<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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
incorporation or organization) Identification No.)
14100 SOUTHWEST FREEWAY, SUITE 500, SUGAR LAND, TEXAS 77478
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (281) 491-4200
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No[ ]
The number of shares of the registrant's common stock outstanding as of August
11, 1999 was 8,851,073.
<PAGE> 2
NEON SYSTEMS, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1999
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at June 30, 1999 and March 31, 1999 ............ 3
Consolidated Statements of Operations for the Three Months Ended
June 30, 1999 and 1998 ............................................... 4
Consolidated Statements of Cash Flows for the Three Months Ended
June 30, 1999 and 1998 ............................................... 5
Condensed Notes to Consolidated Financial Statements ....................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
Of Operations .............................................................. 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk ................. 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ........................................................... 16
Item 2. Changes in Securities and Use of Proceeds ................................... 16
Item 3. Defaults Upon Senior Securities ............................................. 16
Item 4. Submission of Matters to a Vote of Security Holders ......................... 16
Item 5. Other Information ........................................................... 16
Item 6. Exhibits and Reports on Form 8-K ............................................ 16
SIGNATURES .......................................................................... 17
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, 1999 March 31, 1999
------------- --------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash & cash equivalents $ 47,038,633 $ 45,400,015
Accounts receivable-trade 4,738,472 5,438,319
Accounts receivable-related party 511,365 278,817
Deferred income taxes 544,093 571,990
Other current assets 832,357 410,620
------------ ------------
Total current assets 53,664,920 52,099,761
------------ ------------
Furniture & equipment 939,530 895,970
Purchased software 86,246 78,774
Less: accumulated depreciation and amortization (537,149) (487,670)
------------ ------------
Property & equipment, net 488,627 487,074
Other assets, net 45,701 47,916
------------ ------------
Total assets $ 54,199,248 $ 52,634,751
============ ============
LIABILITIES & STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accrued expenses $ 1,137,055 $ 1,222,154
Accounts payable 1,455,641 1,474,763
Taxes payable 787,359 371,844
Deferred income taxes -- 27,897
Deferred maintenance revenue 3,803,446 3,707,997
------------ ------------
Total current liabilities 7,183,501 6,804,655
------------ ------------
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value. Authorized 10,000,000
shares; no shares issued and outstanding -- --
Common stock, $.01 par value. Authorized 30,000,000
shares; 8,850,033 and 8,848,251 shares issued and
outstanding at June 30, 1999 and March 31, 1999
respectively 88,500 88,483
Additional paid-in capital 46,174,908 46,174,124
Accumulated other comprehensive income 47,216 57,849
Unearned portion of deferred compensation (1,574,033) (1,710,371)
Retained earnings 2,279,156 1,220,011
------------ ------------
Total stockholders' equity 47,015,747 45,830,096
Commitments and contingencies (Note 3)
------------ ------------
Total liabilities and stockholders' equity $ 54,199,248 $ 52,634,751
============ ============
</TABLE>
SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE> 4
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
-------------------------------
1999 1998
------------ -----------
<S> <C> <C>
Revenues:
License $ 4,449,670 $ 2,923,416
Maintenance 1,635,992 925,817
------------ -----------
Total revenues 6,085,662 3,849,233
Cost of revenues:
Cost of licenses 94,343 276,603
Cost of maintenance 272,252 200,726
------------ -----------
Total cost of revenues 366,595 477,329
------------ -----------
Gross Profit 5,719,067 3,371,904
Operating expenses:
Sales and marketing 2,454,181 1,417,041
Research and development 1,196,863 765,305
General and administrative 714,334 511,998
Non-cash compensation 136,338 412,884
------------ -----------
Total operating expenses 4,501,716 3,107,228
Operating income 1,217,351 264,676
Interest income 543,497 13,704
Interest expense (572) (21,093)
Other, net (51,978) (27,653)
------------ -----------
Income before provision for income taxes 1,708,298 229,634
Provision for income taxes 649,153 84,965
------------ -----------
Net income 1,059,145 144,669
Dividends on Series A redeemable,
convertible preferred stock -- (25,000)
------------ -----------
Net income applicable to common stockholders $ 1,059,145 $ 119,669
============ ===========
Earnings per share:
Basic $ 0.12 $ 0.05
