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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 Form 10-Q
 
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarter ended December 31, 2006
 o
    
    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, INC.
 (Exact name of registrant as specified in its charter)
 Delaware(State or other jurisdiction of
    
    23-2705700(IRS Employer Identification No.)incorporation or organization)
 3200 Horizon Drive
King of Prussia, Pennsylvania 19406  (Address of principal executive offices)
 (610) 277-8300  (Registrants telephone number including area code)
 þ o
  o þ o
 o þ




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##### 



NEOWARE, INC.
INDEX
 PAGEPART I. FINANCIAL INFORMATIONItem 1.
    
    Consolidated Financial Statements (unaudited)Condensed Consolidated Balance Sheets as of December 31, 2006 and June 30, 2006
    
    3Consolidated Statements of Operations for the Three and Six Months Ended December 31, 2006 and 2005
    
    4Consolidated Statements of Cash Flows for the Three and Six Months Ended  December 31, 2006 and 2005
    
    5Notes to Consolidated Financial Statements
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    14Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    25Item 4.
    
    Controls and Procedures
    
    26PART II. OTHER INFORMATIONItem 1A.
    
    Risk Factors
    
    26Item 4.
    
    Submission to a Vote of Security Holders
    
    38Item 6.
    
    Exhibits
    
    38Signatures
    
    
    
    40Summary of Compensation AgreementSeparation AgreementCertification of Klaus BesierCertification of Keith D. SchneckCertification of Klaus BesierCertification of Keith D. Schneck




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NEOWARE, INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 December 31,
    
    
    June 30,2006
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    31,030
    
    
    $
    19,328Short-term investments
    
    
    76,920
    
    
    
    94,798Accounts receivable, net
    
    
    18,362
    
    
    
    16,877Inventories
    
    
    11,328
    
    
    
    7,734Prepaid income taxes
    
    
    5,567
    
    
    
    1,544Prepaid expenses and other
    
    
    2,287
    
    
    
    1,687Deferred income taxes
    
    
    1,866
    
    
    
    1,866Total current assets
    
    
    147,360
    
    
    
    143,834Property and equipment, net
    
    
    1,495
    
    
    
    1,586Goodwill
    
    
    38,804
    
    
    
    37,761Intangibles, net
    
    
    10,525
    
    
    
    12,175Deferred income taxes
    
    
    4,025
    
    
    
    4,156Other
    
    
    80
    
    
    
    61$
    202,289
    
    
    $
    199,573LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    4,831
    
    
    $
    8,989Accrued compensation and benefits
    
    
    3,460
    
    
    
    2,021Other accrued expenses
    
    
    4,235
    
    
    
    4,159Restructuring reserve
    
    
    549
    
    
    
    600Income taxes payable
    
    
    173
    
    
    
    158Deferred revenue
    
    
    1,151
    
    
    
    973Total current liabilities
    
    
    14,399
    
    
    
    16,900Deferred income taxes
    
    
    807
    
    
    
    755Deferred revenue
    
    
    311
    
    
    
    316Total liabilities
    
    
    15,517
    
    
    
    17,971Stockholders equity:Preferred stock
    
    
    
    
    
    
    Common stock
    
    
    20
    
    
    
    20Additional paid-in capital
    
    
    162,765
    
    
    
    158,671Treasury stock, 100,000 shares at cost
    
    
    (100
    )
    
    
    (100
    )Accumulated other comprehensive income
    
    
    2,089
    
    
    
    556Retained earnings
    
    
    21,998
    
    
    
    22,455Total stockholders equity
    
    
    186,772
    
    
    
    181,602$
    202,289
    
    
    $
    199,573
  3




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NEOWARE, INC.
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Net revenues
    
    $
    23,776
    
    
    $
    29,337
    
    
    $
    45,336
    
    
    $
    55,880Cost of revenuesCost of products (includes stock-based compensation
expense of $26 and $21 for the three months and $52
and $40 for the six months ended December 31, 2006
and 2005)
    
    
    13,575
    
    
    
    16,130
    
    
    
    27,614
    
    
    
    31,699Amortization of intangibles
    
    
    339
    
    
    
    302
    
    
    
    675
    
    
    
    575Total cost of revenues
    
    
    13,914
    
    
    
    16,432
    
    
    
    28,289
    
    
    
    32,274Gross profit
    
    
    9,862
    
    
    
    12,905
    
    
    
    17,047
    
    
    
    23,606Operating expensesSales and marketing
    
    
    5,069
    
    
    
    4,379
    
    
    
    9,481
    
    
    
    8,536Research and development
    
    
    1,596
    
    
    
    1,591
    
    
    
    3,370
    
    
    
    2,886General and administrative
    
    
    4,700
    
    
    
    2,797
    
    
    
    7,350
    
    
    
    5,096Amortization of intangibles
    
    
    590
    
    
    
    477
    
    
    
    1,179
    
    
    
