<PAGE> 1
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 0-25457
NEON SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 76-0345839
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14100 SOUTHWEST FREEWAY, 77478
SUITE 500, (zip code)
SUGAR LAND, TEXAS
(Address of principal executive offices)
</TABLE>
(281) 491-4200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<CAPTION>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
<S> <C>
None None
</TABLE>
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
(Title of Class)
Indicate by check mark whether Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
Registrant as of June 12, 2000 was $207,404,692 based on the last sale price of
$22.00 for Registrant's Common Stock on the Nasdaq National Market on June 12,
2000.
As of June 12, 2000, 9,427,486 shares of the Registrant's Common Stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Selected portions of the Proxy Statement for the 2000 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission not later
than 120 days after the end of Registrant's fiscal year ended March 31, 2000 are
incorporated by reference into Part III of this Form 10-K.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE> 2
NEON SYSTEMS, INC.
FORM 10-K
FOR FISCAL YEAR ENDED MARCH 31, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<C> <S> <C>
PART I
1. Business.................................................... 1
2. Properties.................................................. 20
3. Legal Proceedings........................................... 21
4. Submission of Matters to a Vote of Security Holders......... 22
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 22
6. Selected Consolidated Financial Data........................ 24
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 25
7A. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 31
8. Consolidated Financial Statements and Supplementary Data.... 32
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 49
PART III
10. Directors and Executive Officers of Registrant.............. 49
11. Executive Compensation...................................... 49
12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 49
13. Certain Relationships and Related Transactions.............. 49
PART IV
14. Exhibits, Financial Statements, Schedules and Reports on
Form 8-K.................................................... 49
</TABLE>
i
<PAGE> 3
PART I
This Report contains certain forward-looking statements of the intentions,
hopes, beliefs, expectations, strategies and predictions of NEON Systems, Inc.
("NEON(R)") or its management with respect to future activities or other future
events or conditions within the meaning of Section 27A of the Securities Act of
1933, as amended (the "Act") and Section 21E of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), which are intended to be covered by the
safe harbors created thereby. Investors are cautioned that all forward-looking
statements involve risks and uncertainty, including, without limitation,
variations in quarterly results, volatility of NEON'S stock price, development
by competitors of new or competitive products or services, the entry into the
market by new competitors, the sufficiency of NEON'S working capital and the
ability of NEON to retain management, to implement its business strategy, to
assimilate and integrate any acquisitions, to retain customers or attract
customers from other businesses and to successfully defend itself in ongoing and
future litigation. Although NEON believes that the assumptions underlying the
forward-looking statements contained herein are reasonable, any of the
assumptions could be inaccurate, and, therefore, there can be no assurance that
the forward-looking statements included in this Report will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such information
should not be regarded as a representation by NEON or any other person that the
objectives and plans of NEON will be achieved.
ITEM 1. BUSINESS
OVERVIEW
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 develops, markets and supports software products that allow our customers
to rapidly deploy new business capabilities by leveraging existing applications
and data with the Internet, a process known generically as eBusiness
Integration. In addition, NEON develops, markets and supports Enterprise
Subsystem Management and Enterprise Security Management software products.
NEON's primary product family, known as the eBusiness Integration product
family, consists of two product groups, the Shadow(R) product group and the
iWave(TM) product group.
The Shadow product group provides a scalable set of products for mainframe
data and application access, legacy application renewal and application
development. The Shadow product group consists of the following three products:
- Shadow Direct(R), which enables client/server applications to access and
integrate with mainframe data and applications.
- Shadow Web Server(TM), which enables Web browsers to access and integrate
with mainframe data and applications.
- Shadow Enterprise Direct(R), which provides access and integration
between client/server systems.
All three Shadow 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.
The iWave product group provides a cross-platform enterprise application
integration (EAI) and business-to-business (B2B) integration platform from one
infrastructure. iWave Integrator provides bi-directional, event-driven
integration of enterprise applications and data between disparate computing
applications and across disparate operating environments. iWave Integrator(TM)
allows organizations to rapidly integrate enterprise data and application
sources, improving efficiencies of existing business flows and facilitating the
creation of new high-value applications which leverage existing information
technology assets. Organizations use iWave Integrator to rapidly integrate
dissimilar applications to achieve global information sharing among employees
and to integrate applications and data outside of their organization with
customers, vendors and
1
<PAGE> 4
partners. Furthermore, iWave Integrator is able to accomplish EAI and B2B
integration with high performance and complete management and control
capabilities.
NEON's Enterprise Subsystem Management product family consists of thirteen
data management, monitoring and application utilities that improve the
performance, resource utilization and availability of mainframe subsystem
components, such as IMS and CICS mainframe databases. These products improve
mainframe performance, availability and reliability to support the
ever-increasing demands placed on mainframe subsystems by eBusiness initiatives
that incorporate existing mainframe data and transactional sources.
NEON's Enterprise Security Management product provides cost-effective and
automated management of small numbers of key corporate security issues across
common and interoperable mainframe and desktop environments.
INDUSTRY BACKGROUND
In organizations today, a critical asset is the information technology
infrastructure. Many new organizational initiatives, such as managing
information flow across a supply chain, gaining a deeper understanding of
customer buying habits or characteristics, or engaging in more targeted
marketing, selling and production, depend on the effective delivery of
information where it is needed and when it is needed. Organizations today must
rapidly integrate existing applications and take advantage of the Internet to
deliver new capabilities to suppliers, customers, employees and trading networks
to stay competitive.
One of the greatest challenges to implementing these new strategies is
exploiting powerful new technologies within the existing systems infrastructure
of an enterprise -- specifically, leveraging the Internet into new high-value
applications.
The advantages of the various technologies can be described as follows:
- 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 of improving service levels, reducing costs
and adding new capabilities.
- Enterprise Application Integration. The evolution of EAI technology has
been a key contributor to the increasing emergence of B2B Integration.
EAI technology allows corporations to rapidly automate existing business
flows, integrate existing application and data sources, and deliver new,
high-value applications to customers, suppliers, partners, and employees.
- B2B Integration. B2B integration allows organizations to share
information with customers, suppliers, and partners for quicker, better,
more informed business decisions. The development of the Internet
infrastructure has allowed organizations to support B2B processing, which
is expected to become more prevalent with the emergence of new
communication standards such as Extensible Markup Language (XML).
- 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
significant amounts in mainframe systems. As a result, a substantial
amount of corporate data and records resides on mainframe systems,
representing a wealth of important corporate information that must be
leveraged in the next generation of applications.
- Packaged and Client/Server Applications. For many years, the need to
deliver new applications has exceeded most organizations' internal
development capacity using traditional development methods. Consequently,
organizations have made substantial investments in packaged applications
and have built in-house applications using easy to use client/server
products. The packaged applications
2
<PAGE> 5
provided specific support for a variety of functions, including
enterprise resource planning, customer relationship management (CRM),
human resource management systems and others. The existing packaged
applications and client/server applications continue to provide great
value to organizations and are an ongoing consideration in delivering the
next generation of applications.
INFORMATION TECHNOLOGY CHALLENGES
Organizations need to deliver via the Internet new applications that
combine the capabilities found in existing applications and data sources to
internal and external users, including users in other organizations. While these
applications offer high strategic value, they also create several challenges.
