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UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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Form 10-Q

(Mark One)

| | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934         
| | ------------------------------------------------------------------------------------------------
| |                                                                                                 
| | For the Quarter ended September
    30, 2005                                                    
| |                                                                                                 
| | 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 EmployerIdentification
    No.)
|incorporation or organization)                          |  |                                     
|                                                        |  |                                     
|400 Feheley Drive                                      
|King of Prussia,
    Pennsylvania 19406                
|(Address of principal
    executive offices)           
|                                                       
|(610) 277-8300                                         
|(Registrant's telephone
    number including area code)
|                                                       

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

|Yes: |  | No:
|---- |  | ---

Indicate by check mark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act).

|Yes: |  | No:
|---- |  | ---

Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act).

|Yes: |  | No:
|---- |  | ---

As of November 3, 2005, there were 16,305,679
outstanding shares of the Registrant's Common Stock.

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NEOWARE SYSTEMS, INC.INDEX

|                              | PAGE                                                                                                     
|----------------------------- | ---------------------------------------------------------------------------------------------------------
|                              |                                                                                                          
|PART I. FINANCIAL INFORMATION |                                                                                                          
|Item 1.                       | Consolidated Financial Statements (unaudited)                                                            
|                              |                                                                                                          
|                              | Condensed Consolidated Balance Sheets as of September 30, 2005 and June 30, 2005                         
|                              |                                                                                                          
|                              | Consolidated
	        Statements of Operations for the Three Months Ended September
    30, 2005 and 2004
|                              |                                                                                                          
|                              | Consolidated
	        Statements of Cash Flows for the Three Months Ended September 30, 2005 and 2004    
|                              |                                                                                                          
|                              | Notes to Consolidated Financial Statements                                                               
|                              |                                                                                                          
|Item 2.                       | Management's
	        Discussion and Analysis of Financial Condition
and Results of Operations.          
|                              |                                                                                                          
|Item 3.                       | Quantitative and Qualitative Disclosures About Market
Risk                                               
|                              |                                                                                                          
|Item 4.                       | Controls and Procedures                                                                                  
|PART II.OTHER
INFORMATION     |                                                                                                          
|Item 6.                       | Exhibits                                                                                                 
|                              |                                                                                                          
|Signatures                    | 34                                                                                                       

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NEOWARE SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS(in thousands) 
(Unaudited)

|                            | September 30,                                      |                                               | June 30, |        
|--------------------------- | -------------------------------------------------- | --------------------------------------------- | -------- | -------
|                            | 2005                                               |                                               | 2005     |        
|                            |                                                    |                                               |          |        
|                            |                                                    | ASSETS                                        |          |        
|Current assets:             |                                                    |                                               |          |        
|                            | Cash and
    cash equivalents                      | $                                             | 12,550   |        
|                            | Short-term
    investments                         |                                               | 31,524   |        
|                            | Accounts
    receivable, net                       |                                               | 17,565   |        
|                            | Inventories                                        |                                               | 3,638    |        
|                            | Prepaid expenses and
	      other                  |                                               | 2,021    |        
|                            | Deferred income taxes                              |                                               | 1,015    |        
|                            |                                                    |                                               |          |        
|                            |                                                    | Total
	    current assets                     |          | 68,313 
|                            |                                                    |                                               |          |        
|Property and equipment, net |                                                    | 497                                           |          |        
|Goodwill                    |                                                    | 33,087                                        |          |        
|Intangibles, net            |                                                    | 8,767                                         |          |        
|                            |                                                    |                                               |          |        
|                            |                                                    |                                               | $        | 110,664
|                            |                                                    |                                               |          |        
|                            |                                                    | LIABILITIES
	        AND STOCKHOLDERS EQUITY |          |        
|Current liabilities:        |                                                    |                                               |          |        
|                            | Accounts payable                                   | $                                             | 8,234    |        
|                            | Accrued compensation and benefits                  |                                               | 1,065    |        
|                            | Other accrued expenses                             |                                               | 5,355    |        
|                            | Income taxes payable                               |                                               | 991      |        
|                            | Deferred revenue                                   |                                               | 762      |        
|                            |                                                    |                                               |          |        
|                            |                                                    | Total current liabilities                     |          | 16,407 
|                            |                                                    |                                               |          |        
|Deferred income taxes       |                                                    | 1,151                                         |          |        
|Deferred revenue            |                                                    | 280                                           |          |        
|                            |                                                    |                                               |          |        
|                            |                                                    | Total liabilities                             |          | 17,838 
|                            |                                                    |                                               |          |        
|Stockholders equity:       |                                                    |                                               |          |        
|                            | Preferred stock                                    |                                               | —        |        
|                            | Common stock                                       |                                               | 16       |        
|                            | Additional paid-in capital                         |                                               | 75,904   |        
|                            | Treasury stock, 100,000
    shares at cost         |                                               | (100     | )      
|                            | Accumulated other comprehensive
	    income (loss) |                                               | (193     | )      
|                            | Retained earnings                                  |                                               | 17,199   |        
|                            |                                                    |                                               |          |        
|                            |                                                    | Total
	      stockholders equity             |          | 92,826 
|                            |                                                    |                                               |          |        
|                            |                                                    |                                               | $        | 110,664
|                            |                                                    |                                               |          |        

See accompanying notes to consolidated financial statements.

3

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NEOWARE SYSTEMS, INC.

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

|                                                      | Three Months Ended |                                
|----------------------------------------------------- | ------------------ | -------------------------------
|                                                      | September 30,      |                                
|                                                      |                    |                                
|                                                      | 2005               |                                
|                                                      |                    |                                
|Net revenues                                          | $                  | 26,543                         
|Cost of revenues                                      |                    | 15,842                         
|                                                      |                    |                                
|                                                      |                    | Gross
	    profit              
|                                                      |                    |                                
|                                                      |                    |                                
|Sales and marketing                                   |                    | 4,473                          
|Research and development                              |                    | 1,295                          
|General and administrative                            |                    | 2,298                          
|                                                      |                    |                                
|                                                      |                    | Operating
	    expenses        
|                                                      |                    |                                
|                                                      |                    |                                
|                                                      |                    | Operating
	    income          
|                                                      |                    |                                
|Foreign exchange gain (loss)                          |                    | 9                              
|Interest income, net                                  |                    | 244                            
|                                                      |                    |                                
|                                                      |                    | Income
	    before income taxes
|Income taxes                                          |                    | 1,047                          
|                                                      |                    |                                
|Net income                                            | $                  | 1,841                          
|                                                      |                    |                                
|Earnings per share:                                   |                    |                                
|                                                      |                    | Basic                          
|                                                      |                    |                                
|                                                      |                    | Diluted                        
|                                                      |                    |                                
|                                                      |                    |                                
|Weighted average number of common shares outstanding: |                    |                                
|                                                      |                    | Basic                          
|                                                      |                    |                                
|                                                      |                    | Diluted                        
|                                                      |                    |                                

See accompanying notes to consolidated financial statements.

4

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NEOWARE SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)(Unaudited)

|                                                 |                                                                | Three Months Ended                  |                                      
|------------------------------------------------ | -------------------------------------------------------------- | ----------------------------------- | -------------------------------------
|                                                 |                                                                | September 30,                       |                                      
|                                                 |                                                                |                                     |                                      
|                                                 | 2005                                                           |                                     | 2004                                 
|                                                 |                                                                |                                     |                                      
|Cash flows from operating activities:            |                                                                |                                     |                                      
|                                                 | Net income                                                     | $                                   | 1,841                                
|                                                 | Adjustments to reconcile net income to
 net cash provided      |                                     |                                      
|                                                 |                                                                | by (used in) operating
 activities- |                                      
|                                                 |                                                                |                                     | Amortization
 of intangibles         
|                                                 |                                                                |                                     | Depreciation                         
|                                                 |                                                                |                                     | Non-cash
 share-based compensation   
|                                                 |                                                                |                                     | Tax
 benefit related to stock options
|                                                 | Changes in operating assets and liabilities,
 net of effect    |                                     |                                      
|                                                 |                                                                | from acquisitions-                  |                                      
|                                                 |                                                                | (Increase) decrease
 in:            |                                      
|                                                 |                                                                |                                     | Accounts
 receivable                 
|                                                 |                                                                |                                     | Inventories                          
|                                                 |                                                                |                                     | Prepaid
 expenses and other          
|                                                 |                                                                | Increase (decrease)
 in:            |                                      
|                                                 |                                                                |                                     | Accounts
 payable                    
|                                                 |                                                                |                                     | Accrued
 compensation and benefits   
|                                                 |                                                                |                                     | Other
 accrued expenses              
|                                                 |                                                                |                                     | Income
 taxes payable                
|                                                 |                                                                |                                     | Deferred
 revenue                    
|                                                 |                                                                |                                     |                                      
|                                                 |                                                                |                                     |                                      
|                                                 |                                                                |                                     |                                      
|Cash flows from investing activities:            |                                                                |                                     |                                      
|                                                 | Purchase of Visara thin client business,
 net of cash acquired |                                     | —                                    
|                                                 | Purchases of short-term investments                            |                                     | (900                                 
|                                                 | Sales of short-term investments                                |                                     | 4,250                                
|                                                 | Purchases of property and equipment                            |                                     | (174                                 
|                                                 |                                                                |                                     |                                      
|                                                 |                                                                |                                     |                                      
|                                                 |                                                                |                                     |                                      
|Cash flows from financing activities:            |                                                                |                                     |                                      
|                                                 | Exercise of stock options and warrants                         |                                     | 161                                  
|                                                 | Repayments of capital leases                                   |                                     | (2                                   
|                                                 | Excess tax benefit related to stock options                    |                                     | 446                                  
|                                                 |                                                                |                                     |                                      
|                                                 |                                                                |                                     |                                      
|                                                 |                                                                |                                     |                                      
|Effect of foreign exchange rate changes on cash  |                                                                | (38                                 | )                                    
|                                                 |                                                                |                                     |                                      
|Increase (decrease) in cash and cash equivalents |                                                                | 4,265                               |                                      
|                                                 |                                                                |                                     |                                      
|Cash and cash equivalents, beginning of year     |                                                                | 8,285                               |                                      
|                                                 |                                                                |                                     |                                      
|Cash and cash equivalents, end of year           | $                                                              | 12,550                              |                                      
|                                                 |                                                                |                                     |                                      
|                                                 |                                                                |                                     |                                      
|Supplemental cash flow disclosures:              |                                                                |                                     |                                      
|                                                 | Cash paid for income taxes                                     | $                                   | 2,647                                

See accompanying notes to consolidated financial statements.

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NEOWARE SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENT

Note 1. Basis of Presentation

The accompanying unaudited consolidated financial
    statements of Neoware Systems, Inc. and Subsidiaries (the “Company”)
    have been prepared in accordance with U.S. generally accepted accounting
    principles for interim financial statements. These statements, while unaudited,
    reflect all normal recurring adjustments, which are, in the opinion of management,
    necessary for a fair presentation of the consolidated financial statements.
    The results for the interim periods presented are not necessarily indicative
    of the results that may be expected for any future period. Certain information
    and footnote disclosures included in financial statements have been condensed
    or omitted pursuant to such rules and regulations relating to interim financial
    statements. The consolidated financial statements included in this Form 10-Q
    should be read in conjunction with the audited consolidated financial statements
    and notes thereto included in the Company's Annual Report on Form 10-K for
    the year ended June 30, 2005, filed with the Securities and Exchange Commission
  on September 13, 2005.


Note 2. Recent Accounting Pronouncements

In June 2005, the Financial Accounting Standards
    Board (FASB) issued FASB Staff Position (FSP) No. 143-1, Accounting for
    Electronic Waste Obligations(FSP No. 143-1), which requires an
    entity to recognize an asset retirement liability for its obligation to dispose
    of electronic equipment. FSP No. 143-1 is effective for fiscal years ending
    after June 8, 2005. The Company has no obligations with respect to historical
    waste at September 30, 2005 unless it replaces equipment in the future. The
    European Union (EU) has adopted two directives to facilitate
    the recycling of electrical and electronic equipment sold in the EU. The
    first of these is the Waste Electrical and Electronic Equipment (WEEE)
    directive, which directs EU member states to enact laws, regulations and
    administrative provisions to ensure that producers of electrical and electronic
    equipment are financially responsible for specified collection, recycling,
    treatment, and environmentally sound disposal of products placed on the market
    after August 13, 2005, and from products in use prior to that date that are
    being replaced. All but a few of the 25 EU member countries have transposed
    the directive into law but implementation in certain countries may be delayed
    until later in 2005 or, potentially, into 2006. The EU has also adopted the
    Restriction on the Use of Certain Hazardous Substances in Electrical and
    Electronic Equipment (RoHS) directive. The RoHS directive restricts
    the use of lead, mercury, and certain other substances in electrical and
    electronic products placed on the market in the European Union after July
    1, 2006. The Company is currently evaluating the impact of these directives.
    To date, the impact of these directives has not had a material impact on
    the Companys
    financial
    statements. Similar legislation has been or may be enacted in other areas,
    including in the United States, the cumulative impact of which could be significant
    in the future if the Company is unable to recover these costs in the price
  of our products.


