<PAGE>
 
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            _______________________

                                   FORM 10-Q
                            _______________________

(Mark One)

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

For the Quarter ended March 31, 1998

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

For the transition period from _______ to ________.


                      Commission File Number:  000-21240
                      __________________________________

                             NEOWARE SYSTEMS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

        DELAWARE                                     23-2705700
(STATE OR OTHER JURISDICTION OF            (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)

                               400 FEHELEY DRIVE
                      KING OF PRUSSIA, PENNSYLVANIA 19406
                    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

                                 (610) 277-8300
              (REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE)
                       _________________________________

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.

                                 Yes  X   No 
                                     ---     ---          

As of May 14, 1998, there were outstanding 5,767,932 shares of the Registrant's
Common Stock.
 
                                                         Page 1 of 13 pages
                                                     Exhibit Index is on page 12
<PAGE>
 
                                 NEOWARE SYSTEMS, INC.
                                 ---------------------

                                 INDEX
                                 -----

                                                               Page
                                                              Number
                                                              ------

PART I.  FINANCIAL INFORMATION

Item 1.  Unaudited Consolidated Financial Statements
 
            Consolidated Balance Sheets:
            March 31, 1998 and June 30, 1997                      3
 
            Consolidated Statements of Operations:
            Three and Nine Months Ended March 31, 1998 and 1997   4
 
            Consolidated Statements of Cash Flows:
            Nine Months Ended March 31, 1998 and 1997             5
 
            Notes to Consolidated Financial Statements            6
 
Item 2.  Management's Discussion and Analysis of Financial
            Condition and Results of Operations                   8
 
PART II.    OTHER INFORMATION
 
Item 1.  Legal proceedings                                       12
 
Item 6.  Exhibits and Reports on Form 8-K                        12
 
            Signatures                                           13
<PAGE>
 
                             NEOWARE SYSTEMS, INC.
                             ---------------------

                          CONSOLIDATED BALANCE SHEETS
                          ---------------------------

                                  (UNAUDITED)
<TABLE>
<CAPTION>
                                                                 MARCH 31,             JUNE 30,
                         ASSETS                                    1998                  1997
                         ------                           ---------------------  -------------------
<S>                                                       <C>                    <C>
CURRENT ASSETS:
 Cash and cash equivalents                                          $   119,187          $ 1,452,409
 Accounts receivable, net of allowance for doubtful
  accounts of $130,086 and $124,086                                   5,821,364            9,308,731
 
 Inventories                                                          4,221,208            4,035,202
 Prepaid expenses and other                                           1,133,297              789,179
 Deferred income taxes                                                  416,530              416,530
                                                                    -----------          -----------
         Total current assets                                        11,711,586           16,002,051

Property and equipment, net                                             667,509              680,859
Note receivable                                                         700,000                    -
Capitalized and purchased software, net                               1,485,331            1,630,339
Deferred income taxes                                                    13,866               13,866
                                                                    -----------          -----------
                                                                    $14,578,292          $18,327,115
                                                                    ===========          ===========
          LIABILITIES AND STOCKHOLDERS' EQUITY
          ------------------------------------
CURRENT LIABILITIES:
 Line of credit                                                     $ 2,270,000          $ 3,071,000
 Accounts payable                                                     2,932,366            3,796,549
 Accrued expenses                                                       469,402              516,148
 Deferred revenue                                                       170,219              172,006
                                                                    -----------          -----------
         Total current liabilities                                    5,841,987            7,555,703
                                                                    -----------          -----------
Commitments and Contingencies

STOCKHOLDERS' EQUITY:
 Preferred stock, $.001 par value, 1,000,000 shares
  authorized and none issued and outstanding                                 --                   --
 Common stock, $.001 par value, 50,000,000 shares
 authorized, 5,767,932 and 5,760,820 shares issued and
  outstanding                                                             5,768                5,761
 Additional paid-in capital                                           9,180,664            9,168,171
 Retained (deficit) earnings                                           (419,733)           1,666,951
 Deferred compensation                                                  (30,394)             (69,471)
                                                                    -----------          -----------
         Total stockholders' equity                                   8,736,305           10,771,412
                                                                    -----------          -----------
                                                                    $14,578,292          $18,327,115
                                                                    ===========          ===========
</TABLE> 

   The accompanying notes are an integral part of these financial statements.
<PAGE>
 
                             NEOWARE SYSTEMS, INC.
                             ---------------------

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     -------------------------------------