    792Abandoned acquisition costs
    
    
    857
    
    
    
    
    
    
    
    857
    
    
    
    Total operating expenses (includes stock-based
compensation expense of $2,046 and $776 for the
three months and $2,953 and $1,477 for the six
months ended December 31, 2006 and 2005)
    
    
    12,812
    
    
    
    9,244
    
    
    
    22,237
    
    
    
    17,310Operating income (loss)
    
    
    (2,950
    )
    
    
    3,661
    
    
    
    (5,190
    )
    
    
    6,296Foreign exchange gain (loss)
    
    
    (19
    )
    
    
    52
    
    
    
    (13
    )
    
    
    63Interest income, net
    
    
    954
    
    
    
    247
    
    
    
    1,936
    
    
    
    491Income (loss) before income taxes
    
    
    (2,015
    )
    
    
    3,960
    
    
    
    (3,267
    )
    
    
    6,850Income tax expense (benefit)
    
    
    (2,610
    )
    
    
    1,419
    
    
    
    (2,810
    )
    
    
    2,466Net income (loss)
    
    $
    595
    
    
    $
    2,541
    
    
    $
    (457
    )
    
    $
    4,384Earnings (loss) per share:Basic
    
    $
    0.03
    
    
    $
    0.15
    
    
    $
    (0.02
    )
    
    $
    0.27Diluted
    
    $
    0.03
    
    
    $
    0.15
    
    
    $
    (0.02
    )
    
    $
    0.26Weighted average number of common
shares outstanding:Basic
    
    
    19,965
    
    
    
    16,492
    
    
    
    19,954
    
    
    
    16,383Diluted
    
    
    20,010
    
    
    
    17,088
    
    
    
    19,954
    
    
    
    16,718
  4




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NEOWARE, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Six Months EndedDecember 31,2006
    
    
    2005Cash flows from operating activities:Net income (loss)
    
    $
    (457
    )
    
    $
    4,384Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities-Amortization of intangibles
    
    
    1,854
    
    
    
    1,367Depreciation
    
    
    273
    
    
    
    168Non-cash share-based compensation
    
    
    3,005
    
    
    
    1,517Deferred income taxes
    
    
    138
    
    
    
    Changes in operating assets and liabilities- net of
effect from acquisition-Accounts receivable
    
    
    (1,412
    )
    
    
    (5,458
    )Inventories
    
    
    (3,593
    )
    
    
    1,044Prepaid expenses and other
    
    
    (4,603
    )
    
    
    1,892Accrued compensation and benefits
    
    
    1,433
    
    
    
    1,076Accounts payable
    
    
    (4,167
    )
    
    
    205Other accrued expenses
    
    
    (22
    )
    
    
    (2,927
    )Income taxes payable
    
    
    9
    
    
    
    (2,290
    )Deferred revenue
    
    
    154
    
    
    
    421Net cash provided by (used in) operating activities
    
    
    (7,388
    )
    
    
    1,399Cash flows from investing activities:Purchase of short-term investments
    
    
    (93,300
    )
    
    
    (13,438
    )Sales of short-term investments
    
    
    111,178
    
    
    
    25,362Purchases of property and equipment
    
    
    (200
    )
    
    
    (818
    )Purchase of Visara thin client business
    
    
    
    
    
    
    (2,107
    )Purchase of TeleVideo thin client business
    
    
    
    
    
    
    (3,520
    )Acquisition of Maxspeed, net of cash acquired
    
    
    
    
    
    
    (11,794
    )Net cash provided by (used in) investing activities
    
    
    17,678
    
    
    
    (6,315
    )Cash flows from financing activities:Expense incurred related to the issuance of common stock
    
    
    (3
    )
    
    
    Exercise of stock options
    
    
    445
    
    
    
    5,376Excess tax benefit from share-based payment arrangements
    
    
    647
    
    
    
    1,440Net cash provided by financing activities
    
    
    1,089
    
    
    
    6,816Effect of foreign exchange rate changes on cash
    
    
    323
    
    
    
    (92
    )Increase in cash and cash equivalents
    
    
    11,702
    
    
    
    1,808Cash and cash equivalents, beginning of period
    
    
    19,328
    
    
    
    8,285Cash and cash equivalents, end of period
    
    $
    31,030
    
    
    $
    10,093Supplemental disclosures:Cash paid for income taxes
    
    $
    374
    
    
    $
    4,192
  5




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NEOWARE, INC.
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Note 1. Basis of Presentation
  Note 2. Recent Accounting Pronouncements
 How Taxes Collected
from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement
(That Is, Gross versus Net Presentation)
 Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109.
 Fair Value Measurements
 Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements
 6




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Note 3. Equity-Based Compensation
 Accounting for Employee Stock Award Plans
 Share-Based Payment, Accounting for Stock Based
Compensation, and superseded APB Opinion No. 25, Accounting for Stock Issued to Employees Statement of Cash
Flows
 Classification of Stock-Based Compensation Expense
  Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Cost of revenues
    
