<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FILE PURSUANT TO RULE 424(b)(4)
REGISTRATION NO. 333-69651
PROSPECTUS
MARCH 5, 1999
[LOGO]
2,700,000 SHARES OF COMMON STOCK
- ----------------------------------------------------------------------
<TABLE>
<S> <C>
NEON SYSTEMS, INC.:
- - We develop and sell
software products that
help organizations access
and integrate data,
transactions and
applications from the
Internet and mainframe and
client/server systems.
- - NEON Systems, Inc.
14100 Southwest Freeway
Suite 500
Sugar Land, Texas 77478
(281) 491-4200
TRADING SYMBOL & MARKET:
- - NESY/NASDAQ
OTHER INFORMATION:
- - We are not affiliated with
New Era of Networks, Inc.
which trades under the
symbol NEON.
THE OFFERING:
- - We are offering 2,636,000
of the shares and an
existing stockholder is
offering 64,000 of the
shares.
- - The underwriters have an
option to purchase an
additional 405,000 shares
from NEON to cover over-
allotments.
- - This is our initial public
offering, and no public
market currently exists
for our shares.
- - We plan to use the
proceeds from this
offering for working
capital and other general
corporate purposes as well
as the retirement of
existing indebtedness. We
will not receive any
proceeds from the shares
sold by the selling
stockholder.
- - Closing: March 10, 1999.
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
<S> <C> <C>
Per Share Total
- ----------------------------------------------------------------------------
Public offering price: $ 15.00 $40,500,000
Underwriting fees: 1.05 2,835,000
Proceeds to NEON: 13.95 36,772,200
Proceeds to selling stockholder: 13.95 892,800
- ----------------------------------------------------------------------------
</TABLE>
THIS INVESTMENT INVOLVES RISK. SEE "RISK FACTORS" BEGINNING ON PAGE 6.
- --------------------------------------------------------------------------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
- --------------------------------------------------------------------------------
DONALDSON, LUFKIN & JENRETTE
HAMBRECHT & QUIST
CIBC OPPENHEIMER
THE UNDERSIGNED IS FACILITATING INTERNET DISTRIBUTION.
DLJDIRECT INC.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Prospectus Summary................................................................... 3
Risk Factors......................................................................... 6
Forward-Looking Statements........................................................... 14
Use of Proceeds...................................................................... 14
Dividend Policy...................................................................... 14
Corporate Information................................................................ 14
Capitalization....................................................................... 15
Dilution............................................................................. 16
Selected Consolidated Financial Data................................................. 17
Management's Discussion and Analysis of Financial Condition and Results of
Operations......................................................................... 18
Business............................................................................. 29
Management........................................................................... 42
Certain Transactions................................................................. 49
Principal and Selling Stockholders................................................... 51
Description of Capital Stock......................................................... 53
Shares Eligible for Future Sale...................................................... 55
Underwriting......................................................................... 57
Legal Matters........................................................................ 60
Experts.............................................................................. 60
Available Information................................................................ 60
Index to Consolidated Financial Statements........................................... F-1
</TABLE>
<PAGE>
PROSPECTUS SUMMARY
THIS SUMMARY IS QUALIFIED BY MORE DETAILED INFORMATION APPEARING IN OTHER
SECTIONS OF THIS PROSPECTUS. THE OTHER INFORMATION IS IMPORTANT, SO PLEASE READ
THIS ENTIRE PROSPECTUS CAREFULLY. UNLESS STATED OTHERWISE, THE INFORMATION
CONTAINED IN THIS PROSPECTUS ASSUMES THAT THE UNDERWRITERS' OVER-ALLOTMENT
OPTION TO PURCHASE 405,000 SHARES IS NOT EXERCISED.
OUR BUSINESS
We develop and sell software products that provide a way to integrate
computer programs designed to perform specific functions, which are commonly
called computer applications, with information residing on different computer
systems. In particular, our products provide a way for new applications on the
Internet, which is a low-cost, global infrastructure of computer networks, and
client/ server computer systems to use data and transactions stored on mainframe
computers. Client/server computer systems are newer and more flexible computer
systems. Mainframe computers are computer systems with high processing power
that have traditionally been used by large businesses for storing and utilizing
large amounts of business data. By doing so, our products allow organizations to
take advantage of the pervasive nature of the Internet and the flexibility of
client/server systems while preserving their investment in mainframes.
Importantly, our products provide a more timely, cost-effective way to deploy
new Internet applications or extend existing applications to the Internet to
allow organizations to participate in electronic commerce opportunities or new
ways of doing business using the Internet. Business using the Internet is often
referred to as "e-commerce" or "e-business." We refer to our products as
"Enterprise Access and Integration" software because they permit users to access
mainframe-based data and applications from their personal computers.
We believe that many organizations have new strategic initiatives that
depend on effectively delivering information where it is needed, when it is
needed. One of the greatest challenges to implementing these new strategies is
exploiting powerful new technologies within the existing systems infrastructure
of an enterprise. Specifically, mainframes provide proven reliability,
scalability, security and control as well as time-tested applications.
Client/server systems enable many users and applications to share data from a
central computer resource known as a server. Client/server systems also enable
applications to be developed and deployed more rapidly than mainframe
applications. The Internet enables an organization to easily communicate with
customers, suppliers and partners and to extend employee access to key
applications and information.
Our main product family, Shadow, consists of three software applications:
- SHADOW DIRECT enables client/server applications to access and integrate
with mainframe data and applications
- SHADOW WEB SERVER enables Internet applications to access and integrate
with mainframe data and applications
- SHADOW ENTERPRISE DIRECT provides integration between client/server
systems
We believe our customers select our products for three main reasons. First,
Shadow accesses information directly from the mainframe to the client/server or
Internet application. Most competing products cannot do this and instead require
a separate computer server or application to take the information from the
mainframe and then send it to that application. Second, Shadow is very cost
effective. It is easy-to-use, can be installed quickly and has extensive
administrative capabilities. Third, Shadow can meet demanding application
requirements, such as a large number of users, and provide information from the
mainframe very quickly. In addition to our Shadow products, we market and sell a
suite of software products known as Enterprise Subsystem Management products
that support the growing performance demands on mainframe computers as they
support new users and applications.
3
<PAGE>
Our goal is to be the leading provider of Enterprise Access and Integration
software. The following are key elements of our strategy:
- Maintain and enhance our technological leadership
- Capitalize on the market for Internet applications and e-business
solutions
- Leverage our existing customer base by cross-selling additional products
and expanding license sales to those customers
- Exploit our product development strength
- Maximize the benefits of our direct telesales model, which focuses on the
effective use of the telephone and the Internet for product demonstrations
and product sales to respond more rapidly to customer needs while
maintaining a low cost sales model
Through December 31, 1998, we have shipped our products to over 200
organizations worldwide, including approximately one-fourth of the Fortune 100
companies. Representative domestic and international customers include American
Express, BASF, Dayton Hudson, Deutsche Bank, Exxon, Merrill Lynch, Motorola,
Sears, Skandia, Texaco and the U.S. Postal Service.
THE OFFERING
The following information regarding shares outstanding is as of February 28,
1999. It includes 3,125,000 shares of common stock to be issued on conversion of
outstanding shares of our preferred stock and excludes 3,729,077 shares of
common stock reserved for issuance under our stock plans, of which 1,629,077
shares are subject to outstanding options.
<TABLE>
<S> <C>
Common Stock offered:
By NEON..................................... 2,636,000 shares
By the selling stockholder.................. 64,000 shares
Total................................... 2,700,000 shares
Common Stock to be outstanding
after this offering........................... 8,443,251 shares
Use of proceeds................................. We intend to use the net proceeds of
approximately $36.0 million that we will
receive from this offering for working
capital and other general corporate
purposes as well as the retirement of
approximately $1.0 million of existing
indebtedness. We will not receive any
proceeds from the shares sold by the
selling stockholder.
Nasdaq National Market symbol................... NESY
</TABLE>
4
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
You should read the following summary consolidated financial data together
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our Consolidated Financial Statements and Notes thereto included
elsewhere in this prospectus. The pro forma as adjusted balance sheet data
reflects the following assumptions:
- The conversion of all outstanding shares of preferred stock into shares of
common stock
- The sale of 2,636,000 shares of our common stock in this offering at an
offering price of $15.00 per share after deducting the underwriting
discounts and commissions and estimated offering expenses and the
application of the net proceeds therefrom. See "Capitalization" and "Use
of Proceeds."
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED MARCH 31, DECEMBER 31,
------------------------------- ------------------------
STATEMENT OF OPERATIONS DATA: 1996 1997 1998 1998
--------- --------- --------- ---------
1997
-------------
(UNAUDITED)
Revenues:
<S> <C> <C> <C> <C> <C>
License.......................................... $ 2,190 $ 6,183 $ 9,806 $ 6,389 $ 10,541
Maintenance...................................... 276 1,003 2,397 1,771 3,294
--------- --------- --------- ------ ---------
Total revenues................................. 2,466 7,186 12,203 8,159 13,835
Gross profit....................................... 2,289 6,582 10,908 7,484 12,501
Operating income (loss)............................ (532) 891 1,443 1,089 2,145
Net income (loss).................................. $ (598) $ 816 $ 1,161 $ 875 $ 1,364
--------- --------- --------- ------ ---------
--------- --------- --------- ------ ---------
Net income (loss) applicable to common
stockholders...................................... $ (678) $ 736 $ 1,061 $ 800 $ 1,289
--------- --------- --------- ------ ---------
--------- --------- --------- ------ ---------
Earnings (loss) per common share:
Basic............................................ $ (1.62) $ 0.35 $ 0.45 $ 0.34 $ 0.49
--------- --------- --------- ------ ---------
--------- --------- --------- ------ ---------
Diluted.......................................... $ (1.62) $ 0.14 $ 0.19 $ 0.14 $ 0.20
--------- --------- --------- ------ ---------
--------- --------- --------- ------ ---------
Shares used in computing earnings (loss) per common
share:
Basic............................................ 417 2,094 2,371 2,341 2,608
Diluted.......................................... 417 5,671 6,268 6,238 6,934
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
--------------------------------
PRO FORMA
ACTUAL AS ADJUSTED
--------------- ---------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 4,511 $ 39,434
Working capital........................................... 3,004 38,976
Total assets.............................................. 9,902 44,825
Secured notes payable..................................... 1,049 --
Series A redeemable, convertible preferred stock.......... 1,738 --
Total stockholders' equity................................ 1,840 39,550
</TABLE>
5
<PAGE>
RISK FACTORS
BEFORE YOU INVEST IN OUR COMMON STOCK, YOU SHOULD BE AWARE OF VARIOUS RISKS,
INCLUDING THOSE DESCRIBED BELOW. YOU SHOULD CAREFULLY CONSIDER THESE RISK
FACTORS, TOGETHER WITH ALL OF THE OTHER INFORMATION INCLUDED IN THIS PROSPECTUS,
BEFORE YOU DECIDE WHETHER TO PURCHASE SHARES OF OUR 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.
6
<PAGE>
BECAUSE 90% OF OUR REVENUES ARE DERIVED FROM OUR SHADOW PRODUCT LINE, DECREASED
DEMAND FOR THESE PRODUCTS COULD ADVERSELY AFFECT OUR BUSINESS
Over 90% of our revenues in fiscal 1997 and 1998 and the nine months ended
December 31, 1998 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.
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 software products that support the growing
performance demands on mainframe computers as they support new users and
applications and are referred to as Enterprise Subsystem Management products.
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 offered by us, 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.
7
<PAGE>
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 solutions
- Internal development efforts by corporate information technology
departments
- New entrants to the middleware or enterprise subsystem management markets
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
8
<PAGE>
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 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
9
<PAGE>
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's
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." 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, New Era of Network's use of the "NEON" symbol
on the Nasdaq National Market System may create confusion in the marketplace and
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 December 31, 1998, any disgorgement would not exceed
$1.8 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 would be reasonably
likely to have a material adverse effect on our liquidity and results of
operations.
10
<PAGE>
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 receive 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
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 are currently developing contingency plans
11
<PAGE>
to be implemented 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, after this offering, 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
- Unfavorable publicity affecting our industry or us
- Adverse legal events affecting us
- Sales of NEON common stock by existing stockholders
THE ABSENCE OF AN ACTIVE PUBLIC MARKET FOR OUR COMMON STOCK MAY MAKE IT
DIFFICULT FOR YOU TO RESELL YOUR SHARES AT OR ABOVE THE OFFERING PRICE, AND
THE AVAILABILITY OF SIGNIFICANT AMOUNTS OF COMMON STOCK FOR SALE COULD
ADVERSELY AFFECT ITS MARKET PRICE
Prior to this offering, there has been no public market for our common
stock, and an active public market for our common stock may not develop or
continue after this offering. The initial public offering price for our common
stock was determined by negotiation between NEON and the representatives of the
underwriters, and you may be unable to resell your shares of common stock at or
above that initial offering price.
If our stockholders sell substantial amounts of our common stock in the
public market following this offering, 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. own in the aggregate 4,795,000 shares of our
common stock. If they sell a large portion of their shares on the open market
and at one time, our market price per share may decline. You should read "Shares
Eligible for Future Sale" for a more detailed discussion of when and how many
shares of our common stock may be sold after this offering.
12
<PAGE>
OUR USE OF OFFERING PROCEEDS IS NOT SUBJECT TO A BUSINESS PLAN AND MAY NOT PROVE
BENEFICIAL TO STOCKHOLDERS
Approximately 97% of the net proceeds of this offering has not been
designated for specific uses. Although we do not have a business plan with
respect to the use of the net proceeds of this offering, we expect to use these
net proceeds for working capital and other general corporate purposes and for
the retirement of approximately $1.0 million existing indebtedness. However, our
Board of Directors will have broad discretion with respect to the use of the net
proceeds of this offering and could use the proceeds for other purposes which
may not prove to be beneficial to our stockholders. Our principal reasons for
the offering are to increase our equity capital, to create a public market for
our common stock, to facilitate our future access to public equity markets and
to provide increased visibility of NEON in a marketplace where many of our
competitors are publicly-held companies.
YOU WILL INCUR IMMEDIATE AND SUBSTANTIAL DILUTION
The initial public offering price of the common stock is substantially
higher than the pro forma net tangible book value per share of the outstanding
common stock. As a result, you will incur immediate and substantial dilution of
$10.41 per share based upon an initial public offering price of $15.00 per
share. In the event we issue additional shares of common stock in the future,
you may experience further dilution. Furthermore, we have issued options to
purchase common stock at prices significantly below the initial public offering
price. To the extent such options are exercised, you will experience further
dilution.
OUR OFFICERS AND DIRECTORS CONTROL NEON, AND THESE OFFICERS AND DIRECTORS COULD
CONTROL MATTERS SUBMITTED TO OUR STOCKHOLDERS
Our executive officers and directors and entities affiliated with them will,
in the aggregate, beneficially own approximately 60.9% of our outstanding common
stock following this offering. 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.
13
<PAGE>
FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that involve substantial
risks and uncertainties. You can identify these statements by forward-looking
words such as "may," "will," "expect," "anticipate," "believe," "estimate" and
"continue" or similar words. You should read statements that contain these words
carefully because they discuss our future expectations, contain projections of
our future results of operations or of our financial condition or state other
"forward-looking" information. We believe that it is important to communicate
our future expectations to our investors. However, there may be events in the
future that we are not able to accurately predict or control. The factors listed
in the sections captioned "Risk Factors" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," as well as any
cautionary language in this prospectus, provide examples of risks, uncertainties
and events that may cause our actual results to differ materially from the
expectations we describe in our forward-looking statements. Before you invest in
our common stock, you should be aware that the occurrence of the events
described in the "Risk Factors" section and the "Management's Discussion and
Analysis of Financial Condition and Results of Operations" section and elsewhere
in this prospectus could have a material adverse effect on our business,
operating results and financial condition.
