-----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, VNcHEzV6V+DmD7yy6zpSvB8j6Ic9WG5dKM7oXK8U2xPo3QAAEAiUgPKuPMm/g5Qx J/op5P5OLiXI1jqEM9mAkA== 0001036050-97-000791.txt : 19970930 0001036050-97-000791.hdr.sgml : 19970930 ACCESSION NUMBER: 0001036050-97-000791 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970929 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HDS NETWORK 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-K SEC ACT: SEC FILE NUMBER: 000-21240 FILM NUMBER: 97687398 BUSINESS ADDRESS: STREET 1: 400 FEHELEY DR CITY: KING OF PRUSSIA STATE: PA ZIP: 19406 BUSINESS PHONE: 6102778300 MAIL ADDRESS: STREET 1: 400 FEHELEY DR CITY: KING OF PRUSSIA STATE: PA ZIP: 19406 FORMER COMPANY: FORMER CONFORMED NAME: INFORMATION SYSTEMS ACQUISITION CORP DATE OF NAME CHANGE: 19930108 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 1997 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-21240 ------- NEOWARE SYSTEMS, INC. (Exact name of registrant as specified in its charter.) Delaware 23-2705700 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 400 Feheley Drive, King of Prussia, Pennsylvania 19406 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (610) 277-8300 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered None NASDAQ ------------------- ----------------------------------------- Securities registered pursuant to Section 12(g) of the Act: Units consisting of one share of Common Stock and two Redeemable Common Stock Purchase Warrants; Common Stock, par value $.001 per share; and Redeemable Common Stock Purchase Warrants each to purchase one share of Common Stock for ---------------------------------------------------------------- $5.50 per share --------------- (Title of Class) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X - The aggregate market value of the voting stock held by non-affiliates of the registrant is approximately $24,778,000. Such aggregate market value was computed by reference to the last reported sale price of the Common Stock as reported on the NASDAQ National Market on September 19, 1997. In making such calculation, the registrant does not determine whether any director, officer or other holder of Common Stock is an affiliate for any other purpose. The number of shares of the registrant's Common Stock outstanding as of September 19 , 1997 was 5,760,820. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on December 10, 1997 are incorporated by reference into Part III. Those portions of the Proxy Statement included in response to Item 402(k) and 402(1) of Regulation S-K are not incorporated by reference into Part III.
TABLE OF CONTENTS PAGE ----------------- ---- PART I...................................................................................................1 ITEM 1. BUSINESS...............................................................................1 ITEM 2. PROPERTIES.............................................................................8 ITEM 3. LEGAL PROCEEDINGS......................................................................9 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................................9 PART II..................................................................................................9 ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS..................9 ITEM 6. SELECTED FINANCIAL DATA...............................................................10 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.11 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...........................................15 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...15 PART III................................................................................................16 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT....................................16 ITEM 11. EXECUTIVE COMPENSATION................................................................17 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. ......................17 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........................................17 PART IV.................................................................................................17 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.......................17
PART I Forward-Looking Statements Certain statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 and certain other statements contained in this Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to certain risks and uncertainties, including, but not limited to, quarterly fluctuations in operating results, general economic conditions affecting the demand for computer products, the timing of significant orders, the timing and acceptance of new product introductions including the Company's line of network computers, the mix of distribution channels through which the Company's products are sold, increased competition, the failure to reduce product costs or maintain quality, delays in the receipt of key components, seasonal patterns of spending by customers, continued government funding of projects for which the Company is a subcontractor, increased competition in the desktop computer market and the Company's ability to complete strategic acquisitions. ITEM 1. BUSINESS. General Neoware Systems, Inc., formerly HDS Network Systems, Inc., (the "Company") designs, manufactures and markets a family of network computers that are designed to integrate and deliver information to the desktop in network- centric environments. The Company's @workStation/TM/ and NeoStation/TM/ and related software combine a variety of windowed-display, graphical user interface ("GUI") and communications industry standards to provide the user seamless and transparent access to all information, including text, graphics, and audio and video data, on any type of network. The Company has licensed the Navigator browser from Navio Communications, Inc. Sun Microsystems, Inc.'s Java/TM/ technology and Spyglass, Inc.'s Web browser technologies to provide cost- effective access to information and applications within the corporate enterprise and on the Internet. The functionality of the Company's systems is derived primarily from netOS/TM/, an operating system software product based on open systems technologies, owned and developed by the Company. The Company's hardware products are optimized to run netOS/TM/. The Company's network computers provide certain advantages over PCs, workstations and traditional terminals, particularly with respect to lower administrative costs, reduced obsolescence and improved ease of use. The Company's network computer product line was introduced in June 1996. Prior to the introduction of the network computer, the Company manufactured and marketed a family of desktop computing devices, including multimedia-capable X Window terminals. The X terminal product line was designed around industry standards and allowed users to access multiple forms of information simultaneously, using the industry standard X protocol and industry standard networking interfaces. The Company was formed in November 1992 as a Specified Purpose Acquisition Company ("SPAC"), the objective of which was to acquire an operating business in the information systems industry. During 1993 and 1994, the Company's efforts were limited to organizational activities, completion of an initial public offering and evaluation of possible acquisitions. On March 2, 1995, Human Designed Systems, Inc. ("HDS") was merged into a wholly-owned subsidiary of the Company (the "Merger"). Pursuant to the Merger, all of the outstanding shares of HDS were converted into the right to receive a total of 2,810,000 shares of the Company's Common Stock, 618,200 redeemable common stock purchase warrants and $5,500,000 in cash, in accordance with the exchange ratios set forth in the Merger Agreement. Upon completion of the Merger, the former shareholders of HDS owned approximately 50.1% of the outstanding Common Stock of the Company. At the time of the Merger, the Company changed its name to HDS Network Systems, Inc. In April 1996 HDS was merged into the Company. In September 1996, the Company entered into an agreement with Hitachi Data Systems Corporation whereby the Company, among other things, agreed to sell to Hitachi all of the Company's rights in the mark "HDS" and to cancel certain petitions filed by the Company in the United States Patent and Trademark Office to cancel Hitachi's trademark registrations relating to the mark "HDS." At a Special Meeting of Stockholders held on July 30, 1997, the Company's stockholders approved the Company's name change to Neoware Systems, Inc. In August 1996, the Company formed a new subsidiary, Information Technology Consulting, Inc. ("ITC") for the purpose of acquiring companies in the network computer services field, including information technology staffing companies and client-server consulting companies. In January 1997 the Company announced that ITC entered into a definitive agreement to acquire the business of Global Consulting Group ("Global"), an information technology staffing and consulting company, subject to the consummation by ITC of a public offering of its stock. In March 1997 the Company announced that ITC entered into a definitive agreement to acquire the business of The Reohr Group, Inc. ("Reohr"), an information technology staffing and consulting company, subject to the consummation by ITC of a public offering of its stock. In August 1997, the Company announced that it had entered into an agreement under which ITC will merge with Reohr and Global. Under the agreement, ITC and Global will merge into Reohr, and Neoware, as the sole stockholder of ITC, will receive stock of the surviving entity that will represent ownership of approximately 2% of the entity after the merger. The Company will also be reimbursed for the expenses incurred by the Company and ITC in connection with ITC's efforts to make these acquisitions. In February 1997, the Company formed a new subsidiary, Bridging Data Technology, Inc. (BDT). BDT has acquired and developed a software product, SmartBridge/TM/, which utilizes the "intelligent bridging" approach to upgrading programs and data for Year 2000 compliance. Neoware holds a majority ownership stake in BDT, which is based in Atlanta, GA. The SmartBridge product implements an on-site automated bridge building "factory" that creates intelligent bridge modules. These modules allow the uncoupling of applications and data, enabling conversions to take place quickly and with minimal impact to system performance. Product Strategy The Company's objective is to maintain a leadership position in the evolving market for network computer products. Prior to the introduction of its network computer product family in June 1996, the Company was a leading provider of X Window terminals. The Company believes the market potential of the network computer is significantly larger than that of the X terminal market, and has invested significant resources in sales and marketing and research and development in the current and 2 prior years to bring its new product families to market. The Company's network computer products incorporate the following elements: . Efficient, standards-based Operating System. During the current and prior years, the Company developed and enhanced netOS, an operating system for network computers based on industry standard protocols and technologies. The operating system allows users to access applications and information on multiple platforms, including Windows95(R), WindowsNT(R), Windows 3.1, UNIX/TM/, mainframe and midrange computers, the Internet and Java/TM/. The netOS operating system is used within the Company's own product lines, and the Company has licensed the operating system to other manufacturers of network-centric computing devices. In July 1997, the Company introduced three versions of netOS. Its netOS for WinTerminals/TM/ allows connection to multi-user Windows application servers. The Company's netOS for the Enterprise/TM/ adds the ability to connect with UNIX computers and enterprise systems such as mainframes and midrange computers. The Company's most extensive operating system, netOS for Intranets/TM/, incorporates the functionality of netOS for the Enterprise/TM/ and adds support for Java, the Navigator web browser as well as email and an Internet news reader. . Cost-effective, High-Performance Network Computer Families. The Company offers a full line of network computers, which are bundled with the netOS operating system. The Company's @workStation product family offers a choice of four model lines (@work Basic, Prima, Supra and Duo) with different levels of performance and capability. Each model uses an Intel i960 RISC processor, and the @work Supra models include additional hardware acceleration for faster performance. The @work Duo models incorporate the capability to connect two monitors to one network computer base, keyboard and mouse for applications that require additional screen space. In July 1997, the Company introduced its new line of thin client desktops, known as the NeoStation product family. The NeoStation features a vertical design and simpler administration and setup. The NeoStation 500 is specifically designed to address the market for WinTerminals, thin client desktops that allow users to run Windows applications from central WindowsNT-based servers. Other products in the NeoStation product family, the NeoStation 520 and the NeoStation 540, offer access to legacy and Java applications and the Internet, as well as higher video resolution. The @workStation and NeoStation models can be paired with monitors ranging from 14" to 21" color monitors. . Focus on Multi-vendor Open System Desktop Solutions. The Company concentrates all of its corporate resources on open system technologies designed around industry standards. The Company believes this focus, coupled with its netOS-based vendor- independent solutions, provides a competitive advantage over its broader based computer systems competitors and independent competitors who traditionally have emphasized proprietary technologies instead of those based on open systems. . Diverse Technology Expertise. The Company has significant expertise in a wide range of technical disciplines, including system, windowing and networking software, applications software development, monitor design, graphics acceleration, multimedia 3 design and compression algorithms. . Low-Cost Design and Manufacturing. The Company plans, implements and manages the manufacturing of its products to take advantage of industry-standard components that are widely available in the personal computer industry. This reduces the Company's risks and costs, and allows the Company more easily to increase production of products quickly to meet customer demand. The Company uses a common hardware architecture and integrated circuits which are common throughout its product line and employs industry-standard ASICs to reduce part counts and costs. . Multimedia. A full range of multimedia options can be added to certain Neoware network computer models through additional hardware and software. Through its netVideo technology, the Company lets a network computer user display full motion video from a camera, VCR or TV tuner in a window. The Neoware Conference application, which runs on video-capable network computers, enables users to send audio and video signals over a local area network or the Internet, enabling video teleconferencing. Video is converted by the network computer from analog to digital form so that it can be sent over a network to other individual users, or to groups via an industry-standard technology called IP Multicasting. . Modularity and Use of Standard Peripherals. The Company's lines of network computers are designed to be compatible with a wide range of standard off-the-shelf peripherals, ranging from keyboards and monitors to local hard drives and multimedia options such as video cameras, microphones and VCRs. Customers The Company's customers span a wide range of industries, including aerospace, automotive, education, financial services, government, healthcare, manufacturing and telecommunications. 4 Product Development The Company believes that its ability to expand the market for its network computer products will depend in large part upon its ability to enhance its netOS operating system and its existing line of network computers and to continue developing new products which incorporate the latest improvements in multimedia, desktop integration and open systems technology. Accordingly, the Company is committed to investing significant resources in software and hardware development activities. The Company's current research and development programs include: . Development of new versions of its netOS operating system that will run on a diverse range of microprocessors. 5 . Development of enhanced its connectivity to Windows application servers. . Development of enhanced its Java performance. . Development of lower cost versions of its hardware products. There can be no assurance that any of these development efforts will result in the introduction of new products or that any such products will be commercially successful. Marketing and Sales The principal objectives of the Company's marketing strategy are to increase awareness of the benefits of the Company's network computer products and netOS operating system, maintain the Company's position as a recognized innovator in the network computing industry and differentiate the Company's products from other network computers and personal computers. The Company's marketing activities include participation in trade shows and conferences, advertising and press relations with leading trade publications and the publication of technical articles. The Company distributes its products in North America through direct sales to end user customers, through resellers and through systems integration partners. The Company's products are currently sold by systems integrators for several government procurements, including the U.S. Forest Service's Project 615, in which the Company is a subcontractor to IBM. Sales to IBM for this project are subject to continued government funding, and there is no assurance that IBM will receive adequate funding to allow it to continue to purchase the Company's products. Additionally, the timing of sales to the Company's customers and the continued evolution of the market for network computers will impact the Company's future operating results. The Company has distributors for its products throughout the world, including long-term relationships with distributors in the United Kingdom, France, Scandinavia, Germany, Switzerland, Italy, Spain, Russia, Israel, Jordan, Australia, Japan, Hong Kong, China and India. Foreign revenues, which accounted for approximately 22%, 3% and 6% of net revenues, respectively, in 1997, 1996 and 1995, may be subject to government controls and other risks, including export licenses, federal restrictions on the export of technology, changes in demand resulting from currency exchange fluctuations, political instability, trade restrictions and changes in tariffs. To date, the Company has experienced no material difficulties due to these factors. Service and Support The Company believes that its ability to provide service and support is and will continue to be an important element in the marketing of its products. The Company maintains in-house repair facilities and also provides telephone and electronic mail access to its technical support staff. The Company's technical support specialists not only provide assistance in diagnosing problems but work closely with customers to address system integration issues and to assist in increasing the efficiency and productivity of their systems. The Company provides system level hardware support through its factory-based technical maintenance organization and primarily through contracted field system engineers. 