SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One) |
 |
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| For the fiscal year ended June 30, 2004 | ||
or
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number 000-21240
NEOWARE SYSTEMS, INC.
(Exact name of registrant as specified in its charter.)
Delaware (State or other jurisdiction of incorporation or organization) |
23-2705700 (IRS Employer Identification No.) |
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400 Feheley Drive, King of Prussia, Pennsylvania (Address of principal executive offices) |
19406 (Zip Code) |
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| 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 | None | |
| Securities registered pursuant to Section 12(g) of the Act: | ||
| Common Stock, par value $.001 per share (Title of Class) |
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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 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.
Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES NO
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant computed by reference to the last reported sale price of the Common Stock as reported on the NASDAQ National Market on December 31, 2003 was approximately $215,070,000. 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 7, 2004 was 15,704,286.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held on December 1, 2004 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.
NEOWARE SYSTEMS, INC.
INDEX
| Item 1. | Business |
Overview
Neoware Systems, Inc. provides software, services and solutions to enable thin client appliance computing, which is a computing architecture targeted at business customers as an easier to manage, more secure, more reliable, and more cost-effective solution than traditional PC-based, client server computing. Our software and management tools secure, power and manage a new generation of smart thin client appliances that utilize the benefits of open, industry-standard technologies used in the PC industry to create new alternatives to full-function personal computers used in business, as well as green-screen terminals.
Our software runs on thin client appliances and personal computers, and enables these devices to be secured and centrally managed, as well as to connect to mainframes, midrange, UNIX, Linux and legacy systems. We generate revenues primarily from sales of thin client appliance systems, which include the appliance device and related software marketed under the brand names Eon, Capio, ThinSTAR and Voyager, and to a lesser extent from ThinPC thin client software for PCs, TeemTalk host access software, ezRemote Manager central management software, and services such as training and integration.
Our Company was formed in 1995 as the result of a merger between Human Designed Systems, Inc. (HDS), a privately held technology company, and Information Systems Acquisition Corporation (ISAC), a publicly held company. At the time of the merger, we changed the name of the Company to HDS Network Systems, Inc. and, in connection with the license of certain technology to Hitachi Data Systems in 1997, we changed the name of the Company to Neoware Systems, Inc.
On June 28, 2001, we purchased the thin client business of Boundless Technologies, Inc., which included the Capio product line and associated software and intellectual property and access to the Capio distribution and customer databases, for $1.6 million, excluding transaction costs.
On December 4, 2001, we acquired all of the assets and assumed substantially all of the liabilities of Telcom Assistance Center Corporation, d/b/a ACTIV-e Solutions, a full service information technology consulting company in the server-based computing marketplace. The purchase price was payable in cash of $75,000, 569,727 shares of our newly issued common stock with a market value of $3.24 per share and the assumption of net liabilities of approximately $1.2 million, excluding transaction costs.
On January 8, 2002, we entered into a worldwide alliance with IBM Corporation, under which we are the preferred provider of thin client appliance products to IBM and its customers. In addition, we licensed intellectual property from IBM associated with IBM’s thin client appliance products. As consideration for these agreements, we issued 375,000 shares of newly issued common stock with a market value of $6.26 per share to IBM.
On March 26, 2002, we acquired the thin client business of Network Computing Devices, Inc. (NCD), including the ThinSTAR product line. In addition, we entered into an alliance with NCD to grow the worldwide thin client appliance market. The purchase price was payable in cash of $4.0 million, excluding transaction costs.
On May 24, 2002, we completed a private placement of our common stock to institutional and other accredited investors. We sold 1,600,000 shares of our common stock at a price of $7.50 per share for proceeds of $12.0 million, excluding transaction costs.
On July 1, 2003, we acquired the host access software business of Pericom Holdings PLC (referred to as “TeemTalk software business”), for $9.8 million in cash, excluding transaction costs. We acquired all of the assets of the software business, including the TeemTalk host access software, intellectual property and technology, customer lists, customer contracts and distribution channels and also entered into a non-competition agreement.
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On July 10, 2003, we completed a private placement of our common stock to institutional and other accredited investors. We sold 1,500,000 shares of our common stock at a price of $17.50 per share for proceeds of $26,250,000, excluding transaction costs.