    $
    26
    
    
    $
    21
    
    
    $
    52
    
    
    $
    40Selling and marketing
    
    
    355
    
    
    
    295
    
    
    
    710
    
    
    
    545Research and development
    
    
    94
    
    
    
    102
    
    
    
    189
    
    
    
    207General and administrative
    
    
    1,597
    
    
    
    379
    
    
    
    2,054
    
    
    
    725$
    2,072
    
    
    
    797
    
    
    $
    3,005
    
    
    $
    1,517
 Tax Effect related to Stock-Based Compensation Expense
  Valuation Assumptions for Options Granted during Fiscal 2007
  Expected term
    
    5.1 to 5.5 yearsExpected volatility
    
    71.1 to 76.7%Weighted average volatility
    
    74.8%Risk-free rate
    
    4.5 - 5.1%
  7




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Equity Compensation Plans
      Weighted
    
    
    Remaining
    
    
    IntrinsicAverage
    
    
    Contractual
    
    
    ValueShares
    
    
    Exercise Price
    
    
    Term (years)
    
    
    (in thousands)Outstanding as of June 30, 2006
    
    
    1,956,568
    
    
    $
    12.75Granted
    
    
    395,000
    
    
    
    13.26Exercised
    
    
    (54,346
    )
    
    
    8.19Terminated
    
    
    (232,000
    )
    
    
    13.80Outstanding as of December 31, 2006
    
    
    2,065,222
    
    
    
    12.85
    
    
    
    7.7
    
    
    $
    3,430Options exercisable at December 31, 2006
    
    
    993,866
    
    
    $
    13.99
    
    
    
    6.7
    
    
    $
    1,318Options expected to vest at December 31, 2006
    
    
    762,377
    
    
    $
    11.79
    
    
    
    8.7
    
    
    $
    1,503Options available for future grants at
December 31, 2006
    
    
    1,429,520
  8




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##### Table of Contents



.
  WeightedAverage GrantShares
    
    
    Date Fair ValueUnvested as of June 30, 2006
    
    
    11,290
    
    
    $
    13.29Vested
    
    
    (5,646
    )
    
    
    13.29Unvested as of December 31, 2006
    
    
    5,644
    
    
    
    13.29
  Note 4. Reclassification and Revision
  June 30, 2006
    
    As Reported
    
    Adjustment
    
    As AdjustedCash and cash equivalents
    
    $
    86,223
    
    
    $
    (66,895
    )
    
    $
    19,328Short-term investments
    
    
    27,903
    
    
    
    66,895
    
    
    
    94,798Net cash used in investing activities
    
    
    (11,257
    )
    
    
    (66,895
    )
    
    
    (78,152
    )Increase in cash and cash equivalents
    
    
    77,938
    
    
    
    (66,895
    )
    
    
    11,043
 9




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Note 5. Goodwill and Intangible Assets
   December 31, 2006GrossEstimated
    
    Carrying
    
    
    Accumulated
    
    
    Net Carryinguseful life
    
    Amount
    
    
    Amortization
    
    
    AmountTradenames
    
    Indefinite
    
    $
    368
    
    
    $
    
    
    
    $
    368Non-compete agreements
    
    2-5 years
    
    
    1,688
    
    
    
    673
    
    
    
    1,015Customer relationships
    
    2-5 years
    
    
    7,383
    
    
    
    2,778
    
    
    
    4,605Distributor relationships
    
    5 years
    
    
    2,325
    
    
    
    2,281
    
    
    
    44Acquired technology
    
    5-10 years
    
    
    7,446
    
    
    
    2,953
    
    
    
    4,493$
    19,210
    
    
    $
    8,685
    
    
    $
    10,525June 30, 2006Estimated
    
    Gross Carrying
    
    
    Accumulateduseful life
    
    Amount
    
    
    Amortization
    
    
    Net Carrying AmountTradenames
    
    Indefinite
    
    $
    360
    
    
    $
    
    
    
    $
    360Non-compete agreements
    
    2-5 years
    
    
    1,700
    
    
    
    448
    
    
    
    1,252Customer relationships
    
    2-5 years
    
    
    7,350
    
    
    
    2,031
    
    
    
    5,319Distributor relationships
    
    5 years
    
    
    2,325
    
    
    
    2,079
    
    
    
    246Acquired technology
    
    5-10 years
    
    
    7,506
    
    
    
    2,508
    
    
    
    4,998$
    19,241
    
    
    $
    7,066
    
    
    $
    12,175
  Non-compete agreements
    
    2.3 yearsCustomer relationships
    
    3.4 yearsDistributor relationships
    
    1.8 yearsAcquired technology
    
    3.4 years
  Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Non-compete agreements
    
    $
    129
    
    
    $
    80
    
    
    $
    257
    
    
    $
    114Customer relationships
    
    
    360
    
    
    
    296
    
    
    
    720
    
    
    