6 The Company typically warrants its products against defects in materials and workmanship for one year after purchase by the end user, and offers an extended warranty of up to an additional two years. To date, the Company has not encountered any material product maintenance problems. Competition The desktop computer market is characterized by rapidly changing technology and evolving industry standards. The Company experiences significant competition from suppliers of workstations and personal computers, as well as providers and prospective providers of network computers. Competitive network computer products are offered by a number of established computer manufacturers, including International Business Machines Corporation ("IBM"), Sun Microsystems, Inc. ("Sun") and Oracle Corporation. Each of these companies has substantially greater name recognition, engineering, manufacturing and marketing capabilities and greater financial resources than those of the Company. The Company also competes with a number of other suppliers, including Boundless Technologies, Inc. and Network Computing Devices, Inc. The Company believes that the principal competitive factors among network computer suppliers include breadth of product line, product price/performance, capabilities of the operating system used in the product, software features, network expertise, service and support, and market presence. The Company believes that it competes favorably with respect to these factors. Workstation manufacturers who also offer network computer products may have advantages over independent network computer vendors, including the Company, based on their ability to "bundle" their network computers, workstations and personal computers in certain large system sales. The Company anticipates increased competition from these system suppliers as the network computer market evolves and also expects that other established domestic and foreign computer equipment manufacturers may enter the network computer market. The Company, as well as other manufacturers of network computers, also faces competition from established computer manufacturers whose personal computer and workstation products offer alternatives to network computers for most applications. In the high-performance, technical segment of the market, network computers compete with workstation networks offered by such manufacturers as Digital Equipment Corporation, Hewlett Packard Corporation, IBM and Sun. Because network-based computing does not require application processing capability on every desktop, network computers compete favorably on a price/performance basis with workstation networks and offer cost advantages in initial system installation, as well as subsequent system upgrading and administration. However, the significant market presence and reputation of the larger workstation manufacturers, and customer perceptions regarding their need for desktop application processing capability, constitute obstacles to the penetration of this market segment by network computer manufacturers. Increased competition could result in price reductions, reduced profit margins and loss of market share, which would adversely affect the Company's operating results. There can be no assurance that the Company will be able to continue to compete successfully against current and future competitors as the network computer market evolves and competition increases. At the low end of the commercial segment of the desktop computer market, the Company competes with suppliers of lower cost ASCII and 3270 terminals. These products do not offer the graphics and windowing capabilities offered by the Company's network computers, but are still appealing to certain price sensitive customers. The Company believes that network computers will become increasingly competitive with ASCII and 3270 terminal systems. 7 In all segments of the Company's market, the Company competes with personal computers made by companies such as Compaq Computer Corporation, Dell Computer Corporation and IBM. The Company believes its network computers compete favorably with personal computers in this environment, primarily because of their better integration in a network environment, reduced system administration costs, bundled software features and enhanced ease of use. Manufacturing and Suppliers The Company's production activities are conducted at its King of Prussia, Pennsylvania facility. These operations consist primarily of final assembly, configuration, testing and quality control of material components, sub-assemblies and systems. The Company utilizes an automated manufacturing control system which integrates purchasing, inventory control and cost accounting. The Company tests each network computer in a network environment prior to shipment. In addition, the Company maintains an approved vendor list and control of engineering changes of parts and components. Incoming material is inspected for conformance with the Company's specifications. The Company conducts regular on-site inspection at its vendors' facilities to maintain quality control. The components and sub-assemblies used in the Company's products are either standard, commercially available components or are manufactured to the Company's specifications by independent suppliers, including foreign suppliers who are subject to risks associated with foreign operations such as the imposition of unfavorable governmental controls or other trade restrictions, changes in tariffs and political instability. Although most of the video monitors used in the Company's products are available from more than one supplier, monitors used in some of its products are currently available from a single source. The Company has, from time to time, experienced delays in the receipt of monitors from certain of these suppliers. In addition, the Company is required to place orders for some monitors several months in advance of its anticipated requirements, and its ability to react to short-term increases or decreases in customer demands of these models is, therefore, limited. A number of other components and parts used in the Company's products, including microprocessors, also are currently available only from single sources. Prolonged or repeated delays in the receipt of these components could have a material adverse effect on the Company's operations. The Company has no long-term purchase agreements or other guaranteed supply arrangements with suppliers of these single or limited source components and purchases such components, as well as its other parts and components, pursuant to its standard form of purchase order. The Company has generally been able to obtain adequate supplies of parts and components in a timely manner from existing sources under purchase orders and endeavors to maintain inventory levels adequate to guard against interruptions in supplies. The Company's inability to develop alternative supply sources in the future, or to obtain sufficient components from existing suppliers as required, could adversely affect the Company's operating results. The Company's products also incorporate memory components, such as DRAMs and VRAMs, that are available from multiple sources but have been subject to substantial fluctuations in availability and price. To date, these fluctuations have not had a material effect on the Company's operating results and the Company has been able to obtain an adequate supply of such components. There can be no 8 assurance, however, that the Company will be able to obtain adequate supplies of these components in the future or that price fluctuations will not adversely affect the Company's operating results. Proprietary Rights and Licenses The Company believes that its success will depend primarily on the innovative skills, technical competence and marketing abilities of its personnel rather than upon the ownership of patents or other intellectual property protection methods. In addition, there can be no assurance that any patents issued to the Company will not be challenged, invalidated or circumvented, or that any rights granted thereunder will provide adequate protection to the Company. Certain technology used in the Company's products is licensed from third parties on a royalty-bearing basis. Generally, such licenses grant to the Company non-exclusive, worldwide rights with respect to the subject technology and terminate only upon a material breach by the Company. The Company has licensed technology from Spyglass, Inc., Sun Microsystems, Inc. and Network Computer, Inc. (formerly Navio Communications, Inc.). In addition to these licensing agreements, the Company holds a license agreement with the Open Software Foundation (OSF), and various other licenses which it does not consider to be material. Although the Company has not received any claims that its products infringe on the proprietary rights of third parties, there can be no assurance that third parties will not assert infringement claims against the Company in the future with respect to current or future products or that any such assertion may not require the Company to enter into royalty arrangements or result in costly litigation. Employees As of June 30, 1997, the Company had 76 employees. ITEM 2. PROPERTIES. The Company's principal administrative, marketing, manufacturing and research and development operations are located in King of Prussia, Pennsylvania. The facility consists of approximately 22,000 square feet under a lease which expires in the year 2001. The annual gross rent for the facility currently approximates $81,500. The Company believes that its facilities are adequate for its present requirements, and that suitable additional space will be available as needed. ITEM 3. LEGAL PROCEEDINGS. There are no material legal proceedings pending against the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of security holders of the Company during the fourth quarter of fiscal 1997. 9 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS. Commencing on March 3, 1995, the Company's Common Stock and the Warrants began trading on the NASDAQ Small Cap Market under the symbols HDSX and HDSXW, respectively. Commencing on October 3, 1995, the Common Stock and the Warrants began trading on the NASDAQ National Market. On August 1, 1997, the Company's Common Stock and the Warrants began trading under the symbols NWRE and NWREW, respectively. The following table sets forth the high and low closing bid quotations for the periods indicated.
Common Stock Warrants ------------------------------------------ High Low High Low ---- --- ---- --- 1997 - ---- First Quarter....................... $9 $6 3/8 $3 5/8 $2 1/4 Second Quarter...................... $8 7/8 $6 7/8 $3 1/2 $2 11/32 Third Quarter....................... $9 1/2 $5 1/2 $3 7/8 $1 3/4 Fourth Quarter...................... $7 7/8 $4 5/16 $2 15/16 $1 3/8
10
Common Stock Warrants ------------------------------------------ High Low High Low ---- --- ---- --- 1997 - ---- First Quarter....................... $5 1/2 $4 5/8 $1 3/8 $7/8 Second Quarter...................... $6 5/8 $4 3/4 $2 $1 3/16 Third Quarter....................... $7 3/8 $5 1/8 $2 1/2 $1 11/16 Fourth Quarter...................... $9 1/4 $5 1/4 $4 $1 5/8
The above quotations represent prices between dealers and do not include retail markups or markdowns or commissions. They may not necessarily represent actual transactions. There were approximately 84 holders of record of Common Stock as of September 19, 1997. The Company has never declared or paid any cash dividends on its capital stock and does not intend to pay any cash dividends in the foreseeable future. ITEM 6. SELECTED FINANCIAL DATA. The following table sets forth selected financial data with respect to the Company for the periods indicated. The data below has been derived from the Company's consolidated financial statements which have been audited by Arthur Andersen LLP, independent public accountants, for each of the four years in the period ended June 30, 1997 and by William E. Howe & Co., independent public accountants, for the year ended June 30, 1993. The data set forth below should be read in conjunction with the consolidated Financial Statements of the Company together with the related notes thereto included elsewhere herein and Item 7. Management's Discussion and Analysis of Financial Condition and Results of - -------------------------------------------------------------------------- Operations. Upon the consummation of the Merger, the Company changed its fiscal - ---------- year for accounting and reporting purposes to June 30.
Year Ended June 30, ----------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- STATEMENT OF OPERATIONS DATA: Net revenues $25,467,487 $20,819,444 $21,841,229 $19,495,642 $14,790,305 ----------- ----------- ----------- ----------- ----------- Gross profit 8,581,619 5,115,850 4,990,123 3,596,141 2,865,098 Operating expenses 8,130,823 4,390,344 2,680,209 2,742,126 2,665,435 --------- --------- --------- --------- --------- Operating income 450,796 725,506 2,309,914 854,015 199,663 Interest income (expense), net 69,224 220,277 (23,239) (161,012) (163,514) Income before income taxes, extraordinary item, and cumulative effect of change in accounting for income taxes 520,020 945,783 2,286,675 693,003 36,149 Income taxes 182,791 322,898 843,405 319,561 25,433 Extraordinary item (1) -- -- -- -- 23,517 Cumulative effect of change
11
Year Ended June 30, ----------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- STATEMENT OF OPERATIONS DATA: in accounting for income taxes (2) -- -- -- 81,023 -- ----------- ---------- ---------- Net income $ 337,229 $ 622,885 $ 1,443,270 $ 454,465 $ 34,233 =========== =========== =========== ========== ========== Earnings per share $.11 $.13 $.39 $.16 $.01 ==== ==== ==== ==== ==== Weighted average number of shares outstanding (3) 9,643,938 8,206,705 3,747,633 2,809,983 2,809,983 ========= ========= ========= ========= ========= BALANCE SHEET DATA: Current assets $16,002,051 $11,165,185 $12,373,592 $6,474,654 $4,757,031 Current liabilities 7,555,703 2,449,010 4,554,720 4,971,611 3,710,685 Working capital 8,446,348 8,716,175 7,818,872 1,503,043 1,046,346 Total assets 18,327,115 12,023,903 13,161,155 6,920,222 5,420,133 Long-term debt, excluding current portion -- 3,733 9,293 388,119 602,827 Stockholders' equity 10,771,412 9,481,890 8,494,565 1,503,190 1,031,850
- --------------- (1) Relates to the utilization of net operating loss and tax credit carryforwards. (2) Effective July 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," and reported the cumulative effect of the change in accounting in fiscal 1994. Prior to fiscal 1994, the Company accounted for income taxes in accordance with Accounting Principles Board Opinion No. 11. (3) Weighted average number of shares reflects the number of equivalent shares of Common Stock received by the shareholders of HDS in connection with the Merger with the Company on March 2, 1995. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Introduction The Company provides network computers and related software that are designed to integrate and deliver information to the desktop cost in network- centric environments. The Company's @workStation network computers combine a variety of windowed-display, GUI and communications industry standards to provide the user seamless and transparent access to all information, including text, graphics, audio and video data, on any type of network. The Company has licensed the Navigator web browser, Sun Microsystems, Inc.'s Java/TM/ technology and Spyglass, Inc.'s Web browser technologies that it has incorporated into its products to provide cost-effective access to information and applications within the corporate enterprise and on the Internet. The Company's network computer product line was introduced in June 1996. Prior to the introduction of the network computer, the Company manufactured and marketed a family of desktop computing devices, including multimedia-capable X Window terminals. The X terminal product line was designed around industry standards and allowed users to access multiple forms of information simultaneously, using the industry standard X protocol and industry standard networking interfaces. The Company's current strategy is to become a leader in the emerging market for network computers by focusing on expanding its operating system software products and its network computer 12 hardware. The Company also plans to continue to seek to acquire strategic technologies, products or businesses complementary to its current business. The Company sells its products in North America directly to end users and through resellers, system integrators and OEMs. International sales are generally made through distributors. Results of Operations The following table sets forth, for the periods indicated, certain items from the Company's consolidated statements of operations as a percentage of net revenues.