The first set of challenges is the vast investment required in existing
applications that span the mainframe, client/server and purchased packaged
applications. These existing applications support specific critical operational
aspects of the organization and typically are used by many people on a daily
basis. Time-to-market considerations, skills shortages in the industry and cost
containment limit organizations' abilities to re-write these applications. To
utilize these applications in delivering a new automated business process
internally or via the Internet requires integration infrastructure. This
requirement drives organizations to seek out software products for application
integration and B2B technology infrastructure.
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 software programs, screen-scraping
software 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. Further, these solutions do
not provide real-time integration or current information delivery.
Over the past several years, a number of software products known
generically as application integration servers, have been introduced to provide
organizations with a packaged software product to attempt to solve their access
and integration problems. All of these solutions require significant integration
of underlying applications and data sources via access and integration
infrastructure software.
The traditional access and integration infrastructure technologies,
commonly known as "middleware", have typically suffered from a number of
deficiencies that have limited their ability to support new application
development initiatives:
- 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.
The traditional EAI technologies typically suffer from a number of
deficiencies that limit their ability to support new application development
initiatives in large organizations:
- Poor support for integration of the mainframe IBM System/390
platform -- This platform is the backbone of most large corporations
today and hosts approximately 70% of mission-critical corporate data and
applications. The inability of traditional EAI solutions to support the
mainframe severely limits the usefulness of these solutions in large
organizations.
- Lack of systems management and systems management
integration -- Application deployment in large organizations is dependent
on the resulting applications being manageable and providing availability
3
<PAGE> 6
adequate to support current and future application demands. These
requirements are met via systems management and monitoring capabilities
embedded in the EAI software and the ability of the EAI software to
deliver systems management information to in-house systems management
software. To date, these capabilities have been extremely limited or
absent in EAI software.
- Dependency on professional services -- The complexity associated with the
installation and customization of EAI solutions often requires
organizations to engage outside consultants to assist in the installation
of EAI software. This dependency on consulting resources for the systems
integration component of these solutions increases installation costs and
time to market and the risk of delay or failure due to scarcity of
skilled resources and quality project management, and results in a
dramatic increase in maintenance and support costs over the life of the
application.
- Inability to combine EAI and B2B integration from one
infrastructure -- B2B integration requires technical capabilities beyond
simple integration. Security technologies, compatibility capabilities,
support for legacy Electronic Data Interchange (EDI), XML support and
industry standards for XML interchange are needed. These capabilities are
just now emerging in new software products which are either immature, or
use proprietary technologies that severely limit the ability to leverage
any of the EAI initiatives that an organization may have already
implemented
As a result of these limitations, organizations are increasingly seeking to
deploy more flexible, easy-to-install, cost-effective and high-performance
eBusiness 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
eBusiness Integration
NEON develops, markets and supports eBusiness Integration software. NEON's
primary product family, known as the eBusiness Integration product family,
consists of two product groups, the Shadow product group and the iWave product
group.
The Shadow product group provides a scalable set of products for mainframe
data and application access, legacy application renewal and application
development. The Shadow product group consists of the following three products:
- Shadow Direct, which enables client/server applications to access and
integrate with mainframe data and applications.
- Shadow Web Server, which enables Web browsers to access and integrate
with mainframe data and applications.
- Shadow Enterprise Direct, which provides access and integration between
client/server systems.
The iWave product group provides a cross-platform EAI and B2B integration
platform from one infrastructure. iWave Integrator provides bi-directional,
event-driven integration of enterprise applications and data between disparate
computing applications and across disparate operating environments. iWave
Integrator allows organizations to rapidly integrate enterprise data and
application sources, improving efficiencies of existing business flows and
facilitating the creation of new high-value applications which leverage existing
information technology assets. Organizations use iWave Integrator to rapidly
integrate dissimilar applications to achieve global information sharing among
employees and to integrate applications and data outside of their organization
with customers, vendors and partners. Furthermore, iWave Integrator is able to
accomplish EAI and B2B integration with high performance and complete management
and control capabilities.
4
<PAGE> 7
NEON's eBusiness Integration products provide organizations with the
following benefits in deploying new applications and extending existing
applications:
- Easy to use and Cost-Effective. The NEON eBusiness Integration software
products were designed to be easy to use and compatible with a variety of
other applications and to provide a rapid return on investment. The
Shadow products can typically be installed without on-site assistance
within one day. As a result of this "out-of-the-box" functionality,
customers can rapidly implement and utilize Shadow products in deploying
new applications and extending existing applications with minimal
training. The iWave Integrator product provides numerous application
interfaces that contain application-specific intelligence that speeds
implementation and reduces professional services required for
integration. Typically, two application interfaces can be integrated in
days instead of weeks. Not only is the cost of implementation minimized,
the iWave Integrator solution offers longer term value because it is
adaptable to meet changing business and technology requirements.
- Preserve Information Technology Investment. The NEON eBusiness
Integration software products preserve an organization's investment in
mainframe, client/server, and packaged applications while allowing
customers to take advantage of the benefits of the Internet with more
efficient business integration and new high-value applications. NEON
believes mainframe platforms will play a key role in large organizations
for the foreseeable future. Using the NEON eBusiness Integration product
family, organizations can continue to use these reliable,
mission-critical applications as new technologies and market
opportunities evolve. The NEON eBusiness Integration software products
are unique in the industry in their depth of support provided for the IBM
System/390 environment.
- Flexibility. The NEON eBusiness Integration software products use
industry-standard technologies that allow users to integrate with a
variety of data and application sources. The NEON eBusiness Integration
software products' flexible architecture allows organizations to maximize
the use of existing internal skills and in-house technologies to develop
new applications using off-the-shelf tools. These benefits allow
organizations to quickly implement a NEON integration solution that can
be utilized for a variety of applications.
- High Performance; Scalability. The NEON eBusiness Integration software
products provide "real time" access to and integration with mainframe
systems and packaged applications through Internet or client/server
applications. Although many middleware products provide connectivity to
mainframe systems, few provide the rapid response and scalability
delivered by the NEON eBusiness Integration software products, which
allow information technology groups to broadly expand the user base of an
application without concerns about deteriorating application performance.
- Extensive Management, Monitoring and Control Capabilities. NEON's
eBusiness Integration product family provides a number of utilities that
support all phases of the application lifecycle. The NEON eBusiness
Integration software products' end-to-end diagnostics provide rapid
resolution of development problems, resulting in faster delivery of
applications. The NEON eBusiness Integration product family maintains the
required performance and availability of mainframe-based applications
operating in a distributed environment at significantly reduced system
maintenance costs.
Enterprise Subsystem Management and Enterprise Security Management
In addition to its eBusiness Integration software products, NEON has two
other product families, the Enterprise Subsystem Management and Enterprise
Security Management product families. As organizations increasingly deploy
Internet and client/server applications that are dependent upon mainframe-based
data and applications, new demands will be placed on mainframe subsystems. For
example, when an application that once was subject to use by a single corporate
office is made available to customers through the Internet, it may need to be
operational on a continuous basis to support global operations. The number of
potential users accessing the mainframe may increase substantially, and its
workload may fluctuate dramatically. In addition, corporations require new
strategies to handle increasing and changing security demands. NEON's Enterprise
Subsystem Management software products improve the availability and performance
of mainframe subsystems to support the growing demands placed on the mainframe
to support new users and applications.