    475Distributor relationships
    
    
    101
    
    
    
    116
    
    
    
    202
    
    
    
    233Acquired technologies
    
    
    339
    
    
    
    287
    
    
    
    675
    
    
    
    545$
    929
    
    
    $
    779
    
    
    $
    1,854
    
    
    $
    1,367
  10




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FutureYear Ending June 30,
    
    AmortizationRemainder of fiscal 2007
    
    $
    1,6652008
    
    
    3,2712009
    
    
    2,8362010
    
    
    1,8682011
    
    
    4922012
    
    
    25$
    10,157
 Note 6. Comprehensive Income
  Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Net income (loss)
    
    $
    595
    
    
    $
    2,541
    
    
    $
    (457
    )
    
    $
    4,384Foreign currency translation adjustment
    
    
    1,036
    
    
    
    (774
    )
    
    
    1,533
    
    
    
    (463
    )Comprehensive income
    
    $
    1,631
    
    
    $
    1,767
    
    
    $
    1,076
    
    
    $
    3,921
 Note 7. Revenue Recognition
 Software Revenue Recognition
     11




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Note 8. Major Customers and Dependence on Suppliers
  Three Months Ended
    
    Six Month EndedDecember 31,
    
    December 31,2006
    
    2005
    
    2006
    
    2005Net revenuesNorth American distributor
    
    
    10
    %
    
    
    *
    
    
    
    10
    %
    
    
    *Lenovo
    
    
    *
    
    
    
    25
    %
    
    
    *
    
    
    
    18
    %Customer A
    
    
    *
    
    
    
    *
    
    
    
    *
    
    
    
    13
    %
 December 31,
    
    June 30,2006
    
    2006Accounts receivableCustomer A
    
    
    *
    
    
    
    17
    %Customer B
    
    
    12
    %
    
    
    *Customer C
    
    
    10
    %
    
    
    *Billing agent for Lenovo
    
    
    *
    
    
    
    11
    %
 
 (*) Amounts do not exceed 10% for such period      12




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Note 9. Inventories
  December 31,
    
    
    June 30,2006
    
    
    2006Purchased components and subassemblies
    
    $
    1,558
    
    
    $
    3,243Finished goods
    
    
    9,770
    
    
    
    4,491$
    11,328
    
    
    $
    7,734
  Note 10. Income Taxes
  Note 11. Short-term Borrowings
  Note 12. Earnings per Share
  Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Net income (loss)
    
    $
    595
    
    
    $
    2,541
    
    
    $
    (457
    )
    
    $
    4,384Weighted average shares outstanding:Basic
    
    
    19,965
    
    
    
    16,492
    
    
    
    19,954
    
    
    
    16,383Effect of dilutive employee stock options
    
    
    45
    
    
    
    596
    
    
    
    
    
    
    
    335Diluted
    
    
    20,010
    
    
    
    17,088
    
    
    
    19,954
    
    
    
    16,718Earnings (loss) per common share:Basic
    
    $
    0.03
    
    
    $
    0.15
    
    
    $
    (0.02
    )
    
    $
    0.27Diluted
    
    $
    0.03
    
    
    $
    0.15
    
    
    $
    (0.02
    )
    
    $
    0.26
 13




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Three Months Ended
    
    Six Months EndedDecember 31,
    
    December 31,2006
    
    2005
    
    2006
    
    2005Employee stock options
    
    
    1,022
    
    
    
    64
    
    
    
    1,022
    
    
    
    587
  Note 13. Guarantees
 Indemnifications
  Warranty
   Accrued warranty cost at June 30, 2006
    
    $
    1,177Expense incurred
    
    
    (346
    )Provisions for warranties
    
    
    220Accrued warranty cost at December 31, 2006
    
    $
    1,051
 
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
 Overview
    14




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Strategy
  
    
    Continue to invest in technology development.We believe that we have developed and
acquired the technology to enable a more powerful, secure and cost-effective thin computing
architecture. We have more than a 15-year history of developing this technology including
those of the companies we have acquired. We will continue to invest in technology
development to maintain a our competitive position and drive market share growth.
    
    Focus on the enterprise.We believe the most significant market segment for the thin
client solution is the enterprise customer. As a result, we have focused our development,
sales and marketing efforts on small, medium and large enterprises across a diverse set of
vertical markets. Our access to this highly attractive market is considerably enhanced by
our relationships with our alliance and distribution partners. We will continue to make
significant investments to attract additional enterprise customers and gain market share.
These investments will include additions to the sales teams primarily in the United States
and Europe, as well as additional marketing personnel and programs designed to stimulate
thin client awareness and lead generation.
    
    Enhance channel partnerships. To expand our access to customers, we have developed
relationships with third parties that we believe have strong market positions and customer
relationships. We have developed alliances with IBM, Lenovo, NEC and ClearCube, and other
distributors and resellers, all of which sell our products to their customers. We are
introducing promotional programs and pricing incentives to expand our customer base in this
area and gain market share.
    