Year Ended June 30 ----------------------------------- 1997 1996 1995 ---- ---- ---- Gross Profit 33.7% 24.6% 22.8% Operating expenses: Sales and Marketing 17.7 11.3 6.4 General and administrative 8.8 7.0 3.6 Research and development 5.4 2.8 2.2 Operating income 1.8 3.5 10.6 Interest income (expense), net 0.2 1.0 (0.1) Income before taxes and changes in accounting for income taxes 2.0 4.5 10.5 ---- ---- ---- Income taxes 0.7 1.5 3.9 ---- ---- ---- Net Income 1.3% 3.0% 6.6% ==== ==== ====
Year Ended June 30, 1997 Compared to Year Ended June 30, 1996 For the year ended June 30, 1997, net revenues increased by 22.3% to $25,467,487 from $20,819,444 for the prior fiscal year. The Company's net revenues for the current year primarily represent shipments of its new line of network computers, which was introduced at the end of June 1996, and revenues earned from licensing agreements for its netOS operating system software. Net revenues for the year ended June 30, 1996 represent shipments of the Company's X terminal product line, which the Company marketed and manufactured prior to the introduction of its network computers. The Company is subject to significant variances in its operating results because of the fluctuations in the timing of the receipt of large orders. The Company's gross profit as a percentage of net revenues increased to 33.7% for the year ended June 30, 1997 from 24.6% for the prior fiscal year. The improvement was a result of achieving higher gross margins on the network computer product line, despite comparatively lower selling prices, and from the addition of software licensing revenues. The Company anticipates that gross margins will vary from quarter to quarter depending on the source of the Company's business, including the percentage of revenue derived from hardware and software. The 13 gross profit margin also varies in response to competitive market conditions as well as periodic fluctuations in the cost of memory and other significant components. The market in which the Company competes remains very competitive, and although the Company intends to continue its efforts to reduce the cost of its products, there can be no certainty that the Company will not be required to reduce prices of its products without compensating reductions in the cost to produce its products in order to increase its market share or to meet competitors' price reductions. Operating expenses for the year ended June 30, 1997 were $8,130,823, an increase from operating expenses of $4,390,344 in the prior fiscal year. Sales and marketing expenses increased by $2,171,812 to $4,523,910 for the year ended June 30, 1997 as compared to $2,352,098. These increases were the result of significantly increasing the Company's sales and marketing staff, including opening new sales offices in the United States and in Europe, and increased expenditures for advertising and public relations. The increase also reflects the results of operations of the Company's Bridging Data Technology subsidiary. Research and development expenses for the year ended June 30, 1997 increased by 134.6% or $788,257, to $1,374,027 from $585,770 in the prior year as the Company expanded its investment in engineering resources to develop, adapt or acquire technologies complementary to its current business that will expand the market for its current and future products. General and administrative expenses increased to $2,232,886 for the year ended June 30, 1997 from $1,452,476 in the prior year due to an increase in corporate staff relating to the formation of the Company's Information Technology Consulting and Bridging Data Technology subsidiaries and expenses relating to the recruitment of the Company's new Chief Executive Officer. Operating income decreased to $450,796 for the year ended June 30, 1997 from $725,506 in the previous fiscal year. The decrease in operating income for the period is the result of increased operating expenses relating to the expansion of the Company's sales and marketing and research and development staff as well as the expenses relating to its newlt-formed subsidiaries, which were partially offset by higher net revenues and higher gross profit margins. Net interest income decreased in the year ended June 30, 1997 due to lower interest rates and lower investment balances caused by financing of higher inventory and accounts receivable balances. The effective income tax rates were approximately 35.2% as compared to 34.1% in the prior fiscal year. For the year ended June 30, 1997, net income decreased to $337,229 from $622,885 for the prior year. The decrease in net income resulted from increased operating expenses during the period, as well as lower net interest income, which was partially offset by significant increases in revenues and in gross profit percentages. Year Ended June 30, 1996 Compared to Year Ended June 30, 1995 For the year ended June 30, 1996, net revenues decreased by $1,021,785 or 4.6% to $20,819,444 from $21,841,229 for the prior year. The decrease in revenue is attributable to a lack of growth in the Company's X terminal business, as well as the timing of the introduction of the Company's new network computer product line, which began too late in the fiscal year to contribute significant revenue. Sales to the United States Government, through integration subcontracts and through direct sales, have historically constituted a significant portion of the Company's total net revenues. Sales under Government contracts are subject to continued Government funding, as to which there is no assurance. The Company is subject to significant variances in its periodic operating results because of the fluctuations in the timing of the receipt of large orders. For the year ended June 30, 1996, net income was $622,885 as compared to $1,443,270 for the 14 prior year. The decrease in net income in 1996 was due to significant increases in the Company's investment in both sales and marketing and research and development expenses during the period. These investments, as well as increases in general and administrative expenses, were partially offset by increased gross margins and investment income and a lower effective income tax rate. The Company's gross profit as a percentage of net revenues increased to 24.6% for the year ended June 30, 1996 from 22.8% for the prior fiscal year. The increase in the Company's gross profit margins was primarily due to the Company's ability to reduce the cost of acquiring components used in its products, as well as to its mix of business, as its margins vary within the Company's product line. The market in which the Company competes remains very competitive, and although the Company intends to continue its efforts to reduce the cost of its products, there can be no certainty that the Company will not be required to reduce prices of its products without compensating reductions in the cost to produce its products in order to increase its market share or to meet competitors' price reductions. Operating expenses for the year ended June 30, 1996 were $4,390,344 as compared to $2,680,209 in the prior year. Sales and marketing expenses increased by $947,563 to $2,352,098 for the year ended June 30, 1996 as compared to $1,404,535 for the prior year as a result of increased expenditures for advertising and public relations as well as investments in increasing the Company's sales and marketing staff, in the US, the United Kingdom and Germany. Research and development expenses for the year ended June 30, 1996 increased by $97,419 to $585,770 from $488,351 in the prior year as the Company expanded its investment to develop, adapt or acquire technologies complementary to its current business that will expand the market for its current and future products. General and administrative expenses increased to $1,452,476 for the year ended June 30, 1996 from $787,323 in the prior year due to an increase in corporate staff, increased expenditures relating to the compliance functions required of a public company and the Company's purchase of directors' and officers' liability insurance in the third quarter of the prior fiscal year. Operating income decreased to $725,506 for the year ended June 30, 1996 from $2,309,914 in the previous fiscal year. The decrease in operating income is the result of increased investments in the Company's sales and marketing and research and development expenses as well as increased general and administrative expenses, which were partially offset by higher gross profit margins. Net interest income increased due to the use of the proceeds from the Merger to repay debt and provide interest income. The effective income tax rates were approximately 34.1% in the year ended June 30, 1996 as compared to 36.9% in the prior fiscal year due to the implementation of tax planning. 15 Liquidity and Capital Resources At June 30, 1997, the Company had net working capital of $8,446,348 composed primarily of cash and cash equivalents, accounts receivable and inventory. The Company's principal sources of liquidity included approximately $1,452,000 of cash and cash equivalents and a $5,000,000 bank line of credit facility, of which $1,929,000 was available as of June 30, 1997. The Company used $3,397,512 in cash in operating activities in the 1997 fiscal year compared to using cash of approximately $433,000 during the 1996 fiscal year. The decrease in cash generated from operations during the 1997 fiscal year is primarily due to significant increases in accounts receivable and inventories, which were partially offset by net income and increases in accounts payable and accrued expenses. Cash flow from operations can vary significantly from quarter to quarter depending on the timing of payments from, and shipments to, large customers. Net cash of $1,596,940 was used in financing activities in the 1997 fiscal year due to the licensing of software from others and prepayment of royalties on such licensed software. Net cash of $1,530,291 was generated from investing activities in the 1996 fiscal year from the redemption of approximately $1,959,000 of short-term investments, which was partially offset by purchases of equipment and capitalized software. The Company believes that there will be sufficient funds from current cash, operations and available financing to fund operations and cash expenditures for the next 12 months. Inflation The Company believes that inflation has not had a material effect on its sales and net revenues during the past three years. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statements of the Company are filed under this Item 8, beginning on page F-2 of this Report. 16 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information with respect to directors required by this Item is incorporated by reference to the Section entitled "Election of Directors" in the Company's definitive Proxy Statement for its 1997 Annual Meeting of Stockholders. The following individuals are the current executive officers of the Company:
Name Age Position ---- --- -------- Edward C Callahan, Jr. 51 President and Chief Executive Officer Michael G. Kantrowitz 36 Executive Vice President Steven B. Ahlbom 47 Vice President of Operations Edward M. Parks 45 Vice President of Engineering Scott Holland 36 Vice President of Finance and Administration
17 Mr. Callahan has been President and Chief Executive Officer and a Director of the Company since June 1997. Prior to joining the Company, Mr. Callahan was President and Chief Operating Officer of Summa Four, Inc. of Manchester, NH, a provider of telecommunications switches, from June 1995 until November 1996. Beginning in 1985, Mr. Callahan also held various executive positions in a ten year tenure at Sun Microsystems Computer Corporation. He was most recently Vice President of Global Telecom and Cable; previously, he was Vice President of Strategic Accounts and Vice President of the Northeast Area. Mr. Kantrowitz has been Executive Vice President and a Director of the Company since March 2, 1995. Prior to that, he was an employee of HDS from 1983, holding the positions of Executive Vice President from 1991 until March 1995 and Vice President of Marketing and Sales from 1987 until 1991. Prior to joining HDS, Mr. Kantrowitz held positions with Raytheon Company and Adage Corporation. Mr. Ahlbom has been Vice President of Operations of the Company since March 2, 1995. Prior to that, he held the positions of Vice President of Operations and Manager of Operations of HDS from 1988. Prior to joining HDS, Mr. Ahlbom was World-Wide Quality Assurance Manager for Commodore International from 1987 until 1988, and served as Quality Assurance Manager of Burroughs Corporation. Mr. Parks has been Vice President of Engineering of the Company since March 2, 1995. Prior to that, he held the position of Vice President of Engineering of HDS from 1987. Prior to joining HDS, Mr. Parks was Corporate Director for Product and Market Development and Director of Engineering for Commodore Business Machines from 1984 until 1987, and was employed by Eastman Kodak in engineering management positions from 1974 to 1984. Mr. Holland has served as Vice President-Finance and Administration since May 30, 1995. Prior to joining the Company, he served as the New Jersey Area Manager for Lawyers Title Insurance Corporation from 1993 until 1995. From 1988 until 1993, Mr. Holland held financial and operations management positions with IVT Group, Inc. and Fidelity Bond and Mortgage Company. Prior to that, Mr. Holland was employed by Laventhol & Horwath from 1982 through 1988 in various positions, with the latest position being Manager, Accounting and Auditing. All officers of the Company are appointed annually by the Company's Board and serve at its discretion. 18 ITEM 11. EXECUTIVE COMPENSATION. The information required by this Item is incorporated by reference to the section entitled "Executive Compensation" in the Company's definitive proxy statement for its 1997 Annual Meeting of Stockholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this Item is incorporated by reference to the section entitled "Beneficial Ownership of Common Stock" in the Company's definitive proxy statement for its 1997 Annual Meeting of Stockholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item is incorporated by reference to the section entitled "Certain Transactions" in the Company's definitive proxy statement for its 1997 Annual Meeting of Stockholders. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. Financial Statements - -------------------- See Index to Financial Statements at page F-1. Financial Statement Schedules - ----------------------------- All schedules have been omitted because they are not applicable, or not required, or the information is shown in the financial statements or notes thereto. Exhibits - -------- The following is a list of exhibits filed as part of this annual report on Form 10-K. Where so indicated by footnote, exhibits which were previously filed are incorporated by reference. 19
Exhibit Numbers Description - ------- ----------- 2.1 Agreement of Merger dated as of December 2, 1994 among the Company, ISAC Acquisition Co. and HDS (Exhibit 2.1)(3) 3.1 Certificate of Incorporation (Exhibit 3.1(1) 3.2 Amendment to Certificate of Incorporation (Exhibit 3.2)(2) 3.3 By-laws (Exhibit 3.2)(1) 3.4 Amendment to By-laws, dated July 20, 1995 4.2 Form of Warrant Certificate (Exhibit 4.2)(2) 4.3 Unit Purchase Option Granted to GKN Securities Corp. (Exhibit 4.4)(2) 4.4 Warrant Agreement between Continental Stock Transfer & Trust Company and Registrant (Exhibit 4.4)(3) 4.5 Warrant Agreement, dated March 2, 1995, between Continental Stock Transfer & Trust Company and the Registrant (Exhibit 4.5)(2) 4.6 Loan Agreement between Meridian Bank and the Registrant, dated as of December 20, 1990, Security Agreement between Meridian Bank and the Registrant, and Notes, as amended. (Exhibit 4.6)(2) 10.3 Letter Agreement between GKN Securities Corp. and each of the Initial Stockholders (Exhibit 10.4(1) 10.4 Letter Agreement between Safeguard Scientifics, Inc. and Registrant (Exhibit 10.5)(3) 10.8 Lease between the Registrant and GBF Partners, as amended (Exhibit 10.9)(4) 10.9+ 1995 Stock Option Plan (Exhibit 10.9)(2) 10.11+ Employment Agreement, dated March 2, 1995, between the Registrant and Michael G. Kantrowitz (Exhibit 99.2)(5) 21.* Subsidiaries 23 Consent of Arthur Andersen LLP
- ------------------ * Filed herewith. + Management contract or arrangement. 20 (1) Filed as an Exhibit to the Company's Registration Statement on Form S-1 (File No. 33-56834) filed with the SEC on January 7, 1993. (2) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1994. (3) Filed as an Exhibit to Amendment No. 1 to the Company's Registration Statement on Form S-1 (No. 33-56834) filed with the SEC on February 11, 1993. (4) Filed as an Exhibit to the Company's Registration Statement on Form S-4 (File No. 33-87036) filed with the SEC on December 6, 1994. (5) Filed as an Exhibit to Company's Current Report on Form 8-K dated March 2, 1995. 21 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NEOWARE SYSTEMS, INC. Date: September 29, 1997 By: /s/ Edward C. Callahan, Jr. --------------------- --------------------------------------- Edward C. Callahan, Jr. President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated. Each person in so signing also makes, constitutes and appoints Edward C. Callahan, President and Chief Executive Officer, Michael G. Kantrowitz, Executive Vice President and Scott Holland, Vice President of Finance and Administration, and each of them severally, his or her true and lawful attorney-in-fact, in his or her name, place and stead to execute and cause to be filed with the Securities and Exchange Commission any or all amendments to this report.