5
<PAGE> 8
NEON's Enterprise Security Management product provides cost-effective and
automated management of small numbers of key corporate security issues across
common and interoperable mainframe and desktop environments.
THE NEON STRATEGY
NEON's goal is to continue to grow as a leading provider of eBusiness
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 eBusiness Integration software. The
foundation of its technological leadership is the product architecture
and core code base that underlies the Shadow and iWave products. This
architecture not only provides significant advantages over competing
products, but provides the building blocks for the delivery of new
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 Integration
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. iWave provides
key infrastructure for integration of packaged applications and
enterprise data. NEON intends to immediately leverage its leadership in
Web-enablement of the mainframe data and applications and integration of
CRM applications.
- Leverage Installed Base of Customers. Approximately 350 organizations
worldwide, including approximately one-third 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 iWave Integrator,
Enterprise Subsystem Management products and its Enterprise Security
Management product. In addition, NEON believes there is a large
opportunity to sell organization-wide licenses to its installed customer
base.
- Leverage Partner Relationships. NEON has a growing number of partner
relationships that provide referral and other lead generation
opportunities. In addition, several partners have embedded NEON
technology into their products, thereby resulting in additional NEON
revenues.
- 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.
- Exploit Product Development Strength. NEON employs a product authorship
program that rewards NEON's product authors individually with commissions
based on the market success of the NEON products they author. NEON
believes that the proximity of its product authors to the customer is
critical, and its product authorship program is designed to encourage
NEON's authors to evaluate the effectiveness of a product in the actual
customer environment. This authorship program contributes to NEON's
ability to hire and retain highly skilled authors. In addition to its
internal development resources, NEON distributes Enterprise Subsystem
Management products developed by Peregrine/ Bridge Transfer Corporation
pursuant to a development and distribution agreement. NEON believes that
its relationship with Peregrine/Bridge Transfer Corporation enables it to
address a complementary software market without substantial development
resource commitment.
6
<PAGE> 9
eBusiness Integration Products
The eBusiness Integration product family consists of five major software
products: Shadow Direct, Shadow Web Server for OS/390, Shadow Web Server for VM,
Shadow Enterprise Direct and iWave Integrator. The Shadow Product Group has 15
chargeable add-on components that extend the function of the software product.
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, Linux, Windows NT and Windows 2000. In
multi-tier environments, different parts of a computer program may be
distributed among several tiers of computers or networks. Shadow Direct
eliminates the need for separate hardware and software components and provides a
number of unique connection capabilities to meet a wide variety of corporate
application requirements. Shadow Direct also provides strong performance
qualities, such as scalability, management and control.
Shadow Web Server. Shadow Web Server provides "Web-enablement" of mainframe
applications for access by Web browsers, thereby allowing organizations to
rapidly install and deploy Web-based applications. Shadow Web Server is
available in either a VM or an OS/390 version. 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
NEON's customers the ability to purchase additional capabilities when required,
providing an adaptable solution that meets customers' evolving needs by
extending client attributes, server attributes and/or connection capabilities.
For example, the server is typically extended to support additional data or
transactional sources as the need arises to use these in new applications. The
add-on components provide NEON's customers with an extendable and flexible
long-term solution for their EAI 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.
iWave Integrator. iWave Integrator provides a blending of EAI and B2B
integration and supports over 40 enterprise data and application sources. iWave
Integrator provides maximum flexibility in integration configurations
(point-to-point, data bus, hub and spoke) and facilitates rapid implementation
through configurable integration interfaces. iWave Integrator provides
implementation of adaptive applications that can sense and respond to data,
application, network and system changes.
NEON'S UNIQUE PRODUCT ARCHITECTURE
NEON's eBusiness Integration architecture is central to the 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 eBusiness
Integration architecture allows organizations to implement a single architecture
that meets mainframe access and integration needs and maintains open standards
for flexibility and adaptability.
7
<PAGE> 10
ENTERPRISE SUBSYSTEM MANAGEMENT PRODUCTS
NEON's Enterprise Subsystem Management products cost-effectively maintain
the performance and availability required by mainframe environments as the
demand for new applications increases. NEON develops and markets these products
pursuant to a development and distribution agreement with Peregrine/ Bridge
Transfer Corporation.
NEON provides thirteen Enterprise Subsystem Management products that
address the market opportunity in Information Management Systems (IMS) subsystem
management. These products maintain high availability, integrity and performance
of IMS databases, and the ability to load and unload data, to manage indices and
to place IMS 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.
ENTERPRISE SECURITY MANAGEMENT PRODUCT
NEON's Enterprise Security Management product provides cost-effective and
automated management of corporate security across common and interoperable
mainframe and desktop environments. NEON's Enterprise Security Management
software enables authorized users to focus on business activities while helping
to protect corporate assets in common application-processing environments.
NEON's Halo SSO(TM) product addresses Enterprise Security Management market
opportunities. Halo SSO provides two-way password synchronization and single
sign-on across IBM mainframe and Microsoft Windows NT environments. This product
allows corporations to minimize time spent on password administration and reduce
the risk associated with multiple passwords.
CUSTOMERS
NEON's customer base spans major industries, including automobile,
manufacturing, energy, banking, financial services, publishing, engineering,
government and retail.
NEON provides its products to customers under non-exclusive,
non-transferable licenses. Under NEON's current standard license agreement,
licensed software may be used solely for the customer's internal operations, and
NEON does not sell or transfer title to its products to its customers.
SALES AND MARKETING
NEON sells its products through a direct telesales force and, to a lesser
extent, through independent distributors.
Direct Telesales. NEON utilizes a direct telesales model that minimizes the
number of remote sales offices and customer site visits and focuses on effective
use of the telephone and Internet communications for product demonstrations and
product sales. When necessary, NEON's sales force will also travel to customer
locations for on-site demonstrations and product trials. The direct telesales
model allows NEON's sales representatives to be successful without substantial
travel, thereby improving earning potential and providing a higher quality of
life. NEON believes this model is a significant factor in recruiting and
retaining outstanding sales professionals. NEON believes its direct telesales
approach allows it to achieve better control of the sales process and to respond
more rapidly to customer needs, while maintaining an overall low-cost sales
model. Sales cycles typically range from three to six months.
The direct telesales force for North America is based in Sugar Land, Texas
and generates a substantial majority of NEON's revenues. In January 1997, NEON
established its first international direct telesales office in London, England.
In August 1997, NEON established another international direct telesales office
in Frankfurt, Germany. NEON increased the size of its direct telesales
organization from 31 to 47 individuals over the last fiscal year and expects to
continue hiring sales personnel, both domestically and internationally, over the
next fiscal year. In the first quarter of fiscal 2001, NEON established a
telesales office in Sydney, Australia.
8
<PAGE> 11
Independent Distributors. NEON has also established indirect distribution
channels through independent distributors in Europe, Latin America and the
Pacific Rim. At March 31, 2000, NEON had 15 distributors covering 21 countries.
NEON's distributors typically perform marketing, sales and technical support
functions in their assigned country or region. They may distribute directly to
the customer, via other resellers or through a combination of both channels.
NEON continuously trains its international distributors in both product
capabilities and sales methodologies. For financial information attributable to
each of NEON's geographic sales areas, see "Note 8 -- Operations by Geographic
Location and Significant Customers" in the Notes to Consolidated Financial
Statements.