USE OF PROCEEDS
NEON will receive approximately $36.0 million from its sale of 2,636,000
shares of common stock. If the underwriters exercise their over-allotment option
in full, NEON will receive an additional $5.6 million in net proceeds.
NEON expects to use the net proceeds for working capital and other general
corporate purposes and to retire approximately $1.0 million of existing
indebtedness. The existing indebtedness matures March 31, 1999 and bears
interest at eight percent per annum. Pending these uses, NEON intends to invest
the net proceeds of this offering in short-term, interest-bearing,
investment-grade securities. NEON's principal reasons for this offering are to
increase its equity capital, to create a public market for our common stock, to
facilitate our future access to public equity markets and to provide increased
visibility of NEON in a marketplace where many of its competitors are
publicly-held companies.
NEON will not receive any proceeds from the sale of common stock by the
selling stockholder. See "Principal and Selling Stockholders."
DIVIDEND POLICY
NEON has never paid cash dividends on its common stock. NEON intends to
retain future earnings to finance the expansion of its business and does not
anticipate paying any cash dividends for the foreseeable future. Any future
determination as to the payment of dividends will be at the discretion of the
Board of Directors.
CORPORATE INFORMATION
NEON's World Wide Web address is www.neonsys.com. Information contained in
NEON's Web site does not constitute part of this prospectus.
NEON and SHADOW are registered trademarks of NEON. NEON is in the process of
registering SHADOWDIRECT, SHADOW WEB SERVER, ENTERPRISE DIRECT, AFFINITY SERVER,
SPEED UNLOAD, SPEED LOAD and PDF as trademarks. Each trademark, trade name or
service mark of any other company appearing in this prospectus belongs to its
holder.
14
<PAGE>
CAPITALIZATION
The following table sets forth NEON's cash position and total capitalization
at December 31, 1998:
- On an actual basis
- On a pro forma basis to give effect to (a) the conversion of all
outstanding shares of preferred stock into shares of common stock in this
offering and (b) the amendments to NEON's Certificate of Incorporation
which are to be effective immediately prior to the offering increasing the
number of authorized shares of preferred stock and common stock
- On a pro forma as adjusted basis to reflect the sale of 2,636,000 shares
of common stock by NEON in this offering at an initial public offering
price of $15.00 per share and the application of the net proceeds in the
manner described in "Use of Proceeds."
Read the following information in conjunction with NEON's Consolidated
Financial Statements and the Notes thereto beginning on page F-1 of this
prospectus. The following information regarding shares outstanding is as of
December 31, 1998. It includes 3,125,000 shares of common stock to be issued on
conversion of outstanding shares of our preferred stock and excludes 3,729,077
shares of common stock reserved for issuance under our stock plans, of which
1,629,077 shares are subject to outstanding options.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
-------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- ----------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents....................................... $ 4,511 $ 4,511 $ 39,434
--------- ----------- -------------
--------- ----------- -------------
Secured notes payable........................................... $ 1,049 $ 1,049 $ --
Series A Redeemable, Convertible Preferred Stock, $0.01 par
value, 650,000 shares authorized; 625,000 shares issued and
outstanding (actual); none authorized (pro forma or pro forma
as adjusted)................................................... 1,738 -- --
Stockholders' equity:
Preferred stock, $0.01 par value, 10,000,000 shares
authorized; none outstanding (pro forma and pro forma as
adjusted)................................................... -- -- --
Common stock, $0.01 par value, 10,000,000 shares authorized;
2,682,251 shares outstanding (actual); 30,000,000 shares
authorized; 5,807,251 shares outstanding (pro forma);
8,443,251 shares outstanding (pro forma as adjusted)........ 27 58 84
Additional paid-in capital.................................... 3,328 5,035 40,980
Unearned portion of deferred compensation..................... (1,847) (1,847) (1,847)
Retained earnings............................................. 332 332 332
--------- ----------- -------------
Total stockholders' equity.................................. 1,840 3,578 39,550
--------- ----------- -------------
Total capitalization.................................... $ 4,627 $ 4,627 $ 39,550
--------- ----------- -------------
--------- ----------- -------------
</TABLE>
15
<PAGE>
DILUTION
The pro forma net tangible book value of NEON as of December 31, 1998, after
giving effect to the conversion of all outstanding shares of its preferred stock
into common stock prior to this offering, was $2.8 million, or $0.48 per share
of common stock. Pro forma net tangible book value per share represents the
amount of NEON's total tangible assets less total liabilities, divided by the
total number of shares of common stock outstanding on a pro forma basis. The pro
forma net tangible book value of NEON as of December 31, 1998 would have been
$38.8 million, or $4.59 per share after giving effect to the sale of 2,636,000
shares of common stock offered by NEON (at an initial public offering price of
$15.00 per share) and after deduction of the underwriting discounts and
commissions and estimated offering expenses payable by NEON and the application
of the net proceeds from this offering. This represents an immediate increase in
pro forma net tangible book value of $4.11 per share to existing stockholders
and an immediate dilution of $10.41 per share to new investors purchasing shares
of common stock in this offering. The following table illustrates this per share
dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share...................... $ 15.00
Pro forma net tangible book value per share at December 31,
1998....................................................... $ 0.48
Increase in pro forma net tangible book value per share
attributable to new stockholders........................... 4.11
---------
Pro forma net tangible book value per share after offering... 4.59
---------
Dilution per share to new stockholders....................... $ 10.41
---------
---------
</TABLE>
The following table summarizes on a pro forma basis as of December 31, 1998,
the number of shares of common stock purchased from NEON, the total
consideration paid to NEON and the average price per share paid to NEON by
existing stockholders and by the investors purchasing shares of common stock in
this offering, before deducting underwriting discounts and commissions and
estimated offering expenses:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
---------------------- ----------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ----------- ---------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
Existing stockholders............ 5,807,251 68.8% $3,488,869 8.0% $ 0.60
New stockholders................. 2,636,000 31.2 39,540,000 92.0 15.00
--------- ----- ---------- -----
Total.......................... 8,443,251 100.0% $35,156,869 100.0%
--------- ----- ---------- -----
--------- ----- ---------- -----
</TABLE>
In the event that NEON issues additional shares of common stock in the
future, purchasers of common stock in this offering may experience further
dilution.
The foregoing tables assume (1) the issuance of 3,125,000 shares of common
stock upon conversion of outstanding preferred stock prior to this offering and
(2) no exercise of stock options outstanding as of December 31, 1998. Options to
purchase 1,629,077 shares of common stock held by certain of NEON's employees
were outstanding as of December 31, 1998 at a weighted average exercise price of
$2.26 per share. To the extent these options are exercised, new investors will
experience further dilution. See "Management--Stock Plans."
16
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The selected historical consolidated financial data for each of the three
years in the three-year period ended March 31, 1998, and the nine months ended
December 31, 1998 and as of March 31, 1996, 1997 and 1998 and December 31, 1998,
have been derived from the Consolidated Financial Statements of NEON, which have
been audited by KPMG LLP, independent certified public accountants. The selected
historical consolidated financial data for NEON set forth below for the year
ended March 31, 1995 and the nine months ended December 31, 1997, and as of
March 31, 1995 have been derived from unaudited consolidated financial
statements, which include, in the opinion of management, all adjustments,
consisting only of normal recurring adjustments, that NEON considers necessary
for a fair presentation of financial position and results of operations for
those periods and at that date. The results of operations for the nine months
ended December 31, 1998 are not necessarily indicative of results to be expected
for any future period. The information set forth below should be read in
conjunction with the Consolidated Financial Statements and Notes thereto and
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" which are included elsewhere in this prospectus.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEARS ENDED MARCH 31, DECEMBER 31,
------------------------------------------------------------------ ---------------
1995 1996 1997 1998 1997
--------------- --------------- --------------- --------------- ---------------
STATEMENT OF OPERATIONS DATA:
<S> <C> <C> <C> <C> <C>
Revenues:
License............................... $ 261 $ 2,190 $ 6,183 $ 9,806 $ 6,389
Maintenance........................... 59 276 1,003 2,397 1,771
------- ------- ------- ------- -------
Total revenues...................... 320 2,466 7,186 12,203 8,159
Cost of revenues:
Cost of licenses...................... 4 18 212 552 183
Cost of maintenance................... -- 159 392 743 493
------- ------- ------- ------- -------
Total cost of revenues.............. 4 177 604 1,295 676
------- ------- ------- ------- -------
Gross profit............................ 316 2,289 6,582 10,908 7,484
Operating expenses:
Sales and marketing................... 310 1,307 3,469 5,713 3,735
Research and development.............. 738 1,205 1,525 2,258 1,611
General and administrative............ 60 310 696 1,494 1,048
Non-cash compensation................. -- -- -- -- --
------- ------- ------- ------- -------
Total operating expenses............ 1,108 2,822 5,691 9,465 6,394
------- ------- ------- ------- -------
Operating income (loss)................. (792) (532) 891 1,443 1,089
Interest and other, net................. (4) (66) (67) 28 19
------- ------- ------- ------- -------
Income (loss) before provision for
income taxes.......................... (796) (598) 823 1,471 1,108
Provision for income taxes.............. -- -- 7 310 233
------- ------- ------- ------- -------
Net income (loss)....................... (796) (598) 816 1,161 875
------- ------- ------- ------- -------
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 $ 800
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Earnings (loss) per common share (a):
Basic................................. $ (2.10) $ (1.62) $ 0.35 $ 0.45 $ 0.34
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Diluted............................... $ (2.10) $ (1.62) $ 0.14 $ 0.19 $ 0.14
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Shares used in computing earnings (loss)
per common share (a):
Basic................................. 417 417 2,094 2,371 2,341
Diluted............................... 417 417 5,671 6,268 6,238
<CAPTION>
1998
-------------
STATEMENT OF OPERATIONS DATA:
<S> <C>
Revenues:
License............................... $ 10,541
Maintenance........................... 3,294
-------------
Total revenues...................... 13,835
Cost of revenues:
Cost of licenses...................... 661
Cost of maintenance................... 672
-------------
Total cost of revenues.............. 1,334
-------------
Gross profit............................ 12,501
Operating expenses:
Sales and marketing................... 5,318
Research and development.............. 2,706
General and administrative............ 1,701
Non-cash compensation................. 631
-------------
Total operating expenses............ 10,356
-------------
Operating income (loss)................. 2,145
Interest and other, net................. 44
-------------
Income (loss) before provision for
income taxes.......................... 2,189
Provision for income taxes.............. 825
-------------
Net income (loss)....................... 1,364
-------------
Dividends on series A redeemable,
convertible preferred stock........... (75)
-------------
Net income (loss) applicable to common
stockholders.......................... $ 1,289
-------------
-------------
Earnings (loss) per common share (a):
Basic................................. $ 0.49
-------------
-------------
Diluted............................... $ 0.20
-------------
-------------
Shares used in computing earnings (loss)
per common share (a):
Basic................................. 2,608
Diluted............................... 6,934
</TABLE>
<TABLE>
<CAPTION>
AS OF MARCH 31,
------------------------------------------------------------------
1995 1996 1997 1998
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................. $ 291 $ 131 $ 1,705 $ 2,804
Working capital (deficit)................. (530) 47 876 973
Total assets.............................. 376 730 3,093 6,352
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)
<CAPTION>
AS OF
DECEMBER 31,
1998
-------------
<S> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................. $ 4,511
Working capital (deficit)................. 3,004
Total assets.............................. 9,902
Secured notes payable..................... 1,049
Series A redeemable, convertible preferred
stock................................... 1,738
Total stockholders' equity (deficit)...... 1,840
</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.
17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO APPEARING ELSEWHERE IN
THIS PROSPECTUS.
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 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. 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
$12.2 million in fiscal 1998. NEON's revenues increased $5.7 million, or 70%,
from $8.2 million for the nine months ended December 31, 1997 to $13.8 million
for the nine months ended December 31, 1998. 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 and 1998 and the
nine months ended December 31, 1998, maintenance revenues represented 11%, 14%,
20% and 24% 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 licenses and recognizes license revenues 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 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. In
18
<PAGE>
regards to these foreign operations, NEON is exposed to foreign currency
fluctuations for its net working capital positions. At December 31, 1998, NEON
had unhedged net current assets denominated in British pounds aggregating
545,222 British pounds and unhedged net current liabilities denominated in
Deutsche marks aggregating 376,564 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 27% in fiscal 1996, 1997 and 1998 and the nine
months ended December 31, 1998, 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 from the level experienced in the nine-month period
ended December 31, 1998.
19
<PAGE>
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>
NINE MONTHS
ENDED
YEARS ENDED MARCH 31, DECEMBER 31,
------------------------------------- -----------------
1995 1996 1997 1998 1997 1998
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Revenues:
License......................................... 81.6% 88.8% 86.0% 80.4% 78.3% 76.2%
Maintenance..................................... 18.4 11.2 14.0 19.6 21.7 23.8
------- ------- ------- ------- ------- -------
Total revenues................................ 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenues:
Cost of licenses................................ 1.3 0.7 2.9 4.5 2.2 4.8
Cost of maintenance............................. -- 6.4 5.5 6.1 6.0 4.9
------- ------- ------- ------- ------- -------
Total cost of revenues........................ 1.3 7.1 8.4 10.6 8.3 9.6
------- ------- ------- ------- ------- -------
Gross profit...................................... 98.7 92.9 91.6 89.4 91.7 90.4
Operating expenses:
Sales and marketing............................. 96.9 53.0 48.3 46.8 45.8 38.4
Research and development........................ 230.6 48.9 21.2 18.5 19.7 19.6
General and administrative...................... 18.8 12.6 9.7 12.2 12.9 12.3
Non-cash compensation........................... -- -- -- -- -- 4.6
------- ------- ------- ------- ------- -------
Total operating expenses...................... 346.3 114.4 79.2 77.6 78.4 74.9
------- ------- ------- ------- ------- -------
Operating income (loss)........................... (247.5) (21.6) 12.4 11.8 13.4 15.5
Interest and other, net........................... (1.3) (2.7) (0.9) 0.2 0.2 0.3
------- ------- ------- ------- ------- -------
Income (loss) before provision for income taxes... (248.8) (24.3) 11.5 12.1 13.6 15.8
Provision for income taxes........................ -- -- 0.1 2.5 2.9 6.0
------- ------- ------- ------- ------- -------
Net income (loss)................................. (248.8)% (24.3)% 11.4% 9.5% 10.7% 9.9%
------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- -------
</TABLE>
NINE MONTHS ENDED DECEMBER 31, 1997 COMPARED TO NINE MONTHS ENDED DECEMBER 31,
1998
REVENUES
TOTAL REVENUES. NEON's revenues increased 70% from $8.2 million for the
nine months ended December 31, 1997 to $13.8 million for the nine months ended
December 31, 1998. One customer accounted for 16% of total revenues in the nine
months ended December 31, 1998, but no customer accounted for more than 10% of
total revenues in the nine months ended December 31, 1997.