                                  (Unaudited)
                                        
<TABLE>
<CAPTION>

                                             Three Months Ended                  Nine Months Ended
                                                  March 31,                          March 31,
                                      --------------------------------   --------------------------------
                                            1998             1997              1998             1997
                                      ----------------  ---------------  ----------------  ---------------
<S>                                   <C>               <C>              <C>               <C>
Net revenues                              $ 3,700,832        $6,092,369      $16,312,324       $18,472,791
Cost of revenues                            2,886,364         3,845,093       12,102,132        12,332,528
                                          -----------        ----------      -----------       -----------
        Gross profit                          814,468         2,247,276        4,210,192         6,140,263
                                          -----------        ----------      -----------       -----------
Operating expenses:
 
  Sales and marketing                       1,325,783           993,660        3,838,795         2,776,150
  General and administrative                  796,588           438,496        1,686,348         1,231,247
  Research and development                    384,995           404,712        1,268,857           967,824
  Write-off  of investment in
   subsidiary                                 159,231                 -          159,231                 -
                                          -----------        ----------      -----------       -----------
        Total operating expenses            2,666,597         1,836,868        6,953,231         4,975,221
                                          -----------        ----------      -----------       -----------
        Operating (loss) income            (1,852,129)          410,408       (2,743,039)        1,165,042
Interest (expense) income, net               (127,955)           25,687         (303,215)          101,543
                                          -----------        ----------      -----------       -----------
        (Loss) income before taxes         (1,980,084)          436,095       (3,046,254)        1,266,585
Income tax (benefit) expense                 (626,666)          155,062         (959,570)          429,286
                                          -----------        ----------      -----------       -----------
Net (loss) income                         $(1,353,418)       $  281,033      $(2,086,684)      $   837,299
                                          ===========        ==========      ===========       ===========
Basic earnings per share                        $(.23)             $.05            $(.36)             $.15
                                          ===========        ==========      ===========       ===========
Diluted earnings per share                      $(.23)             $.04            $(.36)             $.11
                                          ===========        ==========      ===========       ===========
Weighted average number of shares
 outstanding in basic earnings per
 share computation                          5,767,932         5,741,587        5,763,191         5,741,587
                                          ===========        ==========      ===========       ===========
 
Weighted average number of shares
 outstanding in diluted earnings  
 per share computation                      5,767,932         7,442,035        5,763,191         7,560,935
                                          ===========        ==========      ===========       ===========
 
</TABLE>

   The accompanying notes are an integral part of these financial statements.
<PAGE>
 
                             NEOWARE SYSTEMS, INC.
                             ---------------------

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                     -------------------------------------

<TABLE>
<CAPTION>
(Unaudited)
                                                                      Nine Months  Ended
                                                                          March 31,
                                                              ---------------------------------
                                                                    1998              1997
                                                              ----------------  ----------------
<S>                                                           <C>               <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net (loss) income                                                $(2,086,684)      $   837,299
 Adjustments to reconcile net (loss) income to net cash
 provided by (used in) operating activities-
   Depreciation and amortization                                      636,536           169,136
   Amortization of deferred compensation                               39,077            39,078
   Tax benefit from carrying back net operating loss                 (959,570)                -
   Write-off of investment in subsidiary                              159,231                 -
 Changes in operating assets and liabilities-
  (Increase) decrease in:
   Accounts receivable                                              3,487,367        (1,602,525)
   Inventories                                                       (186,006)       (1,672,866)
   Prepaid expenses and other                                         615,452          (894,572)
  Increase (decrease) in:
   Accounts payable                                                  (864,183)        1,709,525
   Accrued expenses                                                   (46,746)           30,844
   Deferred revenue                                                    (1,787)           50,655
                                                                  -----------       -----------
      Net cash (used in)
        provided by operating activities                              792,687        (1,333,426)
                                                                  -----------       ----------- 
CASH FLOWS FROM INVESTING ACTIVITIES:
 Purchases of property and equipment                                 (192,643)         (234,508)
 Capitalized software                                                (444,766)          (85,219)
                                                                  -----------       -----------
      Net cash used in investing activities                          (637,409)         (319,727)
                                                                  -----------       -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
 Borrowings under line of credit                                     (801,000)                -
 Increase in note receivable                                         (700,000)                -
 Exercise of stock options                                             12,500           727,674
 Principal payments on long-term debt                                       -            (7,965)
                                                                  -----------       -----------
      Net cash (used in) provided by financing activities          (1,488,500)          719,709
                                                                  -----------       -----------
 
