) revenues and costs of the Business for the year ended December 31, 2003 and the six-month period ended June 30, 2004 and (iii) revenues and margins of the Business by product line and customers for the years ended December 31, 2002 and 2003 and the six-month period ended June 30, 2004. 3.5 Operation of the Business Since December 31, 2003. Except as described on Schedule 3.5, since December 31, 2003 (the "Balance Sheet Date"), Seller has conducted the operation of the Business in the Ordinary Course, and no change has occurred which materially and adversely affects the Assets or the condition (financial or otherwise), results of operations or prospects of the Business, nor, to Seller's knowledge, have any events occurred nor do there exist any circumstances which might reasonably be expected to result, either before or after the Closing Date, in any such change. 3.6 Title to Assets; Licenses. (a) Seller has, and immediately prior to the Closing will have, good, marketable and exclusive title to all of the Assets reflected on the Balance Sheet as owned by Seller and all of the Assets acquired by Seller since the Balance Sheet Date, in each case free and clear of all Liens except as set forth on Schedule 3.6(a). Seller has the valid and enforceable power and unqualified right to use and Transfer to Purchaser, the Assets. (b) Schedule 3.6(b) contains a list of all licenses relating to the Business under which Seller is the licensee, together with (i) the nature of each of the licensed Assets, (ii) the termination date of each such license, (iii) the name of the licensor, (iv) all payments made or required to be made for the fiscal years ended December 31, 2002 and December 31, 2003, and (v) all prepaid payments made thereunder. All licenses pursuant to which Seller licenses from others property are valid, subsisting in full force and effect in accordance with their respective terms, and there is not, under any license, any existing default or event of default (or event that, with notice or passage of time, or both, would constitute a default, or would constitute a basis of force majeure or other claim of excusable delay or nonperformance). Seller has the valid and enforceable right to use and Transfer to Purchaser Seller's rights in and to the licensed Assets. True and complete copies of all licenses listed on Schedule 3.6(b) have been delivered to Purchaser heretofore. Except as set forth on Schedule 3.6(b), no such license will require the consent of the licensor to, or as a result of, the consummation of the transactions contemplated by this Agreement. 11 (c) The delivery to Purchaser at Closing of the instruments of Transfer contemplated by this Agreement will vest in Purchaser good, marketable and exclusive title to the Assets, free and clear of all Liens, except for Liens listed or described on Schedule 3.6(a). (d) Except as set forth in Schedule 3.6(d), no Person, other than Seller, has any rights or interests in the Assets or the Business. (e) The Assets include all of the assets, property and rights, tangible or intangible, required by Purchaser to operate the Business, as currently operated, and to produce, sell, distribute, maintain, design, enhance and license, and design and develop derivatives of, the Products, or derivatives thereof. 3.7 No Litigation. Except as set forth on Schedule 3.7, there is no outstanding judgment, order, decree, award, stipulation or injunction of any Governmental Entity or arbitrator against or Action pending or, to Seller's Knowledge, threatened, against Seller relating to or affecting the Business or the Assets or affecting Seller's ability to perform its obligations under this Agreement or under any agreement or instrument contemplated by this Agreement. Any Action for defective or allegedly defective products or workmanship pending or threatened against Seller, and the details of such Action, are described on Schedule 3.7. 3.8 Income and Other Taxes. Except as set forth on Schedule 3.8: (a) All Tax Returns required to be filed through and including the date hereof in connection with the operations of the Seller's business are true, complete and correct in all respects and have been properly and timely filed, including any extensions of time within which to file any Tax Return, which have been timely filed. No Liens have been imposed on or asserted against any of the Assets as a result of or in connection with any failure to pay any Taxes; (b) All Taxes required to be paid or withheld and deposited through and including the date hereof in connection with the Business have been duly and timely paid or deposited by Seller. Seller has properly withheld or collected all amounts required by law for income Taxes and employment Taxes relating to its employees, creditors, independent contractors and other third parties, and for sales Taxes on sales, and has properly and timely remitted such withheld or collected amounts to the appropriate Governmental Entity. Seller has no liabilities for any Taxes for any taxable period ending prior to or coincident with the Closing Date; and (c) No Tax Return of Seller is currently being audited or is the subject of other Action by any Governmental Entity. Seller has not received any notice from any Governmental Entity of any pending examination or any proposed deficiency, addition, assessment, demand for payment or adjustment relating to or affecting Seller, the Business or the Assets and Seller has no reason to believe that any Governmental Entity may assess (or threaten to assess) any Taxes for any periods ending on or prior to the Closing Date. 12 3.9 Employee Benefit Matters. Schedule 3.9 contains a complete list of all Plans. Each Plan and related trust, annuity, or other funding agreement complies and has been maintained in compliance with all applicable Legal Requirements. Purchaser is not assuming, and shall not be subject to, any liabilities or obligations to Seller's employees as a result of the consummation of the transactions contemplated by this Agreement. All contributions, premiums, and other payments, including, without limitation, employer contributions and employee salary reduction contributions, have been paid when due or accrued in accordance with the past custom and practice of Seller and any ERISA Affiliate. There are no pending or, to Seller's knowledge, threatened Actions (other than routine claims for benefits) asserted or instituted against any Plan or the assets of any Plan, or against Seller, or ERISA Affiliate, trustee, administrator, or fiduciary of such Plan, and Seller has no knowledge of any facts that could form the basis of any such Action. Neither the execution and delivery of this Agreement nor the consummation of the transactions contemplated hereby will constitute a termination of employment or other event entitling any Person to any additional or other benefits, or that would otherwise modify benefits or the vesting of benefits, provided under any Plan. No event has occurred which could subject Seller or any ERISA Affiliate to any material liability (i) under any Legal Requirement relating to any Plan, or (ii) resulting from any obligation of Seller or an ERISA Affiliate to indemnify any Person against liability incurred with respect to or in connection with any Plan. 3.10 Governmental Approvals. (a) To the best of Seller's knowledge, Seller possesses, and is operating in compliance with, all approvals material to the operation of the Business ("Approvals"). Schedule 3.10(a) contains a true and complete list of all Approvals. Each Approval has been lawfully and validly issued, and no proceeding is pending or, to Seller's knowledge, threatened looking toward the revocation, suspension or limitation of any Approval. Each of the Approvals is in full force and effect, and Seller is in compliance with all of the provisions of the Approvals. (b) Except as set forth on Schedule 3.10(b), each of the Approvals (i) is assignable by Seller to Purchaser as contemplated by the Agreement and (ii) will be Transferred to Purchaser by Seller's delivery to Purchaser at Closing of the instruments of Transfer contemplated by this Agreement and will thereafter remain in full force and effect. Except as set forth on Schedule 3.10(b), no notice to or consent, approval, order or authorization of, or registration, declaration or filing with, any Governmental Entity or other third party is required to be obtained or made in connection with the Transfer to Purchaser of the Approvals. (c) The Approvals