LICENSE. License revenues increased 65% from $6.4 million for the nine
months ended December 31, 1997 to $10.5 million for the nine months ended
December 31, 1998. This increase resulted primarily from a $3.8 million increase
in license sales of NEON's Shadow products and a $552,000 increase in license
sales of Enterprise Subsystem Management products. In addition, this increase
resulted primarily from a $3.9 million increase attributed to a greater number
of license sales of existing products and a $262,000 increase due to modest
sales price increases.
MAINTENANCE. Maintenance revenues increased 86% from $1.8 million for the
nine months ended December 31, 1997 to $3.3 million for the nine months ended
December 31, 1998. This increase resulted from an $872,000 increase in first
years' maintenance revenues recognized in association with
20
<PAGE>
new license sales and, to a lesser extent, from a $599,000 increase 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 increased 261% from $183,000, or
3% of license revenues, for the nine months ended December 31, 1997 to $662,000,
or 6% of license revenues, for the nine months ended December 31, 1998. The
dollar and percentage increases in the cost of license revenues were primarily
attributable to increased shipments of new Enterprise Subsystem Management
products sold by NEON under the terms of its distributor agreement with
Peregrine/Bridge Transfer Corporation. See "Business--Peregrine/Bridge Transfer
Corporation Relationship."
COST OF MAINTENANCE. Cost of maintenance revenues includes personnel and
other costs related to NEON's customer support department. Cost of maintenance
revenues increased 37% from $492,000, or 28% of maintenance revenues, for the
nine months ended December 31, 1997 to $672,000, or 20% of maintenance revenues,
for the nine months ended December 31, 1998. 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. 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. These expenses increased 42% from $3.7 million, or 46% of
total revenues, for the nine months ended December 31, 1997 to $5.3 million, or
38% of total revenues, for the nine months ended December 31, 1998. The dollar
increase reflects a $568,000 increase in expenses due to the establishment of
NEON's sales office in Germany and the hiring of additional personnel in NEON's
United Kingdom sales office. This dollar increase also reflects a $900,000
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. 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 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 nine months ended December 31, 1998.
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 68% from $1.6 million, or 20% of total revenues, for the nine months
ended December 31, 1997 to $2.7 million, or 20% of total revenues, for the nine
months ended December 31, 1998. The dollar and percentage increases resulted
primarily from a $739,000 increase in recruitment and compensation costs due to
increased staffing and, to a lesser extent, from increased product commissions
paid to product authors. NEON
21
<PAGE>
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 nine months ended December 31, 1998. 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 increased 62% from
$1.0 million, or 13% of total revenues, for the nine months ended December 31,
1997 to $1.7 million, or 12% of total revenues, for the nine months ended
December 31, 1998. This dollar increase resulted primarily from a $320,000
increase in office and administrative costs associated with NEON's newly
established subsidiaries in the United Kingdom and Germany, a $140,000 increase
in occupancy costs and a $179,000 increase in compensation expense 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 nine-months ended December
31, 1998.
NONCASH COMPENSATION. During the nine months ended December 31, 1998 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 vesting period
of the granted options. During the nine months ended December 31, 1998 $631,000
was recognized as a noncash compensation expense. The remaining differential of
$1.9 million will be recognized over the remaining vesting period of the granted
options.
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 21% and 38% for the nine months ended December 31, 1997 and 1998,
respectively.
FISCAL YEARS ENDED MARCH 31, 1996, 1997 AND 1998
REVENUES
TOTAL REVENUES. Total revenues were $2.5 million, $7.2 million and $12.2
million in fiscal 1996, 1997 and 1998, respectively, representing increases of
191% from fiscal 1996 to fiscal 1997 and 70% from fiscal 1997 to fiscal 1998. No
customer accounted for more than 10% of NEON's total revenues in fiscal 1996,
1997 or 1998.
LICENSE. License revenues were $2.2 million, $6.2 million and $9.8 million
in fiscal 1996, 1997 and 1998, respectively, representing increases of 182% from
fiscal 1996 to fiscal 1997 and 59% from fiscal 1997 to fiscal 1998. The dollar
increase from fiscal 1996 to fiscal 1997 was due primarily to a $3.6 million
increase in license revenues attributable to the increase in the number of
license sales of NEON's existing Shadow products, and to a lesser extent, a
$143,000 increase due to modest product price increases and a $204,000 increase
due to license sales of a new product. The dollar increase from fiscal 1997 to
fiscal 1998 was due to a $2.8 million increase in license revenues attributable
to the increase in the number of license sales of existing products and an
$803,000 increase attributable to sales of newly introduced Enterprise Subsystem
Management products. There were no product price increases during this period.
MAINTENANCE. Maintenance revenues were $275,000, $1.0 million and $2.4
million in fiscal 1996, 1997 and 1998, respectively, representing increases of
264% from fiscal 1996 to fiscal 1997 and 139%
22
<PAGE>
from fiscal 1997 to fiscal 1998. These dollar increases resulted from renewals
of maintenance agreements from NEON's installed base of customers and the
recognition of deferred first-year maintenance service fees.
COST OF REVENUES
COST OF LICENSES. Cost of license revenues was $18,000, $212,000 and
$552,000 in fiscal 1996, 1997 and 1998, respectively, representing 1%, 3% and 6%
of total license revenues in the respective periods. The dollar and percentage
increases in fiscal 1997 and 1998 were due primarily to increased sales of
Enterprise Subsystem Management products, resulting in increased royalties paid
to Peregrine/Bridge Transfer Corporation under NEON's distributor agreement with
Peregrine/Bridge Transfer Corporation.
COST OF MAINTENANCE. Cost of maintenance revenues was $159,000, $392,000
and $743,000 in fiscal 1996, 1997 and 1998, respectively, representing 58%, 39%
and 31% 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.
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing expenses were $1.3 million, $3.5
million and $5.7 million in fiscal 1996, 1997 and 1998, respectively,
representing 53%, 48% and 47% of total revenues in the respective periods. The
dollar increase from fiscal 1996 to 1997 resulted primarily from a $1.8 million
increase in compensation costs due principally to the hiring of additional sales
personnel and to higher commissions paid as a result of NEON's revenue growth.
The dollar increase from fiscal 1997 to fiscal 1998 resulted primarily from a
$1.3 million increase in costs associated with the recently established sales
offices in the United Kingdom and Germany, as well as a $793,000 increase in
compensation costs due to the hiring of additional sales personnel and increased
commissions paid as a result of NEON's revenue growth.
RESEARCH AND DEVELOPMENT. Research and development expenses were $1.2
million, $1.5 million and $2.3 million in fiscal 1996, 1997 and 1998,
respectively, representing 49%, 21% 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 increased product
commissions paid to product authors.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were
$310,000, $696,000 and $1.5 million in fiscal 1996, 1997 and 1998, respectively,
representing 13%, 10% and 12% of total revenues in the respective periods. The
dollar increase in fiscal 1996 to fiscal 1997 resulted primarily from increased
occupancy and support costs. The dollar increase from fiscal 1997 to fiscal 1998
resulted primarily from a $400,000 increase in office and administrative costs
associated with the recently established sales offices in the United Kingdom and
Germany.
PROVISION FOR INCOME TAXES. NEON fully utilized its net operating loss
carryforward 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% for fiscal 1998.
23
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited consolidated statements of
operations data for the 10 quarters ended December 31, 1998, as well as the
percentage of NEON's revenues represented by each item. These data have been
derived from unaudited interim consolidated financial statements prepared on the
same basis as the audited Consolidated Financial Statements contained herein
and, in the opinion of management, include all adjustments, consisting only of
normal recurring adjustments, considered necessary for a fair presentation of
such information when read in conjunction with the Consolidated Financial
Statements and Notes thereto appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
QUARTERS ENDED
-----------------------------------------------------------------------------------------
SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30,
1996 1996 1997 1997 1997 1997 1998 1998 1998
--------- --------- --------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
License............................... $ 1,373 $ 1,864 $ 2,122 $ 1,921 $ 1,861 $ 2,606 $ 3,418 $ 2,923 $ 3,075
Maintenance........................... 187 282 405 451 662 658 626 926 1,061
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Total revenues...................... 1,560 2,146 2,527 2,372 2,523 3,264 4,044 3,849 4,136
Cost of revenues:
Cost of licenses...................... 8 13 183 111 24 48 368 277 251
Cost of maintenance................... 102 99 114 189 149 154 251 200 207
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Total cost of revenues.............. 110 112 297 300 173 202 619 477 458
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Gross profit............................ 1,450 2,034 2,230 2,072 2,350 3,062 3,425 3,372 3,678
Operating expenses:
Sales and marketing................... 562 1,230 1,156 1,092 1,312 1,331 1,978 1,417 1,829
Research and development.............. 372 423 407 493 561 556 647 765 895
General and administrative............ 105 157 346 276 308 466 446 512 524
Non-cash compensation................. -- -- -- -- -- -- -- 413 82
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Total operating expenses............ 1,039 1,810 1,909 1,861 2,181 2,353 3,071 3,107 3,330
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Operating income........................ 411 224 321 210 169 709 354 265 348
Interest and other, net................. (21 ) (17 ) (9 ) (5 ) 0 24 9 (35 ) 50
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Income before provision for income
taxes.................................. 392 207 312 205 169 733 363 230 398
Provision for income taxes.............. -- -- 7 39 40 154 77 85 147
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Net income.............................. $ 392 $ 207 $ 305 $ 166 $ 129 $ 579 $ 286 $ 145 $ 251
--------- --------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- --------- ---------
<CAPTION>
DEC. 31,
1998
---------
<S> <C>
Revenues:
License............................... $ 4,543
Maintenance........................... 1,307
---------
Total revenues...................... 5,850
Cost of revenues:
Cost of licenses...................... 133
Cost of maintenance................... 266
---------
Total cost of revenues.............. 399
---------
Gross profit............................ 5,451
Operating expenses:
Sales and marketing................... 2,072
Research and development.............. 1,046
General and administrative............ 665
Non-cash compensation................. 136
---------
Total operating expenses............ 3,919
---------
Operating income........................ 1,532
Interest and other, net................. 29
---------
Income before provision for income
taxes.................................. 1,561
Provision for income taxes.............. 593
---------
Net income.............................. $ 968
---------
---------
</TABLE>
<TABLE>
<CAPTION>
AS A PERCENTAGE OF TOTAL REVENUES
----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
License............................... 88.0% 86.9% 84.0% 81.0% 73.8% 79.8% 84.5%
Maintenance........................... 12.0 13.1 16.0 19.0 26.2 20.2 15.5
----- ----- ----- ----- ----- ----- -----
Total revenues...................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- ----- ----- -----
Cost of revenues:
Cost of licenses...................... 0.5 0.6 7.2 4.7 1.0 1.5 9.1
Cost of maintenance................... 6.5 4.6 4.5 8.0 6.0 4.7 6.2
----- ----- ----- ----- ----- ----- -----
Total cost of revenues.............. 7.0 5.2 11.8 12.6 6.9 6.2 15.3
----- ----- ----- ----- ----- ----- -----
Gross profit............................ 92.9 94.8 88.2 87.4 93.1 93.8 84.7
Operating expenses:.....................
Sales and marketing................... 36.0 57.3 45.7 46.0 52.0 40.8 48.9
Research and development.............. 23.8 19.7 16.1 20.8 22.2 17.0 16.0
General and administrative............ 6.7 7.3 13.7 11.6 12.2 14.3 11.0
Non-cash compensation................. -- -- -- -- -- -- --
----- ----- ----- ----- ----- ----- -----
Total operating expenses............ 66.6 84.3 75.5 78.5 86.4 72.1 75.9
----- ----- ----- ----- ----- ----- -----
Operating income........................ 26.3 10.4 12.7 8.9 6.7 21.7 8.8
Interest and other, net................. (1.3) (0.8) (0.4) (0.2) 0.0 0.7 0.2
----- ----- ----- ----- ----- ----- -----
Income before provision for income
taxes.................................. 25.1 9.6 12.3 8.6 6.7 22.5 9.0
Provision for income taxes.............. -- -- 0.3 1.6 1.6 4.7 1.9
----- ----- ----- ----- ----- ----- -----
Net income.............................. 25.1% 9.6% 12.1% 7.0% 5.1% 17.7% 7.1%
----- ----- ----- ----- ----- ----- -----
----- ----- ----- ----- ----- ----- -----
<CAPTION>
<S> <C> <C> <C>
Revenues:
License............................... 75.9% 74.3% 77.7%
Maintenance........................... 24.1 25.7 22.3
----- ----- -----
Total revenues...................... 100.0 100.0 100.0
----- ----- -----
Cost of revenues:
Cost of licenses...................... 7.2 6.1 2.3
Cost of maintenance................... 5.2 5.0 4.5
----- ----- -----
Total cost of revenues.............. 12.4 11.1 6.8
----- ----- -----
Gross profit............................ 87.6 88.9 93.2
Operating expenses:.....................
Sales and marketing................... 36.8 44.2 35.4
Research and development.............. 19.9 21.6 17.9
General and administrative............ 13.3 12.7 11.4
Non-cash compensation................. 10.7 2.0 2.3
----- ----- -----
Total operating expenses............ 80.7 80.5 67.0
----- ----- -----
Operating income........................ 6.9 8.4 26.2
Interest and other, net................. (0.9) 1.2 0.5
----- ----- -----
Income before provision for income
taxes.................................. 6.0 9.6 26.7
Provision for income taxes.............. 2.2 3.6 10.1
----- ----- -----
Net income.............................. 3.8% 6.1% 16.5%
----- ----- -----
----- ----- -----
</TABLE>
24
<PAGE>
NEON's quarterly operating results are subject to certain seasonal
fluctuations. Historically, NEON's license revenues have tended to be strongest
in the third and fourth quarters of its fiscal year and to decrease slightly in
its first fiscal quarter. NEON believes this seasonality is due to the calendar
year budgeting cycles of many of its customers, NEON's employee recognition
policies which tend to reward its sales personnel for achieving fiscal year-end
rather than quarterly revenue quotas and the timing of its hiring of sales force
personnel. In future periods, NEON expects that this seasonal trend will
continue to cause first fiscal quarter license revenues to decrease from the
level achieved in the preceding quarter. NEON believes that its quarterly
revenues, expenses and operating results are likely to vary significantly in the
future, that period-to-period comparisons should not be relied upon as
indications of future performance. See "Risk Factors--Because Our Expenses are
Largely Fixed, an Unexpected Revenue Shortfall May Adversely Affect Our
Business" and "--Seasonal Trends in Sales of Our Products May Affect Investors'
Expectations Regarding Our Financial Performance and Adversely Affect Our Stock
Price."
LIQUIDITY AND CAPITAL RESOURCES
NEON's cash and cash equivalent balance increased to $4.5 million at
December 31, 1998 from $2.8 million at March 31, 1998. This increase was due
primarily to positive cash flows from operating activities. Net cash used by
operating activities was $566,000 in fiscal 1996, and net cash provided by
operating activities was $1.9 million, $1.3 million and $1.8 million in fiscal
1997 and 1998 and the nine months ended December 31, 1998, respectively. Net
cash provided by operating activities during fiscal 1997 and 1998 and the nine
months ended December 31, 1998 was primarily the result of operating
profitability.
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 $74,000, $306,000,
$276,000 and $216,000 in fiscal 1996, 1997 and 1998 and the nine months ended
December 31, 1998, respectively, principally for purchases of property and
equipment, including computer hardware and software to support NEON's growing
employee base. As of December 31, 1998, NEON had no material commitment for
capital expenditures.