Decrease in cash and cash equivalents                              (1,333,222)         (933,444)
Cash and cash equivalents, beginning of period                      1,452,409         2,700,298
                                                                  -----------       -----------
Cash and cash equivalents, end of period                          $   119,187       $ 1,766,854
                                                                  ===========       ===========
SUPPLEMENTAL DISCLOSURES:
   Cash paid for income taxes                                     $    50,719       $    27,213
   Cash paid for interest                                         $   261,270       $     3,556
</TABLE>
   The accompanying notes are an integral part of these financial statements.
<PAGE>
 
                             NEOWARE SYSTEMS, INC.
                             ---------------------


              NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
              ----------------------------------------------------



1. BASIS OF PRESENTATION:
   ----------------------

The accompanying unaudited consolidated financial statements of Neoware Systems,
Inc. and Subsidiaries (the "Company") have been prepared in conformity with
generally accepted accounting principles.  The interim financial information,
while unaudited, reflects all normal recurring adjustments which are, in the
opinion of management, necessary to present a fair statement of financial
position and operating results for the interim periods presented.  The results
of operations for the three and nine month periods ended March 31, 1998 are not
necessarily indicative of the results expected for the full year.  These
financial statements should be read in conjunction with the audited financial
statements and notes thereto included in the Company's Annual Report on Form 10-
K filed with the Securities and Exchange Commission.


2. MAJOR CUSTOMERS :
   -----------------

Net revenues from one customer represented 19% of total net revenues for the
three month period ended March 31, 1998 and two customers represented 17% each
of net revenues for the nine month period then ended. Net revenues from one
customer represented 52% of total net revenues for the three month period ended
March 31, 1997 and two customers represented 25 % and 11% of net revenues for
the nine month period then ended. At March 31, 1998, the Company had receivables
from two of its major customers totaling approximately $2,777,000.


3. INVENTORIES:
   ------------

Inventories are stated at the lower of cost or market (first-in, first-out
method) and consisted of the following:
<TABLE>
<CAPTION>
                                                                 March 31,        June 30,
                                                                   1998             1997
                                                             ----------------  --------------
 
<S>                                                          <C>               <C>
Purchased components and subassemblies                             $2,114,352      $1,566,161
Work-in-process                                                       387,985         301,565
Finished goods                                                      1,718,871       2,167,476
                                                                   ----------      ----------
                                                                   $4,221,208      $4,035,202
                                                                   ==========      ==========
</TABLE>
<PAGE>
 
4.   NOTE RECEIVABLE:
     ----------------

In October 1997, the Company merged Information Technology Consulting, Inc., a
wholly-owned subsidiary, into The Reohr Group, Inc. ("Reohr") in exchange for a
2% stock interest in Reohr and the reimbursement of $1 million of expenses
incurred by the Company in connection with its efforts to make certain
acquisitions in the information technology consulting and staffing field.  Of
the total reimbursement, $300,000 was paid in cash and the remaining $700,000
under a note which is due on the earlier of three years or upon the completion
of the initial public offering of Reohr.  The note bears interest at 8% per
annum.  Of the total reimbursement, $292,000 was offset against general and
administrative expenses during the three months ended September 30, 1997 for
costs previously incurred and charged to expense.

5. LINE OF CREDIT:
   ---------------

The Company has a $5,000,000 revolving line of credit ($2,730,000 available at
March 31, 1998) with a bank which expires on November 30, 1998. Borrowings under
the line are at the bank's prime rate. Under the line, the Company is required
to maintain specified ratios of working capital and debt to net worth, as
defined.


6.   EARNINGS PER SHARE
     ------------------


Effective December 31, 1997 the Company adopted SFAS No. 128, "Earnings per
Share", which supersedes APB Opinion No. 15, "Earnings per Share".  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 (loss) 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.  For the three and nine month periods ended March 31, 1997, the
weighted average number of shares outstanding for purposes of calculating
diluted earnings per share included 1,700,448 and 1,819,348 shares,
respectively, attributable to stock options and warrants.   For the three and
nine month periods ended March 31, 1998, there were no dilutive effects of stock
options or warrants as the Company incurred a net loss.  Options and warrants to
purchase 7,794,956 shares of Common Stock at prices ranging from $1.76 to $8.75
per share were outstanding at March 31, 1998. In accordance with the provisions
of SFAS 128, EPS for prior periods have been restated.
<PAGE>
 
ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                              RESULTS OF OPERATIONS.

