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

**Form 10-Q**

| (Mark One) |
|------------|
|            | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE         SECURITIES EXCHANGE ACT OF 1934** |
|       |   |
|       | **For the Quarter ended December 31, 2004** |
|       |   |
|            | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE         SECURITIES EXCHANGE ACT OF 1934** |
|       |   |
|       | **For the transition period from _______ to ________.** |

**Commission File Number: 000-21240**

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

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

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

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

__________________________________________ 

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

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

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

|  |
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**NEOWARE SYSTEMS, INC.****INDEX**

| **PART I.**  | **FINANCIAL INFORMATION**                                                      |          |        |
|--------------|--------------------------------------------------------------------------------|----------|--------|
|         |                                                                           | **Page** |   |
|         |                                                                           |          |   |
| Item 1.      | Consolidated Financial Statements (unaudited)                                  |          |        |
|              | Condensed Consolidated Balance Sheet as of December 31, 2004 and June 30, 2004 | 3        |        |
|              | Consolidated Statement of Operations for the Three and Six    Months Ended     | 4        |        |
|              | December 31, 2004        and 2003                                              |          |        |
|              | Consolidated Statement of Cash Flows for the Three and Six    Months Ended     | 5        |        |
|              | December 31, 2004        and 2003                                              |          |        |
|              | Notes to Consolidated Financial Statements                                     | 6        |        |
|         |                                                                           |     |   |
| Item 2.      | Management's Discussion and Analysis of Financial Condition and                | 13       |        |
|              | Results of Operations.                                                         |          |        |
|         |                                                                           |     |   |
| Item 3.      | Quantitative and Qualitative Disclosures About Market Risk                     | 27       |        |
|         |                                                                           |     |   |
| Item 4.      | Controls and Procedures                                                        | 27       |        |
|         |                                                                           |     |   |
| **PART II.** | **OTHER INFORMATION**                                                          |          |        |
|         |                                                                           |     |   |
| Item 4.      | Submission of Matters to a Security Holder                                     | 27       |        |
| Item 5.      | Other Information                                                              | 27       |        |
| Item 6.      | Exhibits                                                                       | 28       |        |
| Signatures   |                                                                                | 29       |        |

----

**NEOWARE SYSTEMS, INC.**

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

| **ASSETS**                                    | **December 31,    2004** |   | **June 30,    2004** |   |
|-----------------------------------------------|--------------------------|--------|----------------------|--------|
|                                          |                          |   |                      |   |
| Current assets:                               |                     |   |                 |   |
| Cash and cash equivalents                     | $                        | 36,286 |                 | $      | 17,119 |   |
| Short-term investments                        |                     | 16,226 |                 |   | 38,177 |   |
| Accounts receivable,    net                   |                     | 13,322 |                 |   | 10,580 |   |
| Inventories                                   |                     | 3,847  |                 |   | 795 |   |
| Prepaid expenses and    other                 |                     | 833    |                 |   | 1,628 |   |
| Deferred income taxes                         |                     | 643    |                 |   | 643 |   |
|                                          |                          |        |                 |        |  |   |
| Total current assets                          |                     | 71,157 |                 |   | 68,942 |   |
|                                          |                     |   |                 |   |   |   |
| Property and equipment, net                   |                     | 445    |                 |   | 509 |   |
| Goodwill                                      |                     | 20,177 |                 |   | 17,466 |   |
| Intangibles, net                              |                     | 4,656  |                 |   | 3,545 |   |
| Deferred income taxes                         |                     | 145    |                 |   | 145 |   |
|                                          |                          |        |                 |        |  |   |
|                                          | $                        | 96,580 |                 | $      | 90,607 |   |
|                                          |                          |        |                 |        |  |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY** |                     |   |                 |   |   |   |
| Current liabilities:                          |                     |   |                 |   |   |   |
| Accounts payable                              | $                        | 4,326  |                 | $      | 5,685 |   |
| Accrued compensation    and benefits          |                     | 1,792  |                 |   | 1,534 |   |
| Other accrued expenses                        |                     | 1,778  |                 |   | 1,071 |   |
| Income taxes payable                          |                     | 1,771  |                 |   | 854 |   |
| Deferred revenue                              |                     | 982    |                 |   | 739 |   |
|                                          |                          |        |                 |        |  |   |
| Total current liabilities                     |                     | 10,649 |                 |   | 9,883 |   |
|                                          |                     |   |                 |   |   |   |
| Deferred revenue                              |                     | 278    |                 |   | 235 |   |
|                                          |                          |        |                 |        |  |   |
| Total liabilities                             |                     | 10,927 |                 |   | 10,118 |   |
|                                          |                          |        |                 |        |  |   |
|                                          |                     |   |                 |   |   |   |
| Stockholders’ equity:                    |                     |   |                 |   |   |   |
| Preferred stock                               |                     | — |                 |   | — |   |
| Common stock                                  |                     | 16     |                 |   | 16 |   |
| Additional paid-in    capital                 |                     | 72,574 |                 |   | 71,718 |   |
| Accumulated other    comprehensive income     |                     | 1,791  |                 |   | 936 |   |
| Treasury stock, 100,000    shares at cost     |                     | (100   | )                    |   | (100 | ) |
| Retained earnings                             |                     | 11,372 |                 |   | 7,919 |   |
|                                          |                     |        |                      |   |  |  |   |
| Total stockholders’ equity               |                     | 85,653 |                 |   | 80,489 |   |
|                                          |                          |        |                 |        |  |   |
|                                          |                     | $      | 96,580               |   | $ | 90,607 |   |
|                                          |                     |        |                      |   |  |  |   |

See accompanying notes to consolidated financial statements.

3 

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**NEOWARE SYSTEMS, INC.**

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

|                                                    | **Three Months Ended    December 31,** |   | **Six Months Ended    December 31,** |   |
|---------------------------------------------------------|----------------------------------------|--------|--------------------------------------|--------|
|                                                    |                                        |   |                                      |   |
|                                                    | **2004**                               |   | **2003**                             |   | **2004** |   | **2003** |   |
|                                                    |                                        |   |                                      |   |  |   |  |   |
| Net revenues                                            | $                                      | 20,471 |                                 | $      | 15,322 |   | $ | 36,774 |   | $ | 30,336 |   |
| Cost of revenues                                        |                                   | 11,726 |                                 |   | 7,684 |   |   | 20,938 |   |   | 14,733 |   |
|                                                    |                                        |        |                                 |        |  |   |  |  |   |  |  |   |
|    Gross profit                          |                                   | 8,745  |                                 |   | 7,638 |   |   | 15,836 |   |   | 15,603 |   |
|                                                    |                                        |        |                                 |        |  |   |  |  |   |  |  |   |
|                                                    |                                   |   |                                 |   |   |   |   |   |   |   |   |   |
| Sales and marketing                                     |                                   | 3,178  |                                 |   | 3,377 |   |   | 6,281 |   |   | 6,342 |   |
| Research and development                                |                                   | 769    |                                 |   | 687 |   |   | 1,433 |   |   | 1,408 |   |
| General and administrative                              |                                   | 1,647  |                                 |   | 1,478 |   |   | 3,005 |   |   | 2,935 |   |
|                                                    |                                        |        |                                 |        |  |   |  |  |   |  |  |   |
|    Operating expenses                    |                                   | 5,594  |                                 |   | 5,542 |   |   | 10,719 |   |   | 10,685 |   |
|                                                    |                                        |        |                                 |        |  |   |  |  |   |  |  |   |
|                                                    |                                   |   |                                 |   |   |   |   |   |   |   |   |   |
|    Operating income                      |                                   | 3,151  |                                 |   | 2,096 |   |   | 5,117 |   |   | 4,918 |   |
|                                                    |                                   |   |                                 |   |   |   |   |   |   |   |   |   |
| Foreign exchange loss                                   |                                   | (214   | )                                    |   | — |   |   | (237 | ) |   | — |   |
| Interest income, net                                    |                                   | 193    |                                 |   | 94 |   |   | 352 |   |   | 177 |   |
|                                                    |                                        |        |                                 |        |  |   |  |  |   |  |  |   |
|                                                    |                                   |   |                                 |   |   |   |   |   |   |   |   |   |
|    Income before income taxes            |                                   | 3,130  |                                 |   | 2,190 |   |   | 5,232 |   |   | 5,095 |   |
| Income taxes                                            |                                   | 1,064  |                                 |   | 795 |   |   | 1,779 |   |   | 1,836 |   |
|                                                    |                                        |        |                                 |        |  |   |  |  |   |  |  |   |
|                                                    |                                   |   |                                 |   |   |   |   |   |   |   |   |   |
|                                                    |                                   |   |                                 |   |   |   |   |   |   |   |   |   |
| Net income                                              | $                                      | 2,066  |                                 | $      | 1,395 |   | $ | 3,453 |   | $ | 3,259 |   |
|                                                    |                                        |        |                                 |        |  |   |  |  |   |  |  |   |
| Earnings per share:                                     |                                   |   |                                 |   |   |   |   |   |   |   |   |   |
|    Basic                                 | $                                      | 0.13   |                                 | $      | 0.09 |   | $ | .22 |   | $ | 0.21 |   |
|                                                    |                                        |        |                                 |        |  |   |  |  |   |  |  |   |
|    Diluted                               | $                                      | 0.13   |                                 | $      | 0.09 |   | $ | .21 |   | $ | 0.20 |   |
|                                                    |                                        |        |                                 |        |  |   |  |  |   |  |  |   |
| Weighted average number of common                       |                                   |   |                                 |   |   |   |   |   |   |   |   |   |
|       shares outstanding: |                                   |   |                                 |   |   |   |   |   |   |   |   |   |
|    Basic                                 |                                   | 15,754 |                                 |   | 15,743 |   |   | 15,726 |   |   | 15,594 |   |
|                                                    |                                        |        |                                 |        |  |   |  |  |   |  |  |   |
|    Diluted                               |                                   | 16,188 |                                 |   | 16,285 |   |   | 16,111 |   |   | 16,282 |   |
|                                                    |                                        |        |                                 |        |  |   |  |  |   |  |  |   |