NEON's net cash provided by financing activities was $480,000, $2,000,
$28,000 and $144,000 in fiscal 1996, 1997 and 1998 and the nine months ended
December 31, 1998, respectively. Net cash provided by financing activities in
fiscal 1996 consisted of the proceeds received from the issuance of convertible
promissory notes. The cash provided by financing activities in periods
subsequent to fiscal 1996 were from amounts received from the exercise of
employee stock options.
Since November 1995, NEON has financed its working capital requirements and
capital expenditures from internally generated cash flows from operations. From
its inception in May 1993 through November 1995, NEON received an aggregate of
$2.2 million from financing activities through the sale of preferred stock and
convertible promissory notes. Effective March 31, 1997, NEON amended and
consolidated three original notes dated September 29, 1994, March 30, 1995 and
November 22, 1995. Accrued interest of approximately $169,000 was converted to
principal and $250,000 of principal was converted into 125,000 shares of NEON's
Series A Redeemable, Convertible Preferred Stock. The new note in the amount of
approximately $1.0 million is due March 31, 1999 and accrues interest at eight
percent per annum, payable quarterly.
NEON believes that the net proceeds from the sale of the common stock
offered by it hereby, together with its current cash balances and 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.
25
<PAGE>
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, 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 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.
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
December 31, 1998, any disgorgement pursuant to the lawsuit would not exceed
$1.8 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. See
"Business--Legal Proceedings."
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:
- 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 these 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
26
<PAGE>
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 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 assurances 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
operation.
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 is currently developing contingency plans to be
implemented as part of its efforts to identify and correct Year 2000 Problems
affecting its internal systems. NEON expects to complete its contingency plans
by March 31, 1999. Depending on the systems affected, these plans could include:
- Accelerated replacement of affected equipment or software
- Short to medium-term use of backup 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
27
<PAGE>
- 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 condition or results of operations
In calendar year 1998, NEON incurred less than $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 calendar year
1999.
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.
28
<PAGE>
BUSINESS
OVERVIEW
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. 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 flows 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. 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
29
<PAGE>
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, 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.
Due to 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
30
<PAGE>
products in deploying new 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.
- 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, which results 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 markets and sells a suite of
subsystem management software products referred to as Enterprise Subsystem
Management software. 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. In addition, the number of
potential users accessing the mainframe may increase substantially, and its
workload may fluctuate dramatically. 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.
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
31
<PAGE>
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 200 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 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.
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.
32
<PAGE>
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, server and 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 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.
33
<PAGE>
The following graphic depicts the Enterprise Access and Integration
Architecture:
[Schematic depicting NEON's Enterprise Access and Integration architecture.
The graphic sets forth line items for Shadow Client, Shadow Connection, Shadow
Management/Run-Time, Shadow Access and a bottom line item styled "Data and
Applications." At the top of the schematic are three categories styled Internet,
Client/Server and N-Tier depicting the relationship between the product
architecture and the capabilities for enterprise access and integration.]
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 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 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 ACCESS. Shadow Access integrates and supports a series of plug-in
modules for access to data and transactional sources. Organizations 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 markets these products through its
distributor agreement with Peregrine/Bridge Transfer Corporation.
34
<PAGE>
NEON provides five 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.
CUSTOMERS
NEON's customer base spans major industries, including automobile,
manufacturing, energy, banking, financial services, publishing, engineering and
retail. The following is a representative list of NEON's customers that have
purchased at least $100,000 in licensed software and first year maintenance
services since April 1, 1996. One customer accounted for 16% of total revenues
in the nine months ended December 31, 1998.
Allied Dunbar Assurance
Allied Signal
American Express Travel
American Transtech
Avon Products
BASF Computer Services
Blue Cross Blue Shield of
Minnesota
Boeing
Cendant
Consumers Energy
Dayton Hudson
Delta Technology
Deutsche Bank
Duke University Medical
Center
Foundation Health Systems
HM Land Registry
Hyundai Heavy Industries
J. Sainsbury Group
Marks & Spencer
Merrill Lynch
Metro MGI Informatic
Motorola
National Institutes of Health
National Westminster Bank
Norwest Services
Norwich Union Life
Office Depot
Qantas
Reynolds Metals
Royal Bank of Canada
Sears
Severn Trent Systems
Skandia
St. George Bank
State of Illinois
Texaco
Texas Legislative Council
Texas Workforce Commission
Trygg Hansa
U.S. Department of Defense
U.S. Postal Service
Unipart Information Technology
VW Gedas (U.K.)
Wells Fargo Bank
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.
CUSTOMER CASE STUDIES
The following examples illustrate how some of NEON's customers are using
Shadow products to provide rapid, cost-effective access to and connectivity
between enterprise data, transactions and applications. There can be no
assurance that new or existing customers will achieve any or all of the benefits
described below.
SKANDIA
Skandia, headquartered in Sweden, provides worldwide insurance and financial
services to individuals, businesses and the public sector. Skandia employs over
10,000 people.
CHALLENGE. With most of Skandia's data and applications residing on
mainframe systems, Skandia's Information Technology Internet Group was given the
task of integrating those systems with several new Web-based applications. One
application was to provide call center personnel with in-depth information on
customers as they called in, allowing them to respond more quickly and
accurately to
35
<PAGE>
customer inquiries and improve customer satisfaction. On a technical level, this
application was required to integrate with Skandia's telephone systems and call
center software, to provide call center personnel with a complete and updated
profile of the customers before speaking with them over the phone.
RESULT. The initial Web-based application was designed, developed and
integrated with Shadow Web Server in less than two days. Skandia was able to
implement the application on an enterprise-wide basis within nine man-weeks.
Through a browser interface, the application prompts a call center worker for a
customer number, which identifies the customer and provides access to the
appropriate customer records residing on a mainframe. The application contains a
combination of textual information, graphics and links to mainframe-based data,
allowing the call center representative to obtain specific information about the
customer. The Shadow solution provided the high level of security, manageability
and performance required for a distributed Web-based application while
leveraging the benefits of Skandia's mainframe environment. The result was a
significant improvement in customer satisfaction.
TEXACO
Texaco Inc. is one of the world's largest companies principally engaged in
the worldwide exploration for and production, transportation, refining and
marketing of petroleum products.
CHALLENGE. Transporting natural gas from the wellhead to the consumer
requires a cooperative effort among producers, pipeline operators, regional and
local distribution companies and other members of the supply chain.
Historically, it also required the generation and manual processing of paper
documents which accompanied virtually every step of the production, distribution
and billing process. Texaco wanted to replace this process with a Web-based
solution to reduce processing cost, improve the accuracy of data and, more
fundamentally, to improve the integration between the members of its natural gas
supply chain.
RESULT. Shadow Web Server provided the needed access between Texaco's
mainframe environment and the Internet, enabling Texaco to provide an integrated
supply chain solution and a more efficient process for the distribution of
natural gas. The application has saved countless hours of re-keying of
information, produced significant cost savings and substantially improved the
accuracy of transaction data.
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
36
<PAGE>
organization from 21 to 31 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 December 31, 1998, NEON had 11 distributors covering 16
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.
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 relationships 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 recently developed marketing
relationships with BEA Systems, IBM, Microsoft and Netscape. 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. 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
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
37
<PAGE>
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.
Specifically, NEON is currently developing a Shadow product that will simplify
the maintenance of passwords between Microsoft's SNA/Servers and mainframes. In
addition, NEON is continuing to enhance its existing Shadow product line to
include support for the Object Linking and Embedding database, a connectivity
standard used in connecting Windows operating systems to databases, and to
provide a Web-browser-based management interface.
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 its
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, non-transferable 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.
Peregrine/Bridge Transfer Corporation currently employs 12 developers with an
average of 21 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. 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. See
"--Legal Proceedings" and "Certain Transactions--Peregrine/Bridge Transfer
Corporation Agreements."
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
38
<PAGE>
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 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. In addition, NEON
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 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 acknowledgements 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, 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." We are currently opposing in the U.S.
Patent and Trademark Office New Era of Network's 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 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. 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. 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, New Era of Network's use of the
39
<PAGE>
"NEON" symbol on the Nasdaq National Market may create confusion in the
marketplace and result in variations in our 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 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 December 31, 1998, NEON and its subsidiaries employed 77 persons,
including 41 in sales, marketing and field operations, 15 in research and
development, 11 in finance and administration and 10 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. 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.
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, 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
40
<PAGE>
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 December
31, 1998, any disgorgement would not exceed $1.8 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. See "Certain
Transactions--Peregrine/Bridge Transfer Corporation Agreements."
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 would be reasonably likely to have a
material adverse effect on NEON's liquidity and results of operations.
We have 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." See "--Proprietary Rights."
41
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information concerning the executive
officers and directors of NEON as of February 28, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION
<S> <C> <C>
John J. Moores (a)........................ 54 Chairman of the Board of Directors
President, Chief Executive Officer and
Joe Backer................................ 61 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......................... 47 Vice President and General Counsel
Jonathan J. Reed.......................... 42 Vice President of Marketing
Charles E. Noell III (a)(b)............... 48 Director
Norris van den Berg (a)(b)................ 60 Director
Richard Holcomb (a)....................... 36 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, 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 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. 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
42
<PAGE>
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 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, 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 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, 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 a M.S. in Computer Science from North Carolina State
University.
43
<PAGE>
BOARD OF DIRECTORS AND COMMITTEES
Following the offering, NEON's Board of Directors will consist of seven
directors divided into three classes with each class serving for a term of three
years. At each annual meeting of stockholders, directors will be elected by the
holders of the common stock to succeed those directors whose terms are expiring.
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.
The Board of Directors has created a Compensation Committee and an Audit
Committee. The Compensation Committee makes recommendations to the Board of
Directors concerning salaries and incentive compensation for NEON's officers and
employees and administers NEON's 1993 Stock Plan, the 1999 Long-Term Incentive
Plan and the Stock Option Plan for Non-Employee Directors. The members of the
Compensation Committee are Messrs. Holcomb, Moores, Noell and van den Berg
(chairman). The Audit Committee makes recommendations to the Board of Directors
regarding the selection of independent auditors, reviews the results and scope
of audits and other accounting-related services and reviews and evaluates NEON's
internal control functions. The members of the Audit Committee are Messrs. Noell
(chairman) and van den Berg.
DIRECTORS' COMPENSATION
During fiscal 1998, NEON's outside directors were not compensated for
serving as members of NEON's Board of Directors, and NEON expects that such
policy will not change in fiscal 1999, except that outside directors
subsequently joining the Board of Directors will receive option grants under the
Stock Option Plan for Non-Employee Directors as described below. Mr. Holcomb
received an option grant of 13,800 shares in fiscal 1998.
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 after the offering 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 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 sooner, 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.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Messrs. Holcomb, Moores, Noell and van den Berg served on NEON's
Compensation Committee during fiscal 1998. These individuals do not serve as
officers or employees of NEON. The following sets forth interlocks involving the
executive officers and directors of NEON. For serving in the capacities
described below, Messrs. Backer and Reiland received options to purchase stock
in Skunkware, Inc. The other directors and executive officers of NEON receive no
fees or other benefits for serving in their respective capacities.
NEON INTERLOCKS WITH PEREGRINE/BRIDGE TRANSFER CORPORATION. Messrs. Backer,
Noell and van den Berg serve as directors of Peregrine/Bridge Transfer
Corporation. Messrs. Backer and Reiland serve as
44
<PAGE>
the Chief Executive Officer and President and the Chief Financial Officer,
respectively, of Peregrine/ Bridge Transfer Corporation. Mr. Webb serves as the
Vice President and General Counsel of Peregrine/ Bridge Transfer Corporation,
for which Mr. Webb receives an annual salary of $460,000 from Peregrine/ Bridge
Transfer Corporation.
A services agreement between NEON and Peregrine/Bridge Transfer Corporation
provides that Peregrine/Bridge Transfer Corporation will pay NEON for general
and administrative services supplied to it by NEON, for the time spent by NEON's
management developing and implementing Peregrine/ Bridge Transfer Corporation's
product development and marketing strategy and for the use of available space in
NEON's offices from time to time. The services agreement is terminable on
30-days' notice by either party. Peregrine/Bridge Transfer Corporation owes NEON
$23,923 per month under the services agreement. For fiscal 1996, 1997 and 1998,
and the nine months ended December 31, 1998, $41,769, $257,076, $287,076 and
$215,307, respectively, was owed by Peregrine/Bridge Transfer Corporation to
NEON under this arrangement. The scope of and charge for such services were
determined pursuant to negotiations between officers of NEON and the
non-employee directors of Peregrine/Bridge Transfer Corporation, and NEON
believes that the fees for the services provided by it to Peregrine/Bridge
Transfer Corporation are no less favorable than those that would be obtained
from an unaffiliated entity in an arm's-length negotiation.
Based upon NEON's experience during the term of the services agreement with
Peregrine/Bridge Transfer Corporation, NEON believes that Messrs. Backer and
Reiland will devote a minimum of 88% of their working time to the business of
NEON and the balance to Peregrine/Bridge Transfer Corporation. In addition, Mr.
Webb, as general counsel to both NEON and Peregrine/Bridge Transfer Corporation,
presently devotes over 90% of his working time to litigation involving both
corporations.
NEON INTERLOCKS WITH SKUNKWARE, INC. Messrs. Backer, Noell, Moores and van
den Berg serve as the directors of Skunkware, Inc., the sole stockholder of
Peregrine/Bridge Transfer Corporation. Mr. Backer also serves as the Chief
Executive Officer and President of Skunkware, Inc.
POTENTIAL CONFLICTS OF INTEREST ARISING FROM INTERLOCKS. Each director and
executive officer of NEON has a duty of loyalty to act in good faith and with a
reasonable belief that what he does is in NEON's best interest. In the event
that NEON has any dealings or agreements with other software or technology
companies for which any officer or director of NEON concurrently serves as an
officer or director, that officer or director may have a conflict of interest.
Any potential conflicts of interest would be resolved by NEON's outside
directors or by shareholder approval when appropriate as required under the
Delaware General Corporation Law.
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. The following table sets forth the compensation
earned by NEON's Chief Executive Officer and the four most highly compensated
executive officers (collectively, the "Named Executive Officers") other than the
Chief Executive Officer during fiscal 1998. The table excludes certain
perquisites and other personal benefits received by a Named Executive Officer
that do not exceed the lesser of $50,000 or 10% of any such officer's salary and
bonus disclosed in the table.
45
<PAGE>
There were no options or stock appreciation rights granted to the Named
Executive Officers during fiscal 1998.
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
-------------------------------------
OTHER ANNUAL
NAME AND PRINCIPAL POSITION SALARY BONUS COMPENSATION
- -------------------------------------------------------- --------- --------- ---------------
<S> <C> <C> <C>
Joe Backer
President and Chief Executive Officer................. $ 130,000 $ 140,602 $ --
Peter Schaeffer
Chief Technology Officer.............................. 100,000 22,188 --
John S. Reiland
Chief Financial Officer............................... 110,000 22,544 --
Don Pate
Vice President--Worldwide Sales....................... 95,833 96,848 --
Jonathan J. Reed
Vice President of Marketing........................... 112,708 12,695 --
</TABLE>
OPTION EXERCISES IN FISCAL 1998 AND MARCH 31, 1998 OPTION VALUES. The
following table sets forth, for each Named Executive Officer, information
concerning option exercises for fiscal 1998 and the number and value of
securities underlying unexercised options held on March 31, 1998. The
calculations of the value realized and of the unexercised in-the-money options
are based on the offering price, less the exercise price payable for such
shares, multiplied by the number of shares issued upon exercise of the option.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
NUMBER OF OPTIONS HELD AT OPTIONS HELD AT
SHARES MARCH 31, 1998 MARCH 31, 1998
ACQUIRED VALUE -------------------------- --------------------------
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---------------------- ------------- --------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Joe Backer............ 22,000 $ 325,600 115,504 137,496 $1,709,459 $ 2,034,941
Peter Schaeffer....... -- -- 395,835 -- 5,858,358 --
John S. Reiland....... 13,189 195,197 -- 39,561 -- 585,503
Don Pate.............. -- -- 13,189 39,561 195,197 585,503
Jonathan J. Reed...... 3,564 52,302 -- 10,686 -- 156,963
</TABLE>
STOCK PLANS
1999 LONG-TERM INCENTIVE PLAN. The 1999 Plan 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. The purpose of the 1999 Plan is to attract and retain
skilled, qualified executives and key employees to motivate them to achieve
long-range goals and to further identify their interests with those of the other
stockholders of NEON.
