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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 1999
OR
/ / 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: 0-25457
NEON SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 76-0345839
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
14100 SOUTHWEST FREEWAY, SUITE 500, 77478
SUGAR LAND, TEXAS (zip code)
(Address of principal executive offices)
(281) 491-4200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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None None
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Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
(Title of Class)
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Indicate by check mark whether Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
The aggregate market value of the voting stock held by non-affiliates of
Registrant as of June 25, 1999 was $141,121,740.
As of June 25, 1999, 8,850,033 shares of the Registrant's Common Stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Selected portions of the Information Statement for the 1999 Annual Meeting
of Stockholders to be filed with the Securities and Exchange Commission not
later than 120 days after the end of Registrant's fiscal year ended March 31,
1999 are incorporated by reference into Part III of this Form 10-K.
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NEON SYSTEMS, INC.
FORM 10-K
FOR FISCAL YEAR ENDED MARCH 31, 1999
TABLE OF CONTENTS
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PART I
1. Business............................................................................................. 1
2. Properties........................................................................................... 21
3. Legal Proceedings.................................................................................... 21
4. Submission of Matters to a Vote of Security Holders.................................................. 22
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters................................ 24
6. Selected Consolidated Financial Data................................................................. 26
7. Management's Discussion and Analysis of Financial Condition and Results of Operations................ 28
7A. Quantitative and Qualitative Disclosures about Market Risk........................................... 35
8. Consolidated Financial Statements and Supplementary Data............................................. 36
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................. 53
PART III
10. Directors and Executive Officers of Registrant....................................................... 53
11. Executive Compensation............................................................................... 53
12. Security Ownership of Certain Beneficial Owners and Management....................................... 53
13. Certain Relationships and Related Transactions....................................................... 53
PART IV
14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K.................................... 53
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PART I
This Report contains certain forward-looking statements of the intentions,
hopes, beliefs, expectations, strategies and predictions of NEON Systems, Inc.
("NEON") or its management with respect to future activities or other future
events or conditions within the meaning of Section 27A of the Securities Act of
1933, as amended (the "Act") and Section 21E of the Securities Exchange Act of
1934, as amended, which are intended to be covered by the safe harbors created
thereby. Investors are cautioned that all forward-looking statements involve
risks and uncertainty, including, without limitation, variations in quarterly
results, volatility of NEON'S stock price, development by competitors of new or
competitive products or services, the entry into the market by new competitors,
the sufficiency of NEON'S working capital and the ability of NEON to retain
management, to implement its business strategy, to assimilate and integrate any
acquisitions, to retain customers or attract customers from other businesses and
to successfully defend itself in ongoing and future litigation. Although the
Company believes that the assumptions underlying the forward-looking statements
contained herein are reasonable, any of the assumptions could be inaccurate,
and, therefore, there can be no assurance that the forward-looking statements
included in this Report will prove to be accurate. In light of the significant
uncertainties inherent in the forward-looking statements included herein, the
inclusion of such information should not be regarded as a representation by the
Company or any other person that the objectives and plans of the Company will be
achieved.
ITEM 1. BUSINESS
RECENT EVENTS
In March 1999, NEON completed an initial public offering of 3,041,000 shares
of its Common Stock at an offering price of $15.00 per share. NEON's Common
Stock is traded on the Nasdaq National Market under the symbol "NESY."
Immediately prior to the completion of the offering, the holder of NEON's Series
A Redeemable, Convertible Preferred Stock converted all 625,000 shares of Series
A Redeemable, Convertible Preferred Stock then outstanding into 3,125,000 shares
of NEON's Common Stock.
OVERVIEW
NEON develops, markets and supports Enterprise Access and Integration
software. NEON was incorporated in May 1993 and is a successor by merger to NEON
Systems, Inc., an Illinois corporation which was incorporated in June 1991.
NEON's primary product family, Shadow, provides rapid and cost-effective access
to, and connectivity between, enterprise data, transactions and applications.
Shadow products enable the deployment of new applications and the extension of
legacy applications across a variety of computing environments, including the
Internet and client/server and mainframe systems. Shadow Direct enables
client/server applications to access and integrate with mainframe data and
applications. Shadow Web Server enables Web browsers to access and integrate
with mainframe data and applications. Shadow Enterprise Direct provides access
and integration between client/server systems. These products allow
organizations to provide applications that combine the reliability, scalability,
security and control of the mainframe with the flexibility and
cost-effectiveness of the Internet and client/server environments.
INDUSTRY BACKGROUND
In organizations today, a critical asset is the information technology
infrastructure. Many new organizational initiatives, such as managing
information flow across a supply chain, gaining a deeper understanding of
customer buying habits or characteristics, or engaging in more targeted
marketing, selling and production, depend on the effective delivery of
information where it is needed and when it is needed.
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One of the greatest challenges to implementing these new strategies is
exploiting powerful new technologies within the existing systems infrastructure
of an enterprise--specifically, combining the strengths of the mainframe
environment with the benefits of Internet and client/server systems.
The advantages of the various platforms can be described as follows:
- MAINFRAMES. Mainframes offer proven reliability, scalability, security and
control as well as time-tested applications, often representing millions
of dollars of investment for an organization. As a result, many
organizations continue to depend on the mainframe to run core business
processes, such as inventory management, payroll processing and customer
billing and support. Historically, organizations have invested substantial
amounts in mainframe systems. According to International Data Corporation,
in 1997 alone, organizations invested approximately $18 billion in
high-end servers, comprised substantially of mainframe systems. As a
result, a vast amount of corporate data and records resides on mainframe
systems, representing a wealth of important corporate information.
- CLIENT/SERVER SYSTEMS. Client/server systems enable many users and
applications to share data as well as server resources and enable
applications to be developed and deployed more rapidly than mainframe
applications. Many organizations have deployed new client/server
applications, either developed in-house or purchased from packaged
application vendors.
- THE INTERNET. The Internet offers a low-cost, global network
infrastructure that enables organizations to communicate externally with
customers, suppliers and partners and to coordinate internally by
extending employee access to key applications and information. Web-based,
business critical applications typically leverage common Web browser
interfaces and offer a means to improve service levels while reducing
costs.
Organizations are seeking new applications that combine the strengths of the
mainframe environment with the benefits of the Internet and client/server
systems. While these applications offer high strategic value, they create
several challenges. The first set of challenges is organizational. It is very
difficult for organizations to recruit high-quality systems engineers with the
experience necessary to create these new applications. Although some engineers
may understand the complexities of the Internet or client/server environment,
few will be able to combine that expertise with a deep understanding of
mainframe systems. In addition, many talented mainframe systems engineers now
are preoccupied with finding and fixing Year 2000 problems. The shortage of
qualified engineers frequently leads to expensive outsourced development
contracts during a time when internal information technology departments are
under increasing pressure to contain costs.
The second set of challenges is created by the inherent limitations of
existing solutions. Organizations have historically addressed the need to
provide greater access to data and applications by means of a limited number of
inflexible techniques, including data extract programs, screen-scraping and file
transfers. These techniques have typically been implemented in an AD HOC manner
to address specific requirements as they have arisen over time. Accordingly,
they generally require extensive manual custom software coding, provide limited
functionality, flexibility and scalability, and may require a costly, burdensome
and ongoing maintenance program.
Over the past several years, a number of software products, known
generically as "middleware," have been introduced to provide organizations with
a packaged product to attempt to solve their access and integration challenges.
Middleware software provides the connection between a client application and a
server application, database or transaction processing system. Although current
middleware software products provide certain benefits, they generally are
limited in three major areas:
- Many current middleware products have been developed for client/server
systems and cannot integrate directly with mainframe operating systems
without the use of additional databases,
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hardware or proprietary application programming interfaces that limit the
access, adaptability or performance of the solution.
- Many current middleware products do not include, or have a limited number
of, systems management tools, making these products more burdensome for
information technology personnel to manage.
- Many current middleware products are difficult to integrate quickly into
existing information technology infrastructures without a significant
investment of time and other resources.
As a result of these limitations, organizations are increasingly seeking to
deploy more flexible, easy-to-install, cost-effective and high-performance
enterprise access and integration software products that leverage their
investments in older, legacy technology by integrating the strengths of the
mainframe with the benefits of the Internet and client/server systems.
THE NEON SOLUTION
NEON develops, markets and supports Enterprise Access and Integration
software. NEON's primary product family, Shadow, provides rapid and
cost-effective access to, and connectivity between, enterprise data,
transactions and applications. Shadow products enable the deployment of new
applications and the extension of legacy applications across a variety of
computing environments, including the Internet and client/server and mainframe
systems. This allows organizations to provide applications that combine the
reliability, scalability, security and control of the mainframe with the
flexibility and cost-effectiveness of the Internet and client/server
environments. Shadow Direct enables client/server applications to access and
integrate with mainframe data and applications. Shadow Web Server enables Web
browsers to access and integrate with mainframe data and applications. Shadow
Enterprise Direct provides access and integration between client/server systems.
NEON's Shadow products provide organizations with the following benefits in
deploying new applications and extending existing applications:
- EASY TO USE AND COST-EFFECTIVE. The Shadow products were designed to be
easy to use and compatible with a variety of other applications and to
provide a rapid return on investment. The Shadow products can typically be
installed without on-site assistance within one day. As a result of this
"out-of-the-box" functionality, customers can rapidly implement and
utilize Shadow products in deploying new applications and extending
existing applications with minimal training. Furthermore, unlike many
middleware products, the Shadow products do not require additional
hardware and software components to connect distributed computing
applications with mainframe environments. Due to this reduced complexity,
Shadow products lower costs by reducing the management burden on
information technology personnel.
- PRESERVE INFORMATION TECHNOLOGY INVESTMENT. The Shadow products preserve
an organization's investment in mainframe technology while allowing
customers to take advantage of the benefits of the Internet and
client/server environments. NEON believes mainframe platforms will
continue to dominate large-scale information technology systems for the
foreseeable future. Using NEON's Shadow products, organizations can
continue to use these reliable, mission-critical applications as new
technologies and market opportunities evolve.
- FLEXIBILITY. The Shadow products use industry-standard technologies that
allow users to select client-side development tools, mainframe data
sources and connection modes used to connect the client and server. The
Shadow products' flexible architecture allows organizations to maximize
the use of existing internal skills and technologies to develop new
applications using more familiar mainframe and client/server development
tools. These benefits allow organizations to quickly implement a Shadow
product that can be utilized for a variety of applications.
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- HIGH PERFORMANCE; SCALABILITY. The Shadow products provide "real time"
access to and integration with mainframe systems through Internet or
client/server applications. While many middleware products provide
connectivity to mainframe systems, few provide the rapid response and
scalability delivered by the Shadow products. The Shadow products'
scalability allows information technology groups to broadly expand the
user base of an application without concerns about deteriorating
application performance.
- EXTENSIVE MANAGEMENT, MONITORING AND CONTROL CAPABILITIES. The Shadow
products provide a number of utilities that support all phases of the
application lifecycle. The Shadow products' end-to-end diagnostics provide
rapid resolution of development problems, resulting in faster delivery of
applications extended from the mainframe. The Shadow products maintain the
required performance and availability of mainframe-based applications
operating in a distributed environment at significantly reduced system
maintenance costs.
In addition to its Shadow products, NEON has two other product families.
NEON markets and sells a suite of subsystem management software products
referred to as Enterprise Subsystem Management software. NEON also sells two
security products in a newly formed product family known as the Enterprise
Security Management products. As organizations increasingly deploy Internet and
client/server applications that are dependent upon mainframe-based data and
applications, new demands will be placed on mainframe subsystems. For example,
when an application that once was subject to use by a single corporate office is
made available to customers through the Internet, it may need to be operational
on a continuous basis to support global operations. The number of potential
users accessing the mainframe may increase substantially, and its workload may
fluctuate dramatically. In addition, corporations require new strategies to
handle increasing and changing security demands. NEON's Enterprise Subsystem
Management software products improve the availability and performance of
mainframe subsystems to support the growing demands placed on the mainframe to
support new users and applications. NEON Enterprise Security Management products
provide cost-effective and automated management of small numbers of key
corporate security issues across common and interoperable mainframe and desktop
environments.
THE NEON STRATEGY
NEON's goal is to be the leading provider of enterprise access and
integration software. The following are key elements of the NEON strategy:
- MAINTAIN AND ENHANCE TECHNOLOGICAL LEADERSHIP. NEON believes that it is a
technology leader in providing enterprise access and integration software.
The foundation of its technological leadership is the product architecture
and core code base that underlie the Shadow products. This architecture
not only provides significant advantages over competing products, but
provides the building blocks for the delivery of new Shadow products by
NEON. NEON intends to continue to maintain and enhance its technological
leadership by leveraging its proven architecture to rapidly develop and
release new products.
- CAPITALIZE ON MARKET FOR INTERNET APPLICATIONS AND E-BUSINESS SOLUTIONS.
NEON believes that many organizations are looking for cost-effective ways
to take advantage of the new channels, markets and organizational
structures presented by the rapid growth of the Internet. The Shadow
products provide a cost-effective way to "Web-enable" applications and
allow organizations to rapidly deploy new Internet applications and
participate in e-business opportunities. NEON intends to continue to
leverage its leadership in Web-enablement technology for mainframe data
and applications.
- LEVERAGE INSTALLED BASE OF CUSTOMERS. Approximately 220 organizations
worldwide, including approximately one-fourth of the Fortune 100
companies, have purchased NEON's products. NEON's customers span major
industries, including automobile manufacturing, energy, banking, financial
services, publishing, engineering and retail. To date, the majority of
these customers use NEON's products in specific departments, divisions or
locations. NEON believes it can penetrate more
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deeply into existing customer sites as well as cross-sell either new
Enterprise Access and Integration products or Enterprise Subsystem
Management products. In addition, NEON believes there is a large
opportunity to sell organization-wide licenses to its installed customer
base.
- EXPLOIT PRODUCT DEVELOPMENT STRENGTH. NEON employs a product authorship
program that rewards NEON's product authors individually with commissions
based on the market success of the NEON products they author. NEON
believes that the proximity of its product authors to the customer is
critical, and its product authorship program is designed to encourage
NEON's authors to evaluate the effectiveness of a product in the actual
customer environment. This authorship program contributes to NEON's
ability to hire and retain highly skilled authors. In addition to its
internal development resources, NEON distributes Enterprise Subsystem
Management products developed by Peregrine/Bridge Transfer Corporation
pursuant to a development and distribution agreement. NEON believes that
its relationship with Peregrine/Bridge Transfer Corporation enables it to
address a complementary software market without substantial development
resource commitment.
- MAXIMIZE BENEFITS OF DIRECT TELESALES MODEL. NEON utilizes a direct
telesales model that minimizes the number of remote sales offices and
customer site visits and focuses on effective use of the telephone and
Internet communications for product demonstrations and product sales. NEON
believes its direct telesales approach allows it to achieve better control
of the sales process and respond more rapidly to customer needs while
maintaining an efficient, low-cost sales model. NEON intends to continue
to expand its direct telesales force, both domestically and
internationally.
ENTERPRISE ACCESS AND INTEGRATION PRODUCTS
The Shadow product family consists of three major software products: Shadow
Direct, Shadow Web Server and Shadow Enterprise Direct.
SHADOW DIRECT. Shadow Direct provides organizations with direct access to
mainframe-based data, transactions and applications from desktop computers.
Shadow Direct may be used in multi-tier client/ server environments utilizing
computer operating programs such as Unix and Windows NT. In multi-tier
environments, different parts of a computer program may be distributed among
several tiers of computers or networks. Shadow Direct eliminates the need for
separate hardware and software components and provides a number of unique
connection capabilities to meet a wide variety of corporate application
requirements. Shadow Direct also provides strong performance qualities, such as
scalability, management and control.
SHADOW WEB SERVER. Shadow Web Server provides "Web-enablement" of mainframe
applications for access by Web browsers, thereby allowing organizations to
rapidly install and deploy Web-based applications. Shadow Web Server provides
direct Internet access to mainframe-based data and transactions from the most
popular Web browsers. Unlike most competitive products providing Web-based
access to mainframes, Shadow Web Server allows information technology
organizations to utilize existing mainframe programming skills and software
management techniques without extensive retraining in distributed computing
languages and development tools. In addition, Shadow Web Server Web-enables
mainframe applications without compromising mainframe security levels and
provides secure access by supporting industry standard and proprietary NEON
security technologies. Similar to Shadow Direct, Shadow Web Server minimizes the
number of components that limit the scalability, manageability and control of
other products.
Shadow Direct and Shadow Web Server can be enhanced with Shadow Add-on
Components that meet changing application demands. The add-on components give
the customer the ability to purchase additional capabilities when required,
providing an adaptable solution that meets customers' evolving needs by
extending client attributes, server attributes and/or connection capabilities.
For example, the server is typically extended to support additional data or
transactional sources as the need arises to use these in new applications. In
addition, batch encryption and decryption of files is available for sensitive
business
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transmission of data. This add-on component provides a low-cost, cross-platform
encryption technology to provide secure transmission of sensitive business
information. The add-on components provide NEON's customers with an extendable
and flexible long-term solution for their enterprise access and integration
needs.
SHADOW ENTERPRISE DIRECT. Shadow Enterprise Direct provides organizations
with direct access to Unix and Windows NT-based data and applications from the
desktop. Shadow Enterprise Direct eliminates the need for maintaining multiple
database drivers and provides unique connection capabilities to meet a wide
variety of corporate database and applications requirements. Shadow Enterprise
Direct also provides strong performance qualities, such as scalability,
manageability and control.
NEON'S UNIQUE PRODUCT ARCHITECTURE
NEON's Enterprise Access and Integration Architecture is central to the
Shadow products' success. NEON designed this architecture to be open and
significantly less complex than competing architectures. NEON believes its
architecture not only provides significant technological advantages over
competing products, but also reduces the cost of product development and
time-to-market. NEON's Enterprise Access and Integration Architecture allows
organizations to implement a single architecture that meets mainframe access and
integration needs and maintains open standards for flexibility and adaptability.
The Enterprise Access and Integration Architecture consists of four
fundamental architectural elements that work together to deliver flexible,
high-performance capabilities for enterprise access and integration: Shadow
Client, Shadow Connection, Shadow Management/Run-Time and Shadow Access. Each
element represents a substantial NEON investment measured in terms of lines of
code and man-years of development.
SHADOW CLIENT. Shadow Client supports client application programming
interfaces, protocols and security standards for all major application
environments, including the Hypertext Markup Language and Hypertext Transfer
Protocol used in Internet applications and including Open Database Connectivity,
a standard application programming interface used in connection with
client/server systems. In addition, NEON is continuing to develop and intends to
deliver similar products to support emerging technologies such as Java Database
Connectivity, an application program interface used in connecting programs
written in Java to databases.
SHADOW MANAGEMENT/RUN-TIME. Shadow Management/Run-Time is the hub for all
Shadow Add-on Components which allows local and remote access to mainframe-based
data and transactions. Shadow Management/Run-Time provides management,
execution, security and control of the enterprise access environment.
SHADOW CONNECTION. Shadow Connection provides support for a number of
connection options from the client to Shadow Management/Run-Time. These options
provide flexibility, allowing organizations to select connection modes to fit a
variety of application demands.
SHADOW ACCESS. Shadow Access integrates and supports a series of plug-in
modules for access to data and transactional sources. In addition, organizations
can purchase Shadow Add-on Components as their needs evolve. NEON continues to
develop and market additional add-on components to expand the versatility of the
solution.
ENTERPRISE SUBSYSTEM MANAGEMENT PRODUCTS
NEON's Enterprise Subsystem Management products cost-effectively maintain
the performance and availability required by mainframe environments as the
demand for new applications increases. NEON develops and markets these products
pursuant to a development and distribution agreement with Peregrine/Bridge
Transfer Corporation.
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NEON provides six Enterprise Subsystem Management products that address the
market opportunity in Information Management Systems subsystem management. These
products maintain high availability, integrity and performance of Information
Management Systems databases, and the ability to load and unload data, to manage
indices and to place Information Management Systems data where desired. These
products provide cost-effective means to handle demands of existing and new
applications as they are updated to take advantage of Internet and client/server
computing. NEON also provides Customer Information and Control Affinities
Server, a product that addresses the market opportunity for Customer Information
and Control solutions, which are established middleware solutions from IBM for
mainframe computers. This product allows organizations to more completely
realize the advantages of IBM's System/390 SYSPLEX platform in the Customer
Information and Control subsystem area.