Product Strategy
The market for thin client appliances is a subset of the enterprise PC market. We market our thin client appliances as alternatives to personal computers in certain target markets. Our strategy is (1) to focus on increasing sales to large enterprise customers, primarily through our relationship with IBM, and secondarily through other resellers and directly to end users, and, (2) to execute marketing initiatives designed to grow the thin client segment of the PC industry.
We provide our software on top of a number of desktop and embedded operating systems, including Microsoft’s Windows 95, 98, ME, NT, 2000, XP, CE, and XP Embedded, as well as an embedded version of the Linux operating system. We utilize third parties who we believe have strong market positions in the server-based computing market to expand our sales and marketing efforts, which allows us to develop new customer relationships as well as gain access to new markets.
We have developed unique technology and intend to continue to enhance this technology, which enables large numbers of thin client appliances to be deployed in business environments as alternatives to proprietary or PC-based systems. We intend to continue to develop and add our proprietary enhancements to other companies’ operating systems, enabling them to be secured and centrally managed.
We offer host access software, which enables customers to connect their thin client appliances, personal computers and UNIX workstations to a variety of computer systems, including mainframes, minicomputers, UNIX and other servers.
In addition to providing software and appliance products, we offer consulting services and assistance to enterprise customers as they manage the deployment of applications to thin client appliances. We supply our software for use on personal computers and thin clients and we bundle our software with industry-standard thin client appliance platforms to enable complete hardware, software and management solutions for our customers.
We incorporate the following principal elements of our business strategy and products:
| • | Central Administration and Lower Cost of Ownership. Our products are designed to be centrally administered in order to lower total cost of ownership. Customers who utilize our products typically run applications and store files on a server, not on desktop devices as with
a personal computer. This makes administration of our products much easier and more cost-effective than administration of personal computers, since administrative tasks take place at a small number of servers instead of a much larger number of desktops. |
| • | Diverse Technology Expertise. We have significant expertise in a wide range of technical disciplines, including central management, security, embedded operating systems, windowing and networking software, application software development, host access, graphics
acceleration, multimedia design and compression algorithms. Utilizing more than fifteen years of experience designing embedded UNIX operating systems, we have ported our proprietary software technologies to desktop and embedded versions of the Windows and
Linux operating systems to develop unique software products that are designed specifically for server-based computing environments. |
| • | Use of Industry Standard Components. We plan, implement and manage the design of our software and appliance products to take advantage of industry-standard technologies and components that are widely available in the personal computer industry. We believe that
this reduces our risks and costs, and allows us to more easily increase production of our appliance products quickly to meet customer demand. |
| • | Product Upgrades and Enhancements. We sell software upgrades and enhancements to our customers as well as software and enhancements to customers utilizing personal computers and thin client appliances |
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sold by other vendors. This allows customers to expand their use of thin clients, manage all of their appliances through one family of management tools, ezRemote Manager, or other industry-standard management tools, and provide the same end-user experience to all users. This
provides customers extended use of their installed personal computers and thin client appliances without changing hardware, and is intended to provide a continued relationship with, and revenue stream from, our customers. |
| • | Thin Client Appliance Computing Technical Support and Consulting Services. We provide technical support services in addition to software and thin client appliances. This support extends from the thin client appliance through a customer’s network infrastructure,
including their server complex, which allows customers to work with one supplier with the expertise to assist them. |
| • | Host Access Software Expertise. We have significant expertise developing software that allows customers to connect thin client appliances, personal computers and UNIX workstations to mainframes, midrange systems, UNIX servers and other systems. Additionally, we
have licensed host access software from IBM enabling our products to connect to IBM servers with IBM-branded host access software. |
Customers
Our customers span a wide range of industries, including retail, healthcare, transportation, hospitality, education, financial services, government, manufacturing and telecommunications. Our products have been adopted by such customers as 1-800-FLOWERS.COM, Air Canada, Air New Zealand, Ardent Health Services, Autozone, Bed, Bath and Beyond, Bristol Myers Squibb, Caesar’s Palace, California Department of Motor Vehicles, Comcast Cable, Cook County Circuit Court, Costco, CVS, Discount Tire, ESPN, Federated Department Stores, Harley Davidson, Hollywood Video, IBM, Ikea, Keystone Automotive, Kilotou, Lee Memorial HealthCare, Lockheed Martin, National Car Rental, National City Mortgage, National Semiconductor, Nike, Panasonic, Raymour and Flanagan, Renault, Safeway, Sears, Target Corporation, Textron Financial, TJ Maxx Stores, US Veteran’s Administration, Verizon, Wal-Mart and others.