NEON has reserved 2,000,000 shares of its common stock for issuance under
the 1999 Plan. The 1999 Plan will be administered by the Compensation Committee
of the Board of Directors. The purchase price of common stock issuable upon
exercise of incentive stock options must not be less than the fair market value
of the common stock on the date of grant or, in the case of incentive stock
options issued to holders of more than 10% or greater of the outstanding voting
securities of NEON, 110% of the fair market value on the date of grant. The
maximum term of any incentive stock option is ten years. The aggregate fair
market value on the date of the grant of the stock for which incentive stock
options are exercisable for the first time by an employee during any calendar
year may not exceed $100,000. Eligible product authors selected by the
Compensation Committee may elect to
46
<PAGE>
receive non-qualified stock options for NEON common stock in lieu of a specified
percentage of commissions earned during the year, with the exercise price for
those options to be equal to 50% of the fair market value of the common stock on
the date of the grant. Options are exercisable over a period of time in
accordance with the terms of option agreements entered into at the time of the
grant. Options granted under the 1999 Plan are generally nontransferable by the
optionee and, unless otherwise determined by the Compensation Committee, must be
exercised by the optionee during the period of the optionee's employment with
NEON. In the event of a change in control of NEON or certain other significant
events, all options outstanding under the 1999 Plan shall terminate, unless
otherwise provided by the terms of the transaction, provided that immediately
before the effective date of the transaction each holder of an option under the
1999 Plan shall be entitled to purchase the total number of shares of NEON
common stock that such optionee would have been entitled to purchase during the
entire remaining term of the option.
1993 STOCK PLAN. The 1993 Plan was adopted by NEON's Board of Directors and
approved by the stockholders in May 1993. The 1993 Plan provides for the awards
of incentive stock option and non-qualified stock options to directors, officers
and employees of NEON. The 1993 Plan is administered by the Compensation
Committee of the Board of Directors. There are an aggregate of 2,600,000 shares
reserved for issuance upon exercise of options granted under the 1993 Plan. With
certain exceptions, employee options vest ratably over a four-year period
commencing with the date of grant and expire ten years after the date of grant,
unless terminated earlier as a result of termination of employment. As of
December 31, 1998, there were outstanding under the 1993 Plan options to
purchase an aggregate of 1,629,077 shares of NEON common stock at a weighted
average exercise price of $2.26 per share held by 76 employees and one director.
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.
STOCK OPTION PLAN FOR NON-EMPLOYEE DIRECTORS. Under the Stock Option Plan
for Non-Employee Directors, nonqualified stock options will be granted to
outside directors upon their election to NEON's Board of Directors after this
offering. See "--Directors' Compensation."
401(K) PLAN
NEON has adopted the NEON Systems, Inc. 401(k) Plan. NEON's 401(k) Plan is
available to all employees who have attained age 21 and have completed six
months of service. An employee may contribute, on a pre-tax basis, up to 15% of
the employee's wages from NEON, subject to limitations specified under the
Internal Revenue Code. Under the terms of NEON's 401(k) Plan, NEON may make a
discretionary matching contribution equal to a percentage of the employee's
contribution to the 401(k) Plan determined annually by NEON and a discretionary
amount determined annually by NEON and divided among eligible participants based
upon an employee's annual compensation in relation to the aggregate annual
compensation of all eligible participants. Contributions are allocated to each
employee's individual account and are, at the employee's election, invested in
one, all or some combination of the investment funds available under such 401(k)
plan. Employee contributions are fully vested and non-forfeitable. Employees
will vest in any NEON contributions at the rate of 20% for each year of service
commencing after the second year of service. To date, NEON has not made any
matching contributions under the 401(k) plan.
LIMITATIONS OF LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS
Delaware General Corporation Law and NEON's Certificate of Incorporation
limit the liability of each director of NEON to it or its stockholders for
monetary damages for breach of his fiduciary duty as a director, except for:
- Any breach of the director's duty of loyalty to the corporation or its
stockholders
47
<PAGE>
- Acts or omissions not in good faith or that involve intentional misconduct
or a knowing violation of the law
- Unlawful payments of dividends or unlawful stock repurchases or
redemptions
- Any transaction from which the director derived an improper personal
benefit
NEON's Certificate of Incorporation and Bylaws provide that NEON will
indemnify its directors and officers against expense or liability in an action
to the fullest extent permitted by Delaware law. In addition, NEON is also a
party to indemnification agreements with each of its directors. NEON intends to
maintain directors' and officers' liability insurance.
48
<PAGE>
CERTAIN TRANSACTIONS
PEREGRINE/BRIDGE TRANSFER CORPORATION AGREEMENTS
NEON entered into a distributor agreement with Peregrine/Bridge Transfer
Corporation, a database software company, in January 1996. Under the distributor
agreement, NEON marketed and sublicensed certain Enterprise Subsystem Management
products under a non-exclusive worldwide license from Peregrine/Bridge Transfer
Corporation. The distributor agreement provided that NEON pay license fees for
licensed 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 $421,435 to Peregrine/Bridge Transfer Corporation in fiscal 1997,
1998 and the nine months ended December 31, 1998, respectively. NEON did not pay
any license fees to Peregrine/Bridge Transfer Corporation in fiscal 1996.
In December 1998, NEON and Peregrine/Bridge Transfer Corporation amended the
distributor agreement. The amended agreement grants NEON 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 the
Peregrine/Bridge Transfer Corporation Enterprise Subsystem Management products.
The amended distributor agreement has an initial term through March 31, 2004.
See "Business--Product Development--Peregrine/Bridge Transfer Corporation
Relationship." The amended agreement 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 license fees totaling $10.0 million or
more in any single fiscal year. In addition, beginning April 1, 1999, the
amended agreement provides for NEON to make quarterly advances in respect of
anticipated license fees, with the advances to be in equal quarterly payments
based on annualized license fee amounts of $1.0 million, $2.0 million, $3.0
million, $4.0 million and $5.0 million for fiscal 2000, 2001, 2002, 2003 and
2004, respectively. Following the date, if any, in each quarter when the license
fees earned equal the aggregate amount of quarterly advances outstanding on the
first day of such quarter, the license fee that NEON pays under the agreement
decreases from 50% to 40% of the revenues received by NEON, with the decrease
continuing in effect until the start of the next quarter. Upon any termination
or expiration of the distributor agreement, any advances then outstanding are to
be refunded to NEON by Peregrine/Bridge Transfer Corporation. NEON is a co-
defendant with Peregrine/Bridge Transfer Corporation and other parties in a
lawsuit brought by BMC Software. See "Business--Legal Proceedings."
NEON has a services agreement with Peregrine/Bridge Transfer Corporation
pursuant to which Peregrine/Bridge Transfer Corporation pays NEON for certain
services supplied to it by NEON. See "Compensation Committee Interlocks and
Insider Participation--NEON Interlocks with Peregrine/ Bridge Transfer
Corporation."
Due to the timing of cash payments between the two parties related to the
distributor agreement and the services agreement described in the preceding two
paragraphs, NEON has accounts receivable-related party balances of $138,074,
$181,112 and $82,577 as of March 31, 1997 and 1998 and December 31, 1998,
respectively.
OTHER DIRECTORSHIPS
Members of NEON's Board of Directors also serve as officers or directors of
other software or computing companies such as Peregrine Systems, which supplies
software that automates the management of data such as inventory/configuration
management, order and catalog management and financial management, and Pavilion
Technologies, which supplies software for analysis, control and optimization of
manufacturing assets. NEON, Peregrine Systems and Pavilion Technologies, while
all
49
<PAGE>
software companies, are not sufficiently similar in their operations to be
competitors. Thus, NEON does not believe that the concurrent service of NEON's
directors as officers and/or directors of these entities poses potential
conflicts of interest.
PRIVATE PLACEMENT OF SERIES A REDEEMABLE, CONVERTIBLE PREFERRED STOCK
In May 1993, JMI Equity Fund purchased 500,000 shares of Series A
Redeemable, Convertible Preferred Stock of NEON for aggregate consideration of
$1.0 million. These shares are convertible into 2,500,000 shares of common stock
immediately prior to the completion of this offering. Mr. Moores is a limited
partner of JMI Equity Fund and Messrs. Noell and van den Berg are general
partners of JMI Partners, L.P., which is a general partner of JMI Equity Fund.
In connection with this transaction, JMI Equity Fund, NEON and Mr. Schaeffer
entered into a stockholders agreement setting forth the rights of JMI Equity
Fund and Mr. Schaeffer to elect a specified number of directors of NEON.
Pursuant to this stockholders agreement, Messrs. Holcomb, Moores, Noell and
Schaeffer were elected and currently serve as directors of NEON. The
stockholders agreement between JMI Equity Fund, NEON and Mr. Schaeffer will
terminate upon the closing of the offering.
The shares of common stock issued upon conversion of the Series A
Redeemable, Convertible Preferred Stock are entitled to registration rights. See
"Description of Capital Stock--Registration Rights."
ISSUANCE OF CONVERTIBLE DEBT TO JMI EQUITY FUND
In fiscal 1995 and fiscal 1996, JMI Equity Fund made loans to NEON in
aggregate amounts of $300,000 and $830,000, respectively. These loans bear
interest at the rate of eight percent per annum and were evidenced by secured
convertible promissory notes that provide for the conversion of outstanding
amounts under the notes into shares of NEON's Series A Redeemable, Convertible
Preferred Stock. On March 31, 1997, these notes were amended and the notes,
together with accrued interest of approximately $169,000, were consolidated. At
such time, JMI Equity Fund exercised its right to convert $250,000 of the
indebtedness into 125,000 shares of the Series A Redeemable, Convertible
Preferred Stock and relinquished its rights to convert the balance of the
outstanding indebtedness. Upon completion of the offering, these shares will be
converted into 625,000 shares of NEON's common stock. The new note in the amount
of approximately $1.0 million is due March 31, 1999 and bears interest at eight
percent per annum. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
NEON'S POLICY
NEON believes that all of the transactions set forth above were made on
terms no less favorable to NEON than could have been obtained from unaffiliated
third parties. All future transactions, including loans, between NEON and its
officers, directors, principal stockholders and their affiliates will be
approved by a majority of the Board of Directors, including a majority of the
outside directors on the Board of Directors, and will continue to be on terms no
less favorable to NEON than could be obtained from unaffiliated third parties.
50
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
This table sets forth, as of February 28, 1999, certain information
regarding the beneficial ownership of NEON's outstanding common stock, both
before this offering and immediately following this offering by:
- Each person known by NEON to own beneficially more than five percent of
the outstanding common stock
- Each director and each of the Named Executive Officers of NEON
- The selling stockholder
- All directors and executive officers of NEON as a group
The following calculations of the percentage of outstanding shares are based
on 5,807,251 shares of NEON's common stock outstanding as of February 28, 1999
and 8,443,251 shares outstanding immediately following the completion of this
offering and assumes no exercise of the underwriters' over-allotment option. The
calculation includes 3,125,000 shares of NEON common stock issuable upon
conversion of the outstanding shares of preferred stock immediately prior to the
completion of the offering. Beneficial ownership is determined in accordance
with the rules of the Securities and Exchange Commission and generally includes
voting or investment power with respect to securities, subject to community
property laws, where applicable. Shares of NEON common stock subject to options
that are presently exercisable or exercisable within 60 days of February 28,
1999 are deemed to be outstanding and beneficially owned by the person holding
such options for the purpose of computing the percentage of ownership of such
person but are not treated as outstanding for the purpose of computing the
percentage of any other person.
Unless otherwise noted, each of the persons listed below has sole voting and
investment power with respect to his shares and the address for each of the
persons listed below is: c/o NEON Systems, Inc., 14100 Southwest Freeway, Suite
500, Sugar Land, Texas 77478.
<TABLE>
<CAPTION>
SHARES OWNED PRIOR SHARES OWNED AFTER THE
TO THE OFFERING OFFERING
---------------------- SHARES ----------------------
NUMBER PERCENT OFFERED NUMBER PERCENT
--------- ----------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C>
FIVE PERCENT STOCKHOLDER:
JMI Equity Fund, L.P. (a)............... 3,125,000 53.8% -- 3,125,000 37.0%
DIRECTORS AND OFFICERS:
John J. Moores (b)...................... -- -- -- -- --
Charles E. Noell III (c)................ 3,125,000 53.8 -- 3,125,000 37.0
Norris van den Berg (d)................. 3,125,000 53.8 -- 3,125,000 37.0
Richard Holcomb (e)..................... 13,800 * -- 13,800 *
Joe Backer (f).......................... 221,439 3.7 -- 221,439 2.6
Peter Schaeffer (g)..................... 2,065,835 33.3 -- 2,065,835 23.4
John S. Reiland......................... 26,376 * -- 26,376 *
Don Pate (h)............................ 26,376 * -- 26,376 *
Jonathan J. Reed (i).................... 8,551 * -- 8,551 *
SELLING STOCKHOLDER:
Dean Bobrowski.......................... 183,480 3.2 64,000 119,480 1.4
All executive officers and directors as a
group (10 persons) (j)................... 5,535,157 85.8 -- 5,535,157 60.9
</TABLE>
- --------------------------
* Less than one percent. (FOOTNOTES ON FOLLOWING PAGE)
51
<PAGE>
(a) Includes 3,125,000 shares of common stock issuable upon conversion of
625,000 shares of Series A Redeemable, Convertible Preferred Stock held by
JMI Equity Fund, L.P., which conversion will occur prior to the completion
of the offering. The address of JMI Equity Fund, L.P. is 12680 High Bluff
Drive, San Diego, California 92130.
(b) Excludes 3,125,000 shares issuable upon conversion of 625,000 shares of
Series A Redeemable, Convertible Preferred Stock held by JMI Equity Fund,
L.P., of which Mr. Moores is a limited partner. Mr. Moores does not exercise
voting or dispositive control over the shares held by JMI Equity Fund, L.P.
and disclaims beneficial ownership of all such shares except to the extent
of his pecuniary interest therein.
(c) Includes 3,125,000 shares of common stock issuable upon conversion of
625,000 shares of Series A Redeemable, Convertible Preferred Stock held by
JMI Equity Fund, L.P. Mr. Noell is a general partner of JMI Partners, L.P.,
which is a general partner of JMI Equity Fund, L.P. Mr. Noell disclaims
beneficial ownership of all shares held by JMI Equity Fund, L.P. except to
the extent of his pecuniary interest therein.
(d) Includes 3,125,000 shares of common stock issuable upon conversion of
625,000 shares of Series A Redeemable, Convertible Preferred Stock held by
JMI Equity Fund, L.P. Mr. van den Berg is a general partner of JMI Partners,
L.P., which is a general partner of JMI Equity Fund, L.P. Mr. van den Berg
disclaims beneficial ownership of all shares held by JMI Equity Fund, L.P.
except to the extent of his pecuniary interest therein.