ENTERPRISE SECURITY MANAGEMENT PRODUCTS
NEON's Enterprise Security Management products, announced in May 1999,
provide cost-effective and automated management of corporate security across
common and interoperable mainframe and desktop environments. NEON Enterprise
Security Management software enables authorized users to focus on business
activities while helping to protect corporate assets in common application
processing environments.
NEON provides two products that address Enterprise Security Management
market opportunities. Halo SSO provides two-way password synchronization and
single sign-on across IBM mainframe and Microsoft Windows NT environments. This
product allows corporations to minimize time spent on password administration
and reduce the risk associated with multiple passwords. Halo PGP provides
low-cost, cross-platform batch encryption and decryption of files for the IBM
mainframe environment. This product helps ensure privacy of sensitive data
transmissions with low cost of deployment.
CUSTOMERS
NEON's customer base spans major industries, including automobile,
manufacturing, energy, banking, financial services, publishing, engineering,
government and retail.
NEON provides its products to customers under non-exclusive,
non-transferable licenses. Under NEON's current standard license agreement,
licensed software may be used solely for the customer's internal operations, and
NEON does not sell or transfer title to its products to its customers.
SALES AND MARKETING
NEON sells its products through a direct telesales force and, to a lesser
extent, through independent distributors.
DIRECT TELESALES. NEON utilizes a direct telesales model that minimizes the
number of remote sales offices and customer site visits and focuses on effective
use of the telephone and Internet communications for product demonstrations and
product sales. When necessary, NEON's sales force will also travel to customer
locations for on-site demonstrations and product trials. The direct telesales
model allows NEON's sales representatives to be successful without substantial
travel, thereby improving earning potential and providing a higher quality of
life. NEON believes this model is a significant factor in recruiting and
retaining outstanding sales professionals. NEON believes its direct telesales
approach allows it to achieve better control of the sales process and to respond
more rapidly to customer needs, while maintaining an overall low-cost sales
model. Sales cycles typically range from three to six months.
The direct telesales force for North America is based in Sugar Land, Texas
and generates a substantial majority of NEON's revenues. In January 1997, NEON
established its first international direct telesales office in London, England.
In August 1997, NEON established another international direct telesales office
in Frankfurt, Germany. NEON increased the size of its direct telesales
organization from 21 to 31
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individuals over the last fiscal year and expects to continue hiring sales
personnel, both domestically and internationally, over the next fiscal year.
INDEPENDENT DISTRIBUTORS. NEON has also established indirect distribution
channels through independent distributors in Europe, Latin America and the
Pacific Rim. At March 31, 1999, NEON had 12 distributors covering 22 countries.
NEON's distributors typically perform marketing, sales and technical support
functions in their assigned country or region. They may distribute directly to
the customer, via other resellers or through a combination of both channels.
NEON continuously trains its international distributors in both product
capabilities and sales methodologies. For financial information attributable to
each of NEON's geographic sales areas, see "Note 8--Foreign Operations and
Significant Customers" in the Notes to Consolidated Financial Statements.
In addition to its internal marketing activities, NEON has established
relationships with other vendors that are complementary to NEON's efforts to
expand acceptance of the Shadow and Enterprise Subsystem Management products.
NEON's internal marketing activities include trade and road shows, public
relations, news releases, trade article placements and technical analyst
meetings as well as targeted print trade advertising. NEON also relies on its
Internet site and Web-based seminars to supplement its primary marketing
activities.
ORIGINAL EQUIPMENT MANUFACTURER RELATIONSHIPS. NEON has original equipment
manufacturer relationships with Ardent Software (formerly Prism Solutions),
Informatica and Xantel. These companies embed Shadow Direct in their products to
provide access to mainframe-based enterprise data and transactions from their
respective applications. The original equipment manufacturer contracts and
NEON's software limit access to only their applications. In addition to
generating revenues, these relationships provide an opportunity for NEON's
direct telesales force to sell licenses offering broader Shadow product
functionality.
MARKETING RELATIONSHIPS. NEON has developed marketing relationships with
BEA Systems, IBM, Microsoft and SilverStream. NEON believes that these
relationships could present NEON with access to sales opportunities requiring a
unique combination of product features and requirements that are not available
from any of the foregoing vendors acting independently.
CUSTOMER SUPPORT
NEON believes that high-quality and long-term customer support is a critical
requirement for continued growth and increased sales of its products. NEON has
made significant investments in increasing the size of its support organization
in the past and plans to continue to do so in the future. Customer support
personnel provide pre-sale, installation and post-sale technical support by
toll-free telephone, E-mail and facsimile, and through NEON's Internet site and
bulletin boards. Customer support is available on an around-the-clock basis. In
addition, customer service representatives contact each customer within six
months after installation to assess customer satisfaction and obtain feedback.
As a result of the "out-of-the-box" functionality of its products, NEON does not
require a large customer support organization.
PRODUCT DEVELOPMENT
NEON's research and development efforts are focused primarily on expanding
its Enterprise Access and Integration products, continuing to deliver new
Enterprise Subsystem Management products and enhancing the capabilities found in
NEON's new Enterprise Security Management products. NEON believes that
attracting and retaining talented software developers is an important component
of NEON's product development activities. To this end, NEON has instituted a
product authorship incentive program that rewards NEON's product authors
individually with commissions based on the market success of the applications
designed, written, marketed and supported by them. NEON believes that the
proximity of its
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product authors to the customer is critical, and its product authorship program
is designed to encourage NEON's developers to evaluate the effectiveness of a
product in the actual user environment. NEON incorporates the recommendations of
existing and potential customers when developing its products and believes that
continued dialogue with customers is an important element in developing
enhancements to existing products and in the development of new products.
NEON has in the past devoted, and expects in the future to devote, a
significant amount of resources to developing new and enhanced products. NEON
currently has a number of product development initiatives underway. NEON
believes it can deliver practical support for Java in client/server and Internet
computing environments, enhanced operational capabilities for addressing
enterprise security issues, and new management capabilities for IMS subsystems
with more efficient and cost effective utilities. These development efforts will
increase technology leadership in the Enterprise Access and Integration
products, broaden operation issues solved by the Enterprise Security Management
products and provide new alternatives for organizations managing IMS with the
Enterprise Subsystem Management products.
TEXACO WORK AGREEMENT
NEON has a work agreement with Texaco pursuant to which Texaco provides NEON
use of its mainframe computer and certain of its under-utilized data processing
resources. NEON uses Texaco's resources in developing a number of its
application interfaces. The Texaco agreement specifies that ideas, concepts,
know-how and techniques that NEON develops under the agreement are to remain
NEON's property and that Texaco may use such developments solely for its
internal information technology operations. NEON has granted Texaco and its
subsidiaries and affiliates a worldwide, perpetual, nontransferable and
royalty-free license with respect to any products developed pursuant to the work
agreement. Either party to the work agreement may terminate the agreement upon
30-days' written notice to the other party. Upon termination of the work
agreement, NEON would have to locate alternative mainframe sources to develop
certain of its products. NEON believes alternative mainframe sources are
available at reasonable rates.
PEREGRINE/BRIDGE TRANSFER CORPORATION RELATIONSHIP
NEON markets and sells a suite of Enterprise Subsystem Management products,
in addition to its Shadow products, that improve the efficiency and performance
of mainframe environments. These products are developed pursuant to a
development and distribution agreement with Peregrine/Bridge Transfer
Corporation. The Peregrine/Bridge Transfer Corporation agreement provides NEON
with exclusive rights to distribute Peregrine/Bridge Transfer Corporation's
Enterprise Subsystem Management software, with the exception of limited
co-marketing rights held by IBM relating to one of the Peregrine/ Bridge
Transfer Corporation Enterprise Subsystem Management products, as well as access
to Peregrine/ Bridge Transfer Corporation's team of software developers. At
March 31, 1999, Peregrine/Bridge Transfer Corporation employed 13 developers
with an average of 22 years of experience. The agreement grants NEON worldwide
distribution rights through March 31, 2004. The agreement also grants to NEON
first refusal rights to acquire Peregrine/Bridge Transfer Corporation by
matching any third-party offer that Peregrine/Bridge Transfer Corporation or its
stockholder chooses to accept, and an option to acquire Peregrine/Bridge
Transfer Corporation that is exercisable on or after January 1, 2002 or such
earlier date that NEON has paid Peregrine/Bridge Transfer Corporation royalty
payments totaling $10.0 million or more in any single fiscal year. In fiscal
1999, NEON paid license fees to Peregrine/Bridge Transfer Corporation in the
amount of $703,337. NEON believes that its relationship with Peregrine/Bridge
Transfer Corporation provides it with an opportunity to address a new and
related software products market, Enterprise Subsystem Management, without
committing substantial development resources, and enhances its overall research
and development capabilities.
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COMPETITION
NEON competes in markets that are intensely competitive and characterized by
rapidly changing technology and evolving standards. NEON's competitors are
diverse and offer a variety of solutions directed at various segments of the
Enterprise Access and Integration and Enterprise Subsystem Management software
markets. NEON has experienced, and expects to continue to experience, increased
competition from current and potential competitors, many of whom have greater
name recognition, a larger installed customer base and significantly greater
financial, technical, marketing and other resources than NEON.
NEON's Shadow products compete principally with middleware products from
established vendors such as IBM, Oracle, Merant, Sybase and Information Builders
and to a lesser extent with BEA Systems, IONA Technologies, New Era of Networks
and TSI International Software. NEON's Enterprise Subsystem Management products
face significant competition from products offered by BMC Software. NEON
Enterprise Security Management products face significant competition in this
established market from Computer Associates, Proginet, and New Era of Networks.
In addition, NEON also faces competition from:
- Other business applications vendors who may internally develop, or attain
through acquisitions and partnerships, middleware and enterprise subsystem
management solutions
- Internal development efforts by corporate information technology
departments
- New entrants to the middleware or enterprise subsystem management and
enterprise security markets
NEON's competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements or devote greater resources to
the development, promotion and sale of their products than NEON. Increased
competition could result in price reductions, fewer customer orders, reduced
gross margins, longer sales cycles and loss of market share, any of which would
materially adversely affect NEON's business, operating results and financial
condition.
PROPRIETARY RIGHTS
NEON relies primarily on a combination of copyright, trademark and trade
secret laws, confidentiality procedures and contractual provisions to protect
its proprietary rights. However, NEON believes that these measures afford only
limited protection. There can be no assurance that others will not develop
technologies that are similar or superior to NEON's technology or design around
the copyrights and trade secrets owned by NEON. NEON licenses its products
pursuant to software license agreements, which include acknowledgments and
agreements by the licensee that are intended to establish and protect NEON's
proprietary rights and confidential information. NEON believes, however, that
these measures afford only limited protection. Despite NEON's efforts to protect
its proprietary rights, unauthorized parties may attempt to copy aspects of
NEON's products or to obtain and use information that NEON regards as
proprietary. Policing unauthorized use of NEON's products is difficult and NEON
is unable to determine the extent to which piracy of its software products
exists. In addition, the laws of some foreign countries do not protect NEON's
proprietary rights as fully as do the laws of the United States. There can be no
assurance that NEON's means of protecting its proprietary rights will be
adequate or that competition will not independently develop similar or superior
technology.
A number of organizations, including New Era of Networks, Inc., are
utilizing the name "Neon," alone and in combination with other words, as a
trademark, a tradename or both. New Era of Networks is also a developer and
distributor of middleware and other software products. New Era of Networks has
used the acronym "NEON" in its business, is listed on the Nasdaq National Market
under the symbol "NEON" and has sought to obtain federal trademarks for products
and services whose names include the word "NEON." NEON is currently opposing, in
the U.S. Patent and Trademark Office, New Era of Networks' application to
register "NEONET." On December 24, 1998, New Era of Networks filed a complaint
against NEON in the United States District Court for the District of Colorado
seeking (a) a
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declaratory judgment that New Era of Networks' use of certain trademarks,
including "NEONET," does not infringe NEON's rights or constitute unfair
competition and (b) cancellation of NEON's federal trademark registration for
NEON. NEON has filed an Answer denying the material allegations of that
complaint and the parties are currently in discovery. On June 23, 1999, NEON
sued New Era of Networks in District Court in Fort Bend County, Texas, alleging
that New Era of Networks' use of "NEON" is in violation of Texas law concerning
misappropriation of tradenames. In this litigation, NEON seeks to enjoin New Era
of Networks from using "NEON" as its "nickname," its Nasdaq trading symbol, or
in any other manner that is likely to result in confusion in the marketplace or
to dilute the meaning or value of NEON's name. NEON's claims are based upon its
prior and continuous use of "NEON" as its corporate name. NEON believes that it
has superior rights to use "NEON" and that New Era of Networks' use of NEON is
causing confusion in the marketplace.
However, any litigation to enforce NEON's right to use the NEON name in its
business or to prevent others from using the NEON name may be expensive and
time-consuming, will divert management resources and may not be adequate to
protect its business. If NEON should lose any such litigation, it may have to
change its name, which also would be expensive and time-consuming and could
adversely affect its business. In addition, NEON believes that confusion in the
marketplace caused by New Era of Networks' use of the "NEON" symbol on the
Nasdaq National Market may result in variations in NEON's stock price that are
attributable to facts or circumstances relating to New Era of Networks.
NEON has code-sharing arrangements with third parties under which it has
obtained and used certain source code in the development of some of its software
products. If any of these agreements are terminated, NEON could be required to
spend time and software development resources to replace the affected code. Any
diversion of these resources could delay NEON's development of new products or
product enhancements.
NEON is not aware that it is infringing any proprietary rights of third
parties. There can be no assurance, however, that third parties will not claim
infringement by NEON of their intellectual property rights. BMC Software, Inc.
("BMC Software") has brought suit against NEON and other parties alleging
misappropriation and infringement of certain trade secrets. See "--Legal
Proceedings." NEON expects that software product developers will increasingly be
subject to infringement claims as the number of products and competitors in
NEON's industry segment grows and the functionality of products in different
industry segments overlaps. Any such claims, with or without merit, could be
time-consuming to defend, result in costly litigation, divert management's
attention and resources, cause product shipment delays or require NEON to enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to NEON, if at all. In the
event of a successful claim of product infringement against NEON and failure or
inability of NEON to either license the infringed or similar technology or
develop alternative technology on a timely basis, NEON's business, operating
results and financial condition could be materially adversely affected.
HUMAN RESOURCES
As of March 31, 1999, NEON and its subsidiaries employed 90 persons,
including 51 in sales, marketing and field operations, 18 in research and
development, 10 in finance and administration and 11 in client services. None of
NEON's employees are represented by a labor union. NEON has experienced no work
stoppages and believes its relationship with its employees is good. Competition
for qualified personnel in NEON's industry is intense.
FACILITIES
NEON's principal administrative, engineering, manufacturing, marketing and
sales facility is approximately 34,300 square feet and is located in Sugar Land,
Texas. The lease for this facility will expire on August 31, 2003. In addition,
NEON leases offices in London, England and Frankfurt, Germany and operates
development sites in Redmond, Washington and Columbus, Georgia and a telesales
office in Fairfax, Virginia. Management believes that its current facilities are
adequate to meet its needs through the
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next 12 months and that, if required, suitable additional space will be
available on commercially reasonable terms to accommodate expansion of NEON's
operations.
LEGAL PROCEEDINGS
BMC Software filed suit against Peregrine/Bridge Transfer Corporation,
Skunkware, Inc., the privately held sole stockholder of Peregrine/Bridge
Transfer Corporation, John J. Moores (a director of NEON) and other parties in
the District Court of Travis County, Texas, 200th Judicial District. In December
1996, NEON was named as a codefendant in that suit. BMC Software alleges
misappropriation and infringement of certain trade secrets, confidential
information and corporate opportunity, as well as breach of contract and
fiduciary relations by the individuals. The alleged trade secrets relate
principally to the design of NEON's Partitioned Database Facility product and
specific features of the Information Management Systems utility products
obtained from Peregrine/Bridge Transfer Corporation for marketing by NEON. In
the lawsuit, BMC Software states that it is seeking to enjoin further
distribution of the Peregrine/Bridge Transfer Corporation Partitioned Database
Facility and utilities products. It is also seeking to recover damages based
upon the disgorgement of all revenues derived from the sale or license of these
products through the date of judgment. NEON believes that, with respect to its
sales of these products through March 31, 1999, any disgorgement would not
exceed $1.9 million. Furthermore, BMC Software is seeking to hold
Peregrine/Bridge Transfer Corporation, NEON, Skunkware and Mr. Moores jointly
and severally liable for these damages. Peregrine/Bridge Transfer Corporation is
defending against BMC Software's claims on the basis that the alleged secrets
are matters of general knowledge in the industry and/or that the specific
techniques alleged are not incorporated into the Peregrine/Bridge Transfer
Corporation products. Peregrine/Bridge Transfer Corporation also asserts that
the claims made against the Partitioned Database Facility product are barred by
the statute of limitations.
NEON and Peregrine/Bridge Transfer Corporation contend that the alleged
corporate opportunity did not exist for BMC Software and in any event was not
usurped by Peregrine/Bridge Transfer Corporation or NEON. Peregrine/Bridge
Transfer Corporation and NEON have filed counterclaims against BMC Software for
anti-competitive practices. Peregrine/Bridge Transfer Corporation is defending
NEON in the lawsuit pursuant to an indemnification provision in the distributor
agreement between NEON and Peregrine/Bridge Transfer Corporation.
Peregrine/Bridge Transfer Corporation is minimally capitalized, and there can be
no assurance that Peregrine/Bridge Transfer Corporation will continue to have
sufficient resources to fund the costs and expenses of the lawsuit or indemnify
NEON against an adverse judgment. If Peregrine/Bridge Transfer Corporation
should cease defending NEON in the lawsuit, NEON will be required to provide its
own defense and may not be able to recover the related costs from
Peregrine/Bridge Transfer Corporation. If BMC Software is successful with regard
to its claims in lawsuit, NEON believes that any loss of revenues NEON would
suffer if the court enjoins the sale of the Partitioned Database Facility and
utilities products would not have a material adverse effect on NEON's liquidity,
business or results of operations. If NEON were required to pay damages based
upon the disgorgement of all revenues derived from the sale or license of these
products, NEON believes that the payment could have a material adverse effect on
NEON's liquidity and results of operations.
NEON has filed an opposition in the U.S. Patent and Trademark Office
opposing New Era of Networks' application to register "NEONET." On December 24,
1998, New Era of Networks, Inc. filed a complaint against NEON in the United
States District Court for District of Colorado seeking (a) a declaratory
judgment that New Era of Networks' use of certain trademarks, including
"NEONET," does not infringe NEON's rights or constitute unfair competition and
(b) cancellation of NEON's federal trademark registration for "NEON." On June
23, 1999, NEON filed suit against New Era of Networks in the District Court in
Fort Bend County, Texas seeking to enjoin New Era of Networks from using "NEON"
as its "nickname," stock symbol or in any manner that does or is likely to cause
confusion in the marketplace or dilute the value of NEON's name. NEON believes
that it has superior rights to use "NEON" based upon its prior and continuous
use of "NEON" as part of its corporate name. See
"--Proprietary Rights."
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EXECUTIVE OFFICERS AND DIRECTORS OF NEON
The following table sets forth certain information concerning each of the
executive officers and directors of NEON as of June 25, 1999:
<TABLE>
<CAPTION>
NAME AGE TITLE
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
John J. Moores (a)................................... 54 Chairman of the Board of Directors
Joe Backer........................................... 61 President, Chief Executive Officer and Director
Peter Schaeffer...................................... 43 Chief Technology Officer and Director
John S. Reiland...................................... 49 Chief Financial Officer and Director
Don Pate............................................. 43 Vice President--Worldwide Sales
Wayne E. Webb, Jr.................................... 48 Vice President and General Counsel
Jonathan J. Reed..................................... 43 Vice President of Marketing
Charles E. Noell III (a)(b).......................... 47 Director
Norris van den Berg (a)(b)........................... 60 Director
Richard Holcomb (a).................................. 37 Director
</TABLE>
- ------------------------
(a) Member of the Compensation Committee.
(b) Member of the Audit Committee.