Sales directly to IBM accounted for 18% of net revenues in fiscal 2004. IBM resells our products to individual resellers and end-users, none of which contributed sales of more than 10% of our net revenues for the year ended June 30, 2004. Sales to IBM accounted for 17% of net revenues and sales to a European distributor accounted for 16% of net revenues in fiscal 2003. Each of these customers resells our products to individual resellers and/or end-users, none of which contributed sales of more than 10% of our net revenues for the year ended June 30, 2004. One customer provided 10% of net revenues in fiscal 2002.
In addition to our direct sales to IBM, IBM purchases our products through distributors. We estimate that indirect sales to IBM and its customers have ranged from zero to 10% of net revenue in individual quarters in fiscal 2004 and 2003, and may continue to vary significantly from quarter to quarter.
Product Development
We believe that our ability to expand the market for our products will depend in large part upon our ability to develop cross-platform enhancements to the Windows and Linux operating systems, and to continue to develop new software products that incorporate the latest improvements in performance, capability and manageability targeted specifically at host access and server-based computing environments. Accordingly, we are committed to investing significant resources in software development activities. During fiscal 2004, 2003 and 2002, research and development expenses totaled $2.8 million, $1.8 million and $1.4 million, respectively. In addition, we have acquired technology in connection with our acquisitions and our alliance with IBM.
Our current research and development programs include:
| • | Development of enhancements to the Windows, Windows CE, XP Embedded and Linux operating systems designed to make them more manageable and secure in server-based computing environments. |
| • | Development of server-based remote management software designed to manage the wide-scale deployments of large numbers of network-connected thin client appliances. |
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| • | Development of our TeemTalk host access product line, which provides connectivity to mainframes, minicomputers, UNIX and legacy servers from thin clients, personal computers and UNIX workstations. |
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 our marketing strategy are to grow the thin client segment of the PC market, increase awareness of the benefits of our products, maintain our position as a recognized innovator in the thin client appliance segment of the PC market and differentiate our products from alternative types of devices, including personal computers. Our marketing activities include participation in trade shows and conferences, advertising, press relations with leading trade publications and the publication of technical articles.
Our products have won numerous awards, including “Editor’s Choice” from PC Magazine, “Best Windows-based Terminal” and “Editors Choice” from Network Computing, “Best Buy” from Network Solutions, “Byte Best” from Byte Magazine, “Top of the World” from SCO World, “Crossroads A-List” from Open Systems Advisors, “Best Buy” from PC Dealer, “Gold Award for Excellence” from Computing Magazine, “Five Stars for Features and Overall Performance” from PC Pro, “Best Buy” from PC Week UK, “5-Star PC Digest Recommends” from PC Digest and Reader’s Choice Award from Windows & .NET Magazine.
We distribute our products in North America through IBM, value-added resellers, system integrators, distributors, direct sales to end users and OEMs, and via the Internet.
We utilize distributors for our products throughout the world, and have relationships with distributors in the United States, United Kingdom, Canada, France, Scandinavia, Germany, Denmark, Belgium, Netherlands, Austria, Switzerland, Italy, Spain, Russia, Israel, India, Egypt, Latvia, Korea, Philippines, New Zealand, Australia, Malaysia, South Africa, and elsewhere.
Net revenues from our international customers accounted for approximately 38%, 39% and 30% of net revenues, respectively, in fiscal 2004, 2003 and 2002. Our international sales are typically transacted in US dollars, however the prices of our products are based upon the market price for alternative products, including personal computers, in each market. For a discussion of risks associated with our international sales, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors Affecting the Company and Future Operating Results—If we are unable to continue generating substantial revenues from international sales our business” in Item 7, which is incorporated herein by reference.