See accompanying notes to consolidated financial statements. 

4

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**NEOWARE SYSTEMS, INC.**

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

|                                                                                                                        | **Six Months Ended    December 31,** |    |
|-----------------------------------------------------------------------------------------------------------------------------|--------------------------------------|---------|
|                                                                                                                        |                                      |    |
|                                                                                                                        | **2004**                             |    | **2003** |   |
| Cash flows from operating activities:                                                                                       |                                      |    |  |   |
|    Net income                                                                                                | $                                    | 3,453   |   | $ | 3,259 |   |
|    Adjustments to reconcile net income to net cash provided by operating                                     |                                      |    |   |  |   |   |
|          activities:                                                           |                                      |    |   |  |   |   |
|          Depreciation                                                          |                                      | 130     |   |  | 136 |   |
|          Amortization of intangibles                                           |                                      | 647     |   |  | 503 |   |
|          Tax benefit on stock option exercises                                 |                                      | 121     |   |  | 1,618 |   |
|    Changes in operating assets and liabilities, net of effect from acquisitions:                             |                                      |    |   |  |   |   |
|          Accounts receivable                                                   |                                      | (2,742  | ) |  | 1,819 |   |
|          Inventories                                                           |                                      | (3,052  | ) |  | 33 |   |
|          Prepaid expenses and other                                            |                                      | 796     |   |  | (107 | ) |
|          Accounts payable                                                      |                                      | (1,359  | ) |  | (573 | ) |
|          Accrued compensation and benefits                                     |                                      | 258     |   |  | (353 | ) |
|          Other accrued expenses                                                |                                      | 707     |   |  | (47 | ) |
|          Income taxes payable                                                  |                                      | 921     |   |  | (21 | ) |
|          Deferred revenue                                                      |                                      | 285     |   |  | 186 |   |
|                                                                                                                        |                                      |         |   |  |  |   |
|             Net cash provided by operating activities           |                                      | 165     |   |  | 6,453 |   |
|                                                                                                                        |                                      |         |   |  |  |   |
| Cash flows from investing activities:                                                                                       |                                      |    |   |  |   |   |
|    Purchase of the Visara thin client business                                                               |                                      | (3,799  | ) |  | — |   |
|    Purchase of the TeemTalk software business                                                                |                                      | —  |   |  | (9,995 | ) |
|    Purchases of short-term investments                                                                       |                                      | (20,233 | ) |  | (22,056 | ) |
|    Sales of short-term investments                                                                           |                                      | 42,184  |   |  | 14,414 |   |
|    Purchase of intangible assets                                                                             |                                      | —  |   |  | (125 | ) |
|    Purchases of property and equipment                                                                       |                                      | (66     | ) |  | (106 | ) |
|                                                                                                                        |                                      |         |   |  |  |   |
|             Net cash provided by (used in) investing activities |                                      | 18,086  |   |  | (17,868 | ) |
|                                                                                                                        |                                      |         |   |  |  |   |
| Cash flows from financing activities:                                                                                       |                                      |    |   |  |   |   |
|    Repayments of capital leases                                                                              |                                      | (5      | ) |  | (3 | ) |
|    Proceeds from issuance of common stock, net of expenses                                                   |                                      | —  |   |  | 24,609 |   |
|    Expenses for prior issuance of common stock                                                               |                                      | —  |   |  | (3 | ) |
|    Exercise of stock options and warrants                                                                    |                                      | 735     |   |  | 830 |   |
|                                                                                                                        |                                      |         |   |  |  |   |
|             Net cash provided by financing activities           |                                      | 730     |   |  | 25,433 |   |
|                                                                                                                        |                                      |         |   |  |  |   |
|                                                                                                                        |                                      |    |   |  |   |   |
| Effect of foreign exchange rate changes on cash                                                                             |                                      | 186     |   |  | (28 | ) |
|                                                                                                                        |                                      |         |   |  |  |   |
|                                                                                                                        |                                      |    |   |  |   |   |
|    Increase in cash and cash equivalents                                                                     |                                      | 19,167  |   |  | 13,990 |   |
| Cash and cash equivalents, beginning of period                                                                              |                                      | 17,119  |   |  | 26,014 |   |
|                                                                                                                        |                                      |         |   |  |  |   |
|    Cash and cash equivalents, end of period                                                                  | $                                    | 36,286  |   | $ | 40,004 |   |
|                                                                                                                        |                                      |         |   |  |  |   |
|                                                                                                                        |                                      |    |   |  |   |   |
| Supplemental disclosures:                                                                                                   |                                      |    |   |  |   |   |
|       Cash paid for income taxes                                                              | $                                    | 46      |   | $ | 264 |   |

See accompanying notes to consolidated financial statements. 

5

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

**Note 1.    Basis of Presentation**

     The accompanying unaudited consolidated financial statements of Neoware Systems, Inc. and Subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in theUnited States of America for interim financial statements. These statements, while unaudited, reflect all normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the consolidated financialstatements. 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 oromitted 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 notesthereto included in the Company's Annual Report on Form 10-K for the year ended June 30, 2004, filed with the Securities and Exchange Commission on September 13, 2004. 