============ ===========
Diluted $ 0.10 $ 0.02
============ ===========
Shares used in computing earnings per share:
Basic 8,849,896 2,551,862
Diluted 10,236,134 6,810,236
</TABLE>
SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE> 5
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
-------------------------------
1999 1998
------------ -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,059,145 $ 144,669
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 49,479 41,194
Non-cash compensation expense 136,338 412,884
Increase (decrease) in cash resulting from changes in:
Accounts receivable 467,299 (245,527)
Other current assets (421,737) 126,863
Other assets 2,215 (116)
Accrued expenses (85,099) (439,630)
Accounts payable (19,122) 321,539
Taxes payable 415,515 (185,035)
Deferred maintenance revenue 95,449 246,380
------------ -----------
Net cash provided by operating activities 1,699,482 423,221
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of furniture and equipment (43,560) (37,388)
Purchases of computer software (7,472) --
------------ -----------
Net cash used in investing activities (51,032) (37,388)
------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 801 86,805
------------ -----------
Net cash provided by financing activities 801 86,805
------------ -----------
Net increase in cash and cash equivalents 1,649,251 472,638
Effect of exchange rates on cash (10,633) 1,109
Cash and cash equivalents at beginning of period 45,400,015 2,804,073
------------ -----------
Cash and cash equivalents at end of period $ 47,038,633 $ 3,277,820
============ ===========
Supplemental disclosure of non-cash financing activities:
Cash paid during the period for income taxes $ 233,638 $ 274,542
============ ===========
</TABLE>
SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
<PAGE> 6
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION
NEON Systems, Inc. and subsidiaries (collectively, "NEON") are 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.
The condensed consolidated financial statements included herein have been
prepared by the Company without audit pursuant to the rules and regulations of
the Securities and Exchange Commission. The financial statements reflect all
normal and recurring adjustments which in the opinion of management are
necessary for fair presentation of the financial position, results of
operations and cash flows for the interim periods presented. The results of
operations for the periods presented are not necessarily indicative of the
results to be expected for the full year. The accompanying unaudited condensed
financial statements should be read in conjunction with the financial
statements and notes included in the Company's annual Report on Form 10-K for
the fiscal year ended March 31, 1999.
NOTE 2--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>
THREE MONTHS ENDED JUNE 30,
-----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net income $ 1,059,145 $ 144,669
Dividends on series A redeemable, convertible preferred stock -- (25,000)
----------- -----------
Net income applicable to common stockholders $ 1,059,145 $ 119,669
=========== ===========
Weighted average number of common shares outstanding during the period:
Basic 8,849,896 2,551,862
Dilutive stock options 1,386,238 1,133,374
Series A redeemable, convertible preferred stock -- 3,125,000
----------- -----------
Diluted 10,236,134 6,810,236
=========== ===========
Income per common share:
Basic $ 0.12 $ 0.05
=========== ===========
Diluted $ 0.10 $ 0.02
=========== ===========
</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 an expense over the vesting period of the granted options. During
the three months ended June 30, 1999, $136,000 was recognized as a non-cash
compensation expense. The remaining differential of $1,574,033 will be
recognized over the remaining vesting period, approximately three years, of the
granted options.
6
<PAGE> 7
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--CONTINGENCIES
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 infringement 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 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 defending the lawsuit or to 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, with respect to its sales activities through June 30, 1999,
any disgorgement pursuant to the lawsuit would not exceed $2.1 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.
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.
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. This and any
other litigation to enforce NEON's right to use the NEON name in NEON's
business or to prevent others from using the NEON name may be expensive and
time-consuming, may 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.
7
<PAGE> 8
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--CONTINGENCIES (CONTINUED)
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 any of these matters will not have a material adverse effect on
NEON's consolidated financial position, results of operations or liquidity.