    Expand and deepen our geographic footprint.Our business was historically focused on the
U.S. market. In fiscal year 2004, we determined to expand our global footprint as part of a
strategic expansion of our development and integration organization through the
acquisitions of Maxspeed, Mangrove, Qualystem and ThinTune, as well as through partnerships
with global distributors such as NEC, ClearCube and local providers. As a result, we now
have a global footprint, with operations primarily in the US and Europe. We believe that
international markets will be a significant source of growth and we intend to continue to
increase our presence by expanding our reseller relationships and through select
acquisitions.
    
    Grow our business through strategic acquisitions.Our acquisition strategy has been
focused on expanding our geographic reach, acquiring businesses with technologies that
increase our ownership of core intellectual property, and with products that can be sold
through our existing channels to the same end-user customers, leveraging our existing
organization. We have also sought to augment our software development resources and add to
our integration capability on a global basis. We intend to continue to pursue select
strategic acquisitions in the future.
    
    Capitalize on the growing adoption of industry-standard and open-source technologies. We
believe that many enterprise customers are seeking industry-standard technologies, not
proprietary solutions that require them to use a single vendor. As a result, we integrate
our products into industry-standard solutions, and utilize open-source and other
industry-standard technologies. In our supply chain we leverage the high volumes of the PC
industry and PC supply chain techniques to lower our costs. We believe our commitment to
open-source, cross-platform and industry-standard software technologies, and our use of the
high volume supply chain efficiencies of the PC industry, represent significant
differentiators and competitive advantages for us.
 Recent Acquisitions
 15




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##### Table of Contents



Financial Highlights
  Three Months Ended
    
    Six Months EndedDecember 31,
    
    December 31,2006
    
    2005
    
    2006
    
    2005Net revenues (in thousands)
    
    $
    23,776
    
    
    $
    29,337
    
    
    $
    45,336
    
    
    $
    55,880% Change
    
    
    (19
    %)
    
    
    43
    %
    
    
    (19
    %)
    
    
    52
    %Gross profit margin
    
    
    41
    %
    
    
    44
    %
    
    
    38
    %
    
    
    42
    %Diluted earnings (loss) per share
    
    $
    0.03
    
    
    $
    0.15
    
    
    $
    (0.02
    )
    
    $
    0.26
    16




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##### Table of Contents



Critical Accounting Policies and Estimates
  
    
    Revenue recognition
    
    Valuation of long-lived and intangible assets and goodwill
    
    Accounting for income taxes
    
    Stock based compensation
  Revenue Recognition
  Multiple Element Arrangements
 Software Revenue Recognition
  17




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##### Table of Contents



The Fee is Fixed or Determinable
  Collection is Probable
  Stock Rotation Rights and Price Protection
  Valuation of Long-Lived and Intangible Assets and Goodwill
  Goodwill and Other Intangible Assets
 
    
    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.
 Accounting for the Impairment or Disposal of Long-Lived Assets.
 18




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##### Table of Contents




    
    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.
  Accounting for Income Taxes
  Stock-Based Compensation
 Accounting for
Stock Issued to Employees, Accounting for Stock-Based Compensation Accounting for Stock-Based Compensation  Transition and Disclosure
 Share-Based Payment,
 19




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##### Table of Contents



Three Months Ended
    
    
    Six Months EndedDecember 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2006
    
    
    2005Cost of revenues
    
    $
    26
    
    
    $
    21
    
    
    $
    52
    
    
    $
    40Selling and marketing
    
    
    355
    
    
    
    295
    
    
    
    710
    
    
    
    545Research and development
    
    
    94
    
    
    
    102
    
    
    
    189
    
    
    
    207General and administrative
    
    
    1,597
    
    
    
    379
    
    
    
    2,054
    
    
    
    725$
    2,072
    
    
    
    797
    
    
    $
    3,005
    
    
    $
    1,517
   Results of Operations
 Net Revenues
 Three Months Ended
    
    
    
    
    
    Six Months EndedDecember 31,
    
    
    
    
    
    December 31,%2006
    
    2005
    
    % Change
    
    2006
    
    2005
    
    ChangeNet revenues
    
    $
    23,776
    
    
    $
    29,337
    
    
    
    (19
    %)
    
    $
    45,336
    
    
    $
    55,880
    
    
    
    (19
    %)
   20




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##### Table of Contents



Three Months Ended
    
    Six Month EndedDecember 31,
    
    December 31,2006
    
    2005
    
    2006
    
    2005Net revenuesNorth American distributor
    
    
    10
    %
    
    
    *
    
    
    
    10
    %
    
    
    *Lenovo
    
    
    *
    
    
    
    25
    %
    
    
    *
    
    
    
    18
    %Customer A
    
    
    *
    
    
    
    *
    
    
    
    *
    
    
    
    13
    %
 
 (*) Amounts do not exceed 10% for such period Cost of Revenues and Gross Profit Margin
 Three Months Ended
    