Signature Title Date --------- ----- ---- /s/ Arthur R. Spector Chairman of the Board September 29, 1997 - ----------------------------- Arthur R. Spector /s/ Edward C. Callahan, Jr. President, Chief Executive September 29, 1997 - ----------------------------- Officer and Director (Principal Edward C. Callahan, Jr. Executive Officer) /s/ Michael G. Kantrowitz Executive Vice President and September 29, 1997 - ----------------------------- Director Michael G. Kantrowitz /s/ Scott Holland Vice President-Finance and September 29, 1997 - ----------------------------- Administration (Principal Financial Scott Holland Officer and Principal Accounting Officer) /s/ Howard L. Morgan Director September 29, 1997 - ------------------------------ Howard L. Morgan /s/ John M. Ryan Director September 29, 1997 - ------------------------------ John M. Ryan /s/ Carl G. Sempier Director September 29, 1997 - ------------------------------ Carl G. Sempier /s/ James W. Dixon Director September 29, 1997 - ------------------------------ James W. Dixon
INDEX TO FINANCIAL STATEMENTS -----------------------------
Page ---- Neoware Systems, Inc. Report of Independent Public Accountants F-2 Consolidated Financial Statements-- Consolidated Balance Sheets F-3 Consolidated Statements of Operations F-4 Consolidated Statements of Stockholders' Equity F-5 Consolidated Statements of Cash Flows F-6 Notes to Consolidated Financial Statements F-7
F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Neoware Systems, Inc.: We have audited the accompanying consolidated balance sheets of Neoware Systems, Inc. (a Delaware corporation) and subsidiaries as of June 30, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended June 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Neoware Systems, Inc. and subsidiaries as of June 30, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1997 in conformity with generally accepted accounting principles. Arthur Andersen LLP Philadelphia, Pa., August 27, 1997 NEOWARE SYSTEMS, INC. --------------------- CONSOLIDATED BALANCE SHEETS ---------------------------
June 30 ---------------------------- ASSETS 1997 1996 ------ ------------- ------------ CURRENT ASSETS: Cash and cash equivalents $ 1,452,409 $ 2,700,298 Accounts receivable, net of allowance for doubtful accounts of $124,086 and $36,762 9,308,731 4,914,007 Inventories 4,035,202 2,354,254 Prepaid expenses and other 789,179 761,156 Deferred income taxes 416,530 435,470 ------------- ------------ Total current assets 16,002,051 11,165,185 PROPERTY AND EQUIPMENT, net 680,859 668,420 CAPITALIZED AND PURCHASED SOFTWARE, net 1,630,339 190,298 DEFERRED INCOME TAXES 13,866 - ------------- ------------ $ 18,327,115 $ 12,023,903 ============= ============ LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Line of credit $ 3,071,000 $ - Current portion of long-term debt - 4,232 Accounts payable 3,796,549 1,927,897 Accrued expenses 516,148 316,937 Deferred revenue 172,006 199,944 Income taxes payable - - Total current liabilities 7,555,703 2,449,010 ------------- ------------ LONG-TERM DEBT - 3,733 ------------- ------------ DEFERRED INCOME TAXES - 89,270 ------------- ------------ COMMITMENTS AND CONTINGENCIES (Note 11) STOCKHOLDERS' EQUITY: Preferred stock, $.001 par value, 1,000,000 shares authorized and none issued and outstanding -- -- Common stock, $.001 par value, 50,000,000 shares authorized, 5,760,820 and 5,619,595 shares issued and outstanding 5,761 5,620 Additional paid-in capital 9,168,171 8,268,123 Retained earnings 1,666,951 1,329,722 Deferred compensation (69,471) (121,575) ------------- ------------ Total stockholders' equity 10,771,412 9,481,890 ------------- ------------ $ 18,327,115 $ 12,023,903 ============= ============
The accompanying notes are an integral part of these financial statements. NEOWARE SYSTEMS, INC. --------------------- CONSOLIDATED STATEMENTS OF OPERATIONS -------------------------------------
Year Ended June 30 ---------------------------------------------------- 1997 1996 1995 ------------ ------------ ------------ NET REVENUES $ 25,467,487 $ 20,819,444 $ 21,841,229 COST OF REVENUES 16,885,868 15,703,594 16,851,106 ------------ ------------ ------------ Gross profit 8,581,619 5,115,850 4,990,123 ------------ ------------ ------------ OPERATING EXPENSES: Sales and marketing 4,523,910 2,352,098 1,404,535 General and administrative 2,232,886 1,452,476 787,323 Research and development 1,374,027 585,770 488,351 ------------ ------------ ------------ Total operating expenses 8,130,823 4,390,344 2,680,209 ------------ ------------ ------------ Operating income 450,796 725,506 2,309,914 INTEREST INCOME (EXPENSE), net 69,224 220,277 (23,239) ------------ ------------ ------------ Income before income taxes 520,020 945,783 2,286,675 INCOME TAXES 182,791 322,898 843,405 ------------ ------------ ------------ NET INCOME $ 337,229 $ 622,885 $ 1,443,270 ============ ============ ============ EARNINGS PER SHARE $ .11 $ .13 $ .39 ============ ============ ============ WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 9,643,938 8,206,705 3,747,633 ============ ============ ============
The accompanying notes are an integral part of these financial statements. NEOWARE SYSTEMS, INC. --------------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY -----------------------------------------------
Common Stock Common Additional ------------------------------ Stock Paid-in Shares Amount Warrants Capital ------------ ------------ ------------ ------------ BALANCE AT JUNE 30, 1994 2,479,198 $ 2,479 $ 19,687 $ 768,837 Exercise of stock options 309,378 310 -- 228,534 Tax benefit on options exercised -- -- -- 163,556 Exercise of Common stock warrants 53,341 53 (19,687) 25,259 Retirement of treasury stock (31,934) (32) -- (99,968) Dividend -- -- -- (3,951,380) Reverse merger with Information Systems Acquisition Corporation (Note 1) 2,800,000 2,800 -- 10,629,912 Deferred compensation (Note 8) -- -- -- 191,046 Amortization of deferred compensation -- -- -- -- Net income -- -- -- -- ------------ ------------ ------------ ------------ BALANCE AT JUNE 30, 1995 5,609,983 5,610 -- 7,955,796 Tax benefit of acquired net operating loss carryforward -- -- -- 300,000 Exercise of stock options 9,612 10 -- 12,327 Amortization of deferred compensation -- -- -- -- Net income -- -- -- -- ------------ ------------ ------------ ------------ BALANCE AT JUNE 30, 1996 5,619,595 $ 5,620 $ -- $ 8,268,123 Exercise of common stock warrants 18,050 18 -- 99,257 Exercise of stock options 123,175 123 -- 733,655 Tax benefit on options exercised -- -- -- 67,136 Amortization of deferred compensation -- -- -- -- Net income -- -- -- -- ------------ ------------ ------------ ------------ BALANCE AT JUNE 30, 1997 5,760,820 $ 5,761 $ -- $ 9,168,171 ============ ============ ============ ============ Retained Treasury Deferred Earnings Stock Compensation Total ------------ ------------ ------------ ------------ BALANCE AT JUNE 30, 1994 812,187 $ (100,000) -- $ 1,503,190 Exercise of stock options -- -- -- 228,844 Tax benefit on options exercised -- -- -- 163,556 Exercise of Common stock warrants -- -- -- 5,625 Retirement of treasury stock -- 100,000 -- -- Dividend (1,548,620) -- -- (5,500,000) Reverse merger with Information Systems Acquisition Corporation (Note 1) -- -- -- 10,632,712 Deferred compensation (Note 8) -- -- (191,046) -- Amortization of deferred compensation -- -- 17,368 17,368 Net income 1,443,270 -- -- 1,443,270 ------------ ------------ ------------ ------------ BALANCE AT JUNE 30, 1995 706,837 -- (173,678) 8,494,565 Tax benefit of acquired net operating loss carryforward -- -- -- 300,000 Exercise of stock options -- -- -- 12,337 Amortization of deferred compensation -- -- 52,103 52,103 Net income 622,885 -- -- 622,885 ------------ ------------ ------------ ------------ BALANCE AT JUNE 30, 1996 $ 1,329,722 $ -- $ (121,575) $ 9,481,890 Exercise of common stock warrants -- -- -- 99,275 Exercise of stock options -- -- -- 733,778 Tax benefit on options exercised -- -- -- 67,136 Amortization of deferred compensation -- -- 52,104 52,104 Net income 337,229 -- -- 337,229 ------------ ------------ ------------ ------------ BALANCE AT JUNE 30, 1997 $ 1,666,951 $ -- $ (69,471) $ 10,771,412 ============ ============ ============ ============
The accompanying notes are an integral part of these financial statements. NEOWARE SYSTEMS, INC. --------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS -------------------------------------
For the Year Ended June 30 ---------------------------------------------------- 1997 1996 1995 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 337,229 $ 622,885 $ 1,443,270 Adjustments to reconcile net income to net cash provided by (used in) operating activities- Depreciation and amortization 361,121 357,878 356,347 Amortization of deferred compensation 52,104 52,103 17,368 Deferred income taxes (84,196) (66,860) 82,101 Changes in operating assets and liabilities- (Increase) decrease in: Accounts receivable (4,394,724) 850,669 (2,173,044) Inventories (1,680,948) (138,239) 418,802 Prepaid expenses and other (28,023) (594,479) (67,247) Increase (decrease) in: Accounts payable 1,868,652 (869,755) 474,218 Accrued expenses 199,211 (83,637) 3,623 Deferred revenue (27,938) 62,740 21,078 Income taxes payable -- (626,375) 330,558 ------------ ------------ ------------ Net cash provided by (used in) operating activities (3,397,512) (433,070) 907,074 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment, net (216,661) (291,227) (421,864) Prepaid royalty -- -- (150,000) Purchase/redemption of short-term investments -- 1,959,324 (1,959,324) Capitalized and purchased software (1,596,940) (137,806) (126,478) ------------ ------------ ------------ Net cash provided by (used in) investing activities (1,813,601) 1,530,291 (2,657,666) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from (repayment of) line of credit 3,071,000 (589,000) (991,000) Principal payments on long-term debt (7,965) (5,243) (634,194) Exercise of stock options 733,778 12,337 228,844 Tax benefits on options exercised 67,136 -- 163,556 Exercise of warrants 99,275 -- 5,625 Payment of dividend -- -- (5,500,000) Proceeds from reverse merger (Note 1) -- -- 10,632,712 ------------ ------------ ------------ Net cash provided by (used in) financing activities 3,963,224 (581,906) 3,905,543 ------------ ------------ ------------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,247,889) 515,315 2,154,951 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 2,700,298 2,184,983 30,032 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS, END OF YEAR $ 1,452,409 $ 2,700,298 $ 2,184,983 ============ ============ ============ SUPPLEMENTAL DISCLOSURES OF NONCASH OPERATING ACTIVITIES: Cash paid for income taxes $ 27,213 $ 1,026,500 $ 267,190 Cash paid for interest 61,560 10,069 124,706
The accompanying notes are an integral part of these financial statements. NEOWARE SYSTEMS, INC. --------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ 1. COMPANY BACKGROUND: ------------------- Neoware Systems, Inc. (the Company) is a leading international supplier of network computers and related software which are cost-effective solutions for the integration and delivery of information and applications to the desktop. The Company's network computers are based on an open architecture, incorporating industry standards to enable seamless access to multiple forms of information, including text, graphics, audio and video data, on any type of network. On March 2, 1995, Human Designed Systems, Inc. (HDS) merged with and into ISAC Acquisition Co., a wholly owned subsidiary of Information Systems Acquisition Corporation (ISAC). ISAC issued 2,810,000 shares of Common stock, cash of $5,500,000 and warrants to purchase 618,200 shares of ISAC Common stock at $5.50 per share to the shareholders of HDS. ISAC then changed its name to HDS Network Systems, Inc. On July 30, 1997, the Company changed its name to Neoware Systems, Inc. The merger resulted in HDS's stockholders having majority ownership of the merged entity. The merger was treated as an issuance of shares by HDS for the net assets of ISAC, which is primarily cash. The consolidated statements of operations and cash flows of HDS are presented as the historical operating results and cash flows of the merged entity. The historical stockholders equity of HDS prior to the merger has been retroactively restated for the equivalent number of shares received in the merger after giving effect to the difference in par value of ISAC's and HDS's stock with an offset to paid-in capital. Pro forma information is not presented since the combination is not considered a business combination for financial reporting purposes. In August 1996, the Company formed a new subsidiary, Information Technology Consulting, Inc. (ITC) for the purpose of acquiring companies in the computer services field, including information technology staffing companies and client- server consulting companies. In January 1997, the Company announced that ITC entered into a definitive agreement to acquire Global Consulting Group (Global) and in March 1997 an agreement was entered into to acquire The Reohr Group, Inc. (Reohr). In August 1997, the proposed transactions were revised whereby ITC will merge with Reohr and Global. The Company, as the sole stockholder of ITC, will receive stock of the surviving entity representing approximately 2% ownership of the entity after the merger. The Company will also be reimbursed for the expenses incurred by the Company and ITC in connection with ITC's efforts to complete these transactions. The fiscal 1997 statement of operations reflects approximately $291,000 of internal costs incurred and charged to expense related to these efforts. The transaction is expected to close prior to December 31, 1997. The reimbursement of costs previously charged to expense will be recorded as income at that time. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: ------------------------------------------- Principles of Consolidation - --------------------------- The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany profits, accounts and transactions have been eliminated in consolidation. Use of Estimates - ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash Equivalents - ---------------- The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents for the purpose of determining cash flows. Cash equivalents at June 30, 1997 consist of money market funds. Inventories - ----------- Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method. Property and Equipment - ---------------------- Property and equipment are stated at cost. Additions and improvements that significantly extend the useful life of an asset are capitalized. Expenditures for repairs and maintenance are charged to operations as incurred. Depreciation and amortization are provided using the straight-line and accelerated methods over the estimated useful lives of the assets as follows: Computer equipment 3-5 years Office furniture and equipment 5-7 years Leasehold improvements Lease term Other 3-5 years