In addition to its internal marketing activities, NEON has established
relationships with other vendors that are complementary to NEON's efforts to
expand acceptance of its eBusiness Integration 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 (OEM) Relationships. NEON has OEM
relationships with BMC Software, Landmark Systems, Informatica, Tesseract,
Xantel and OPUS Solutions. These companies market or embed the Shadow products
in their products to provide access to mainframe-based enterprise data and
transactions from their respective applications. The original equipment
manufacturer contracts and NEON's software limit access to only their
applications. In addition to generating revenues, these relationships provide an
opportunity for NEON's direct telesales force to sell licenses offering broader
Shadow product functionality.
Marketing Relationships. NEON has developed marketing relationships with
Remedy, Siebel Systems, Clarify, EDS, IBM Global Services, Gemstone Systems, BEA
Systems, IBM, Microsoft, Tantau, SilverStream Systems, Landmark Systems, and
Computer Associates (Sterling Software). 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, 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 eBusiness Integration products, continuing to deliver new Enterprise
Subsystem Management products and enhancing the capabilities found in NEON's new
Enterprise Security Management product. 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
continued dialogue with customers is an important element in developing
enhancements to existing products and in the development of new products.
9
<PAGE> 12
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
has utilized a plan of continuous product improvement and enhancement.
Therefore, at any point in time a number of product development initiatives will
be underway. Currently, NEON is addressing enterprise security issues, expanding
the number of applications and data sources supported by iWave Integrator and
developing more efficient and cost effective utilities for IMS subsystems
management. These development efforts will broaden operational issues solved by
the Enterprise Security Management product, expand the potential market for the
iWave Integrator product and provide new alternatives for organizations managing
IMS with the Enterprise Subsystem Management products.
TEXACO WORK AGREEMENT
NEON has a work agreement with Texaco pursuant to which Texaco provides
NEON use of its mainframe computer and certain of its under-utilized data
processing resources. NEON uses Texaco's resources in developing a number of its
application interfaces. The Texaco agreement specifies that ideas, concepts,
know-how and techniques that NEON develops under the agreement are to remain
NEON's property and that Texaco may use such developments solely for its
internal information technology operations. NEON has granted Texaco and its
subsidiaries and affiliates a worldwide, perpetual, nontransferable and
royalty-free license with respect to any products developed pursuant to the work
agreement. Either party to the work agreement may terminate the agreement upon
30 days' written notice to the other party. Upon termination of the work
agreement, NEON would have to locate alternative mainframe sources to develop
certain of its products. NEON believes alternative mainframe sources are
available at reasonable rates.
PEREGRINE/BRIDGE TRANSFER CORPORATION RELATIONSHIP
NEON markets and sells a suite of Enterprise Subsystem Management products,
in addition to its Shadow products, that improve the efficiency and performance
of mainframe environments. These products are developed pursuant to a
development and distribution agreement with Peregrine/Bridge Transfer
Corporation. The Peregrine/Bridge Transfer Corporation agreement provides NEON
with exclusive rights to distribute Peregrine/Bridge Transfer Corporation's
Enterprise Subsystem Management software, with the exception of limited
co-marketing rights held by IBM relating to one of the Peregrine/Bridge Transfer
Corporation Enterprise Subsystem Management products, as well as access to
Peregrine/Bridge Transfer Corporation's team of software developers. At March
31, 2000, Peregrine/Bridge Transfer Corporation employed 13 developers with an
average of 24 years of experience. The agreement grants NEON worldwide
distribution rights through March 31, 2004. The agreement also grants to NEON
first refusal rights to acquire Peregrine/Bridge Transfer Corporation by
matching any third-party offer that Peregrine/Bridge Transfer Corporation or its
stockholder chooses to accept, and an option to acquire Peregrine/Bridge
Transfer Corporation that is exercisable on or after January 1, 2002 or such
earlier date that NEON has paid Peregrine/Bridge Transfer Corporation royalty
payments totaling $10.0 million or more in any single fiscal year. In fiscal
2000, NEON paid license fees to Peregrine/Bridge Transfer Corporation in the
aggregate amount of $979,246. 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.
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
eBusiness Integration, Enterprise Subsystems Management and Enterprise Security
Management markets. NEON has experienced, and expects to continue to experience,
increased competition from current and potential competitors, many of whom have
greater name recognition, a larger installed customer base and significantly
greater financial, technical, marketing and other resources than NEON.
NEON's eBusiness Integration Shadow products compete principally with
products from established vendors such as IBM, Oracle, Merant, Sybase, Vitria,
Active, Crossworlds, Information Builders, BEA
10
<PAGE> 13
Systems, IONA Technologies, New Era of Networks and TSI International Software,
and NEON's eBusiness Integration iWave product group competes with products
offered by entities such as Active Software, Vitria Technologies and
Crossworlds. NEON's Enterprise Subsystem Management products face significant
competition from products offered by BMC Software and IBM. NEON's Enterprise
Security Management product faces significant competition in this established
market from Computer Associates, Proginet, Blockade Systems Corporation and New
Era of Networks. In addition, NEON also faces competition from:
- Other business applications vendors who may internally develop, or attain
through acquisitions and partnerships, eBusiness integration and
enterprise subsystem management solutions
- Internal development efforts by corporate information technology
departments
- New entrants to the eBusiness integration or enterprise subsystem
management and enterprise security markets
NEON's competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements or devote greater resources to
the development, promotion and sale of their products than NEON. Increased
competition could result in price reductions, fewer customer orders, reduced
gross margins, longer sales cycles and loss of market share, any of which would
materially adversely affect NEON's business, operating results and financial
condition.
PROPRIETARY RIGHTS
NEON relies primarily on a combination of copyright, trademark and trade
secret laws, confidentiality procedures and contractual provisions to protect
its proprietary rights. However, NEON believes that these measures afford only
limited protection. There can be no assurance that others will not develop
technologies that are similar or superior to NEON's technology or design around
the copyrights and trade secrets owned by NEON. NEON licenses its products
pursuant to software license agreements, which include acknowledgments and
agreements by the licensee that are intended to establish and protect NEON's
proprietary rights and confidential information. NEON believes, however, that
these measures afford only limited protection. Despite NEON's efforts to protect
its proprietary rights, unauthorized parties may attempt to copy aspects of
NEON's products or to obtain and use information that NEON regards as
proprietary. Policing unauthorized use of NEON's products is difficult and NEON
is unable to determine the extent to which piracy of its software products
exists. In addition, the laws of some foreign countries do not protect NEON's
proprietary rights as fully as do the laws of the United States. There can be no
assurance that NEON's means of protecting its proprietary rights will be
adequate or that competition will not independently develop similar or superior
technology.