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


In May 2005, the FASB issued SFAS No. 154, “Accounting
      Changes and Error Corrections” (“SFAS No. 154”)
      which
replaces Accounting Principles Board (APB) Opinion No. 20 “Accounting Changes” and
SFAS No. 3, “Reporting
Accounting Changes in
Interim Financial StatementsAn Amendment of APB Opinion No. 28.” SFAS
No. 154 provides guidance on the accounting for and reporting of accounting changes
and error corrections. It establishes retrospective application, or the latest
practicable date, as the required method for reporting a change in accounting
principle and the reporting of a correction of an error. SFAS No. 154 is effective
for accounting changes and corrections of errors made in
fiscal years beginning after December 15, 2005 and is required to be adopted
by the Company in the first quarter of fiscal 2007. The Company is currently
evaluating the effect that the adoption of SFAS No. 154 will have on its consolidated
results of operations and financial condition but does not expect it to have
a material impact.


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Note 3. Equity-Based Compensation

Accounting for Employee Stock Award Plans

On July 1, 2005, the Company adopted SFAS No.
    123 (revised 2004), Share-Based Payment, (SFAS No. 123R)
    which was issued in December 2004. SFAS No. 123R revises SFAS No. 123, “Accounting
    for Stock1Based Compensation,” and supersedes APB Opinion No. 25, “Accounting
    for Stock Issued to Employees,” and its related interpretations.
    SFAS No. 123R requires recognition of the cost of employee services received
    in exchange for an award of equity instruments in the financial statements
    over the period the employee is required to perform the services in exchange
    for the award. SFAS No. 123R also requires measurement of the cost of employee
    services received in exchange for an award based on the grant-date fair value
    of the award. SFAS No. 123R also amends SFAS No. 95, “Statement
    of Cash Flows,” to require that excess tax benefits be reported
    as financing cash inflows, rather than as a reduction of taxes paid, which
    is included within operating cash flows. The Company adopted SFAS No. 123R
    using the modified prospective method. Accordingly, prior period amounts
    have not been restated. Under this application, the Company is required to
    record compensation expense for all awards granted after the date of adoption
    and for the unvested portion of previously granted awards that remain outstanding
  at the date of adoption.


Classification of Stock-Based Compensation Expense

Stock-based compensation expense in the first quarter of fiscal 2006 is as follows
(in thousands):


|                           | Three Months Ended |     
|-------------------------- | ------------------ | ----
|                           | September 30,      |     
|                           |                    |     
|                           |                    | 2005
|                           |                    |     
|Cost of revenues           | $                  | 19  
|Selling and marketing      |                    | 250 
|Research and development   |                    | 105 
|General and administrative |                    | 346 
|                           |                    |     
|                           | $                  | 720 
|                           |                    |     

Tax Effect related to Stock-based Compensation Expense

SFAS No. 123R provides that income tax effects
    of share-based payments are recognized in the financial statements for those
    awards that will normally result in tax deductions under existing tax law.
    Under current U.S. federal tax law, the Company would receive a compensation
    expense deduction related to non-qualified stock options only when those
    options are exercised and vested shares are received. Accordingly, the financial
    statement recognition of compensation cost for non-qualified stock options
    creates a deductible temporary difference which results in a deferred tax
    asset and a corresponding deferred tax benefit in the income statement. The
    Company does not recognize a tax benefit for compensation expense related
    to incentive stock options (ISOs) unless the underlying shares are disposed
    in a disqualifying disposition. Accordingly, compensation expense related
    to ISOs is treated as a permanent difference for income
tax purposes.


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Fair Value Disclosures  Prior to SFAS No. 123R Adoption

Before the adoption of SFAS No. 123R, the Company
    applied APB Opinion No. 25 to account for its stock-based awards. Under APB
    Opinion No. 25, the Company was not required to recognize compensation expense
    for the cost of stock options. Had the Company adopted SFAS No. 123 for the
  first quarter of fiscal 2005, the impact would have been as follows:


|Net income:                                                                                                                                  |   |       |  
|-------------------------------------------------------------------------------------------------------------------------------------------- | - | ----- | -
|As reported                                                                                                                                  | $ | 1,387 |  
|Deduct:
	      Total stock-based employee compensationexpense determined
	      under the fair value based method for all awards, net of tax |   | (639  | )
|                                                                                                                                             |   |       |  
|Pro
	      forma                                                                                                                             | $ | 748   |  
|                                                                                                                                             |   |       |  
|Basic earnings per share:                                                                                                                    |   |       |  
|As
	      reported                                                                                                                           | $ | 0.09  |  
|                                                                                                                                             |   |       |  
|Pro
	      forma                                                                                                                             | $ | 0.05  |  
|                                                                                                                                             |   |       |  
|Diluted earnings per share:                                                                                                                  |   |       |  
|As
	      reported                                                                                                                           | $ | 0.09  |  
|                                                                                                                                             |   |       |  
|Pro
	      forma                                                                                                                             | $ | 0.05  |  
|                                                                                                                                             |   |       |  

The
    fair value of the Companys stock-based awards to employees during the first quarter of fiscal 2005 was estimated at the date of grant using the Black-Scholes closed form
  option-pricing model (Black-Scholes), assuming no dividends and using the valuation assumptions noted in the following table. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated
  period of time outstanding) of the stock options granted was estimated using the historical exercise behavior of employees. Expected volatility was based on historical volatility for a period equal to the stock options
expected life, and calculated on a daily basis.


|Expected term                            | 7 years       | 
|---------------------------------------- | ------------- | 
|Expected and weighted average volatility | 115.47%       | 
|Risk-free rate                           | 3.99% - 4.08% | 

Valuation Assumptions for Options Granted during the First Quarter of Fiscal
2006

The fair value of each stock option granted during
    the first quarter of fiscal 2006 was estimated at the date of grant using
    Black-Scholes, assuming no dividends and using the following valuation assumptions
    noted in the following table. The risk-free rate is based on the U.S. Treasury
    yield curve in effect at the time of grant. The expected life (estimated
    period of time outstanding) of the stock options granted was estimated using
    the historical exercise behavior of employees. Expected volatility was based
    on historical volatility for a period equal to the stock options expected
  life, and calculated on a daily basis.


|Expected term                            | 5.5 years     | 
|---------------------------------------- | ------------- | 
|Expected and weighted average volatility | 100.07%       | 
|Risk-free rate                           | 3.91% - 4.24% | 

The above assumptions were used to determine the
    weighted average per share fair value of $7.35 for stock options granted
  during the first quarter of fiscal 2006.


Equity Compensation Plans

In December
        2004 the Companys stockholders approved the 2004 Equity Incentive Plan (the 2004 Plan),
        and the 1995 Stock Option Plan and the 2002 Non-Qualified Stock Option
        Plan were terminated as to any shares then available for future grant.
        The 2004
        Plan permits the Company to grant equity-based awards to its directors,
        executives and a broad-based category of employees. The 2004 Plan provides
        for the issuance
        of up to
      1,500,000 shares of common stock plus all outstanding options which terminate,
        expire or are canceled under the terminated plans on or after December
        1, 2004. Under the terms of the 2004 Plan, the exercise price of options
        granted
        cannot be less than fair market value on the date of grant. Non-employee
        director options that are automatically granted upon the person first
        becoming a director vest and become exercisable six months after the
        date of grant
        and options granted annually vest and
      become exercisable for one-half the shares six months from the date of
        grant and for the balance of the grant one year from the date of grant.
        All options
that have been granted expire ten years from thegrant
date, although the committee or board may define vesting and expiration dates
for all options granted under the 2004 Plan, except for automatic grants of options
to non-employee directors.


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In May 2005, the Companys Board of Directors
    approved the acceleration of the vesting of certain underwater unvested stock
    options held by certain employees that had option exercise prices of greater
    than $14.00 per share. As a result of the acceleration, options to purchase
    532,376 shares of the Company's common stock became immediately exercisable.
    Of these options, approximately seventy percent were scheduled to vest within
    the next eighteen months. The Companys stock price had ranged from $6.30
    to $12.23
    over the pervious twelve months. The decision to accelerate vesting of these
    underwater stock options was made primarily to avoid recognizing compensation
    cost in the Consolidated Statements of Operations in future financial statements
    upon the Company's adoption of SFAS No. 123R on July 1, 2005 and that the
    incentive and retention value of these options was significantly lower than
  their valuation using the Black-Scholes methodology.


The Companys primary type of share-based
    compensation consists of stock options generally vesting over four years.
    The Company funds shares issued upon exercise out of available authorized
  shares.


A summary of the status of the Companys stock option plans as of September
  30, 2005 is presented below:


|                                          |           |   |   | Weighted       |  | Remaining   |  | Intrinsic      | 
|----------------------------------------- | --------- | - | - | -------------- |  | ----------- |  | -------------- | 
|                                          |           |   |   | Average        |  | Contractual |  | Value          | 
|                                          | Shares    |   |   | Exercise Price |  | Term        |  | (in thousands) | 
|                                          |           |   |   |                |  |             |  |                | 
|Outstanding as of June 30, 2005           | 2,253,075 |   | $ | 11.81          |  |             |  |                | 
|Granted                                   | 230,250   |   |   | 11.21          |  |             |  |                | 
|Exercised                                 | (55,625   | ) |   | 2.89           |  |             |  |                | 
|Terminated                                | (15,875   | ) |   | 11.09          |  |             |  |                | 
|                                          |           |   |   |                |  |             |  |                | 
|Outstanding as of September 30, 2005      | 2,411,825 |   |   | 11.95          |  | 8.1         |  | 11,547,000     | 
|                                          |           |   |   |                |  |             |  |                | 
|Options exercisable at September 30, 2005 | 1,107,196 |   |   | 14.32          |  | 6.9         |  | 2,677,000      | 

The total intrinsic value of options exercised for the first quarter of fiscal
  2006 was $600,000.


The following table presents information regarding
  unvested share activity during the first quarter of fiscal 2006:


|                                  |           |   |   | Weighted      | 
|--------------------------------- | --------- | - | - | ------------- | 
|                                  |           |   |   | Average Grant | 
|                                  |           |   |   | Date Fair     | 
|                                  | Shares    |   |   | Value         | 
|                                  |           |   |   |               | 
|Unvested as of June 30, 2005      | 1,124,471 |   | $ | 8.49          | 
|Granted                           | 230,250   |   |   | 7.35          | 
|Vested                            | (41,092   | ) |   | —             | 
|Forfeited                         | (9,000    | ) |   | 8.90          | 
|                                  |           |   |   |               | 
|Unvested as of September 30, 2005 | 1,304,629 |   |   | 8.40          | 
|                                  |           |   |   |               | 

As of September 30, 2005, there was $6.9 million
    of total unrecognized compensation cost related to non-vested share-based
    compensation arrangements related to stock options granted under the Plan.
    That cost is expected to be recognized over a weighted-average period of
  1.5 years.


The 2004 Plan permits the Company to grants restricted
    stock which may impose conditions, including continued employment or performance
    conditions. The terms and conditions applicable to a restricted stock issuance,
    including the vesting periods and conditions, and the form of consideration
    payable, if any, shall be determined by the Compensation Committee. However,
    that in no event shall the grant, issuance, retention, vesting and/or settlement
    of restricted stock that are based on performance criteria and level of achievement
    versus such criteria be subject to a performance period of less than one
    year and no condition that is based upon continued employment or the passage
    of time shall provide for vesting or settlement in full of a restricted stock
  award over a period of less than three years from the date the award is made.


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During the quarter ended September 30, 2005, the
    Company granted 9,191 shares of restricted stock to an employee that vest
    over three years. The total value of the award was $100,000 on the date
    of grant. The Company is recognizing compensation expense related to this
    award
    on
    a straight-line basis over the vesting period. Changes in the Companys
  restricted stock for the first quarter of fiscal 2006 were as follows:


|                                  |        |  |   | Weighted        | 
|--------------------------------- | ------ |  | - | --------------- | 
|                                  |        |  |   | Average Grant   | 
|                                  | Shares |  |   | Date Fair Value | 
|                                  |        |  |   |                 | 
|Unvested as of June 30, 2005      | —      |  | $ | —               | 
|Granted                           | 9,191  |  |   | 10.88           | 
|                                  |        |  |   |                 | 
|Unvested as of September 30, 2005 | 9,191  |  |   | 10.88           | 
|                                  |        |  |   |                 | 

Note 4.Business Combination

In October 2005 the Company entered into an Agreement
    and Plan of Merger to acquire Maxspeed Corporation
    (“Maxspeed”), a provider of customized thin client solutions,
    headquartered in Palo Alto, California, with research, development and sales
    offices in Beijing and Shanghai, China.
The merger agreement contained customary representations, warranties, covenants and indemnifications. As
part of the transaction, the Company will also enter into noncompetition agreements with two of Maxspeeds
shareholders.
 The consideration payable by the Company is expected to be $24.0
    million in cash, subject to adjustment based on Maxspeed's cash and net working
    capital at closing, of which $1.4 million will be held back to fund restructuring
    costs and $4.8 million of which will be held in an escrow account for up
    to two years for indemnification claims. Maxspeed is required to provide
    a minimum
    of $9.0 million of cash and $3.7 million of net working capital excluding
    cash as of closing, with dollar-for-dollar downward adjustments in the consideration
    if these requirements are not satisfied. The common shareholders of Maxspeed
    are also eligible to receive a potential cash earnout of up to $4.0 million,
    based on defined revenues through December 31, 2006. The acquisition
    will be accounted for using the purchase method of accounting and the results
    of operations of Maxspeed will be included in the Companys statements
  of operations from the date of the acquisition.