**Note 2.    Recent Accounting Pronouncements**

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

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

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

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

6

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**Note 3.     Stock-Based Compensation**

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

|                                                                                    | **Three Months Ended** |   | **Six Months Ended** |   |
|-----------------------------------------------------------------------------------------|------------------------|--------|----------------------|--------|
|                                                                                    | **December 31,**       |   | **December 31,**     |   |
|                                                                                    |                        |   |                      |   |
|                                                                                    | **2004**               |   | **2003**             |   | **2004** |   | **2003** |   |
| **Net income**                                                                          |                        |   |                      |   |  |   |  |   |
|    As reported                                                           | $                      | 2,066  |                 | $      | 1,395 |   | $ | 3,453 |   | $ | 3,259 |   |
|    Less:                                                                 |                   |   |                 |   |   |   |   |   |   |   |   |   |
|       Total stock-based employee                          |                   |   |                 |   |   |   |   |   |   |   |   |   |
|          compensation expense determined   |                   |   |                 |   |   |   |   |   |   |   |   |   |
|          under the fair value based method |                   |   |                 |   |   |   |   |   |   |   |   |   |
|          for all awards, net of tax        |                   | (727   | )                    |   | (774 | ) |   | (1,366 | ) |   | (1,435 | ) |
|                                                                                    |                        |        |                 |        |  |   |  |  |   |  |  |   |
|    Pro forma                                                             | $                      | 1,339  |                 | $      | 621 |   | $ | 2,087 |   | $ | 1,824 |   |
|                                                                                    |                        |        |                 |        |  |   |  |  |   |  |  |   |
|                                                                                    |                   |   |                 |   |   |   |   |   |   |   |   |   |
| Basic earnings per share:                                                               |                   |   |                 |   |   |   |   |   |   |   |   |   |
|    As reported                                                           | $                      | 0.13   |                 | $      | 0.09 |   | $ | 0.22 |   | $ | 0.21 |   |
|                                                                                    |                        |        |                 |        |  |   |  |  |   |  |  |   |
|    Pro forma                                                             | $                      | 0.08   |                 | $      | 0.04 |   | $ | 0.13 |   | $ | 0.12 |   |
|                                                                                    |                        |        |                 |        |  |   |  |  |   |  |  |   |
| Diluted earnings per share:                                                             |                   |   |                 |   |   |   |   |   |   |   |   |   |
|    As reported                                                           | $                      | 0.13   |                 | $      | 0.09 |   | $ | 0.21 |   | $ | 0.20 |   |
|                                                                                    |                        |        |                 |        |  |   |  |  |   |  |  |   |
|    Pro forma                                                             | $                      | 0.08   |                 | $      | 0.04 |   | $ | 0.13 |   | $ | 0.11 |   |
|                                                                                    |                        |        |                 |        |  |   |  |  |   |  |  |   |

     The fair value of the Company’s stock-based awards to employees was estimated at the date of grant using the Black-Scholes option pricing model, assuming an estimated life of five to ten years, nodividends, volatility of 70% - 126%, and risk-free interest rates of 2.1% - 6.8%. 

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

**Note 4.   Business Combination**

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

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

7

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

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

|                       | **Six Months Ended    December 31,** |   |
|----------------------------|--------------------------------------|--------|
|                       |                                      |   |
|                       | **2004**                             |   | **2003** |   |
|                       |                                      |   |  |   |
| Total net revenue          | $                                    | 38,125 |   | $ | 34,506 |   |
| Net income                 |                                 | 3,490  |   |   | 3,251 |   |
| Basic earnings per share   |                                 | 0.22   |   |   | 0.21 |   |
| Diluted earnings per share |                                 | 0.22   |   |   | 0.20 |   |

**Note 5.       Goodwill and Intangible Assets**

     The carrying amount of goodwill was $20.2 million and $17.5 million at December 31, 2004 and June 30, 2004, respectively. The increase in goodwill is due to the acquisition of the Visara business (See Note4) and the impact of changes in foreign exchange rates. 

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

|                      |                             |   |   **December 31, 2004**   |   |
|---------------------------|----------------------------------|--------|-----------------------------------------------|--------|
|                      |                             |   |                                               |   |
|                      | **Estimated     Useful    Life** |   | **Gross     Carrying    Amount**              |   | **Accumulated    Amortization** |   | **Net     Carrying    Amount** |   |
|                      |                                  |   |                                               |        |   |  |  |   |  |  |   |
| Tradenames                | Indefinite                       |   | $                                             | 266    |   | $ | — |   | $ | 266 |   |
| Customer relationships    | 2-4 years                        |   |                                          | 1,232  |   |   | 460 |   |   | 772 |   |
| Distributor relationships | 5 years                          |   |                                          | 2,325  |   |   | 1,381 |   |   | 944 |   |
| Acquired technology       | 5-10 years                       |   |                                          | 3,368  |   |   | 694 |   |   | 2,674 |   |
|                      |                             |   |                                               |        |   |  |  |   |  |  |   |
|                      |                             |   | $                                             | 7,191  |   | $ | 2,535 |   | $ | 4,656 |   |
|                      |                             |   |                                               |        |   |  |  |   |  |  |   |

|                      |                             |   |   **June 30, 2004**   |   |
|---------------------------|----------------------------------|--------|-------------------------------------------|--------|
|                      |                             |   |                                           |   |
|                      | **Estimated     Useful    Life** |   | **Gross     Carrying    Amount**          |   | **Accumulated    Amortization** |   | **Net     Carrying    Amount** |   |
|                      |                                  |   |                                           |        |   |  |  |   |  |  |   |
| Tradenames                | Indefinite                       |   | $                                         | 259    |   | $ | — |   | $ | 259 |   |
| Customer relationships    | 2 years                          |   |                                      | 546    |   |   | 273 |   |   | 273 |   |
| Distributor relationships | 5 years                          |   |                                      | 2,325  |   |   | 1,149 |   |   | 1,176 |   |
| Acquired technology       | 5-10 years                       |   |                                      | 2,253  |   |   | 416 |   |   | 1,837 |   |
|                      |                             |   |                                           |        |   |  |  |   |  |  |   |
|                      |                             |   | $                                         | 5,383  |   | $ | 1,838 |   | $ | 3,545 |   |
|                      |                             |   |                                           |        |   |  |  |   |  |  |   |

8

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

|                      | **Three Months Ended** |   | **Six Months Ended** |   |
|---------------------------|------------------------|--------|----------------------|--------|
|                      | **December 31,**       |   | **December 31,**     |   |
|                      |                        |   |                      |   |
|                      | **2004**               |   | **2003**             |   | **2004** |   | **2003** |   |
|                      |                        |   |                      |   |  |   |  |   |
| Customer relationships    | $                      | 123    |                 | $      | 125 |   | $ | 191 |   | $ | 125 |   |
| Distributor relationships |                   | 116    |                 |   | 110 |   |   | 233 |   |   | 220 |   |
| Acquired technologies     |                   | 137    |                 |   | 82 |   |   | 223 |   |   | 158 |   |
|                      |                        |        |                 |        |  |   |  |  |   |  |  |   |
|                      | $                      | 376    |                 | $      | 317 |   | $ | 647 |   | $ | 503 |   |
|                      |                        |        |                 |        |  |   |  |  |   |  |  |   |

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

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

|                                       |   | **Future**       |   |
|--------------------------------------------|--------|------------------|--------|
|    **Year Ending June 30,** |   | **Amortization** |   |
|                                            |   |                  |   |
| Remainder of fiscal 2005                   |   | $                | 744    |   |
| 2006                                       |   |             | 1,111  |   |
| 2007                                       |   |             | 861    |   |
| 2008                                       |   |             | 671    |   |
| 2009                                       |   |             | 677    |   |
| 2010 through 2013                          |   |             | 326    |   |
|                                       |   |                  |        |   |
|                                       |   | $                | 4,390  |   |
|                                       |   |                  |        |   |

**Note 6.   Comprehensive Income**

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

|                                                      | **Three Months Ended** |   | **Six Months Ended** |   |
|-----------------------------------------------------------|------------------------|--------|----------------------|--------|
|                                                      | **December 31,**       |   | **December 31,**     |   |
|                                                      |                        |   |                      |   |
|                                                      | **2004**               |   | **2003**             |   | **2004** |   | **2003** |   |
|                                                      |                        |   |                      |   |  |   |  |   |
| Net income                                                | $                      | 2,066  |                 | $      | 1,395 |   | $ | 3,453 |   | $ | 3,259 |   |
|    Foreign currency translation adjustment |                   | 850    |                 |   | 664 |   |   | 855 |   |   | 677 |   |
|                                                      |                        |        |                 |        |  |   |  |  |   |  |  |   |
| Comprehensive income                                      | $                      | 2,916  |                 | $      | 2,059 |   | $ | 4,308 |   | $ | 3,936 |   |
|                                                      |                        |        |                 |        |  |   |  |  |   |  |  |   |

**Note 7.   Revenue Recognition**

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

     Revenue related to post-contract support services is generally recognized with the initial product sale when the fee is included with the initial product fee, post-contract services are for one year orless, the estimated cost of providing such services during the arrangement is insignificant, and unspecified updates and enhancements offered during the period historically have been and are expected to continue to be minimal and infrequent.Otherwise, revenue from extended warranty and post-contract support service contracts is recorded as deferred revenue and subsequently recognized over the term of the related support period. 