A number of organizations, including New Era of Networks, Inc., are
utilizing the name "Neon," alone and in combination with other words, as a
trademark, a tradename or both. New Era of Networks is also a developer and
distributor of middleware and other software products. New Era of Networks has
used the acronym "NEON" in its business, is listed on the Nasdaq National Market
under the symbol "NEON" and has sought to obtain federal trademarks for products
and services whose names include the word "NEON." NEON is currently opposing, in
the U.S. Patent and Trademark Office, New Era of Networks' application to
register "NEONET." On December 24, 1998, New Era of Networks filed a complaint
against NEON in the United States District Court for the District of Colorado
seeking (a) a declaratory judgment that New Era of Networks' use of certain
trademarks, including "NEONET," does not infringe NEON's rights or constitute
unfair competition and (b) cancellation of NEON's federal trademark registration
for NEON. NEON has filed an Answer denying the material allegations of that
complaint. On February 11, 2000, the judge in the Colorado proceeding advised
the parties that the court intends to grant summary judgment for cancellation of
the federal trademark registration for the "NEON" mark. If such judgment is
entered, it will not affect NEON's right to use the "NEON" mark, which NEON
believes to be superior to those of New Era of Networks. Discovery related to
this litigation has been completed but no trial date has been set. On June 23,
1999, NEON sued New Era of Networks in District Court in Fort Bend County,
Texas, alleging that New Era of Networks' use of "NEON" is in violation of Texas
law concerning misappropriation of tradenames, and at
11
<PAGE> 14
the time of filing of this Report the parties were in the discovery phase of
this litigation. In this litigation, NEON seeks to enjoin New Era of Networks
from using "NEON" as its "nickname," its Nasdaq trading symbol, or in any other
manner that is likely to result in confusion in the marketplace or to dilute the
meaning or value of NEON's name. NEON's claims are based upon its prior and
continuous use of "NEON" as its corporate name. NEON believes that it has
superior rights to use "NEON" and that New Era of Networks' use of NEON is
causing confusion in the marketplace.
However, any litigation to enforce NEON's right to use the NEON name in its
business or to prevent others from using the NEON name may be expensive and
time-consuming, will divert management resources and may not be adequate to
protect its business. If NEON should lose any such litigation, it may have to
change its name, which also would be expensive and time-consuming and could
adversely affect its business. In addition, NEON believes that confusion in the
marketplace caused by New Era of Networks' use of the "NEON" symbol on the
Nasdaq National Market may result in variations in NEON's stock price that are
attributable to facts or circumstances relating to New Era of Networks.
NEON has code-sharing arrangements with third parties under which it has
obtained and used certain source code in the development of some of its software
products. If any of these agreements are terminated, NEON could be required to
spend time and software development resources to replace the affected code. Any
diversion of these resources could delay NEON's development of new products or
product enhancements.
NEON is not aware that it is infringing any proprietary rights of third
parties. There can be no assurance, however, that third parties will not claim
infringement by NEON of their intellectual property rights. NEON expects that
software product developers will increasingly be subject to infringement claims
as the number of products and competitors in NEON's industry segment grows and
the functionality of products in different industry segments overlaps. Any such
claims, with or without merit, could be time-consuming to defend, result in
costly litigation, divert management's attention and resources, cause product
shipment delays or require NEON to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on terms
acceptable to NEON, if at all. In the event of a successful claim of product
infringement against NEON and failure or inability of NEON to either license the
infringed or similar technology or develop alternative technology on a timely
basis, NEON's business, operating results and financial condition could be
materially adversely affected.
HUMAN RESOURCES
As of March 31, 2000, NEON and its subsidiaries employed 134 persons,
including 77 in sales, marketing and field operations, 33 in research and
development, 11 in finance and administration and 13 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.
12
<PAGE> 15
EXECUTIVE OFFICERS AND DIRECTORS OF NEON
The following table sets forth certain information concerning each of the
executive officers and directors of NEON as of June 12, 2000:
<TABLE>
<CAPTION>
NAME AGE TITLE
---- --- -----
<S> <C> <C>
John J. Moores(a)..................... 55 Chairman of the Board of Directors
Joe Backer............................ 62 President, Chief Executive Officer and
Director
Peter Schaeffer....................... 44 Chief Technology Officer and Director
John S. Reiland....................... 50 Chief Financial Officer and Director
Don Pate.............................. 44 Vice President -- Worldwide Sales
Wayne E. Webb, Jr. ................... 49 Vice President and General Counsel
Jonathan J. Reed...................... 44 Vice President of Marketing
Kevin O'Brien......................... 43 Vice President of Technical Operations
Charles E. Noell III(a)(b)............ 48 Director
Norris van den Berg(a)(b)............. 61 Director
Richard Holcomb(a).................... 38 Director
George Ellis(b)....................... 51 Director
</TABLE>
---------------
(a) Member of the Compensation Committee.
(b) Member of the Audit Committee.
John J. Moores has served as Chairman of NEON's Board of Directors since
May 1993. Since December 1994, Mr. Moores has served as owner and Chairman of
the Board of the San Diego Padres Baseball Club, L.P. and since September 1991
as Chairman of the Board of JMI Services, Inc., a private investment company. In
1980, Mr. Moores founded BMC Software, a vendor of system software utilities,
and served as its President and Chief Executive Officer until 1986 and as its
chairman of the Board until 1992. Mr. Moores also serves as Chairman of the
Board of Peregrine Systems, Inc., an infrastructure management software company,
and numerous privately held companies, including Skunkware, Inc. Mr. Moores
serves as a director of BindView Development Corporation, a systems management
software company. Mr. Moores holds a B.S. in Economics and a J.D. from the
University of Houston.
Joe Backer has served as NEON's President and Chief Executive Officer and
as a member of NEON's Board of Directors since November 1995. From December 1993
to October 1995, Mr. Backer was a private investor. Mr. Backer held the position
of Senior Vice President of BMC Software from November 1989 to November 1993.
Mr. Backer also serves as President, Chief Executive Officer and a member of the
Board of Directors of Peregrine/Bridge Transfer Corporation and Skunkware, Inc.
In addition, Mr. Backer serves as a member of the Board of Directors of Pavilion
Technologies Inc., a privately held software company headquartered in Austin,
Texas. Mr. Backer holds a B.S. in Electrical Engineering from Purdue University.
Peter Schaeffer is NEON's founder and has been a member of the Board of
Directors of NEON and NEON's predecessor-in-interest, NEON Systems, Inc., an
Illinois corporation, since July 1991. Since November 1995, Mr. Schaeffer has
served as NEON's Chief Technology Officer. From July 1991 to October 1995, Mr.
Schaeffer served as NEON's President and Chief Executive Officer. From June 1990
to June 1991, Mr. Schaeffer was employed with Goal Systems International, Inc.,
a privately held software development company. In 1986, Mr. Schaeffer co-founded
MVS Software, a privately held software development company, and was Vice
President -- Technology of MVS Software until April 1990. Mr. Schaeffer holds a
B.S. in Organic Chemistry from the University of Chicago.
John S. Reiland has served as NEON's Chief Financial Officer since July
1996 and as a member of NEON's Board of Directors since November 1998. Mr.
Reiland also serves as Chief Financial Officer of Peregrine/Bridge Transfer
Corporation. From June 1994 to April 1996, Mr. Reiland served as Senior Vice
President, Chief Financial Officer and a director of Pointe Communications
Corporation, an international telecommunication and Internet service provider.
From May 1991 to May 1994, Mr. Reiland served as Vice
13
<PAGE> 16
President of Motor Columbus AG, an international long-distance telephone service
reseller, and also served as Chief Executive Officer of its subsidiary, WorldCom
International, Inc. Mr. Reiland is a Certified Public Accountant and holds a
B.B.A. in Accounting from the University of Houston.
Don Pate has served as NEON's Vice President -- Worldwide Sales since March
1998 and served as NEON's Vice President of Sales from November 1996 to March
1998. From October 1989 to November 1996, Mr. Pate served in several sales and
sales management positions with BMC Software, including Manager of International
Sales, Sales Operations Manager and Regional Manager. Prior to that, Mr. Pate
was a salesman for the IBM Corporation. Mr. Pate holds a B.S. in Economics and
Psychology from Houston Baptist University.