JOHN J. MOORES has served as Chairman of NEON's Board of Directors since May
1993. Since December 1994, Mr. Moores has served as owner and Chairman of the
Board of the San Diego Padres Baseball Club, L.P. and since September 1991 as
Chairman of the Board of JMI Services, Inc., a private investment company. In
1980, Mr. Moores founded BMC Software, a vendor of system software utilities,
and served as its President and Chief Executive Officer until 1986 and as its
chairman of the Board until 1992. Mr. Moores also serves as Chairman of the
Board of Peregrine Systems, Inc., an infrastructure management software company,
and numerous privately held companies, including Skunkware, Inc. Mr. Moores
serves as a director of BindView Development Corporation, a systems management
software company. Mr. Moores holds a B.S. in Economics and a J.D. from the
University of Houston.
JOE BACKER has served as NEON's President and Chief Executive Officer and as
a member of NEON's Board of Directors since November 1995. From December 1993 to
October 1995, Mr. Backer was a private investor. Mr. Backer held the position of
Senior Vice President of BMC Software from November 1989 to November 1993. Mr.
Backer also serves as President, Chief Executive Officer and a member of the
Board of Directors of Peregrine/Bridge Transfer Corporation and Skunkware, Inc.
In addition, Mr. Backer serves as a member of the Board of Directors of Pavilion
Technologies Inc., a privately held software company headquartered in Austin,
Texas. Mr. Backer holds a B.S. in Electrical Engineering from Purdue University.
PETER SCHAEFFER is NEON's founder and has been a member of the Board of
Directors of NEON and NEON's predecessor-in-interest, NEON Systems, Inc., an
Illinois corporation, since July 1991. Since November 1995, Mr. Schaeffer has
served as NEON's Chief Technology Officer. From July 1991 to October 1995, Mr.
Schaeffer served as NEON's President and Chief Executive Officer. From June 1990
to June 1991, Mr. Schaeffer was employed with Goal Systems International, Inc.,
a privately held software development company. In 1986, Mr. Schaeffer co-founded
MVS Software, a privately held software development company, and was Vice
President--Technology of MVS Software until April 1990. Mr. Schaeffer holds a
B.S. in Organic Chemistry from the University of Chicago.
JOHN S. REILAND has served as NEON's Chief Financial Officer since July 1996
and as a member of NEON's Board of Directors since November 1998. Mr. Reiland
also serves as Chief Financial Officer of Peregrine/Bridge Transfer Corporation.
From June 1994 to April 1996, Mr. Reiland served as Senior Vice President, Chief
Financial Officer and a director of Pointe Communications Corporation, an
international telecommunication and Internet service provider. From May 1991 to
May 1994, Mr. Reiland served as Vice President of Motor Columbus AG, an
international long-distance telephone service reseller, and also
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served as President of its subsidiary, WorldCom International, Inc. Mr. Reiland
is a Certified Public Accountant and holds a B.B.A. in Accounting from the
University of Houston.
DON PATE has served as NEON's Vice President-Worldwide Sales since March
1998 and served as NEON's Vice President of Sales from November 1996 to March
1998. From October 1989 to November 1996, Mr. Pate served in several sales and
sales management positions with BMC Software, including Manager of International
Sales, Sales Operations Manager and Regional Manager. Prior to that, Mr. Pate
was a salesman for the IBM Corporation. Mr. Pate holds a B.S. in Economics and
Psychology from Houston Baptist University.
WAYNE E. WEBB, JR. has served as NEON's Vice President and General Counsel
since June 1998. Mr. Webb is also Vice President and General Counsel of
Peregrine/Bridge Transfer Corporation. From August 1989 through May 1998, Mr.
Webb was a partner in the law firm of Fulbright & Jaworski LLP. Mr. Webb holds a
B.S. in Electrical Engineering from Rice University and a J.D. from the
University of Texas at Austin.
JONATHAN J. REED has served as NEON's Vice President of Marketing since
January 1999. From January 1998 through December 1998, Mr. Reed served as NEON's
Director of Marketing. From July 1996 to December 1997, Mr. Reed served as
NEON's Principal Consultant and Technical Marketing Manager. From April 1995
until July 1996, Mr. Reed served as Alliance Manager for Sybase, Inc., a
distributed computing company. From March 1991 to April 1995, Mr. Reed was
employed by BMC Software where he served as a Commercial Analyst. Mr. Reed holds
a B.S. in Biology from the University of Houston and an M.S. in Management and
Computer Science from Houston Baptist University.
CHARLES E. NOELL III has served as a director of NEON since May 1993. Since
January 1992, Mr. Noell has served as President and Chief Executive Officer of
JMI Services, Inc., and as a General Partner of JMI Partners, L.P., which is the
General Partner of JMI Equity Fund, L.P. Mr. Noell is a director of Peregrine
Systems, Inc. and also serves as a director of Transaction Systems Architects,
Inc., an electronic funds transfer company. Mr. Noell also serves on the board
of numerous privately held companies, including Peregrine/Bridge Transfer
Corporation and Skunkware, Inc. Mr. Noell holds a B.A. in History from the
University of North Carolina at Chapel Hill and an M.B.A. from Harvard
University.
NORRIS VAN DEN BERG has served as a director of NEON since May 1993. Mr. van
den Berg has served as a General Partner of JMI Partners, L.P., which is the
General Partner of JMI Equity Fund, L.P., since July 1991. Mr. van den Berg is
also a director of Peregrine Systems, Inc., Peregrine/Bridge Transfer
Corporation and Skunkware, Inc. Mr. van den Berg holds a B.A. in Philosophy and
Mathematics from the University of Maryland.
RICHARD HOLCOMB has served as a director of NEON since May 1993. Mr. Holcomb
is a co-founder of haht Software, a privately held software company, and has
served as its Chairman of the Board since 1995. Mr. Holcomb co-founded Q+E
Software, a privately held supplier of client/server database access technology,
and from 1986 through 1994 served as its President. Mr. Holcomb serves as an
appointed member of the North Carolina Information Resources Management
Commission and on the board of the North Carolina Electronics and Technologies
Association. Mr. Holcomb holds a B.A. in Computer Science from the University of
South Carolina and an M.S. in Computer Science from North Carolina State
University.
RISK FACTORS
This report and the annual report to stockholders contain certain
forward-looking statements within the meaning of the federal securities laws.
Actual results and the timing of certain events could differ materially from
those projected in or contemplated by the forward-looking statements due to a
number of factors, including, without limitation, those set forth below and
elsewhere in this report. In addition to the other information in this report,
the following factors, which may affect NEON's current position and
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future prospects, should be considered carefully in evaluating NEON and an
investment in its common stock.
BECAUSE OUR EXPENSES ARE LARGELY FIXED, AN UNEXPECTED REVENUE SHORTFALL MAY
ADVERSELY AFFECT OUR BUSINESS
Our expense levels are based primarily on our estimates of future revenues
and are largely fixed. We also intend to hire additional personnel to support
additional growth of our business. We may be unable to adjust spending rapidly
enough to compensate for any unexpected revenue shortfall. Accordingly, any
significant shortfall in revenues in relation to our planned expenditures would
reduce, and possibly eliminate, any operating income and could materially
adversely affect our business, operating results and financial condition.
BECAUSE WE CANNOT ACCURATELY PREDICT THE AMOUNT AND TIMING OF INDIVIDUAL SALES,
OUR QUARTERLY OPERATING RESULTS MAY VARY SIGNIFICANTLY. THIS MAY ADVERSELY
IMPACT OUR STOCK PRICE
Our future operating results may vary significantly from quarter to quarter
due to a variety of factors, many of which are outside our control. Therefore,
it is likely that in one or more future quarters our results may fall below the
expectations of securities analysts and investors. Although we have numerous
customer trials of our products in process at any given time, we operate with
virtually no order backlog because our products are shipped and revenues are
recognized shortly after orders are received. In addition, the amount of
revenues associated with sales of our software can vary significantly. In
various quarters in the past, we have derived a significant portion of our
software license revenues from a small number of relatively large sales. An
inability to close one or more large sales that we had targeted to close in a
particular period could materially adversely affect our operating results for
that period. Moreover, we typically realize a majority of our software license
revenues in the last month of a quarter. As a result, minor delays in the timing
of customer orders can shift a sale from its contemplated quarter of completion
to a subsequent quarter and cause significant variability in our operating
results for any particular period. Further, we believe that period-to-period
comparisons of our operating results are not necessarily a meaningful indication
of future performance. If our quarterly results do not meet investors'
expectations, the trading price of our common stock would likely decline.
SEASONAL TRENDS IN SALES OF OUR PRODUCTS MAY AFFECT INVESTORS' EXPECTATIONS
REGARDING OUR FINANCIAL PERFORMANCE AND ADVERSELY AFFECT OUR STOCK PRICE
Historically, our revenues have tended to be strongest in the third and
fourth quarters of our fiscal year and to decrease slightly in our first fiscal
quarter. The expectations of investors who rely on our third or fourth quarter
results in a given year may be adversely impacted if this seasonal trend
continues. We believe that our seasonality is due in part to the calendar year
budgeting cycles of many of our customers, our employee recognition policies
which tend to reward our sales personnel for achieving fiscal year-end rather
than quarterly revenue quotas, and the timing of our hiring of sales force
personnel. In future periods, we expect that this seasonal trend will continue
to cause first fiscal quarter license revenues to decrease from the level
achieved in the preceding quarter.
BECAUSE A SIGNIFICANT PERCENTAGE OF OUR REVENUES ARE DERIVED FROM OUR SHADOW
PRODUCT LINE, DECREASED DEMAND FOR THESE PRODUCTS COULD ADVERSELY AFFECT OUR
BUSINESS
An average of 90% of our revenues over fiscal 1997, 1998 and 1999 was
derived from Shadow Direct and Shadow Web Server. We anticipate that these
products will account for a substantial amount of our revenues for the
foreseeable future. Consequently, our future success will depend on continued
market acceptance of Shadow Direct and Shadow Web Server and enhancements to
these products. Competition, technological change or other factors could reduce
demand for, or market acceptance of, these products and could have a material
adverse effect on our business, operating results and financial condition.
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REDUCED CUSTOMER RELIANCE UPON MAINFRAME COMPUTERS COULD ADVERSELY AFFECT OUR
BUSINESS
We are dependent upon the continued use and acceptance of mainframe
computers in a computing environment increasingly based on distributed
platforms, including client/server and Internet-based computing networks.
Decreased use of the mainframe or in the growth of demand for Web-based and
client/ server applications accessing mainframe data and transactions could have
a material adverse effect on our business, operating results and financial
condition. We derive our revenues primarily from our Shadow products, and, to a
lesser extent, from our suite of Enterprise Subsystem Management software
products that support the growing performance demands on mainframe computers as
they support new users and applications and our new Enterprise Security
Management Products that help to protect corporate assets in common application
processing environments. Although demand for mainframe access and management
solutions has grown in recent years, it may not continue to grow. Our continued
success depends on a number of factors, including:
- Continued use of the mainframe as a central repository of mission-critical
data and transactions
- Growth in business demands for access to the data, applications and
transactions residing on mainframe computers from Web-based and
client/server applications
LOSS OF OUR CHIEF TECHNOLOGY OFFICER OR OUR PRODUCT AUTHORS COULD ADVERSELY
AFFECT OUR BUSINESS
Our success is dependent upon the continued service and skills of our
executive officers and our product authors, none of whom is bound by an
employment agreement. If we lose the services of any of these key personnel, it
could have a negative impact on our business because of their unique skills,
years of industry experience and the difficulty of promptly finding qualified
replacement personnel. Particularly, the services of Peter Schaeffer, our
founder and Chief Technology Officer, would be difficult to replace. We do not
intend to maintain "key-man" life insurance policies covering any of our
employees. Significant competition exists for employees with the skills required
to author the products and perform the maintenance services that we offer, and
we may not be able to continue to retain sufficient numbers of highly skilled
employees.
WE MAY LOSE MARKET SHARE AND BE REQUIRED TO REDUCE PRICES AS A RESULT OF
COMPETITION FROM OUR EXISTING COMPETITORS, OTHER VENDORS AND INFORMATION
SYSTEMS DEPARTMENTS OF CUSTOMERS
We compete in markets that are intensely competitive and feature rapidly
changing technology and evolving standards. Our competitors may be able to
respond more quickly than we can to new or emerging technologies and changes in
customer requirements. Competitive pressures could reduce our market share or
require us to reduce the price of our products, either of which could have a
material adverse effect on our business, operating results and financial
condition.
Our potential field of competitors continues to expand as both organizations
and vendors recognize the need for products that permit users to access
mainframe-based data and applications for integration with applications on their
personal computers that we refer to as Enterprise Access and Integration
products, and Enterprise Subsystem Management products. Our Shadow products
compete principally with products that provide the connection between a client
application and a server application, database or transaction processing system,
known as middleware software products, from established vendors such as IBM,
Oracle and Information Builders, and to a lesser extent with BEA Systems, IONA
Technologies, New Era of Networks and TSI International Software. Our Enterprise
Subsystem Management products face significant competition from BMC Software. We
expect to experience increased competition from current and potential
competitors, many of which have significantly greater financial, technical,
marketing and other resources than we do. We may also face competition from:
- Other business application software vendors who may internally develop, or
attain through acquisitions and partnerships, middleware and enterprise
subsystem management and enterprise security solutions
- Internal development efforts by corporate information technology
departments
- New entrants to the middleware or enterprise subsystem management markets
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WE MAY NOT HAVE THE RESOURCES TO SUCCESSFULLY MANAGE ADDITIONAL GROWTH
Our recent growth has placed significant demands on management as well as on
our administrative, operational and financial resources. Our inability to
sustain or manage any additional growth could have a material adverse effect on
our business, operating results and financial condition. In addition, expansion
of our existing international operations and entry into additional international
markets will require significant management attention and financial resources.
To manage any additional growth, we must:
- Expand our sales, marketing and customer support organizations
- Invest in the development of enhancements to existing products and new
products that meet changing customer needs
- Further develop our technical expertise so that we can influence and
respond to emerging industry standards
- Improve our operational processes and management controls
RAPID TECHNOLOGICAL CHANGE COULD RENDER OUR PRODUCTS OBSOLETE
Our markets are characterized by rapid technological change, frequent new
product introductions and enhancements, uncertain product life cycles, changes
in customer requirements and evolving industry standards. The introduction of
new products embodying new technologies and the emergence of new industry
standards could render our existing products obsolete which would have a
material adverse effect on our business, operating results and financial
condition. Our future success will depend upon our ability to continue to
develop and introduce a variety of new products and product enhancements to
address the increasingly sophisticated needs of our customers. We may experience
delays in releasing new products and product enhancements in the future.
Material delays in introducing new products or product enhancements may cause
customers to forego purchases of our products and purchase those of our
competitors.
WE MAY BE UNABLE TO ENFORCE OR DEFEND OUR OWNERSHIP AND USE OF PROPRIETARY
TECHNOLOGY
Our success depends to a significant degree upon our proprietary technology.
We rely on a combination of trademark, trade secret and copyright law, and
contractual restrictions and passwords to protect our proprietary technology.
However, these measures provide only limited protection, and we may not be able
to detect unauthorized use or take appropriate steps to enforce our intellectual
property rights, particularly in foreign countries where the laws may not
protect our proprietary rights as fully as in the United States. Companies in
the software industry have experienced substantial litigation regarding
intellectual property. Any litigation to enforce our intellectual property
rights would be expensive and time-consuming, would divert management resources
and may not be adequate to protect our business.
We could be subject to claims that we have infringed the intellectual
property rights of others. In addition, we may be required to indemnify our
distribution partners and end-users for similar claims made against them. Any
claims against us could require us to spend significant time and money in
litigation, pay damages, develop new intellectual property or acquire licenses
to intellectual property that is the subject of the infringement claims. These
licenses, if required, may not be available on acceptable terms. As a result,
intellectual property claims against us could have a material adverse effect on
our business, operating results and financial condition.
LOSS OF CODE-SHARING OR DISTRIBUTOR RIGHTS COULD DIVERT OUR RESOURCES FROM NEW
PRODUCT DEVELOPMENT
We have code-sharing arrangements with third parties under which we have
obtained and used some source code in the development of some of our software
products. If any of these agreements are terminated, we could be required to
discontinue our use of the acquired code, and we would have to spend time and
software development resources to replace that code. Any diversion of these
resources could
17
<PAGE>
delay our development of new products or product enhancements. In addition, we
license several of our Enterprise Subsystem Management products from
Peregrine/Bridge Transfer Corporation pursuant to a distributor agreement with
an initial term through March 31, 2004. The license may be terminated by either
party in the event of default. The termination of the distributor agreement
could have a material adverse effect on our business, operating results and
financial condition.
OUR PLANNED EXPANSION OF OUR INTERNATIONAL OPERATIONS MAY MAKE US MORE
SUSCEPTIBLE TO GLOBAL ECONOMIC FACTORS, FOREIGN TAX LAW ISSUES AND BUSINESS
PRACTICES AND CURRENCY FLUCTUATIONS
We currently have limited experience in developing local versions of our
products and marketing and distributing our products internationally. We plan to
expand our current international operations and to establish additional
facilities and marketing relationships in additional regions. We have
established direct telesales subsidiary offices in Germany and the United
Kingdom to market and sell our products in Europe. We have distributors in
Europe, Latin America and the Pacific Rim to market and sell our products in
those regions. We plan to expand our current international operations and to
establish additional facilities and marketing relationships in additional
regions. Our international operations are subject to particular risks,
including:
- Impact of recessions in economies outside the United States
- Difficulty in accounts receivable collection and longer collection periods
- Cost of enforcement of contractual obligations
- Difficulties and costs of managing foreign operations
- Limited protection for intellectual property rights in some countries
- Currency exchange rate fluctuations
- Political and economic instability
- Potentially adverse tax consequences
Our international revenues are generally denominated in local currencies. We
do not currently engage in currency hedging activities; however, we may
implement a program to mitigate foreign currency transaction risk in the future.
Future fluctuations in currency exchange rates may adversely affect our revenues
from international sales.
USE OF OUR NAME BY OTHERS MAY CAUSE CONFUSION IN THE MARKET
A number of organizations, including New Era of Networks, Inc., are
utilizing the name "Neon," both alone and in combination with other words, as a
trademark, a tradename or both. Any litigation to enforce our right to use the
NEON name in our business or to prevent others from using the NEON name would be
expensive and time-consuming, would divert management resources and may not be
adequate to protect our business. New Era of Networks is also a developer and
distributor of middleware and other software products. New Era of Networks has
used the acronym "NEON" in its business, is listed on the Nasdaq National Market
System under the symbol "NEON" and has sought to obtain federal trademarks for
products and services whose names include the word "NEON." We are currently
opposing, in the U.S. Patent and Trademark Office, New Era of Networks'
application to register "NEONET." New Era of Networks has filed a complaint
against NEON in the United States District Court for the District of Colorado
seeking (1) a declaratory judgment that New Era of Networks' use of certain
trademarks, including "NEONET," does not infringe our rights or constitute
unfair competition and (2) cancellation of our federal trademark registration
for "NEON." NEON has filed an Answer denying the material allegation of that
complaint and the parties are currently in discovery. On June 23, 1999, NEON
sued New Era of Networks in District Court in Fort Bend County, Texas, seeking
to enjoin New Era of Networks' use of "NEON" as its "nickname," stock symbol or
in any manner that does or is likely to cause confusion in
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<PAGE>
the marketplace or dilute the value of NEON's name. If we should lose any such
litigation, we may have to change our name, which also would be expensive and
time-consuming and could adversely affect our business. In addition, NEON
believes that New Era of Networks' use of the "NEON" symbol on the Nasdaq
National Market System creates confusion in the marketplace and may result in
variations in our stock price that are attributable to facts or circumstances
relating to New Era of Networks.
CONTINUED INVOLVEMENT IN BMC SOFTWARE LITIGATION COULD DIVERT OUR RESOURCES AND
AN ADVERSE JUDGMENT COULD MATERIALLY AFFECT OUR FINANCIAL POSITION
We license several of our Enterprise Subsystem Management products from
Peregrine/Bridge Transfer Corporation. Peregrine/Bridge Transfer Corporation,
NEON and other parties have been sued by BMC Software alleging misappropriation
and infringement of certain trade secrets, confidential information and
corporate opportunity, and an unfavorable judgment in this action could
materially affect our financial position. BMC Software is seeking damages based
upon the disgorgement of all revenues derived from the sale or license of
certain of our Enterprise Subsystem Management products and is seeking to enjoin
our distribution of these products. NEON believes that, with respect to its
sales activities through March 31, 1999, any disgorgement would not exceed $1.9
million. Peregrine/Bridge Transfer Corporation has agreed to indemnify us
against damages arising from third-party intellectual property infringement
claims related to products that we license from it, including the products
subject to this lawsuit. However, Peregrine/ Bridge Transfer Corporation may not
have sufficient resources to continue to fund the costs and expenses of the
lawsuit or to indemnify us against an adverse judgment. We believe that BMC
Software's claims are without merit and Peregrine/Bridge Transfer Corporation is
defending this action vigorously on our behalf. We believe that any loss of
revenues we would suffer if the court enjoins the sale of particular products
subject to this lawsuit would not have a material adverse effect on our
liquidity, business or results of operations. If NEON were required to pay
damages based upon the disgorgement of all revenues derived from the sale or
license of these products, we believe that the payment could have a material
adverse effect on our liquidity and results of operations.