    
    
    
    
    
    Six Months EndedDecember 31,
    
    
    
    
    
    
    December 31,%2006
    
    
    2005
    
    
    % Change
    
    
    2006
    
    
    2005
    
    
    ChangeCost of products
    
    $
    13,575
    
    
    $
    16,130
    
    
    
    (16
    %)
    
    $
    27,614
    
    
    $
    31,699
    
    
    
    (13
    %)Amortization of
intangibles
    
    
    339
    
    
    
    302
    
    
    
    12
    
    
    
    675
    
    
    
    575
    
    
    
    17Total cost of revenues
    
    
    13,914
    
    
    
    16,432
    
    
    
    (15
    )
    
    
    28,289
    
    
    
    32,274
    
    
    
    (12
    )Gross profit margin
    
    
    41
    %
    
    
    44
    %
    
    
    
    
    
    
    38
    %
    
    
    42
    %
      21




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##### Table of Contents



Selling and Marketing
 Three Months Ended
    
    
    
    
    
    Six Months EndedDecember 31,
    
    
    
    
    
    December 31,%2006
    
    2005
    
    % Change
    
    2006
    
    2005
    
    ChangeSelling and marketing
    
    $
    5,069
    
    
    $
    4,379
    
    
    
    16
    %
    
    $
    9,481
    
    
    $
    8,536
    
    
    
    11
    %As a percentage of revenue
    
    
    21
    %
    
    
    15
    %
    
    
    
    
    
    
    21
    %
    
    
    15
    %
     Research and Development
 Three Months Ended
    
    
    
    
    
    Six Months EndedDecember 31,
    
    
    
    
    
    December 31,%2006
    
    2005
    
    % Change
    
    2006
    
    2005
    
    ChangeResearch and development
    
    $
    1,596
    
    
    $
    1,591
    
    
    
    
    %
    
    $
    3,370
    
    
    $
    2,886
    
    
    
    17
    %As a percentage of revenue
    
    
    7
    %
    
    
    5
    %
    
    
    
    
    
    
    7
    %
    
    
    5
    %
     General and Administrative
 Three Months Ended
    
    
    
    
    
    Six Months EndedDecember 31,
    
    
    
    
    
    December 31,%2006
    
    2005
    
    % Change
    
    2006
    
    2005
    
    ChangeGeneral and administrative
    
    $
    4,700
    
    
    $
    2,797
    
    
    
    68
    %
    
    $
    7,350
    
    
    $
    5,096
    
    
    
    44
    %As a percentage of revenue
    
    
    20
    %
    
    
    10
    %
    
    
    
    
    
    
    16
    %
    
    
    9
    %
 22




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##### Table of Contents



Amortization of Intangibles
 Three Months Ended
    
    
    
    
    
    Six Months EndedDecember 31,
    
    
    
    
    
    December 31,%2006
    
    2005
    
    % Change
    
    2006
    
    2005
    
    ChangeAmortization of intangibles
    
    $
    590
    
    
    $
    477
    
    
    
    24
    %
    
    $
    1,179
    
    
    $
    792
    
    
    
    49
    %As a percentage of revenue
    
    
    2
    %
    
    
    2
    %
    
    
    
    
    
    
    3
    %
    
    
    1
    %
  Abandoned Acquisition Costs
  Interest Income
 Three Months Ended
    
    
    
    
    
    Six Months EndedDecember 31,
    
    
    
    
    
    December 31,%2006
    
    2005
    
    % Change
    
    2006
    
    2005
    
    ChangeInterest income
    
    $
    954
    
    
    $
    247
    
    
    
    286
    %
    
    $
    1,936
    
    
    $
    491
    
    
    
    294
    %As a percentage of revenue
    
    
    4
    %
    
    
    1
    %
    
    
    
    
    
    
    4
    %
    
    
    1
    %
  Income Tax Expense (Benefit)
 23




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##### Table of Contents



Three Months Ended
    
    
    
    
    
    Six Months EndedDecember 31,
    
    
    
    
    
    December 31,%2006
    
    2005
    
    % Change
    
    2006
    
    2005
    
    ChangeIncome tax expense
(benefit)
    
    $
    (2,610
    )
    
    $
    1,419
    
    
    
    (284
    %)
    
    $
    (2,810
    )
    
    $
    2,466
    
    
    
    (214
    %)As a percentage of revenue
    
    
    (11
    %)
    
    
    5
    %
    
    
    
    
    
    
    (6
    %)
    
    
    4
    %
 - -
 Liquidity and Capital Resources
   Cash flows provided by (used in) operating activities:
 Cash flows provided by investing activities:
 Cash flows provided by financing activities:
 Contractual Obligations
  Remainder
    
    
    2008 and
    
    
    2010 and
    
    
    2012 andTotal
    
    
    of 2007
    
    
    2009
    
    
    2011
    
    
    thereafterProduct purchase obligations
    
    $
    5,962
    
    
    $
    5,962
    
    
    $
    
    
    