Wayne E. Webb, Jr. has served as NEON's Vice President and General Counsel
since June 1998. Mr. Webb is also Vice President and General Counsel of
Peregrine/Bridge Transfer Corporation. From August 1989 through May 1998, Mr.
Webb was a partner in the law firm of Fulbright & Jaworski LLP. Mr. Webb holds a
B.S. in Electrical Engineering from Rice University and a J.D. from the
University of Texas at Austin.
Jonathan J. Reed has served as NEON's Vice President of Marketing since
January 1999. From January 1998 through December 1998, Mr. Reed served as NEON's
Director of Marketing. From July 1996 to December 1997, Mr. Reed served as
NEON's Principal Consultant and Technical Marketing Manager. From April 1995
until July 1996, Mr. Reed served as Alliance Manager for Sybase, Inc., a
distributed computing company. From March 1991 to April 1995, Mr. Reed was
employed by BMC Software where he served as a Commercial Analyst. Mr. Reed holds
a B.S. in Biology from the University of Houston and an M.S. in Management and
Computer Science from Houston Baptist University.
Kevin O'Brien has served as NEON's Vice President of Technical Operations
since April 2000. From March 1996 until April 2000, Mr. O'Brien served as NEON's
Manager of Customer Support. In August 1995, Mr. O'Brien began his employment
with NEON as a Customer Support Representative. From April 1994 until August
1995, Mr. O'Brien served as Customer Support Leader for Mission Critical
Software. Prior to that, Mr. O'Brien was employed by BMC Software where he
served as a Product Author. Mr. O'Brien holds a B.E. in Electrical Engineering
from Cork University in Ireland.
Charles E. Noell III has served as a director of NEON since May 1993. Since
January 1992, Mr. Noell has served as President and Chief Executive Officer of
JMI Services, Inc., and as a General Partner of JMI Partners, L.P., which is the
General Partner of JMI Equity Fund, L.P. Mr. Noell is a director of Peregrine
Systems, Inc. and also serves as a director of Transaction Systems Architects,
Inc., an electronic funds transfer company. Mr. Noell also serves on the board
of numerous privately held companies, including Peregrine/ Bridge Transfer
Corporation and Skunkware, Inc. Mr. Noell holds a B.A. in History from the
University of North Carolina at Chapel Hill and an M.B.A. from Harvard
University.
Norris van den Berg has served as a director of NEON since May 1993. Mr.
van den Berg has served as a General Partner of JMI Partners, L.P., which is the
General Partner of JMI Equity Fund, L.P., since July 1991. Mr. van den Berg is
also a director of Peregrine Systems, Inc., Peregrine/Bridge Transfer
Corporation and Skunkware, Inc. Mr. van den Berg holds a B.A. in Philosophy and
Mathematics from the University of Maryland.
Richard Holcomb has served as a director of NEON since May 1993. Mr.
Holcomb is a co-founder of haht Software, a privately held software company, and
has served as its Chairman of the Board since 1995. Mr. Holcomb co-founded Q+E
Software, a privately held supplier of client/server database access technology,
and from 1986 through 1994 served as its President. Mr. Holcomb serves as an
appointed member of the North Carolina Information Resources Management
Commission and on the board of the North Carolina Electronics and Technologies
Association. Mr. Holcomb holds a B.A. in Computer Science from the University of
South Carolina and an M.S. in Computer Science from North Carolina State
University.
George Ellis has served as a director of NEON since January 2000. Mr. Ellis
is currently a Managing Director of Chaparral Ventures. Mr. Ellis was a founder
of Sterling Commerce and served as its Executive Vice President and Chief
Financial Officer from 1995 through 1996. Mr. Ellis served as Chief Financial
14
<PAGE> 17
Officer of Sterling Software, Inc. from 1985 through 1996. Mr. Ellis also has
held financial and operations management roles at Texas Instruments, Inmos
Corporation and other technology-related companies. Mr. Ellis is an officer of
The Communities Foundation of Texas and a member of the Board of Advisors to the
law school at Southern Methodist University. Mr. Ellis currently serves on the
Board of Directors of AremisSoft and Future Three. Mr. Ellis is a certified
public accountant and an attorney in the State of Texas. Mr. Ellis holds a B.S.
in Accounting from Texas Tech University and a J.D. from Southern Methodist
University.
RISK FACTORS
This Report and the annual report to stockholders contain certain
forward-looking statements within the meaning of the federal securities laws,
and which are intended to be covered by the safe harbors available under such
laws. Actual results and the timing of certain events could differ materially
from those projected in or contemplated by the forward-looking statements due to
a number of factors, including, without limitation, those set forth below and
elsewhere in this Report. In addition to the other information in this Report,
the following factors, which may affect NEON's current position and future
prospects, should be considered carefully in evaluating NEON and an investment
in its common stock.
BECAUSE OUR EXPENSES ARE LARGELY FIXED, AN UNEXPECTED REVENUE SHORTFALL MAY
ADVERSELY AFFECT OUR BUSINESS
Our expense levels are based primarily on our estimates of future revenues
and are largely fixed. We also intend to hire additional personnel to support
additional growth of our business. We may be unable to adjust spending rapidly
enough to compensate for any unexpected revenue shortfall. Accordingly, any
significant shortfall in revenues in relation to our planned expenditures would
reduce, and possibly eliminate, any operating income and could materially
adversely affect our business, operating results and financial condition.
BECAUSE WE CANNOT ACCURATELY PREDICT THE AMOUNT AND TIMING OF INDIVIDUAL SALES,
OUR QUARTERLY OPERATING RESULTS MAY VARY SIGNIFICANTLY. THIS MAY ADVERSELY
IMPACT OUR STOCK PRICE
Our future operating results may vary significantly from quarter to quarter
due to a variety of factors, many of which are outside our control. Therefore,
it is likely that in one or more future quarters our results may fall below the
expectations of securities analysts and investors. Although we have numerous
customer trials of our products in process at any given time, we operate with
virtually no order backlog because our products are shipped and revenues are
recognized shortly after orders are received. In addition, the amount of
revenues associated with sales of our software can vary significantly. In
various quarters in the past, we have derived a significant portion of our
software license revenues from a small number of relatively large sales. An
inability to close one or more large sales that we had targeted to close in a
particular period could materially adversely affect our operating results for
that period. Moreover, we typically realize a majority of our software license
revenues in the last month of a quarter. As a result, minor delays in the timing
of customer orders can shift a sale from its contemplated quarter of completion
to a subsequent quarter and cause significant variability in our operating
results for any particular period. Further, we believe that period-to-period
comparisons of our operating results are not necessarily a meaningful indication
of future performance. If our quarterly results do not meet investors'
expectations, the trading price of our common stock would likely decline.