NOTE 4-- FOREIGN OPERATIONS
The table below summarizes selected financial information with respect
to NEON's operations by geographic locations.
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
-------------------------------
1999 1998
------------ -----------
<S> <C> <C>
Revenues:
United States $ 4,480,660 $ 3,009,196
Europe 1,605,002 840,037
------------ -----------
$ 6,085,662 $ 3,849,233
============ ===========
Operating income (loss):
United States $ 1,879,956 $ 458,537
Europe (662,605) (193,861)
------------ -----------
$ 1,217,351 $ 264,676
============ ===========
Identifiable assets:
United States $ 50,954,898 $ 5,272,540
Europe 3,244,350 1,668,351
------------ -----------
$ 54,199,248 $ 6,940,891
============ ===========
</TABLE>
NOTE 5-- RECENTLY ISSUED 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 NEON's fiscal year 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 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 quarters of fiscal
years beginning after June 15, 2000. Under its present operations, this
statement will have no impact on NEON's financial position or results of
operations.
8
<PAGE> 9
ITEM 2. 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 certain forward-looking statements
that involve risks and uncertainties. The Company's actual results and the
timing of certain events could differ materially from those discussed in the
forward-looking statements as a result of certain factors, including those set
forth under the heading "Risk Factors" in the Company's filings with the
Securities and Exchange Commission, including its Form 10-K for the fiscal year
ended March 31, 1999.
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 $3.8 million in the three
months ended June 30, 1998, to $6.1 million in the three months ended June 30,
1999, an increase of $2.3 million, or 58%. 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. Maintenance revenues in the
three months ended June 30, 1998 and 1999 represented 24% and 27% 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.
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 June 30, 1999, NEON had unhedged net current assets denominated in British
pounds aggregating 918,304 British pounds and unhedged net current liabilities
denominated in deutschemarks aggregating 12,705 deutschemarks. At that date,
NEON had no material commitments that would be satisfied in currencies other
than U.S. dollars. In other
9
<PAGE> 10
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
25% and 34% of total revenues in the three months ended June 30, 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 operation data expressed as a percentage of total revenues:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
---------------------------
1999 1998
---- ----
<S> <C> <C>
Revenues:
License 73% 76%
Maintenance 27 24
--- ----
Total revenues 100 100
Cost of revenues:
Cost of licenses 2 7
Cost of maintenance 4 5
--- ----
Total cost of revenues 6 12
--- ----
Gross profit 94 88
Operating expenses:
Sales and marketing 40 37
Research and development 20 20
General and administrative 12 13
Non-cash compensation 2 11
--- ----
Total operating expenses 74 81
--- ----
Operating income 20 7
Interest and other, net 8 (1)
--- ----
Income before provision for income taxes 28 6
Provision for income taxes 11 2
--- ----
Net income 17% 4%
=== ====
</TABLE>
THREE MONTHS ENDED JUNE 30, 1999 COMPARED TO THREE MONTHS ENDED JUNE 30, 1998
REVENUES
Total revenues. NEON's revenues increased $2.3 million or 58% from
$3.8 million for the three months ended June 30, 1998 to $6.1 million for the
three months ended June 30, 1999. No customer accounted for more than 10% of
total revenues in the three months ended June 30, 1998, but one customer
accounted for 29% and a second customer 18% of total revenues in the three
months ended June 30, 1999.
License. License revenues increased $1.5 million or 52% from $2.9
million for the three months ended June 30, 1998 to $4.4 million for the three
months ended June 30, 1999. Essentially all of this increase resulted from
increased license sales of NEON's Shadow products.
Maintenance. Maintenance revenues increased $710,000 or 77% from
$926,000 for the three months ended June 30, 1998 to $1.6 million for the three
months ended June 30, 1999. This increase resulted
10
<PAGE> 11
approximately equally from increases in first years maintenance revenues
recognized in association with new license sales and increases in maintenance
agreement renewals from NEON's installed base of customers.