    $
    
    
    
    $
    Operating leases
    
    
    3,480
    
    
    
    574
    
    
    
    1,439
    
    
    
    900
    
    
    
    567Other purchase obligations
    
    
    95
    
    
    
    95
    
    
    
    
    
    
    
    
    
    
    
    $
    9,537
    
    
    $
    6,631
    
    
    $
    1,439
    
    
    $
    900
    
    
    $
    567
 24




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##### Table of Contents



Off Balance Sheet
  Forward-Looking Statements
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
    25




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##### Table of Contents



Item 4 Controls and Procedures
   
 PART II      OTHER INFORMATION
 
 Item 1A. Risk Factors
  The success of our strategy depends on our ability to attract, retain and grow our business with
large enterprise customers, and the long sales cycle with these customers makes planning and
inventory management difficult and future financial results less predictable.
   
    
    our sales personnel generally need to explain and demonstrate the benefits of a
large-scale deployment of our products to potential and existing customers prior to sale;
    
    our technical personnel typically spend a significant amount of time assisting
potential customers in their testing and evaluation of our products and services and in
integrating the products to suit their needs;
    
    our large-scale customers are typically large and medium size organizations that
carefully research their technology needs and the many potential projects prior to making
capital expenditures for IT infrastructure; and
    
    before making a purchase, our potential customers usually must obtain approvals from
various levels of decision makers within their organizations, and this process can be
lengthy.
  26




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##### Table of Contents



Our success may depend on our ability to attract, retain and grow our business with small and
medium sized customers.
  Because we rely on resellers and distributors, including IBM and Lenovo, to sell our products, our
revenues could be negatively impacted if these companies do not continue to purchase products from
us.
    Our business could be adversely affected if we are unable to expand and diversify our distribution
channels.
  27




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##### Table of Contents



If we are unable to continue generating substantial revenues from international sales and
effectively managing our international operations our business could be adversely affected.
 , ,
  Our business is dependent on customer adoption of thin client devices as an alternative to personal
computers, and a decrease in their rates of adoption could adversely affect our ability to increase
our revenues.
   Our acquisition and alliance activities could disrupt our ongoing business, and we may not be able
to successfully complete and integrate future acquisitions we may complete, which may materially
adversely affect our growth and our operating results. 28
    Table of Contents     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 products, we are
susceptible to supply shortages that could prevent us from shipping customer orders on time, if at
all, and result in lost sales. In addition, our outsourcing activities for other functions may fail
to reduce costs and may disrupt operations.
   29




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##### Table of Contents



Our ability to accurately forecast our quarterly sales is limited, although our costs are
relatively fixed in the short term, and we expect our business to be affected by rapid
technological change, which may adversely affect our quarterly operating results.
   
    
    Linearity  Our quarterly sales have historically reflected a pattern in which a
disproportionate percentage of sales occur in the last month of the quarter due to typical
customer buying patterns in the IT industry. This pattern makes prediction of revenues and
earnings for each financial period especially difficult and uncertain and increases the
risk of unanticipated variations in quarterly results and financial condition;
 30




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##### Table of Contents




    
    Significant Orders  We are subject to variances in our quarterly operating results
because of the fluctuations in the timing of our receipt of large orders. If even a small
number of large orders are delayed until after a quarter ends, or do not materialize, our
operating results could vary substantially from quarter to quarter and net income could be
substantially less than expected. Conversely, if even a small number of large orders are completed in an earlier quarter than that which was
anticipated, our revenues and net income could be substantially higher than expected,
making it possible that sales and net income in future periods may decline sequentially.
Further, if orders substantially exceed predicted demand, we may not be able to fulfill all
of the orders received in the last few weeks of the quarter;
    
    Seasonality  We have experienced seasonal reductions in business activity in some
quarters based upon customer activity and based upon our partners seasonality. This
pattern has generally resulted in lower sales in our first and third quarters than in the
prior sequential quarters; and
    
    Stock-based compensation expense  Starting in the quarter ended September 30, 2005, we
began recording stock-based compensation expense as calculated under SFAS No. 123R. The
non-cash impact of stock-based compensation expense during fiscal 2006 was $3.4 million
and is expected to be $4.7 million in fiscal 2007. Such amounts may change as a result of
additional grants, forfeitures, modifications in assumptions and other factors.
  