OUR PRODUCTS MAY CONTAIN UNDETECTED SOFTWARE ERRORS, WHICH COULD ADVERSELY
AFFECT OUR BUSINESS
Our software products and the software products that we sell for others are
complex and may contain undetected errors. These undetected errors could result
in adverse publicity, loss of revenues, delay in market acceptance or claims
against us by customers, all of which could seriously damage our business,
operating results and financial condition. We have previously discovered
software errors in certain of the products that we have developed or sold.
Despite testing, we cannot be certain that errors will not be found in current
versions, new versions or enhancements of our products after commencement of
commercial shipments.
THE COMPLEX TECHNOLOGY OF OUR PRODUCTS SUBJECTS US TO LIABILITY CLAIMS
Because our products provide critical database access, integration and
management functions, we may face significant liability claims if our customers
believe that our products have failed to perform their intended functions.
Liability claims could require us to spend significant time and money in
litigation or to pay significant damages. As a result, any such claims, whether
or not successful, could have a material adverse effect on our reputation and
business, operating results and financial condition. Our agreements with
customers typically contain provisions intended to limit our exposure to
liability claims. However, these contract provisions may not preclude all
potential claims.
YEAR 2000 ISSUES MAY EXPOSE US TO LIABILITY
Some computers, software and other equipment include programming code in
which calendar year data is abbreviated to only two digits. As a result of this
design decision, some of these systems, including our systems and those of third
parties that we rely upon, could fail to operate or fail to produce correct
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<PAGE>
results if "00" is interpreted to mean 1900, rather than 2000. These problems
are widely expected to increase in frequency and severity as the year 2000
approaches and are commonly referred to as the "Year 2000 Problem."
The Year 2000 Problem presents us with several potential risks including,
but not limited to, the following:
- SOFTWARE SOLD TO CUSTOMERS. Once licensed, our products interact with
other non-NEON developed products and operate on computer systems that are
not under our control. These factors could affect the performance of our
products if a Year 2000 Problem existed in a different facet of a
customer's information technology infrastructure.
- INTERNAL INFRASTRUCTURE. The Year 2000 Problem could affect computers,
software and other equipment that we use internally as well as divert
management's attention from ordinary business activities. In addition to
computers and related systems, the operation of our office and facilities
equipment, such as fax machines, photocopiers, telephone switches,
security systems, elevators and other common devices may be affected by
the Year 2000 Problem.
- SUPPLIERS/THIRD-PARTY RELATIONSHIPS. There can be no assurance that our
suppliers or other third parties that we rely upon will resolve any or all
Year 2000 Problems with their systems on a timely basis.
- STRAIN ON INFORMATION TECHNOLOGY RESOURCES. The Year 2000 Problem is
currently placing a strain on organizations' information technology
budgets and resources. Some organizations may lack sufficient resources to
undertake the type of integration projects that the NEON Shadow product
line enables at the same time that they are addressing the Year 2000
Problem.
We are in the process of resolving all Year 2000 Problems that could
materially adversely affect our business, financial condition or results of
operations. We have developed contingency plans as part of our efforts to
identify and correct Year 2000 Problems affecting our internal systems. However,
we believe that it is not possible to determine with complete certainty that all
Year 2000 Problems affecting us will be identified or corrected in a timely
manner. If we fail to identify and correct all Year 2000 Problems affecting our
internal systems, or if we are forced to implement our contingency plans, our
business, financial condition or results of operations could be materially
adversely affected. For additional information, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Year 2000 Issues."
AS A TECHNOLOGY COMPANY, OUR COMMON STOCK MAY BE SUBJECT TO ERRATIC PRICE
FLUCTUATIONS
From time to time, the stock market experiences significant price and volume
fluctuations, which may affect the market price of our Common Stock for reasons
unrelated to our performance. Recently, such volatility has particularly
impacted the stock prices of publicly-traded technology companies. In the past,
securities class action litigation has been instituted against a company
following periods of volatility in the market price of a company's securities.
If similar litigation were instituted against us, it could result in substantial
costs and a diversion of our management's attention and resources, which could
have an adverse effect on our business. In addition, the market price of our
common stock may be subject to significant fluctuations in response to numerous
factors, including:
- Variations in our annual or quarterly financial results or those of our
competitors
- Changes by financial research analysts in their estimates of our earnings
or our failure to meet such estimates
- Conditions in the economy in general or in the software and other
technology industries
- Announcements of key developments by competitors
- Loss of key personnel
20
<PAGE>
- Unfavorable publicity affecting our industry or us
- Adverse legal events affecting us
- Sales of NEON common stock by stockholders
THE AVAILABILITY OF SIGNIFICANT AMOUNTS OF OUR COMMON STOCK FOR SALE COULD
ADVERSELY AFFECT ITS MARKET PRICE
If our stockholders begin to sell substantial amounts of our common stock in
the public market, the market price of our common stock could fall. A
substantial number of sales, or the perception that such sales might occur, also
might make it more difficult for us to sell equity or equity-related securities
in the future at a time and price that we deem appropriate. We have granted
registration rights to two of our stockholders, Peter Schaeffer and JMI Equity
Fund, L.P. Those rights enable these stockholders to require that we register,
at our expense, resales of their shares of common stock. Mr. Schaeffer and JMI
Equity Fund, L.P. beneficially own in the aggregate approximately 4.85 million
shares of our common stock. If they sell a 1arge portion of their shares on the
open market and at one time, our market price per share may decline.
OUR OFFICERS AND DIRECTORS CONTROL NEON, AND THESE OFFICERS AND DIRECTORS COULD
CONTROL MATTERS SUBMITTED TO OUR STOCKHOLDERS
At present, our executive officers and directors and entities affiliated
with them beneficially own approximately 55.1% of our outstanding Common Stock.
As a result, these stockholders, if they act together, could control all matters
submitted to our stockholders for a vote, including the election of directors
and the approval of mergers and other business combination transactions.
PROVISIONS OF OUR CHARTER AND BYLAWS AND DELAWARE LAW COULD DETER TAKEOVER
ATTEMPTS
Provisions of our Certificate of Incorporation and Bylaws as well as
Delaware law could make it more difficult for a third party to acquire us, even
if doing so would be beneficial to our stockholders. We are subject to the
provisions of Delaware law which restrict certain business combinations with
interested stockholders, which may have the effect of inhibiting a
non-negotiated merger or other business combinations.
ITEM 2. PROPERTIES
NEON's principal administrative, engineering, manufacturing, marketing and
sales facility is approximately 34,300 square feet and is located in Sugar Land,
Texas. The lease for this facility will expire on August 31, 2003. In addition,
NEON leases offices in London, England and Frankfurt, Germany and operates
development sites in Redmond, Washington and Columbus, Georgia and a telesales
office in Fairfax, Virginia. Management believes that its current facilities are
adequate to meet its needs through the next 12 months and that, if required,
suitable additional space will be available on commercially reasonable terms to
accommodate expansion of NEON's operations.
ITEM 3. LEGAL PROCEEDINGS
BMC Software filed suit against Peregrine/Bridge Transfer Corporation,
Skunkware, Inc., the privately held sole stockholder of Peregrine/Bridge
Transfer Corporation, John J. Moores (a director of NEON) and other parties in
the District Court of Travis County, Texas, 200th Judicial District. In December
1996, NEON was named as a codefendant in that suit. BMC Software alleges
misappropriation and infringement of certain trade secrets, confidential
information and corporate opportunity, as well as breach of contract and
fiduciary relations by the individuals. The alleged trade secrets relate
principally to the design of the Partitioned Database Facility product and
specific features of the Information Management Systems utility products
obtained from Peregrine/Bridge Transfer Corporation for marketing by NEON. In
the lawsuit,
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BMC Software states that it is seeking to enjoin further distribution of the
Peregrine/Bridge Transfer Corporation Partitioned Database Facility and
utilities products. It is also seeking to recover damages based upon the
disgorgement of all revenues derived from the sale or license of these products
through the date of judgment. NEON believes that, with respect to its sales of
these products through March 31, 1999, any disgorgement would not exceed $1.9
million. Furthermore, BMC Software is seeking to hold Peregrine/Bridge Transfer
Corporation, NEON, Skunkware and Mr. Moores jointly and severally liable for
these damages. Peregrine/Bridge Transfer Corporation is defending against BMC
Software's claims on the basis that the alleged secrets are matters of general
knowledge in the industry and/or that the specific techniques alleged are not
incorporated into the Peregrine/Bridge Transfer Corporation products.
Peregrine/Bridge Transfer Corporation also asserts that the claims made against
the Partitioned Database Facility product are barred by the statute of
limitations.
NEON and Peregrine/Bridge Transfer Corporation contend that the alleged
corporate opportunity did not exist for BMC Software and in any event was not
usurped by Peregrine/Bridge Transfer Corporation or NEON. Peregrine/Bridge
Transfer Corporation and NEON have filed counterclaims against BMC Software for
anti-competitive practices. Peregrine/Bridge Transfer Corporation is defending
NEON in the lawsuit pursuant to an indemnification provision in the distributor
agreement between NEON and Peregrine/Bridge Transfer Corporation.
Peregrine/Bridge Transfer Corporation is minimally capitalized, and there can be
no assurance that Peregrine/Bridge Transfer Corporation will continue to have
sufficient resources to fund the costs and expenses of the lawsuit or indemnify
NEON against an adverse judgment. If Peregrine/Bridge Transfer Corporation
should cease defending NEON in the lawsuit, NEON will be required to provide its
own defense and may not be able to recover the related costs from
Peregrine/Bridge Transfer Corporation. If BMC Software is successful with regard
to its claims in lawsuit, NEON believes that any loss of revenues NEON would
suffer if the court enjoins the sale of the Partitioned Database Facility and
utilities products would not have a material adverse effect on NEON's liquidity,
business or results of operations. If NEON were required to pay damages based
upon the disgorgement of all revenues derived from the sale or license of these
products, NEON believes that the payment could have a material adverse effect on
NEON's liquidity and results of operations.
NEON has filed an opposition in the U.S. Patent and Trademark Office
opposing New Era of Networks' application to register "NEONET." On December 24,
1998, New Era of Networks, Inc. filed a complaint against NEON in the United
States District Court for District of Colorado seeking (a) a declaratory
judgment that New Era of Networks' use of certain trademarks, including
"NEONET," does not infringe NEON's rights or constitute unfair competition and
(b) cancellation of NEON's federal trademark registration for "NEON." NEON has
filed an Answer denying the material allegations of that complaint, and the
parties are currently in discovery. On June 23, 1999, NEON sued New Era of
Networks in Fort Bend County, Texas, alleging that New Era of Networks' use of
"NEON" is in violation of Texas law concerning misappropriation of tradenames.
In this litigation, NEON seeks to enjoin New Era of Networks from using "NEON"
as its "nickname," its Nasdaq trading symbol, or in any other manner that is
likely to result in confusion in the marketplace or to dilute the meaning or
value of NEON's name. NEON's claims are based upon its prior and continuous use
of "NEON" as its corporate name. NEON believes that it has superior rights to
use "NEON" and that New Era of Networks' use of NEON is causing confusion in the
marketplace.
In addition, NEON is, from time to time, a party to litigation arising in
the normal course of its business. Management believes that none of such actions
will have a material adverse effect on the financial condition or results of
operations of NEON.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Prior to the initial public offering of NEON's Common Stock in March 1999,
on January 19, 1999 a special meeting of NEON's stockholders was held at NEON's
executive offices in Sugar Land, Texas.
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ELECTION OF DIRECTORS. At the special meeting, each of John J. Moores, Joe
Backer, Peter Schaeffer, Charles E. Noell III, Norris van den Berg and Richard
Holcomb were reelected, and John S. Reiland was elected, to the Board of
Directors of NEON. Messers. Moores, Noell and van den Berg were elected by vote
of 625,000 shares of the then-outstanding Series A Redeemable, Convertible
Preferred Stock, with no votes cast against such election or withheld or
abstained.
Messrs. Holcomb, Schaeffer and Backer were each reelected by vote of
1,840,083 of NEON's then-outstanding 2,682,251 shares of Common Stock, with no
votes cast against such election and 842,168 votes withheld or abstained.
Mr. Reiland was elected to the Board by vote of 625,000 shares of the
then-outstanding Series A Redeemable, Convertible Preferred Stock and 1,840,083
of NEON's then-outstanding 2,682,251 shares of Common Stock, with no votes cast
against such election and 842,168 votes withheld or abstained.
APPROVAL OF AMENDED AND RESTATED CERTIFICATE OF INCORPORATION. The sole
holder of the 625,000 shares of NEON's Series A Redeemable Convertible Preferred
Stock then-outstanding and holders of 1,840,083 of NEON's then-outstanding
2,682,251 shares of Common Stock voted to adopt the Amended and Restated
Certificate of Incorporation of NEON, and no votes were against such election
and 842,168 votes withheld or abstained.
The Amended and Restated Certificate of Incorporation provides that NEON
shall have authorized (i) 30,000,000 shares of Common Stock, par value $0.01 per
share, and (ii) 10,000,000 shares of Preferred Stock, $0.01 per share, with such
preferred stock to be issued in one or more series and with such designations,
powers, preferences and rights as may be determined by NEON's Board of Directors
and without further action by NEON's stockholders.
The Amended and Restated Certificate of Incorporation also provides that
NEON's directors are to be divided into three classes, with each class serving
for a term of three years. Messrs. Backer and Noell are Class I directors whose
terms will expire in 2000; Messrs. Holcomb and van den Berg are Class II
directors whose terms will expire in 2001; and Messrs. Moores, Reiland and
Schaeffer are Class III directors whose terms will expire in 2002.
In addition, the Amended and Restated Certificate of Incorporation also
provides:
- That any action required or permitted to be taken by stockholders of NEON
must be effected at a duly called annual or special meeting of the
stockholders and may not be effected by a consent in writing
- That special meetings of stockholders of NEON may be called only by the
Chairman of the Board, the Chief Executive Officer or a majority of the
members of NEON's Board of Directors
- That vacancies on the Board of Directors, including newly created
directorships, can be filled only by a majority of the directors then in
office
- That directors of NEON may be removed only for cause and only by the
affirmative vote of holders of at least 66 2/3% of the outstanding shares
of voting stock, voting together as a single class
APPROVAL OF AMENDED AND RESTATED BYLAWS. The sole holder of the 625,000
shares of NEON's Series A Redeemable, Convertible Preferred Stock
then-outstanding and holders of 1,840,083 shares of NEON's then-outstanding
2,682,251 shares of Common Stock voted to adopt Amended and Restated Bylaws for
NEON, with no votes cast against such election and 842,168 votes withheld or
abstained.
APPROVAL OF 1999 LONG-TERM INCENTIVE PLAN AND STOCK OPTION PLAN FOR
NON-EMPLOYEE DIRECTORS. The sole holder of the 625,000 shares of NEON's Series A
Redeemable, Convertible Preferred Stock then outstanding and the holders of
1,840,083 shares of NEON's then-outstanding 2,682,251 shares of Common Stock
voted to adopt the NEON Systems, Inc. 1999 Long-Term Incentive Plan and the NEON
Systems, Inc. Stock Option Plan for Non-Employee Directors, with no votes cast
against such election and 842,168 votes withheld or abstained.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
NEON's Common Stock trades on the Nasdaq Stock Market under the symbol
"NESY." NEON completed its initial public offering in March 1999 and sold
3,041,000 shares of its common stock at a price of $15.00 per share. The
following table sets forth, for NEON's fiscal period indicated, the range of
high and low last reported sale prices for the Common Stock since the initial
public offering.
<TABLE>
<CAPTION>
FISCAL YEAR 1999 HIGH LOW
- ------------------------------------------------------------------------------------------------ --------- ---------
<S> <C> <C>
Fourth Quarter (March 5, 1999-March 31, 1999)................................................... $ 55.00 15.00
</TABLE>
During the past three years and prior to its March 1999 initial public
offering, NEON issued unregistered shares of its Common Stock to a limited
number of persons as described below. NEON also issued 625,000 shares of its
Series A Redeemable, Convertible Preferred Stock, par value $.01 per share, to
JMI Equity Fund, L.P. in the transaction described in paragraph (2) below.
(1) From August 1996 through March 31, 1999, NEON issued and sold 547,506
shares of common stock to employees at prices ranging from $0.01 to $1.00
per share upon exercise of stock options granted pursuant to NEON's 1993
Stock Plan.
(2) In March 1997, NEON issued and sold 625,000 shares of Series A
Redeemable, Convertible Preferred Stock to JMI Equity Fund, L.P. pursuant
to the conversion of $250,000 in convertible debt held by such limited
partnership.
(3) In June 1998, NEON issued and sold 47,780 shares of common stock to
Wayne E. Webb, Jr. for an aggregate purchase price of $86,004 pursuant to
a restricted stock purchase effected under the 1993 Stock Plan.
(4) Effective immediately prior to the consummation of the sale of shares of
common stock pursuant to NEON's public offering, NEON issued 3,125,000
shares of its common stock to JMI Equity Fund, L.P. pursuant to the
conversion of 625,000 shares of its Series A Redeemable, Convertible
Preferred Stock held by such entity.
None of the foregoing transactions involved any underwriters, underwriting
discounts or commissions, or any public offering, and NEON believes that each
transaction was exempt from the registration requirements of the Act by virtue
of Section 4(2) thereof or Rule 701 pursuant to compensatory benefit plans and
contracts relating to compensation as provided under such Rule 701. The
recipients in such transactions represented their intention to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof, and appropriate legends were affixed to the share
certificates and instruments issued in such transactions. All recipients had
adequate access, through their relationships with NEON, to information about
NEON.
HOLDERS
On June 25, 1999, the last reported sale price of the common stock on the
Nasdaq Stock Market was $32.75 per share. At June 25, 1999, there were 113
holders of record of NEON's common stock, although NEON believes that the number
of beneficial owners of its common stock is substantially greater, and 8,850,033
shares outstanding.
In March 1999, the Company completed the initial public offering of its
common stock (the "IPO"). The Commission declared the Registration Statement
(File No. 333-69651) relating to the IPO effective on March 4, 1999. In the IPO,
the Company issued and sold 3,041,000 shares for an aggregate price to the
public of $45,615,000 and a certain selling stockholder sold 64,000 shares of
common stock for an
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aggregate offering price of $960,000. The IPO was a firm commitment
underwriting, and the managing underwriters of the IPO were Donaldson, Lufkin &
Jenrette Securities Corporation, Hambrecht & Quist LLC and CIBC Oppenheimer
Corp. The underwriting discount incurred by the Company relating to the IPO was
$3,193,050. Net offering proceeds received by the Company from the IPO were
approximately $41.2 million. Approximately $1.0 million of the proceeds received
by the Company from the IPO were used to repay existing indebtedness. Pending
final application, the Company has invested the proceeds received by it from the
IPO (other than the proceeds used to repay the existing indebtedness described
above) in short term, interesting-bearing, investment-grade securities.
DIVIDENDS
NEON has never declared any cash dividends on its common stock. NEON does
not anticipate paying any cash dividends on its common stock in the foreseeable
future and intends to retain its earnings, if any, to finance the expansion of
its business and for general corporate purposes. Any payment of future dividends
will be at the discretion of the Board of Directors and will depend upon, among
other things, NEON's earnings, financial condition, capital requirements, level
of indebtedness, contractual restrictions and other factors that NEON's Board of
Directors deems relevant.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The selected consolidated financial data below should be read in conjunction
with Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations," and Item 8, "Consolidated Financial Statements and
Supplementary Data," included elsewhere herein.