     Revenue from consulting and training services is recognized upon performance. 

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

9

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

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

**Note 8. 	      Major Customers and Dependence on Suppliers**

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

|                                         | **Three Months Ended** |   | **Six Month Ended** |   |
|----------------------------------------------|------------------------|--------|---------------------|--------|
|                                         | **December 31,**       |   | **December 31,**    |   |
|                                         |                        |   |                     |   |
|                                         | **2004**               |   | **2003**            |   | **2004** |   | **2003** |   |
|                                         |                        |   |                     |   |  |   |  |   |
| **Net revenues**                             |                   |   |                |   |   |   |   |   |
|    IBM                        | 23%                    |   | 12%                 |   | 20% |   | 13% |   |
|    North American distributor | 13%                    |   | *                   |   | 11% |   | * |   |
|    European distributor       | *                      |   | 10%                 |   | * |   | * |   |

|                                         | **December 31,** |   |
|----------------------------------------------|------------------|--------|
|                                         |                  |   |
|                                         | **2004**         |   | **2003** |   |
|                                         |                  |   |  |   |
| **Accounts receivable**                      |             |   |   |   |
|    IBM                        | 18%              |   | 12% |   |
|    North American distributor | 10%              |   | * |   |
|    European distributor       | 14%              |   | 10% |   |

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

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

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

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

10

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

**Note 9.  	      Inventories**

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

|                                   | **December 30,    2004** |   | **June 30,    2004** |   |
|----------------------------------------|--------------------------|--------|----------------------|--------|
|                                   |                          |   |                      |   |
| Purchased components and subassemblies | $                        | 295    |                 | $      | 234 |   |
| Finished goods                         |                     | 3,552  |                 |   | 561 |   |
|                                   |                          |        |                 |        |  |   |
|                                   | $                        | 3,847  |                 | $      | 795 |   |
|                                   |                          |        |                 |        |  |   |

**Note 10. 	       Income Taxes**

     The Company accounts for income taxes in accordance with SFAS No. 109, “*Accounting for Income Taxes*.” Under the asset-and-liability method of SFASNo. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases. Deferred taxassets 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 andliabilities of a change in tax rates is recognized in income in the period that includes the enactment date. 

**Note 11.  	      Short-term Borrowings**

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

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

11

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**Note 12.  	       Earnings per Share**

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

|                                                        | **Three Months Ended** |   | **Six Months Ended** |   |
|-------------------------------------------------------------|------------------------|--------|----------------------|--------|
|                                                        | **December 31,**       |   | **December 31,**     |   |
|                                                        |                        |   |                      |   |
|                                                        | **2004**               |   | **2003**             |   | **2004** |   |   | **2003** |   |
|                                                        |                        |   |                      |   |  |   |  |  |   |
| Net income                                                  | $                      | 2,066  |                 | $      | 1,395 |   | $ | 3,453 |   | $ | 3,259 |   |
|                                                        |                        |        |                 |        |  |   |  |  |   |  |  |   |
|                                                        |                   |   |                 |   |   |   |   |   |   |   |   |   |
| Weighted average shares outstanding:                        |                   |   |                 |   |   |   |   |   |   |   |   |   |
|    Basic                                     |                   | 15,754 |                 |   | 15,743 |   |   | 15,726 |   |   | 15,594 |   |
|    Effect of dilutive employee stock options |                   | 434    |                 |   | 529 |   |   | 385 |   |   | 673 |   |
|    Effect of dilutive warrants               |                   | — |                 |   | 13 |   |   | — |   |   | 15 |   |
|                                                        |                        |        |                 |        |  |   |  |  |   |  |  |   |
|    Diluted                                   |                   | 16,188 |                 |   | 16,285 |   |   | 16,111 |   |   | 16,282 |   |
|                                                        |                        |        |                 |        |  |   |  |  |   |  |  |   |
|                                                        |                   |   |                 |   |   |   |   |   |   |   |   |   |
| Earnings per common share:                                  |                   |   |                 |   |   |   |   |   |   |   |   |   |
|    Basic                                     | $                      | 0.13   |                 | $      | 0.09 |   | $ | 0.22 |   | $ | 0.21 |   |
|                                                        |                        |        |                 |        |  |   |  |  |   |  |  |   |
|    Diluted                                   | $                      | 0.13   |                 | $      | 0.09 |   | $ | 0.21 |   | $ | 0.20 |   |
|                                                        |                        |        |                 |        |  |   |  |  |   |  |  |   |

     The following table sets forth the potential common shares that were excluded from the dilutive earnings per share computations (in thousands): 

|                   | **Three Months Ended** |   | **Six Months Ended** |   |
|------------------------|------------------------|--------|----------------------|--------|
|                   | **December 31,**       |   | **December 31,**     |   |
|                   |                        |   |                      |   |
|                   | **2004**               |   | **2003**             |   | **2004** |   | **2003** |   |
|                   |                        |   |                      |   |  |   |  |   |
| Employee stock options | 1,621                  |        | 225                  |        | 1,392 |  | 129 |   |
| Warrants               | 13                     |        | —               |        | 13 |  | — |   |
|                   |                        |   |                      |   |  |   |  |   |
|                   | 1,634                  |        | 225                  |        | 1,405 |  | 129 |   |
|                   |                        |   |                      |   |  |   |  |   |

**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 supplierarising 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. 

***     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, ongoingproduct 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. During fiscal 2004, the Company began providing for a three-year warranty period. As of December 31, 2004, the Company’s standard warranty service period ranges from one to threeyears.

     The changes in the Company’s warranty liability are as follows for the six months ended December 31, 2004 (in thousands): 

| Accrued warranty cost at June 30, 2004             | 264 |   |
|----------------------------------------------------|-----|--------|
|    Provisions for warranties issued | 168 |   |
|    Settlements made                 | (87 | )      |
|                                               |     |   |
| Accrued warranty cost at December 31, 2004         | 345 |   |
|                                               |     |   |

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**Note 14.    Related Party Transactions**

     For the six months ended December 31, 2003, the Company had sales of $113,000, to a customer of which one of the Company’s directors is an executive officer and director. 

**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 appliance computing, which is a computing architecture targeted at business customers as an easier to manage, more secure, more reliable,and more cost-effective solution than traditional PC-based, client server computing. Our software and management tools secure, power and manage a new generation of smart thin client appliances that utilize the benefits of open, industry-standardtechnologies 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 hostsystems. We generate revenues primarily from sales of thin client appliance systems, which include the appliance device and related software marketed under the brand names Eon and Capio, and to a lesser extent from ThinPC thin client software forPCs, TeemTalk host access software for servers and PCs, ezRemote Manager central management software, and services such as training and integration.

     We sell our products and services worldwide through our direct sales force, distributors, our alliance with IBM and other indirect channels, such as resellers and systems integrators. Our internationalsales 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 maintainoffices in the UK, Germany, France, Austria, Sweden, Australia, and the Netherlands.