(e) Includes 13,800 shares of common stock issuable upon exercise of outstanding
stock options that are presently exercisable or will become exercisable
within 60 days of February 28, 1999.
(f) Includes 20,000 shares held by John Backer and Kristin Backer, the children
of Mr. Backer, as to which Mr. Backer disclaims beneficial ownership.
Includes 201,439 shares of common stock issuable upon exercise of
outstanding stock options that are presently exercisable or will become
exercisable within 60 days of February 28, 1999.
(g) Includes 395,835 shares of common stock issuable upon exercise of
outstanding stock options that are presently exercisable or will become
exercisable within 60 days of February 28, 1999.
(h) Includes 26,376 shares of common stock issuable upon exercise of outstanding
stock options that are presently exercisable or will become exercisable
within 60 days of February 28, 1999.
(i) Includes 3,206 shares of common stock issuable upon exercise of outstanding
stock options that are presently exercisable or will become exercisable
within 60 days of February 28, 1999.
(j) Includes 640,656 shares of common stock issuable upon exercise of
outstanding stock options that are presently exercisable or will become
exercisable within 60 days of February 28, 1999.
John J. Moores, a director of NEON, has advised NEON that he may acquire, in
his individual capacity and/or in his capacity as a trustee of various trusts,
up to 400,000 shares of NEON's common stock from one or more existing NEON
stockholders, including up to 200,000 shares from Peter Schaeffer, Chief
Technology Officer and a director of NEON. Mr. Moores has advised that he
intends to consummate this purchase immediately before the closing of this
offering for a purchase price per share equal to the net price per share
received by the selling stockholder in the offering.
52
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the closing of this offering NEON's authorized capital stock will
consist of 30,000,000 shares of common stock, $0.01 par value per share, and
10,000,000 shares of preferred stock, $0.01 par value per share, issuable in
series. There will be 5,807,251 shares of NEON common stock outstanding
immediately prior to consummation of the offering, held of record by 54
stockholders, and there will be no shares of preferred stock outstanding.
COMMON STOCK
Holders of NEON common stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. The holders of common stock are
not entitled to cumulate voting rights with respect to the election of
directors, and as a result, minority stockholders will not be able to elect
directors on the basis of their votes alone. Subject to preferences that may be
applicable to any then outstanding shares of preferred stock, holders of common
stock are entitled to receive ratably such dividends as may be declared by the
Board of Directors out of funds legally available therefor. See "Dividend
Policy." In the event of a liquidation, dissolution or winding up of NEON,
holders of the common stock are entitled to share ratably in all assets
remaining after payment of liabilities and the liquidation preference of any
then outstanding preferred stock. Holders of common stock have no preemptive,
conversion or other rights to subscribe for additional securities of NEON. There
are no redemption or sinking fund provisions applicable to the common stock. All
outstanding shares of common stock are, and all shares of common stock to be
outstanding upon completion of the offering will be, validly issued, fully paid
and nonassessable.
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 and restrictions thereof,
including dividend rights, conversion rights, voting 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. The issuance of preferred stock could adversely
affect the voting power of holders of NEON's common stock and the likelihood
that such holders will receive dividend payments and payments upon liquidation
and could have the effect of delaying, deferring or preventing a change in
control of NEON. Accordingly, the issuance of shares of preferred stock may
discourage bids for the common stock or may otherwise adversely affect the
market price of the common stock. NEON has no present plan to issue any shares
of preferred stock.
REGISTRATION RIGHTS
NEON is a party to a registration rights agreement among NEON, Mr. Schaeffer
and JMI Equity Fund. Under the terms of the registration rights agreement, JMI
Equity Fund and Mr. Schaeffer are entitled to registration rights with respect
to the 4,795,000 shares of common stock owned by them, which includes the
3,125,000 shares of common stock to be issued to JMI Equity Fund upon conversion
of the 625,000 shares of preferred stock prior to completion of the offering.
Each time NEON proposes to register any of its securities under the Securities
Act, whether for its own account or for other stockholders, JMI Equity Fund and
Mr. Schaeffer are entitled to have their shares of common stock registered by
NEON as well, unless NEON is registering its securities on Form S-4 or Form S-8.
Additionally, JMI Equity Fund may require NEON to prepare and file two
registration statements under the Securities Act at NEON's expense to register
the shares of common stock held by JMI Equity Fund. JMI Equity Fund may also
require NEON to file additional registration statements on Form S-3 at its
request. All of these registration rights are subject to conditions and
limitations, including the right of the underwriters of an offering to limit the
number of shares included in the
53
<PAGE>
registration and the right of NEON not to effect a requested registration within
90 days after the effective date of a NEON registration statement for a firm
commitment underwritten public offering in which JMI Equity Fund and Mr.
Schaeffer shall have been entitled to register their shares. NEON must pay
expenses related to the registering and distributing of its shares of common
stock held by JMI Equity Fund and Mr. Schaeffer under the registration rights
agreement.
DELAWARE ANTI-TAKEOVER LAW AND CERTAIN CHARTER PROVISIONS
DELAWARE ANTI-TAKEOVER STATUTE. NEON is subject to the provisions of
Section 203 of the Delaware General Corporation Law, an anti-takeover law.
Subject to certain exceptions, the statute prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person became an interested stockholder, unless
- Prior to such date, the board of directors of the corporation approved
either the business combination or the transaction which resulted in the
stockholder becoming an interested stockholder
- Upon consummation of the transaction which resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced, excluding for purposes of determining the
number of shares outstanding those shares owned (x) by persons who are
directors and also officers and (y) by employee stock plans in which
employee participants do not have the right to determine confidentially
whether shares held subject to the plan will be tendered in a tender or
exchange offer or
- On or subsequent to such date, the business combination is approved by the
board of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at
least 66 2/3% of the outstanding voting stock which is not owned by the
interested stockholder
For purposes of Section 203, a "business combination" includes a merger,
asset sale or other transaction resulting in a financial benefit to the
interested stockholder, and an "interested stockholder" is a person who,
together with affiliates and associates, owns (or within three years prior to
the date of determination whether the person is an "Interested Stockholder," did
own) 15% or more of the corporation's voting stock.
CERTIFICATE OF INCORPORATION. On January 19, 1999, NEON's stockholders
approved certain amendments to the Certificate of Incorporation, effective
immediately prior to the consummation of the offering, to provide:
- For the authorization of the board of directors to issue, without further
action by the stockholders, up to 10,000,000 shares of preferred stock in
one or more series and to fix the rights, preferences, privileges and
restrictions thereof
- 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 the board of directors
- For a classified 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
54
<PAGE>
- 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
These provisions are intended to enhance the likelihood of continuity and
stability in the composition of the board of directors and in the policies
formulated by the board of directors and to discourage certain types of
transactions that may involve an actual or threatened change of control of NEON.
These provisions are designed to reduce the vulnerability of NEON to an
unsolicited proposal for a takeover of NEON that does not contemplate the
acquisition of all of its outstanding shares, or an unsolicited proposal for the
restructuring or sale of all or part of NEON. Such provisions, however, could
discourage potential acquisition proposals and could delay or prevent a change
in control of NEON. Such provisions may also have the effect of preventing
changes in the management of NEON. See "Risk Factors--Provisions of Our Charter
and Bylaws and Delaware Law Could Deter Takeover Attempts."
TRANSFER AGENT AND REGISTRAR
NEON's shares of common stock have been approved for quotation on the Nasdaq
National Market under the symbol "NESY." The Transfer Agent and Registrar for
the common stock is ChaseMellon Shareholder Services, L.L.C., and its address is
2323 Bryan Street, Suite 2300, Dallas, Texas 75201.
SHARES ELIGIBLE FOR FUTURE SALE
Prior to the offering, there has been no public market for NEON's common
stock. Upon completion of the offering and assuming no exercise of stock options
after February 28, 1999, there will be an aggregate of 8,443,251 shares of
NEON's common stock outstanding. Of these shares, all of the shares sold in the
offering will be freely transferable without restriction or limitation under the
Securities Act of 1933, as amended, unless purchased by "affiliates" of NEON, as
defined under the Securities Act. The remaining 5,743,251 shares are "restricted
shares" within the meaning of Rule 144 under the Securities Act, and are subject
to restrictions under the Securities Act and the lock-up agreements described
below.
NEON's stockholders and option holders have agreed not to sell, offer for
sale, or otherwise dispose of any NEON common stock for a period of 180 days
from the date of this prospectus without the prior written consent of Donaldson,
Lufkin & Jenrette Securities Corporation. In addition, during the 180-day
period, NEON has agreed not to file any registration statement with respect to
its common stock or any securities convertible into or exercisable or
exchangeable for common stock without the prior written consent of Donaldson,
Lufkin & Jenrette Securities Corporation. Beginning 180 days after the date of
this prospectus, 5,682,166 of the restricted shares will become available for
sale in the public market, subject to the volume and other limitations of Rule
144. JMI Equity Fund and Mr. Schaeffer have certain rights to have 4,795,000
shares registered in the future under the Securities Act pursuant to the terms
of an agreement with NEON. See "Description of Capital Stock-- Registration
Rights."
In general, under Rule 144, as currently in effect, a person (or persons
whose shares are required to be aggregated) who has beneficially owned, for at
least one year, shares of common stock that have not been registered under the
Securities Act or that were acquired from an "affiliate" of NEON is entitled to
sell within any three-month period the number of shares of common stock that
does not exceed the greater of (1) one percent of the number of then outstanding
shares or (2) the average weekly reported trading volume during the four
calendar weeks preceding the sale. Sales under Rule 144 are also subject to
certain notice and manner of sale requirements and to the availability of
current public information about NEON and must be made in unsolicited brokers'
transactions or to a
55
<PAGE>
market maker. A person who is not an "affiliate" of NEON under the Securities
Act during the three months preceding a sale and who has beneficially owned such
shares for at least two years is entitled to sell such shares under Rule 144
without regard to the volume, notice, information and manner of sale provisions
of such rule. Affiliates of NEON must comply with the restrictions and
requirements of Rule 144 when transferring restricted shares even after the two
year holding period has expired and must comply with the restrictions and
requirements of Rule 144 other than the one-year holding period in order to sell
unrestricted shares. Rule 144 does not require the same person to have held the
securities for the applicable periods.
Any employee, officer or director of, or consultant to, NEON who purchased
or was awarded shares or options to purchase shares pursuant to a written
compensatory plan or contract is entitled to rely on the resale provisions of
Rule 701 under the Securities Act, which permits affiliates and non-affiliates
to sell such shares without having to comply with the holding period
restrictions of Rule 144, in each case commencing 90 days after the date of this
prospectus. In addition, non-affiliates may sell such shares without complying
with the public information, volume and notice provisions of Rule 144. Rule 701
is available for option holders of NEON as to all 595,286 shares issued pursuant
to the exercise of options granted prior to this offering.
After the offering, NEON intends to file a registration statement on Form
S-8 to register all of the shares of Common Stock reserved for issuance pursuant
to the 1993 Stock Plan, the 1999 Long-Term Incentive Plan and the Stock Option
Plan for Non-Employee Directors. Accordingly, shares issued upon exercise of
such options will be freely tradeable by holders who are not affiliates of NEON
and, subject to the volume and other limitations of Rule 144, by holders who are
affiliates of NEON.
Prior to the offering, there has been no market for the NEON common stock.
No predictions can be made of the effect, if any, that market sales of shares of
common stock or the availability of such shares for sale will have on the market
price prevailing from time to time. Nevertheless, sales of significant amounts
of NEON's common stock could adversely affect the prevailing market price of the
common stock, as well as impair the ability of NEON to raise capital through the
issuance of additional equity securities. See "Risk Factors--Availability of
Significant Amounts of Common Stock for Sale Could Adversely Affect Its Market
Price and the Absence of an Active Public Market for Our Common Stock May Make
It Difficult for You to Resell Your Shares At or Above the Offering Price."
56
<PAGE>
UNDERWRITING
Subject to the terms and conditions contained in an underwriting agreement
dated March 5, 1999, the underwriters named below, who are represented by
Donaldson, Lufkin & Jenrette Securities Corporation, Hambrecht & Quist LLC and
CIBC Oppenheimer Corp., have severally agreed to purchase from NEON and the
selling stockholder the respective number of shares of common stock set forth
opposite their names below.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS: SHARES
<S> <C>
Donaldson, Lufkin & Jenrette Securities................................... 986,625
Hambrecht & Quist......................................................... 657,750
CIBC Oppenheimer.......................................................... 548,125
BancBoston Robertson Stephens............................................. 35,000
Bear, Stearns & Co. Inc................................................... 35,000
BT Alex. Brown............................................................ 35,000
Lehman Brothers Inc....................................................... 35,000
Warburg Dillon Read LLC................................................... 35,000
SG Cowen Securities Corporation........................................... 35,000
Chatsworth Securities, LLC................................................ 17,500
Gerard Klauer Mattison & Co., LLC......................................... 17,500
Gruntal & Co., L.L.C...................................................... 17,500
Harris Webb & Garrison, Inc............................................... 17,500
Hoak Breedlove Wesneski & Co.............................................. 17,500
C.L. King & Associates.................................................... 17,500
Legg Mason Wood Walker, Incorporated...................................... 17,500
McDonald Investments Inc., a KeyCorp Company.............................. 17,500
Needham & Company, Inc.................................................... 17,500
Pennsylvania Merchant Group............................................... 17,500
Piper Jaffray Inc......................................................... 17,500
Redwine & Company, Inc.................................................... 17,500
Sanders Morris Mundy...................................................... 17,500
Sands Brothers & Co., Ltd................................................. 17,500
SoundView Technology Group, Inc........................................... 17,500
Southwest Securities, Inc................................................. 17,500
C.E. Unterberg, Towbin.................................................... 17,500
-----------
Total..................................................................... 2,700,000
-----------
-----------
</TABLE>
The underwriting agreement provides that the obligations of the several
underwriters to purchase and accept delivery of the shares of common stock
offered hereby are subject to approval by their counsel of certain legal matters
and to certain other conditions. The underwriters are obligated to purchase and
accept delivery of all the shares of common stock offered hereby (other than
those shares covered by the over-allotment option described below) if any are
purchased.
The underwriters initially propose to offer the shares of NEON common stock
in part directly to the public at the initial public offering price set forth on
the cover page of this prospectus and in part to certain dealers (including the
underwriters) at such price less a concession not in excess of $0.63 per share.
The underwriters may allow, and such dealers may re-allow, to certain other
dealers a concession not in excess of $0.10 per share. After the initial
offering of the common stock, the public offering price and other selling terms
may be changed by the representatives of the underwriters at any time without
notice. The underwriters do not intend to confirm sales to any accounts over
which they exercise discretionary authority.
57
<PAGE>
DLJDIRECT Inc., an affiliate of Donaldson, Lufkin & Jenrette Securities
Corporation and a member of the selling group, is facilitating the distribution
of the shares sold in the offering over the Internet. The underwriters have
agreed to allocate a limited number of shares to DLJDIRECT Inc. for sale to
brokerage account holders.
NEON has granted to the underwriters an option, exercisable within 30 days
after the date of this prospectus, to purchase, from time to time, in whole or
in part, up to an aggregate of 405,000 additional shares of common stock at the
initial public offering price less underwriting discounts and commissions. The
underwriters may exercise such option solely to cover overallotments, if any,
made in connection with the offering. To the extent that the underwriters
exercise such option, each underwriter will become obligated, subject to certain
conditions, to purchase its pro rata portion of such additional shares based on
such underwriter's percentage underwriting commitment as indicated in the
preceding table.