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
---------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1996 1997 1998 1999
--------- --------- --------- ---------
1995
-------------
(UNAUDITED)
Statement of Operations Data:
Revenues:
License..................................................... $ 261 $ 2,190 $ 6,183 $ 9,806 $ 15,420
Maintenance................................................. 59 276 1,003 2,397 4,596
------ --------- --------- --------- ---------
Total revenues............................................ 320 2,466 7,186 12,203 20,016
Cost of revenues:
Cost of licenses............................................ 4 18 212 552 1,032
Cost of maintenance......................................... -- 159 392 743 986
------ --------- --------- --------- ---------
Total cost of revenues.................................... 4 177 604 1,295 2,018
------ --------- --------- --------- ---------
Gross profit.................................................. 316 2,289 6,582 10,908 17,998
Operating expenses:
Sales and marketing......................................... 310 1,307 3,469 5,713 7,418
Research and development.................................... 738 1,205 1,525 2,258 3,800
General and administrative.................................. 60 310 696 1,494 2,566
Non-cash compensation....................................... -- -- -- -- 767
------ --------- --------- --------- ---------
Total operating expenses.................................. 1,108 2,822 5,691 9,465 14,551
------ --------- --------- --------- ---------
Operating income (loss)....................................... (792) (532) 891 1,443 3,447
Interest and other, net....................................... (4) (66) (67) 28 185
------ --------- --------- --------- ---------
Income (loss) before provision for income taxes............... (796) (598) 823 1,471 3,632
Provision for income taxes.................................... -- -- 7 310 1,380
------ --------- --------- --------- ---------
Net income (loss)............................................. (796) (598) 816 1,161 2,252
Dividends on series A redeemable convertible preferred
stock....................................................... (80) (80) (80) (100) (75)
------ --------- --------- --------- ---------
Net income (loss) applicable to common stockholders........... $ (876) $ 678) $ 736 $ 1,061 $ 2,177
------ --------- --------- --------- ---------
------ --------- --------- --------- ---------
Earnings (loss) per common share (a):
Basic......................................................... $ 2.10 $ (1.62) $ 0.35 $ 0.45 $ 0.71
------ --------- --------- --------- ---------
------ --------- --------- --------- ---------
Diluted....................................................... $ (2.10) $ (1.62) $ 0.14 $ 0.19 $ 0.30
------ --------- --------- --------- ---------
------ --------- --------- --------- ---------
Shares used in computing earnings (loss)
per common share (a):
Basic....................................................... 417 417 2,094 2,371 3,065
Diluted..................................................... 417 417 5,671 6,268 7,517
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
AS OF MARCH 31,
---------------------------------------------------------
1996 1997 1998 1999
1995 --------- --------- --------- ---------
-------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents................................... $ 291 $ 131 $ 1,705 $ 2,804 $ 45,400
Working capital (deficit)................................... (530) 47 876 973 45,295
Total assets................................................ 376 730 3,093 6,352 52,635
Secured notes payable....................................... 650 1,130 1,049 1,049 --
Series A redeemable, convertible preferred stock............ 1,153 1,233 1,563 1,663 --
Total stockholders' equity (deficit)........................ (1,637) (2,228) (1,416) (234) 45,830
</TABLE>
- ------------------------
(a) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the calculation of earnings (loss) per common share and shares
used in computing earnings (loss) per common share.
27
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion contains forward-looking statements that involve
risks and uncertainties. NEON's actual results could differ materially from
those discussed in the forward-looking statements as a result of certain factors
including those set forth under "Risk Factors" and elsewhere in this report. The
following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto appearing elsewhere in
this report.
OVERVIEW
NEON develops, markets and supports Enterprise Access and Integration
software. NEON was incorporated in May 1993 and is a successor by merger to NEON
Systems, Inc., an Illinois corporation which was incorporated in June 1991. NEON
introduced its first generally available products, Shadow Direct and Shadow Web
Server, in November 1994 and January 1995, respectively. NEON introduced the
third member of the Shadow product line, Shadow Enterprise Direct, in February
1996. NEON's Shadow products provide rapid and cost-effective access to and
connectivity between enterprise data, transactions and applications. Shadow
Direct enables client/server applications to access and integrate with mainframe
data and applications. Shadow Enterprise Direct provides access and integration
between client/server systems. In addition, through its distributor agreement
with Peregrine/Bridge Transfer Corporation, NEON launched the first of its
Enterprise Subsystem Management products in January 1997. This product line,
which currently consists of six products, improves the availability and
performance of mainframe subsystems to support the growing demands placed on the
mainframe.
NEON has devoted significant resources to building its sales and marketing
functions, resulting in revenues increasing from $2.5 million in fiscal 1996 to
$20.0 million in fiscal 1999. NEON's revenues increased $7.8 million, or 64%,
from $12.2 million in fiscal 1998 to $20.0 million in fiscal 1999. NEON has been
profitable since the quarter ended September 30, 1996. However, there can be no
assurance that NEON will remain profitable on a quarterly or annual basis.
Management expects to continue to devote substantial resources to its sales and
marketing functions in the future.
NEON derives revenues exclusively from software licenses and maintenance
services. Historically, NEON's Shadow products have generated substantially all
of its revenues. License fees, which are based upon the number and capacity of
servers as well as the number of client users, are generally due upon license
grant and include a one-year maintenance period. The license sales process
typically takes three to six months. After the initial year of license, NEON
provides ongoing maintenance services, which include technical support and
product enhancements, for an annual fee based upon the current price of the
products. Since NEON's inception, over 95% of customers have elected to continue
maintenance service after the first year. In fiscal 1996, 1997, 1998 and 1999,
maintenance revenues represented 11%, 14%, 20% and 23% of total revenues,
respectively. Maintenance revenues are expected to continue to increase as a
percentage of total revenues as NEON's customer base continues to grow.
NEON recognizes revenues in accordance with the American Institute of
Certified Public Accountants Statement of Position 97-2. NEON sells its products
under perpetual license and recognizes license revenues when all of the
following conditions are met: a non-cancellable license agreement has been
signed; the product has been delivered; there are no material uncertainties
regarding customer acceptance; collection of the receivable is probable; and no
other significant vendor obligation exists. Maintenance revenues are recognized
ratably over the maintenance service period, which is typically one year. The
portion of maintenance revenues that has not yet been recognized as revenue is
reported as deferred revenue on NEON's balance sheet.
28
<PAGE>
NEON conducts its business in the United Kingdom and Germany through two
wholly-owned consolidated subsidiaries. Revenues from these subsidiaries are
denominated in local currencies. Pursuant to these foreign operations, NEON is
exposed to foreign currency fluctuations for its net working capital positions.
At March 31, 1999, NEON had unhedged net current assets denominated in British
pounds aggregating 705,857 British pounds and unhedged net current liabilities
denominated in Deutsche marks aggregating 175,266 Deutsche marks. At that date,
NEON had no material commitments that would be satisfied in currencies other
than U.S. dollars. In other international markets, NEON conducts substantially
all of its business through independent third-party distributors. Revenues
derived from third-party distributors are denominated in U.S. dollars. Revenues
recognized from sales to customers outside North America, primarily in Europe,
represented approximately 20%, 11%, 41% and 28% in fiscal 1996, 1997, 1998 and
1999, respectively. The British pound and the German mark have been relatively
stable against the U.S. dollar for the past several years. As a result, foreign
currency fluctuations have not had a significant impact on NEON's revenues or
operating results. Management does not currently have an active foreign exchange
hedging program; however, NEON may implement a program to mitigate foreign
currency transaction risk in the future. Although NEON's international
operations and sales levels are subject to economic, fiscal and monetary policy
of foreign governments, to date these factors have not had a material effect on
NEON's results of operations or liquidity. NEON expects that revenues from
international operations should not vary substantially as a percentage of total
revenue and from the level experienced in fiscal 1999.
RESULTS OF OPERATIONS
The following table sets forth, for the periods illustrated, certain
statement of operations data expressed as a percentage of total revenues:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------------------
<S> <C> <C> <C> <C> <C>
1995 1996 1997 1998 1999
--------- --------- --------- --------- ---------
Revenues:
License............................................................. 81.6% 88.8% 86.0% 80.4% 77.0%
Maintenance......................................................... 18.4 11.2 14.0 19.6 23.0
--------- --------- --------- --------- ---------
Total revenues.................................................... 100.0 100.0 100.0 100.0 100.0
Cost of revenues:
Cost of licenses.................................................... 1.3 0.7 2.9 4.5 5.2
Cost of maintenance................................................. -- 6.4 5.5 6.1 4.9
--------- --------- --------- --------- ---------
Total cost of revenues............................................ 1.3 7.1 8.4 10.6 10.1
--------- --------- --------- --------- ---------
Gross profit.......................................................... 98.7 92.9 91.6 89.4 89.9
Operating expenses:
Sales and marketing................................................. 96.9 53.0 48.3 46.8 37.1
Research and development............................................ 230.6 48.9 21.2 18.5 19.0
General and administrative.......................................... 18.8 12.6 9.7 12.2 12.8
Non-cash compensation............................................... -- -- -- -- 3.8
--------- --------- --------- --------- ---------
Total operating expenses.......................................... 346.3 114.4 79.2 77.6 72.7
--------- --------- --------- --------- ---------
Operating income (loss)............................................... (247.5) (21.6) 12.4 11.8 17.2
Interest and other, net............................................... (1.3) (2.7) (0.9) 0.2 0.9
--------- --------- --------- --------- ---------
Income (loss) before provision for
income taxes........................................................ (248.8) (24.3) 11.5 12.1 18.1
Provision for income taxes............................................ -- -- 0.1 2.5 6.9
--------- --------- --------- --------- ---------
Net income (loss)..................................................... (248.8)% (24.3)% 11.4% 9.5% 11.3%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
29
<PAGE>
FISCAL YEARS ENDED MARCH 31, 1997, 1998 AND 1999
REVENUES
TOTAL REVENUES. Total revenues were $7.2 million, $12.2 million and $20.0
million in fiscal 1997, 1998 and 1999, respectively, representing increases of
70% from fiscal 1997 to fiscal 1998 and 64% from fiscal 1998 to fiscal 1999. One
customer accounted for 12% of NEON's total revenues in fiscal 1999.
LICENSE. License revenues were $6.2 million, $9.8 million, and $15.4
million in fiscal 1997, 1998 and 1999, respectively, representing increases of
59% from fiscal 1997 to fiscal 1998 and 57% from fiscal 1998 to fiscal 1999. The
license revenue increases were attributable to increases in the number of
license sales of NEON's existing Shadow products, and to a lesser extent, to
license sales of new Enterprise Subsystem Management products. Product price
increases during the periods were not significant.
MAINTENANCE. Maintenance revenues were $1.0 million, $2.4 million and $4.6
million in fiscal 1997, 1998 and 1999, respectively, representing increases of
139% from fiscal 1997 to fiscal 1998 and 92% from fiscal 1998 to fiscal 1999.
These increases resulted from renewals of maintenance agreements from NEON's
installed base of customers and the recognition of deferred first-year
maintenance service fees on an increased level of license sales.
COST OF REVENUES
COST OF LICENSES. Cost of license revenues includes costs of product
licenses, such as product manuals, distribution and media costs for NEON's
software products, as well as royalty payments to third parties related to
license revenues primarily resulting from NEON's sales of Enterprise Subsystem
Management products. Cost of license revenues was $212,000, $552,000 and $1.0
million in fiscal 1997, 1998 and 1999, respectively, representing 3%, 6% and 7%
of total license revenues in the respective periods. The dollar and percentage
increases were due primarily to increased sales of Enterprise Subsystem
Management products, resulting from increased royalties paid to Peregrine/Bridge
Transfer Corporation under NEON's distributorship agreement with
Peregrine/Bridge Transfer Corporation.
COST OF MAINTENANCE. Cost of maintenance revenues includes personnel and
other costs related to NEON's customer support departments. Cost of maintenance
revenues was $392,000, $743,000 and $986,000 in fiscal 1997, 1998 and 1999,
respectively, representing 39%, 31% and 21% of total maintenance revenues in the
respective periods. The dollar increases during the periods were due principally
to increases in the number of technical support staff providing support to
NEON's growing customer base. The percentage decreases resulted primarily from
maintenance revenues outpacing the need for additional support staff. NEON
anticipates that the cost of maintenance revenues will continue to decrease as a
percentage of maintenance revenues as NEON's customer base continues to expand.
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing expenses include salaries,
commissions, bonuses, benefits and travel expenses of sales, presales support
and marketing personnel, together with trade show participation and other
promotional expenses. Sales and marketing expenses were $3.5 million, $5.7
million and $7.4 million in fiscal 1997, 1998 and 1999, respectively,
representing 48%, 47% and 37% of total revenues in the respective periods. The
dollar increase from fiscal 1997 to fiscal 1998 resulted primarily from an
increase in costs associated with the recently established sales offices in the
United Kingdom and Germany, as well as increases in compensation costs due to
the hiring of additional sales personnel and increased commissions paid as a
result of NEON's revenue growth. The dollar increase from fiscal 1998 to fiscal
1999 reflects an increase in additional compensation expenses incurred in the
hiring of additional North American sales personnel and the payment of increased
sales commissions as a result of NEON's revenue growth. The percentage decrease
is primarily a result of an increase in NEON's revenues and, to a lesser extent,
an increase in sales by NEON's North American and European internal sales
personnel, who
30
<PAGE>
command lower sales commissions than NEON's independent international
distributors. As NEON continues to devote resources to the expansion of its
sales and marketing organization, NEON expects that annual sales and marketing
expenses will increase in absolute dollars but should not vary substantially as
a percentage of total revenues from the level experienced in the fiscal year
ended March 31, 1999.
RESEARCH AND DEVELOPMENT. Research and development expenses include
salaries, bonuses and benefits to product authors, product developers and
product documentation personnel and the computer hardware, software and
telecommunication expenses associated with these personnel. NEON compensates
product authors based on a percentage of product license revenues generated by
products for which they are responsible. Research and development expenses were
$1.5 million, $2.3 million and $3.8 million in fiscal 1997, 1998 and 1999,
respectively, representing 21%, 19% and 19% of total revenues in the respective
periods. The dollar increases in these periods were primarily attributable to
increased compensation costs due to additional staffing and, to a lesser extent,
increased product commissions paid to product authors. Research and development
expenses are expected to increase in absolute dollar amounts but not vary
substantially as a percentage of total revenues from the level experienced in
the fiscal year ended March 31, 1999. NEON has adopted Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed." Research and development expenditures
generally have been charged to operations as incurred and any capitalizable
amounts have been immaterial.
GENERAL AND ADMINISTRATIVE. General and administrative expenses include
salaries, personnel and related costs for NEON's executive, financial, legal and
administrative staff. General and administrative expenses were $696,000, $1.5
million and $2.6 million in fiscal 1997, 1998 and 1999, respectively,
representing 10%, 12% and 13% of total revenues in the respective periods. The
increases resulted primarily from increases in office and administrative costs
associated with NEON's newly established subsidiaries in the United Kingdom and
Germany, increases in occupancy costs and increases in compensation expenses due
principally to administrative personnel additions necessary to support NEON's
growth. NEON anticipates general and administrative expenses will continue to
increase in absolute dollars but should not vary substantially as a percentage
of total revenues from the level experienced in the fiscal year ended March 31,
1999.
NON-CASH COMPENSATION. During the fiscal year ended March 31, 1999, the
Company granted stock options at prices considered to be below the then fair
value of the underlying stock. The cumulative differential between the fair
value of the underlying stock and the exercise price of the granted options was
$2.5 million. This amount will be recognized as expense over the four-year
vesting period of the granted options. During the fiscal year ended March 31,
1999, $767,000 was recognized as a non-cash compensation expense. The remaining
differential of $1.7 million will be recognized over the remaining vesting
period of the granted options.
PROVISION FOR INCOME TAXES. NEON fully utilized its net operating loss
carry-forward for U.S. income tax purposes in fiscal 1998. NEON's U.S. income
taxes prior to fiscal 1998 were offset by net operating loss carry-forwards. The
effective income tax rate was 21% and 38% for fiscal 1998 and 1999,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
NEON's cash and cash equivalent balance increased to $45.4 million at March
31, 1999 from $2.8 million at March 31, 1998 and $1.7 million at March 31, 1997.
This increase was due primarily to the $41.2 million net proceeds received from
NEON's March 1999 initial public offering as well as positive cash flows from
operating activities.
Net cash provided by operating activities was $1.9 million, $1.3 million and
$2.5 million in fiscal 1997, 1998 and 1999, respectively. Net cash provided by
operating activities during these three fiscal years was
31
<PAGE>
primarily the result of increased profitability from the growth of NEON's
business offset by increases in accounts receivable.
A majority of NEON's revenues are recorded in the latter half of each
quarter. Accordingly, as NEON's quarterly revenues have increased, the aggregate
balance of accounts receivable-trade has also increased. Future increases in
NEON's accounts receivable-trade balance will reduce cash flows otherwise
available from NEON's operating results.
Net cash used by NEON in investing activities was $306,000, $276,000 and
$234,000 in fiscal 1997, 1998 and 1999, respectively, principally for purchases
of property and equipment, including computer hardware and software to support
NEON's growing employee base. As of March 31, 1999, NEON had no material
commitment for capital expenditures.
NEON's net cash provided by financing activities was $2,000, $28,000 and
$40.2 million in fiscal 1997, 1998 and 1999, respectively. Net cash provided by
financing activities in fiscal 1999 consisted primarily of the $41.2 million net
proceeds received from NEON's initial public offering in March 1999 offset by
the repayment of $1.0 million of secured notes payable. The cash provided by
financing activities in fiscal 1997 and 1998 was from amounts received from the
exercise of employee stock options.
NEON believes that its current balances of cash and short-term investments
in marketable investment securities as well as cash provided by future
operations will be sufficient to meet its working capital and anticipated
capital expenditure requirements for at least the next 12 months. Thereafter,
NEON may require additional funds to support its working capital requirements or
for other purposes and may seek to raise such additional funds through public or
private equity financing or from other sources. There can be no assurance that
additional financing will be available at all, or if available, that such
financing will be obtainable on terms acceptable to NEON or that any additional
financing will not be dilutive.
In December 1996, NEON was added as a defendant in litigation brought by BMC
Software, Inc. Peregrine/Bridge Transfer Corporation, Skunkware, Inc., the
privately held sole stockholder of Peregrine/ Bridge Transfer Corporation, and
John J. Moores also are defendants in the lawsuit. In the lawsuit, BMC Software
alleges misappropriation and infringement of certain trade secrets, confidential
information and corporate opportunity, as well as breach of contract and
fiduciary relationships by the individuals. BMC Software states in the lawsuit
that it is seeking to enjoin further distributions of the Peregrine/Bridge
Transfer Corporation Partitioned Database Facility and utilities products. It is
also seeking to recover damages based upon the disgorgement of all revenues
derived from the sale or license of these products through the date of
judgement. As a result of NEON's involvement in the litigation, members of
NEON's senior management were initially required to devote a significant amount
of attention to the lawsuit. NEON also made certain modifications to its
business plan and certain of its products in its 1997 and 1998 fiscal years as a
result of the lawsuit. NEON believes that, with respect to its sales activities
through March 31, 1999, any disgorgement pursuant to the lawsuit would not
exceed $1.9 million. NEON believes that any loss of revenues NEON would suffer
if the court enjoins the sale of the Partitioned Database Facility and utilities
products would not have a material adverse effect on NEON's liquidity, business
or results of operations. If NEON were required to pay damages based upon the
disgorgement of all revenues derived from the sale or license of these products,
NEON believes that the payment could have a material adverse effect on NEON's
liquidity and results of operations.
YEAR 2000 ISSUES
BACKGROUND AND ASSESSMENT. Some computers, software and other equipment
include programming code in which calendar year data is abbreviated to only two
digits. As a result of this design decision, some of these systems could fail to
operate or fail to produce correct results if "00" is interpreted to mean 1900,
rather than 2000. These problems are widely expected to increase in frequency
and severity as the Year 2000 approaches and are commonly referred to as the
Year 2000 Problem.
32
<PAGE>
In assessing the effect of the Year 2000 Problem on NEON, management
determined that three general areas existed that needed to be evaluated:
- Software products sold to customers
- Internal infrastructure
- Supplier/third party relationships
A discussion of the various activities related to assessment and actions
resulting from those evaluations is set forth below.