Revenues from Europe, the Middle East and Africa, (“EMEA”)    based on the location of our customers,  were as follows: 

|                       | **Three Months Ended** |   |         |   | **Six Months Ended** |   |         |   |
|----------------------------|------------------------|--------|--------------|--------|----------------------|--------|--------------|--------|
|                       | **December 31,**       |   |         |   | **December 31,**     |   |         |   |
|                       |         |   | ****         |   |       |   | ****         |   |
|                       | ******2004**           |   | ******2003** |   | **% Change**         |   | ******2004** |   | **2003** |   | **% Change** |   |
|                       |                        |        |         |        |                      |   |              |   |  |  |   |  |  |   |  |   |
| EMEA revenues              | $                      | 6,758  |         | $      | 6,021                |   | 12           | %      | $ | 11,792 |   | $ | 11,446 |   | 3 | % |
| Percentage of net          |                   |   |         |   |                 |   |         |   |   |   |   |   |   |   |   |   |
|    revenues |                   | 33     | %            |   | 39                   | %      |         |   |   | 32 | % |   | 38 | % |   |   |

**      Strategy**

     The market for thin client appliances is part of the enterprise personal computers (PC) market. We market our thin client appliances as alternatives to PCs in certain target markets. Our strategies are tofocus on introducing new products that compete more effectively with PCs, increasing sales to large enterprise customers, primarily through our relationship with IBM, and secondarily through other resellers and directly to end-users, and to executemarketing initiatives designed to grow the thin client segment of the PC industry. We expect that the combination of these actions, including the introduction of new products, will result in increased revenues with overall gross profit margins inapproximately the 40% to 45% range in calendar 2005. 

     We expect to continue to grow the company organically and through acquisitions. Our acquisition strategy is focused on acquiring businesses with products that can be sold through our existing channels tothe same end user customers, leveraging our existing organization. On January 27, 2005, the Company acquired all of the outstanding stock of Mangrove Systems SAS, a privately held provider of Linux software solutions and on January 12, 2005 theCompany entered into an Asset Purchase Agreement to acquire the TeleVideo, Inc. thin client business including all thin client assets, certain contract obligations, a trademark license, product brands, customer lists, customer contracts andnon-competition agreements. We intend to continue to evaluate strategic acquisitions and partnerships in the future. 

13

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**Financial Highlights**

      Net revenue, gross profit margin  and earnings per share are key measurements of our financial results. For the  second quarter of fiscal 2005, net revenue was $20.5 million, an increase of  34% from the same period in fiscal 2004. Gross profit margins were 43% in the  second quarter of fiscal 2005 as compared to 50% in the same period in fiscal  2004. This decrease was consistent with our strategy to compete more effectively  with personal computers and to pursue large enterprise customers. Diluted earnings  per share were $0.13 in the second quarter of fiscal 2005, compared to $0.09  in the same period in fiscal 2004. For the first half of fiscal 2005, net revenue  was $36.8 million, an increase of 21% from the same period in fiscal 2004. Gross  profit margins were 43% in the first half of fiscal 2005 as compared to 51%  in the same period in fiscal 2004. Diluted earnings per share were $0.21 in  the first half of fiscal 2005, compared to $0.20 in the same period in fiscal  2004.

      We have a significant balance    of  cash and short-term investments. As of December 31, 2004, our cash, cash    equivalents  and short- term investments were $52.5 million, compared to $55.3 million at     June 30, 2004, which represented approximately 72% of tangible assets. We    used  $3.8 million in the first half of fiscal 2005 to acquire the Visara business.     We utilize cash in ways that our management believes provides an optimal    return  on investment. Cash has principally been used to acquire businesses. Subsequent     to December 31, 2004 we used $2.6 million of cash and issued 153,683 common  shares valued at $1.3 million to acquire Mangrave and entered into an Asset    Purchase Agreement to acquire the TeleVideo thin client business which requires    the payment of $5.0 million upon consummation of the transaction.

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

**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 significantareas that involve management’s judgments and estimates. These critical accounting policies and estimates include: 

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

     These policies and estimates and our procedures related to these policies and estimates are described in detail below and under specific areas within the discussion and analysis of our financial conditionand 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 Report on Form 10-K for the year ended June 30, 2004 forfurther discussion of the Company’s accounting policies and estimates. 

***Revenue Recognition***

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

*     Multiple Element Arrangements*

     Net revenues include sales of thinclient 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 appliancesystem 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-elementarrangement. Revenue is recognized on product sales when 

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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 orless, the estimated cost of providing such services during the arrangement is insignificant, and unspecified upgrades and enhancements offered during the period historically have been and are expected to continue to be minimal and infrequent.Otherwise, revenue from extended warranty and post-contract support service contracts is recorded as deferred revenue and subsequently recognized over the term of the related support period. 

*     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 arrangementsthat 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 feesbecome 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 wehave 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 notprobable, 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 orgreater 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 protectionclaims 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 anarrangement, we recognize revenue when the claims can be reasonably estimated. 

***Valuation of Long-Lived and Intangible Assets and Goodwill***

     In connection with acquisitions, we allocate portions of the purchase price to intangible assets, consisting of acquired technology, distributor and customer relationships and tradenames based onindependent 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*. Weare 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 soleoperating 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, 

15

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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 isexpected 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 fairvalue. 

|   | 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 December 30, 2004, goodwill and amortizable intangible assets are $20.2 million and $4.7 million, respectively. A decreasein 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 exposure as well as assesstemporary 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 classifiedas 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 ofcurrent 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 providedfor income taxes in our balance sheet and results of operations. We must also assess the likelihood that deferred tax assets will be realized from future taxable income and, based on our assessment, establish a valuation allowance, if required.

**Results of Operations**

***Net Revenues***

|         | **Three Months Ended** |   |     | **Six Months Ended** |         |   |
|--------------|------------------------|--------|----------|----------------------|--------------|--------|
|         | **December 31,**       |   |     | **December 31,**     |         |   |
|         |                        |   | ****     |       |              |        |  |  |  |   | **** |
|         | **2004**               |   | **2003** |                 | **% Change** |   |   | **2004** |   | **2003** |   | **% Change** |
|         |                        |   |          |                 |              |   |  |  |   |  |   |  |
| Net revenues | $                      | 20,471 |     | $                    | 15,322       |   | 34 % |   | $ | 36,774 |   | $ | 30,336 |   | 21% |

     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 second quarter and the first half of fiscal2005 over the same periods in fiscal 2004 is primarily the result****of increased unit sales of our thin client appliance products. We believe the increases were primarily driven by sales growth fromincreasing market acceptance of thin client products.****

     In calendar 2005 we expect total netrevenue to increase 20% to 30% over the same period in calendar 2004, as a resultof increasedpenetration of the PC market, continued growth of our relationship with IBM,and the acquisitions we recently completed.

***Cost of Revenues and Gross Profit Margin***

|                | **Three Months Ended    December 31,** |   |    |   |         | **Six Months Ended    December 31,** |   |    |
|---------------------|----------------------------------------|--------|--------------|--------|--------------|--------------------------------------|--------|--------------|
|                |                                        |   | ****         |   |         |                                      |   | ****         |
|                | **2004**                               |   | **2003**     |   | **% Change** | ****                                 |   | **2004**     |   | **2003** |   | **% Change** |
|                |                                        |   |              |   |              |                                 |   |              |   |  |   |  |
| Cost of revenues    | $                                      | 11,726 |         | $      | 7,684        |                                 | 53%    |         | $ | 20,938 |   | $ | 14,733 |   | 42% |
| Gross profit margin |                                   | 43     | %            |   | 50           | %                                    |   |         |   | 43 | % |   | 51 | % |   |

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     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 benefitsfor personnel who fulfill product orders and deliver services, and distribution costs. 

     The increase in cost of revenues in the second quarter and the first half of fiscal 2005 over the same periods in fiscal 2004 is primarily the result****of theadditional cost associated with increased unit sales of our thin client appliance products (51% and 41%, respectively). 

     We have benefited from manufacturing efficiencies and component cost reductions achieved through our outsourced offshore manufacturing model. This model depends on high volume production of our thin clientappliance products using components commonly used in personal computers. Changes in this model could have a significant impact on our gross profit margins. 