Service and Support
We provide systems integration services, and technical support at customers’ sites, as well as via telephone and electronic mail. Our technical support specialists provide assistance in diagnosing problems and assisting with integrating our products with servers, networks and application software.
We typically warrant our thin client appliance products against defects in materials and workmanship for three years after purchase by the end user. To date, we have not encountered any material product maintenance problems.
Our products are typically not returnable by customers after they are sold. Demonstration units sold to customers under our ezDemo program are returnable within 30 days of shipment. Certain of our distributors have the right to return a limited number of products to us, based upon their sales volume in prior periods. These returns must be accompanied by a corresponding sales order of equivalent or greater value.
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Competition
The thin client segment of the personal computer market is characterized by changing technology and evolving industry standards. We experience significant competition from suppliers of personal computers, as well as other providers of thin client appliance products.
Competitive products are offered by a number of established computer manufacturers, including Dell Computer, Hewlett Packard, Sun Microsystems and Wyse Technology. In addition, IBM sells personal computer products which can compete with our offerings. Personal computers can be configured with software, such as an ICA client from Citrix Systems, or an RDP client from Microsoft, that allows them to operate as thin client appliances. Thin client appliances compete favorably on a price/performance basis with personal computers and offer cost advantages in initial system installation, as well as subsequent system upgrading and administration. However, the significant market presence and reputation of personal computer manufacturers, and customers’ perceptions regarding their need for desktop application processing capability, constitute obstacles to the penetration of the personal computer portion of the market by thin client appliance suppliers. Increased competition could result in price reductions, reduced profit margins and loss of market share, which would adversely affect our operating results.
Some of our competitors have substantially greater name recognition, engineering, manufacturing and marketing capabilities and greater financial resources than we do. We believe that the principal competitive factors among suppliers include technical expertise, software capabilities, breadth of product line, product price/performance, investment protection, network expertise, service and support, and market presence. We believe that we compete favorably with respect to these factors.
At the low end of the commercial segment of the desktop computer market, we compete with suppliers of ASCII and 3270 compatible terminals. These products do not offer the graphics and windowing capabilities offered by our products, but are still appealing to certain customers. We believe that thin client appliances have become increasingly competitive with ASCII and 3270 terminal systems and replacement of such terminal systems represents a substantial market for our products.
Manufacturing and Suppliers
We provide our software and management tools on thin client appliances designed, manufactured and assembled for us by third parties. We primarily depend upon a sole source supplier in China for our thin client appliance products. We have entered into an agreement with this supplier, pursuant to which the parties are only committed to purchase and manufacture products under individually accepted purchase orders. We also depend on a limited number of sources to supply several other products and components.
Our thin client appliances utilize industry-standard hardware components used in high volume in the PC industry. We believe that this lowers the cost of designing and manufacturing our products and allows us to continue to lower the cost of our products as the costs of personal computers decline. We use this strategy to compete with other companies that design and manufacture their own proprietary hardware. We believe that this strategy has allowed us to lower the cost of our products and operations, and has allowed us to increase sales and lower inventory levels.
Proprietary Rights and Licenses
We believe that our success will depend primarily on the innovative skills, technical competence and marketing abilities of our personnel as well as the ownership of our intellectual property. We do not currently have any patents that protect our rights to our intellectual property.
Certain technology used in our products is licensed from third parties, either on a non-royalty-bearing basis or on a royalty-bearing basis. Generally, such licenses grant us non-exclusive, worldwide rights with respect to the subject technology and terminate upon a material breach. We have licensed technology from IBM, Citrix Systems, Inc., Microsoft Corporation and NCD.
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Employees
As of August 31, 2004, we had 114 full time employees.
Other Information
Our Internet website is located at http://www.neoware.com. We make available free of charge on our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, or SEC. Other than the information expressly set forth in this annual report, the information contained, or referred to, on our website is not incorporated into this annual report.