Long-Lived Assets - ----------------- The Company follows Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." Accordingly, in the event that facts and circumstances indicate that property and equipment, and intangible or other assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the assets is compared to the assets carrying amount to determine if a write-down to market value or discounted cash flow value is necessary. Revenue Recognition - ------------------- Product revenue is recognized at the time of title transfer, which ordinarily occurs at the time of shipment. From time to time, customers request delayed shipment, usually because of customer scheduling for systems integration. If the Company's substantial performance obligations otherwise have been fulfilled, revenue on such delayed shipment transactions generally is recognized. Service contract revenue is recognized ratably over the contract period. Product warranty costs and an allowance for sales returns are accrued at the time revenues are recognized. Research and Development - ------------------------ Costs incurred in the development of new software products and enhancements to existing software products are charged to expense as incurred until the technological feasibility of the product has been established. After technological feasibility has been established, any additional costs are capitalized in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed". Capitalized software costs are amortized to cost of revenues over the expected life of the product, not to exceed three years. The Company capitalized $285,968, $137,806, and $126,478 of software development cost and amortized $147,977 $134,795, and $118,292 in fiscal 1997, 1996 and 1995, respectively. Accumulated amortization was $753,280 and $605,303 at June 30, 1997 and 1996, respectively. In addition, the Company entered into various licensing agreements in Fiscal 1997 which required upfront cash payments of $1,600,000 in the aggregate and royalties based on unit sales. The Company continually evaluates whether events and circumstances have occurred that indicate that unamortized product development costs may not be recoverable or that the amortization period should be revised. Earnings Per Share - ------------------ The Company utilized the modified treasury stock method for the years ended June 30, 1997 and 1996 to compute earnings per share since common share equivalents at the end of the year exceeded 20 percent of the number of common shares outstanding. Earnings per common and common equivalent share (primary earnings per share) is computed using the weighted average number of common shares and common share equivalents (stock options and warrants, using the treasury stock method) outstanding. If the inclusion of common stock equivalents has an anti-dilutive effect in the aggregate, it is excluded from the earnings per share calculation. Fully diluted earnings per share is not materially different from the primary earnings per share indicated. All share and per share amounts have been adjusted retroactively to give effect to the equivalent number of shares received by the HDS stockholders in the merger discussed in Note 1. Income Taxes - ------------ The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes," effective July 1, 1993. 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 their 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. New Accounting Pronouncements - ----------------------------- SFAS No. 129, "Disclosure of Information About Capital Structure", was issued in February 1997. SFAS 129 will not result in any substantive changes in the Company's disclosures. 3. MAJOR CUSTOMERS AND FOREIGN REVENUES: ------------------------------------- Net revenues from two customers represented 25% and 15%of total net revenues in fiscal 1997 and 16% and 27% of total net revenues in fiscal 1996, while net revenues from three customers represented 25%, 12% and 11% of total net revenues in fiscal 1995. Revenues from one of the significant customers in fiscal 1996 and two of the significant customers in fiscal 1995 were under subcontracts for systems integration contracts for major US government procurements. The procurement projects are subject to funding by the US government and there are no assurances that such funding will continue. At June 30, 1997 and 1996, the Company had receivables from these customers of approximately $5,937,000 and $1,923,000, respectively. The Company's products are used in a broad range of industries for a variety of applications. Sales are made to both domestic and international customers. Net foreign revenues in fiscal 1997, 1996 and 1995 were approximately 22%, 3% and 6%, respectively, and were transacted in US dollars. 4. CONSOLIDATED BALANCE SHEET COMPONENTS: -------------------------------------- Inventories consisted of the following:
June 30 ------------------------ 1997 1996 ---------- ---------- Purchased components and subassemblies $1,566,161 $ 942,210 Work-in-process 301,565 173,792 Finished goods 2,167,476 1,238,252 ---------- ---------- $4,035,202 $2,354,254 ========== ==========
Property and equipment consisted of the following:
June 30 --------------------------- 1997 1996 ----------- ----------- Computer equipment $ 749,082 $ 695,200 Office furniture and equipment 318,989 216,462 Leasehold improvements 357,053 344,039 Other 127,712 95,156 ----------- ----------- 1,552,836 1,350,857 Less- Accumulated depreciation and amortization (871,977) (682,437) ----------- ----------- $ 680,859 $ 668,420 =========== ===========
5. LINE OF CREDIT: --------------- The Company has a $5,000,000 revolving line of credit with a bank which expires on December 31, 1997, subject to annual renewal. Borrowings under the line bear interest at the bank's prime rate (8.5% at June 30, 1997). At June 30, 1997 there was $1,929,000 available for borrowing under the line. Under the line, the Company is required to maintain specified ratios of working capital and debt to net worth, as defined. The maximum amount borrowed under the line of credit was $3,071,000 in fiscal 1997, $1,206,000 in fiscal 1996 and $2,046,000 in fiscal 1995. The average amounts outstanding were $997,269, $247,917 and $1,085,000 in fiscal 1997, 1996 and 1995, respectively, and the weighted average interest rate during such years was 6.2%, 8.69% and 9%, respectively. 6. LONG-TERM DEBT: --------------- The Company had a term loan payable in monthly installments of approximately $400, including interest at 7.8%, with final payment due in July 1998. The loan was paid off in November 1996. 7. INCOME TAXES: ------------- The components of income taxes are as follows:
For the Year Ended June 30 ------------------------------------------- 1997 1996 1995 --------- --------- --------- Current- Federal $ 258,515 $ 377,528 $ 606,313 State 8,472 12,230 154,991 --------- --------- --------- 266,987 389,758 761,304 --------- --------- --------- Deferred- Federal (70,725) (57,551) 71,014 State (13,471) (9,309) 11,087 --------- --------- --------- (84,196) (66,860) 82,101 --------- --------- --------- $ 182,791 $ 322,898 $ 843,405 ========= ========= =========
The federal statutory income tax rate is reconciled to the effective tax rate as follows:
For the Year Ended June 30 ------------------------------- 1997 1996 1995 ------ ------ ------ Federal statutory rate 34.0% 34.0% 34.0% State income taxes, net 0.8 0.8 5.5 Expenses not deductible for tax 0.2 0.4 -- Other 0.2 (1.1) (2.6) ------ ------ ------ 35.2% 34.1% 36.9% ------ ------ ------
Income tax expense differs from the amount currently payable as certain transactions are reported in different periods for financial reporting and tax purposes. The principal differences relate to depreciation and amortization, the capitalization of software development costs, service contract revenue and accrued expenses. The tax effect of temporary differences that gave rise to the deferred tax assets and liabilities are as follows:
June 30 ----------------------- 1997 1996 --------- --------- Net deferred tax asset, current- Accruals, allowances and reserves $ 175,710 $ 109,487 Operating loss carryforwards 300,200 300,200 Deferred revenue 67,942 78,978 Capitalized inventory costs (127,322) (53,195) --------- --------- $ 416,530 $ 435,470 ========= ========= Net deferred tax asset (liability), long term-Losses of subsidiary $ 144,226 $ -- Capitalized software costs (129,678) (75,164) Differences in book/tax depreciation (682) (14,106) --------- --------- $ 13,866 $ 89,270 ========= =========
The Company has recorded no valuation allowances against deferred tax assets at June 30, 1997 and 1996. In fiscal 1996, the Company recognized a $300,000 income tax benefit from a net operating loss carryforward of ISAC (see Note 1) and recorded this benefit as a deferred tax asset and an increase in additional paid-in capital. 8. STOCK OPTIONS AND WARRANTS: --------------------------- The Company has an incentive stock option plan (the "Plan") for employees and directors. The Company is authorized to issue options for the purchase of up to 1,100,000 shares of Common Stock. Under the terms of the Plan, the exercise price of options granted cannot be less than fair market value on the date of grant. Employee options generally vest and become exercisable ratably over four years. Director options vest and become exercisable ratably six months and one year from the date of grant. All options expire five years from the grant date. As of June 30, 1997, the Company had options outstanding under the Plan for the purchase of 697,349 shares of Common Stock at prices ranging from $5.125 to $7.875 per share. Options to purchase 422,750 shares of Common Stock were vested at June 30, 1997. In November 1994, a stock option to purchase 20,000 shares of Common stock of HDS at $2.50 per share was granted, which has been exchanged in connection with the merger into an option to purchase 28,448 shares of Common Stock of the Company at $1.76 per share. Deferred compensation of $191,046 was recorded for the difference between the exercise price and merger consideration, and is being amortized over the option vesting period. As of June 30, 1997, the options outstanding under this grant were for 14,224 shares, none of which were vested. HDS issued other stock options and warrants in earlier years and all such outstanding options and warrants were exercised prior to the merger (see Note 1). After giving effect to the merger of ISAC and HDS discussed in Note 1, there are 5,700,510 warrants outstanding to purchase Common Stock at $5.50 per share. The warrants are exercisable over seven years and expire in March 2000 through March 2002. The warrants will be redeemable at a price of $.01 per warrant upon 30 days notice at any time, only in the event that the last price of the Common Stock is at least $10 per share for 20 consecutive trading days ending on the third day prior to the one on which notice of redemption is given. 9. EARNINGS PER SHARE ------------------ Earnings per share for the years ended June 30, 1997 and 1996 are calculated as follows:
1997 1996 ---- ---- Net income as reported $ 337,229 $ 622,885 Imputed interest income, net of income taxes 687,996 443,986 ---------- ---------- Adjusted net income $1,025,225 $1,066,871 ========== ========== Actual number of shares outstanding 5,760,820 5,607,850 Net additional shares arising from exercise of warrants and options 3,883,118 2,598,855 ---------- ---------- Weighted average number of shares outstanding 9,643,938 8,206,705 ========== ========== Earnings per share $ .11 $ .13 ====== ======
SFAS No. 128, "Earnings per Share", which supersedes APB Opinion No. 15, "Earnings per Share", was issued in February 1997. SFAS 128 requires dual presentation of basic and diluted earnings per share (EPS) for complex capital structures on the face of the income statement. Basic EPS is computed by dividing income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from the exercise or conversion of securities into common stock, such as stock options. SFAS 128 is required to be adopted for the Company's fiscal year ending June 30, 1998 and, when adopted, will require restatement of prior periods' EPS. 10. ACCOUNTING FOR STOCK-BASED COMPENSATION --------------------------------------- In October 1995, the Financial Accounting Standards Board adopted SFAS No. 123, "Accounting for Stock-Based Compensation". The Company adopted this standard during year ended June 30, 1997. The Company has elected to adopt the disclosure requirement of this pronouncement only. The adoption of this pronouncement, therefore, had no impact on the Company's financial position or results of operations. Had compensation cost been calculated based on the fair value at the grant date for awards in 1997 and 1996 consistent with the provisions of SFAS 123, the Company's net income and net income per share would have been changed to the following pro forma amounts:
1997 1996 ---- ---- Net income As reported $ 337,229 $ 622,885 Proforma $ 167,446 $ 606,798 Earnings per share As reported $ .11 $ .13 Proforma $ .09 $ .13
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997 and 1996 no dividend yield; expected volatility of 62.10% - 75.58%; risk-free interest rates of approximately 5.40% - 6.76%; and an expected life of 5 years. The pro forma effect on net income for 1997 and 1996 is not representative of the pro forma effect on net income and in future years because it does not take into consideration pro forma compensation expense related to grants made prior to fiscal 1996. 