     Gross margins declined as plannedand are expected to fluctuate in the future due to changes in product mix, reductionin sales prices due to increased sales to large enterprise customers and increasedprice competition,  the percentage of revenues derived from thin client appliancesystems and software and changes in the cost of thin client appliances, memoryand other components.Accordingly, in calendar 2005 we expect gross margins to be in the range of 40%to 45%. 

***Selling and Marketing***

|                       | **Three Months Ended** |   |     |   | **Six Months Ended** |   |     |   |     |
|----------------------------|------------------------|--------|----------|--------|----------------------|--------|----------|--------|----------|
|                       | **December 31,**       |   |     |   | **December 31,**     |   |     |   |     |
|                       |         |   | ****     |   |       |   | ****     |
|                       | **2004**               |   | **2003** |   | **% Change**         |   | **2004** |   | **2003** |   | **% Change** |
|                       |                        |   |          |   |                      |   |          |   |          |   |  |
| Selling and marketing      | $                      | 3,178  |     | $      | 3,377                |   | (6) %    |   | $        | 6,281 |   | $ | 6,342 |   | (1)% |
| As a percentage of revenue |                   | 16     | %        |   | 22                   | %      |     |   |     | 17 | % |   | 21 | % |   |

     Selling and marketing expenses consist primarily of salaries, related benefits, commissions, amortization of intangibles related to customer and distribution relationships and other costs associated withour sales and marketing efforts. The decrease in selling and marketing expense in the second quarter of fiscal 2005 over the same period in fiscal 2004 is primarily due to a decrease in head count. 

     We expect sales and marketing expensesto grow during calendar 2005 and to remain relatively constant as a percentageofrevenue. Spending levels in any one quarter will vary depending upon the timingof individualmarketing initiatives. 

***Research and Development***

|                       | **Three Months Ended** |   |     |   | **Six Months Ended** |   |    |
|----------------------------|------------------------|--------|----------|--------|----------------------|--------|--------------|
|                       | **December 31,**       |   |     |   | **December 31,**     |   |    |
|                       |         |   | ****     |   |       |   | ****         |
|                       | **2004**               |   | **2003** |   | **% Change**         |   | **2004**     |   | **2003** |   | **% Change** |
|                       |                        |   |          |   |                      |   |              |   |  |   |  |
| Research and development   | $                      | 769    |     | $      | 687                  |   | 12%          |   | $ | 1,433 |   | $ | 1,408 |   | 2% |
| As a percentage of revenue |                   | 4      | %        |   | 4                    | %      |         |   |   | 4 | % |   | 5 | % |   |

     Research and development expenses consist primarily of salaries, related benefits, and other engineering related costs. The increase in research and development expense in the second quarter of fiscal 2005over the same period in fiscal 2004 is primarily the result of an increase in compensation levels.

     We believe that a significant levelof research and development investment is required to remain competitive andexpect research and development expenses to grow during calendar 2005 and toincreaseas a percentage of revenue. 

***General and Administrative***

|                       | **Three Months Ended** |   |     |   | **Six Months Ended** |   |    |
|----------------------------|------------------------|--------|----------|--------|----------------------|--------|--------------|
|                       | **December 31,**       |   |     |   | **December 31,**     |   |    |
|                       |         |   | ****     |   |       |   | ****         |
|                       | **2004**               |   | **2003** |   | **% Change**         |   | **2004**     |   | **2003** |   | **% Change** |
|                       |                        |   |          |   |                      |   |              |   |  |   |  |
| General and administrative | $                      | 1,647  |     | $      | 1,478                |   | 11%          |   | $ | 3,005 |   | $ | 2,935 |   | 2% |
| As a percentage of revenue |                   | 8      | %        |   | 10                   | %      |         |   |   | 8 | % |   | 10 | % |   |

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     General and administrative expenses consist primarily of salaries, related benefits, corporate insurance, such as director and officer liability insurance and fees related to the obligations of a publiccompany and fees for legal, audit and tax services. The increase in general and administrative expenses in the second quarter of fiscal 2005 over the same periods in fiscal 2004 is primarily the result of an increase in compensation levels,partially offset by a decrease in the provision for doubtful accounts. 

     We expect general and administrativeexpenses to grow during calendar 2005 and to grow slightly asa percentage of revenue. 

***Income Taxes***

|                       | **Three Months Ended** |   |     |   | **Six Months Ended** |   |     |
|----------------------------|------------------------|--------|----------|--------|----------------------|--------|--------------------|
|                       | **December 31,**       |   |     |   | **December 31,**     |   |     |
|                       |                        |   | ****     |   |                      |   | ****               |
|                       | **2004**               |   | **2003** |   | **% Change**         |   | **2004**           |   | **2003** |   | **% Change** |
|                       |                        |   |          |   |                      |   |                    |   |  |   |  |
| Income taxes               | $                      | 1,064  |     | $      | 795                  |   | 34                 | % | $ | 1,779 |   | $ | 1,836 |   | (3)% |
| As a percentage of revenue |                   | 5      | %        |   | 5                    | %      |               |   |   | 5 | % |   | 6 | % |   |
| Effective tax rate         |                   | 34     | %        |   | 36                   | %      |               |   |   | 34 | % |   | 36 | % |   |

      Our effective tax rate in the second  quarter and first half of fiscal 2005 differed from the combined federal and  state statutory rates due primarily to 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. The decrease  in our effective tax rate in the second quarter and first half of fiscal 2005  over the same periods in fiscal 2004 is primarily due to the fact that no EIE  tax benefit was recorded in the second quarter or first half of fiscal 2004  because the EIE benefit had not been claimed.

      In October 2004 the EIE was repealed  and will be phased out through calendar year 2006. Absent other changes that  could impact our effective tax rate, such as the implementation of tax strategies  that we are currently evaluating, we expect our effective tax rate to be 34%  for fiscal 2005 and to increase two percentage points as the EIE is phased out  over the next two years; however, the impact of the manufacturing deduction  for the Jobs Creation Act has not been determined at this time and could have  a favorable impact on our effective income tax rate beginning in fiscal 2006.

**Liquidity and Capital Resources**

     As of December 31, 2004, we had net working capital of $60.5 million consisting primarily of cash and cash equivalents, short-term investments and accounts receivable. Our principal sources of liquidityinclude $52.5 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 $10.0 million. Upon suchrequest, 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 forany advance cannot exceed 180 days. There were no borrowings under the Offering Basis Loan Agreement during the three months ended December 31, 2004. 

      Cash and cash equivalents and    short-term  investments decreased by $2.8 million during the first half of    fiscal 2005,  primarily as a result of the acquisition of the Visara business, partially    offset  by the exercise of stock options. Subsequent to December 31, 2004    we used $2.6  million of cash and issued 153,682 common shares valued at $1.3 million to    acquire Mangrove and entered into an Asset Purchase Agreement to acquire    the TeleVideo thin client business which requires to payment of $5.0 million    upon consummation of the transaction.

      ***Cash flows provided by operating  activities:***Our largest source of operating cash  flows are payments from our customers for the purchase 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 decreased in the first half of  fiscal 2005 compared to the same period in fiscal 2004 primarily due to, an  increase in accounts receivable and an increase in inventory. Inventory primarily increased as a  result of advance purchases of inventory due to our primary supplier’s  financial condition. Additionally, accounts payable decreased, which was offset  by an increase in income taxes payable. 

     ***Cash flows used in investing activities:***The cash out flows from investing activities in the first half of fiscal 2005 relate to the acquisition of the Visara business anda decrease in the net purchase of short-term investments. We typically purchase short-term investments with surplus cash.

     ***Cash flows provided by financing activities:***The cash in flows from financing activities in the first half of fiscal 2005 was primarily the result of the exercise ofemployee stock options. 