The public may also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1- 800-SEC-0330. The SEC also maintains an Internet website that contains reports, proxy and information statements and other information regarding issuers, such as Neoware, that file electronically with the SEC. The SEC’s Internet site is located at http://www.sec.gov.
| Item 2. | Properties |
Our principal administrative, marketing and research and development operations are located in King of Prussia, Pennsylvania. Our primary facility consists of approximately 22,000 square feet under a lease with an expiration date of September 30, 2005. The annual gross rent for the facility, including operating expenses, is approximately $230,000. In March 2002, we entered into a two-year lease, which was extended in January 2004, for approximately 4,800 square feet at an adjacent facility in King of Prussia. The annual gross rent for this facility, including operating expenses, is approximately $100,000. We also lease a number of sales offices in the US, Europe and Australia, and a development office in the UK. We believe that our growth will likely require us to lease additional facilities and that suitable additional space will be available as needed.
| Item 3. | Legal Proceedings |
None.
| Item 4. | Submissions of Matters to a Vote of Security Holders |
None.
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| Item 5. | Market for Registrant’s Common Equity and Related Stockholder Matters |
Price Range of Common Stock |
Our common stock began trading on the NASDAQ National Market on August 7, 2002. Prior to that date, our common stock was traded on the NASDAQ SmallCap Market. Prior to August 1, 1997, our common stock traded under the symbol HDSX and, effective on that date, began trading under the symbol NWRE. The following table sets forth the high and low closing bid quotations for our common stock for the periods indicated.
| High | Low | ||||||
Fiscal 2004 |
|||||||
First Quarter |
$ | 21.00 | $ | 14.85 | |||
Second Quarter |
$ | 20.20 | $ | 12.98 | |||
Third Quarter |
$ | 13.65 | $ | 9.27 | |||
Fourth Quarter |
$ | 12.25 | $ | 7.79 | |||
Fiscal 2003 |
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First Quarter |
$ | 18.72 | $ | 10.50 | |||
Second Quarter |
$ | 20.91 | $ | 10.94 | |||
Third Quarter |
$ | 17.69 | $ | 10.76 | |||
Fourth Quarter |
$ | 16.16 | $ | 8.63 | |||
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 141 holders of record of our common stock as of September 7, 2004.
Dividend Policy |
We have never declared or paid any cash dividends on our capital stock and do not intend to pay any cash dividends in the foreseeable future.
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| Item 6. | Selected Financial Data |
The following table sets forth selected financial data with respect to our Company for the periods indicated. The data selected below have been derived from the consolidated financial statements of Neoware Systems, Inc., which have been audited by KPMG LLP, independent registered public accounting firm, for the years ended June 30, 2004, 2003 and 2002 and by Arthur Andersen LLP, independent public accountants, for the other years presented. The data set forth below should be read in conjunction with our Consolidated Financial Statements together with the related notes thereto included elsewhere herein and Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (in thousands, except per share data).
| For the Year Ended June 30, | ||||||||||||||||
| 2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||
Statement of Operations Data: |
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Net revenues |
$ | 63,165 | $ | 57,522 | $ | 34,310 | $ | 17,655 | $ | 11,045 | ||||||
Gross profit |
30,380 | 25,973 | 13,965 | 5,962 | 2,319 | |||||||||||
Operating expenses |
23,003 | 16,134 | 10,983 | 6,431 | 4,431 | |||||||||||
Operating income (loss) |
7,377 | 9,839 | 2,982 | (469 | ) | (2,112 | ) | |||||||||
Foreign exchange loss |
(106 | ) | — | — | — | — | ||||||||||
Loss on investment |
— | (300 | ) | — | (812 | ) | — | |||||||||
Interest income, net |
392 | 323 | 296 | 772 | 292 | |||||||||||
Income (loss) before income taxes |
7,663 | 9,862 | 3,278 | (509 | ) | (1,820 | ) | |||||||||
Income taxes (benefit) |
2,269 | 3,550 | (1,347 | ) | — | — | ||||||||||
Net income (loss) |
$ | 5,394 | $ | 6,312 | $ | 4,625 | $ | (509 | ) | $ | (1,820 | ) | ||||
Basic earnings (loss) per share |
$ | 0.34 | $ | 0.46 | $ | 0.42 | $ | (0.05 | ) | $ | (0.25 | ) | ||||
Diluted earnings (loss) per share |
$ | 0.34 | $ | 0.43 | $ | 0.39 | $ | (0.05 | ) | $ | (0.25 | ) | ||||
Weighted average number of common shares outstanding: |
||||||||||||||||