SOFTWARE PRODUCTS SOLD TO CUSTOMERS. Several years ago, NEON initiated and
completed a recoding of its software products that made them Year 2000
compliant. All earlier versions of the software products previously delivered to
customers have been replaced with those recoded products. Subsequently developed
products have been tested for Year 2000 compliance and NEON believes that these
products are Year 2000 compliant. All of NEON's products have been tested for
Year 2000 compliance. The ongoing product development activities of NEON
continually consider and address the Year 2000 Problem in their development.
However, once licensed, NEON's products interact with other non-NEON developed
products and operate on computer systems that are not under NEON's control.
These factors could affect the performance of NEON's products if a Year 2000
Problem existed in a different facet of a customer's information technology
infrastructure. NEON has not and will not assess the existence of these
potential problems in its customers' various environments. NEON does not believe
that the development of Year 2000 compliant products has created or will create
a significant increase in the development costs of its software products.
INTERNAL INFRASTRUCTURE. NEON has completed examining and verifying that
all of its personal computers, servers and software are Year 2000 compliant.
This examination revealed that a small number of personal computers were not
compliant. NEON is in the process of replacing or upgrading all items noted that
were not Year 2000 compliant. NEON has researched and found that the vendors of
all of its critical applications have represented that their products are Year
2000 compliant. NEON has completed upgrading its financial and accounting
software. This upgrade involved purchasing an upgraded version of its existing
financial and accounting software package that the vendor certifies to be free
of Year 2000 Problems. The costs related to these efforts have not been and are
not expected to be material to NEON's business, financial condition or results
of operations.
NEON has assessed potential problems associated with embedded technology.
These assessments indicate that, due to the nature of NEON's operations, the
non-information technology systems (i.e., embedded technology such as
microcontrollers) do not represent a significant area of risk relative to Year
2000 readiness. NEON's operations do not include capital-intensive equipment
with embedded microcontrollers.
NEON has not utilized the resources of third parties to assess and/or
validate the reliability of its assessment of the Year 2000 Problem.
Additionally, NEON does not expect to do so in the future. To date the
assessment and corrections of the Year 2000 Problem have not led to the
deferment of information technology-related projects.
SUPPLIERS/THIRD PARTY RELATIONSHIPS. As mentioned above, NEON has been
gathering information from vendor Web sites and available compliance statements
and has initiated communications with third-party suppliers of the major
computers, software and other equipment used, operated or maintained by NEON to
identify and, to the extent possible, resolve issues involving the Year 2000
Problem. NEON relies on outside vendors for water, electrical and
telecommunications services as well as climate control, building access and
other infrastructure services. NEON is not capable of independently evaluating
the Year 2000 compliance of the systems utilized to supply these services. NEON
has received no assurance of compliance from the providers of these services.
There can be no assurance that these suppliers will resolve any
33
<PAGE>
or all Year 2000 Problems with these systems before the occurrence of a material
disruption to the business of NEON or any of its suppliers. Any failure of these
third-parties to resolve Year 2000 problems with their systems in a timely
manner could have a material adverse effect on NEON's business, financial
condition or results of operations.
STRAIN ON CUSTOMER'S INFORMATION TECHNOLOGY RESOURCES. Some organizations'
systems may be seriously disrupted as a result of the Year 2000 Problem. As a
result, their attention and capital expenditures could shift away from the need
for applications addressed by NEON's products to capital expenditures required
to resolve their Year 2000 Problems.
CONTINGENCY PLANS. NEON has developed contingency plans to be implemented
as part of its efforts to identify and correct Year 2000 Problems affecting its
internal systems. Depending on the systems affected, these plans could include:
- Accelerated replacement of affected equipment or software
- Short to medium-term use of back-up equipment and software
- Increased work hours for NEON personnel or use of contract personnel to
correct on an accelerated schedule any Year 2000 Problems which arise or
to provide manual workarounds for information systems
- Other similar approaches
If NEON is required to implement any of these contingency plans, such plans
could have a material adverse effect on NEON's business, financial conditions or
results of operations.
In fiscal 1999, NEON incurred less that $50,000 in expenses relating to
identification and correction of Year 2000 Problems, and NEON does not expect to
incur more than $50,000 in expenses for such activities in fiscal 2000.
Based on the actions taken to date as discussed above, NEON is reasonably
certain that it has or will identify and resolve all Year 2000 Problems that
could materially adversely affect its business and operations.
NEW ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use," which establishes
new accounting and reporting standards for the costs of computer software
developed or obtained for internal use. This statement will be applied
prospectively in fiscal 2000. The impact of this new standard is not expected to
have a significant effect on NEON's financial position or results of operations.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-up Activities," which requires costs of start-up activities to be expensed
as incurred. This statement is effective in fiscal 2000. The statement requires
capitalized costs related to start-up activities to be expensed as a cumulative
effect of a change in accounting principle when the statement is adopted. The
adoption of this new standard will not have a significant effect on NEON's
financial position or results of operations.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement establishes new
accounting and reporting standards requiring that all derivative instruments
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at its
fair value. The statement requires that changes in the derivative's fair value
be recognized currently in earnings unless specific hedge accounting criteria
are met. Special accounting for qualifying hedges allows a derivative's gains
and losses to offset related results on the
34
<PAGE>
hedged item in the income statement and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting. This statement is effective for all fiscal years beginning
after June 15, 1999. Under present operations, this statement will have no
impact on NEON's financial position or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Pursuant to the General Instructions to Item 305 of Regulation S-K, the
quantitative and qualitative disclosures called for by Item 7A of Form 10-K and
by Item 305 of Regulation S-K do not require additional disclosure by NEON at
this time.
35
<PAGE>
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NEON SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Independent Auditors' Report............................................................................... 37
Consolidated Balance Sheets................................................................................ 38
Consolidated Statements of Operations...................................................................... 39
Consolidated Statements of Stockholders' Equity (Deficit).................................................. 40
Consolidated Statements of Cash Flows...................................................................... 41
Notes to Consolidated Financial Statements................................................................. 42
</TABLE>
36
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
NEON Systems, Inc.:
We have audited the accompanying consolidated balance sheets of NEON
Systems, Inc. and subsidiaries (collectively, the "Company") as of March 31,
1998 and 1999, and the related consolidated statements of operations,
stockholders' equity (deficit) and cash flows for each of the years in the
three-year period ended March 31, 1999. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
NEON Systems, Inc. and subsidiaries as of March 31, 1998 and 1999, and the
results of their operations and their cash flows for each of the years in the
three-year period ended March 31, 1999, in conformity with generally accepted
accounting principles.
KPMG LLP
Houston, Texas
April 22, 1999
37
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF MARCH 31,
---------------------------
1998 1999
------------ -------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.......................................................... $ 2,804,073 $ 45,400,015
Accounts receivable-trade.......................................................... 2,283,194 5,438,319
Accounts receivable-related party.................................................. 181,112 278,817
Deferred tax assets................................................................ 380,532 571,990
Other current assets............................................................... 246,193 410,620
------------ -------------
Total current assets............................................................. 5,895,104 52,099,761
------------ -------------
Property and equipment:
Furniture and equipment............................................................ 662,155 895,970
Purchased software................................................................. 78,774 78,774
Less accumulated depreciation and amortization..................................... (289,131) (487,670)
------------ -------------
Property and equipment, net...................................................... 451,798 487,074
Other assets, net.................................................................... 5,268 47,916
------------ -------------
Total assets..................................................................... $ 6,352,170 $ 52,634,751
------------ -------------
------------ -------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accrued expenses................................................................... $ 564,217 $ 1,222,154
Accounts payable................................................................... 359,819 1,474,763
Taxes payable...................................................................... 365,056 371,844
Deferred tax liabilities........................................................... -- 27,897
Deferred maintenance revenue....................................................... 2,584,340 3,707,997
Secured notes payable (Note 2)..................................................... 1,049,101 --
------------ -------------
Total current liabilities........................................................ 4,922,533 6,804,655
------------ -------------
Series A redeemable, convertible preferred stock, $.01 par value. Authorized 650,000
shares; 625,000 issued and outstanding at March 31, 1998 (Note 3).................. 1,663,333 --
STOCKHOLDERS' EQUITY (DEFICIT):
Preferred stock, $.01 par value. Authorized 10,000,000 shares; no shares issued and
outstanding at March 31, 1999.................................................... -- --
Common stock, $.01 par value. Authorized 10,000,000 and 30,000,000 shares at March
31, 1998 and 1999, respectively; 2,535,801 and 8,848,251 shares issued and
outstanding at March 31, 1998 and 1999, respectively............................. 25,358 88,483
Additional paid-in capital......................................................... 698,751 46,174,124
Accumulated other comprehensive income (loss)...................................... (962) 57,849
Unearned portion of deferred compensation.......................................... -- (1,710,371)
Retained earnings (accumulated deficit)............................................ (956,843) 1,220,011
------------ -------------
Total stockholders' equity (deficit)............................................. (233,696) 45,830,096
Commitments and contingencies (Note 7)
------------ -------------
Total liabilities and stockholders' equity (deficit)............................. $ 6,352,170 $ 52,634,751
------------ -------------
------------ -------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
38
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------
1997 1998 1999
------------ ------------ -------------
<S> <C> <C> <C>
Revenues:
License............................................................. $ 6,183,089 $ 9,806,287 $ 15,420,415
Maintenance......................................................... 1,002,563 2,396,520 4,595,781
------------ ------------ -------------
Total revenues.................................................... 7,185,652 12,202,807 20,016,196
Cost of revenues:
Cost of licenses.................................................... 211,688 551,736 1,031,708
Cost of maintenance................................................. 392,384 742,953 986,392
------------ ------------ -------------
Total cost of revenues............................................ 604,072 1,294,689 2,018,100
------------ ------------ -------------
Gross profit.......................................................... 6,581,580 10,908,118 17,998,096
Operating expenses:
Sales and marketing................................................. 3,469,286 5,712,689 7,417,664
Research and development............................................ 1,525,313 2,257,915 3,800,091
General and administrative.......................................... 696,349 1,494,278 2,566,500
Non-cash compensation............................................... -- -- 767,284
------------ ------------ -------------
Total operating expenses........................................ 5,690,948 9,464,882 14,551,539
------------ ------------ -------------
Operating income...................................................... 890,632 1,443,236 3,446,557
Interest income....................................................... 23,660 64,029 212,474
Interest expense...................................................... (91,209) (85,521) (81,667)
Other, net............................................................ 202 49,151 54,660
------------ ------------ -------------
Income before provision for income taxes............................ 823,285 1,470,895 3,632,024
Provision for income taxes............................................ 6,865 309,802 1,380,170
------------ ------------ -------------
Net income.......................................................... 816,420 1,161,093 2,251,854
Dividends on series A redeemable, convertible preferred stock......... (80,000) (100,000) (75,000)
------------ ------------ -------------
Net income applicable to common stockholders........................ $ 736,420 $ 1,061,093 $ 2,176,854
------------ ------------ -------------
------------ ------------ -------------
Earnings per common share:
Basic............................................................... $ 0.35 $ 0.45 $ 0.71
------------ ------------ -------------
------------ ------------ -------------
Diluted............................................................. $ 0.14 $ 0.19 $ 0.30
------------ ------------ -------------
------------ ------------ -------------
Shares used in computing earnings per common share:
Basic............................................................... 2,094,087 2,370,525 3,065,219
Diluted............................................................. 5,671,433 6,267,775 7,517,217
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
39
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
ACCUMULATED UNEARNED RETAINED TOTAL
ADDITIONAL OTHER PORTION OF EARNINGS STOCKHOLDERS'
COMMON PAID-IN COMPREHENSIVE DEFERRED (ACCUMULATED EQUITY
STOCK CAPITAL INCOME (LOSS) COMPENSATION DEFICIT) (DEFICIT)
--------- ------------- -------------- ------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Balance at March 31, 1996........ $ 20,870 $ 505,216 $ -- $ -- $ (2,754,356) $ (2,228,270)
Net income....................... -- -- -- -- 816,420 816,420
Foreign currency translation
gain........................... -- -- 1,133 -- -- 1,133
Comprehensive income............. -- -- -- -- -- 817,553
Exercise of stock options........ 1,734 654 -- -- -- 2,388
Stock option grants.............. -- 71,842 -- -- -- 71,842
Preferred stock dividends........ -- -- -- -- (80,000) (80,000)
--------- ------------- ------- ------------- ------------- --------------
Balance at March 31, 1997........ 22,604 577,712 1,133 -- (2,017,936) (1,416,487)
Net income....................... -- -- -- -- 1,161,093 1,161,093
Foreign currency translation
loss........................... -- -- (2,095) -- -- (2,095)
Comprehensive income............. -- -- -- -- -- 1,158,998
Exercise of stock options........ 2,754 25,028 -- -- -- 27,782
Tax benefit related to exercise
of stock options............... -- 82,349 -- -- -- 82,349
Stock option grants.............. -- 13,662 -- -- -- 13,662
Preferred stock dividends........ -- -- -- -- (100,000) (100,000)
--------- ------------- ------- ------------- ------------- --------------
Balance at March 31, 1998........ 25,358 698,751 (962) -- (956,843) (233,696)
Net income....................... -- -- -- -- 2,251,854 2,251,854
Foreign currency translation
gain........................... -- -- 58,811 -- -- 58,811
Comprehensive income............. -- -- -- -- -- 2,310,665
Exercise of stock options........ 1,465 142,814 -- -- -- 144,279
Tax benefit related to exercise
of stock options............... -- 23,709 -- -- -- 23,709
Deferred compensation related to
options granted................ -- 2,477,655 -- (2,477,655) -- --
Amortization of deferred stock
compensation................... -- -- -- 767,284 -- 767,284
Preferred stock dividends........ -- -- -- -- (75,000) (75,000)
Preferred stock conversion to
common stock................... 31,250 1,707,083 -- -- -- 1,738,333
Initial public offering.......... 30,410 41,124,112 -- -- -- 41,154,522
--------- ------------- ------- ------------- ------------- --------------
Balance at March 31, 1999........ $ 88,483 $ 46,174,124 $ 57,849 $(1,710,371) $ 1,220,011 $ 45,830,096
--------- ------------- ------- ------------- ------------- --------------
--------- ------------- ------- ------------- ------------- --------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
40
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------
<S> <C> <C> <C>
1997 1998 1999
------------ ------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.......................................................... $ 816,420 $ 1,161,093 $ 2,251,854
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization..................................... 73,291 144,344 198,539
Deferred tax expense.............................................. -- (380,532) (163,561)
Noncash compensation expense...................................... 71,842 13,662 767,284
Increase (decrease) in cash resulting from changes in:
Accounts receivable............................................. (567,418) (1,424,468) (3,252,830)
Other current assets............................................ 10,925 (218,291) (164,427)
Other assets.................................................... 380 (5,268) (42,648)
Accrued expenses................................................ 311,594 199,211 657,937
Accounts payable................................................ 84,776 204,686 1,114,944
Customer deposits............................................... 146,400 (146,400) --
Taxes payable................................................... 32,785 364,263 30,497
Deferred maintenance revenue.................................... 895,512 1,437,081 1,123,657
------------ ------------ -------------
Net cash provided by operating activities............................. 1,876,507 1,349,381 2,521,246
------------ ------------ -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of furniture and equipment................................ (260,897) (263,219) (233,815)
Purchases of computer software...................................... (45,159) (12,964) --
------------ ------------ -------------
Net cash used in investing activities................................. (306,056) (276,183) (233,815)
------------ ------------ -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable.......................................... -- -- (1,049,101)
Issuance of common stock............................................ 2,388 27,782 41,298,801
------------ ------------ -------------
Net cash provided by financing activities............................. 2,388 27,782 40,249,700
------------ ------------ -------------
Net increase in cash and cash equivalents............................. 1,572,839 1,100,980 42,537,131
Effect of exchange rates on cash...................................... 1,133 (2,095) 58,811
Cash and cash equivalents at beginning of period...................... 131,216 1,705,188 2,804,073
------------ ------------ -------------
Cash and cash equivalents at end of period............................ $ 1,705,188 $ 2,804,073 $ 45,400,015
------------ ------------ -------------
------------ ------------ -------------
Supplemental disclosure of non-cash financing activities:
Conversion of Series A Redeemable, Convertible Preferred Stock into
common stock...................................................... $ -- $ -- $ 1,738,333
------------ ------------ -------------
------------ ------------ -------------
Conversion of note payable and accrued interest into preferred
stock............................................................. $ 250,000 $ -- $ --
------------ ------------ -------------
------------ ------------ -------------
Cash paid during the year for income taxes............................ $ -- $ 242,930 $ 1,542,690
------------ ------------ -------------
------------ ------------ -------------
Cash paid during the year for interest................................ $ -- $ 83,928 $ 97,916
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
41
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
NEON Systems, Inc. and subsidiaries (collectively, "NEON") is comprised of
the parent company, NEON Systems, Inc., and its wholly-owned international
subsidiaries, NEON Systems (UK) Ltd. and NEON Systems (GmbH). NEON develops,
markets and supports Enterprise Access and Integration software. NEON's primary
product family, Shadow, helps organizations access and integrate data,
transactions and applications from the Internet and mainframe and client/server
systems.
BASIS OF CONSOLIDATION OF FINANCIAL STATEMENTS
All significant intercompany balances and transactions have been eliminated
in consolidation.
ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
REVENUE RECOGNITION
Revenues from software license sales are recognized when all of the
following conditions are met: a non-cancelable license agreement has been
signed; the product has been delivered; there are no material uncertainties
regarding customer acceptance; collection of the receivable is probable; and no
other significant vendor obligations exist. License revenues generally include
software maintenance agreements for the first year following the date of sale.
In such cases, revenues are allocated between license fees and maintenance
revenues based on NEON specific evidence. Revenues from first-year maintenance
agreements and separately priced software maintenance agreements for subsequent
years are deferred and recognized ratably on a straight-line basis over the
maintenance period.
NEON also markets and sells its products through independent foreign
distributors. License and maintenance revenues from these transactions are
recognized when all of the above conditions are met.
The American Institute of Certified Public Accountants issued Statement of
Position ("SOP") 97-2, SOFTWARE REVENUE RECOGNITION in October 1997, which
replaces the previous revenue recognition rules provided by SOP 91-1. SOP 97-2
is effective for transactions entered into in fiscal years beginning after
December 15, 1997. NEON recognizes revenue in accordance with the provisions of
SOP 97-2.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is computed using
accelerated methods for computer hardware and straight-line methods for other
property based on the estimated useful lives, generally three to seven years, of
the various classes of property.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents (interest-bearing deposits) with original
maturities of less than three months are included in cash and cash equivalents.
42
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
NEON accounts for income taxes using an asset and liability approach, which
requires the recognition of deferred income tax assets and liabilities for the
expected future tax consequences of events that have been recognized in NEON's
financial statements or tax returns. Deferred income tax assets and liabilities
are determined based on the temporary differences between the financial
statement and tax bases of assets and liabilities using enacted tax rates.
PER SHARE INFORMATION
Per share information is based on the weighted average number of common
shares outstanding during each period for the basic computation and, if
dilutive, the weighted-average number of potential common shares resulting from
the assumed conversion of outstanding stock options and convertible preferred
stock for the diluted computation.
A reconciliation of the numerators and denominators of the basic and diluted
per share computation is as follows:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
----------------------------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Net income.............................................................. $ 816,420 $ 1,161,093 $ 2,251,854
Dividends on series A redeemable, convertible preferred stock........... (80,000) (100,000) (75,000)
------------ ------------ ------------
Net income applicable to common stockholders............................ $ 736,420 $ 1,061,093 $ 2,176,854
------------ ------------ ------------
------------ ------------ ------------
Weighted average number of common shares outstanding during the period:
Basic................................................................... 2,094,087 2,370,525 3,065,219
Dilutive stock options.................................................. 452,346 772,251 1,549,601
Series A redeemable, convertible preferred stock........................ 3,125,000 3,125,000 2,902,397
------------ ------------ ------------
Diluted................................................................. 5,671,433 6,267,775 7,517,217
------------ ------------ ------------
------------ ------------ ------------
Income per common share:
Basic................................................................... $ 0.35 $ 0.45 $ 0.71
------------ ------------ ------------
------------ ------------ ------------
Diluted................................................................. $ 0.14 $ 0.19 $ 0.30
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
During the fiscal year ended March 31, 1999 NEON granted stock options at
prices considered to be below the then fair value of the underlying stock. The
cumulative differential between the fair value of the underlying stock and the
exercise price of the granted options was $2.5 million. This amount is being
recognized as expense over the vesting period of the granted options. During the
fiscal year ended March 31, 1999, $767,000 was recognized as a non-cash
compensation expense. The remaining differential of $1,710,371 will be
recognized over the remaining vesting period, approximately four years, of the
granted options.