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 decreased $182,000 or 66% from
$277,000, or 9% of license revenues, for the three months ended June 30, 1998
to $95,000, or 2% of license revenues, for the three months ended June 30,
1999. The decreases in the cost of license revenues were attributable to
decreased shipments of Enterprise Subsystem Management products sold by NEON
under the terms of its distributor agreement with Peregrine/Bridge Transfer
Corporation.
Cost of maintenance. Cost of maintenance revenues includes personnel
and other costs related to NEON's customer support department. Cost of
maintenance revenues increased $72,000 or 36% from $200,000, or 22% of
maintenance revenues, for the three months ended June 30, 1998 to $272,000, or
17% of maintenance revenues, for the three months ended June 30, 1999. The
dollar increase was due principally to increased customer support costs in
providing maintenance services to NEON's growing installed customer base. The
percentage decrease resulted primarily from maintenance revenues outpacing
NEON's need for additional support staff.
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. These expenses increased $1.0 million or 73% from $1.4
million, or 37% of total revenues, for the three months ended June 30, 1998 to
$2.5 million, or 40% of total revenues, for the three months ended June 30,
1999. The dollar increase reflects a $269,000 increase in expenses related to
NEON's sales offices in Germany and the United Kingdom. This dollar increase
also reflects a $489,000 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. Additionally,
the dollar increase includes approximately $308,000 of increased marketing and
selling expenses.
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
increased $432,000 or 56% from $765,000, or 20% of total revenues, for the
three months ended June 30, 1998 to $1.2 million, or 20% of total revenues, for
the three months ended June 30, 1999. The dollar increase includes a $231,000
increase in recruitment and compensation costs due to increased staffing and,
to a lesser extent, from increased product commissions paid to product authors.
The dollar increase also includes $131,000 of increased operating expenses,
principally due to office and computer facilities required by a larger number
of research and development staff. NEON anticipates that it will continue to
devote substantial resources to product research and development for the
foreseeable future. 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 three months ended June 30, 1999.
NEON has followed Statement of Financial Accounting Standards No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed" for the past several years. Research and development expenditures in
general have been charged to operations as incurred and any capitalization
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 increased
$202,000 or 40% from $512,000, or 13% of total revenues, for the three months
ended June 30, 1998 to $714,000, or 12% of total revenues, for the three months
ended June 30,1999. This dollar increase resulted primarily from a $93,000
increase in legal and accounting costs and a $50,000 increase in office rental
expenses, principally due to the Company's headquarters office expansion. 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 three months ended June 30, 1999.
11
<PAGE> 12
Non-cash compensation. During the twelve months prior to NEON's
initial public offering on March 5, 1999 the Company granted stock options at
prices subsequently 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 vesting period of
the granted options. During the three months ended June 30, 1999, $136,000 was
recognized as a noncash compensation expense. The remaining differential of
$1.6 million will be recognized over the remaining vesting period of the
granted options.
Interest income. Interest income increased $530,000 from $14,000 for
the three months ended June 30, 1998 to $544,000 for the three months ended
June 30, 1999. This increase reflects the increase in the Company's cash and
cash equivalents balances resulting primarily from the $41.2 million of net
proceeds received from NEON's March 1999 initial public offering.
Provision for income taxes. NEON fully utilized its net operating loss
carryforward for U.S. income tax purposes in fiscal 1998. The effective income
tax rate was 37% and 38% for the three months ended June 30, 1998 and 1999,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
NEON's cash and cash equivalent balance increased to $47.0 million at
June 30, 1999 from $45.4 million at March 31, 1999. This increase was due
primarily to interest earned on investment of the net proceeds received from
our March 1999 initial public offering as well as positive cash flows from
collections of accounts receivable-trade.
Net cash provided by operating activities was $423,000 and $1.7
million in the three months ended June 30, 1998 and 1999, respectively.
Increased net cash provided by operating activities during the three months
ended June 30, 1999 versus the three months ended June 30, 1998 was primarily
the result of increased profitability from the growth of our business.
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 $37,000 and $51,000
in the three months ended June 30, 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 June 30, 1999, NEON had no
material commitment for capital expenditures.