are all of the rights and authorizations required by Legal Requirements for the operation of the Business. All of the Approvals are owned or held by Seller free and clear of all Liens or other encumbrances of any nature whatsoever. (d) To Seller's knowledge, Seller or Purchaser would be able to renew all such Approvals by the terms thereof or in the ordinary course of business without the need to comply with any special qualifications procedures or to pay any amounts other than regular fees prescribed by law. 13 3.11 Assumed Contracts. (a) Schedule 3.11(a) contains a true and complete list and description of all Assumed Contracts, other than the Plans. True and complete copies of all such Assumed Contracts have been delivered to Purchaser heretofore. (b) Except as described on Schedule 3.11(b): (i) each Contract is legal, valid, binding, enforceable and in full force and effect; (ii) no event or condition has occurred or become known to Seller or is alleged to have occurred that constitutes or, with notice or the passage of time, or both, would constitute a default or a basis of force majeure or other claim of excusable delay, termination, nonperformance or accelerated or increased rights by Seller or any other Person under any of the Contracts; (iii) no person with whom Seller has a Contract is in default thereunder or has failed to perform fully thereunder by reason of force majeure or other claim of excusable delay, termination or nonperformance thereunder; (iv) none of the Contracts currently is subject to renegotiation, either in whole or in part; (v) no consent of any third party is required under any Contract as a result of or in connection with, and the enforceability of any Contract will not be affected in any manner by, the execution, delivery and performance of this Agreement; (vi) no Contract has materially impaired or will materially impair the ability of Seller to perform its obligations under this Agreement; and (vii) no Assumed Contract which is a license contains any minimum quantity commitments. 3.12 Employee and Labor Matters. (a) Schedule 3.12(a) contains a true and complete list of all labor, collective bargaining, union and similar agreements under or by which Seller is obligated, and true and complete copies of all such agreements have been delivered to Purchaser heretofore. (b) Except as set forth on Schedules 3.12(a) and 3.12(b), neither Purchaser nor Seller will have any responsibility for continuing any person in the employ (or retaining any person as a consultant) from and after the Closing or have any liability for any severance payments to or similar arrangements with any such Person. 14 (c) There is not occurring or, to Seller's knowledge, threatened, any strike, slow down, picket, work stoppage or other concerted action by any union or other group of employees or other persons against Seller or its products. Except for activities by the unions that are parties to any of the agreements listed on Schedule 3.12(a) with respect to the existing members of such unions, to Seller's knowledge, no union or other labor organization has attempted to organize any of the employees of Seller engaged in the Business. (d) Seller has complied with all Legal Requirements relating to employment and labor, and, to Seller's knowledge, no facts or circumstances exist that could provide a reasonable basis for a claim of wrongful termination by any current or former employee of Seller engaged in the Business. 3.13 Principal Customers and Suppliers. (a) Schedule 3.13(a) contains a true and complete list of the name and address of each customer that purchased in excess of 5% of Seller's sales of goods or services of the Business during the twelve months ended on August 30, 2004, and since that date no such customer has terminated its relationship with or adversely curtailed its purchases from Seller or indicated (for any reason) its intention so to terminate its relationship or curtail its purchases. (b) Schedule 3.13(b) contains a true and complete list of each supplier from whom Seller purchased in excess of 5% of Seller's purchases of goods or services of the Business during the twelve months ended on August 30, 2004 and since that date no such supplier has terminated its relationship with or adversely curtailed its accommodations, sales or services to Seller or indicated (for any reason) its intention to terminate such relationship or curtail its accommodations, sales or services. (c) Except as set forth on Schedule 3.13(c), Seller is not involved in any claim or controversy with any of the customers or suppliers who are listed on Schedule 3.13(a) or 3.13(b). 3.14 Compliance with Law. Through and including the date hereof, Seller (i) has not violated or operated the Business in violation of, and has not used the Assets in violation of, any Legal Requirement, (ii) to Seller's knowledge, has not been alleged to be in violation of any Legal Requirement, and (iii) has not received any notice of any alleged violation of, or any citation for noncompliance with, any Legal Requirement. 3.15 Product Warranties. Except as set forth in Schedule 3.15, (a) there are no warranties express or implied, written or oral, with respect to the Business and (b) there are no pending or threatened claims with respect to any such warranty, and Seller has no liability with respect to any such warranty, whether known or unknown, absolute, accrued, contingent or otherwise and whether due or to become due. 15 3.16 Intellectual Property. (a) Title. Schedule 3.16(a) contains a complete and correct list of all Intellectual Property that is owned by Seller and primarily related to, used in, held for use in connection with, or necessary for the conduct of, or otherwise material to the Business (the "Owned Intellectual Property"). Seller owns or has the right to use pursuant to license, sublicense, agreement or permission all Intellectual Property, including all Intellectual Property Rights, free and clear of any Liens (except as set forth on Schedule 3.6(a)) and free from any requirement of any past, present or future royalty payments, license fees, charges or other payments, or conditions or restrictions whatsoever. The Intellectual Property comprises all of the Intellectual Property and Intellectual Property Rights used in and/or necessary to the conduct and operation of the Business as now being conducted by Seller. (b) Development. Other than "shrink-wrap" and similar widely available binary code and commercial end-user licenses, to the extent that any Intellectual Property has been developed or created independently or jointly by any Person other than Seller for which Seller has, directly or indirectly, paid, Seller has a written agreement with such Person with respect thereto, and Seller thereby has obtained ownership of, and is the exclusive owner of, all such Intellectual Property and associated Intellectual Property Rights by operation of law or by valid assignment. None of the Intellectual Property was developed by or on behalf of or using grants or any other subsidies of any governmental entity. (c) Transfer. Except as set forth on Schedule 3.16(c), immediately after the Closing, Purchaser will own all of the Owned Intellectual Property and will have a right to use all other Intellectual Property, free and clear of any Liens (except as set forth on Schedule 3.6(a)) and on the same terms and conditions as in effect prior to the Closing. (d) No Infringement. The operation of the Business does not, and will not, when conducted by Purchaser, infringe or otherwise conflict with any rights of any Person in respect of any Intellectual Property. Except as set forth on Schedule 3.16(d), Seller has not received any notice from any Person claiming that such operation or any act, product, technology or service of Seller infringes or misappropriates the Intellectual Property of any Person (nor does Seller have knowledge of any claims or any basis therefor). There have been no assertions to Seller by any Persons relating to the invalidity or unenforceability of any Intellectual Property. To Seller's knowledge, none of the Intellectual Property is being infringed or otherwise used or available for use, by any other Person. (e) Licensing Arrangements. Schedule 3.16(e) sets forth all agreements, arrangements or laws (i) pursuant to which Seller has licensed Intellectual Property to, or the use of Intellectual Property is otherwise permitted (through non-assertion, settlement or similar agreements or