NEON and the selling stockholder have agreed to indemnify the underwriters
against certain liabilities, including liabilities under the Securities Act, or
to contribute to payments that the underwriters may be required to make in
respect thereof.
Each of NEON, its executive officers, directors, stockholders and option
holders have agreed, subject to certain exceptions, not to
- Offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option, right
or warrant to purchase or otherwise transfer or dispose of, directly or
indirectly, any shares of common stock or any securities convertible into
or exercisable or exchangeable for common stock or
- Enter into any swap or other arrangement that transfers all or a portion
of the economic consequences associated with the ownership of any common
stock
for a period of 180 days after the date of this prospectus without the prior
written consent of Donaldson, Lufkin & Jenrette Securities Corporation. In
addition, during such 180-day period, NEON has also agreed not to file any
registration statement with respect to, and each of its executive officers,
directors and certain stockholders of NEON has agreed not to make any demand
for, or exercise any right with respect to, the registration of any shares of
NEON's common stock or any securities convertible into or exercisable or
exchangeable for common stock without the prior written consent of Donaldson,
Lufkin & Jenrette Securities Corporation. However, Donaldson, Lufkin & Jenrette
Securities Corporation may, in its sole discretion, release all or any portion
of the securities subject to the lock-up agreements. NEON has determined that if
the lock-up with respect to a significant number of shares has been waived,
whether with respect to a single stockholder or a number of stockholders, it
would review applicable securities laws and, if public disclosure would be
appropriate, disclose the waiver.
Prior to the offering, there has been no established trading market for
NEON's common stock. The initial public offering price of the shares of NEON's
common stock offered hereby was determined by negotiation among NEON and the
representatives of the underwriters. The factors considered in determining the
initial public offering price included the history of and the prospects for the
industry in which NEON competes, the past and present operations of NEON, the
historical results of operations of NEON, the prospects for future earnings of
NEON, the recent market prices of securities of generally comparable companies
and the general condition of the securities markets at the time of the offering.
Other than in the United States, no action has been taken by NEON, the
selling stockholder or the underwriters that would permit a public offering of
the shares of common stock offered hereby in any jurisdiction where action for
that purpose is required. The shares of common stock offered hereby may not be
offered or sold, directly or indirectly, nor may this prospectus or any other
offering material
58
<PAGE>
or advertisements in connection with the offer and sale of any shares of common
stock be distributed or published in any jurisdiction, except under
circumstances that will result in compliance with the applicable rules and
regulations of such jurisdiction. Persons with this prospectus should inform
themselves about and observe any restrictions relating to the offering and the
distribution of this prospectus. This prospectus does not constitute an offer to
sell or a solicitation of an offer to buy any shares of common stock offered
hereby in any jurisdiction in which such an offer or a solicitation is unlawful.
In connection with the offering, the underwriters may engage in transactions
that stabilize, maintain or otherwise affect the price of NEON's common stock.
Specifically, the underwriters may overallot the offering, creating a syndicate
short position. The underwriters may bid for and stabilize the price of the
common stock. In addition, the underwriting syndicate may reclaim selling
concessions from syndicate members and selected dealers if they repurchase
previously distributed common stock in syndicate covering transactions, in
stabilizing transactions or otherwise. These activities may stabilize or
maintain the market price of the common stock above independent market levels.
The underwriters are not required to engage in these activities, and may end any
of these activities at any time.
59
<PAGE>
LEGAL MATTERS
The validity of the issuance of the shares of common stock offered by this
prospectus will be passed upon for NEON by Locke Liddell & Sapp LLP, Dallas,
Texas. Certain legal matters in connection with the offering will be passed upon
for the underwriters by Brobeck, Phleger & Harrison LLP, Austin, Texas.
EXPERTS
The consolidated financial statements of NEON Systems, Inc. and subsidiaries
as of March 31, 1997 and 1998 and December 31, 1998, and for each of the years
in the three-year period ended March 31, 1998 and the nine-month period ended
December 31, 1998 have been included herein and in the registration statement in
reliance upon the report of KPMG LLP, independent certified public accountants,
appearing elsewhere herein and in the registration statement, and upon the
authority of such firm as experts in accounting and auditing.
AVAILABLE INFORMATION
NEON has filed with the Securities and Exchange Commission, Washington, D.C.
20549, a registration statement on Form S-1 under the Securities Act with
respect to the shares of common stock offered hereby. This prospectus does not
contain all the information set forth in the registration statement and the
exhibits and schedules thereto. For further information with respect to NEON and
the shares offered by this prospectus, you should refer to the registration
statement, including the exhibits and schedules filed thereto. Statements
contained in this prospectus as to the contents of any agreement, contract or
other document referred to are qualified by and subject to the copy of such
contract or other document filed as an exhibit to the registration statement or
such other document. You may inspect a copy of the registration statement
without charge at the Commission's principal office in Washington, D.C. and
obtain copies of all or any part thereof upon payment of certain fees from the
Public Reference Section of the Commission at the Commission's principal office,
450 Fifth Street, N.W., Washington, D.C. 20549, or at the Commission's Regional
Offices in New York, located at 7 World Trade Center, Suite 1300, New York, New
York 10048, or in Chicago, located at 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. The Commission maintains an Internet site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Commission. The Commission's World
Wide Web address is www.sec.gov.
NEON intends to furnish holders of its common stock with annual reports
containing, among other information, audited financial statements certified by
an independent public accounting firm and quarterly reports containing unaudited
condensed financial information for the first three quarters of each fiscal
year. NEON intends to furnish such other reports as it may determine or as may
be required by law.
60
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Independent Auditors' Report............................................................................... F-2
Consolidated Balance Sheets................................................................................ F-3
Consolidated Statements of Operations...................................................................... F-4
Consolidated Statements of Stockholders' Equity (Deficit).................................................. F-5
Consolidated Statements of Cash Flows...................................................................... F-6
Notes to Consolidated Financial Statements................................................................. F-7
</TABLE>
F-1
<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,
1997 and 1998 and December 31, 1998, 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, 1998 and the nine-month period ended
December 31, 1998. 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, 1997 and 1998 and December
31, 1998 and the results of their operations and their cash flows for each of
the years in the three-year period ended March 31, 1998 and the nine-month
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
KPMG LLP
Houston, Texas
January 29, 1999
F-2
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF MARCH 31, AS OF
----------------------- DECEMBER 31,
1997 1998 1998
----------- ---------- -------------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents...................................................... $ 1,705,188 $2,804,073 $4,510,841
Accounts receivable--trade.................................................... 901,764 2,283,194 4,029,301
Accounts receivable--related party............................................ 138,074 181,112 82,577
Deferred tax assets........................................................... -- 380,532 595,053
Other current assets.......................................................... 27,902 246,193 109,852
----------- ---------- -------------
Total current assets........................................................ 2,772,928 5,895,104 9,327,624
----------- ---------- -------------
Property and equipment:
Furniture and equipment....................................................... 398,936 662,155 748,422
Purchased software............................................................ 65,810 78,774 78,774
Less accumulated depreciation and amortization.............................. (144,787) (289,131) (430,313)
----------- ---------- -------------
Property and equipment, net................................................. 319,959 451,798 396,883
Other assets, net............................................................... -- 5,268 177,702
----------- ---------- -------------
Total assets................................................................ $ 3,092,887 $6,352,170 $9,902,209
----------- ---------- -------------
----------- ---------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accrued expenses............................................................... $ 365,006 $ 564,217 $ 355,233
Accounts payable.............................................................. 155,133 359,819 804,836
Taxes payable................................................................. 83,142 365,056 472,569
Deferred tax liabilities...................................................... -- -- 27,897
Customer deposits............................................................. 146,400 -- --
Deferred maintenance revenue.................................................. 1,147,259 2,584,340 3,614,393
Secured notes payable (Note 2)................................................ -- 1,049,101 1,049,101
----------- ---------- -------------
Total current liabilities................................................... 1,896,940 4,922,533 6,324,029
----------- ---------- -------------
Secured notes payable (Note 2).................................................. 1,049,101 -- --
Series A redeemable, convertible preferred stock, $.01 par value. Authorized
650,000 shares; 625,000 shares issued and outstanding at March 31, 1997 and
1998 and December 31, 1998 (Note 3)........................................... 1,563,333 1,663,333 1,738,333
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, $.01 par value. Authorized 10,000,000 shares; 2,260,380,
2,535,801 and 2,682,251 shares issued and outstanding at March 31, 1997 and
1998 and December 31, 1998, respectively..................................... 22,604 25,358 26,823
Additional paid-in capital.................................................... 577,712 698,751 3,342,929
Accumulated other comprehensive income (loss)................................. 1,133 (962) (15,404)
Unearned portion of deferred compensation..................................... -- -- (1,846,711)
Retained earnings (accumulated deficit)....................................... (2,017,936) (956,843) 332,210
----------- ---------- -------------
Total stockholders' equity (deficit)........................................ (1,416,487) (233,696) 1,839,847
Commitments and contingencies (Note 7)........................................
----------- ---------- -------------
Total liabilities and stockholders' equity (deficit)........................ $ 3,092,887 $6,352,170 $9,902,209
----------- ---------- -------------
----------- ---------- -------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-3
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED MARCH 31, DECEMBER 31,
------------------------------- -----------------------
1996 1997 1998 1997 1998
--------- --------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C>
(UNAUDITED)
Revenues:
License....................... $2,190,454 $6,183,089 $9,806,287 $6,388,598 $10,541,224
Maintenance................... 275,458 1,002,563 2,396,520 1,770,500 3,293,622
--------- --------- --------- ----------- ----------
Total revenues.............. 2,465,912 7,185,652 12,202,807 8,159,098 13,834,846
Cost of revenues:
Cost of licenses.............. 17,614 211,688 551,736 183,356 661,515
Cost of maintenance........... 158,509 392,384 742,953 492,147 672,399
--------- --------- --------- ----------- ----------
Total cost of revenues...... 176,123 604,072 1,294,689 675,503 1,333,914
--------- --------- --------- ----------- ----------
Gross profit.................... 2,289,789 6,581,580 10,908,118 7,483,595 12,500,932
Operating expenses:
Sales and marketing........... 1,306,937 3,469,286 5,712,689 3,734,795 5,317,752
Research and development...... 1,205,069 1,525,313 2,257,915 1,610,751 2,706,036
General and administrative.... 310,018 696,349 1,494,278 1,048,654 1,701,472
Non-cash compensation......... -- -- -- -- 630,944
--------- --------- --------- ----------- ----------
Total operating expenses.... 2,822,024 5,690,948 9,464,882 6,394,200 10,356,204
--------- --------- --------- ----------- ----------
Operating income (loss)......... (532,235) 890,632 1,443,236 1,089,395 2,144,728
Interest income................. -- 23,660 64,029 49,051 67,101
Interest expense................ (66,175) (91,209) (85,521) (63,149) (63,687)
Other, net...................... -- 202 49,151 32,705 40,509
--------- --------- --------- ----------- ----------
Income (loss) before provision
for income taxes.............. (598,410) 823,285 1,470,895 1,108,002 2,188,651
Provision for income taxes...... -- 6,865 309,802 232,680 824,598
--------- --------- --------- ----------- ----------
Net income (loss)............... (598,410) 816,420 1,161,093 875,322 1,364,053
Dividends on series A
redeemable, convertible
preferred stock............... (80,000) (80,000) (100,000) (75,000) (75,000)
--------- --------- --------- ----------- ----------
Net income (loss) applicable to
common stockholders........... $(678,410) $ 736,420 $1,061,093 $ 800,322 $1,289,053
--------- --------- --------- ----------- ----------
--------- --------- --------- ----------- ----------
Earnings (loss) per common
share:
Basic......................... $ (1.62) $ 0.35 $ 0.45 $ 0.34 $ 0.49
--------- --------- --------- ----------- ----------
--------- --------- --------- ----------- ----------
Diluted....................... $ (1.62) $ 0.14 $ 0.19 $ 0.14 $ 0.20
--------- --------- --------- ----------- ----------
--------- --------- --------- ----------- ----------
Shares used in computing
earnings (loss) per common
share:
Basic......................... 417,393 2,094,087 2,370,525 2,340,797 2,607,587
Diluted....................... 417,393 5,671,433 6,267,775 6,238,048 6,933,985
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-4
<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, 1995... $ 20,870 $ 418,216 $ -- $ -- $(2,075,946) $ (1,636,860)
Net loss.................... -- -- -- -- (598,410) (598,410)
Stock option grants......... -- 87,000 -- -- -- 87,000
Preferred stock dividends... -- -- -- -- (80,000) (80,000)
----------- ----------- --------------- ------------- ------------ --------------
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.................. -- -- -- -- 1,364,053 1,364,053
Foreign currency translation
loss...................... -- -- (14,442) -- -- (14,442)
Comprehensive income........ -- -- -- -- -- 1,349,611
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........ -- -- -- 630,944 -- 630,944
Preferred stock dividends... -- -- -- -- (75,000) (75,000)
----------- ----------- --------------- ------------- ------------ --------------
Balance at December 31,
1998...................... $ 26,823 $3,342,929 $ (15,404) $(1,846,711) $ 332,210 $ 1,839,847
----------- ----------- --------------- ------------- ------------ --------------
----------- ----------- --------------- ------------- ------------ --------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-5
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED MARCH 31, DECEMBER 31,
------------------------------- ----------------------
1996 1997 1998 1997 1998
--------- --------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................. $(598,410) $ 816,420 $1,161,093 $ 875,322 $1,364,053
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation and amortization.... 31,283 73,291 144,344 108,258 141,182
Deferred tax expense............. -- -- (380,532) -- (186,624)
Noncash compensation expense..... 87,000 71,842 13,662 -- 630,944
Increase (decrease) in cash
resulting from changes in:
Accounts receivable............ (433,920) (567,418) (1,424,468) (1,905,747) (1,647,572)
Other current assets........... (38,827) 10,925 (218,291) (14,580) 136,341
Other assets................... 1,531 380 (5,268) -- (172,434)
Accrued expenses............... 139,837 311,594 199,211 (96,147) (208,984)
Accounts payable............... (4,854) 84,776 204,686 18,011 445,017
Customer deposits.............. -- 146,400 (146,400) (146,400) --
Taxes payable.................. 15,427 32,785 364,263 149,538 131,222
Deferred maintenance revenue... 234,736 895,512 1,437,081 1,415,855 1,030,053
--------- --------- --------- ----------- ---------
Net cash provided by (used in)
operating activities............... (566,197) 1,876,507 1,349,381 404,110 1,792,467
--------- --------- --------- ----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of furniture and
equipment........................ (74,025) (260,897) (263,219) (147,169) (86,267)
Purchases of computer software..... -- (45,159) (12,964) -- --
--------- --------- --------- ----------- ---------
Net cash used in investing
activities......................... (74,025) (306,056) (276,183) (147,169) (215,536)
--------- --------- --------- ----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable........ 480,000 -- -- -- --
Issuance of common stock........... -- 2,388 27,782 16,368 144,279
--------- --------- --------- ----------- ---------
Net cash provided by financing
activities......................... 480,000 2,388 27,782 16,368 144,279
--------- --------- --------- ----------- ---------
Net increase (decrease) in cash and
cash equivalents................... (160,222) 1,572,839 1,100,980 273,309 1,721,210
Effect of exchange rates on cash..... -- 1,133 (2,095) 2,365 (14,442)
Cash and cash equivalents at
beginning of period................ 291,438 131,216 1,705,188 1,705,188 2,804,073
--------- --------- --------- ----------- ---------
Cash and cash equivalents at end of
period............................. $ 131,216 $1,705,188 $2,804,073 $1,980,862 $4,510,841
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
Conversion of note payable and
accrued interest into preferred
stock.............................. $ -- $ 250,000 $ -- $ -- $ --
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
Cash paid during the period for
income
taxes.............................. $ -- $ -- $ 242,930 $ 131,902 $ 905,206
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
Cash paid during the period for
interest........................... $ -- $ -- $ 83,928 $ 62,946 $ 83,928
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-6
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
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.
