NEOWARE SYSTEMS INC - 10-Q Quarterly Report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

(Mark One)
	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the Quarter ended December 31, 2004

	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the transition period from _______ to ________.

Commission File Number: 000-21240

NEOWARE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

Delaware	23-2705700
(State or other jurisdiction of	(IRS Employer Identification No.)
incorporation or organization)

400 Feheley Drive
King of Prussia, Pennsylvania 19406
(Address of principal executive offices)

(610) 277-8300
(Registrant's telephone number including area code)

__________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No

As of February 7, 2005, there were 16,145,196 outstanding shares of the Registrant's Common Stock.

NEOWARE SYSTEMS, INC.
INDEX

PART I.	FINANCIAL INFORMATION
		Page

Item 1.	Consolidated Financial Statements (unaudited)
	Condensed Consolidated Balance Sheet as of December 31, 2004 and June 30, 2004	3
	Consolidated Statement of Operations for the Three and Six Months Ended	4
	December 31, 2004 and 2003
	Consolidated Statement of Cash Flows for the Three and Six Months Ended	5
	December 31, 2004 and 2003
	Notes to Consolidated Financial Statements	6

Item 2.	Management's Discussion and Analysis of Financial Condition and	13
	Results of Operations.

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27

Item 4.	Controls and Procedures	27

PART II.	OTHER INFORMATION

Item 4.	Submission of Matters to a Security Holder	27
Item 5.	Other Information	27
Item 6.	Exhibits	28
Signatures		29

NEOWARE SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)

ASSETS	December 31, 2004			June 30, 2004

Current assets:
Cash and cash equivalents	$	36,286		$	17,119
Short-term investments		16,226			38,177
Accounts receivable, net		13,322			10,580
Inventories		3,847			795
Prepaid expenses and other		833			1,628
Deferred income taxes		643			643

Total current assets		71,157			68,942

Property and equipment, net		445			509
Goodwill		20,177			17,466
Intangibles, net		4,656			3,545
Deferred income taxes		145			145

	$	96,580		$	90,607

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,326		$	5,685
Accrued compensation and benefits		1,792			1,534
Other accrued expenses		1,778			1,071
Income taxes payable		1,771			854
Deferred revenue		982			739

Total current liabilities		10,649			9,883

Deferred revenue		278			235

Total liabilities		10,927			10,118


Stockholders’ equity:
Preferred stock		—			—
Common stock		16			16
Additional paid-in capital		72,574			71,718
Accumulated other comprehensive income		1,791			936
Treasury stock, 100,000 shares at cost		(100	)		(100	)
Retained earnings		11,372			7,919

Total stockholders’ equity		85,653			80,489

	$	96,580		$	90,607

See accompanying notes to consolidated financial statements.

NEOWARE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

	Three Months Ended December 31,					Six Months Ended December 31,

	2004			2003		2004			2003

Net revenues	$	20,471		$	15,322	$	36,774		$	30,336
Cost of revenues		11,726			7,684		20,938			14,733

Gross profit		8,745			7,638		15,836			15,603


Sales and marketing		3,178			3,377		6,281			6,342
Research and development		769			687		1,433			1,408
General and administrative		1,647			1,478		3,005			2,935

Operating expenses		5,594			5,542		10,719			10,685


Operating income		3,151			2,096		5,117			4,918

Foreign exchange loss		(214	)		—		(237	)		—
Interest income, net		193			94		352			177


Income before income taxes		3,130			2,190		5,232			5,095
Income taxes		1,064			795		1,779			1,836



Net income	$	2,066		$	1,395	$	3,453		$	3,259

Earnings per share:
Basic	$	0.13		$	0.09	$	.22		$	0.21

Diluted	$	0.13		$	0.09	$	.21		$	0.20

Weighted average number of common
shares outstanding:
Basic		15,754			15,743		15,726			15,594

Diluted		16,188			16,285		16,111			16,282

See accompanying notes to consolidated financial statements.