PREFERRED STOCK
NEON's Board of Directors has the authority, without further action by the
stockholders, to issue up to 10,000,000 shares of preferred stock in one or more
series and to fix the rights, preferences, privileges,
43
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1--ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
and restrictions thereof, including dividend rights, conversion rights, terms of
redemption, liquidation preferences, sinking fund terms and the number of shares
constituting any series or the designation of such series, without any further
vote or action by stockholders.
RESEARCH AND PRODUCT DEVELOPMENT COSTS
Research and development costs are charged to expense as incurred. Software
development costs that qualify for capitalization under Statement of Financial
Accounting Standards ("SFAS") No. 86, ACCOUNTING FOR THE COSTS OF COMPUTER
SOFTWARE TO BE SOLD, LEASED, OR OTHERWISE MARKETED, are evaluated for
recoverability by NEON. No such costs have been capitalized to date as the
impact on the financial statements would be immaterial.
STOCK OPTION PLAN
Prior to April 1, 1996, NEON accounted for its stock option plan in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations.
As such, compensation expense has been recorded on the date of grant only if the
estimated value of the underlying stock exceeded the exercise price. On April 1,
1996, NEON adopted SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, which
permits entities to recognize as expense over the vesting period the fair value
of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also
allows entities to continue to apply the provisions of APB Opinion No. 25 and
provide pro forma net income and pro forma earnings per share disclosures for
employee stock option grants made in 1996 and future years as if the
fair-value-based method defined in SFAS No. 123 had been applied. NEON has
elected to continue to apply the provisions of APB Opinion No. 25 and provide
the pro forma disclosure provisions of SFAS No. 123.
FOREIGN CURRENCY TRANSLATION
For NEON's international subsidiaries, the functional currencies are the
British pound and the German mark. Accordingly, assets and liabilities of the
subsidiaries are translated into U.S. dollars at year-end exchange rates. Income
and expense items are translated at average rates prevailing during the period.
The adjustments resulting from translating the financial statements of the
international subsidiaries are reflected as a cumulative translation adjustment
included in stockholders' equity (deficit) as a component of comprehensive
income.
STOCK SPLIT
In August 1996, NEON's Board of Directors declared a five-for-one stock
split of NEON's common stock which was effected as a dividend. All stock-related
data in the consolidated financial statements and related notes reflects this
stock split for all periods presented.
COMPREHENSIVE INCOME
NEON adopted Statement of Financial Accounting Standards No. 130 ("SFAS
130"), COMPREHENSIVE INCOME, beginning with NEON's first quarter of fiscal year
1999. The components of comprehensive income include only net income and foreign
currency translation gains (losses) of $1,133, ($2,095), and $58,811 for the
years ended March 31, 1997, 1998 and 1999, respectively.
44
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--SECURED NOTE PAYABLE
During the year ended March 31, 1997 NEON amended and consolidated three
original notes dated September 29, 1994, March 30, 1995 and November 22, 1995
for $300,000, $350,000 and $480,000, respectively. These notes and accrued
interest of $169,101 at March 31, 1997 were converted to a new senior note in
the principal amount of $1,049,101 and $250,000 of principal was converted into
125,000 shares of NEON's Series A Redeemable, Convertible Preferred Stock.
The new note was secured by accounts receivable and property and equipment
and accrues interest at the rate of eight percent per annum. Proceeds from the
initial public offering were used to retire the note in March 1999.
NOTE 3--SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Series A Redeemable, Convertible Preferred Stock was convertible into
shares of NEON common stock. Each share of Series A Redeemable, Convertible
Preferred Stock was convertible into five shares of common stock (subject to
adjustment upon the occurrence of certain events). The Series A Redeemable,
Convertible Preferred Stock also had voting rights based on the common stock
conversion ratio.
The Series A Redeemable, Convertible Preferred Stock accrued annual
dividends at $0.16 per share. The Series A Redeemable, Convertible Preferred
Stock had mandatory conversion and mandatory redemption provisions, which
required among other things that the Series A Redeemable, Convertible Preferred
Stock be redeemed in April 2000, at the original issuance price of $2.00 per
share plus cumulative unpaid dividends. Series A Redeemable, Convertible
Preferred Stock dividends accrued, but not yet declared, at March 31, 1997, 1998
and 1999 were $313,333, $413,333 and $0, respectively.
Immediately prior to the completion of the initial public offering, the
holder of the Series A Redeemable, Convertible Preferred Stock converted the
625,000 shares then outstanding into 3,125,000 shares of common stock.
NOTE 4--STOCK OPTION PLANS
Under the 1993 Stock Plan for the officers and employees of NEON, the Board
of Directors authorized the grant of non-qualified incentive stock options to
purchase up to 2,600,000 shares of NEON's Common Stock. Such options become
exercisable either on the date of grant or in such installments as the grant may
specify up to 10 years from the date of grant.
In January 1999, NEON adopted the 1999 Long-Term Incentive Plan which
provides for the grant of incentive stock options and non-qualified stock
options to purchase NEON common stock, stock appreciation rights, restricted
stock and performance units, to key employees of NEON. NEON has reserved
2,000,000 shares of its common stock for issuance under the 1999 Plan. In
connection with NEON's adoption of the 1999 Plan, NEON will not make any new
grants under the 1993 Plan and options previously issued under the 1993 Plan
will be exercisable in accordance with their terms.
NEON has adopted the Stock Option Plan for Non-Employee Directors for
compensation of its outside directors and has reserved 100,000 shares of its
common stock for issuance thereunder. Outside directors joining the Board of
Directors will receive options to purchase 7,500 shares of NEON common stock
exercisable at the fair market value of the common stock at the close of
business on the date immediately preceding the date of grant (the initial
outside directors will be eligible for such grants upon their re-election to the
Board of Directors). These annual options will vest equally in 33 1/3%
increments
45
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--STOCK OPTION PLANS (CONTINUED)
over the three-year period from the date of grant. All stock options granted
pursuant to the Stock Option Plan for Non-Employee Directors will be
nonqualified stock options and will remain exercisable for a period of ten years
from the date of grant or, if earlier, six months after the option holder ceases
to be a director of NEON. In the event of a change in control of NEON or certain
other significant events, all options outstanding under the Stock Option Plan
for Non-Employee Directors shall terminate, provided that immediately before the
effective date of such transaction each holder of an outstanding option under
the Stock Option Plan for Non-Employee Directors shall be entitled to purchase
the total number of shares of common stock that such option holder would have
been entitled to purchase during the entire remaining term of the option.
At March 31, 1999, stock options to acquire 1,629,077 shares were granted
and outstanding, with exercise prices ranging from $0.01 to $12.35 per share.
These options generally vest over periods of up to four years from the date of
grant. The compensation cost related to these grants has been charged to expense
for approximately $72,000, $13,700, and $767,300 for the years ended March 31,
1997, 1998 and 1999, respectively. As of March 31, 1999 there was $1,710,371 of
deferred compensation related to granted but non-vested stock options. This
deferred compensation is being recognized over the vesting period of the
options.
NEON applies APB Opinion No. 25 in accounting for its Plans and,
accordingly, compensation cost has been recognized to the extent that the
estimated value of the underlying stock exceeds the exercise price on the date
of the grant. Had NEON determined compensation cost based on SFAS No. 123,
NEON's net income and per share amounts would have been the pro forma amounts
indicated below:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
--------------------------------------
1997 1998 1999
---------- ------------ ------------
<S> <C> <C> <C>
Net income as reported.......................................... $ 816,420 $ 1,161,093 $ 2,251,854
---------- ------------ ------------
---------- ------------ ------------
Net income, pro forma........................................... $ 802,539 $ 1,097,780 $ 2,164,250
---------- ------------ ------------
---------- ------------ ------------
Net income per share as reported................................ $ 0.35 $ 0.45 $ 0.71
---------- ------------ ------------
---------- ------------ ------------
Net income (loss) per share, pro forma.......................... $ 0.34 $ 0.42 $ 0.69
---------- ------------ ------------
---------- ------------ ------------
</TABLE>
Prior to the Company's initial public offering, the fair value of each
option grant was determined on the date of grant using the minimum value method.
Subsequent to the offering, the fair value was determined using the
Black-Scholes model. The weighted average fair market value of an option granted
during 1997, 1998 and 1999 was $0.22, $0.86 and $5.54, respectively. Except for
the volatility assumption, which was only used under the Black-Scholes model,
the following range of assumptions was used to perform the calculations:
expected life of five years in 1997, 1998 and 1999; risk-free interest rate
ranges of 6.5% during 1997, 5.9% during 1998 and 5.8% during 1999; no expected
volatility in 1997 and 1998 and expected volatility of 141% in 1999; and no
expected dividend yield for the three years ended March 31, 1999. Because
additional stock options are expected to be granted each year, the above pro
forma disclosures are not representative of pro forma effects on reported
financial results for future years.
46
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--STOCK OPTION PLANS (CONTINUED)
Stock option activity during periods indicated is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
---------- -----------
<S> <C> <C>
Balance at March 31, 1996........................................................ 1,035,585 $ 0.14
Granted.......................................................................... 371,025 0.22
Exercised........................................................................ (173,415) 0.04
Forfeited........................................................................ (28,500) 0.20
----------
Balance at March 31, 1997........................................................ 1,204,695 0.18
Granted.......................................................................... 303,920 0.86
Exercised........................................................................ (275,421) 0.09
Forfeited........................................................................ (24,054) 0.44
----------
Balance at March 31, 1998........................................................ 1,209,140 0.36
Granted.......................................................................... 624,590 5.54
Exercised........................................................................ (146,450) 0.97
Forfeited........................................................................ (58,203) 1.26
----------
Balance at March 31, 1999........................................................ 1,629,077 $ 2.26
----------
----------
</TABLE>
At March 31, 1999, the weighted average remaining contractual life of
outstanding options was 8.3 years. At March 31, 1997, 1998 and 1999, the number
of options exercisable was 583,061, 566,936 and 746,708, respectively, and the
weighted average exercise prices of those options were $0.18, $0.20 and $0.25,
respectively.
NOTE 5--INCOME TAXES
The provision (benefit) for income taxes consists of the following:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
------------------------------------
1997 1998 1999
--------- ----------- ------------
<S> <C> <C> <C>
United States Federal:
Current.......................................................... $ -- $ 647,905 $ 1,414,724
Deferred......................................................... -- (354,340) (189,260)
State-current...................................................... -- 23,210 100,000
Foreign-current.................................................... 6,865 (6,973) 54,706
--------- ----------- ------------
$ 6,865 $ 309,802 $ 1,380,170
--------- ----------- ------------
--------- ----------- ------------
</TABLE>
47
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--INCOME TAXES (CONTINUED)
For the years ended March 31, 1997, 1998, and 1999, NEON's effective income
tax rate differed from the statutory tax rate as follows:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------------------------------------------
1997 1998 1999
------------------------ ------------------------ -------------------------
<S> <C> <C> <C> <C> <C> <C>
Statutory tax rate......................... $ 279,917 34.0% $ 500,105 34.0% $ 1,234,888 34.0%
Increase (decrease) in valuation
allowance.................................. (279,917) (34.0) (217,427) (14.8) 205,729 5.7
AMT Credits................................ -- -- -- -- (105,858) (2.9)
State tax expense.......................... -- -- 23,210 1.6 66,000 1.8
Foreign sales corporation.................. -- -- -- -- (48,550) (1.3)
Other...................................... 6,865 1.0 3,914 0.3 27,961 0.7
----------- ----- ----------- ----- ------------ ---
Effective tax rate......................... $ 6,865 1.0% $ 309,802 21.1% $ 1,380,170 38.0%
----------- ----- ----------- ----- ------------ ---
----------- ----- ----------- ----- ------------ ---
</TABLE>
As of March 31, 1997, 1998, and 1999, deferred tax assets were as follows:
<TABLE>
<CAPTION>
AS OF MARCH 31,
--------------------------------------
1997 1998 1999
----------- ----------- ------------
<S> <C> <C> <C>
Deferred maintenance revenues............................................. $ 424,142 $ 318,291 $ 212,284
Deferred compensation expense............................................. -- -- 283,588
Net operating loss carryforwards:
United Kingdom.......................................................... 18,465 54,484 --
Germany................................................................. 225,180 430,909
Other..................................................................... -- 7,757 76,118
----------- ----------- ------------
Total deferred tax assets............................................... 442,607 605,712 1,002,899
Valuation allowance..................................................... (442,607) (225,180) (430,909)
----------- ----------- ------------
Net deferred tax assets................................................. $ -- $ 380,532 $ 571,990
----------- ----------- ------------
----------- ----------- ------------
</TABLE>
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized and a valuation allowance is recorded.
At March 31, 1999, NEON has a net operating loss carryforward for income tax
purposes of $1,267,380 related to Germany, which is available to offset future
taxable income in Germany, if any. The net operating loss is carried forward
indefinitely. During the year ended March 31, 1999, NEON utilized its United
Kingdom net operating loss of $160,247.
NOTE 6--RELATED PARTY TRANSACTIONS
NEON entered into a distributor agreement with Peregrine/Bridge Transfer
Corporation, a database software company, in January 1996. In December 1998,
NEON amended its distributor agreement with Peregrine/Bridge Transfer
Corporation whereby Peregrine/Bridge Transfer Corporation has granted the
Company an exclusive, worldwide license to market and sublicense Enterprise
Subsystem Management products, with the exception of limited co-marketing rights
held by IBM relating to one of Peregrine/ Bridge Transfer Corporation's
Enterprise Subsystem Management products. The amended distributor
48
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--RELATED PARTY TRANSACTIONS (CONTINUED)
agreement has an initial term through March 31, 2004. The distributor agreement
provides that NEON pay license fees for license products and for maintenance and
support and upgrade services equal to 50% of the revenues received by NEON. NEON
incurred license fees of $117,350, $448,917, and $703,337 for the years ended
March 31, 1997, 1998 and 1999, respectively to Peregrine/Bridge Transfer
Corporation. NEON also has a services agreement with Peregrine/Bridge Transfer
Corporation pursuant to which Peregrine/ Bridge Transfer Corporation reimburses
NEON for Peregrine/Bridge Transfer Corporation's share of the general and
administrative expenses supplied to it by NEON and for the time spent by NEON's
management developing and implementing Peregrine/Bridge Transfer Corporation's
product development and market strategy. Such amounts are presented as a
reduction of general and administrative expenses in the accompanying
consolidated financial statements. Peregrine/Bridge Transfer Corporation pays
NEON $23,923 per month under the services agreement. Such amounts totaled
$257,076 for the year ended March 31, 1997 and $287,076 for each of the years
ended March 31, 1998 and 1999, and are included as a reduction of general and
administrative expenses in the accompanying statements of operations. Due to the
timing of cash payments between the two parties related to the distributor
agreement and the services agreement described above, NEON has accounts
receivable-related party of $138,074, $181,112 and $278,817 as of March 31,
1997, 1998 and 1999, respectively.
NEON and Peregrine/Bridge Transfer Corporation have certain common
directors. In addition, the controlling stockholder of Peregrine/Bridge Transfer
Corporation's sole shareholder, Skunkware, Inc., is NEON's chairman of the Board
of Directors. NEON's president and chief executive officer, chief financial
officer, and general counsel have the same responsibilities at Peregrine/Bridge
Transfer Corporation.
NOTE 7--COMMITMENTS AND CONTINGENCIES
NEON leases office space and computer software under operating lease
agreements expiring through fiscal 2004. Future minimum rental payments under
operating leases having initial or remaining noncancelable lease terms in excess
of one year are as follows:
<TABLE>
<S> <C>
YEARS ENDING MARCH 31,
2000............................................................ $ 897,840
2001............................................................ 839,697
2002............................................................ 842,549
2003............................................................ 829,390
2004............................................................ 375,905
---------
$3,785,381
---------
---------
</TABLE>
Total rent expense under all operating leases was $168,964, $433,035, and
$715,636 in the years ended March 31, 1997, 1998 and 1999, respectively.
In December 1996, NEON was named as a codefendant in a lawsuit originally
filed in August 1995 against Peregrine/Bridge Transfer Corporation, a director
of NEON and a group of employees of Peregrine/Bridge Transfer Corporation who
were also former employees of BMC Software. NEON is a distributor for
Peregrine/Bridge Transfer Corporation. BMC Software alleges misappropriation and
infringment of certain trade secrets, confidential information and corporate
opportunity, as well as breach of contract and fiduciary relations by the
individuals. BMC Software states in the lawsuit that it is seeking to enjoin
further distribution of the Peregrine/Bridge Transfer Corporation Partitioned
Database Facility and utilities products. It is also seeking to recover damages
based upon the disgorgement of all revenues
49
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--COMMITMENTS AND CONTINGENCIES (CONTINUED)
derived from the sale or license of these products through the date of judgment.
Furthermore, BMC Software is seeking to hold Peregrine/Bridge Transfer
Corporation, NEON and a director of NEON jointly and severally liable for these
damages.
NEON believes that the lawsuit is without merit and has filed counterclaims
against BMC Software for anti-competitive practices. Peregrine/Bridge Transfer
Corporation is defending NEON in the lawsuit pursuant to an indemnification
provision in the distributor agreement between NEON and Peregrine/ Bridge
Transfer Corporation. Peregrine/Bridge Transfer Corporation is minimally
capitalized, and there can be no assurance that Peregrine/Bridge Transfer
Corporation will continue to have sufficient resources to fund the costs and
expenses of the lawsuit or indemnify NEON against an adverse judgment. If
Peregrine/ Bridge Transfer Corporation should cease defending NEON in the
lawsuit, NEON will be required to provide its own defense and may not be able to
recover the related costs from Peregrine/Bridge Transfer Corporation. NEON
believes that any loss of revenues NEON would suffer if the court enjoins the
sale of the Partitioned Database Facility and utilities products would not have
a material adverse effect on NEON's liquidity, business or results of
operations. If NEON were required to pay damages based upon the disgorgement of
all revenues derived from the sale or license of these products, NEON believes
that the payment could have a material adverse effect on NEON's liquidity and
results of operations.
A number of organizations, including New Era of Networks, are utilizing the
name "Neon," alone and in combination with other words, as a trademark, a
tradename or both. New Era of Networks is also a developer and distributor of
middleware and other software products. New Era of Networks has used the acronym
"NEON" in its business, is listed on the Nasdaq National Market under the symbol
"NEON" and has sought to obtain federal trademarks for products and services
whose names include the word "NEON." NEON is currently opposing in the U.S.
Patent and Trademark Office New Era of Networks' application to trademark
"NEONET." On December 24, 1998, New Era of Networks filed a complaint against
NEON in the United States District Court for the District of Colorado seeking
(1) a declaratory judgment that New Era of Networks' use of certain trademarks,
including "NEONET," does not infringe NEON's rights or constitute unfair
competition and (2) cancellation of NEON's federal trademark registration for
NEON. NEON has filed an Answer denying the material allegations of that
complaint, and the parties are currently engaged in discovery.
NEON is involved in various other claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on NEON's
consolidated financial position, results of operations or liquidity.
50
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--FOREIGN OPERATIONS AND SIGNIFICANT CUSTOMERS
The table below summarizes selected financial information with respect to
NEON's operations by geographic location. NEON's United Kingdom operations
accounted for over 96% of total European revenues in fiscal 1997, 1998 and 1999.
During the fiscal year ended March 31, 1999, NEON had one customer which
accounted for 12% of the consolidated revenue.
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
------------------------------------------
<S> <C> <C> <C>
1997 1998 1999
------------ ------------- -------------
Revenues:
United States.................................... $ 6,821,990 $ 9,923,198 $ 15,500,792
Europe........................................... 363,662 2,279,609 4,515,404
------------ ------------- -------------
$ 7,185,652 $ 12,202,807 $ 20,016,196
------------ ------------- -------------
------------ ------------- -------------
Operating income (loss):
United States.................................... $ 870,019 $ 2,140,816 $ 3,780,724
Europe........................................... 20,613 (697,580) (334,167)
------------ ------------- -------------
$ 890,632 $ 1,443,236 $ 3,446,557
------------ ------------- -------------
------------ ------------- -------------
Identifiable assets:
United States.................................... $ 2,456,061 $ 3,964,737 $ 49,896,957
Europe........................................... 636,826 2,387,433 2,737,794
------------ ------------- -------------
$ 3,092,887 $ 6,352,170 $ 52,634,751
------------ ------------- -------------
------------ ------------- -------------
</TABLE>
NOTE 9--SUBSEQUENT EVENTS (UNAUDITED)
On June 23, 1999, NEON sued New Era of Networks in Fort Bend County, Texas,
alleging that New Era of Networks' use of "NEON" was in violation of Texas law
concerning misappropriation of tradenames. In this litigation, NEON seeks to
enjoin New Era of Networks from using "NEON" as its "nickname," its Nasdaq
trading symbol, or in any other manner that is likely to result in confusion in
the marketplace, or to dilute the meaning or value of NEON's name. NEON's claims
are based upon its prior and continuous use of "NEON" as its corporate name.