In October 2005, the Company completed the acquisition
    of the thin client business of TeleVideo, Inc. (TeleVideo) for $3.4 million
    in cash. The Company acquired substantially all of the assets of TeleVideos
    thin client business, including primarily all thin client assets, a trademark
    license, product brands, customer lists, customer
    contracts and
    non-competition agreements. The acquisition will be accounted for using the
    purchase method of accounting and the results of operations of TeleVideo
    will be included in the Companys statements of operations from the
  date of the acquisition.


During the quarter ended September 30, 2005, the
    Company recorded additional goodwill and accrued expenses of $2.1 million
    representing the amount earned by the sellers of the Visara thin client business
    pursuant to an earn-out arrangement for revenues, as defined, measured from
    the acquisition date, September 22, 2004, through September 30, 2005. The
  Company expects to pay this amount in November 2005.


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Note 5. Goodwill and Intangible Assets

The carrying amount of goodwill was $33.1 million and $31.2 million at September 30, 2005 and June 30, 2005, respectively. The increase in goodwill is due to contingent consideration
payable to Visara International, Inc. of $2.1 and the impact of changes in foreign exchange rates.


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


|                          |             |  |   | September 30, 2005 | 
|------------------------- | ----------- |  | - | ------------------ | 
|                          |             |  |   |                    | 
|                          |             |  |   | Gross              | 
|                          | Estimated   |  |   | Carrying           | 
|                          | useful life |  |   | Amount             | 
|                          |             |  |   |                    | 
|Tradenames                | Indefinite  |  | $ | 256                | 
|Non-compete agreements    | 3-5 years   |  |   | 551                | 
|Customer relationships    | 3-5 years   |  |   | 3,757              | 
|Distributor relationships | 5 years     |  |   | 2,325              | 
|Acquired technology       | 5-10 years  |  |   | 6,036              | 
|                          |             |  |   |                    | 
|                          |             |  | $ | 12,925             | 
|                          |             |  |   |                    | 

|                          |             |  |   | June 30, 2005 | 
|------------------------- | ----------- |  | - | ------------- | 
|                          |             |  |   |               | 
|                          |             |  |   | Gross         | 
|                          | Estimated   |  |   | Carrying      | 
|                          | useful life |  |   | Amount        | 
|                          |             |  |   |               | 
|Tradenames                | Indefinite  |  | $ | 259           | 
|Non-compete agreements    | 2-5 years   |  |   | 551           | 
|Customer relationships    | 2-5 years   |  |   | 3,770         | 
|Distributor relationships | 5 years     |  |   | 2,325         | 
|Acquired technology       | 5-10 years  |  |   | 6,081         | 
|                          |             |  |   |               | 
|                          |             |  | $ | 12,986        | 
|                          |             |  |   |               | 

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


|                          | Three Months Ended |    
|------------------------- | ------------------ | ---
|                          | September 30,      |    
|                          |                    |    
|                          | 2005               |    
|                          |                    |    
|Non-compete agreements    | $                  | 35 
|Customer relationships    |                    | 179
|Distributor relationships |                    | 116
|Acquired technologies     |                    | 258
|                          |                    |    
|                          | $                  | 588
|                          |                    |    

Amortization expense for customer relationships and distributor relationships is included in sales and marketing expenses and amortization expense for acquired technologies is included in cost
of revenues. Amortization expense for non-compete agreements is classified depending on the classification of the related employee.


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


|                         | Future       |      
|------------------------ | ------------ | -----
|Year Ending June 30,     | Amortization |      
|                         |              |      
|Remainder of fiscal 2006 | $            | 1,816
|2007                     |              | 2,105
|2008                     |              | 1,840
|2009                     |              | 1,653
|2010                     |              | 952  
|2011 through 2013        |              | 145  
|                         |              |      
|                         | $            | 8,511
|                         |              |      

Note 6. Comprehensive Income

Excluding net income, the Companys source of other comprehensive income is unrealized income (loss) relating to foreign exchange rate fluctuations. The following summarizes the components
of comprehensive income (in thousands):


|                                        |   | Three Months Ended |  
|--------------------------------------- | - | ------------------ | -
|                                        |   | September 30,      |  
|                                        |   |                    |  
|                                        |   | 2005               |  
|                                        |   |                    |  
|Net income                              | $ | 1,841              |  
|Foreign currency translation adjustment |   | (311               | )
|                                        |   |                    |  
|Comprehensive income                    | $ | 1,530              |  
|                                        |   |                    |  

Note 7. Revenue Recognition

Net revenues include sales of thin client appliance systems, which include the appliance device and related software, and services. To date, sales of standalone software products and services
have not exceeded 10% of our consolidated revenues for any period. The Company follows AICPA Statement of Position No. 97-2, Software Revenue Recognition
(SOP 97-2) for revenue recognition because the software component of the thin client appliance systems is more than incidental to the thin client appliance systems as a whole. These products and services are sold either separately or as
part of a multiple-element arrangement. Revenue is recognized on product sales when persuasive evidence of an arrangement exists, delivery of the product has occurred, the fee is fixed or determinable and collectibility is probable.


Revenue related to post-contract support services is generally recognized with the initial product sale when the fee is included with the initial product fee, post-contract services are for one
year or less, the estimated cost of providing such services during the arrangement is insignificant, and unspecified upgrades and enhancements offered during the period are expected to continue to be minimal and infrequent. Otherwise, revenue from
extended warranty and post-contract support service contracts is recorded as deferred revenue and subsequently recognized over the term of the contract. Vendor specific objective evidence of these amounts is determined by the price charged when
these elements are sold separately, generally based on the renewal rate.


Stock rotation rights and price protection are provided to certain distributors. Stock rotation rights are generally limited to a maximum amount per quarter and require a corresponding order of
equal or greater value at the time of the stock rotation. Price protection provides for a rebate in the event the Company reduces the price of products for which the distributors have yet to sell to end-users. The Company reserves for these
arrangements based on a specific review of known issues, historical experience and the level of inventories in the distribution channel and reduces current period revenue accordingly.


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


The Company offers fixed-price support or maintenance contracts, including extended warranties, to its customers ranging from one to five years. Revenue from these transactions is recognized
over the related term. The difference between the amount recognized and the amount collected for these arrangements is recorded as deferred revenue.


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Note 8. Major Customers and Dependence on Suppliers

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


|             | Three Months Ended |  
|------------ | ------------------ | -
|             | September 30,      |  
|             |                    |  
|             | 2005               |  
|             |                    |  
|Net revenues |                    |  
|Customer A   | 22                 | %
|Customer B   | 12                 | %
|Lenovo       | 10                 | %
|IBM          | *                  |  

|                    | September 30, |  
|------------------- | ------------- | -
|                    |               |  
|                    | 2005          |  
|Accounts receivable |               |  
|Customer A          | 28            | %

|   
|---
|(*)

In April 2005, in connection with the sale of IBMs Personal Computing Division to Lenovo Group Limited, the Company entered into a mirror agreement with Lenovo, under which Lenovo can
purchase Neowares products under the same terms as IBM. The Companys agreement with IBM remains in effect.


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


For the three months ended September 30, 2005 and 2004 revenues from Europe, the Middle East and Africa, based on the location of the Companys primary selling activities with its
customers accounted for 26% and 31%, respectively, of net revenues. No single international region accounted for more than 10% of net revenue for the three months ended September 30, 2005. Sales to the United Kingdom accounted for 18% of net revenue
for the three months ended September 30, 2004.


The Company depends upon a limited number of sole source suppliers for its thin client appliance products and for several industry standard components, which also subject the Company to risks
associated with foreign operations such as the imposition of unfavorable governmental controls or other trade restrictions, changes in tariffs, political instability and currency fluctuations. Although the Company has identified alternative
suppliers that could produce comparable products, it is likely there would be an interruption of supply during any transition, which would limit the Companys ability to ship product to fully meet customer demand. If this were to happen, the
Companys revenue would decline and its profitability would be adversely impacted.


Note 9. Inventories

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


|                                       |   | September 30, |  |   | June 30, | 
|-------------------------------------- | - | ------------- |  | - | -------- | 
|                                       |   | 2005          |  |   | 2005     | 
|                                       |   |               |  |  
|Purchased components and subassemblies | $ | 471           |  | $ | 417      | 
|Finished goods                         |   | 3,167         |  |   | 2,634    | 
|                                       |   |               |  |  
|                                       | $ | 3,638         |  | $ | 3,051    | 
|                                       |   |               |  |  

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Note 10. Income Taxes

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


Note 11. Credit Facility

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


Note 12. Earnings per Share

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


|                                          |   | Three Months Ended | 
|----------------------------------------- | - | ------------------ | 
|                                          |   | September 30,      | 
|                                          |   |                   
|                                          |   | 2005               | 
|                                          |   |                    | 
|Net income                                | $ | 1,841              | 
|                                          |   |                    | 
|Weighted average shares outstanding:      |   |                    | 
|Basic                                     |   | 16,271             | 
|Effect of dilutive employee stock options |   | 163                | 
|                                          |   |                    | 
|Diluted                                   |   | 16,434             | 
|                                          |   |                    | 
|Earnings per common share:                |   |                    | 
|Basic                                     | $ | .11                | 
|                                          |   |                    | 
|Diluted                                   | $ | .11                | 
|                                          |   |                    | 

The following table sets forth the potential common shares that were excluded from the dilutive earnings per share computations because their effect would be anti-dilutive (in thousands):


|                       | Three Months Ended | 
|---------------------- | ------------------ | 
|                       | September 30,      | 
|                       |                    | 
|                       | 2005               | 
|                       |                    | 
|Employee stock options | 934                | 
|                       |                    | 

Note 13. Guarantees

Indemnifications

In the ordinary course of business, from time-to-time the Company enters into contractual arrangements under which it may agree to indemnify its customer for losses incurred by the customer or
supplier arising from certain events as defined within the particular contract, which may include, for example, litigation or intellectual property infringement claims. The Company has not identified any losses that are probable under these
provisions and, accordingly, no liability related to these indemnification provisions has been recorded.


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Warranty

The Company provides for the estimated cost of product warranties at the time it recognizes revenue. The Company actively monitors and evaluates the quality of its component suppliers; however,
ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure affect the estimated warranty obligation. If actual product failure rates, material usage or service delivery costs differ from
estimates, revisions to the estimated warranty liability would be required. The Companys standard warranty service period ranges from one to three years.


The changes in the Companys warranty liability
    during the first quarter of fiscal 2006 are as follows (in thousands):


|Accrued warranty cost at June 30, 2005      | $ | 896  |  
|------------------------------------------- | - | ---- | -
|Settlements made                            |   | (108 | )
|Provisions for warranties                   |   | 130  |  
|                                            |   |     
|Accrued warranty cost at September 30, 2005 | $ | 918  |  
|                                            |   |     

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

Overview

We provide software, services and solutions to enable thin client computing, which is a computing architecture targeted at business customers as an easier to manage, more secure, more reliable,
and more cost-effective solution than traditional PC-based, client server computing. Our software and management tools secure, power and manage a new generation of smart thin client appliances that utilize the benefits of open, industry-standard
technologies used in the PC industry to create new alternatives to full-function personal computers and green screen terminals used in business.


Our software runs on thin client appliances and personal computers, and enables these devices to be secured and centrally managed, as well as to connect to mainframes, midrange, UNIX, Linux and
host systems. We generate revenues primarily from sales of thin client appliance systems, which include the appliance device and related software and to a lesser extent from TeemTalk host access software for servers and PCs, ezRemote Manager central
management software, Neoware Image Manager software, and services such as training and integration.To date, sales of standalone software products and services have not exceeded 10% of our
consolidated revenues for any period.


We sell our products and services worldwide through our direct sales force, distributors, our alliances with IBM and Lenovo and other indirect channels, such as resellers and systems
integrators. Our international sales are primarily made through distributors and resellers and are collectible primarily in US dollars, while the associated operating expenses are payable in foreign currencies. In addition to our headquarters in the
United States, we maintain offices in the UK, Germany, France, Austria, Sweden, and Australia.


In April 2005, in connection with the sale of IBMs Personal Computing Division to Lenovo Group Limited, we entered into a mirror agreement with Lenovo, under which Lenovo can purchase our
products under the same terms as IBM. Our agreement with IBM remains in effect.