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***Contractual Obligations***

The following is a summary of our contractual obligations as  of December 31, 2004: 

|                         |   **Year Ending June 30,**      |   |
|------------------------------|------------------------------------------------|--------|
|                         |   ***(****in thousands)*   |   |
|                         |                                                |   |
|                         | **Remainder        of**              |   |   |   |   |   |
|                         |  **2005**                                 |   | **2006** |   | **Total** |   |
|                         |                                                |        |   |  |  |   |  |  |   |
| Product purchase obligations | $                                              | 4,838  |   | $ | — |   | $ | 4,838 |   |
| Operating and capital leases |                                           | 313    |   |   | 216 |   |   | 529 |   |
| Other purchase obligations   |                                           | 112    |   |   | — |   |   | 112 |   |
|                         |                                                |        |   |  |  |   |  |  |   |
|                         | $                                              | 5,263  |   | $ | 216 |   | $ | 5,479 |   |
|                         |                                                |        |   |  |  |   |  |  |   |

     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 equityfinancings. 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. However, we may seek additional sources of funding in orderto fund acquisitions, including 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. 

**Factors Affecting the Company 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 amaterial 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 two years, we have increased operating expenses significantly as a foundation for us to stimulate growth in our market, and we expect to continue incurring significant operating expenses. Ifwe do not increase revenues or appropriately manage further increases in operating expenses, our profitability will suffer.****

     Our business has grown during the past three years through both internal expansion and business acquisitions, and this has put pressure on our infrastructure, internal systems and managerial resources. Thenumber of our employees increased from 89 employees at December 31, 2001 to 116 employees at December 31, 2004. Our new employees include a number of senior executive officers and other key managerial, technical, sales and marketing personnel. Tomanage 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 beadversely 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 thegrowth of our foreign operations, we now have facilities located in multiple locations, and we have limited experience coordinating a geographically separated organization.

***Although we have generated operating profits for the past three 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 stockdeclining.***

     Although we have generated operating profits in the past three fiscal years, we incurred net losses in prior periods. We expect to continue to incur significant operating expenses. Our operating expensesmay increase in the future reflecting the hiring of additional key personnel as we continued to implement our growth strategy, including our plan to introduce new products to compete with PC-based solutions and other thin client companies. As aresult, 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 likelycause us to incur losses and negatively impact the price of our common stock.

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***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, resultingin losses.***

     Our gross margins  can vary significantly from quarter to quarter depending on average selling  prices, fixed 20 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 inresponse 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 reducethe 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 meetcompetitors' price reductions. Our new 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 byselling 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 is expected to continue to result in a decline in our gross margins. Ifour sales do not increase as a result of these new strategies, our profitability will decline, and we may experience losses. 

***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 bycorporations 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, weface 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 clientappliance products. 

|   | 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; |
|   | •                                                                                          | 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, including PC manufacturers, our business and our operating results wouldbe 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.***

     Since June 2001, we have made sixacquisitions and entered into an alliance with IBM, and we may make additionalacquisitionsas part of our growth strategy. There is no assurance that we will successfullyintegrate future acquisitions into our business. We may be unable to retain keyemployees or key business relationships of the acquired businesses, consolidateIT infrastructures, combine administrative, research and development andother operations and combine product offerings, and integration of the businessesmay divert the attention and resources of our management. Our failure to successfullyintegrate acquired businesses into our operations could have a material adverseeffect on our business, operating results and financial condition. Even if futureacquisitions are successfully integrated, we may not receive the expected benefitsof the transactions if we find that the acquired business does not further ourbusiness strategy or that we paid more than what the assets were worth. Managingacquisitions and alliances requires management resources, which may divert ourattention from other business 

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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.

***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 ourquarterly 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 andfacilities, 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 couldfluctuate.

     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 foreach 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 untilafter 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 pulled into a quarter from a futurequarter, 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; and |
|   | • | 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 inlower sales in our first and third quarters than in the prior sequential quarters.                                                                                                                                                                                                                                                                                                                                                 |

     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.

***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 maintainmarket 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 donot 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.

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***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 marketshare.***

     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. Linus Torvalds, the original developer of the Linux kernel, and a small group of independent engineers are primarily responsible for the developmentand evolution of the Linux kernel. 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. To date, we have optimized our Linux-basedoperating system based on a version of Red Hat Linux. If we were unable to access Red Hat Linux, we would be required to spend additional time to obtain a tested, recognized version of the Linux kernel from another source or develop our ownoperating system internally, which could significantly increase our costs.

***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 affectsales 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’slawsuit 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 incurexpenses 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 supplyshortages that could prevent us from shipping customer orders on time, if at all, and result in lost sales. In addition, if we implement an outsourcing strategy for other functions, we 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 severalother 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 intariffs, 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 resultin 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. 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. We have 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 at December 31, 2004 and may continue to increase  inventory levels and to decrease cash balances. In addition, if the supplier  is unable to resolve its cash liquidity constraints, we could face an interruption  of supply of our products, resulting in a decline in our revenues and profits.  

     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 may expand our outsourcingactivities where we believe a third party may be able to provide those services in a more efficient manner. If we are unable to effectively develop and implement our outsourcing strategy, we may not realize cost structure efficiencies and ouroperating and financial results could be materially adverselyaffected. In addition, if our third party service providers experience businessdifficulties or are unable to provide business process services as anticipated,we may need to seek alternative service providers or resume providing such businessprocesses internally which could be costly and time consuming and have an adversematerial effect on our operating and financial results.

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***If we are unable to continue generating substantial revenues from international sales our business could be adversely affected.***

      We derive a substantial portion  of our revenue from international sales . Our ability to sell our products 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. Although most of our international sales are denominated in US  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. 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.

***Because we rely on distributors and IBM 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 currentdistributors, including IBM, 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 ofeffort 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. 

     We derive a substantial portion of our revenue from sales made directly to IBM and through our other distributors. A significant portion of our other revenue was derived from sales to resellers. If ourdistributors 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.

     As a result of our alliance with IBM, we rely on IBM for distribution of our products to IBM's customers. Sales directly to IBM have ranged from 12% to 18% of our net sales during the past two fiscal years.IBM is under no obligation to continue to actively market our products. In addition to our direct sales to IBM, IBM can purchase our products through individual distributors and/or resellers. Furthermore, IBM can influence an end-users decisions topurchase our products even though the end-user may not purchase our products through IBM. While it is difficult to quantify the net revenues associated with these purchases we believe that these sales could be significant and can vary significantlyfrom quarter to quarter. 

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

     Although we have not received any claims that our products infringe on the proprietary rights of third parties, if we were to receive such claims in the future, responding to such claims, regardless oftheir merit, 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 alicensing 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 ofinfringement 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.

***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 renderedobsolete 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 productscould be rendered obsolete if products based on new technologies are introduced or new industry standards emerge.

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***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. If we are unable to protect our intellectual property, othervendors could sell products with features similar to ours, and this could reduce demand for our products, which would harm our operating results.

***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 ourproducts, 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 inattracting 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 ourbusiness 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. Further, 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.***

     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 tomaximize 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 inexcess of our stock price, which could affect our ability to retain or attract present and prospective employees. In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004),“*Share-Based Payment,”*which replaces SFAS No. 123, “*Accounting for Stock-Based Compensation,”*(SFAS No. 123R) and supercedesAccounting Principles Board Opinion No. 25, “*Accounting for Stock Issued to Employees.”*SFAS No. 123R requires all share-based payments to employees, including grants of stock options, to berecognized in the financial statements based on their fair values beginning with the first interim or annual period beginning after June 15, 2005. We are required to adopt SFAS No. 123R in the first quarter of fiscal 2006 and expect that it willhave 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 newregulations 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 togrant 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 compensation costs, and we may change our equity compensationstrategy, which may make it more difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business.