SEASONAL TRENDS IN SALES OF OUR PRODUCTS MAY AFFECT INVESTORS' EXPECTATIONS
REGARDING OUR FINANCIAL PERFORMANCE AND ADVERSELY AFFECT OUR STOCK PRICE
Historically, our revenues have tended to be strongest in the third and
fourth quarters of our fiscal year and to decrease slightly in our first fiscal
quarter. The expectations of investors who rely on our third or fourth quarter
results in a given year may be adversely impacted if this seasonal trend
continues. We believe that our seasonality is due in part to the calendar year
budgeting cycles of many of our customers, our employee recognition policies
which tend to reward our sales personnel for achieving fiscal year-end rather
than quarterly revenue quotas, and the timing of our hiring of sales force
personnel. In future periods, we expect
15
<PAGE> 18
that this seasonal trend will continue to cause first fiscal quarter license
revenues to decrease from the level achieved in the preceding quarter.
BECAUSE A SIGNIFICANT PERCENTAGE OF OUR REVENUES ARE DERIVED FROM OUR SHADOW
PRODUCT GROUP, DECREASED DEMAND FOR THESE PRODUCTS COULD ADVERSELY AFFECT OUR
BUSINESS
Approximately 90% of our revenues over fiscal 2000, 1999 and 1998 was
derived from Shadow Direct, Shadow Web Server and Shadow Enterprise Direct. 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, Shadow Web Server and
Shadow Enterprise Direct 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 which is 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, comprising
a portion of our eBusiness Integration product family, and, to a lesser extent,
from our suite of Enterprise Subsystem Management software products that support
the growing performance demands on mainframe computers as they support new users
and applications and our new Enterprise Security Management product that helps
to protect corporate assets in common application processing environments.
Although demand for mainframe access and management solutions has grown in
recent years, it may not continue to grow. Our continued success depends on a
number of factors, including:
- Continued use of the mainframe as a central repository of
mission-critical data and transactions
- Growth in business demands for access to the data, applications and
transactions residing on mainframe computers from Web-based and
client/server applications
LOSS OF OUR CHIEF TECHNOLOGY OFFICER OR OUR PRODUCT AUTHORS COULD ADVERSELY
AFFECT OUR BUSINESS
Our success is dependent upon the continued service and skills of our
executive officers and our product authors, none of whom is bound by an
employment agreement. If we lose the services of any of these key personnel, it
could have a negative impact on our business because of their unique skills,
years of industry experience and the difficulty of promptly finding qualified
replacement personnel. Particularly, the services of Peter Schaeffer, our
founder and Chief Technology Officer, would be difficult to replace. We do not
intend to maintain "key-man" life insurance policies covering any of our
employees. Significant competition exists for employees with the skills required
to author the products and perform the maintenance services that we offer, and
we may not be able to continue to retain sufficient numbers of highly skilled
employees.
WE MAY LOSE MARKET SHARE AND BE REQUIRED TO REDUCE PRICES AS A RESULT OF
COMPETITION FROM OUR EXISTING COMPETITORS, OTHER VENDORS AND INFORMATION SYSTEMS
DEPARTMENTS OF CUSTOMERS
We compete in markets that are intensely competitive and feature rapidly
changing technology and evolving standards. Our competitors may be able to
respond more quickly than we can to new or emerging technologies and changes in
customer requirements. Competitive pressures could reduce our market share or
require us to reduce the price of our products, either of which could have a
material adverse effect on our business, operating results and financial
condition.
Our potential field of competitors continues to expand as both
organizations and vendors recognize the need for products that permit users to
access mainframe-based data and applications for integration with applications
on their personal computers that we refer to as eBusiness Integration products,
and Enterprise
16
<PAGE> 19
Subsystem Management products. Our Shadow product group competes 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, and our iWave
product group competes with products offered by Active Software, Vitria
Technologies and Crossworlds. Our Enterprise Subsystem Management products face
significant competition from BMC Software, and our Enterprise Security
Management product competes with products offered by Computer Associates,
Proginet, Blockade Systems Corporation and New Era of Networks. We expect to
experience increased competition from current and potential competitors, many of
which have significantly greater financial, technical, marketing and other
resources than we do. We may also face competition from:
- Other business application software vendors who may internally develop,
or attain through acquisitions and partnerships, middleware and
enterprise subsystem management and enterprise security solutions
- Internal development efforts by corporate information technology
departments
- New entrants to the middleware or enterprise subsystem management markets
WE MAY NOT HAVE THE RESOURCES TO SUCCESSFULLY MANAGE ADDITIONAL GROWTH
Our recent growth has placed significant demands on management as well as
on our administrative, operational and financial resources. Our inability to
sustain or manage any additional growth could have a material adverse effect on
our business, operating results and financial condition. In addition, expansion
of our existing international operations and entry into additional international
markets will require significant management attention and financial resources.
To manage any additional growth, we must:
- Expand our sales, marketing and customer support organizations
- Invest in the development of enhancements to existing products and new
products that meet changing customer needs
- Further develop our technical expertise so that we can influence and
respond to emerging industry standards
- Improve our operational processes and management controls
RAPID TECHNOLOGICAL CHANGE COULD RENDER OUR PRODUCTS OBSOLETE
Our markets are characterized by rapid technological change, frequent new
product introductions and enhancements, uncertain product life cycles, changes
in customer requirements and evolving industry standards. The introduction of
new products embodying new technologies and the emergence of new industry
standards could render our existing products obsolete which would have a
material adverse effect on our business, operating results and financial
condition. Our future success will depend upon our ability to continue to
develop and introduce a variety of new products and product enhancements to
address the increasingly sophisticated needs of our customers. We may experience
delays in releasing new products and product enhancements in the future.
Material delays in introducing new products or product enhancements may cause
customers to forego purchases of our products and purchase those of our
competitors.
WE MAY BE UNABLE TO ENFORCE OR DEFEND OUR OWNERSHIP AND USE OF PROPRIETARY
TECHNOLOGY
Our success depends to a significant degree upon our proprietary
technology. We rely on a combination of trademark, trade secret and copyright
law, and contractual restrictions and passwords to protect our proprietary
technology. However, these measures provide only limited protection, and we may
not be able to detect unauthorized use or take appropriate steps to enforce our
intellectual property rights, particularly in foreign countries where the laws
may not protect our proprietary rights as fully as in the United States.
Companies in the software industry have experienced substantial litigation
regarding intellectual property. Any
17
<PAGE> 20
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, and have recently established
a telesales subsidiary office in Australia. We have distributors in Europe,
Latin America and the Pacific Rim to market and sell our products in those
regions. We plan to expand our current international operations and to establish
additional facilities and marketing relationships in additional regions. Our
international operations are subject to particular risks, including:
- Impact of recessions in economies outside the United States
- Difficulty in accounts receivable collection and longer collection
periods
- Cost of enforcement of contractual obligations
- Difficulties and costs of managing foreign operations
- Limited protection for intellectual property rights in some countries
- Currency exchange rate fluctuations
- Political and economic instability
- Potentially adverse tax consequences
Our international revenues are generally denominated in local currencies.
We do not currently engage in currency hedging activities; however, we may
implement a program to mitigate foreign currency transaction risk in the future.
Future fluctuations in currency exchange rates may adversely affect our revenues
from international sales.