Revenues from Europe, the Middle East and Africa (EMEA), based on the location of our customers, were as follows (in thousands):


|                           | Three Months Ended |       |   |     
|-------------------------- | ------------------ | ----- | - | ----
|                           | September 30,      |       |   |     
|                           |                    |       |   |     
|                           | 2005               |       |   | 2004
|                           |                    |       |   |     
|International revenues     | $                  | 6,906 |   | $   
|Percentage of net revenues |                    | 26    | % |     

Strategy

The market for thin client appliances is part of the
enterprise personal computer (PC) market. We market our thin client appliances
as alternatives to PCs in certain target markets. Our strategies are to focus
on selling thin client software and appliance products that compete effectively
with PCs, increasing sales to large enterprise customers, primarily through our
relationships with IBM and Lenovo, and secondarily through other resellers and
directly to end-users, and to execute marketing initiatives designed to grow
the thin client segment of the PC
industry.


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We utilize third parties we believe have strong market positions in the server-based computing market to expand our sales and marketing efforts, which allows us to develop new customer relationships as well as gain access to new markets. We expect to continue to grow our business organically and through acquisitions. Our acquisition strategy is focused on enhancing our geographic reach, enhancing our channels of distribution, as well as acquiring businesses with products that can be sold through our existing channels to the same end user customers, leveraging our existing organization. We intend to continue to evaluate strategic acquisitions and partnerships in the
future.


Based on this strategy, on November 2, 2005 we provided the following forward
looking guidance:


| | • | Subject to closing the Maxspeed transaction
        by December 31, 2005 and continued market acceptance ofour
        new products, we believe that our fiscal 2006 revenues will increase
        approximately 40%, to approximately $110
    million, compared to our fiscal 2005 revenues.                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | • | Gross margins for fiscal 2006 are projected
        to be in the 40% to 45% range, including approximately $275,000
        per quarter of amortization of intangibles related to completed acquisitions.
        Gross margins will likely vary from
        this range by one or two percentage points in any particular quarter
        due to product mix, including mix of
        revenue from software products, which carry higher than average gross
        margins, and from the new Neoware e900
    product line, which carries lower than average gross margins.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | • | Operating expenses for fiscal 2006 are projected
          to increase during the year, but are expected to beleveraged
          with revenue growth to approximately 30% of revenue or less during
          the fiscal year, including approximately $395,000
          per quarter of amortization of intangibles related to completed acquisitions
          and approximately $700,000 per
    quarter of stock-based compensation expense.                                                                                                                             

Acquisitions

In October 2005 the Company entered into an Agreement
    and Plan of Merger to acquire Maxspeed Corporation
    (“Maxspeed”), a provider of customized thin client
solutions, headquartered in Palo Alto, California, with research, development
    and sales offices in Beijing and Shanghai, China. The acquisition is expected
    to close by December 31, 2005.
	The merger agreement contained customary representations, warranties, covenants and indemnifications. As
part of the transaction, the Company will also enter into noncompetition agreements with two of Maxspeeds
shareholders.


In October 2005, we completed the acquisition of
    the thin client business of TeleVideos thin client business, which
    included certain contract obligations, a trademark license, product brands,
    customer
    lists,
    customer
    contracts and non-competition agreements.


In April 2005, we acquired all of the outstanding
    shares of Qualystem Technology S.A.S., a provider of software that streams
    Windows® and application components on-demand from a server to
other servers, personal computers, and thin clients.


In March 2005, we acquired the ThinTune thin client
    business of eSeSIX Computer which included customer lists, intellectual property
    and technology, and also entered into reseller, supplier and non-competition
    agreements and on March 4, 2005 acquired all of the outstanding shares of
    eSeSIX Tech, eSeSIX Computers development and engineering affiliate.
    eSeSIX Computer together with eSeSIX Tech are collectively referred to as
    the
ThinTune thin client business.


In January 2005, we acquired all of the outstanding shares of Mangrove Systems S.A.S., a provider of Linux software solutions. As a result of the Mangrove acquisition, we acquired customer
lists, intellectual property and technology and non-compete agreements.


In September 2004, we acquired the thin client business of Visara International, Inc, including customer lists, intellectual property and technology, and also entered into reseller, supplier
and non-competition agreements.


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Financial Highlights

Net revenue, gross profit margin, and earnings per
    share are key measurements of our financial results. Revenue for the first
    quarter of fiscal 2006 quarter was $26.5 million, an increase
of 63% over the same period in fiscal 2005. Gross profit margins were 40.3% for the first quarter of fiscal 2006 as compared to 43.5% in the same period in fiscal 2005. The revenue increase and gross profit margin percentage decrease is due
primarily to initial revenues from sales of the new Neoware e900 thin client product, which was primarily sold to one retail customer and which carries higher average selling prices and lower percentage gross margins than other Neoware products. The
revenue increase is also due to increased sales of Neoware products to large enterprise customers. Diluted earnings per share were $0.11 for the first quarter of fiscal 2006, compared to $0.09
in the same period in fiscal 2005, as a result of increased earnings from revenue
growth offset by increased operating expenses, including the impact of increased
amortization and stock based compensation expense.


We have a significant balance of cash and short-term
    investments. As of September 30, 2005, our cash, cash equivalents and short-term
    investments were $44.1 million, compared to $43.2
million at June 30, 2005. Subsequent to September 30, 2005, we completed the
    acquisition of the TeleVideo thin client business which required the payment
    of $3.4 million of cash. During the quarter ended September 30, 2005,
    we recorded
additional goodwill and accrued expenses of $2.1 million representing the
amount earned by the sellers of the Visara thin client business pursuant to an
earn-out arrangement based on revenues, as defined, measured from the acquisition
date, September  22, 2004, through September 30, 2005. The Company expects to
pay this amount in November 2005. In addition we have other potential earn-out
arrangements entered into in connection with recently completed transactions.
Generally
these
earn-outs
are based on achieved levels of
revenue during the twelve months subsequent to completion of the transaction.
In October 2005, we also entered into a definitive agreement to acquire Maxspeed
Corporation which is expected to close by December 31, 2005 and would require
a net cash
payment of approximately $13.6 million, plus a potential earnout based upon
revenue.


Critical Accounting Policies and Estimates

We believe that there are several accounting policies
    that are critical to understanding our historical and future performance,
    as these policies affect the reported amounts of revenue and other significant
    areas that involve managements judgments and estimates. These critical
accounting policies and estimates include:


| | • | Revenue recognition                                           
| | - | --------------------------------------------------------------
| |   |                                                               
| | • | Valuation of long-lived and intangible assets
    and goodwill
| |   |                                                               
| | • | Accounting for income taxes                                   
| |   |                                                               
| | • | Stock Based Compensation                                      

These policies and estimates and our procedures
    related to these policies and estimates are described in detail below and
    under specific areas within the discussion and analysis of our financial
    condition and results of operations. Please refer to Note 1, Organization and Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in our annual financial statements as of June 30, 2005
included in our Annual Report on Form 10-K for further discussion of the Companys
accounting policies and estimates.


Revenue Recognition

For each type of arrangement, we make judgments regarding the fair value of multiple elements contained in our arrangements, judgments regarding whether fees are fixed or determinable,
judgments regarding whether collectability is probable, and judgments related to accounting for potential distributor stock rotation rights and price protection. These judgments, and their effect on revenue recognition, are discussed below.


Multiple Element Arrangements

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


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Revenue related to post-contract support services is generally recognized with the initial product sale when the fee is included with the initial product fee, post-contract services are for one
year or less, the estimated cost of providing such services during the arrangement is insignificant, and unspecified upgrades and enhancements offered during the period are expected to continue to be minimal and infrequent. Otherwise, revenue from
extended warranty and post-contract support service contracts is recorded as deferred revenue and subsequently recognized over the term of the related support period. Vendor specific objective evidence (VSOE) of these amounts is determined by the
price charged when these elements are sold separately, generally based on the renewal rate.


The Fee is Fixed or Determinable

We make judgments at the outset of an arrangement regarding whether the fees are fixed or determinable. The majority of our payment terms are within 30 to 60 days after invoice date. We review
arrangements that have payment terms extending beyond 60 days on a case-by-case basis to determine if the fee is fixed or determinable. If we determine at the outset of an arrangement that the fees are not fixed or determinable, we recognize revenue
as the fees become due and payable.


Collection is Probable

We make judgments at the outset of an arrangement
    regarding whether collection is probable. Probability of collection is assessed
    on a customer-by-customer basis. We typically sell to customers with whom
    we have had a history of successful collections. New customers are subjected
    to a credit review process to evaluate the customers financial position
    and ability to pay. If we determine at the outset of an arrangement that
    collection
is not probable, revenue is recognized upon receipt of payment.


Stock Rotation Rights and Price Protection

We provide certain distributors with stock rotation rights and price protection. Stock rotation rights are generally limited to a maximum amount per quarter and require a corresponding order of
equal or greater value at the time of the stock rotation. We provide price protection as a rebate in the event that we reduce the price of products that our distributors have yet to sell to end-users. We estimate potential stock rotation and price
protection claims based on historical experience and the level of inventories in the distribution channel and reduce current period revenue accordingly. If we cannot reasonably estimate claims related to stock rotations and price protection at the
outset of an arrangement, we recognize revenue when the claims can be reasonably estimated.


Valuation of Long-Lived and Intangible Assets and Goodwill

In connection with acquisitions, we allocate portions of the purchase price to intangible assets, consisting of acquired technology, distributor and customer relationships, trade names and
non-compete agreements based on independent appraisals received after each acquisition, with the remainder allocated to goodwill.


We assess the realizability of goodwill and intangible
    assets with indefinite useful lives pursuant to SFAS No. 142, Goodwill and Other Intangible
Assets. We are required to perform a SFAS No. 142
impairment test at least annually, or sooner if events or changes in circumstances
indicate that the carrying amount may not be recoverable. We have determined
that the reporting unit level is our sole operating segment. The test for goodwill
is a two-step process:


First, we compare the carrying amount of our reporting unit, which is the book value of the entire Company, to the fair value of our reporting unit. If the carrying amount of our reporting unit
exceeds its fair value, we have to perform the second step of the process. If not, no further testing is needed.


If the second part of the analysis is required,
    we allocate the fair value of our reporting unit to all assets and liabilities
    as if the reporting unit had been acquired in a business combination at the
    date of the impairment test. We then compare the implied fair value of our
    reporting units goodwill to its carrying amount. If the carrying amount of our reporting units
    goodwill exceeds its fair value, we recognize an impairment loss in an amount
equal to that excess.


We review our long-lived assets, including amortizable
    intangibles, for impairment when events indicate that their carrying amount
    may not be recoverable in accordance with SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets.When
we determine that one or more impairment indicators are present for an asset,
we compare  the carrying amount of the asset to net future undiscounted cash
flows that the asset is expected to generate. If the carrying amount of the asset
is greater than the net future undiscounted cash flows that the asset is  expected to generate, we compare the fair value to the book value of the asset. If the fair value is less than the book value, we recognize an impairment loss. The impairment loss is the excess of the carrying amount of the
asset over its fair value.


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Some of the events that we consider as impairment indicators for our long-lived assets, including goodwill, are:


| | • | Significant underperformance of the company
    relative to expected operating results;
| | - | ---------------------------------------------------------------------------------------
| |   |                                                                                        
| | • | Our net book value compared to our market capitalization;                              
| |   |                                                                                        
| | • | Significant adverse economic and industry trends;                                      
| |   |                                                                                        
| | • | Significant decrease in the market value of
    the asset;                             
| |   |                                                                                        
| | • | The extent that we use an asset or changes
    in the manner that we use it; and       
| |   |                                                                                        
| | • | Significant changes to the asset since we
    acquired it.                             

We have not recorded an impairment loss on goodwill
    or other long-lived assets. At September 30, 2005, goodwill and intangible
    assets are $33.1 million and $8.8 million, respectively. A
decrease in the fair value of our business could trigger an impairment charge
related to goodwill and or amortizable intangible assets.


Accounting for Income Taxes

We are required to estimate our income taxes in each federal, state and international jurisdiction in which we operate. This process requires that we estimate the current tax expense as well as
assess temporary differences between the accounting and tax treatment of assets and liabilities, including items such as accruals and allowances not currently deductible for tax purposes. The income tax effects of the differences we identify are
classified as current or long-term deferred tax assets and liabilities in our consolidated balance sheets. Our judgments, assumptions and estimates relative to the current provision for income tax take into account current tax laws, our
interpretation of current tax laws and possible outcomes of future audits conducted by foreign and domestic tax authorities. Changes in tax laws or our interpretation of tax laws and the resolution of future tax audits could significantly impact the
amounts provided for income taxes in our balance sheet and results of operations. We must also assess the likelihood that deferred tax assets will be realized from future taxable income and, based on our assessment, establish a valuation allowance,
if required.