Basic |
15,683 | 13,601 | 10,905 | 10,226 | 7,375 | |||||||||||
Diluted |
16,020 | 14,696 | 11,851 | 10,226 | 7,375 | |||||||||||
| June 30, | ||||||||||||||||
|
|
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| 2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||
Balance
Sheet Data: |
||||||||||||||||
Current
assets
|
$ | 68,942 | $ | 42,770 | $ | 29,723 | $ | 16,436 | $ | 17,995 | ||||||
Current
liabilities
|
9,879 | 7,495 | 5,893 | 2,699 | 2,191 | |||||||||||
Working
capital
|
59,063 | 35,275 | 23,830 | 13,737 | 15,804 | |||||||||||
Total
assets
|
90,607 | 54,376 | 42,399 | 18,789 | 18,668 | |||||||||||
Total stockholders’ equity |
80,489 | 46,627 | 36,602 | 16,090 | 16,477 | |||||||||||
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Overview |
Business |
We provide software, services and solutions to enable thin client appliance computing, which is a computing architecture targeted at business customers as an easier to manage, more secure, more reliable, and more cost-effective solution than traditional PC-based, client server computing. Our software and management tools secure, power and manage a new generation of smart thin client appliances that utilize the benefits of open, industry-
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standard technologies used in the PC industry to create new alternatives to full-function personal computers used in business, as well as green-screen terminals.
Our software runs on thin client appliances and personal computers, and enables these devices to be secured and centrally managed, as well as to connect to mainframes, midrange, UNIX, Linux and legacy systems. We generate revenues primarily from sales of thin client appliance systems, which include the appliance device and related software marketed under the brand names Eon, Capio, ThinSTAR and Voyager, and to a lesser extent from ThinPC thin client software for PCs, TeemTalk host access software for servers, ezRemote Manager central management software, and services such as training and integration.
We sell our products and services worldwide through our direct sales force, distributors, our alliance with IBM and other indirect channels, such as VARs and systems integrators. Our international sales are primarily made through distributors and resellers and are collectable primarily in US dollars, while the associated operating expenses are payable in foreign currencies. In addition to our headquarters in the United States, we maintain offices in the UK, Germany, France, Austria, Sweden, Australia, and the Netherlands.
Our international revenues, primarily from Europe, were as follows (in thousands):
| 2004 | 2003 | 2002 | ||||||||
International revenue |
$ | 23,992 | $ | 22,434 | $ | 10,293 | ||||
As a percentage of net revenues |
38% | 39% | 30% | |||||||
Percentage change over prior period |
7% | 118% | ||||||||
Strategy |
The market for thin client appliances is a subset of the enterprise PC market. We market our thin client appliances as alternatives to personal computers in certain target markets. Our strategy is (1) to focus on increasing sales to large enterprise customers, primarily through our relationship with IBM, and secondarily through other resellers and directly to end users, and, (2) to execute marketing initiatives designed to grow the thin client segment of the PC industry. We expect that the combination of these actions will result in increased revenues with overall gross profit margins in approximately the 40% to 45% range in fiscal 2005.
Financial Position |
In fiscal 2004 our operating results were affected by several factors, including, lack of growth in the PC market, changes in the competitive landscape and contributions from the TeemTalk acquisition. In fiscal 2004, we grew more slowly than in prior years, and responded by changing our strategy as noted above. Since we completed the acquisition of the TeemTalk software business, we have increased sales of this product, which contributed to our growth and profitability. Also during the year, we spent approximately $1.6 million pursuing acquisitions that were not completed.
Net revenue, gross profit margin and earnings per share are key measurements of our financial results. For fiscal 2004, net revenue was $63.1 million, an increase of 10% from fiscal 2003. Gross profit margins were 48% in fiscal 2004 as compared to 45% in fiscal 2003. Diluted earnings per share was $0.34 in fiscal 2004, compared to $0.43 in fiscal 2003, as a result of earnings leverage from revenue growth offset by the write-off of abandoned acquisition costs and an additional 1,300,000 diluted shares outstanding primarily from the sale of stock in July 2003.