otherwise) by, any other Person and (ii) pursuant to which Seller has had Intellectual Property licensed to it, or has otherwise been permitted to use Intellectual Property (through non-assertion, settlement or similar agreements or otherwise). All of the agreements or arrangements set forth on Schedule 3.16(e)(x) are in full force and effect in accordance with their terms and no default exists thereunder by Seller, or to the knowledge of Seller after due inquiry, by any 16 other party thereto, (y) are free and clear of all Liens, and (z) do not contain any change in control or other terms or conditions that will become applicable or inapplicable as a result of the consummation of the transactions contemplated by this Agreement. The consummation of the transactions contemplated by this Agreement will neither violate nor result in the breach, modification, cancellation, termination or suspension of such arrangements and agreements. Seller has delivered to Purchaser true and complete copies of all licenses and arrangements (including amendments) set forth on Schedule 3.16(e). All royalties, license fees, charges and other amounts payable by, on behalf of, to, or for the account of, the Seller in respect of any Intellectual Property are disclosed in the Financial Statements. (f) No Intellectual Property Litigation or Disputes. No claim or demand of any Person has been made nor is there any proceeding that is pending, or to the knowledge of Seller after due inquiry, threatened, nor is there a reasonable basis therefor, which (i) challenges the rights of Seller in respect of any Intellectual Property, (ii) asserts that Seller is infringing or otherwise in conflict with, or is, except as set forth in Schedule 3.16(f), required to pay any royalty, license fee, charge or other amount with regard to, any Intellectual Property, or (iii) claims that any default exists under any agreement or arrangement listed on Schedule 3.16(f). None of the Intellectual Property is subject to any outstanding order, ruling, decree, judgment or stipulation by or with any court, arbitrator, or administrative agency, or has been the subject of any litigation within the last five years, whether or not resolved in favor of Seller. Except as set forth in Schedule 3.16(f), there are no contracts, licenses or agreements between Seller and any other Person with respect to the Intellectual Property under which there is any dispute regarding the scope of such agreement or performances under such agreement, including with respect to any payments to be made or received by Seller thereunder. (g) Due Registration, Etc. To the extent deemed necessary or appropriate by Seller, the Owned Intellectual Property has been duly registered with, filed in or issued by, as the case may be, the United States Patent and Trademark Office, United States Copyright Office or such other filing offices, domestic or foreign, and Seller has taken such other reasonable steps to ensure full protection under any applicable laws or regulations, and such registrations, filings, issuances and other actions remain in full force and effect. Seller has no knowledge of any necessary steps to protect the Intellectual Property which have not been taken, which if not taken would jeopardize Seller's Rights to the Intellectual Property. In each case in which Seller has acquired any Intellectual Property related to the Business from any Person, Seller has obtained a valid and enforceable assignment sufficient to irrevocably transfer all rights in such Intellectual Property to Seller and, to the maximum extent provided for by, and in accordance with, applicable laws and regulations, Seller has recorded each such assignment with the relevant governmental authorities, including the PTO, the U.S. Copyright Office, or respective equivalents in any relevant foreign jurisdiction, as the case may be. (h) Use of Name and Mark. Schedule 3.16(h) lists all names and Marks presently used in the Business and, except as separately set forth in Schedule 3.16(h), there are, and immediately after the Closing will be, no contractual restriction or limitations pursuant to any orders, decisions, injunctions, judgments, awards or decrees of any Governmental Authority on the Purchaser's right to use the names and marks in the conduct of the Business as presently carried on by Seller or as such Business may be extended by Purchaser. 17 (i) Protection of Information. Except as disclosed on Schedule 3.16(i), Seller has taken reasonable steps to protect Seller's rights in Seller's confidential information and trade secrets that it wishes to protect or any trade secrets or confidential information of third parties provided to Seller relating to the Business, and, without limiting the foregoing, Seller has and enforces a policy requiring each employee and consultant engaged in the Business to execute a proprietary information/confidentiality agreement substantially in the form provided to Seller and all current and former employees and consultants of Seller engaged in the Business have executed such an agreement. (j) Effect of Agreement. Neither this Agreement nor the transactions contemplated by this Agreement, including the assignment to Purchaser expressly, by operation of law or otherwise of any contracts or agreements, will result in (i) Purchaser or Seller granting to any third party any right to or with respect to any Intellectual Property owned by, or licensed to, any of them (ii) Purchaser being bound by, or subject to, any non-competition or other material restriction on the operation or scope of its businesses or (iii) Purchaser being obligated to pay any royalties or other material amounts to any third party in excess of those payable by Purchaser, in the absence of this Agreement or the transaction contemplated hereby. 3.17 Operation of the Business. Except as set forth in Schedule 3.17, (a) Seller has operated the Business only through Seller and not through any other divisions or any direct or indirect subsidiary or affiliate of Seller and (b) no part of the operation of the Business is operated by or through any entity other than Seller. 3.18 Brokers' Fees. No broker, finder or similar agent has been employed by or on behalf of Seller in connection with this Agreement or the transactions contemplated hereby, and Seller has not entered into any agreement or understanding of any kind with any person or entity for the payment of any brokerage commission, finder's fee or any similar compensation in connection with this Agreement or the transactions contemplated hereby. 3.19 Disclosure. No representation or warranty of Seller in this Agreement and no information contained in any Schedule or other writing delivered pursuant to this Agreement or at the Closing contains or will contain any untrue statement of a material fact or omits or will omit to state a material fact required to make the statements herein or therein not misleading. 3.20 Transactions with Affiliates. Except as set forth on Schedule 3.20, there are no written or oral contracts or agreements between Seller and its Affiliates relating to the Business. 3.21 Capitalization of Seller. The authorized capital stock of Seller consists of 1,000 shares of common stock, of which 100 shares are issued and outstanding, and no shares of Preferred Stock. There are no options, warrants or other rights to acquire the common stock of Seller. Schedule 3.21 sets forth the names of the holders of the common stock of Seller. 18 3.22 No Liquidation or Winding-Up; Fairness of Consideration. (a) No order has been made or petition presented, or resolution passed for the winding-up or liquidation of Seller and there is not outstanding: (i) any petition or order for the winding-up of Seller; (ii) any appointment of a receiver over the whole or part of the undertaking of assets of Seller; (iii) any petition or order for administration of Seller; (iv) any voluntary arrangement between Seller and any of its creditors; (v) any distress or execution or other process levied in respect of Seller which remains undischarged; or (vi) any unfulfilled or unsatisfied judgment or court order against Seller relating to the Business or the Assets. (b) There are no circumstances which would entitle any Person to present a petition for the winding-up or administration of Seller or to appoint a receiver over the whole or any part of the Assets of Seller. (c) Seller is not deemed unable to pay its debts within the meaning of applicable law. (d) Neither the execution and delivery of this Agreement nor the performance of the transactions contemplated hereby will result in a transfer which is fraudulent under 6 Del. C. ss.ss.1304 or 1305. (e) The operations of Seller have not been terminated. (f) The consideration paid by Purchaser under this Agreement for the Assets represents reasonably equivalent value for the Assets. Seller is not entering into this Agreement with the intent to defraud, delay or hinder its creditors and the consummation of the transactions contemplated by this Agreement will not have any such effect. 