NEOWARE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, except per share data)
(unaudited)

	Six Months Ended December 31,

	2004			2003
Cash flows from operating activities:
Net income	$	3,453		$	3,259
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation		130			136
Amortization of intangibles		647			503
Tax benefit on stock option exercises		121			1,618
Changes in operating assets and liabilities, net of effect from acquisitions:
Accounts receivable		(2,742	)		1,819
Inventories		(3,052	)		33
Prepaid expenses and other		796			(107	)
Accounts payable		(1,359	)		(573	)
Accrued compensation and benefits		258			(353	)
Other accrued expenses		707			(47	)
Income taxes payable		921			(21	)
Deferred revenue		285			186

Net cash provided by operating activities		165			6,453

Cash flows from investing activities:
Purchase of the Visara thin client business		(3,799	)		—
Purchase of the TeemTalk software business		—			(9,995	)
Purchases of short-term investments		(20,233	)		(22,056	)
Sales of short-term investments		42,184			14,414
Purchase of intangible assets		—			(125	)
Purchases of property and equipment		(66	)		(106	)

Net cash provided by (used in) investing activities		18,086			(17,868	)

Cash flows from financing activities:
Repayments of capital leases		(5	)		(3	)
Proceeds from issuance of common stock, net of expenses		—			24,609
Expenses for prior issuance of common stock		—			(3	)
Exercise of stock options and warrants		735			830

Net cash provided by financing activities		730			25,433


Effect of foreign exchange rate changes on cash		186			(28	)


Increase in cash and cash equivalents		19,167			13,990
Cash and cash equivalents, beginning of period		17,119			26,014

Cash and cash equivalents, end of period	$	36,286		$	40,004


Supplemental disclosures:
Cash paid for income taxes	$	46		$	264

See accompanying notes to consolidated financial statements.

NEOWARE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
(unaudited)

Note 1. Basis of Presentation

The accompanying unaudited consolidated financial statements of Neoware Systems, Inc. and Subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements. These statements, while unaudited, reflect all normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the consolidated financial statements. The results for the interim periods presented are not necessarily indicative of the results that may be expected for any future period. Certain information and footnote disclosures included in financial statements have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements. The consolidated financial statements included in this Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended June 30, 2004, filed with the Securities and Exchange Commission on September 13, 2004.

Note 2. Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), “Share-Based Payment”, which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” (SFAS No. 123R) and supercedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values beginning with the first interim or annual period beginning after June 15, 2005. The pro forma disclosures previously permitted under SFAS No. 123 no longer will be an alternative to financial statement recognition. The Company is required to adopt SFAS 123R in the first quarter of fiscal 2006. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. The Company is evaluating the requirements of SFAS 123R and expects that the adoption of SFAS 123R will have a material impact on its financial statements.

In December 2004, the FASB issued FASB Staff Position (FSP) No. FAS 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004.” The American Jobs Creation Act includes a tax deduction of up to 9 percent (when fully phased-in) of the lesser of (a) “qualified production activities income,” as defined in the Act, or (b) taxable income (after the deduction for the utilization of any net operating loss carry forwards). This tax deduction is limited to 50 percent of W-2 wages paid by the taxpayer. Pursuant to FSP No. 109-1, the deduction should be accounted for as a special deduction in accordance with SFAS No. 109 rather than as a tax rate reduction. FSP No. 109-1 is effective upon issuance. The Company is eligible for this deduction beginning in fiscal 2006 and will account for it as a special deduction. The Company has not yet determined the impact that this deduction will have on its effective rate in fiscal 2006.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Asset’s” an amendment of APB Opinion No. 29. SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges beginning in the Company’s first quarter of fiscal 2006. The adoption of SFAS No. 153 will not have any effect on the Company’s financial statements.

In December 2004, the FASB issued FASB Staff Position (FSP) No. FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004.” The American Jobs Creation Act (Job Act) introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FSP No. 109-2 provides accounting and disclosure guidance for the repatriation provision. FSP No. 109-2 is effective immediately and the Job Act was enacted in October 2004. FSP No. 109-2 allows for time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. The Company has not yet completed evaluating the impact of the repatriation provisions. Accordingly, the Company has not adjusted amounts that have been reinvested in foreign jurisdictions under APB No. 23, “Accounting for Income Taxes — Special Areas,” to reflect the repatriation provisions of the Jobs Act.