11. COMMITMENTS AND CONTINGENCIES: ------------------------------ The Company leases its principal facility and an automobile under noncancelable operating leases. The facility lease expires in 2001 and the auto lease expires in fiscal 2000. Rent expense under these leases was $73,168, $72,929 and $142,039 in fiscal 1997, 1996 and 1995, respectively. Minimum required lease payments are $112,324 in 1998, $112,324 in 1999, $100,527 in 2000 and $15,350 in 2001. The Company sponsors a profit sharing/401(k) plan (the "Plan") for all of its employees who meet certain age and years of employment requirements. Participants may make voluntary contributions to the Plan and the Company makes a matching contribution of 50% of the first $1,000 of such contributions. The Company's contributions were $47,600, $20,139 and $18,901 in fiscal 1997, 1996 and 1995, respectively. Upon consummation of the merger transaction discussed in Note 1, an employment agreement with an officer was executed. The agreement is for a three-year term and provides for base compensation of $125,000 per year. The Company has entered into various licensing agreements which required upfront cash payments in the aggregate of $1,600,000 and royalties based on unit sales. The Company is from time to time involved in certain legal actions arising in the ordinary course of business. In the Company's opinion, the outcome of any such actions will not have a material adverse effect on the Company's financial position or results of operations. EX-10.10 2 1995 STOCK OPTION PLAN Exhibit 10.10 1995 STOCK OPTION PLAN [Adopted by the Board of Directors on November 29, 1994] PART I DEFINITIONS AND ADMINISTRATIVE MATTERS -------------------------------------- SECTION 1. Purpose; Definitions The purpose of the Information Systems Acquisition Corporation 1995 Stock Option Plan (the "Plan") is to enable employees, officers, directors and independent contractors of Information Systems Acquisition Corporation ("the Company") to (i) own shares of stock in the Company, (ii) participate in the stockholder value which has been created, (iii) have a mutuality of interest with other stockholders and (iv) enable the Company to attract, retain and motivate employees, officers, directors and independent contractors of particular merit. For the purposes of the Plan, the following terms shall be defined as set forth below: (a) "Board" means the Board of Directors of the Company. ----- (b) "Code" means the Internal Revenue Code of 1986, as amended from time to ---- time, and any successor thereto. (c) "Committee" means the Committee designated by the Board to administer --------- the Plan. (d) "Company" means Information Systems Acquisition Corporation, its ------- Subsidiaries or any successor organization. (e) "Disability" means permanent and total disability within the meaning of ---------- Section 22(e)(3) of the Code. (f) "Disinterested Person" shall have the meaning set forth in the Rules. -------------------- (g) "Eligible Independent Contractor" means an independent contractor hired ------------------------------- by the Company who is neither an Employee of the Company nor a Non-Employee Director. (h) "Employee" means any person, including a director, who is employed by -------- the Company and is compensated for such employment by a regular salary. (i) "Exchange Act" means the Securities Exchange Act of 1934, as amended. ------------ (j) "Fair Market Value" means the per share value of the Stock as of any ----------------- given date, as determined by reference to the price of the last traded share of Stock on the over-the-counter market, as reported by the National Association of Securities Dealers, Inc. Automated Quotation ("NASDAQ") System for such date or the next preceding date that Stock was traded on such market, or, in the event the Stock is listed on a stock exchange, the closing price per share of Stock as reported on such exchange for such date. (k) "Incentive Stock Option" means any Stock Option intended to be and ---------------------- designated as an "Incentive Stock Option" within the meaning of Section 422 of the Code. (l) "Insider" means a Participant who is subject to Section 16 of the ------- Exchange Act. (m) "Non-Employee Director" means any member of the Board who is not an --------------------- Employee of the Company and is not compensated for employment by a regular salary. (n) "Non-Qualified Stock Option" means any Stock Option that is not an -------------------------- Incentive Stock Option. (o) "Participant" means an Employee, officer, Non-Employee Director or ----------- Eligible Independent Contractor to whom an award is granted pursuant to the Plan. (p) "Plan" means the Information Systems Acquisition Corporation 1995 Stock ---- Option Plan, as hereinafter amended from time to time. (q) "Rules" means Rule 16(b)(3) and any successor provisions promulgated by ----- the Securities and Exchange Commission under Section 16 of the Exchange Act. (r) "Securities Act" shall mean the Securities Act of 1933, as amended. -------------- (s) "Securities Broker" means the registered securities broker acceptable ----------------- to the Company who agrees to effect the cashless exercise of an Option pursuant to Section 5(d) hereof. (t) "Stock" means the Common Stock of the Company, par value $.01 per ----- share. (u) "Stock Option" or "Option" means any option to purchase shares of Stock ------------ ------ (including Restricted Stock, if the Committee so determines) granted pursuant to Section 5 below. (v) "Subsidiary" means any corporation owned, in whole or in part, by the ---------- Company. SECTION 2. Administration 2.1 The portion of the Plan with respect to the grant of Options pursuant to Part II shall be administered by a Committee of not less than three Directors who shall be Disinterested Persons appointed by the Board and who shall serve at the pleasure of the Board; provided further, however, that, notwithstanding the foregoing, Part II of the Plan shall be administered by such number of Disinterested Persons as and to the extent required by the Rules. The Committee shall have the authority to grant pursuant to the terms of the Plan: Stock Options to Employees (including directors who are Employees) and officers of the Company, and Eligible Independent Contractors. In particular, the Committee shall, subject to the limitations and terms of the Plan, have the authority: -2- (i) to select the officers, directors (who are Employees) and other Employees of the Company, and the Eligible Independent Contractors to whom Stock Options may from time to time be granted hereunder; (ii) to determine whether and to what extent incentive Stock Options are to be granted hereunder; (iii) to determine the number of shares to be covered by each such award granted hereunder; (iv) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any award granted hereunder, including the option or exercise price and any restrictions or limitations, based upon such factors as the Committee shall determine, in its sole discretion; (v) to determine whether and under what circumstances a Stock Option may be exercised and settled in cash or Stock or without a payment of cash; (vi) to determine whether, to what extent and under what circumstances Stock and other amounts payable with respect to an award under this Plan shall be deferred either automatically or at the election of the Participant; and (vii) to amend the terms of any outstanding award (with the consent of the Participant) to reflect terms not otherwise inconsistent with the Plan, including amendments concerning exercise price changes, vesting acceleration or forfeiture waiver regarding any award or the extension of a Participant's right with respect to awards granted under the Plan, as a result of termination of employment or service or otherwise, based on such factors as the Committee shall determine, in its sole discretion. The Committee shall have the authority to adopt, alter and repeal such administrative rules, guidelines and practices governing the Plan as it shall, from time to time deem advisable; to interpret the terms and provisions of the Plan and any award issued under the Plan (and any agreements relating thereto); and to otherwise supervise the administration of the Plan, provided that the Committee may delegate to the Chief Executive Officer of the Company, or such other officer as may be designated by the Committee, the authority, subject to guidelines prescribed by the Committee, to grant Options to Employees and Eligible Independent Contractors who are not then subject to the provisions of Section 16 of the Exchange Act, and to determine the number of shares to be covered by any such Option, and the Committee may authorize any one or more of such persons to execute and deliver documents on behalf of the Committee, provided that no such delegation may be made that would cause grants of Options to persons subject to Section 16 of the Exchange Act to fail to comply with all applicable conditions of Rule 16b-3 or its successors under the Exchange Act. Determinations, interpretations or other actions made or taken by the Committee pursuant to the provisions of the Plan shall be final and binding and conclusive for all purposes and upon all persons. No member of the Board or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any Stock Option granted under it. Nothing herein shall be deemed to expand the personal liability of a member of the Board or Committee beyond that which may arise under any applicable standards set forth in the Company's by-laws and Delaware law, nor shall anything herein limit any rights to indemnification or advancement of expenses to which any member of the Board or the Committee may be entitled under any by-law, agreement, vote of the stockholders or directors, or otherwise. -3- 2.2 The portion of the Plan with respect to the grant of Options pursuant to Part III shall be administered by the Board. Grants of Stock Options under Part III of the Plan and the amount, price and timing of the awards to be granted will be automatic, as described in Part III hereof. All questions of interpretation of the Plan with respect to the grant of Options pursuant to Part III will be determined by the Board, and such determination shall, unless otherwise determined by the Board, be final and conclusive on all persons having any interest hereunder. SECTION 3. Stock Subject to the Plan 3.1 The aggregate number of shares of Stock that may be issued or transferred under the Plan is 1,100,000, subject to adjustment pursuant to Section 3.2 below. In the event that the Company's redeemable common stock purchase warrants (the "Warrants") are called for redemptioin by the Company, the aggregate number of shares of Stock that may be issued or transferred under the Plan shall be increased to 1,500,000, subject to adjustment pursuant to Section 3.2 below. Such shares may be authorized but unissued shares or reacquired shares. If the number of shares of Stock issued under the Plan and the number of shares of Stock subject to outstanding awards (taking into account the share counting requirements established under the Rules) equals the maximum number of shares of Stock authorized under the Plan, no further awards shall be made unless the Plan is amended in accordance with the Rules or additional shares of Stock become available for further awards under the Plan. If and to the extent that Options granted under the Plan terminate, expire or are canceled without having been exercised, such shares shall again be available for subsequent awards under the Plan. 3.2 If any change is made to the Stock (whether by reason of merger, consolidation, reorganization, recapitalization, stock dividend, stock split, combination of shares, or exchange of shares or any other change in capital structure made without receipt of consideration), then unless such event or change results in the termination of all outstanding awards under the Plan, the Board or the Committee shall preserve the value of the outstanding awards by adjusting the maximum number and class of shares issuable under the Plan to reflect the effect of such event or change in the Company's capital structure, and by making appropriate adjustments to the number and class of shares subject to an outstanding award and/or the option price of each outstanding Option, except that any fractional shares resulting from such adjustments shall be eliminated by rounding any portion of a share equal to .500 or greater up, and any portion of a share equal to less than .500 down, in each case to the nearest whole number. 3.3 In any fiscal year of the Company, the maximum number of shares of Common Stock with respect to which Options may be granted to any optionee shall not exceed 5% of the Common Stock outstanding, as adjusted for stock splits, stock dividends or other similar changes affecting the Common Stock. SECTION 4. Designation of Optionees 4.1 Optionees under Part II of the Plan shall be selected, from time to time, by the Committee from among those Employees and Eligible Independent Contractors who, in the opinion of the Committee, occupy responsible positions and who have the capacity to contribute materially to the continued growth, development and long-term success of the Company and its Subsidiaries. 4.2 All Non-Employee Directors on the date of grant shall be eligible to receive Options under Part III of the Plan. -4- PART II GRANTS TO EMPLOYEES AND ELIGIBLE INDEPENDENT CONTRACTORS -------------------------------------------------------- SECTION 5. Stock Options Any Stock Option granted under Part II of the Plan shall be in such form as the Committee may from time to time approve. Stock Options granted under Part II of the Plan may be of two types: (i) Incentive Stock Options and (ii) Non-Qualified Stock Options. The Committee shall have the authority to grant Incentive Stock Options, Non-Qualified Stock Options or both types of Stock Options. To the extent that any Stock Option does not qualify as an Incentive Stock Option, it shall constitute a Non-Qualified Stock Option. Anything in the Plan to the contrary notwithstanding, no term of this Plan relating to Incentive Stock Options shall be interpreted, amended or altered, nor shall any discretion or authority granted under the Plan be so exercised, so as to disqualify the Plan under Section 422 of the Code, or, without the consent of the optionee(s) affected, to disqualify any Incentive Stock Option under Section 422. Options granted hereunder shall be subject to the following terms and conditions and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Committee shall deem appropriate: 5.1 Option Price. The option price per share of Stock purchasable ------------ under a Stock Option shall be determined by the Committee at the time of grant; provided, however, that the option price per share for any Stock Option shall be not less than 100% of the Fair Market Value of the Stock on the date of grant. Any Incentive Stock Option granted to any optionee who, at the time the Option is granted, owns more than 10% of the voting power of all classes of stock of the Company or of a Parent or Subsidiary corporation (within the meaning of Section 424 of the Code), shall have an exercise price no less than 110% of Fair Market Value per share on the date of the grant. 5.2 Option Term. The term of each Stock Option shall be fixed by the ----------- Committee, but no Stock Option shall be exercisable more than ten years after the date the Stock Option is granted. However, any Incentive Stock Option granted to any optionee who, at the time the Option is granted, owns more than 10% of the voting power of all classes of stock of the Company or of a Parent or Subsidiary corporation may not have a term of more than five years. No Option may be exercised by any person after expiration of the term of the Option. 5.3 Exercisability. Stock Options shall be exercisable at such time -------------- or times and subject to such terms and conditions as shall be determined by the Committee at or after grant. If the Committee provides, in its discretion, that any Stock Option is exercisable only in installments, the Committee may waive such installment exercise provisions at any time at or after grant in whole or in part, based on such factors as the Committee shall determine, in its sole discretion. 