3.23 Product Returns. To the best of Seller's knowledge, there are no Products that are in the worldwide distribution channel on the Closing Date that are awaiting resale to third parties. ARTICLE IV REPRESENTATIONS AND WARRANTIES OF PURCHASER Purchaser hereby represents and warrants to, and covenants and agrees with, Seller that: 4.1 Organization and Good Standing. Purchaser has been duly organized and is existing as a corporation in good standing under the laws of the State of Delaware with full corporate power and authority to enter into this Agreement and to consummate the transactions contemplated hereby. 4.2 Execution and Delivery. This Agreement has been duly authorized by all necessary corporate action on the part of Purchaser, has been duly executed and delivered by Purchaser and constitutes the legal, valid and binding agreement of Purchaser enforceable against Purchaser in accordance with its terms. 19 4.3 No Conflicts. The execution, delivery and performance of this Agreement by Purchaser and the consummation by Purchaser of the transactions contemplated hereby will not conflict with or result in the violation of the provisions of the Certificate of Incorporation or Bylaws of Purchaser. 4.4 Compliance with Law. Through and including the date hereof, Purchaser (i) to Purchaser's knowledge, has not been alleged to be in violation of any Legal Requirement, and (ii) has not received any notice of any alleged violation of, or any citation for noncompliance with, any Legal Requirement. 4.5 No Restrictions Against Purchase of Assets. Except as listed or described on Schedule 4.5, the execution and delivery of this Agreement by Purchaser does not and the performance by Seller of the transactions contemplated hereby to be performed by it will not, conflict with, or result in any violation of, or constitute a default (with or without notice or lapse of time, or both) under, or give rise to a right of termination, cancellation or acceleration of any obligation or to loss of a material benefit under, (a) the certificate of incorporation or bylaws of Purchaser, (b) any Legal Requirement to which Purchaser is subject, (c) any material agreement of Purchaser, or (d) any material licenses of Purchaser. No consent, approval, order or authorization of, or registration, declaration or filing with, any Governmental Entity is required to be obtained or made by or with respect to Purchaser under any Legal Requirement in connection with the execution and delivery of this Agreement by Purchaser or the performance by Purchaser of the transactions contemplated hereby to be performed by it. 4.6 Brokers' Fees. No broker, finder or similar agent has been employed by or on behalf of Purchaser in connection with this Agreement or the transactions contemplated hereby, and Purchaser has not entered into any agreement or understanding of any kind with any person or entity for the payment of any brokerage commission, finder's fee or any similar compensation in connection with this Agreement or the transactions contemplated hereby. ARTICLE V ADDITIONAL COVENANTS 5.1 Covenants of Seller. Seller agrees to: (a) use its best efforts to obtain (and to cooperate with Purchaser in obtaining) any consent, authorization or approval of, or exemption by, any Person required to be obtained or made by Seller in connection with the transactions contemplated by this Agreement; and (b) use its best efforts to bring about the satisfaction of the conditions precedent to Closing set forth in Article VI of this Agreement; 5.2 Covenants of Purchaser. Purchaser agrees to use its best efforts to bring about the satisfaction of the conditions precedent to Closing set forth in Section 6.2 of this Agreement. 5.3 Expenses. All costs and expenses (including, without limitation, all legal fees and expenses and fees and expenses of any brokers, finders or similar agents) incurred in connection with this Agreement and the transactions contemplated hereby shall be paid by the party incurring the same. 20 5.4 Further Assurances. (a) Subject to the terms and conditions of this Agreement, each of the parties hereto agrees to use its best efforts to take, or cause to be taken, all action, and to do, or cause to be done, all things necessary, proper or advisable under applicable Legal Requirements, to consummate and make effective the transactions contemplated by this Agreement. (b) If at any time after the Closing any further action is necessary or desirable to carry out the purposes of this Agreement, Seller and Purchaser, and the proper officers or directors of Seller and Purchaser, as the case may be, shall take or cause to be taken all such necessary or convenient action and execute, and deliver and file, or cause to be executed, delivered and filed, all necessary or convenient documentation. (c) Without limiting the foregoing, Seller hereby agrees that it shall use its best efforts and take any further action necessary or desirable in accordance with all applicable laws to protect any and all trade secrets and confidential or proprietary information related to the Business from disclosure or use by any current or former employees. 5.5 Inconsistent Action. Seller shall not take or cause or suffer to be taken, any action that would cause any of the representations or warranties of Seller in this Agreement to be untrue, incorrect, incomplete or misleading. 5.6 Employee Matters. (a) Seller acknowledges and agrees that after the Closing, neither Purchaser nor Seller shall be required to employ or retain any employee of Seller or any other Person. (b) Except to the extent expressly included in Assumed Liabilities or in another paragraph of this Section 5.6, Purchaser does not, and shall not, assume or be responsible for any obligation or liability arising out of any employment relationship of Seller, and without limiting the foregoing, Purchaser shall have no liability or obligation in connection with current or former employees or agents of Seller or any dependent or beneficiary of any of them by reason of their relationship to Seller. Without limiting the foregoing, Seller shall remain liable for, and shall pay on or before the Closing, the following in connection with current or former employees or agents of Seller (or any dependent or beneficiary of them): (i) unpaid wages, salaries or other compensation; (ii) contributions to or payments under employee benefit plans, programs, policies, arrangements or understandings; (iii) accrued, but unused, holiday, sick leave and severance pay, if any; 21 (iv) liabilities or obligations under any collective bargaining agreement or bargaining relationship; or (v) claims, demands, administrative proceedings or suits arising out of, or in connection with, alleged unlawful employment practices of Seller. (c) Seller shall remain responsible for all liabilities and obligations in connection with claims for post-employment medical, vision and dental benefits that may be required under IRC Section 4980B made by or in respect of any employee of Seller whose employment terminated on or prior to the Closing Date and any "qualified beneficiary" (within the meaning of IRC Section 4980B) of any such employee who is receiving post-employment medical and dental benefits or whose "qualifying event" (within the meaning of IRC Section 4980B) entitling such individual to such benefits occurred on or before the Closing Date. (d) Seller shall be responsible for giving any notice that may be required by the Worker Adjustment and Retraining Notification Act ("WARN"), or any similar state or local statue or ordinance, as a result of the purchase of the Business both as to (i) layoffs or facility closings ordered prior to the Closing Date, including layoff of employees who are not employed or retained by Purchaser, or (ii) decisions to layoff employees employed or retained by Purchaser made within 90 days after the Closing Date. Purchaser agrees to give Seller notice of any decision to layoff employees employed or retained by Purchaser made within 90 days after the Closing Date. (e) For a period of five (5) years following the Closing Date, Purchaser agrees that it shall not directly solicit, divert or hire away, or directly attempt to solicit, divert, or hire away, any person employed by Seller, whether or not such employee is a full-time employee or a temporary employee of Seller and whether or not such employment is pursuant to written agreement and whether or not such employment is for a determined period or is at will; provided, however that nothing contained herein shall prohibit Purchaser from hiring any employee of Seller who contacts Purchaser regarding employment by Purchaser. 