Note 3. Stock-Based Compensation

The Company applies Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations for stock options and other stock-based awards while disclosing pro forma net income and earnings per share as if the fair value method had been applied in accordance with SFAS No. 123, “Accounting for Stock-based Compensation” and FAAS No. 148 “Accounting for Stock Based Compensation Transition and Disclosure.” Had compensation cost been recognized consistent with SFAS No. 123 and SFAS No. 148, the Company’s consolidated net income and earnings per share would have been as follows (in thousands, except per share data):

	Three Months Ended						Six Months Ended
	December 31,						December 31,

	2004			2003			2004			2003
Net income
As reported	$	2,066		$	1,395		$	3,453		$	3,259
Less:
Total stock-based employee
compensation expense determined
under the fair value based method
for all awards, net of tax		(727	)		(774	)		(1,366	)		(1,435	)

Pro forma	$	1,339		$	621		$	2,087		$	1,824


Basic earnings per share:
As reported	$	0.13		$	0.09		$	0.22		$	0.21

Pro forma	$	0.08		$	0.04		$	0.13		$	0.12

Diluted earnings per share:
As reported	$	0.13		$	0.09		$	0.21		$	0.20

Pro forma	$	0.08		$	0.04		$	0.13		$	0.11

The fair value of the Company’s stock-based awards to employees was estimated at the date of grant using the Black-Scholes option pricing model, assuming an estimated life of five to ten years, no dividends, volatility of 70% - 126%, and risk-free interest rates of 2.1% - 6.8%.

In December 2004 the Company’s stockholders approved the 2004 Equity Incentive Plan (“the 2004 Plan”) and the 1995 Stock Option Plan (“1995 Plan”) and the 2002 Non-Qualified Stock Option Plan (the “2002 Plan”) were terminated as to any shares then available for future grant. The 2004 Plan permits the Company to grant equity-based awards to its directors, executives and a broad-based category of employees. The 2004 Plan provides for the issuance of up to 1,500,000 shares of common stock plus all outstanding options which terminate, expire or are canceled under the existing plans on or after December 1, 2004.

Note 4. Business Combination

On January 27, 2005, the Company acquired all of the outstanding stock of Mangrove Systems SAS (“Mangrove”), a privately held provider of Linux software solutions, for $2.6 million in cash and 153,682 shares of the Company’s common stock valued at $1.3 million plus an earn-out based upon performance. The acquisition will be accounted for using the purchase method of accounting and the results of operations of Mangrove will be included in the Company’s statements of operations from the date of the acquisition.

On January 12, 2005 the Company entered into an Asset Purchase Agreement to acquire the TeleVideo, Inc. (“TeleVideo”); thin client business including all thin client assets, certain contract obligations, a trademark license, product brands, customer lists, customer contracts and non-competition agreements for $5.0 million in cash plus an earn-out based upon performance. The boards of both companies have approved the transaction, and the two majority stockholders of TeleVideo owning approximately 62% of its common stock have executed a written consent approving the transaction. Therefore, no further stockholder action will be required to approve the transaction, and TeleVideo will not hold a stockholders meeting in connection with the transaction. TeleVideo will file an information statement with the Securities and Exchange Commission and, subject to clearance by the SEC, will distribute it to its stockholders. The acquisition is expected to close in March 2005. The acquisition will be accounted for using the purchase method of accounting and results of operations of TeleVideo will be included in the Company's statements of operations from the date of acquisition.

On September 22, 2004, the Company acquired the thin client business of Visara International, Inc. (referred to as the “Visara business”), for $3.8 million in cash, including transaction costs, plus an earn-out based upon performance. The Company acquired substantially all of the assets of the Visara business, including primarily customer lists, intellectual property and technology, and also entered into reseller, supplier and non-competition agreements. The acquisition was accounted for using the purchase method of accounting. The Company has completed the preliminary allocation of the purchase price, based on an independent valuation, as follows: $2.1million to goodwill, $1.0 million to acquired technology and $650,000 to customer relationships. The allocation of the purchase price will be adjusted once the final valuation of assets acquired is completed. The results of operations of the Visara business have been included in the Company’s statements of operations from the date of the acquisition.

The following unaudited pro forma information presents the results of the Company’s operations as though the Visara acquisition had been completed as of July 1, 2003. The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the actual results of operations had the acquisition been completed as of July 1, 2003 or the results that may occur in the future (in thousands, except per share data):

	Six Months Ended December 31,

	2004		2003

Total net revenue	$	38,125	$	34,506
Net income		3,490		3,251
Basic earnings per share		0.22		0.21
Diluted earnings per share		0.22		0.20

Note 5. Goodwill and Intangible Assets

The carrying amount of goodwill was $20.2 million and $17.5 million at December 31, 2004 and June 30, 2004, respectively. The increase in goodwill is due to the acquisition of the Visara business (See Note 4) and the impact of changes in foreign exchange rates.