INTRODUCTION

  The Company provides thin client computers and related software that are
designed to integrate and deliver information to the desktop cost effectively in
network-centric environments.  The Company's @workStation and NeoStation thin
client computers combine a variety of windowed-display, graphical user interface
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 Netscape Navigator/TM/,
Citrix's ICA/TM/  and Sun Microsystems, Inc.'s Java/TM/ technology 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 current strategy is to become a leader in the emerging market
for thin client computers by focusing on expanding its software products and its
thin client computer hardware.  The Company also plans to continue to develop
strategic partnerships and 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 distributors,
resellers, system integrators and OEMs.  International sales are generally made
through distributors.

  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 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 October 1997, the Company merged ITC with Reohr and Global.  Under the
merger, ITC and Global merged into Reohr, and Neoware received stock that
represents a 2% ownership of Reohr.   The Company was also reimbursed for the
expenses incurred by the Company and ITC in connection with ITC's efforts to
make these acquisitions, $300,000 of which was paid in cash.  The remainder of
the expenses were reimbursed by a $700,000 note from Reohr that is repayable on
the earlier of three years or the consummation of an initial public offering of
Reohr.  The note bears interest at 8% per annum.

     In February 1997, the Company formed  a new subsidiary, Bridging Data
Technology, Inc. ("BDT").  BDT has acquired and further developed a software
product, SmartBridge, 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. Effective March 31, 1998, the Company wrote off the full
amount of its investment in Bridging Data Technology, Inc.  This write-off
reflects the Company's evaluation that recovery, if any, of its investment in 
BDT will not occur in the near future. Future cash advances to or distributions
from BDT, if any, will be recorded as expense or income in the period during
which the transaction occurs.

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.
<PAGE>
 
<TABLE>
<CAPTION>
                                                    Three Months Ended    Nine Months Ended
                                                        March 31,             March 31,
                                                   --------------------   ------------------
                                                    1998         1997        1998      1997
                                                   ------       ------      ------    ------
<S>                                               <C>           <C>       <C>         <C>
Gross profit                                        22.0%        36.9%       25.8%     33.2%
Operating expenses:                                                                
   Sales and marketing                              35.8         16.3        23.5      15.0
   General and administrative                       21.5          7.3        10.3       6.7
   Research and development                         10.4          6.6         7.8       5.2
   Write-off of investment in subsidiary             4.3            -         1.0         -
                                                   -----        -----       -----     -----
Operating (loss) income                            (50.0)         6.7       (16.8)      6.3
    Interest (expense) income, net                  (3.5)         0.4        (1.9)      0.6
                                                   -----        -----       -----     -----
(Loss) income before taxes                         (53.5)         7.1       (18.7)      6.9
    Income tax (benefit) expense                   (16.9)         2.5        (5.9)      2.4
                                                   -----        -----       -----     -----
                                                                                   
Net (loss) income                                  (36.6)%        4.6%      (12.8)%     4.5%
                                                   =====        =====       =====     =====
 
</TABLE>

  Net revenues for the three month  period ended March 31, 1998 decreased to
$3,700,832 from $6,092,369 for the comparable period in the prior fiscal year.
For the nine month period ended March 31, 1998, net revenues decreased to
$16,312,324, a decrease of 12% from $18,472,791 for the comparable period in the
prior fiscal year. The decrease in net revenues for the three and nine month
periods ended March 31, 1998 versus the comparable periods in the prior year was
attributable to the completion of the Company's transition from its older X-
terminal product line and the delay in the full scale implementation of thin
client computers by corporate customers as they await the deployment of Windows
Terminal Server from Microsoft. Sales to two of the Company's major customers
declined significantly during the quarter ended March 31, 1998, as a result of
completing delivery of product under existing purchase orders, and are expected
to remain at this level for the foreseeable future. The three and nine month
periods ended March 31, 1997 benefited from significant revenues from two of the
Company's major customers and revenues earned from licensing agreements for its
netOS software for thin client computers. The Company is subject to significant
variances in its quarterly 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 decreased to 22.0%
for the three month period ended March 31, 1998 from 36.9% for the comparable
period in the prior year. The  gross profit as a percentage of net revenues
decreased to 25.8% for the nine month period ended March 31, 1998 from 33.2% for
the comparable period in the prior fiscal year. The decline in gross profit
percentage for the three and nine month periods ended March 31, 1998 was
primarily the result of the Company's fixed manufacturing overhead which
increased product costs due to the reduced production volumes, and increased
competitive pressures, which resulted in selling price reductions without
corresponding cost reductions. The reduced gross profit was also attributable to
substantially less revenue from software licensing as well as an increase in the
percentage of sales through third party sales channels and reduced sales to two
of its major customers during the three months ended March 31, 1998. The Company
anticipates that the gross profit percentage will vary from quarter to quarter
depending on the mix of business, including the mix of hardware and software
revenues. 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 assurance 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 three and nine month periods ended March 31, 1998
were $2,666,597 and $6,953,231, respectively, versus $1,836,868 and $4,975,221
for the comparable periods in the prior fiscal year.  Research and development
expenses for the three month period ended March 31, 1998 
<PAGE>
 