5.7 Assignments; Consents. To the extent that the assignment of any Contract, license or other agreement or arrangement or any claim, right or benefit arising thereunder or resulting therefrom is not permitted without the consent of a third party, this Agreement shall constitute an agreement to assign such Contract, license or other agreement or arrangement, subject only to such consent; and any transfer or assignment to Purchaser by Seller of any interest under any such Contract, license or other agreement or arrangement that requires the consent of a third party shall be made subject to such consent or approval being obtained. In the event any such consent or approval is not obtained on or prior to the Closing Date, Seller shall continue to use its commercially reasonable efforts to obtain any such approval or consent after the Closing Date until such time as such consent or approval has been obtained, and Seller will cooperate with Purchaser in any lawful and economically feasible arrangement to provide that Purchaser shall receive the interest of Seller in the benefits under any such Contract, license or other agreement or arrangement, including performance by Seller, as agent, if economically feasible, provided that 22 Purchaser shall undertake to pay or satisfy the corresponding liabilities for the enjoyment of such benefit to the extent Purchaser would have been responsible therefor hereunder if such consent or approval had been obtained. Nothing in this Section 5.7 shall be deemed a waiver by Purchaser of its right to have received on or before the Closing an effective assignment of all of the Assets nor shall this Section 5.7 be deemed to constitute an agreement to exclude from Purchaser any of the Assets described under Section 2.1. 5.8 Sufficiency of Assets. Following the Closing, if Purchaser determines that Seller has failed to Transfer to Purchaser any assets, properties or rights (including, without limitation, any rights with respect to the Retained Technology licensed to Purchaser pursuant to the terms of the License Agreement), tangible or intangible, except for the Excluded Assets (other than as provided above with respect to the Retained Technology licensed to Purchaser pursuant to the terms of the License Agreement), necessary for Purchaser to operate the Business as currently operated, and to produce, sell, distribute, maintain, design, enhance and license, and design and develop derivatives of, the Products, or derivatives thereof, Seller shall promptly take all actions as shall be necessary, or otherwise reasonably requested by Purchaser, to transfer such assets, properties and rights to Purchaser. 5.9 Waiver. Any term or provision of this Agreement may be waived in writing at any time by the party or parties entitled to the benefits thereof. Any waiver effected pursuant to this Section 5.9 shall be binding upon all parties hereto. No failure to exercise and no delay in exercising any right, power or privilege shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power or privilege preclude the exercise of any other right, power or privilege. No waiver of any breach of any covenant or agreement hereunder shall be deemed a waiver of any preceding or subsequent breach of the same or any other covenant or agreement. The rights and remedies of each party under this Agreement are in addition to all other rights and remedies, at law or in equity, that such party may have against the other parties. 5.10 Tax Assessments and Audits. Seller shall furnish promptly to Purchaser a copy of all notices of proposed assessment or similar notices or reports that are received from any taxing authority and which relate to the Business or the Assets for periods ending on or prior to the Closing Date. ARTICLE VI CONDITIONS PRECEDENT TO CLOSING 6.1 Conditions of Purchaser. Notwithstanding any other provision of this Agreement, the obligations of Purchaser and Seller to consummate the transactions contemplated hereby shall be subject to the satisfaction, at or prior to the Closing Date, of the following conditions: (a) There shall not be instituted and pending or threatened any Action before any Governmental Entity (i) challenging or otherwise seeking to restrain or prohibit the consummation of the transactions contemplated hereby or (ii) seeking to prohibit the direct or indirect ownership or operation by Purchaser of all or a material portion of the Business or Assets, or to compel Purchaser or Seller to dispose of or hold separate all or a material portion of the Business or Assets of Seller or Purchaser; 23 (b) The representations and warranties of Seller and Purchaser in this Agreement shall be true and correct as of the date of this Agreement and shall be true and correct in all material respects (or in all respects in the case of any representation or warranty subject to a materiality qualification) on and as of the Closing Date with the same effect as if made on the Closing Date, except for those representations and warranties which address matters only as of a particular date (which shall be true and correct as of such date) and Seller and Purchaser shall have complied with all covenants and agreements and satisfied all conditions on Seller's or Purchaser's (as applicable) part in this Agreement or any Ancillary Agreement to be performed or satisfied on or prior to the Closing Date. (c) Purchaser shall have received from counsel for Seller, a written opinion dated the Closing Date and addressed to Purchaser, in substantially the form attached as Exhibit F hereto; (d) Purchaser shall have received from the President of Seller a certificate dated the Closing Date to the effect that the conditions set forth in Section 6.1(b) have been satisfied and that Seller's Board of Directors and the stockholders of Seller have approved the Agreement and the transactions contemplated hereby; (e) Purchaser will have received such bills of sale, assignments, certificates of title and other instruments of transfer (the "Transfer Documents") duly executed by Seller, in such forms and covering such matters as Purchaser may reasonably request, Transferring the Assets to Purchaser; (f) Seller and James T. Matthews shall each have entered into and delivered to Purchaser the Noncompetition Agreements. (g) Purchaser shall have concluded (through its representatives, accountants, counsel and other experts) an investigation of the condition (financial and other), results of operations, properties, assets, prospects and operations of the Business and shall be satisfied, in its sole discretion, with the results thereof; (h) All corporate and other proceedings and actions taken in connection with the transactions contemplated hereby and all certificates, opinions, agreements, instruments, releases and documents referenced herein or incident to the transactions contemplated hereby shall be in form and substance satisfactory to Purchaser and Seller and their respective counsel; (i) All consents and assignments from third parties, including from any Governmental Entity or other Person, relating to the Contracts or the conduct and operation of the Business as currently conducted and operated, shall have been obtained; 24 (j) No act, event or condition shall have occurred after the date hereof which Purchaser determines has had or could have a Material Adverse Effect on the Business or the Assets; (k) The Board of Directors and Stockholders of Seller shall have authorized and approved this Agreement and the transactions contemplated hereby; (l) Seller, Purchaser and the Escrow Agent shall have entered into the Escrow Agreement. (m) Seller and Purchaser shall have entered into the Transitional Supply Agreement. (n) Seller and Purchaser shall have entered into the License Agreement. (o) Seller and Purchaser shall have entered into the Reseller Agreement. 