INTERIM FINANCIAL INFORMATION (UNAUDITED)
The unaudited consolidated financial statements for the nine-month period
ended December 31, 1997 have been prepared on the same basis as the audited
financial statements and, in the opinion of management, include all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the financial position and results of operations of such interim
period in accordance with generally accepted accounting principles.
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 exists. 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.
F-7
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
NOTE 1--ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 interest-bearing deposits with original maturities of less than
three months are included in cash and cash equivalents. Cash equivalents consist
of highly liquid investments with original maturities of three months or less.
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.
F-8
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
NOTE 1--ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
A reconciliation of the numerators and denominators of the basic and diluted
per share computation is as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED MARCH 31, DECEMBER 31,
-------------------------------------- -------------------------
1996 1997 1998 1997 1998
---------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
(UNAUDITED)
Net income (loss)................................. $ (598,410) $ 816,420 $ 1,161,093 $ 875,322 $ 1,364,053
Dividends on series A redeemable, convertible
preferred stock................................. (80,000) (80,000) (100,000) (75,000) (75,000)
---------- ----------- ----------- ----------- -----------
Net income (loss) applicable to common
stockholders.................................. $ (678,410) $ 736,420 $ 1,061,093 $ 800,322 $ 1,289,053
---------- ----------- ----------- ----------- -----------
---------- ----------- ----------- ----------- -----------
Weighted average number of common shares
outstanding during the period:
Basic......................................... 417,393 2,094,087 2,370,525 2,340,797 2,607,587
Dilutive stock options........................ -- 452,346 772,251 772,251 1,201,399
Series A redeemable, convertible preferred
stock....................................... -- 3,125,000 3,125,000 3,125,000 3,125,000
---------- ----------- ----------- ----------- -----------
Diluted....................................... 417,393 5,671,433 6,267,775 6,238,048 6,933,985
---------- ----------- ----------- ----------- -----------
---------- ----------- ----------- ----------- -----------
Income (loss) per common share:
Basic......................................... $ (1.62) $ 0.35 $ 0.45 $ 0.34 $ 0.49
---------- ----------- ----------- ----------- -----------
---------- ----------- ----------- ----------- -----------
Diluted....................................... $ (1.62) $ 0.14 $ 0.19 $ 0.14 $ 0.20
---------- ----------- ----------- ----------- -----------
---------- ----------- ----------- ----------- -----------
</TABLE>
The calculation of common shares outstanding for the diluted computation for
the year ended March 31, 1996 excludes the effect of shares of Series A
Redeemable, Convertible Preferred Stock which are convertible into 3,125,000
shares of NEON common stock and dilutive stock options. The inclusion of such
potential common shares in the diluted per share computations would be
antidilutive since NEON incurred a net loss for the year ended March 31, 1996.
During the nine months ended December 31, 1998 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
nine months ended December 31, 1998 $631,000 was recognized as a noncash
compensation expense. The remaining differential of $1,846,711 will be
recognized over the remaining vesting period of the granted options.
PREFERRED STOCK
The carrying value of the Series A Redeemable, Convertible Preferred Stock
is periodically increased by amounts representing dividends not currently
declared or paid, but which are payable under the mandatory redemption features.
F-9
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
NOTE 1--ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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).
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 foreign currency
translation gains/losses of $1,133, ($2,095), and ($14,442) for the years ended
March 31, 1997 and 1998, and the nine-month period ended December 31, 1998,
respectively.
F-10
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
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 is secured by accounts receivable and property and equipment
and accrues interest at the rate of eight percent per annum. The principal
amount of the note is due March 31, 1999.
NOTE 3--SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Series A Redeemable, Convertible Preferred Stock is convertible into
shares of NEON common stock. Each share of Series A Redeemable, Convertible
Preferred Stock is convertible into five shares of common stock (subject to
adjustment upon the occurrence of certain events). The Series A Redeemable,
Convertible Preferred Stock also has voting rights based on the common stock
conversion ratio.
The Series A Redeemable, Convertible Preferred Stock accrues annual
dividends at $0.16 per share. The Series A Redeemable, Convertible Preferred
Stock has mandatory conversion and mandatory redemption provisions, which
require 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 and
1998 and December 31, 1998 were $313,333, $413,333 and $488,333, respectively.
NOTE 4--STOCK OPTION PLAN
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 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. See further discussion of the 1999 Plan in Note 9.
At December 31, 1998, 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 $87,000, $72,000 and $13,700 for the years ended March 31,
1996, 1997 and 1998, respectively, and $630,944 for the nine months ended
December 31, 1998. As of December 31, 1998 there was $1,846,711 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 Plan 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,
F-11
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
NOTE 4--STOCK OPTION PLAN (CONTINUED)
NEON's net income (loss) and diluted per share amounts would have been the pro
forma amounts indicated below:
<TABLE>
<CAPTION>
NINE
MONTHS
ENDED
DECEMBER
YEARS ENDED MARCH 31, 31,
--------------------------------- ----------
1996 1997 1998 1998
---------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Net income (loss) as reported..................... $ (598,410) $816,420 $1,161,093 $1,364,053
---------- -------- ---------- ----------
---------- -------- ---------- ----------
Net income (loss), pro forma...................... $ (553,160) $802,539 $1,097,780 $1,323,399
---------- -------- ---------- ----------
---------- -------- ---------- ----------
Net income (loss) per share as reported........... $ (1.62) $ 0.35 $ 0.45 $ 0.49
---------- -------- ---------- ----------
---------- -------- ---------- ----------
Net income (loss) per share, pro forma............ $ (1.62) $ 0.34 $ 0.42 $ 0.48
---------- -------- ---------- ----------
---------- -------- ---------- ----------
</TABLE>
The per share weighted average fair values of stock options granted during
fiscal years ended March 31, 1997 and 1998 were $0.22 and $0.86, respectively
and $5.54 for the nine month period ended December 31, 1998, on the dates of
grant using the minimum value method with the following weighted average
assumptions: fiscal year 1997 -- no expected dividend yield, risk-free interest
rate of
6.5%, and an expected life of five years; fiscal year 1998 -- no expected
dividend yield, risk-free interest rate of 5.9%, and an expected life of five
years; and nine months ended December 31, 1998 -- no expected dividend yield,
risk-free interest rate of 5.8%, and an expected life of five years.
F-12
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
NOTE 4--STOCK OPTION PLAN (CONTINUED)
Stock option activity during periods indicated is as follows:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF AVERAGE
SHARES EXERCISE PRICE
---------- --------------
<S> <C> <C>
Balance at March 31, 1995.................... 703,255 $ 0.13
Granted.................................... 332,330 0.17
----------
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 December 31, 1998................. 1,629,077 2.26
----------
----------
</TABLE>
At December 31, 1998, the weighted average remaining contractual life of
outstanding options was 8.5 years. At March 31, 1997 and 1998 and December 31,
1998, the number of options exercisable was 583,061, 566,936 and 697,825,
respectively, and the weighted average exercise prices of those options were
$0.18, $0.20 and $0.23, respectively.
NOTE 5--INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED MARCH 31, DECEMBER 31,
--------------------------- -----------------
1996 1997 1998 1998
-------- ------ --------- -----------------
<S> <C> <C> <C> <C>
United States Federal:
Current................................................... $ -- $ -- $ 647,905 1$,022,777
Deferred.................................................. -- -- (354,340) (214,521)
State--current.............................................. -- -- 23,210 4,188
State--deferred............................................. -- -- -- 12,154
Foreign--current............................................ -- 6,865 (6,973) --
-------- ------ --------- -----------------
$ -- $6,865 $ 309,802 $824,598
-------- ------ --------- -----------------
-------- ------ --------- -----------------
</TABLE>
F-13
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
NOTE 5--INCOME TAXES (CONTINUED)
For the years ended March 31, 1997 and 1998 and the nine months ended
December 31, 1998, NEON's effective income tax rate differed from the statutory
tax rate as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED MARCH 31, DECEMBER 31,
------------------------------------------- --------------------
1997 1998 1998
-------------------- -------------------- --------------------
<S> <C> <C> <C> <C> <C> <C>
Statutory tax rate........................... $ 279,917 34.0% $ 500,105 34.0% $ 744,141 34.0%
Increase (decrease) in valuation
allowance.................................. (279,917) (34.0) (217,427) (14.8) 114,273 5.2
State tax expense............................ -- -- 23,210 1.6 8,787 0.4
Foreign sales corporation.................... -- -- -- -- (52,700) (2.4)
Other........................................ 6,865 1.0 3,914 0.3 10,097 0.5
---------- ------- ---------- ------- ---------- -------
Effective tax rate........................... $ 6,865 1.0% $ 309,802 21.1% $ 824,598 37.7%
---------- ------- ---------- ------- ---------- -------
---------- ------- ---------- ------- ---------- -------
</TABLE>
As of March 31, 1997 and 1998, and December 31, 1998, deferred tax assets
were as follows:
<TABLE>
<CAPTION>
AS OF AS OF
MARCH 31, DECEMBER 31,
-------------------- ------------
1997 1998 1998
--------- --------- ------------
<S> <C> <C> <C>
Deferred maintenance revenues................ $ 424,142 $ 318,291 $ 212,442
Deferred compensation expense................ -- -- 233,197
Net operating loss carryforwards:
United Kingdom............................. 18,465 54,484 155,937
Germany.................................... -- 225,180 332,930
Other...................................... -- 7,757 --
--------- --------- ------------
Total deferred tax assets................ 442,607 605,712 934,506
Valuation allowance...................... (442,607) (225,180) (339,453)
--------- --------- ------------
Net deferred tax assets.................. $ -- $ 380,532 $ 595,053
--------- --------- ------------
--------- --------- ------------
</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. The valuation
allowance (increased) decreased $(194,271), $279,917, $217,427 and $(114,273)
during the years ended March 31, 1996, 1997 and 1998 and for the nine months
ended December 31, 1998, respectively.
At December 31, 1998, NEON has net operating loss carryforwards for income
tax purposes of $503,024 and $979,210 related to the United Kingdom and Germany,
respectively, which are available to offset future taxable income in the
respective country, if any. The net operating losses are carried forward
indefinitely.
F-14
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
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 Enterprise
Subsystem Management products. The amended distributor 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 $0, $117,350 and $448,917 for the years ended March 31, 1996, 1997 and
1998, respectively, and $92,268 and $421,435 for the nine-month periods ended
December 31, 1997 and 1998, 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
$41,769, $257,076 and $287,076 for the years ended March 31, 1996, 1997 and
1998, respectively and $215,307 for each of the nine-month periods ended
December 31, 1997 and 1998, 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 $82,577 as of March 31, 1997,
1998 and December 31, 1998, 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 2000. Future minimum rental payments under operating
leases having initial or remaining noncancelable lease terms in excess of one
year are as follows:
<TABLE>
<CAPTION>
YEARS ENDING MARCH 31,
<S> <C>
1999......................................... $ 546,878
2000......................................... 695,520
2001......................................... 685,620
2002......................................... 685,620
2003......................................... 685,620
Thereafter................................... 228,540
----------
$3,527,798
----------
----------
</TABLE>
F-15
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
NOTE 7--COMMITMENTS AND CONTINGENCIES (CONTINUED)
Total rent expense under all operating leases was $58,331, $168,964 and
$433,035 in the years ended March 31, 1996, 1997 and 1998, respectively and
$334,734 and $369,478 for the nine months ended December 31, 1997 and 1998,
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 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 would be reasonably
likely to 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 Network's 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. Any litigation to enforce our 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.
F-16
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
NOTE 7--COMMITMENTS AND 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 these matters will not have a material adverse effect on NEON's
consolidated financial position, results of operations or liquidity.
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 1996, 1997 and 1998.
During the nine-month period ended December 31, 1998, NEON had one customer
which accounted for 16% of the consolidated revenue.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED MARCH 31, DECEMBER 31,
--------------------------------------- -----------------------------
1996 1997 1998 1998
----------- ----------- ----------- -------------
1997
-------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
United States................ $ 2,465,912 $ 6,821,990 $ 9,923,198 $ 6,537,931 $ 10,983,078
Europe....................... -- 363,662 2,279,609 1,621,167 2,851,768
----------- ----------- ----------- ------------- -------------
$ 2,465,912 $ 7,185,652 $12,202,807 $ 8,159,098 $ 13,834,846
----------- ----------- ----------- ------------- -------------
----------- ----------- ----------- ------------- -------------
Operating income (loss):
United States................ $ (532,235) $ 870,019 $ 2,140,816 $ 1,294,713 $ 3,018,887
Europe....................... -- 20,613 (697,580) (205,318) (874,159)
----------- ----------- ----------- ------------- -------------
$ (532,235) $ 890,632 $ 1,443,236 $ 1,089,395 $ 2,144,728
----------- ----------- ----------- ------------- -------------
----------- ----------- ----------- ------------- -------------
Identifiable assets:
United States................ $ 730,037 $ 2,456,061 $ 3,964,737 $ 3,586,984 $ 7,509,083
Europe....................... -- 636,826 2,387,433 1,740,815 2,393,126
----------- ----------- ----------- ------------- -------------
$ 730,037 $ 3,092,887 $ 6,352,170 $ 5,327,799 $ 9,902,209
----------- ----------- ----------- ------------- -------------
----------- ----------- ----------- ------------- -------------
</TABLE>
NOTE 9--SUBSEQUENT EVENTS
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.
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 after the offering 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 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 sooner, six months after the
option holder ceases to be a director of NEON. In the event of a change in
control of
F-17
<PAGE>
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 1997 IS UNAUDITED.)
NOTE 9--SUBSEQUENT EVENTS (CONTINUED)
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.
F-18
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MARCH 5, 1999
[LOGO]
2,700,000 SHARES OF COMMON STOCK
--------------
PROSPECTUS
-----------------
DONALDSON, LUFKIN & JENRETTE
HAMBRECHT & QUIST
CIBC OPPENHEIMER
----------------
DLJDIRECT INC.
- ------------------------------------------------------------
We have not authorized any dealer, sales person or other person to give you
written information other than this prospectus or to make representations as to
matters not stated in this prospectus. You must not rely on unauthorized
information. This prospectus is not an offer to sell these securities or our
solicitation of your offer to buy the securities in any jurisdiction where that
would not be permitted or legal. Neither the delivery of this prospectus nor any
sales made hereunder after the date of this prospectus shall create an
implication that the information contained herein or the affairs of NEON have
not changed since the date hereof.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Until March 30, 1999 (25 days after the date of this prospectus), all dealers
that effect transactions in these shares of common stock may be required to
deliver a prospectus. This is in addition to the dealer's obligation to deliver
a prospectus when acting as an underwriter and with respect to their unsold
allotments or subscriptions.
- --------------------------------------------------------------------------------