5.4 Method of Exercise. Subject to whatever installment exercise ------------------ provisions apply under Section , Stock Options may be exercised in whole or in part at any time and from time to time during the Option period, by giving written notice of exercise to the Company specifying the number of shares to be purchased. Such notice shall be accompanied by payment in full of the purchase price, either by -5- cash, check, or such other instrument as the Committee may accept. As determined by the Committee, in its sole discretion, at or after grant, payment in full or in part may also be made in the form of unrestricted Stock already owned by the optionee (based upon the Fair Market Value of a share of Stock on the business date preceding tender if received prior to the close of the stock market and at the Fair Market Value on the date of tender if received after the stock market closes); provided, however, that, (i) in the case of an Incentive Stock Option, the right to make a payment in the form of unrestricted Stock already owned by the optionee may be authorized only at the time the Option is granted and (ii) the Company may require that the Stock has been owned by the Participant for a minimum period of time specified by the Committee. In addition, if such unrestricted Stock was acquired through exercise of an Incentive Stock Option, such Stock shall have been held by the optionee for a period of not less than the holding period described in Section 422(a)(1) of the Code on the date of exercise, or if such Stock was acquired through exercise of a Non-Qualified Stock Option or of an option under a similar plan of the Company, such Stock shall have been held by the optionee for a period of more than one year on the date of exercise, and further provided that the optionee shall not have tendered Stock in payment of the exercise price of any other Option under the Plan or any other stock option plan of the Company within six calendar months of the date of exercise. To the extent permitted under the applicable laws and regulations, at the request of the Participant, and with the consent of the Committee, the Company shall permit payment to be made by means of a "cashless exercise" of an Option. Payment by means of a cashless exercise shall be effected by the Participant delivering to the Securities Broker irrevocable instructions to sell a sufficient number of shares of Stock to cover the cost and expenses associated therewith and to deliver such amount to the Company. No shares of Stock shall be issued until full payment therefor has been made. An optionee shall not have any right to dividends or other rights of a stockholder with respect to shares subject to the Option until such time as Stock is issued in the name of the optionee following exercise of the Option in accordance with the Plan. 5.5 Stock Option Agreement. Each Option granted under this Plan ---------------------- shall be evidenced by an appropriate Stock Option agreement, which agreement shall expressly specify whether such Option is an Incentive Stock Option or a Non-Qualified Stock Option and shall be executed by the Company and the optionee. The agreement shall contain such terms and provisions, not inconsistent with the Plan, as shall be determined by the Committee. Such terms and provisions may vary between optionees or as to the same optionee to whom more than one Option may be granted. 5.6 Replacement Options. If an Option granted pursuant to the Plan ------------------- may be exercised by an optionee by means of a stock-for-stock swap method of exercise as provided in above, then the Committee may, in its sole discretion and at the time of the original Option grant, authorize the Participant to automatically receive a replacement Option pursuant to this part of the Plan. This replacement Option shall cover a number of shares determined by the Committee, but in no event more than the number of shares equal to the difference between the number of shares of the original Option exercised and the net shares received by the Participant from such exercise. The per share exercise price of the replacement Option shall equal the then current Fair Market Value of a share of Stock, and shall have a term extending to the expiration date of the original Option. The Committee shall have the right, in its sole discretion and at any time, to discontinue the automatic grant of replacement Options if it determines the continuance of such grants to no longer be in the best interest of the Company. -6- 5.7 Non-transferability of Options. No Stock Option shall be ------------------------------ transferable by the optionee other than by will, by the laws of descent and distribution, pursuant to a qualified domestic relations order, or as permitted under the Rules, and all Stock Options shall be exercisable, during the optionee's lifetime, only by the optionee. Notwithstanding the foregoing, the Committee may grant non-qualified Options that are transferable, without payment of consideration, to immediate family members (i.e., spouses, children and grandchildren) of the Optionee or to trusts for, or partnerships whose only partners are, such family members. The Committee may also amend outstanding non-qualified Options to provide for such transferability. 5.8 Termination of Employment by Reason of Death. Unless otherwise -------------------------------------------- determined by the Committee at or after grant, if any optionee dies during the optionee's period of employment by the Company, or during the periods referred to in Sections 5.9, 5.10 or 5.11, any Stock Option held by such optionee may thereafter be exercised, to the extent then exercisable or on such accelerated basis as the Committee may determine at or after grant, by the legal representative of the estate or by the legatee of the optionee under the will of the optionee, for a period of one year (or such shorter period as the Committee may specify at grant) from the date of such death or until the expiration of the stated term of such Stock Option, whichever period is shorter. 5.9 Termination of Employment by Reason of Disability. Unless ------------------------------------------------- otherwise determined by the Committee at or after grant, if an optionee's employment by the Company terminates by reason of Disability, any Stock Option held by such optionee may thereafter be exercised by the optionee, to the extent it was exercisable at the time of termination, or on such accelerated basis as the Committee may determine at or after grant, for a period of one year (or such shorter period as the Committee may specify at grant) from the date of such termination of employment or until the expiration of the stated term of such Stock Option, whichever period is shorter. In the event of termination of employment by reason of Disability, if an Incentive Stock Option is exercised after the expiration of the exercise periods that apply for purposes of Section 422 of the Code, such Stock Option will thereafter be treated as a Non-Qualified Stock Option. 5.10 Termination of Employment Upon Retirement. Unless otherwise ----------------------------------------- determined by the Committee at or after grant, if an optionee's employment terminates due to retirement (as hereinafter defined), any Stock Option held by such optionee may thereafter be exercised by the optionee, to the extent it was exercisable at the date of retirement, or on such accelerated basis as the Committee may specify at grant, for a period of one-year (or such shorter period as the Committee may specify at grant) from the date of such retirement or until the expiration of the stated term of such Stock Option, whichever period is shorter. For purposes of this Section 5.10, "Retirement" shall mean any Employee retirement under the Company's retirement policy. 5.11 Other Termination of Employment. Unless otherwise determined by ------------------------------- the Committee at or after grant, in the event of termination of employment (voluntary or involuntary) for any reason other than death, Disability or retirement, or if an Employee is terminated for cause, any Stock Option held by such optionee may thereafter be exercised by the optionee, to the extent it was exercisable at the time of such termination or on such accelerated basis as the Committee may determine at or after grant, for a period of three months (or such shorter period as the Committee may specify at grant) from the date of such termination of employment or the expiration of the stated term of such Stock Option, whichever period is shorter. If an Employee is terminated for cause, any Stock Option held by such Optionee shall terminate immediately. -7- 5.12 Incentive Stock Option Limitation. The aggregate Fair Market --------------------------------- Value (determined as of the time of grant) of the Stock with respect to which Incentive Stock Options are exercisable for the first time by the optionee during any calendar year under the Plan and/or any other stock option plan of the Company shall not exceed $100,000. 5.13 Termination of Eligible Independent Contractors Options. The ------------------------------------------------------- termination provisions of Options granted to Eligible Independent Contractors shall be determined by the Committee in its sole discretion. 5.14 Withholding and Use of Shares to Satisfy Tax Obligations. The -------------------------------------------------------- obligation of the Company to deliver Stock upon the exercise of any Option shall be subject to applicable federal, state and local tax withholding requirements. If the exercise of any Option is subject to the withholding requirements of applicable federal tax laws, the Committee, in its discretion (and subject to such withholding rules ("Withholding Rules") as shall be adopted by the Committee), may permit the optionee to satisfy the federal withholding tax, in whole or in part, by electing to have the Company withhold (or by delivering to the Company) shares of Stock, which Stock shall be valued, for this purpose, at their Fair Market Value on the date the amount of tax required to be withheld is determined (the "Determination Date"). Such election must be made in compliance with and subject to the Withholding Rules, and the Committee may not withhold shares of Stock in excess of the number necessary to satisfy the minimum federal income tax withholding requirements. If Stock acquired under the exercise of an Incentive Stock Option is used to satisfy such withholding requirement, such Stock must have been held by the optionee for a period of not less than the holding period described in Section 422(a)(1) of the Code on the Determination Date. If Stock acquired through the exercise of a Non-Qualified Stock Option or of an option under a similar plan is delivered by the optionee to the Company to satisfy such withholding requirement, such Stock must have been held by the optionee for a period of more than one year on the Determination Date. For Optionees subject to Section 16 of the Exchange Act, to the extent required by Section 16, the election to have Stock withheld by the Corporation hereunder must be either (a) an irrevocable election made six months before the Determination Date; or (b) an irrevocable election where both the election and the Determination Date occur during one of the ten-day periods beginning on the third business day following the date of release of the Company's quarterly or annual summary financial data and ending on the twelfth business day following such release. 5.15 Issuance of Shares and Compliance with Securities Acts. Within ------------------------------------------------------ a reasonable time after exercise of an Option, the Company shall cause to be delivered to the optionee a certificate for the Stock purchased pursuant to the exercise of the Option. At the time of any exercise of any Option, the Company may, if it shall deem it necessary and desirable for any reason connected with any law or regulation of any governmental authority relative to the regulation of securities, require the optionee to represent in writing to the Company that it is his or her then intention to acquire the Stock for investment and not with a view to distribution thereof and that such optionee will not dispose of such Stock in any manner that would involve a violation of applicable securities laws. In such event, no Stock shall be issued to such holder unless and until the Company is satisfied with such representation. Certificates for shares of Stock issued pursuant to the exercise of Options may bear an appropriate securities law legend. -8- PART III GRANTS TO NON-EMPLOYEE DIRECTORS -------------------------------- SECTION 6. Grant of Options Options to purchase 10,000 shares of Common Stock, subject to adjustment as provided in Section 3.2 (the "Initial Options") and options to purchase 5,000 shares, subject to adjustments as provided in Section 3.2, (the "Annual Options"), shall be granted to Non-Employee Directors as follows: (a) Each Non-Employee Director on the 30th day after the stockholders of the Company have approved the Plan shall be granted an Initial Option. (b) Each Non-Employee Director who is not granted an Initial Option pursuant to Section 6(a), shall be granted an Initial Option on the first business day immediately following the date that such person is first elected or appointed to serve as a Non-Employee Director. (c) Each year on January 1, each Non-Employee Director on such date shall be granted an Annual Option. SECTION 7. Types of Options All options granted under Part III of the Plan shall be non-qualified Stock Options for purposes of the Code. SECTION 8. Option Price The purchase price of each share of Stock issuable upon exercise of an Option will be equal to the Fair Market Value of the Stock on the date of grant. SECTION 9. Option Term and Rights to Exercise 9.1 Period of Option and Rights to Exercise. Except as set forth --------------------------------------- herein, each Non-Employee Director who receives options under this Plan must continue to hold office as a Non-Employee Director of the Company for six months from the date that the Initial Option is granted and six months from the date each Annual Option is granted before he can exercise any part thereof. Thereafter, subject to the provisions of the Plan, options will vest and be exercisable as follows: (a) Initial Options. --------------- (i) Each Initial Option will vest and be exercisable in full six months from the date of grant. (ii) The right to exercise an Initial Option will expire on the fifth anniversary of the date on which the option was granted. (iii) Once an Initial Option has become exercisable, such option may be exercised in whole at any time or in part from time to time until the expiration of the -9- option, whether or not any option granted previously to the optionee remains outstanding at the time of such exercise. (b) Annual Options. -------------- (i) Each Annual Option will vest and be exercisable on a cumulative basis as to 2,500 shares beginning six months from the date of grant and 2,500 additional shares beginning on the first anniversary of the date of grant. (ii) The right to exercise an Annual Option will expire on the fifth anniversary of the date on which the option was granted. (iii) Once each installment of an Annual Option has become exercisable, it may be exercised in whole at any time or in part from time to time until the expiration of the option, whether or not an option granted previously to the optionee remains outstanding at the time of such exercise. SECTION 10. Payment of Option Price Payment or provision for payment of the purchase price shall be made as follows: (i) in cash or check; (ii) by exchange of Stock valued at its Fair Market Value on the date of exercise; (iii) by means of a cashless exercise procedure by the delivery to the Company of an exercise notice and