During fiscal 2004, we strengthened our balance sheet and added to our cash position. We have a significant balance of cash and short-term investments and we generated cash from operations during fiscal 2004. As of June 30, 2004, our cash, cash equivalents and short- term investments were $55.3 million, compared to $29.2 million at June 30, 2003, which represented approximately 79% of tangible assets. Cash provided by operating activities in fiscal 2004 was $10.9 million. Financing activities provided $25.5 million in 2004 due primarily to the private placement of 1,500,000 shares of our common stock. We utilize cash in ways that our management believes provides an optimal return on investment. Cash has principally been used to acquire businesses.
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Critical Accounting Policies and Estimates |
We believe that there are several accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenue and other significant areas that involve management’s judgments and estimates. These critical accounting policies and estimates include:
| • | Revenue recognition |
| • | Valuation of long-lived and intangible assets and goodwill |
| • | Accounting for income taxes |
These policies and estimates and our procedures related to these policies and estimates are described in detail below and under specific areas within the discussion and analysis of our financial condition and results of operations. Please refer to Note 1, “Organization and Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements for further discussion of the Company’s accounting policies and estimates.
Revenue Recognition |
We make significant judgments related to revenue recognition. For each type of arrangement, we make significant judgments regarding the fair value of multiple elements contained in our arrangements, judgments regarding whether fees are fixed or determinable, judgments regarding whether collectibility is probable, and judgments related to accounting for potential distributor stock rotation rights and price protection. These judgments, and their effect on revenue recognition, are discussed below.
Multiple Element Arrangements |
Net revenues include sales of thin client appliance systems, which include the appliance device and related software, maintenance and technical support. We follow AICPA Statement of Position No. 97-2, “Software Revenue Recognition” (“SOP 97-2”), for revenue recognition because the software component of the thin client appliance system is more than incidental to the thin client appliance systems as a whole. These products and services are sold either separately or as part of a multiple-element arrangement. Revenue is recognized on product sales when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable and collectibility is probable.
Revenue related to post-contract support services is generally recognized with the initial product sale when the fee is included with the initial product fee, post-contract services are for one year or less, the estimated cost of providing such services during the arrangement is insignificant, and unspecified upgrades and enhancements offered during the period historically have been and are expected to continue to be minimal and infrequent. Otherwise, revenue from extended warranty and post-contract support service contracts is recorded as deferred revenue and subsequently recognized over the term of the contract.
The Fee is Fixed or Determinable |
We make judgments at the outset of an arrangement regarding whether the fees are fixed or determinable. The vast majority of our payment terms are within 30 to 60 days after invoice date. We review arrangements that have payment terms extending beyond 60 days on a case-by-case basis to determine if the fee is fixed or determinable. If we determine at the outset of an arrangement that the fees are not fixed or determinable, we recognize revenue as the fees become due and payable.
Collection is Probable |
We make judgments at the outset of an arrangement regarding whether collection is probable. Probability of collection is assessed on a customer-by-customer basis. We typically sell to customers with whom we have had a history of successful collections. New customers are subjected to a credit review process to evaluate the customer’s
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financial position and ability to pay. If we determine at the outset of an arrangement that collection is not probable, revenue is recognized upon receipt of payment.
Stock Rotation Rights and Price Protection |
We provide certain distributors with stock rotation rights and price protection. Stock rotation rights are generally limited to a maximum amount per quarter and require a corresponding order of equal or greater value at the time of the stock rotation. We provide price protection as a rebate in the event that we reduce the price of products that our distributors have yet to sell to end users. We estimate potential stock rotation and price protection claims based on historical experience and the level of inventories in the distribution channel and reduce current period revenue accordingly. If we cannot reasonably estimate at the outset of an arrangement containing stock rotation rights and price protection, we recognize revenue when the claims can be reasonably estimated.
Valuation of Long-Lived and Intangible Assets and Goodwill. |
In connection with acquisitions, we allocate portions of the purchase price to intangible assets, consisting of acquired technology, distributor and customer relationships and tradenames based on independent appraisals received after each acquisition, with the remainder allocated to goodwill.
We assess the realizability of goodwill and intangible assets with indefinite useful lives pursuant to SFAS No. 142, Goodwill and Other Intangible Assets. We are required to perform a SFAS No. 142 impairment test annually, or sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable. We have determined that the reporting unit level is our sole operating segment. The test for goodwill is a two-step process:
First, we compare the carrying amount of our reporting unit, which is the book value of the entire Company, to the fair value of our reporting unit. If the carrying amount of our reporting unit exceeds its fair value, we have to perform the second step of the process. If not, no further testing is needed.