decreased to $384,995 versus $404,712 for the comparable period in the prior
year as a result of a decline in depreciation expense allocated to research and
development during fiscal 1998. Research and development expenses for the nine
month period ended March 31, 1998 increased to $1,268,857 versus $967,824 for
the comparable period in the prior year which reflects the Company's commitment
to developing, adapting or acquiring technologies that will expand the market
for its current and future products. Sales and marketing expenses increased to
$1,325,783 and $3,838,795 for the three and nine month periods ended March 31,
1998 as compared to $993,660 and $2,776,150 for the comparable periods in the
prior year. The increase reflects the cost of additions to the Company's sales
and technical staff as the Company completed the transition from focusing on
internal telesales to utilizing a senior external sales force. Management
believes the external sales force will allow the Company to better support a two
tier distribution channel. The 1998 periods were also impacted by costs related
to BDT and a reduction in advertising expense. General and administrative
expenses increased to $796,588 and $1,686,348 for the three and nine month
periods ended March 31, 1998 versus $438,496 and $1,231,247 in the comparable
periods in the prior year, primarily as a result of the addition of the
Company's Chief Executive Officer and MIS staff, expenses related to BDT, and
increased franchise taxes and depreciation expense which were partially offset
by the reimbursement of expenses related to ITC.

  Net interest expense for the three and nine month periods ended March 31, 1998
was $127,955 and $303,215, respectively, versus net interest income of  $25,687
and $101,543 for the comparable periods in the prior year.  The increased
interest cost is attributable to increased line of credit borrowings required to
finance higher inventory and accounts receivable balances.

  The effective income tax rates were approximately 31.5% and 33.0% during
fiscal 1998 and 1997, respectively.

  For the three and nine month periods ended March 31, 1998, the Company
incurred net losses of $1,353,418 and $2,086,684, respectively, as compared
to net income of $281,033 and $837,299 for the comparable periods in the prior
fiscal year. The decrease in net income for the three month period ended March
31, 1998 was attributable to lower net revenues, reduced gross profit margins
and increased operating expenses, including approximately $269,000 of net
expenses related to the Company's investment in BDT, which includes $159,000 for
the write-off the remaining investment. The decline in net income for the nine
month period ended March 31, 1998 versus the comparable period in the prior
fiscal year was attributable to the Company's continued investment in both sales
and technical staff and research and development expenses. In addition, the
Company incurred net expenses of approximately $716,000 related to its
investment in BDT which were partially offset by the reimbursement for net
expenses of approximately $292,000 previously incurred in connection with its
investment in ITC. The decline in net income was also impacted by the increase
in net interest expense which was offset by recognition of the income tax
benefit from carrying back the net operating loss to recover taxes paid in prior
years.

LIQUIDITY AND CAPITAL RESOURCES

  At March 31, 1998, the Company had net working capital of approximately
$5,870,000 composed primarily of accounts receivable and inventory.  The
Company's principal source of liquidity is a $5,000,000 bank line of credit
facility, $2,730,000 of which was available as of March 31, 1998.  The bank line
of credit expires on November 30, 1998.

  Cash and cash equivalents decreased by approximately $1,333,000 during the
nine month period ended March 31, 1998, primarily as a result of the operating
loss, acquisition costs incurred in connection with the formation of the
Company's subsidiary, ITC, for which the Company was reimbursed $300,000 in cash
and a $700,000 note receivable, purchases of equipment, investment in purchased
and capitalized software, repayments under the line of credit and a decrease in
accounts payable and accrued expenses, which were partially offset by a decrease
in accounts receivable.