6.2 Conditions of Seller. Notwithstanding any other provision of this Agreement, and except as set forth below, the obligations of Seller to consummate the transactions contemplated hereby shall be subject to the satisfaction, at or prior to the Closing, of the conditions set forth in subsections (a), (b), (l), (m), (n) and (o) of Section 6.1 of this Agreement, and Seller shall have received from Purchaser a certificate signed by an authorized officer of Purchaser that the conditions set forth in Section 6.1(b) have been satisfied and that its Board of Directors has approved this Agreement and the transactions contemplated hereby. ARTICLE VII POST-CLOSING OBLIGATIONS 7.1 Seller-Assumed Warranty Obligations. Notwithstanding, and not in limitation of, any other provision herein, Seller shall assume, commencing at the Closing, all obligations and liabilities of any nature whatsoever arising out of, relating to, or in connection with the matters set forth in this Section 7.1. (a) Seller shall retain sole responsibility for, and shall bear the cost of complying with, all warranties (the "Warranties") in existence on the Closing Date with respect to Products sold by Seller on or prior to the Closing Date until the expiration of such Warranties and on sales of Products supplied to Purchaser pursuant to the Transitional Supply Agreement. (b) Exhibit G hereto sets forth the Warranties. (c) Seller agrees to provide all services required to correct, repair or replace Products or parts thereof covered by the Warranties in accordance with the terms of the Warranties. Such services shall be consistent, in all material respects, with the quality and manner of performance of similar services provided by or made available to under the Warranties prior to the Closing Date. Seller shall use business practices, standards and internal controls that are substantially the same as those used by Seller prior to the 25 Closing Date and consistent with past practices, with only such changes as are agreed to between Seller and Purchaser. Not in limitation of the foregoing, Seller shall repair or replace and ship at least 95% of units of Products returned pursuant to the terms of the Warranties in accordance with the following time schedule: (i) within 10 business days after receipt of the Products, for Products that were in production in the 12 calendar month period prior to the return; and (ii) within 10 business days after receipt of the Products, for Products that were in production in the 13 to 36 calendar month period prior to the return. 7.2 Seller-Assumed Support Services Obligations. Notwithstanding any other provision herein to the contrary, Seller shall assume, commencing at the Closing, all obligations and liabilities of any nature whatsoever arising out of, relating to, or in connection with the matters set forth in this Section 7.2. (a) For the three-month period commencing on the Closing Date, Seller shall have the responsibility for and shall bear the cost of providing engineering and technical support services, access to Seller's key personnel and documentation, introductions to vendors and customers and other similar support (the "Transitional Services") to assist Purchaser with respect to the manufacturing, distribution and sales of the Products, as set forth in Exhibit H hereto. Services provided by Seller under this Section 7.2(a) shall be consistent, in all material respects, with the quality and manner of performance of similar services provided by or made available to support the Products in connection with Seller's operations prior to the Closing Date. Seller shall use business practices, standards and internal controls that are substantially the same as those used by Seller prior to the Closing Date and consistent with past practices, with only such changes as are agreed to between Seller and Purchaser. (b) Seller shall designate at least one contact person within Seller who is knowledgeable and experienced in the design, workings, capabilities and use of the Products who will be responsible for initially responding to inquiries relating to the support services to be provided on behalf of Purchaser. 7.3 Continued Operations; No Bankruptcy. Seller intends to continue its operations consistent with its past practices after the Closing Date, other than as contemplated by this Agreement. As of the date hereof and as of the Closing Date, Seller does not intend or expect to file or seek relief under the United States Bankruptcy Code or any other insolvency or similar law after the Closing Date. Seller intends to use its commercially reasonable best efforts to discourage and avoid any involuntary petition by creditors or others to place Seller in any bankruptcy case or proceeding under the United States Bankruptcy Code or any other insolvency law or similar law. 7.4 Sales Incentive Program. Immediately following the Closing, Seller and Purchaser shall establish a sales incentive bonus program (the "Incentive Bonus Program") for certain identified sales staff of Seller ("Eligible Sales Staff") engaged in the transition of customer accounts from Seller to Purchaser 26 during the Earn-Out Period. Seller and Purchaser shall each contribute an amount equal to one and one-half percent (1.50%) of the first $8,000,000 of Earn-Out Revenues during the Earn-Out Period (i.e. $120,000) to the Incentive Bonus Program (each such contribution, a "Sales Incentive Contribution" and, collectively, the "Sales Incentive Contributions"). The Sales Incentive Contributions shall be funded by Purchaser and Seller on a quarterly basis within fifteen (15) days following the end of each fiscal quarter and any payments to Eligible Sales Staff shall be made within thirty (30) days following the end of each fiscal quarter, commencing with the fiscal quarter ending December 31, 2004. In the event that Seller fails to make any Sales Incentive Contribution(s) as required by the terms hereof, Purchaser shall have the right, but not the obligation, to make such Sales Incentive Contribution(s) on Seller's behalf and to set off the amount(s) thereof against the amount of any Contingent Consideration payable to Seller pursuant to Section 2.4(b) hereof. The administration of the Sales Bonus Program (i.e. determination of eligible staff, defined level of support, projected payment amounts, etc.) shall be determined by one designated representative of Seller and two designated representatives of Purchaser and all such determinations shall be final. The amount of any Sales Incentive Contributions that are not distributed to Eligible Sales Staff on or before the end of the Earn-Out Period pursuant to the terms of the Incentive Bonus Program shall be returned to Purchaser and Seller in the same proportions as such Incentive Sales Contributions were originally made within thirty (30) days following the end of the Earn-Out Period. All Incentive Sales Contributions shall be held by Purchaser pending distribution to Eligible Sales Staff and/or return to Purchaser and Seller as provided herein. In the event that Purchaser and Seller are unable to agree on the determination of any matter under this Section 7.4, either Purchaser or Seller may deliver to the other a Dispute Notice and, thereafter, the parties shall endeavor to resolve such disputed items in the manner, and pursuant to the terms, provided in Section 2.4(b)(iv) hereof. 