Stock Based Compensation

Prior to June 30, 2005, we accounted for employee
    stock option plans based on the intrinsic value method in accordance with
    Accounting Principles Board (APB) Opinion No. 25, Accounting
    for Stock Issued to Employees,and related
    Interpretations and had adopted the disclosure requirements of SFAS No. 123, Accounting
    for Stock-Based Compensation(SFAS No.123), as amended by SFAS
    No. 148, Accounting for Stock-Based Compensation–Transition
    and
Disclosure (SFAS No. 148). Accordingly, compensation cost for stock
options was measured as the excess, if any, of the quoted market price of the
Companys
stock at the grant date over the amount an employee must pay to acquire the stock.
The Company granted stock options with exercise prices equal to the market price
of the underlying stock on the date of grant; therefore, the Company did not
record stock-based compensation expense under APB
Opinion No. 25.


In December 2004, the Financial Accounting Standards
    Board (FASB) issued SFAS No. 123R, Share-Based
    Paymentsto require that compensation cost relating to share-based payment arrangements be recognized in the financial statements. As of July 1, 2005, we adopted SFAS No. 123R using the modified prospective method, which requires measurement of
compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of stock options were determined using the Black-Scholes valuation model,
which is consistent with our valuation techniques previously utilized for stock options in footnote disclosures required under SFAS No. 123, as amended by SFAS No. 148. Such fair value is recognized as expense over the service period, net of
estimated forfeitures. The adoption of SFAS No.123R resulted in no cumulative change in accounting as of the date of adoption.


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On March 29, 2005, the Securities and Exchange Commission published Staff Accounting Bulletin No. 107 (SAB 107), which provides the Staffs views on a variety of matters relating to
stock-based payments. SAB 107 requires stock-based compensation to be classified in the same expense line items as cash compensation. Information about stock-based compensation included in the results of operations for the quarters ending September
30, 2005 and 2004 is as follows (in thousands):


|                           | Three Months Ended
September
30, |     
|-------------------------- | -------------------------------- | ----
|                           |                                  |     
|                           |                                  | 2005
|                           |                                  |     
|Cost of revenues           | $                                | 19  
|Selling and marketing      |                                  | 250 
|Research and development   |                                  | 105 
|General and administrative |                                  | 346 
|                           |                                  |     
|                           | $                                | 720 
|                           |                                  |     

We expect stock based compensation expense related
to stock options to be approximately $700,000
per quarter before income taxes for the remainder of fiscal 2006. Such amounts
may change as a result of additional grants, forfeitures, modifications in assumptions
and other factors. SFAS No. 123R provides that income tax effects of share-based
payments are recognized in the financial statements for those awards which will
normally result
in tax deductions under existing tax law. Under current U.S. federal tax law,
we would receive a compensation expense deduction related to non-qualified stock
options only when those options are exercised and vested shares are received.
Accordingly, the financial statement recognition of compensation cost for non-qualified
stock options creates a deductible temporary difference which results in a deferred
tax asset and a corresponding deferred tax benefit in the income statement.
We do  not recognize a tax benefit for compensation expense related
to incentive stock options (ISOs) unless the underlying shares are disposed in
a disqualifying disposition. Accordingly, compensation expense related to ISOs
is treated as
a permanent difference for income tax purposes.


For stock-based compensation arrangements we make judgments about the fair value of the awards, including the expected term of the award, volatility of the underlying stock and estimated
forfeitures, which impact the amount of compensation expense recognized in the financial statements.


Results of Operations

Net Revenues(in thousands):

|             | Three Months EndedSeptember 30, |        |  |  
|------------ | ------------------------------- | ------ |  | -
|             |                                 |        |  |  
|             |                                 | 2005   |  |  
|             |                                 |        |  |  
|Net revenues | $                               | 26,543 |  | $

We derive revenues primarily from the sale of thin client appliances, which include an appliance device and related software. The increase in net revenues in the first quarter of fiscal 2006 is
substantially due to increased thin client appliance systems revenue driven by an increase in sales from increasing market acceptance of our thin client products, significant initial sales from a major retail customer of the new Neoware e900 thin
client product which carries a significantly higher selling price than our core thin client products, an increase in our customer base from our sales activities including those from recent acquisitions and our alliances with IBM and
Lenovo.


The following table sets forth sales to customers comprising 10% or more of our net revenue:


|             | Three Months Ended September 30, |  
|------------ | -------------------------------- | -
|             |                                  |  
|             | 2005                             |  
|             |                                  |  
|Net revenues |                                  |  
|Customer A   | 22                               | %
|Customer B   | 12                               | %
|Lenovo       | 10                               | %
|IBM          | *                                |  

|   
|---
|(*)

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Cost of Revenues and Gross Profit Margin(in thousands):

|                    | Three Months Ended
 September 30, |        |   |  
|------------------- | --------------------------------- | ------ | - | -
|                    |                                   |        |   |  
|                    |                                   | 2005   |   |  
|                    |                                   |        |   |  
|Cost of revenues    | $                                 | 15,842 |   | $
|Gross profit margin |                                   | 40     | % |  

Cost of revenues consists primarily of the cost of thin client appliances, which include an appliance device and related software, and, to a lesser extent, overhead including salaries and
related benefits for personnel who fulfill product orders, delivery services, warranty obligations, amortization of intangibles related to acquisitions, distribution costs and stock based compensation expense commencing in the first quarter of
fiscal 2006. The increase in cost of revenues in the first quarter of fiscal 2006 is primarily the result of unit sales growth and, to a lesser extent, to increased amortization of intangibles related to acquisitions completed in fiscal 2005 and
increases in inventory and warranty reserves due to higher unit sales volume. Cost of revenues in the first quarter of fiscal 2006 includes $273,000 of amortization of intangibles related to acquisitions compared to $101,000 of amortization
in the same period in fiscal 2005.


We continue to benefit from manufacturing efficiencies and component cost reductions achieved through our outsourcing model. This model depends on high volume production of our thin client
appliance products using components commonly used in personal computers.


The change in gross profit margin in the first quarter of fiscal 2006 is the result of sales of the new Neoware e900 thin client which carries higher average selling prices and lower percentage
gross margins of approximately 25%. Percentage gross margin on the other non-e900 revenue was approximately 44%.


Gross margins are expected to fluctuate in the future due to changes in product mix, reduction in sales prices due to increased sales to large enterprise customers and increased price
competition, the percentage of revenues derived from thin client appliance systems, and software and changes in the cost of thin client appliances, memory and other components.


Sales and Marketing(in thousands):

|                                | Three Months Ended
September 30, |       |   |  
|------------------------------- | -------------------------------- | ----- | - | -
|                                |                                  |       |   |  
|                                |                                  | 2005  |   |  
|                                |                                  |       |   |  
|Sales and marketing             | $                                | 4,473 |   | $
|As a percentage of net revenues |                                  | 17    | % |  

Sales and marketing expenses consist primarily of salaries, related benefits, commissions, advertising, direct marketing, the cost of trade shows, amortization of intangibles related to
customer and distribution relationships and other costs associated with our sales and marketing efforts, and stock based compensation expense commencing in the first quarter of fiscal 2006. Sales and marketing expense declined as a percentage of
revenue in the first quarter of fiscal 2006 as we used our existing sales and marketing infrastructure to cover the larger customer base generated from our expanded sales and marketing activities and acquisitions. The increase in sales and marketing
expense in the first quarter of fiscal 2006 compared to the same period in fiscal 2005 is primarily the result of increasing our organizational investments in the United States and Europe, including personnel additions and targeted marketing
initiatives designed to stimulate growth in the thin client segment of the PC market, increased amortization and stock based compensation. Amortization of intangibles related to customer relationships was $315,000 in the first quarter of fiscal
2006 compared to $170,000 in the same period in fiscal 2005. We expect sales and marketing expenses to increase in absolute dollars in fiscal 2006, but to remain in the same range as fiscal 2005 as percentage of revenues as revenues grow.
Spending levels in any one quarter will vary depending upon the timing of individual marketing initiatives.


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Research and Development(in thousands):

Three
            Months Ended
      September 30,2005
    
    
    2004
    
    % ChangeResearch and development
    $
    1,295
    
    $
    664
    
    95
    %As a percentage of net revenues
    
    5
    %
    
    4
    % Research and development
      expenses consist primarily of salaries, related benefits,
    and other engineering related costs,and stock based compensation expense commencing in the first quarter of fiscal 2006. The increase in research and development expense in the first quarter of fiscal 2006 compared to the same period in fiscal 2005 is primarily the result
  of an increase in staff levels, including additional personnel from acquisitions and stock based compensation. We believe that a significant level of research and development investment is required to remain competitive and expect research and
  development expenses to increase in absolute dollars in fiscal 2006, but to remain relatively constant as percentage of revenues as revenues grow.


General and Administrative(in thousands):

|                                | Three Months Ended
 September 30, |       |   |  
|------------------------------- | --------------------------------- | ----- | - | -
|                                |                                   |       |   |  
|                                |                                   | 2005  |   |  
|                                |                                   |       |   |  
|General and administrative      | $                                 | 2,298 |   | $
|As a percentage of net revenues |                                   | 9     | % |  

General and administrative expenses consist primarily of salaries, related benefits, corporate insurance, such as director and officer liability insurance, fees related to the obligations of a
public company and fees for legal, audit and tax services,and stock based compensation expense commencing in the first quarter of fiscal 2006. The increase in general and
administrative expenses in the first quarter of fiscal 2006 compared to the same period in fiscal 2005 is primarily the result of the cost of stock-based compensation, an increase in staffing levels, increases in compensation levels and bonus
provisions based on financial results, and added costs for legal, accounting and compliance activities associated with audit, tax and compliance with Section 404 of the Sarbanes-Oxley Act. The increase in staffing levels reflects additional
personnel related to our organizational investments in executive management and other positions. We expect general and administrative expenses to increase in absolute dollars in fiscal 2006, but decline slightly as a percentage of revenues as
revenues grow.


Income Taxes(in thousands):

|                   | Three Months
	        Ended
September 30, |       |   |  
|------------------ | ----------------------------------------- | ----- | - | -
|                   |                                           |       |   |  
|                   |                                           | 2005  |   |  
|                   |                                           |       |   |  
|Income taxes       | $                                         | 1,047 |   | $
|Effective tax rate |                                           | 36    | % |  

Our effective tax rate in the first quarter of fiscal 2006 differed from the combined federal and state statutory rates due primarily to the non-deductible portion of stock based compensation
expense associated with ISOs commencing in the first quarter of fiscal 2006, partially offset by the tax benefit from the Extraterritorial Income Exclusion (EIE). The EIE provides a tax benefit by excluding a portion of income from
qualified foreign sales from gross income. In the September 2005 quarter we also benefited to a lesser extent from foreign income taxes in lower tax rate countries.


In October 2004 the EIE was repealed and will be phased out through calendar year 2006. As a result, we expect our effective tax rate to increase as the EIE is phased out over the next two
fiscal years; however, the impact of the manufacturing deduction for the Jobs Creation Act has not been determined at this time and that, along with other initiatives we may undertake, could have a favorable impact on our effective income tax rate
beginning in fiscal 2006. In addition, certain of our recent acquisitions are located in foreign tax jurisdictions which may have an impact on our overall effective tax rate. Based on these factors, we estimate that our effective tax rate (including
the impact of stock based compensation) will be 36% for fiscal 2006.


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Liquidity and Capital Resources

As of September 30, 2005, we had net working capital of $51.9 million compared to $50.4 million at June 30, 2005. Our principal sources of liquidity include $44.1 million of cash
and cash equivalents and short-term investments and an Offering Basis Loan Agreement with a bank under which we can request short-term loan advances up to an aggregate principal amount of $10 million. Upon such request, the bank would provide us
with the interest rate, terms and conditions applicable to the requested loan advance. The funds would be committed upon agreement of such terms by both parties. Unless otherwise agreed to by the bank, the term for any advance cannot exceed 180
days. There were no borrowings under the Offering Basis Loan Agreement during the first quarter of fiscal 2006.


Cash and cash equivalents and short-term investments
increased by $900,000 during the September 2005 quarter from June 30, 2005,
primarily as a result of operating cash flows and the  exercise of stock options
and related tax benefits, partially offset by purchases of property and equipment.
Subsequent to September 30, 2005, we completed the acquisition of the TeleVideo
thin client business which required the payment of $3.4
million of cash. During the quarter ended September 30, 2005, we recorded additional
goodwill and accrued expenses of $2.1
million representing the amount earned by the sellers of the Visara thin client
business pursuant to an earn-out arrangement based on revenues, as defined, measured
from the acquisition date, September 22, 2004, through September 30, 2005. We
expect
to pay this amount in November 2005.In
addition  we have other potential earn-out arrangements with recently completed
transactions. Generally these earn-outs are based on achieved levels of revenue
during the twelve months subsequent to completion of the transaction. In October
2005, we also
entered into a definitive agreement to acquire Maxspeed Corporation which is
expected to close by December 31, 2005 and will require a net cash payment at
closing of approximately $13.6 million.