Intangible assets with finite useful lives are amortized over their respective estimated useful lives. The following table provides a summary of the Company’s intangible assets (in thousands):

		December 31, 2004

	Estimated Useful Life	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount

Tradenames	Indefinite	$	266	$	—	$	266
Customer relationships	2-4 years		1,232		460		772
Distributor relationships	5 years		2,325		1,381		944
Acquired technology	5-10 years		3,368		694		2,674

		$	7,191	$	2,535	$	4,656

		June 30, 2004

	Estimated Useful Life	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount

Tradenames	Indefinite	$	259	$	—	$	259
Customer relationships	2 years		546		273		273
Distributor relationships	5 years		2,325		1,149		1,176
Acquired technology	5-10 years		2,253		416		1,837

		$	5,383	$	1,838	$	3,545

The amortization expense of intangible assets is set forth below (in thousands):

	Three Months Ended				Six Months Ended
	December 31,				December 31,

	2004		2003		2004		2003

Customer relationships	$	123	$	125	$	191	$	125
Distributor relationships		116		110		233		220
Acquired technologies		137		82		223		158

	$	376	$	317	$	647	$	503

Amortization expense for customer relationships and distributor relationships is included in sales and marketing expenses and amortization expense for acquired technologies is included in cost of revenues.

The following table provides estimated future amortization expense related to intangible assets (assuming there is no write down associated with these intangible assets causing an acceleration of expense) (in thousands):

	Future
Year Ending June 30,	Amortization

Remainder of fiscal 2005	$	744
2006		1,111
2007		861
2008		671
2009		677
2010 through 2013		326

	$	4,390

Note 6. Comprehensive Income

Excluding net income, the Company’s sources of other comprehensive income are unrealized income relating to foreign exchange rate fluctuations. The following summarizes the components of comprehensive income (in thousands):

	Three Months Ended				Six Months Ended
	December 31,				December 31,

	2004		2003		2004		2003

Net income	$	2,066	$	1,395	$	3,453	$	3,259
Foreign currency translation adjustment		850		664		855		677

Comprehensive income	$	2,916	$	2,059	$	4,308	$	3,936

Note 7. Revenue Recognition

Net revenues include sales of thin client appliance systems, which include the appliance device and related software, and services. The Company follows AICPA Statement of Position No. 97-2, “Software Revenue Recognition” (“SOP 97-2”) for revenue recognition because the software component of the thin client appliance systems is more than incidental to the thin client appliance systems as a whole. These products and services are sold either separately or as part of a multiple-element arrangement. Revenue is recognized on product sales when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable and collectibility is probable.

Revenue related to post-contract support services is generally recognized with the initial product sale when the fee is included with the initial product fee, post-contract services are for one year or less, the estimated cost of providing such services during the arrangement is insignificant, and unspecified updates 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 related support period.

Revenue from consulting and training services is recognized upon performance.

Stock rotation rights and price protection are provided to certain distributors. Stock rotation rights are generally limited to a maximum amount per quarter and require a corresponding order of equal or greater value at the time of

the stock rotation. Price protection provides for a rebate in the event the Company reduces the price of products which the distributors have yet to sell to end-users. The Company reserves for these arrangements based on historical experience and the level of inventories in the distribution channel and reduces current period revenue accordingly.

Product warranty costs are accrued at the time the related revenues are recognized.

Note 8. Major Customers and Dependence on Suppliers

The following table sets forth sales to customers comprising 10% or more of the Company’s net revenue and accounts receivable balances:

	Three Months Ended		Six Month Ended
	December 31,		December 31,

	2004	2003	2004	2003

Net revenues
IBM	23%	12%	20%	13%
North American distributor	13%	*	11%	*
European distributor	*	10%	*	*

	December 31,

	2004	2003

Accounts receivable
IBM	18%	12%
North American distributor	10%	*
European distributor	14%	10%

(*) Amounts do not exceed 10% for such period

IBM and the Company’s distributors resell the Company’s products to individual resellers and/or end-users. The percentage of revenue derived from IBM, individual distributors, resellers or end-users can vary significantly from quarter to quarter. In addition to the Company’s direct sales to IBM, IBM can purchase the Company’s products through individual distributors and/or resellers. Furthermore, IBM can influence an end-user’s decision to purchase the Company’s products even though the end-user may not purchase the Company’s products through IBM. While it is difficult to quantify the net revenues associated with these purchases, the Company believes that these sales are significant and can vary significantly from quarter to quarter.