7.5 Use of Seller's Name by Purchaser. Seller agrees that Purchaser shall have the right to use the name "Visara," and any variants thereof, in the marketing, sale and distribution of the Products during the period commencing on the date hereof and continuing up to and including the date that is sixty (60) days following the last day of the Earn-Out Period in connection with the manufacturing, sale and/or distribution of Products. ARTICLE VIII INDEMNIFICATION 8.1 Survival. Notwithstanding any investigation conducted at any time with regard thereto by or on behalf of Purchaser, the representations and warranties of Seller contained in this Agreement or in any Exhibit or Schedule hereto and the representations and warranties of Purchaser contained in Sections 4.5 and 4.6 hereto shall survive the Closing and the consummation of the transactions contemplated hereby (and any examination or investigation by or on behalf of any party hereto); provided, however, that (i) the representations and warranties contained in Sections 3.1, 3.3, 3.6 and 4.5, and the related claims for indemnification, shall survive until the fifth anniversary of the Closing Date; (ii) the representations and warranties contained in Section 3.8, and the related claims for indemnification, shall survive until sixty (60) days after the expiration of the applicable statute of limitations, (iii) all claims for 27 indemnification arising out of or resulting from the State of New Jersey Litigation (as defined in Section 8.2) shall survive until a final, non-appealable judgment is issued with respect thereto, and (iv) all other representations and warranties, and related claims for indemnification, shall survive until the second anniversary of the Closing Date. The termination of the representations and warranties provided herein shall not affect the rights of a party in respect of any claim made prior to the expiration of the applicable survival period. The agreements and covenants contained in this Agreement shall survive the Closing Date indefinitely or in accordance with their terms, if any. 8.2 Indemnification. (a) Seller covenants and agrees to defend, indemnify and hold harmless Purchaser and each Person who controls Purchaser from and against any Damages arising out of or resulting from: (i) any inaccuracy in or breach of any representation or warranty made by Seller in this Agreement or in any writing delivered pursuant to this Agreement or at the Closing; (ii) the failure of Seller to perform or observe fully any covenant, agreement or provision to be performed or observed by Seller pursuant to this Agreement; (iii) Purchaser's waiver of any applicable bulk sales laws; or (iv) that certain litigation between the State of New Jersey v. Visara International, Inc., Civil 04-1776 (SRC) (the State of New Jersey Litigation"), it being understood that the $50,000 limitation contained in Section 8.6 shall not apply to any claim for indemnification by Purchaser under this Section 8.2(iv). (b) Purchaser covenants and agrees to defend, indemnify and hold harmless Seller and each Person who controls Seller from and against any Damages arising out of or resulting from the failure of Purchaser to perform or observe the covenants contained in Section 2.4(b) hereof 8.3 Procedures. If either party seeks indemnification under this Article VIII, it shall give notice ("Claim Notice") to the other party of the basis of the claim (the "Claim") (i) within a reasonable time after discovery of the facts and (ii) in any event, within the time periods set forth in Section 8.1, provided that the failure to give such notice shall not relieve the indemnifying party of any liability hereunder except to the extent that the indemnified party is materially adversely prejudiced by such failure. The indemnifying party shall give notice to the indemnified party within thirty (30) days after receipt of the notice requested by this Section 8.3 advising whether it (i) acknowledges its obligation to indemnify the indemnified party or (ii) disputes its obligation to indemnify the indemnified party. If the indemnifying party acknowledges its indemnification obligation with respect to the Claim, and (i) such Claim is based upon an asserted liability or obligation to a person or entity that is not a party to this Agreement (a "Third Party Claim"), the indemnifying party shall have the right to defend or settle such Third Party Claim or (ii) if such Claim is not a Third Party Claim, the indemnified party shall be entitled to immediate satisfaction of such Claim. If the indemnifying party does not notify the indemnified party within fifteen (15) business days 28 following receipt of notice of a Claim that is not a Third Party Claim that it disputes such Claim, such Claim shall be deemed a liability of the indemnifying party and the indemnifying party shall pay the amount of the Claim on demand by the indemnified party, or in the case of any notice in which the amount of the Claim is estimated, on such later date when the amount of the Claim is finally determined. If the indemnifying party disputes the Claim in a timely manner as set forth herein, the indemnifying party and the indemnified party shall proceed in good faith to negotiate a resolution of the dispute, or, if necessary, to resolve the dispute in a manner determined by the parties or by any other means elected by the indemnified party. 8.4 Third Party Claims. (a) The indemnifying party shall have thirty (30) days after receipt of the Claim Notice to undertake, conduct and control, through counsel satisfactory to the indemnified party, and at the indemnifying party's expense, the settlement or defense of a Third Party Claim, and the indemnified party shall cooperate with the indemnifying party in connection therewith, provided that (i) the indemnifying party shall permit the indemnified party to participate in such settlement or defense through counsel chosen by the indemnified party, provided that the fees and expenses of such counsel shall not be borne by the indemnifying party, and (ii) the indemnifying party shall not settle any Third Party Claim without the indemnified party's consent. So long as the indemnifying party is vigorously contesting any such Third Party Claim in good faith, the indemnified party shall not pay or settle such claim without the indemnifying party's consent, which consent shall not be unreasonably withheld, conditioned or delayed. Notwithstanding the foregoing, if the indemnifying party assumes control of such defense, and there exists a conflict of interest between the interests of the indemnifying party and those of the indemnified party with respect to such Third Party Claim as determined by the indemnifying party's counsel such that the indemnifying party's counsel can no longer represent the interests of the indemnifying party and the indemnified party with respect to such third Party Claim, the indemnified party may retain counsel satisfactory to it and the reasonable fees and expenses of such counsel to the indemnified party shall be paid by the indemnifying party. (b) If the indemnifying party does not notify the indemnified party within thirty days after receipt of the Claim Notice that it elects to undertake the defense of the Third Party Claim described therein, the indemnified party shall have the right to contest, settle or compromise the Third Party Claim in the exercise of its reasonable discretion, on behalf of and for the account and risk of the indemnifying party; provided that the indemnified party shall notify the indemnifying party of any compromise or settlement of any such Third Party Claim. (c) Seller shall not be entitled to assume the defense for any Third Party Claim (and shall be liable for the reasonable fees and expenses incurred by the Purchaser in defending such claim) if the Third Party Claim seeks an order, injunction or other equitable relief or relief for other than money damages against Purchaser which Purchaser determines, after conferring with its counsel, cannot be separated from any related claim for money damages and which, if successful, would adversely affect the Assets or the Business, properties or prospects of the Business. 8.5 Indemnification Exclusive. Except as provided herein, the foregoing indemnification provisions shall be the sole and exclusive remedy after the Closing Date for money damages available to the indemnified party for breach of any representations, warranties or covenants contained herein, but shall not limit any other remedy to which the indemnified party may be entitled. Nothing 29 in this Agreement shall be construed as limiting in any way the remedies that may be available to the indemnified party in the event of fraud relating to the representations, warranties or covenants made by the indemnifying party in this Agreement. 8.6 Limitation on Amount. Seller shall not be liable for claims made under this Article VIII until the aggregate amount of the Damages incurred by Purchaser shall exceed $50,000, in which event the indemnification obligations of Seller shall apply to the amount of all claims made under this Article VIII, provided, however, that any amount recoverable by Purchaser in accordance with Section 2.6 shall not be subject to the $50,000 threshold, and further provided, however, that Seller shall not be liable in the aggregate pursuant to this Article VIII for an amount in excess of $3,350,000, plus the amount, if any, of the Contingent Consideration paid to Seller. ARTICLE IX REBATE AND MARKETING PROGRAMS 9.1 List of Programs. Visara is not contingently liable to pay any amounts under any market development fund ("MDF"), marketing and rebate programs or any special price quote ("SPQ") program with regard to inventory of the Products in the worldwide distribution channel and in transit to distributors worldwide on the Closing Date. Any claims arising under any Seller's SPQ programs from customers will be the sole responsibility of Seller. 