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***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 are evaluating our internal controls over financial reporting to allow management  to report on, and our independent auditors to attest to, our internal controls  over financial reporting as of June 30, 2005. We are currently performing the  system and process evaluation and testing (and any necessary remediation) required  in an effort to comply with the management certification and auditor attestation  requirements of Section 404 of the Sarbanes-Oxley Act. As a result, we expect  to incur additional expenses and diversion of management’s time, which  could materially increase our operating expenses and accordingly reduce our  net income. While we anticipate being able to fully implement the requirements  relating to internal controls over financial reporting and all other aspects  of Section 404 in a timely fashion, we cannot be certain as to the outcome of  our testing and resulting remediation. If our independent registered public  accountants are not satisfied with our internal controls over financial reporting  or the level at which these controls are documented, designed, operated or reviewed,  or if the independent auditors’ interpretation of the requirements, rules  or regulations are different than ours, 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.****

***We license our TeemTalk and Mangrove software to other thin client providers who may choose to license alternative products from other suppliers who are not their competitors.***

     We license our TeemTalk and Mangrove software to certain of our competitors, including Wyse Technology, Hewlett Packard and VXL. Although it is our strategy to continue to generate sales of this software bylicensing it to other thin client vendors, these vendors may seek alternative products from suppliers who are not their direct competitors. If we were to lose one or more of these customers, our revenue and profits would decline.

***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 tobe 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 failto 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 agreementswith 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 orto pay significant damages. Any such claims, whether or not successful, could seriously damage our reputation and our business.

***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 benegatively affected.

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***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 ofnew 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 financialperformance 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 provisionsinclude 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 alarge 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 securitiesconvertible 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 regarding gross profit margins and increased revenues in    calendar 2005 as the result of our marketing strategy to compete more effectively    with  PCs; our consummation of our acquisition of the TeleVideo thin client business;    our expectation to grow the company organically and through acquisitions;    anticipated  lower cash balances and increased inventory levels due to our accelerated payments    to one of our suppliers; our commitment to continue investing in software    development;  our expectations regarding the growth of our revenues as a result of increased    penetration of the PC market and our relationship with IBM; our expectations    as to revenues, gross margins, research and development expenses, sales and    marketing expenses, and general and administrative expenses for calendar    2005 and our effective tax  rate for fiscal 2005; our acquisition of businesses and technologies; 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,****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 TeleVideo 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. 

**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 ourinvestment portfolio. We invest in instruments that meet high credit quality standards, as specified in our investment policy.

     As of December 31, 2004 and June 30,2004, cash equivalents and short-term investments consisted primarily of corporatenotes and government securities, certificates of deposit, and other specificmoneymarket instruments of similar liquidity and credit quality.Due to the conservative nature of our investment portfolio, a sudden change ininterest rates would not have a material effect on the value of the portfolio.

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**Item 4****.****  Controls and Procedures**

     Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of our disclosure controls and procedures; assuch term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of December 31, 2004 (the “Evaluation Date”). Based on the evaluation performed, our Chief Executive Officer and Chief Financial Officerhave concluded that, as of the Evaluation Date, our 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 bedisclosed by us in our 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 December 31, 2004 that have materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting. 

**PART II. OTHER INFORMATION**

**Item 4.   Submission of Matters to a Vote of Security Holders**

      On December 1, 2004, the Company  held its Annual Meeting of Stockholders. The Stockholders voted to elect five  members to the Board of Directors and on proposals to approve the Company’s  2004 Equity Incentive Plan and to ratify the selection of KPMG LLP as the Company's independent registered public  accountants for the fiscal year ending June 30,  2005. 

     Elected to the Board of Directors were Michael G. Kantrowitz (13,064,390 shares voted for election and 866,786 shares were withheld), John M. Ryan (13,050,954 shares voted for election and 880,222 shareswere withheld), Christopher G. McCann (12,872,243 shares voted for election and 1,058,933 shares were withheld), John P. Kirwin, III (13,104,046 shares voted for election and 790,770 shares were withheld) and David D. Gathman (13,137,996 sharesvoted for election and 793,180 shares were withheld). 

      The proposal to approve the 2004  Equity Incentive Plan was approved, with 4,629,967 shares voting against, 2,522,622  shares voting in favor, 29,965 shares abstaining, and 6,748,622 broker non-votes.  

      The proposal to select of KPMG  LLP as the Company's independent registered public accountants was ratified,  with 13,562,553 shares voting in favor of ratification, 355,648 shares voting  against ratification and 12,975 shares abstaining. 

**Item 5.    Other Information**

      As reported in Item 4 of Part II  of this report, our stockholders approved the Neoware Systems, Inc. 2004 Equity  Incentive Plan (the “2004 Plan”) at the Annual Meeting of Stockholders  held on December 1, 2004. Our Board of Directors adopted the 2004 Plan on October  19, 2004, subject to stockholder approval. The 2004 Plan terminates our 2002  Non-Qualified Stock Option Plan (the “2002 Plan”) and 1995 Stock Option  Plan (the “1995 Plan”) as to any shares available for grant under  such plans after December 1, 2004. As approved by our stockholders, 1,500,000  shares of newly authorized Common Stock are available for grant under the 2004  Plan, in addition to up to 1,750,000 shares of our Common Stock subject to outstanding  options under the 2002 Plan and 1995 Plan if such options terminate, expire  or are canceled without having been exercised on or after December 1, 2004.  A description of the terms and conditions of the 2004 Plan, along with a copy  of the 2004 Plan, was included in our definitive Proxy Statement dated October  25, 2004 filed with the Securities and Exchange Commission on October 25, 2004  and furnished in connection with our Annual Meeting of Stockholders held on  December 1, 2004, and incorporated by reference.

     On December 1, 2004, options    to acquire a total of 145,000 shares  of our common stock were granted to    three executive officers pursuant to the  terms of the 2004 Plan and one executive officer pursuant to the terms of the     2002 Plan. In addition, each non-employee director received an automatic    grant  of options to acquire 7,500 shares pursuant to the 2004 Plans.

     At a meeting held on January 20, 2005, our Board of Director approved an amendment to the 2004 Plan (the “Amendment”) allowing the committee of the Board of Directors that administers the 2004 Plan todetermine the amount of time, up to a maximum of 12 months, an outstanding stock option or stock appreciation right may remain exercisable after the death of a participant under the 2004 Plan. Prior to the Amendment, the 2004 Plan provided that anoption or stock appreciation right would remain exercisable for a period of 12 months after the death of the participant. 

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**Item 6. Exhibits**

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

| **Exhibit**                    |    |                                |                                                                                                   |
|--------------------------------|---------|-------------------------------------|--------------------------------------------------------------------------------------------------------|
| **Numbers**                    |    |                                | **Description**                                                                                        |
| 10.1                           | *† |                                | 2004 Equity Incentive Plan                                                                             |
|                           |    |                                |                                                                                                   |
| 10.2                           | *† |                                | Amendment to 2004 Equity Incentive Plan (effective January      20, 2005)                              |
|                           |    |                                |                                                                                                   |
| 10.3                           | *† |                                | Form of Annual Director Grant Agreement under the Registrant's      2004 Equity Incentive Plan         |
|                           |    |                                |                                                                                                   |
| 10.4                           | *† |                                | Form of Incentive Stock Option Award Agreement under the      Registrant's 2004 Equity Incentive Plan  |
|                           |    |                                |                                                                                                   |
| 10.5                           | *       |                                | Form of Stock Option Award Agreement for Optionees Residing      in France under the Registrant's      |
|                           |    |                                | 2004 Equity Incentive Plan                                                                             |
|                           |    |                                |                                                                                                   |
| 10.6                           | *† |                                | Form of Non-Qualified Stock Option Award Agreement under      the Registrant's 2004 Equity             |
|                           |    |                                | Incentive Plan                                                                                         |
|                           |    |                                |                                                                                                   |
| 10.7                           | *† |                                | 2004 Executive Bonus Plan                                                                              |
|                           |    |                                |                                                                                                   |
| 10.8                           | *† |                                | Compensation Arrangement between the Registrant and Peter      Bolton dated December 1, 2004           |
|                           |    |                                |                                                                                                   |
| 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                            |
|                           |    |                                |                                                                                                   |
| *          |    | Filed herewith.                     |
|                           |    |                                |                                                                                                   |
| †     |    | Management contract or arrangement. |

 

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

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