For the three months ended December 31, 2004 and 2003 revenues from Europe, the Middle East and Africa, based on the location of the Company’s primary selling activities with its customers accounted for 33% and 39%, respectively, of net revenues. Sales to the United Kingdom accounted for 11% of net revenue for the three months ended December 31, 2004 and 2003. For the six months ended December 31, 2004 and 2003 revenues from Europe, the Middle East and Africa, based on the location of the Company’s primary selling activities with its customers accounted for 32% and 38%, respectively of net revenues. Sales to the United Kingdom accounted for 14% of net revenue for the six months ended December 31, 2004. No single international region accounted for more than 10% of net revenue for the six months ended December 31, 2003.

The Company depends upon a limited number of sole source suppliers for its thin client appliance products and for several of the components in them. One of the Company’s suppliers who supplies a substantial portion of the Company’s thin client products has informed the Company that it is experiencing cash liquidity constraints and is evaluating and undertaking financial restructuring actions. As a result, the Company has agreed to accommodate the supplier by purchasing products for inventory in advance of our contractual obligations and the Company anticipates continuing this practice until such time as the supplier’s cash liquidity situation is resolved. Accordingly, inventory levels at December 31, 2004 increased and may continue to increase and the Company’s cash balances may decrease, although the Company’s management does not believe that such changes have had or will have a material adverse impact on its financial condition. In the event that the supplier is unable to resolve its cash liquidity constraints, the Company could face an interruption in the supply of a substantial portion of its products. Although the Company has identified alternative suppliers that could produce comparable products, it is likely there would be an interruption of supply during any transition, which would limit the Company’s ability to ship product to fully meet customer demand. If this were to happen, the Company’s revenue would decline and its profitability would be adversely impacted.

The Company also depends on limited sources to supply several other industry standard components and relies on certain foreign suppliers, which also subject the Company to risks associated with foreign operations such as the imposition of unfavorable governmental controls or other trade restrictions, changes in tariffs, political instability and currency fluctuations. A weakening dollar could result in greater costs to the Company for its components.

Note 9. Inventories

Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out method and consists of the following (in thousands):

	December 30, 2004		June 30, 2004

Purchased components and subassemblies	$	295	$	234
Finished goods		3,552		561

	$	3,847	$	795

Note 10. Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” Under the asset-and-liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Note 11. Short-term Borrowings

In December 2004, the Company entered into an Offering Basis Loan Agreement with a bank under which the Company can request short-term loan advances up to an aggregate principal amount of $10.0 million. Upon such request, the bank would provide the Company with the interest rate, terms and conditions applicable to the requested loan advance. The funds would be committed upon agreement of such terms by both parties. Unless otherwise agreed to by the bank, the term for any advance cannot exceed 180 days. There were no borrowings under the Offering Basis Loan Agreement during the three months ended December 31, 2004.

Prior to entering into the Offering Basis Loan Agreement the Company had a line of credit agreement with a bank, which provided for borrowings up to $2.0 million subject to certain limitations, as defined. The line of credit matured on December 31, 2004. During the six months ended December 31, 2004 and 2003, there were no borrowings under the line.

Note 12. Earnings per Share

The Company applies SFAS No. 128, “Earnings per Share,” which requires dual presentation of basic and diluted earnings per share (“EPS”) for complex capital structures on the face of the statement of operations. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from the exercise or conversion of securities into common stock, such as stock options and warrants. The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):

	Three Months Ended				Six Months Ended
	December 31,				December 31,

	2004		2003		2004			2003

Net income	$	2,066	$	1,395	$	3,453	$	3,259


Weighted average shares outstanding:
Basic		15,754		15,743		15,726		15,594
Effect of dilutive employee stock options		434		529		385		673
Effect of dilutive warrants		—		13		—		15

Diluted		16,188		16,285		16,111		16,282