NEON believes that it has superior rights to use "NEON" and that New Era of
Networks' use of NEON is causing confusion in the marketplace. Any litigation to
enforce NEON's right to use the NEON name in NEON's business or to prevent
others from using the NEON name would be expensive and time-consuming, would
divert management resources and may not be adequate to protect NEON's business.
If NEON should lose any such litigation, it may have to change its name, which
also would be expensive and time-consuming and could adversely affect NEON's
business.
NOTE 10--QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth certain unaudited quarterly information with
respect to the Company's results of operations for the years ended 1997, 1998
and 1999. Earnings per share are computed
51
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10--QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
independently for each of the quarters presented. Therefore, the sum of the
quarterly earnings per share may not equal the total earnings per share amounts
for the fiscal year.
<TABLE>
<CAPTION>
1999 QUARTER
------------------------------------------
<S> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1ST 2ND 3RD 4TH
--------- --------- --------- ---------
Revenues............................................... $ 3,849 $ 4,136 $ 5,850 $ 6,181
Gross profit........................................... 3,372 3,678 5,451 5,497
Net income............................................. 145 251 968 888
Earnings per common share:
Basic................................................ $ 0.05 $ 0.09 $ 0.35 $ 0.20
Diluted.............................................. $ 0.02 $ 0.04 $ 0.14 $ 0.11
<CAPTION>
1998 QUARTER
------------------------------------------
1ST 2ND 3RD 4TH
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues............................................... $ 2,372 $ 2,523 $ 3,264 $ 4,044
Gross profit........................................... 2,072 2,350 3,062 3,425
Net income............................................. 166 129 579 286
Earnings per common share:
Basic................................................ $ 0.06 $ 0.04 $ 0.23 $ 0.11
Diluted.............................................. $ 0.03 $ 0.02 $ 0.09 $ 0.04
<CAPTION>
1997 QUARTER
------------------------------------------
1ST 2ND 3RD 4TH
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues............................................... $ 953 $ 1,560 $ 2,146 $ 2,527
Gross profit........................................... 867 1,450 2,034 2,230
Net income............................................. (88) 392 207 305
Earnings per common share:
Basic................................................ $ (0.05) $ 0.18 $ 0.09 $ 0.13
Diluted.............................................. $ (0.05) $ 0.07 $ 0.04 $ 0.05
</TABLE>
52
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Information called for by Item 10 will be set forth under the caption
"Election of Directors" in NEON's Information Statement with respect to its
Annual Meeting of Stockholders to be held August 24, 1999, which will be filed
not later than 120 days after the end of NEON's fiscal year ended March 31, 1999
and which is incorporated herein by this reference.
ITEM 11. EXECUTIVE COMPENSATION
Information called for by Item 11 will be set forth under the caption
"Executive Compensation" in NEON's Information Statement with respect to its
Annual Meeting of Stockholders to be held August 24, 1999, which will be filed
not later than 120 days after the end of NEON's fiscal year ended March 31, 1999
and which is incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information called for by Item 12 will be set forth under the caption
"Security Ownership of Certain Beneficial Owners and Management" in NEON's
Information Statement with respect to its Annual Meeting of Stockholders to be
held August 24, 1999, which will be filed not later than 120 days after the end
of NEON's fiscal year ended March 31, 1999 and which is incorporated herein by
this reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information called for by Item 13 will be set forth under the caption
"Certain Relationships and Related Transactions" in NEON's Information Statement
with respect to its Annual Meeting of Stockholders to be held August 24, 1999,
which will be filed not later than 120 days after the end of NEON's fiscal year
ended March 31, 1999 and which is incorporated herein by this reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are being filed as part of this Report:
(a)(1) Consolidated Financial Statements
See Index to Consolidated Financial Statements on page 35.
(a)(2) All other schedules are omitted because they are not applicable, not
required or the required information is in the Financial Statements
or the Notes thereto.
(a)(3) The following exhibits are filed or incorporated by reference as
part of this Report as required by Item 601 of Regulation S-K. The
exhibits designated by an asterisk are management contracts and
compensatory plans and arrangements required to be filed as exhibits
to this Report.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
3.1 Amended and Restated Certificate of Incorporation of NEON Systems, Inc. (incorporated by reference to
Exhibit 3.1 to NEON's Registration Statement on Form S-1 (Registration Number 333-69651) effective March
5, 1999).
</TABLE>
53
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
3.2 Bylaws of NEON Systems, Inc. (incorporated by reference to Exhibit 3.2 to NEON's Registration Statement
on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
4.1 Specimen Stock Certificate (incorporated by reference to Exhibit 4.1 to NEON's Registration Statement on
Form S-1 (Registration Number 333-69651) effective March 5, 1999).
4.2 Certificate of Incorporation, as amended and Bylaws of NEON Systems, Inc. (see Exhibits 3.1 and 3.2).
10.1* NEON Systems, Inc. 1993 Stock Plan. (incorporated by reference to Exhibit 10.1 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.2* NEON Systems 401(k) Plan (incorporated by reference to Exhibit 10.2 to NEON's Registration Statement on
Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.3* NEON Systems, Inc. 1999 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.3 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.4* NEON Systems, Inc. Stock Option Plan for Non-Employee Directors (incorporated by reference to Exhibit
10.4 to NEON's Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5,
1999).
10.5 Distributor Agreement dated as of January 1, 1996 by and between Peregrine/Bridge Transfer Corporation
and NEON Systems, Inc., as amended (incorporated by reference to Exhibit 10.5 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.6 Texaco Inc. Information Technology Department Miscellaneous Work Agreement dated as of July 1, 1991
between NEON Systems, Inc. and Texaco, Inc. (incorporated by reference to Exhibit 10.6 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.7 Series A Stock Purchase Agreement dated as of May 19, 1993 by and between NEON Systems, Inc., JMI Equity
Fund, L.P. and Peter Schaeffer (incorporated by reference to Exhibit 10.7 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.8 Secured Convertible Promissory Note Purchase Agreement dated as of September 29, 1994 by and between
NEON Systems, Inc. and JMI Equity Fund, L.P., as amended (incorporated by reference to Exhibit 10.8 to
NEON's Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.9 Secured Convertible Promissory Note Purchase Agreement dated as of March 30, 1995 by and between NEON
Systems, Inc. and JMI Equity Fund, L.P., as amended (incorporated by reference to Exhibit 10.9 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.10 Secured Convertible Promissory Note Purchase Agreement dated as of November 22, 1995 by and between NEON
Systems, Inc. and JMI Equity Fund, L.P. (incorporated by reference to Exhibit 10.10 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
</TABLE>
54
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
10.11 Secured Promissory Note dated March 31, 1997 to the order of JMI Equity Fund, L.P. in the original
principal amount of $1,049,100.78, as amended (incorporated by reference to Exhibit 10.11 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.12 Amendment to Convertible Debt Documentation and Exercise of Conversion Right dated March 31, 1997 by and
between NEON Systems, Inc. and JMI Equity Fund, L.P. (incorporated by reference to Exhibit 10.12 to
NEON's Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.13 Registration Rights Agreement dated as of May 19, 1993 by and between NEON Systems, Inc., JMI Equity
Fund, L.P. and Peter Schaeffer (incorporated by reference to Exhibit 10.13 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.14* Form of Indemnification Agreement between NEON Systems, Inc. and each of its directors (incorporated by
reference to Exhibit 10.14 to NEON's Registration Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
10.15 Lease Agreement between Turner Andreac, LLC and NEON Systems, Inc. for office space located at 14100
Southwest Freeway, Suite 500 in Sugar Land, Texas (incorporated by reference to Exhibit 10.15 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.16 Lease Agreement, dated December 9, 1996, between Nu-Swift Sovereign Limited and NEON Systems (U.K.)
Limited for office space located at Sovereign House 26/30 London Road in Twickenham, Middlesex
(incorporated by reference to Exhibit 10.16 to NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999).
10.17 Lease Agreement dated September 1, 1997 between NEON Systems GmbH and Triple P. Deutschland GmbH
(incorporated by reference to Exhibit 10.17 to NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999).
10.18 Agreement by and between Goal Systems International, Inc., NEON Systems, Inc. and Peter Schaeffer dated
January 8, 1992 (incorporated by reference to Exhibit 10.18 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.19 Stockholders Agreement dated May 19, 1993 by and among NEON Systems, Inc. and JMI Equity Fund, L.P. and
Peter Schaeffer (incorporated by reference to Exhibit 10.19 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.20 Stock Restriction Agreement dated May 19, 1993 by and among NEON Systems, Inc., Peter Schaeffer and JMI
Equity Fund, L.P. (incorporated by reference to Exhibit 10.20 to NEON's Registration Statement on Form
S-1 (Registration Number 333-69651) effective March 5, 1999).
10.21 Service Agreement dated as of December 18, 1998 by and among NEON Systems, Inc. and Peregrine/Bridge
Transfer Corporation (incorporated by reference to Exhibit 10.21 to NEON's Registration Statement on
Form S-1 (Registration Number 333-69651) effective March 5, 1999).
10.22 Stock Purchase Agreement dated June 1, 1998 by and between NEON Systems, Inc. and Wayne E. Webb, Jr.
(incorporated by reference to Exhibit 10.22 to NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999).
</TABLE>
55
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
10.23 Stockholders Agreement, dated June 1, 1998, by and between NEON Systems, Inc. and Wayne E. Webb, Jr.
(incorporated by reference to Exhibit 10.23 to NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999).
10.24 Form of NEON Distributor Agreement (incorporated by reference to Exhibit 10.24 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999).
11.1+ Statement regarding Computation of Per Share Earnings.
21.1 Subsidiaries of NEON Systems, Inc. (incorporated by reference to Exhibit 21.1 to NEON's Registration
Statement on Form S-1 (Registration number 333-69651) effective March 5, 1999).
24.1+ Power of Attorney (included on first signature page).
27.1+ Financial Data Schedule for year ended March 31, 1999.
</TABLE>
- ------------------------
+ Filed herewith
* Management contract or compensatory plan or arrangement. NEON will furnish a
copy of any exhibit listed above to any stockholder without charge upon
written request to Mr. John Reiland, 14100 Southwest Freeway, Suite 500,
Sugar Land, Texas 77478.
(b) Reports on Form 8-K.
The Company did not file any Form 8-K Current Reports during the last
quarter of the fiscal year ended March 31, 1999.
(c) The Index to Exhibits filed or incorporated by reference pursuant to
Item 601 of Regulation S-K and the Exhibits being filed with this Report
are included following the signature page to this Form 10-K.
(d) Not applicable.
56
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
NEON SYSTEMS, INC.
By: /s/ JOE BACKER
-----------------------------------------
Joe Backer,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: June 29, 1999
</TABLE>
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes and constitutes
Joe Backer and John S. Reiland, and each of them singly, his true and lawful
attorneys-in-fact with full power of substitution and resubstitution, for him
and in his name, place and stead, in any and all capacities to sign and file any
and all amendments to this report with all exhibits thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, and he
hereby ratifies and confirms all that said attorneys-in-fact or any of them, or
their substitutes, may lawfully do or cause to be done by virtue hereof.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
/s/ JOHN J. MOORES
- ------------------------------ Chairman of the Board June 29, 1999
John J. Moores
President and Chief
/s/ JOE BACKER Executive officer
- ------------------------------ (Principal Executive June 29, 1999
Joe Backer Officer) and Director
/s/ PETER SCHAEFFER
- ------------------------------ Chief Technology Officer June 29, 1999
Peter Schaeffer and Director
Chief Financial Officer
/s/ JOHN S. REILAND (Principal Financial and
- ------------------------------ Accounting Officer) and June 29, 1999
John S. Reiland Director
/s/ CHARLES E. NOELL III
- ------------------------------ Director June 29, 1999
Charles E. Noell III
/s/ NORRIS VAN DEN BERG
- ------------------------------ Director June 29, 1999
Norris van den Berg
/s/ RICHARD HOLCOMB
- ------------------------------ Director June 29, 1999
Richard Holcomb
</TABLE>
57
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<S> <C>
3.1 Amended and Restated Certificate of Incorporation of NEON Systems, Inc. (incorporated by reference to
Exhibit 3.1 to NEON's Registration Statement on Form S-1 (Registration Number 333-69651) effective March
5, 1999)
3.2 Bylaws of NEON Systems, Inc. (incorporated by reference to Exhibit 3.2 to NEON's Registration Statement
on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
4.1 Specimen Stock Certificate (incorporated by reference to Exhibit 4.1 to NEON's Registration Statement on
Form S-1 (Registration Number 333-69651) effective March 5, 1999)
4.2 Certificate of Incorporation, as amended and Bylaws of NEON Systems, Inc. (see Exhibits 3.1 and 3.2)
10.1* NEON Systems, Inc. 1993 Stock Plan. (incorporated by reference to Exhibit 10.1 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.2* NEON Systems 401(k) Plan (incorporated by reference to Exhibit 10.2 to NEON's Registration Statement on
Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.3* NEON Systems, Inc. 1999 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.3 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.4* NEON Systems, Inc. Stock Option Plan for Non-Employee Directors (incorporated by reference to Exhibit
10.4 to NEON's Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5,
1999)
10.5 Distributor Agreement dated as of January 1, 1996 by and between Peregrine/Bridge Transfer Corporation
and NEON Systems, Inc., as amended (incorporated by reference to Exhibit 10.5 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.6 Texaco Inc. Information Technology Department Miscellaneous Work Agreement dated as of July 1, 1991
between NEON Systems, Inc. and Texaco, Inc. (incorporated by reference to Exhibit 10.6 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.7 Series A Stock Purchase Agreement dated as of May 19, 1993 by and between NEON Systems, Inc., JMI Equity
Fund, L.P. and Peter Schaeffer (incorporated by reference to Exhibit 10.7 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.8 Secured Convertible Promissory Note Purchase Agreement dated as of September 29, 1994 by and between
NEON Systems, Inc. and JMI Equity Fund, L.P., as amended (incorporated by reference to Exhibit 10.8 to
NEON's Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.9 Secured Convertible Promissory Note Purchase Agreement dated as of March 30, 1995 by and between NEON
Systems, Inc. and JMI Equity Fund, L.P., as amended (incorporated by reference to Exhibit 10.9 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
</TABLE>
58
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<S> <C>
10.10 Secured Convertible Promissory Note Purchase Agreement dated as of November 22, 1995 by and between NEON
Systems, Inc. and JMI Equity Fund, L.P. (incorporated by reference to Exhibit 10.10 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.11 Secured Promissory Note dated March 31, 1997 to the order of JMI Equity Fund, L.P. in the original
principal amount of $1,049,100.78, as amended (incorporated by reference to Exhibit 10.11 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.12 Amendment to Convertible Debt Documentation and Exercise of Conversion Right dated March 31, 1997 by and
between NEON Systems, Inc. and JMI Equity Fund, L.P. (incorporated by reference to Exhibit 10.12 to
NEON's Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.13 Registration Rights Agreement dated as of May 19, 1003 by and between NEON Systems, Inc., JMI Equity
Fund, L.P. and Peter Schaeffer (incorporated by reference to Exhibit 10.13 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.14 Form of Indemnification Agreement between NEON Systems, Inc. and each of its directors (incorporated by
reference to Exhibit 10.14 to NEON's Registration Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999)
10.15 Lease Agreement between Turner Andreac, LLC and NEON Systems, Inc. for office space located at 14100
Southwest Freeway, Suite 500 in Sugar Land, Texas (incorporated by reference to Exhibit 10.15 to NEON's
Registration Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.16 Lease Agreement, dated December 9, 1996, between Nu-Swift Sovereign Limited and NEON Systems (U.K.)
Limited for office space located at Sovereign House 26/30 London Road in Twickenham, Middlesex
(incorporated by reference to Exhibit 10.16 to NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999)
10.17 Lease Agreement dated September 1, 1997 between NEON Systems GmbH and Triple P. Deutschland GmbH
(incorporated by reference to Exhibit 10.17 to NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999)
10.18 Agreement by and between Goal Systems International, Inc., NEON Systems, Inc. and Peter Schaeffer dated
January 8, 1992 (incorporated by reference to Exhibit 10.18 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999)
10.19 Stockholders Agreement dated May 19, 1993 by and among NEON Systems, Inc. and JMI Equity Fund, L.P. and
Peter Schaeffer (incorporated by reference to Exhibit 10.19 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999)
10.20 Stock Restriction Agreement dated May 19, 1993 by and among NEON Systems, Inc., Peter Schaeffer and JMI
Equity Fund, L.P (incorporated by reference to Exhibit 10.20 to NEON's Registration Statement on Form
S-1 (Registration Number 333-69651) effective March 5, 1999)
</TABLE>
59
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<S> <C>
10.21 Service Agreement dated as of December 18, 1998 by and among NEON Systems, Inc. and Peregrine/Bridge
Transfer Corporation (incorporated by reference to Exhibit 10.21 to NEON's Registration Statement on
Form S-1 (Registration Number 333-69651) effective March 5, 1999)
10.22 Stock Purchase Agreement dated June 1, 1998 by and between NEON Systems, Inc. and Wayne E. Webb, Jr.
(incorporated by reference to Exhibit 10.22 to NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999)
10.23 Stockholders Agreement, dated June 1, 1998, by and between NEON Systems, Inc. and Wayne E. Webb, Jr.
(incorporated by reference to Exhibit 10.23 to NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999)
10.24 Form of NEON Distributor Agreement (incorporated by reference to Exhibit 10.24 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651) effective March 5, 1999)
11.1+ Statement regarding Computation of Per Share Earnings
21.1 Subsidiaries of NEON Systems, Inc. (incorporated by reference to Exhibit 21.1 to NEON's Registration
Statement on Form S-1 (Registration number 333-69651) effective March 5, 1999).
24.1+ Power of Attorney (included on first signature page)
27.1+ Financial Data Schedule for year ended March 31, 1999
</TABLE>
- ------------------------
+ Filed herewith
* Management contract or compensatory plan or arrangement. NEON will furnish a
copy of any exhibit listed above to any stockholder without charge upon
written request to Mr. John Reiland, 14100 Southwest Freeway, Suite 500,
Sugar Land, Texas 77478.
60
<PAGE>
Exhibit 11.1
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
Years Ended March 31,
--------------------------------------
1997 1998 1999
---- ---- -----
<S> <C> <C> <C>
Weighted average number of
common shares outstanding
during the period:
Basic 1,739,683 2,411,524 3,065,219
Dilutive stock options 843,828 1,128,617 1,549,601
Series A redeemable,
convertible preferred
share 3,125,000 3,125,000 2,902,397
--------- --------- ---------
Diluted 5,708,511 6,665,141 7,517,217
--------- --------- ---------
--------- --------- ---------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENT OF OPERATIONS OF THE
COMPANY AS OF MARCH 31, 1999 AND FOR THE YEAR THEN ENDED AND IS QUALIFIED IN
IT'S ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 45,400,015
<SECURITIES> 0
<RECEIVABLES> 5,438,319
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 52,099,761
<PP&E> 974,744
<DEPRECIATION> (487,670)
<TOTAL-ASSETS> 52,634,751
<CURRENT-LIABILITIES> 6,804,655
<BONDS> 0
0
0
<COMMON> 88,483
<OTHER-SE> 46,231,973
<TOTAL-LIABILITY-AND-EQUITY> 52,634,751
<SALES> 0
<TOTAL-REVENUES> 20,016,196
<CGS> 0
<TOTAL-COSTS> 2,018,100
<OTHER-EXPENSES> 14,551,539
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 81,667
<INCOME-PRETAX> 3,632,024
<INCOME-TAX> 1,380,170
<INCOME-CONTINUING> 2,251,854
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,251,854
<EPS-BASIC> 0.73
<EPS-DILUTED> 0.30
</TABLE>