If the second part of the analysis is required, we allocate the fair value of our reporting unit to all assets and liabilities of our reporting units as if the reporting unit had been acquired in a business combination at the date of the impairment test. We then compare the implied fair value of our reporting unit’s goodwill to its carrying amount. If the carrying amount of our reporting unit’s goodwill exceeds its fair value, we recognize an impairment loss in an amount equal to that excess.
We review our long-lived assets, including amortizable intangibles, for impairment when events indicate that their carrying amount may not be recoverable. When we determine that one or more impairment indicators are present for an asset, we compare the carrying amount of the asset to net future undiscounted cash flows that the asset is expected to generate. If the carrying amount of the asset is greater than the net future undiscounted cash flows that the asset is expected to generate, we compare the fair value to the book value of the asset. If the fair value is less than the book value, we recognize an impairment loss. The impairment loss is the excess of the carrying amount of the asset over its fair value.
Some of the events that we consider as impairment indicators for our long-lived assets, including goodwill, are:
| • | Significant underperformance relative to expected operating results; |
| • | Our net book value compared to our market capitalization; |
| • | Significant adverse economic and industry trends; |
| • | Significant decrease in the market value of the asset; |
| • | The extent that we use an asset or changes in the manner that we use it; and |
| • | Significant changes to the asset since we acquired it. |
We have not recorded an impairment loss on goodwill or other long-lived assets. At June 30, 2004, goodwill and amortizable intangible assets are $17.5 million and $3.5 million, respectively. A decrease in the fair value of our business could trigger an impairment charge related to goodwill.
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Accounting for Income Taxes |
We are required to estimate our income taxes in each federal, state and international jurisdiction in which we operate. This process requires that we estimate the current tax exposure as well as assess temporary differences between the accounting and tax treatment of assets and liabilities, including items such as accruals and allowances not currently deductible for tax purposes. The income tax effects of the differences we identify are classified as current or long-term deferred tax assets and liabilities in our consolidated balance sheets. Our judgments, assumptions and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of future audits conducted by foreign and domestic tax authorities. Changes in tax laws or our interpretation of tax laws and the resolution of future tax audits could significantly impact the amounts provided for income taxes in our balance sheet and results of operations. We must also assess the likelihood that deferred tax assets will be realized from future taxable income and, based on our assessment, establish a valuation allowance, if required.
Results of Operations |
Net Revenues (in
thousands):
|
| 2004 | 2003 | 2002 | ||||||||
Net revenue |
$ | 63,165 | $ | 57,522 | $ | 34,310 | ||||
Percentage change over prior period |
10 | % | 68 | % | ||||||
We derive revenues primarily from the sale of thin client appliances, which include an appliance device and related software. The increase in net revenues in fiscal 2004 reflects increases in revenue from our thin client appliance products (5%) and software (5%). The increases were driven by sales growth from increasing market acceptance of our thin client products and our alliance with IBM, our acquisition and growth in revenues of the TeemTalk software business and increasing sales of our other software products. The increase in net revenues in fiscal 2003 was primarily attributable to an increase in sales of our thin client appliance products sold as a result of the increasing acceptance in the marketplace of thin client technology and our increased access to customers as a result of our greater market share, our alliance with IBM, and our larger sales organization.
While we believe that the increase in total net revenue achieved in recent periods is not necessarily indicative of future results, we expect total net revenue to increase in fiscal 2005, as a result of increased penetration of the PC market and continued growth of our relationship with IBM, relatively consistent with the growth levels experienced during fiscal 2004. We believe that we are seeing positive initial results from the new marketing and product strategies that we initiated earlier this year, and believe that if we can successfully implement these initiatives, our revenues may grow at a faster rate. Additionally, we completed only one acquisition in our fiscal 2004. If we complete additional acquisitions in fiscal 2005, our revenues may grow at a faster rate.
Cost of Revenues
and Gross Profit Margin (in thousands):
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| 2004 | 2003 | 2002 | ||||||||