Cash flows provided by operating activities:Our largest source of operating cash flows is payments from our customers for the purchase or
license of our products. Our primary uses of cash from operating activities are for the purchase of thin client appliances, software licenses, personnel related expenditures and marketing expenses. Cash flow from operating activities in the first
quarter of fiscal 2006 was $522,000 compared to $436,000 used in operations in the first quarter of fiscal 2005. The increase in cash flow from operating activities is primarily due to higher net income exclusive of non-cash charges,
including depreciation, amortization and stock-based compensation expense, and higher increases in accounts payable and decreases in prepaid expenses in the first quarter of fiscal 2006 versus the first quarter of fiscal 2005, partially offset by
income tax payments made during the first quarter of fiscal 2006.


Cash flows used in investing activities:The cash flows from investing activities in the first quarter of fiscal 2006 related primarily to
purchases and sales of short-term investments, which we typically purchase with surplus cash. During the first quarter of fiscal 2005 we used $3.8 million of cash to acquire the Visara thin client business.


Cash flows provided by financing activities:The cash flows from financing activities related primarily to the exercise of employee stock
options and related tax benefits.


Contractual Obligations

The following is a summary of our contractual obligations as of September 30, 2005 (in thousands):


|                             |   |        |  |   |       |  |   | 2007 and |  |   | 2009 and |  |   | 2011 and   | 
|---------------------------- | - | ------ |  | - | ----- |  | - | -------- |  | - | -------- |  | - | ---------- | 
|                             |   | Total  |  |   | 2006  |  |   | 2008     |  |   | 2010     |  |   | thereafter | 
|                             |   |        |  |   |       |  |   |          |  |   |          |  |   |            | 
|Product purchase obligations | $ | 8,146  |  | $ | 8,146 |  | $ | —        |  | $ | —        |  | $ | —          | 
|Operating leases             |   | 3,306  |  |   | 545   |  |   | 939      |  |   | 847      |  |   | 975        | 
|Other purchase obligations   |   | 970    |  |   | 970   |  |   | —        |  |   | —        |  |   | —          | 
|                             |   |        |  |   |       |  |   |          |  |   |          |  |   |            | 
|                             | $ | 12,422 |  | $ | 9,661 |  | $ | 939      |  | $ | 847      |  | $ | 975        | 
|                             |   |        |  |   |       |  |   |          |  |   |          |  |   |            | 

The above table excludes potential amounts under contractual
earn-outs related to our recent acquisitions and up to $1.0 million of contingent
amounts payable pursuant to arrangements with executive officers which provide
for severance
obligations in the event of a change in control. Subsequent
to September 30, 2005, we completed the acquisition of the TeleVideo thin client
business which required the payment of $3.4 million of
cash and entered into a definitive agreement to acquire Maxspeed which will require
a net cash payment at closing of approximately $13.6 million. Also, we expect
to pay the Visara earn-out consideration of $2.1 million in November 2005.


We expect to fund current operations and other cash expenditures through the use of available cash, cash from operations, funds available under our credit facility and, potentially, new debt or
equity financings. Management
believes that we will have sufficient funds from current cash, operations and
available financing to fund operations and cash expenditures for the foreseeable
future. We may seek additional sources of funding in order to fund acquisitions,
including using our ability to issue debt and equity securities
under our $100 million shelf registration, which was declared effective by
the SEC on September 29, 2003.


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Factors Affecting Neoware and Future Operating Results

Operating results for a particular future period are difficult to predict and, therefore, prior results are not necessarily indicative of results to be expected in future periods. Factors that
could have a material adverse effect on our business, results of operations, and financial condition include, but are not limited to, the following:


Our future results may be affected by industry trends and specific risks in our business. Some of the factors that could materially affect our future results include those described below.

During the past several years, we have increased operating expenses significantly as a foundation for us to stimulate growth in our market, and we expect to increase our operating expenses
during fiscal 2006. If we do not increase revenues or appropriately manage further increases in operating expenses, our profitability will suffer.


Our business has grown through both internal expansion and business acquisitions, and this has put pressure on our infrastructure, internal systems and managerial resources. The number of our
employees increased from 112 employees at September 30, 2004 to 142 employees at September 30, 2005. Our new employees include a number of senior executive officers and other key managerial, technical, sales and marketing personnel, as well as
international employees. To manage our growth effectively, we must continue to improve and expand our infrastructure, including operating and administrative systems and controls, and continue managing and integrating our personnel in an efficient
manner. Our business may be adversely affected if we do not integrate and train our new employees quickly and effectively and coordinate among our executive, engineering, finance, marketing, sales, operations and customer support organizations. In
addition, because of the growth of our international operations, we now have facilities located in multiple countries, and we have limited experience coordinating a geographically separated organization.


Although we have generated operating profits for the past four fiscal years,
we have a prior history of losses and may experience losses in the future, which
could result in the market price of our common stock
declining.

Although we have generated operating profits in the past several fiscal years, we incurred net losses in prior periods. We expect to continue to incur significant operating expenses. Our
operating expenses may increase in the future reflecting the hiring of additional key personnel as we continue to implement our growth strategy, including our plan to introduce new products to compete with PC-based solutions and other thin client
companies, and our planned investment in continuing to commercialize the technology we have acquired. As a result, we will need to generate significant revenues to maintain profitability. If we do not maintain profitability, the market price for our
common stock may decline.


Our financial resources may not be enough for our capital and corporate development needs, and we may not be able to obtain additional financing. A failure to maintain and increase our revenues
would likely cause us to incur losses and negatively impact the price of our common stock.


Our gross margins can vary significantly, based upon a variety of factors. If we are unable to sustain adequate gross margins we may be unable to reduce operating expenses in the short term, resulting in losses.

Our gross margins can
vary significantly from quarter to quarter depending on average selling prices,
fixed costs in relation to revenue levels and the mix of our business, including
the  percentage of revenues derived from thin client appliances, software, third
party products and consulting services. Our 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 PC market in which we compete remains
very competitive, and although we intend to continue our efforts to reduce the
cost of our products,there can be no certainty that we will not be required to reduce
prices of our products without compensating reductions in the cost to produce
our products in order to maintain or increase our market share or to meet competitors'
price  reductions. Our marketing strategy is targeted at increasing the size
of the thin client segment of the PC industry, in part by lowering prices to
make thin clients more competitive with personal computers, and in addition by
selling a larger
percentage of products to large enterprise customers, who typically demand lower
prices because of their volume purchases. This strategy has resulted in, and
may in the future result in, a decline in our gross margins. Additionally, we
have recently  introduced new products, including our Neoware e900 product line,
which has higher average selling prices but lower percentage grossmargins
than our traditional products. If our sales do not continue to increase as a
result of these strategies, our profitability will decline, and we may experience
losses.


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Our business is dependent on customer adoption of thin client appliances as an alternative to personal computers, and a decrease in their rates of adoption could adversely affect our ability to increase our
revenues.

We are dependent on the growing use of thin client appliances to perform discrete tasks for corporate and Internet-based networks to increase our revenues. If thin client appliances are not
  accepted by corporations as an alternative to personal computers, the result would be slower than anticipated revenue growth or even a decline in our revenues.


Thin client appliances have historically represented a very small percentage
of the overall PC market, and, if sales do not grow as a percentage of the PC
market, or if the overall PC market were to decline, our revenues may not grow
or may decline.


We may not be able to effectively compete against PC and thin client providers
as a result of their greater financial resources and brand awareness.

In the desktop PC market, we face significant competition from makers of traditional
personal computers, many of which are larger companies that have greater name
recognition than we have. In addition, we face significant competition from thin
client providers, including Hewlett Packard, Wyse Technology and other, smaller
companies. Increased competition may negatively affect our business and future
operating results by leading to price reductions, higher selling expenses or
a reduction in our market share. Our strategy to seek to increase our share of
the overall PC market by targeting our core markets may create increased pressure,
including pricing pressure, on certain of our thin client appliance products.
While we believe that this will enable us to increase our revenues, there is
no assurance that we will be successful in this approach. In fact, our implementation
of this strategy may result in reductions in gross and operating margins as we
compete to attract business. Our inability to successfully implement this strategy
could have an adverse impact on our revenues.


Our future competitive performance depends on a number of factors, including
our ability to:


| | • | continually
        develop and introduce new products and services with better prices and
        performance than offered
    by our competitors in the PC market;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                     
| | • | offer a wide range of products; and                                                                                                                                 
| |   |                                                                                                                                                                     
| | • | offer high-quality products and services.                                                                                                                           

If we are unable to offer products and services that compete successfully with
the products and services offered by our competitors in the PC market, our business
and our operating results would be harmed. In addition, if in responding to competitive
pressures, we are forced to lower the prices of our products and services and
we are unable to reduce our costs, our business and operating results would be
harmed.


We may not be able to successfully integrate future acquisitions we may
complete, which may materially adversely affect our growth and our operating
results.

As part of our business strategy, we frequently engage in discussions with third
parties regarding, and enter into agreements relating to, possible acquisitions,
strategic alliances and outsourcing transactions in order to further our business
objectives. In order to pursue this strategy successfully, we must identify suitable
candidates for these transactions, complete these transactions, some of which
may be complex, and manage post-closing issues such as the integration of acquired
companies or employees. Integration and other risks of acquisitions, strategic
alliances and outsourcing transactions can be more pronounced for more complicated
transactions, or if multiple transactions are pursued simultaneously. However,
if we fail to identify and complete successfully transactions that further our
strategic objectives, we may be required to expend resources to develop products
and technology internally, we may be at a competitive disadvantage or we may
be adversely affected by negative market perceptions, any of which may have a
material adverse effect on our revenue and selling, general and administrative
expenses.


Since June 2001, we have completed nine acquisitions and entered into an alliance
with IBM, and we plan to make additional acquisitions as part of our growth strategy.
There is no assurance that we will successfully integrate the three European
acquisitions we completed in the third and fourth quarters of fiscal year 2005,
the TeleVideo or pending Maxspeed acquisition or future acquisitions into our
business. We may be unable to retain key employees or key business relationships
of the acquired businesses, consolidate IT infrastructures, manage supply chain
integration, combine administrative, research and development and other operations
and combine product offerings, and integration of the businesses may divert the
attention and resources of our management. Our failure to successfully integrate
acquired businesses into our operations could have a material adverse effect
on our business, operating results and financial condition. Even if such acquisitions
are successfully integrated, we may not receive the expected benefits of the
transactions if we find that the acquired business does not further our business
strategy or that we paid more than what the business was worth. Managing acquisitions
and alliances requires management resources, which may divert our attention from
other business operations. As a result, the effects of any completed or future
transactions on financial results may differ from our expectations. During fiscal
2004, we spent approximately $1.6 million pursuing acquisitions that we did
not complete. We intend to continue to pursue acquisitions, and if we do not
complete them, the cost of pursuing acquisitions will impact our profitability.




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Our ability to accurately forecast our quarterly sales is limited, although our costs are relatively fixed in the short term, and we expect our business to be affected by rapid technological change, which may
adversely affect our quarterly operating results.

Our ability to accurately forecast our quarterly sales is limited, which makes
      it difficult to predict the quarterly revenues that we will recognize.
      In addition, most of our costs are for personnel and facilities, which
      are relatively fixed in the short term. If we have a shortfall in revenues
      in relation to our expenses, we may be unable to reduce our expenses quickly
      enough to avoid losses. As a result, our quarterly operating
results could fluctuate.


Future operating results will continue to be subject to quarterly fluctuations
based on a wide variety of factors, including:


| | • | Linearity  Our quarterly sales have historically
          reflected a pattern in which a disproportionate percentage of sales
          occur in the last month of the quarter. This pattern makes prediction
          of revenues and earnings for each financial period especially difficult
          and uncertain and increases the risk of unanticipated variations in
          quarterly results and financial
condition;                                                                                                                                                                                                                                                                                                                         
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | • | Significant Orders  We are subject to
          variances in our quarterly operating results because of the fluctuations
          in the timing of our receipt of large orders. If even a small number
          of large orders are delayed until after a quarter ends, our operating
          results could vary substantially from quarter to quarter and net income
          could be substantially less than expected. Conversely, if even a small
          number of large orders are completed in an earlier quarter than that
          which was anticipated, our revenues and net income could be substantially
          higher than expected, making it possible that sales and net income
      in future periods may decline sequentially;
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | • | Seasonality  We have experienced
          seasonal reductions in business activity in some quarters based upon
          customer activity and based upon our partners seasonality. This
          pattern has generally resulted in lower sales in our first and third
          quarters
than in the prior sequential quarters; and                                                                                                                                                                                                                                                                                                                                                                                                                     
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | • | Stock based compensation expense  Starting
          in the quarter ending September 30, 2005, we began recording stock-based
          compensation expense as calculated under SFAS No. 123R. We expect the
          non-cash impact of stock based compensation expense during fiscal 2006
          to be in the range of $2.5 to $3.0 million. Such amounts may
          change as a result of additional grants, forfeitures, modifications
      in assumptions and other factors.                                                                                                                                                                                                                                                                 

There are factors
    that may affect the market acceptance of our products, some of which are
beyond our control, including the following:


| | • | the growth and changing requirements of the
    thin client segment of the PC market;                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                   
| | • | the quality, price, performance and total
    cost of ownership of our products compared to personal computers;                                                   
| |   |                                                                                                                                                                   
| | • | the availability, price, quality and performance
    of competing products and technologies; and                                                                  
| |   |                                                                                                                                                                   
| | • | the successful development of our relationships
        with software providers, original equipment manufacturers and existing
    and potential channel partners.