irrevocable instructions to the Securities Broker to sell a sufficient number of shares of Stock to pay the purchase price of the shares of Common Stock as to which such exercise relates and to deliver promptly such amount to the Company; or (iv) by any combination of the foregoing. Where payment of the purchase price is to be made with shares of Stock acquired through exercise of a non-qualified Stock Option or of an option under a similar plan of the Company, such Stock shall have been held by the optionee for a period of more than one year on the date of exercise, and further provided that the optionee shall not have tendered Stock in payment of the exercise price of any other Option under the Plan or any other stock option plan of the Company within six calendar months of the date of exercise. SECTION 11. Termination of Service Upon cessation of service as a Non-Employee Director (for reasons other than retirement or death), including cessation of service due to physical or mental disability that prevents such person from rendering further services as a Non-Employee Director, only those options exercisable at the date of cessation of service shall be exercisable by the Non-Employee Director. Such options shall be exercisable for a period of three months from cessation of service of the Non-Employee Director or the expiration of the Option, whichever period is shorter. Upon the retirement or death of a Non-Employee Director, options shall be exercisable as follows: (a) Retirement. Upon retirement as a Non-Employee Director after ---------- the Non-Employee Director has served for at least six consecutive years as a director, all Options shall continue to be exercisable during their terms as if such person had remained a Non-Employee Director. -10- (b) Death. In the event of the death of a Non-Employee Director ----- while a member of the Board, or within the period after termination of service referred to in the first paragraph of Section 11, the Options granted to him shall be exercisable, to the extent then exercisable, for a period of one year from the date of the Non-Employee Director's death, or until the expiration of the Option, whichever period is shorter. SECTION 12. No Guaranteed Term of Office Nothing in this Plan or any modification thereof, and no grant of an option, or any term thereof, shall be deemed an agreement or condition guaranteeing to any Non-Employee Director any particular term of office or limiting the right of the Company, the Board or the stockholders to terminate the term of office of any Non-Employee Director under the circumstances set forth in the Company's Certificate of Incorporation or Bylaws, or as otherwise provided by law. SECTION 13. Other Restrictions Sections 5.5, 5.7 and 5.15 of the Plan shall apply to options granted pursuant to Part III of the Plan. PART IV MISCELLANEOUS ------------- SECTION 14. Change in Control A "Change in Control" for purposes of this Plan shall mean any one of the events described below: 14.1 at any time during a period of two (2) consecutive years, at least a majority of the Board shall not consist of Continuing Directors. "Continuing Directors" shall mean directors of the Company at the beginning of such two-year period and directors who subsequently became such and whose selection or nomination for election by the Company's shareholders was approved by a majority of the then Continuing Directors; or 14.2 any person or "group" (as determined for purposes of Regulation 13D-G promulgated by the Commission under the Exchange Act or under any successor regulation), but excluding any majority-owned subsidiary or any employee benefit plan sponsored by the Company or any subsidiary or any trust or investment manager for the account of such a plan, shall have acquired "beneficial ownership" (as determined for purposes of such regulation) of the Company's securities representing fifty percent (50%) or more of the combined voting power of the Company's then outstanding securities unless such acquisition is approved in advance by a majority of the directors of the Company who were in office immediately preceding such acquisition and any individual selected to fill any vacancy created by reason of the death or disability of any such director; or 14.3 the Company becomes a party to a merger, consolidation or share exchange in which either (i) the Company will not be the surviving corporation or (ii) the Company will be the surviving corporation and any outstanding shares of Common Stock will be converted into shares of any other company (other than a reincorporation or the establishment of a holding company involving no -11- change in ownership of the Company or other securities or cash or other property (excluding payments made solely for fractional shares); or 14.4 the Company's shareholders (i) approve any plan or proposal for the disposition or other transfer of all, or substantially all, of the assets of the Company, whether by means of a merger, reorganization, liquidation or dissolution or otherwise or (ii) dispose of, or become obligated to dispose of, 50% or more of the outstanding capital stock of the Company by tender offer or otherwise. If a Change in Control has occurred, all outstanding options granted under the Plan shall be immediately exercisable by the holder of the option for the total remaining number of Shares covered by the option and shall survive any such event. SECTION 15. Amendments and Termination The Board may amend, alter or discontinue the Plan at any time and from time to time, but no amendment, alteration or discontinuation shall be made which would impair the rights of an optionee or Participant under a Stock Option award theretofore granted, without the optionee's or Participant's consent, or which, without the approval of the Company's stockholders, would require stockholder approval under the Rules. Except for awards made pursuant to Part III, the Committee may amend the terms of any Stock Option theretofore granted, prospectively or retroactively, but no such amendment shall impair the rights of any holder without the holder's consent. Except for awards made to Non-Employee Directors pursuant to Part III, the Committee may also substitute new Stock Options for previously granted Stock Options, including previously granted Stock Options having higher option prices. Subject to the above provisions, the Board shall have broad authority to amend the Plan to take into account changes in applicable tax laws, securities laws and accounting rules, as well as other developments. SECTION 16. Unfunded Status of Plan The Plan is intended to constitute an "unfunded" plan of incentive and deferred compensation. With respect to any payments not yet made to a Participant or optionee by the Company, nothing contained herein shall give any such Participant or optionee any rights that are greater than those of a general creditor of the Company. In its sole discretion, the Committee may authorize the creation of trusts or other arrangements to meet the obligations created under the Plan to deliver Stock or payments in lieu of or with respect to awards hereunder; provided, however, that, unless the Committee otherwise determines with the consent of the affected Participant, the existence of such trusts or other arrangements is consistent with the "unfunded" status of the Plan. SECTION 17. General Provisions 17.1 All certificates for shares of Stock or other securities delivered under the Plan shall be subject to such stock-transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations and other requirements of the Securities Act, the Exchange Act, any stock exchange or over-the-counter market upon which the Stock is then listed, and any applicable federal or state securities law, and the Committee or the Board may cause a legend or legends to be put on any such certificates to make appropriate reference to such restrictions. -12- 17.2 Nothing contained in this Plan shall prevent the Board from adopting other or additional compensation arrangements, subject to stockholder approval if such approval is required, and such arrangements may be either generally applicable or applicable only in specific cases. 17.3 The adoption of the Plan shall not confer upon any Participant any right to continued employment with the Company nor shall it interfere in any way with the right of the Company to terminate its relationship with any of its Employees, directors or Independent Contractors at any time. 17.4 No later than the date as of which an amount first becomes includable in the gross income of the Participant for federal income tax purposes with respect to any award under the Plan, the Participant who is an Employee of the Company shall pay to the Company, or make arrangements satisfactory to the Committee regarding the payment of, any federal, state, or local taxes of any kind required by law to be withheld with respect to such amount. To the extent permitted by the Committee, in its sole discretion, the minimum required withholding obligations may be settled with Stock, including Stock that is part of the award that gives rise to the withholding requirement. The obligations of the Company under the Plan shall be conditional on such payment or arrangements and the Company shall, to the extent permitted by law, have the right to deduct any such taxes from any payment of any kind otherwise due to the Participant. 17.5 The Committee shall establish such procedures as it deems appropriate for a Participant to designate a beneficiary to whom any amounts payable in the event of the Participant's death are to be paid. 17.6 The Plan shall be governed by and subject to all applicable laws and to the approvals by any governmental or regulatory agency as may be required. SECTION 18. Effective Date and Term of Plan The Plan shall be effective as of the effective date of the merger of Human Designed Systems, Inc. with and into ISAC Acquisition Co., a wholly-owned subsidiary of the Company (the "Effective Date"), subject to the consent or approval of the Company's stockholders as provided below. No Stock Option award shall be granted pursuant to the Plan on or after ten years from the Effective Date, but Stock Options granted prior to such tenth anniversary may be exercised after such date. If the Plan is not approved by a majority of the votes cast at a duly held meeting at which a quorum representing a majority of all outstanding voting stock of the Company is, either in person or by proxy, present and voting on the Plan, within 12 months after such effective date, any Incentive Stock Options that have been granted shall automatically become Non-Qualified Stock Options. SECTION 19. Interpretation A determination of the Committee as to any question which may arise with respect to the interpretation of the provisions of this Plan or any Options shall be final and conclusive, and nothing in this Plan, or in any regulation hereunder, shall be deemed to give any Participant, his legal representatives, assigns or any other person any right to participate herein except to such extent, if any, as the Committee may have determined or approved pursuant to this Plan. The Committee may consult with legal counsel who may be counsel to the Company and shall not incur any liability for any action taken in good faith in reliance upon the advice of such counsel. -13- SECTION 20. Governing Law With respect to any Incentive Stock Options granted pursuant to the Plan and the agreements thereunder, the Plan, such agreements and any Incentive Stock Options granted pursuant thereto shall be governed by the applicable Code provisions to the maximum extent possible. Otherwise, the laws of the State of Delaware shall govern the operation of, and the rights of Participants under, the Plan, the agreements and any Options granted thereunder. SECTION 21. Compliance With The Rules 21.1 Unless an Insider could otherwise transfer shares of Stock issued hereunder without incurring liability under Section 16(b) of the Exchange Act, at least six months must elapse from the date of grant of an Option to the date of disposition of the Stock issued upon exercise of such Option. 21.2 It is the intent of the Company that this Plan comply in all respects with the Rules in connection with any grant of Options to, or other transaction by, an Insider. Accordingly, if any provision of this Plan or any agreement relating to an Option does not comply with the Rules as then applicable to any such Insider, such provision will be construed or deemed amended to the extent necessary to conform to such requirements with respect to such person. In addition, the Committee shall have no authority to make any amendment, alteration, suspension, discontinuation, or termination of the Plan or any agreement hereunder, or take other action if such authority would cause an Insider's transactions under the Plan not to be exempt under the Rules. 21.3 Certain restrictive provisions of the Plan have been implemented to facilitate the Company's and Insiders' compliance with the Rules. The Committee, in its discretion, may waive certain of these restrictions, provided the waiver does not relate in any way to an Insider and, provided further, such waiver or amendment is carried out in accordance with Section 6 hereof. SECTION 22. Substitution of Options in a Merger, Consolidation or Share Exchange In the event that the Company becomes a party to a merger, consolidation or share exchange (a "Business Combination") and in connection therewith substitutes options under the Plan for options of another party to such Business Combination, notwithstanding the provisions of the Plan, the terms of such substituted options may have the same terms and conditions (provided that the number of shares issuable and the exercise prices are adjusted in accordance with the terms of the Business Combination) as the former options of such other party to the Business Combination, provided, however, that the exercise price of the Options to be granted under the Plan shall be lawful consideration as determined by the Committee. -14- EX-21 3 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21 Subsidiaries ------------ Name State of Incorporation - ------------------ ---------------------- HDS Network Systems Investments, Inc. Delaware Human Designed Systems Licensing, Inc. Delaware Information Technology Consulting, Inc. Delaware Bridging Data Technology, Inc. Delaware EX-23 4 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS Exhibit 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into the Company's previously filed Registration Statement File No. 33-93942, No. 33-87036 and No. 333-20185. ARTHUR ANDERSEN LLP Philadelphia, Pa., September 26, 1997 EX-27 5 FINANCIAL DATA SCHEDULE
5 YEAR YEAR JUN-30-1997 JUN-30-1996 JUL-01-1996 JUL-01-1995 JUN-30-1997 JUN-30-1996 1,452,409 2,700,298 0 0 9,308,731 4,914,007 0 0 4,035,202 2,354,254 16,002,051 11,165,185 680,859 668,420 0 0 18,327,115 12,023,903 7,555,703 2,449,010 0 0 0 0 0 0 5,761 5,620 10,765,651 9,476,270 10,771,412 9,481,890 25,467,487 20,819,444 0 0 16,885,868 15,703,594 8,130,823 4,390,344 0 0 0 0 0 0 520,020 945,783 182,791 322,898 0 0 0 0 0 0 0 0 337,229 622,885 0.11 0.13 0 0
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