NEON's net cash provided by financing activities was $87,000 and
$1,000 in the three months ended June 30, 1998 and 1999, respectively. Net cash
provided by financing activities in both periods 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
12
<PAGE> 13
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 June
30, 1999, any disgorgement pursuant to the lawsuit would not exceed $2.1
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 would be reasonably likely to 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.
In assessing the effect of the Year 2000 Problem on NEON, management
determined that there existed three general areas that needed to be evaluated:
o Software products sold to customers
o Internal infrastructure
o 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.
13
<PAGE> 14
NEON has not utilized the resources of third parties to assess and/or
validate the reliability of its 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 Websites 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 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 customers' 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:
o Accelerated replacement of affected equipment or software
o Short to medium-term use of back-up equipment and software
o 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
o 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
To date, 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 year 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.
14
<PAGE> 15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to a variety of risks, including foreign currency
exchange rate fluctuations and changes in the market value of its investments.
In seeking to minimize the risks and/or costs associated with such activities,
the Company manages exposure to change in interest rates and foreign currency
exchange rates.
The majority of our foreign currency transactions are denominated in
the British pound sterling, which is the functional currency of NEON Systems
(UK) Ltd. As sales contracts are denominated and settled in the functional
currency, risks associated with currency fluctuations are minimized to
foreign currency translation adjustments. The Company does not currently
hedge against foreign currency translation risks and believes that foreign
currency exchange risk is not significant to its operations.
The Company adheres to a conservative investment policy, whereby its
principal concern is the preservation of liquid funds while maximizing its
yield on such assets. Cash and cash equivalents approximated $47 million at
June 30, 1999, and were invested in different types of money market securities.
The Company believes that a near-term change in interest rates would not
materially affect its financial position, results of operations or net cash
flows for fiscal year 2000.
15
<PAGE> 16
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS-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. This and any other litigation to enforce NEON's
right to use the NEON name in NEON's business or to prevent others
from using the NEON name may be expensive and time-consuming, may
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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS-In March 1999, the Company
completed the initial public offering of its common stock (the "IPO").
The Securities and Exchange 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 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 was used to repay existing indebtedness. The remainder of
the proceeds from the IPO (other than the proceeds used to repay the
existing indebtedness and other uses described above) has been
invested in short term, interesting-bearing, investment-grade
securities.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES-Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS-Not Applicable
ITEM 5. OTHER INFORMATION-Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit 27 - Financial Data Schedule
(b) REPORTS ON FORM 8-K - NEON did not file any reports on Form 8-K
during the first quarter of its fiscal year 2000, which was the
quarter for which this report is filed.
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NEON SYSTEMS, INC.
August 12, 1999 /s/ JOE BACKER
---------------------------------------
Joe Backer
President and Chief Executive Officer
/s/ JOHN REILAND
---------------------------------------
August 12, 1999 John S. Reiland
Chief Financial Officer
(Principal accounting officer)
17
<PAGE> 18
INDEX TO EXHIBIT
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
<S> <C>
27 -Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<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 JUNE 30, 1999 AND FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 47,038,633
<SECURITIES> 0
<RECEIVABLES> 5,249,837
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 53,664,920
<PP&E> 1,025,776
<DEPRECIATION> 537,149
<TOTAL-ASSETS> 54,199,248
<CURRENT-LIABILITIES> 7,183,501
<BONDS> 0
0
0
<COMMON> 88,500
<OTHER-SE> 46,927,247
<TOTAL-LIABILITY-AND-EQUITY> 54,199,248
<SALES> 0
<TOTAL-REVENUES> 6,085,662
<CGS> 0
<TOTAL-COSTS> 366,595
<OTHER-EXPENSES> 4,501,716
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 572
<INCOME-PRETAX> 1,708,298
<INCOME-TAX> 649,153
<INCOME-CONTINUING> 1,059,145
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,059,145
<EPS-BASIC> 0.12
<EPS-DILUTED> 0.10
</TABLE>