  The Company generated approximately $793,000 in cash from operating activities
in the nine month period ended March 31, 1998 compared to using cash in
operations of approximately $1,333,000 
<PAGE>
 
during the comparable period of fiscal 1997. The collection of significant
accounts receivable from two of the Company's major customers resulted in the
positive cashflow from operations during the nine months ended March 31, 1998.

  The Company expects to fund current operations and other cash expenditures
through the use of available cash, cash from operations, funds available under
its credit facility, possible new sources of debt financing, and the sale of its
securities. However, ultimately, the Company must achieve profitable operations
in order to provide adequate funding for the longterm.

YEAR 2000 COMPLIANCE

  The Company's management information systems primarily use software products
purchased from commercial sources with minor customization.  Updates to these
products are routinely installed by the Company to upgrade the systems and
correct known defaults in the software.  All major systems have been reviewed
for Year 2000 issues and, where necessary, upgraded software has been identified
and implementation schedules are in process.  There have been no significant
incremental costs identified with updates that specifically address Year 2000
compliance.  The Company is also reviewing its products and services for
compliance with Year 2000 requirements.  Based on a preliminary review, the
Company's products were determined to be Year 2000 compliant.  Notwithstanding
the Year 2000 compliance of the Company's systems and products, there can be no
assurance that the Company will not be adversely affected by the failure of
distributors, suppliers, customers and vendors with which it interacts to become
Year 2000 compliant.


FORWARD-LOOKING STATEMENTS

  The foregoing "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. These statements are
subject to certain risks and uncertainties that could cause actual results to
differ materially from those anticipated, including but not limited to,
quarterly fluctuations in operating results, general economic conditions
affecting the demand for computer products, customer acceptance of the Company's
line of thin client computers and related software, the successful
implementation of the Company's two tier distribution channel, pricing
pressures, the growth of the thin client marketplace, the timing of significant
orders, increased competition, development, introduction, delivery and customer
acceptance of new products and delays in the receipt of key components.  The
Company does not undertake to update any forward-looking statements made herein.



PART II.  OTHER INFORMATION


ITEM 1. LEGAL PROCEEDINGS

  On March 11, 1998 a complaint encaptioned Cerrato, Inc. et al. v. Neoware 
Systems, Inc. et al., 98 Civ. 1748 (JSM) was filed in the United States District
Court for the Southern District of New York, naming as defendants the Company,
its Chairman, and its former CFO. The Complaint asserts claims under (SS) 10(b) 
of the Securities and Exchange Act of 1934, Rule 10(b)-5 promulgated thereunder,
and common law. The complaint, which was filed as a purported class action on 
behalf of purchasers of the Company's common stock during the period from June 
15, 1996 through August 15, 1997, alleges, inter alia, that the defendants made 
misrepresentations related to plans for various acquisitions by a subsidiary of 
the company and a spinoff. A First Amended Complaint ("FAC") was filed on or 
about May 1, 1998. The FAC adds claims on behalf of a second purported class -- 
purchasers of the Company's stock from November 13, 1997 through May 1, 1998 -- 
related to the Company's announcement, on April 30, 1998, that it would be 
restating certain financial results previously reported for the first two 
quarters of fiscal 1998. Defendant's time to respond to the FAC has not yet 
expired.
<PAGE>
 
  On May 5, 1998, a complaint was filed in the Court of Common Pleas of
Montgomery County against the Company by Development Concepts, Inc.  The
complaint asserts claims for common law breach of contract, fraud,
misrepresentation, breach of warranty and violations of the federal Lanham Act
arising primarily from the parties' contractual relationships.  The complaint
seeks an indeterminate amount of monetary damages in excess of $1,500,000.  The
Company disputes the validity of these claims and intends to defend the claims
vigorously.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

  (a)  Exhibits:

       None

  (b)  Reports on Form 8-K:

       None
<PAGE>
 
                                 SIGNATURES

  Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunder duly authorized.


                             NEOWARE SYSTEMS, INC.



Date:  May 15, 1998          By: /S/ EDWARD C. CALLAHAN, JR.
                                 -----------------------------
                             Edward C. Callahan, Jr., President and Chief
                             Executive Officer



Date:  May 15, 1998          By: /S/ EDWARD T. LACK, JR.
                                 -----------------------
                             Edward T. Lack, Jr., Chief Financial Officer 
                             (Principal Accounting Officer and
                             Principal Financial Officer)