We may not succeed
    in developing and marketing our software and thin client appliance products
and our operating results may decline as a result.


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Because some of our products use embedded
        versions of Microsoft Windows as their operating system, an inability
        to license these operating systems on favorable terms could impair our
        ability to introduce new
products and maintain market share.

We may not be able to introduce new products on a timely basis because some of our products use embedded versions of Microsoft Windows as their operating system. Microsoft provides Windows to
  us, and we do not have access to the source code for certain versions of the Windows operating system. If Microsoft fails to continue to enhance and develop its embedded operating systems, or if we are unable to license these operating systems on
favorable terms, our operations may suffer.


Because some of our products use Linux as their operating system, the failure of Linux developers to enhance and develop the Linux kernel could impair our ability to release new products and maintain market
share.

We may not be able to release new products on a timely basis because some of our products use Linux as their operating system. The heart of Linux, the Linux kernel, is maintained by third
  parties. If this group of developers fails to further develop the Linux kernel, we would have to either rely on another party to further develop the kernel or develop it ourselves, which would increase our costs and slow our development efforts.


Actions taken by the SCO Group (SCO) could impact the sale of our Linux products, negatively affecting sales of some of our products.

SCO has taken legal action against
    IBM and certain other corporations, and sent letters to Linux customers alleging
    that certain Linux kernels infringe on SCO's Unix intellectual property and
    other rights, and that SCO intends to aggressively protect those rights.
    While we are not a party to any legal proceeding with SCO, since some of
    our products use Linux as their operating system, SCO's allegations, regardless
    of merit, could
  adversely affect sales of such products. SCO has brought claims against certain
    end user customers of the Linux operating system and threatened to bring
    claims against other end-users of Linux for copyright violations arising
    out of the facts alleged in SCOs lawsuit against IBM. Some of these
    claims could be indemnified under indemnities we have given or may give to
    certain customers. In the event that claims for indemnification are brought
    against the customers that we have indemnified, we could incur expenses reimbursing
the customers for their costs, and if the claims were successful, for damages.


Because we depend on sole source, limited source and foreign source suppliers for the design and manufacture of our thin client products and for key components in our thin client appliance products, we are
  susceptible to supply shortages that could prevent us from shipping customer orders on time, if at all, and result in lost sales. In addition, our outsourcing activities for other functions may fail to reduce costs and may disrupt
operations.

We depend upon single source suppliers for the design and manufacture of our thin client appliance products and for several of the components in them. We also depend on limited sources to
  supply several other industry standard components. The third party designers and manufacturers of our thin client products have access to our intellectual property which increases the risk of infringement or misappropriation of this intellectual
property.


We primarily rely on foreign suppliers, which subjects us to risks associated with foreign operations such as the imposition of unfavorable governmental controls or other trade restrictions,
  changes in tariffs, political instability and currency fluctuations. A weakening dollar could result in greater costs to us for our components. Severe Acute Respiratory Syndrome and similar medical crises could also disrupt manufacturing processes
and result in quarantines being imposed in the future.


We have in the past experienced
    and may in the future experience shortages of, or difficulties in acquiring,
    certain components. A significant portion of our revenues is derived from
    the sale of thin client appliances that are bundled with our software. Third
    parties design and produce these thin client appliances for us, and we typically
    do not have long-term supply contracts with them obligating them to continue
    producing products for
  us. The absence of such agreements means that, with little or no notice, these
    suppliers could refuse to continue to manufacture all or some of our products
    that we require or change the terms under which they manufacture our products.
    If our suppliers were to stop manufacturing our products, we might be unable
    to replace the lost manufacturing capacity on a timely basis. If we experience
    shortages of these products, or of their components, we may not be able to
    deliver our products to
  our customers, and our revenues would decline. If these suppliers were to change
    the terms under which they manufacture for us, our manufacturing costs could
    increase and our cost of revenues could increase, resulting in a decline
    in gross margins. If we were unable to adequately address the supply issues,
    we might have to reengineer some products resulting in further costs and
    delays. In addition, a failure of our suppliers to maintain their viability
    and financial condition could result in
  changes in payment and other terms of our relationships and their inability
    to produce and deliver our products on time and in sufficient quantities.
    During fiscal year 2005, we accommodated one of our suppliers by purchasing
    products for inventory in advance of our contractual obligations due to the
    suppliers cash liquidity constraints which increased inventory and decreased cash balances. Additionally, a new domestic supplier required an advance payment of $1.1
million at June 30, 2005, which was recorded as aprepaid
expense, to fund a portion of the initial start up production quantities related
to a larger order.




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In addition to using third party suppliers for the manufacture of our products and supply of our components, to achieve additional cost savings or operational benefits, we have expanded, and
  may in the future expand, our outsourcing activities where we believe a third party may be able to provide those services in a more efficient manner. In fiscal year 2005, we entered into an agreement with a company located in India under which they
  provide software development services to us. To the extent that we rely on partners or third party service providers for the provision of software development services and key business process functions, we may incur increased business continuity
  risks. We may no longer be able to exercise control over some aspects of software development and the development, support or maintenance of operations and processes, including the internal controls associated with our business operations and
  processes, which could adversely affect our business.If we are unable to effectively develop and implement our outsourcing strategy, we may not realize cost structure
  efficiencies and our operating and financial results could be materially adversely affected. In addition, if our third party service providers experience business difficulties or are unable to provide the services as anticipated, we may need to seek
alternative service providers or resume providing such services internally which could be costly and time consuming and have an adverse material effect on our operating and financial results.


If we are unable to continue generating substantial revenues from international sales and effectively managing our international operations our business could be adversely affected.

We derive a substantial portion of our revenue from international sales primarily in Europe, Middle East and Africa (EMEA). Our EMEA activities accounted for approximately 35% of revenues for
  the 2005 fiscal year. In addition, a portion of our operations consists of manufacturing, software and product development, and sales activities outside of the U.S.Our ability
  to sell our products and conduct our operations internationally is subject to a number of risks. General economic and political conditions in each country could adversely affect demand for our products and services in these markets. We may also
  experience reduced intellectual property and contract rights protection as a result of different business practices in certain countries, which could have an adverse effect on our business and financial results. Although most of our international
  sales are denominated in U.S. Dollars, currency exchange rate fluctuations could result in lower demand for our products or lower pricing resulting in reduced revenue and margins, as well as currency translation losses. In addition, a weakening
dollar has resulted in increased costs for our international operations, and could result in greater costs for our international operations in the future.


Changes to and compliance with a variety of foreign laws and regulations may increase our cost of doing business in these jurisdictions. We incur additional legal compliance costs associated
  with our international operations and could become subject to legal penalties in foreign countries if we do not comply with local laws and regulations which may be substantially different from those in the United States. In many foreign countries,
  particularly those with developing economies, it is common to engage in business practices that are prohibited by United States regulations applicable to us, such as the Foreign Corrupt Practices Act, and any violations of such laws by our employees
  or contractors could have a material adverse effect on our business. Trade protection measures and import and export licensing requirements subject us to additional regulation and may prevent us from shipping products to a particular market, and
  increase our operating costs. In addition, our future results could be adversely affected by difficulties in staffing and managing our international operations, which have significantly expanded and become more complex as a result of the European
acquisitions completed in the third and fourth quarters of fiscal year 2005.


Because we rely on distributors, IBM and Lenovo to sell
our products, our revenues could be negatively impacted if these companies do
not continue to purchase products from us.

We cannot be certain that we will be able to attract or retain distributors to market our products effectively or provide timely and cost-effective customer support and service. None of our current distributors, including
  IBM or Lenovo, is obligated to continue selling our products or to sell our new products. We cannot be certain that any distributors will continue to represent our products or that our distributors will devote a sufficient amount of effort and
  resources to selling our products in their territories. We need to expand our indirect sales channels, and if we fail to do so, our growth could be limited. A number of our distributors in turn distribute via their own networks of channel partners
with whom we have no direct relationship. Our distribution channel could be affected by disruptions in the relationships of and with our channel partners and their networks.


We derive a substantial portion of
      our revenue from sales made directly to IBM customers through Lenovoand
  through our other distributors. A significant portion of our other revenue
      is derived from sales to resellers. If Lenovo or our distributors were
      to discontinue
  sales of our products or reduce their sales efforts, it could adversely affect
  our operating
  results. In addition, there can be no assurance as to the continued viability
and financial condition of our distributors.




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As a result of our alliance with IBM and Lenovo,
    we rely on the parties for distribution of our products to their customers.
    Sales directly to IBM and Lenovo accounted for 19% of our net sales during
    fiscal 2005. IBM and Lenovo are under no obligation to continue to actively
    market our products. In addition to our direct sales to IBM and Lenovo, IBM
    and Lenovo can purchase our products through individual distributors and/or
    resellers.
Furthermore, IBM can influence an end-users decisions to purchase our products
even though the end-user may not purchase our products through IBM or Lenovo.
While it is difficult to quantify the net revenues associated with these purchases
we believe that these sales could be significant and can vary significantly from
quarter to quarter.


Our business may suffer if it is alleged or found that we have infringed
the intellectual property rights of others.

In the course of our business, third parties may claim that we are infringing upon their intellectual property rights. We evaluate the validity of the claims and determine whether we will
negotiate licenses to use the technology. Even if we believe that the claims are without merit, responding to such claims could be time consuming, result in costly litigation, divert management's attention and resources and cause us to incur
significant expenses. There is no assurance, in the event of such claims, that we would be able to enter into a licensing arrangement on acceptable terms or that litigation would not occur. In the event that there were a temporary or permanent
injunction entered prohibiting us from marketing or selling certain of our products, or a successful claim of infringement against us requiring us to pay royalties to a third party, and we failed to develop or license a substitute technology, our
business, results of operations or financial condition could be materially adversely affected.


In addition, certain products or technologies developed by us, including for
example the Linux-based products, may incorporate so-called open source software.
Open source software is typically licensed for use at no initial charge, but
certain open source software licenses impose on the licensee of the applicable
open source software certain requirements to license or make available to others
both the open source software as well as the software that relates to, or interacts
with, the open source software. Our ability to commercialize products or technologies
incorporating open source software may be restricted as a result of using such
open source software because, among other
reasons:


| | • | open source license terms may be ambiguous
        and may result in being subject to unanticipated obligations regarding
    our products and technologies;                                          
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                       
| | • | competitors may have improved access to
    information that may help them develop competitive products;                                                                                              
| |   |                                                                                                                                                                                                       
| | • | open source software cannot be protected
    under trade secret law; and                                                                                                                              
| |   |                                                                                                                                                                                                       
| | • | it may be difficult for us to accurately determine
        the origin of the open source code and whether the open source
        software in fact infringes third party intellectual property
rights.

Thin client appliance products, like personal
        computers, are subject to rapid technological change due to changing
        operating system software and network hardware and software configurations,
        and our products
could be rendered obsolete by new technologies.

The PC market is characterized by rapid technological change, frequent new product introductions, uncertain product life cycles, changes in customer demands and evolving industry standards. Our
products could be rendered obsolete if products based on new technologies are introduced or new industry standards emerge.


We may not be able to preserve the value of our products' intellectual
property because we do not have any patents and other vendors could challenge
our other intellectual property rights.

Our products are differentiated
from those of our competitors by our internally developed technology that is
incorporated into our products. We rely upon patent, copyright, trademark and
trade secret laws in the United States and similar laws in other countries, and
agreements with our employees, customers, suppliers and other parties, to establish
and maintain our intellectual property rights. However, any of our intellectual
property
rights could be challenged, invalidated or circumvented, which could result in
costly product redesign efforts, discontinuance of certain product offerings
or other competitive harm. Further, the laws of certain countries do not protect
our proprietary rights to the same extent as do the laws of the United States.
Therefore, in certain jurisdictions in which we operate or in which we have outsourced
operations we may be unable to protect our proprietary technology adequately
against
unauthorized third-party copying or use, which could adversely affect our competitive
position and cause us to incur substantial legal fees. If we are unable to protect
our intellectual property, other vendors could sell products with features similar
to ours, and this could reduce demand for our products, which would harm our
operating results.


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We may repatriate cash from our foreign
          subsidiaries, which could result in additional income taxes that could
          negatively impact our results of operations and financial position.
        In addition, if foreign
  countries currency policies limit our ability to repatriate the needed
funds, our business and results of operations could be adversely impacted.