    
    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;
    
    the timely development and introduction of new and enhanced products; and
    
    the successful development of our relationships with software providers, original
equipment manufacturers and existing and potential channel partners.
  Our inventory management is complex as we sell a significant mix of products and our revenues and
gross margins could suffer if we fail to manage the issues properly.
 past several quarters.
 Our gross margins can vary significantly, based upon a variety of factors. If we are unable to
sustain adequate gross margins we may be unable to reduce operating expenses in the short term,
resulting in losses.
  31




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##### Table of Contents



.
 During the past several years, we have increased operating expenses significantly as a foundation
for us to stimulate our growth and growth in our market, and we expect to increase our operating
expenses during fiscal 2007, including increases needed to implement our new sales and marketing
initiatives. If we do not increase revenues or appropriately manage further increases in operating
expenses, our profitability will suffer.
  We may not generate sufficient future taxable income to allow us to realize our deferred tax
assets.
  Our business may suffer if it is alleged or found that we have infringed the intellectual
property rights of others.
  32




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##### Table of Contents




    
    open source license terms may be ambiguous and may result in being subject to
unanticipated obligations regarding our products and technologies;
    
    competitors may have improved access to information that may help them develop
competitive products;
    
    open source software cannot be protected under trade secret law; and
    
    it may be difficult for us to accurately determine the origin of the open source code
and whether the open source software in fact infringes third party intellectual property
rights.
 Thin client device products, like personal computers, are subject to rapid technological change due
to changing operating system software and network hardware and software configurations, and our
products could be rendered obsolete by new technologies.
  If we are unable to rapidly and successfully develop and introduce new products and manage our
inventory, we will not be able to satisfy customer demand.
 ,
  We may not be able to preserve the value of our products intellectual property because other
vendors could challenge our intellectual property rights.
  33




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##### Table of Contents



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.
   
    
    continually develop and introduce new products and services with better prices and
performance than offered by our competitors in the PC market;
    
    offer a wide range of products; and
    
    offer high-quality products and services.
   Actions taken by the SCO Group (SCO) could impact the sale of our Linux products, negatively
affecting sales of some of our products.
  In order to continue to grow our revenues, we may need to hire additional executives and personnel
and update
 34




---



##### Table of Contents



our IT infrastructure.
   
    
    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.
  If we determine that any of our goodwill or intangible assets, including technology purchased in
acquisitions, are impaired, we would be required to take a charge to earnings, which could have a
material adverse effect on our results of operations.
  We might repatriate cash from our foreign subsidiaries, which could result in additional income
taxes that could negatively impact our results of operations and financial position. In addition,
if foreign countries currency policies limit our ability to repatriate the needed funds, our
business and results of operations could be adversely impacted.
  Although we have generated operating profits for the past five fiscal years, we have a prior
history of losses and may experience losses in the future, which could result in the market price
of our common stock declining. 35
    Table of Contents     Because some of our products use embedded versions of Microsoft Windows as their operating system,
an inability to license these operating systems on favorable terms could impair our ability to
introduce new products and maintain market share.
  Because some of our products use Linux as their operating system as well as other open source
technologies, the failure of open source developers to enhance and develop open source software
that we use could impair our ability to release new products and maintain market share.
  If our contracts with Citrix and other vendors of software applications were terminated, our
business would be materially adversely affected.
  Unforeseen environmental costs could impact our future earnings.
 .
 Recent regulations related to equity compensation could adversely affect our ability to attract and
retain key personnel and affect our operating results.
  36




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##### Table of Contents



Share-Based Payment
 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.
 .
 Errors in our products could harm our business and our operating results.
  
    
    the loss of or delay in market acceptance and sales of our products;
    
    diversion of development resources;
    
    injury to our reputation;
    
    unsaleable inventory; or
    
    increased maintenance and warranty costs.
   Our stock price can be volatile. 37
    Table of Contents  ,
 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.
  Provisions in our charter documents and Delaware law may delay or prevent acquisition of us, which
could decrease the value of your shares.
  
 Item 4. Submission of Matters to a Vote of Security Holders
     
 Item 6. Exhibits
  38
    Table of Contents  ExhibitNumber
    
    Description10.1
    
    Summary of Cash Compensation Policy for Non-Employee Directors. Exhibit 10.1 (1)10.2
    
    Summary of Compensation Arrangement with Peter Bolton, Executive Vice President 
Europe, Middle East and Africa, and James Kirby, Executive Vice President Sales  Americas
and APAC.10.3
    
    Separation Agreement and General Release of All Claims between the Company and Wei
Ching dated November 17, 2006.31.1
    
    Certification of Klaus Besier as President and Chief Executive Officer of Neoware,
Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Keith D. Schneck as Executive Vice President and Chief Financial
Officer of Neoware, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification of Klaus Besier as President and Chief Executive Officer of Neoware,
Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification Keith D. Schneck as Executive Vice President and Chief Financial
Officer of Neoware, Inc pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
    
    Management contract or arrangement.(1)
    
    Filed as an Exhibit to Registrants Current Report on Form 8K filed on November 2, 2006. 39
    Table of Contents  SIGNATURES
  NEOWARE, INC.Date:  February 9, 2007
    By:
    /s/ KLAUS BESIERKlaus BesierPresident and Chief Executive Officer Date: February 9, 2007
    By:
    /s/ KEITH D. SCHNECKKeith D. SchneckExecutive Vice President and Chief Financial Officer 40