9.2 Marketing Rights. Seller shall provide a prominent link, with the content approved by Purchaser, from the main page of Seller's website at www.visara.com (or any successor website), from the products page at www.visara.com/prod_thin_clients.htm and such other pages as Purchaser may reasonably request to Purchaser's website at www.neoware.com for a two-year period commencing on the Closing Date. ARTICLE X GENERAL PROVISIONS 10.1 Notices. All notices and other communications under or in connection with this Agreement shall be in writing and shall be deemed given (a) if delivered personally (including by overnight express or messenger), upon delivery, (b) if delivered by registered or certified mail (return receipt requested), upon the earlier of actual delivery or three days after being mailed, or (c) if given by telecopy, upon confirmation of transmission by telecopy, in each case to the parties at the following addresses: (a) If to the Purchaser, addressed to: Neoware Systems, Inc. 400 Feheley Drive King of Prussia, Pennsylvania 19406 Attention: Michael G. Kantrowitz, President and Chief Executive Officer Facsimile: (610) 275-5739 30 With a copy to: McCausland, Keen & Buckman Radnor Court, Suite 160 259 N. Radnor-Chester Road Radnor, Pennsylvania 19087 Attention: Nancy D. Weisberg, Esquire Facsimile: (610) 341-1099 (b) If to Seller, addressed to: Visara International, Inc. 6833 Mount Herman Road Morrisville, NC 27560 Attn: James T. Matthews, Chief Executive Officer Facsimile: (919) 882-0163 With a copy to: Levene Gouldin & Thompson, LLP 450 Plaza Drive Vestal, NewYork 13850 Attention: Howard M. Rittberg, Esquire Facsimile: (607) 763-9211 10.2 Severability. If any term or provision of this Agreement or the application thereof to any circumstance shall, in any jurisdiction and to any extent, be invalid or unenforceable, such term or provision shall be ineffective as to such jurisdiction to the extent of such invalidity or unenforceability without invalidating or rendering unenforceable such term or provision in any other jurisdiction, the remaining terms and provisions of this Agreement or the application of such terms and provisions to circumstances other than those as to which it is held invalid or enforceable. 10.3 Entire Agreement. This Agreement, including the annexes and schedules attached hereto and other documents referred to herein, contains the entire understanding of the parties hereto in respect of its subject matter and supersedes all prior and contemporaneous agreements and understandings, oral and written, between the parties with respect to such subject matter. 10.4 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of Purchaser and Seller and their respective successors, heirs and assigns; provided, however, that Seller shall not directly or indirectly transfer or assign any of Seller's rights or obligations hereunder in whole or in part without the prior written consent of Purchaser. Subject to the foregoing, this Agreement is not intended to benefit, and shall not run to the benefit of or be enforceable by, any other person or entity other than the parties hereto and their permitted successors and assigns. 31 10.5 Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemed an original, but all such counterparts together shall constitute but one and the same Agreement. 10.6 Recitals, Schedules, Exhibits and Annexes. The recitals, schedules, exhibits and annexes to this Agreement are incorporated herein and, by this reference, made a part hereof as if fully set forth at length herein. 10.7 Construction. (a) The article, section and subsection headings used herein are inserted for reference purposes only and shall not in any way affect the meaning or interpretation of this Agreement. (b) As used in this Agreement, the masculine, feminine or neuter gender, and the singular or plural, shall be deemed to include the others whenever and wherever the context so requires. (c) For the purposes of this Agreement, unless the context clearly requires, "or" is not exclusive. 10.8 Governing Law. This Agreement shall be governed by and construed in accordance with the internal laws (and not the law of conflicts) of the Commonwealth of Pennsylvania. 10.9 Passage of Title and Risk of Loss. Legal title, equitable title and risk of loss with respect to the Assets will not pass to Purchaser until such Assets are Transferred at the Closing, which transfer, once it has occurred, will be deemed effective for tax, accounting and other computational purposes as of 11:59 P.M. (Eastern Time) on the Closing Date. 10.10 Bulk Sales. Purchaser hereby waives compliance by Seller with the provisions of the bulk sales laws of any jurisdiction, if applicable, provided that Seller agrees to indemnify Purchaser for claims of creditors of Seller with respect to liabilities not expressly assumed by Purchaser pursuant to this Agreement. [REMAINDER OF PAGE INTENTIONALLY LEFT BLANK] 32 IN WITNESS WHEREOF, each of the parties hereto has executed this Agreement, or has caused this Agreement to be executed on its behalf by a representative duly authorized, all as of the date first above set forth. NEOWARE SYSTEMS, INC. By: /s/ Keith D. Schneck ------------------------------- Name: Keith D. Schneck ----------------------------- Title: Chief Financial Officer ---------------------------- VISARA INTERNATIONAL, INC. By: /s/ James T. Matthews ------------------------------- Name: James T. Matthews ----------------------------- Title: President ---------------------------- 33 EX-31 3 ex31-1.txt EXHIBIT 31.1 EXHIBIT 31.1 CERTIFICATION I, Michael Kantrowitz, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Neoware Systems, Inc.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 8, 2004 /s/ MICHAEL KANTROWITZ ----------------------------------------------- Michael Kantrowitz Chairman, President and Chief Executive Officer (Principal Executive Officer) EX-31 4 ex31-2.txt EXHIBIT 31.2 EXHIBIT 31.2 CERTIFICATION I, Keith D. Schneck, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Neoware Systems, Inc.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 8, 2004 /s/ KEITH D. SCHNECK ---------------------------------------------------- Keith D. Schneck Executive Vice President and Chief Financial Officer (Principal Financial Officer) EX-32 5 ex32-1.txt EXHIBIT 32.1 EXHIBIT 32.1 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 the quarterly report of Neoware Systems, Inc. (the "Company") on Form 10-Q for the quarter ended September 30, 2004 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. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to such officer's knowledge: (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 results of operations of the Company as of the dates and for the periods expressed in the Report. /s/ MICHAEL KANTROWITZ - ----------------------------------------------- Michael Kantrowitz Chairman, President and Chief Executive Officer (Principal Executive Officer) November 8, 2004 The foregoing certification is being furnished to the Securities and Exchange Commission pursuant to 18 U.S.C. Section 1350 as an exhibit to the Report and is not being filed as part of the Report or as a separate disclosure document. EX-32 6 ex32-2.txt EXHIBIT 32.2 EXHIBIT 32.2 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 September 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Keith D. Schneck, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to such officer's knowledge: (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 results of operations of the Company as of the dates and for the periods expressed in the Report. /s/ KEITH D. SCHNECK - ---------------------------------------------------- Keith D. Schneck Executive Vice President and Chief Financial Officer (Principal Financial Officer) November 8, 2004 The foregoing certification is being furnished to the Securities and Exchange Commission pursuant to 18 U.S.C. Section 1350 as an exhibit to the Report and is not being filed as part of the Report or as a separate disclosure document. -----END PRIVACY-ENHANCED MESSAGE-----