One or more of our foreign subsidiaries may hold a portion of our cash and cash equivalents. If we need additional cash to acquire assets or technology, or to support our operations in the United States, and if the
  currency policies of these foreign countries allow us, we may repatriate some of our cash from these foreign subsidiaries to the United States. Depending on our financial results and the financial results of our subsidiaries at the time that the
  cash is repatriated, we may incur additional income taxes from the repatriation, which could negatively affect our results of operations and financial position. In addition, if the currency policies of these foreign countries prohibit or limit our
ability to repatriate the needed funds, our business and results of operations could be adversely impacted.


Unforeseen environmental costs could impact our future earnings.

The European Union (EU) has adopted two directives to facilitate the recycling of electrical and electronic equipment sold in the EU. The first of these is the Waste Electrical and
Electronic Equipment (WEEE) directive, which directs EU member states to enact laws, regulations and administrative provisions to ensure that producers of electrical and electronic equipment are financially responsible for specified
collection, recycling, treatment, and environmentally sound disposal of products placed on the market after August 13, 2005, and from products in use prior to that date that are being replaced. The EU has also adopted the Restriction on the Use of
Certain Hazardous Substances in Electrical and Electronic Equipment (RoHS)
directive. The RoHS directive restricts the use of lead, mercury, and certain
other substances in electrical and electronic products placed on the market in
the European Union after July 1, 2006. We are currently evaluating the impact
of these directives. Similar legislation has been or may be enacted in other
areas, including in the United States, the cumulative impact of which could be
significant if we
are unable to recover these costs in the price of our product.


We may not be able to attract software developers to bundle their products
with our thin client appliances.

Our thin client appliances include our own software, plus software from other companies for specific markets. If we are unable to attract software developers, and are unable to include their
software in our products, we may not be able to offer our thin client appliances for certain important target markets, and our financial results will suffer.


In order to continue to grow our revenues, we may need to hire additional
personnel.

In order to continue to develop and market our line of thin client appliances, we may need to hire additional personnel. Competition for employees is significant and we may experience
difficulty in attracting qualified people.


Future growth that we may experience will place a significant strain on our management, systems and resources. To manage the anticipated growth of our operations, we may be required
to:


| | • | improve existing and implement new operational,
        financial and management information controls, reporting
    systems and procedures;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                             
| | • | hire, train and manage additional qualified
    personnel; and                                                                              
| |   |                                                                                                                                             
| | • | establish relationships with additional suppliers
    and partners while maintaining our existing relationships.                            

We rely on the services of certain key personnel,
        and those persons' knowledge of our business and technical expertise
would be difficult to replace.

Our products, technologies and operations are complex and we are substantially dependent upon the continued service of our existing personnel. The loss of any of our key employees could
adversely affect our business and profits and slow our product development processes. Except for our Chairman and CEO, we generally do not have employment agreements with our key employees. We do not maintain key person life insurance on any of our
employees.


Recent and proposed regulations related to equity compensation could adversely
affect our ability to attract and retain key personnel and affect our operating
results.

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We have historically used stock options as a key
    component of our employee compensation program. We believe that stock options
    and other long-term equity incentives directly motivate our employees to
    maximize long-term stockholder value, and, through the use of vesting, encourage
    employee retention and allow us to provide competitive compensation packages,
    although in recent periods many of our employee stock options have had
exercise prices in excess of our stock price, which could affect our ability
    to retain or attract present and prospective employees. The adoption of Statement
    of Financial Accounting Standards No. 123 (revised 2004), Share-Based
    Payment(SFAS No. 123R) requires all share-based payments to employees, including grants of stock options, to be recognized in the financial statements based on their fair
values beginning with the first annual period beginning after June 15, 2005. We adopted SFAS No. 123R in the first quarter of fiscal 2006 and expect that it will have a material impact on our financial statements. In addition, new regulations
implemented by The Nasdaq National Market requiring stockholder approval for all stock option plans, as well as new regulations implemented by the New York Stock Exchange prohibiting NYSE member organizations from voting on equity-compensation plans
unless the beneficial owner of the shares has given voting instructions, could make it more difficult for us to grant options to employees in the future. As a result of these new regulations, it may be more difficult or expensive for us to grant
options to employees, we will incur increased cash compensation costs, and we may change our equity compensation strategy, which may make it more difficult to attract, retain and motivate employees, each of which could materially and adversely
affect our business.


In the event we are unable to satisfy regulatory requirements relating
to internal controls over financial reporting, or if these internal controls
are not effective, our business and financial results may
suffer.

The Sarbanes-Oxley Act of 2002 and newly enacted
    rules and regulations of the Securities and Exchange Commission and the National
    Association of Securities Dealers impose new duties on us and our executives,
    directors, attorneys and independent registered public accountants. In order
    to comply with the Sarbanes-Oxley Act and such new rules and regulations,
    we have recently completed our evaluation of our internal controls over financial
    reporting to allow management to report on, and our independent registered
    public accounting firm to attest to, our internal controls over financial
    reporting. As a result, we have incurred additional expenses and diversion
    of managements
time, which has materially increased our operating expenses and accordingly reduced
    our net income. While our evaluation resulted in our conclusion that as of
    June 30, 2005 our internal controls over financial reporting were effective,
    we cannot be
certain as to the outcome of our testing in future periods.If
our independent registered public accounting firm is not satisfied with our internal
controls over financial reporting or the level at which these controls are documented,
designed, operated or reviewed, or if our independent registered public accounting
firms interpretation of the requirements, rules or regulations are different than ours in the
future, then they may decline to attest to managements assessment or issue an adverse opinion on managements
assessment and/or our internal controls over financial reporting. This could
result in an adverse reaction in the financial marketplace due to a loss of investor
confidence in the reliability of our financial statements, which ultimately could
negatively impact the market price of our shares.


Errors in our products could harm our business and our operating results.

Because our software and thin client appliance products are complex, they could contain errors or bugs that can be detected at any point in a product's life cycle. Although many of these errors
may prove to be immaterial, any of these errors could be significant. Detection of any significant errors may result in:


| | • | the loss of or delay in market
    acceptance and sales of our products;
| | - | ------------------------------------------------------------------------
| |   |                                                                         
| | • | diversion of development resources;                                     
| |   |                                                                         
| | • | injury to our reputation; or                                            
| |   |                                                                         
| | • | increased maintenance and warranty
    costs.                           

These problems could harm our business and future operating results. Occasionally, we have warranted that our products will operate in accordance with specified customer requirements. If our
products fail to conform to these specifications, customers could demand a refund for the purchase price or assert claims for damages.


Moreover, because our
products are used in connection with critical distributed computing systems services,
we may receive significant liability claims if our products do not work properly.
Our agreements with customers typically contain provisions intended to limit
our exposure to liability claims. However, these limitations may not preclude
all potential claims. Liability claims could require us to spend significant
time and money in
litigation or to pay significant damages. Any such claims, whether or not successful,
could seriously damage our reputation and our business.


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If our contracts with Citrix and other vendors of software applications were terminated, our IT services business would be materially adversely affected.

We depend on third-party suppliers to provide us with key software applications in connection with our IT services business. If such contracts and relationships were terminated, our revenues
would be negatively affected.


Our stock price can be volatile.

Our stock price, like that of other technology companies, can be volatile. For example, our stock price can be affected by many factors such as quarterly increases or decreases in our revenues
or earnings, changes in revenues or earnings estimates or publication of research reports by analysts; speculation in the investment community about our financial condition or results of operations and changes in revenue or earnings estimates,
announcement of new products, technological developments, alliances, acquisitions or divestitures by us or one of our competitors or the loss of key management personnel. In addition, general macroeconomic and market conditions unrelated to our
financial performance may also affect our stock price.


Provisions in our charter documents and Delaware law may delay or prevent
acquisition of us, which could decrease the value of your shares.

Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it harder for a third party to acquire us without the consent of our board of directors. These
provisions include advance notice procedures with respect to stockholder proposals and the nomination of candidates for election as directors. Delaware law also imposes some restrictions on mergers and other business combinations between us and any
holder of 15% or more of our outstanding common stock.


The issuance of additional equity securities may have a dilutive effect
on our existing stockholders and could lead to a decline in the price of our
common stock.

Any additional issuance of equity securities, including for acquisitions, may
have a dilutive effect on our existing stockholders. In addition, the perceived
risk associated with the possible sale of a large number of shares could cause
some of our stockholders to sell their stock, thus causing the price of our stock
to decline. Subsequent sales of our common stock in the open market or the private
placement of our common stock or securities convertible into common stock could
also have an adverse effect on the market price of the shares. If our stock price
declines, it may be more difficult or we may be unable to raise additional capital.


Forward-Looking Statements

This quarterly report on Form 10-Q contains statements
    that are forward-looking statements within the meaning of the Private Securities
    Litigation Reform Act of 1995, such as statements regarding: our expectation
    to grow the company organically and through acquisitions; the expansion of
    our geographic reach and distribution channels; our expectations regarding
    revenues, gross margins, operating expenses, research and development
expenses, sales and marketing expenses, general and administrative expenses and
    our effective tax rate for fiscal 2006; our acquisition of businesses and
    technologies; future strategic partnerships; our expectation of stock-based
    compensation for the balance of fiscal 2006; the closing of the Maxspeed
    acquisition; the availability of cash or other financing sources to fund
    future operations; cash expenditures and acquisitions, and our potential
    issuance of debt and equity securities under
our $100 million shelf registration. These forward-looking statements involve risks and uncertainties. The factors set forth below, and those contained in "Factors Affecting the Company and Future Operating Results" and
set forth elsewhere in this report, could cause actual results to differ materially
from those predicted in any such forward-looking statement. Factors that could
affect our actual results include our ability to maintain our relationship with
IBM, Lenovo and other
partners, the timing and receipt of future orders, our timely development and customers' acceptance of our products, pricing pressures, rapid technological changes in the
industry, growth of overall thin client sales through the capture of a greater portion of the PC market, increased competition, our ability to attract and retain qualified personnel, the economic viability of our suppliers and channel partners,
adverse changes in customer order patterns, our ability to identify and successfully consummate and integrate future acquisitions, including the Maxspeed acquisition, adverse changes in general economic conditions in the U. S. and internationally,
risks associated with foreign operations and political and economic uncertainties associated with current world events.


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Item 3.   Quantitative and Qualitative Disclosures
About Market Risk

We earn interest income from our balances of cash, cash equivalents and short-term investments. This interest income is subject to market risk related to changes in interest rates that
primarily affects our investment portfolio. We invest in instruments that meet high credit quality standards, as specified in our investment policy.


As of September 30, 2005 and June 30, 2005, cash equivalents and short-term investments consisted primarily of corporate notes and government securities, certificates of deposit, auction rate
securities and other specific money market instruments of similar liquidity and credit quality. Due to the conservative nature of our investment portfolio, a sudden change in interest rates would not have a material effect on the value of the
portfolio.


We have operations in the United Kingdom, Germany,
    France, Austria, Sweden and Australia that are subject to foreign currency
    fluctuations. As currency rates change, translation of the foreign
entities statements of operations from local currencies to U.S. dollars affects year-to-year comparability of operating results. Additionally, we have investments in each of these countries for which we recognize unrealized gains and losses
through other comprehensive income within stockholders equity for foreign
currency fluctuations.


Item 4.   Controls and Procedures

Under the supervision and with the participation
    of the Companys Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of our disclosure
controls and procedures; as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of September 30, 2005 (the Evaluation Date). Based on the evaluation performed, our Chief Executive Officer
and Chief Financial Officer have concluded that, as of the Evaluation Date, the Companys disclosure controls and procedures were effective in recording, processing, summarizing and reporting in the periods specified in the SECs
rules and forms the information required to be disclosed by the Company in its
reports filed or furnished under the Exchange Act.


There have not been any changes in our internal control over financial reporting during the quarter ended September 30, 2005 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.


PART II.   OTHER INFORMATION

Item 6.   Exhibits

The following exhibits are being filed as part of this quarterly report on Form
10-Q:


|Exhibit |  |                                                                                                  
|------- |  | -------------------------------------------------------------------------------------------------
|Numbers |  | Description                                                                                      
|        |  |                                                                                                  
|31.1    |  | Certification of Michael Kantrowitz as Chairman, President and Chief Executive Officer of Neoware
|        |  | Systems, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                          
|        |  |                                                                                                  
|31.2    |  | Certification of Keith D. Schneck as Executive Vice President and Chief Financial Officer of     
|        |  | Neoware Systems, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                  
|        |  |                                                                                                  
|32.1    |  | Certification of Michael Kantrowitz as Chairman, President and Chief Executive Officer of        
|        |  | Neoware Systems, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                  
|        |  |                                                                                                  
|32.2    |  | Certification Keith D. Schneck as Executive Vice President and Chief Financial Officer of Neoware
|        |  | Systems, Inc pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                           

33


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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:  November
         9, 2005 | By: /s/ MICHAEL KANTROWITZ                          
|                                 | Michael Kantrowitz                                  
|                                 | Chairman, President and Chief Executive Officer     
|                                 |                                                     
|                                 |                                                     
|Date: 
November 9, 2005          | By: /s/ KEITH D. SCHNECK                            
|                                 | Keith D. Schneck                                    
|                                 | Executive Vice President and Chief Financial Officer

34

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