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
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
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.
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.
. 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.
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.
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
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.
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.
ITEM 3. LEGAL PROCEEDINGS.
There are no material legal proceedings pending against the Company.
ITEM 4.
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.
PART II
ITEM 5.
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.
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.
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.
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
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 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
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
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.
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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements of the Company are filed under this Item 8, beginning on page of this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None. PART III
ITEM 10.
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:
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.
ITEM 11.
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.
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.
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.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
Financial Statements - --------------------
See Index to Financial Statements at page.
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.
- ------------------ * Filed herewith. + Management contract or arrangement.
(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.
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.
-----------------------------
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 ---------------------------
The accompanying notes are an integral part of these financial statements.
NEOWARE SYSTEMS, INC. ---------------------
CONSOLIDATED STATEMENTS OF OPERATIONS -------------------------------------
The accompanying notes are an integral part of these financial statements.
NEOWARE SYSTEMS, INC. --------------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY -----------------------------------------------
The accompanying notes are an integral part of these financial statements.
NEOWARE SYSTEMS, INC. ---------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS -------------------------------------
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:
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:
Property and equipment consisted of the following:
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:
The federal statutory income tax rate is reconciled to the effective tax rate as follows:
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:
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:
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:
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.