18
<PAGE> 21
USE OF OUR NAME BY OTHERS MAY CAUSE CONFUSION IN THE MARKET
A number of organizations, including New Era of Networks, Inc., are
utilizing the name "Neon," both alone and in combination with other words, as a
trademark, a tradename or both. Any litigation to enforce our right to use the
NEON name in our business or to prevent others from using the NEON name would be
expensive and time-consuming, would divert management resources and may not be
adequate to protect our business. New Era of Networks is also a developer and
distributor of middleware and other software products. New Era of Networks has
used the acronym "NEON" in its business, is listed on the Nasdaq National Market
System under the symbol "NEON" and has sought to obtain federal trademarks for
products and services whose names include the word "NEON." We are currently
opposing, in the U.S. Patent and Trademark Office, New Era of Networks'
application to register "NEONET." New Era of Networks has filed a complaint
against NEON in the United States District Court for the District of Colorado
seeking (1) a declaratory judgment that New Era of Networks' use of certain
trademarks, including "NEONET," does not infringe our rights or constitute
unfair competition and (2) cancellation of our federal trademark registration
for "NEON." NEON has filed an answer denying the material allegation of that
complaint. On February 11, 2000, the judge in the Colorado proceeding advised
the parties that the court intends to grant summary judgment for cancellation of
the federal trademark registration for the "NEON" mark. If such judgment is
entered, it will not affect NEON's right to use the "NEON" mark, which NEON
believes is superior to that of New Era of Networks. Discovery related to this
litigation has been completed, but no trial date has been set. On June 23, 1999,
NEON sued New Era of Networks in District Court in Fort Bend County, Texas,
seeking to enjoin New Era of Networks' use of "NEON" as its "nickname," stock
symbol or in any manner that does or is likely to cause confusion in the
marketplace or dilute the value of NEON's name. If we should lose any such
litigation, we may have to change our name, which also would be expensive and
time-consuming and could adversely affect our business. In addition, NEON
believes that New Era of Networks' use of the "NEON" symbol on the Nasdaq
National Market System creates confusion in the marketplace and may result in
variations in our stock price that are attributable to facts or circumstances
relating to New Era of Networks.
OUR PRODUCTS MAY CONTAIN UNDETECTED SOFTWARE ERRORS, WHICH COULD ADVERSELY
AFFECT OUR BUSINESS
Our software products and the software products that we sell for others are
complex and may contain undetected errors. These undetected errors could result
in adverse publicity, loss of revenues, delay in market acceptance or claims
against us by customers, all of which could seriously damage our business,
operating results and financial condition. We have previously discovered
software errors in certain of the products that we have developed or sold.
Despite testing, we cannot be certain that errors will not be found in current
versions, new versions or enhancements of our products after commencement of
commercial shipments.
THE COMPLEX TECHNOLOGY OF OUR PRODUCTS SUBJECTS US TO LIABILITY CLAIMS
Because our products provide critical database access, integration and
management functions, we may face significant liability claims if our customers
believe that our products have failed to perform their intended functions.
Liability claims could require us to spend significant time and money in
litigation or to pay significant damages. As a result, any such claims, whether
or not successful, could have a material adverse effect on our reputation and
business, operating results and financial condition. Our agreements with
customers typically contain provisions intended to limit our exposure to
liability claims. However, these contract provisions may not preclude all
potential claims.
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
19
<PAGE> 22
effect on our business. In addition, the market price of our common stock may be
subject to significant fluctuations in response to numerous factors, including:
- Variations in our annual or quarterly financial results or those of our
competitors
- Changes by financial research analysts in their estimates of our earnings
or our failure to meet such estimates
- Conditions in the economy in general or in the software and other
technology industries
- Announcements of key developments by competitors
- Loss of key personnel
- Unfavorable publicity affecting our industry or us
- Adverse legal events affecting us
- Sales of NEON common stock by stockholders
THE AVAILABILITY OF SIGNIFICANT AMOUNTS OF OUR COMMON STOCK FOR SALE COULD
ADVERSELY AFFECT ITS MARKET PRICE
If our stockholders sell substantial amounts of our common stock in the
public market, the market price of our common stock could fall. A substantial
number of sales, or the perception that such sales might occur, also might make
it more difficult for us to sell equity or equity-related securities in the
future at a time and price that we deem appropriate. We granted registration
rights to two of our stockholders, Peter Schaeffer and JMI Equity Fund, L.P.
Those rights enabled these stockholders to require that we register, at our
expense, resales of their shares of common stock. Mr. Schaeffer and the
individuals and entities to which JMI Equity Fund, L.P. recently distributed its
shares of our common stock beneficially own in the aggregate approximately 3.8
million 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.
OUR OFFICERS AND DIRECTORS CONTROL NEON, AND THESE OFFICERS AND DIRECTORS COULD
EFFECTIVELY CONTROL MATTERS SUBMITTED TO OUR STOCKHOLDERS
At present, our executive officers and directors and entities affiliated
with them beneficially own approximately 47% of our outstanding Common Stock. As
a result, these stockholders, if they act together and obtain the assent of
another 3% of our outstanding common stockholders, could control all matters
submitted to our stockholders for a vote, including the election of directors
and the approval of mergers and other business combination transactions.
PROVISIONS OF OUR CHARTER AND BYLAWS AND DELAWARE LAW COULD DETER TAKEOVER
ATTEMPTS
Provisions of our Certificate of Incorporation and Bylaws as well as
Delaware law could make it more difficult for a third party to acquire us, even
if doing so would be beneficial to our stockholders. We are subject to the
provisions of Delaware law which restrict certain business combinations with
interested stockholders, which may have the effect of inhibiting a
non-negotiated merger or other business combinations.
ITEM 2. PROPERTIES
NEON's principal administrative, engineering, manufacturing, marketing and
sales facility is approximately 51,700 square feet and is located in Sugar Land,
Texas. The lease for this facility will expire on March 31, 2005. In addition,
NEON leases offices in London, England; Frankfurt, Germany; and Sydney,
Australia and operates development sites in Redmond, Washington; Colorado
Springs, Colorado and Cary, North Carolina. 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.
20
<PAGE> 23
ITEM 3. LEGAL PROCEEDINGS
A number of organizations, including New Era of Networks, Inc., are
utilizing the name "NEON," alone and in combination with other words, as a
trademark, a tradename or both. New Era of Networks is also a developer and
distributor of middleware and other software products. New Era of Networks has
used the acronym "NEON" in its business, is listed on the Nasdaq National Market
under the symbol "NEON" and has sought to obtain federal trademarks for products
and services whose names include the word "NEON." NEON is currently opposing in
the U.S. Patent and Trademark Office New Era of Networks' application to
trademark "NEONET." On December 24, 1998, New Era of Networks filed a complaint
against NEON in the United States District Court for the District of Colorado
seeking (1) a declaratory judgment that New Era of Networks' use of certain
trademarks, including "NEONET," does not infringe NEON's rights or constitute
unfair competition and (2) cancellation of NEON's federal trademark registration
for NEON. NEON has filed an Answer denying the material allegations of that
complaint. On February 11, 2000, the judge in the Colorado proceeding advised
the parties that the court intends to grant summary judgment for cancellation of
the federal trademark registration for the "NEON" mark. If such judgment is
entered, it will not affect NEON's right in the "NEON" mark, which NEON believes
to be superior to that of New Era of Networks. Discovery has been completed in
the action, but no trial date has been set.
On June 23, 1999, NEON sued New Era of Networks in Fort Bend County, Texas,
alleging that New Era of Networks' use of "NEON" was in violation of Texas law
concerning tradenames and trademarks, and at the time of filing of this Report
the parties were in the discovery phase of this litigation. In this litigation,
NEON seeks to enjoin New Era of Networks from using "NEON" as its "nickname,"
its Nasdaq trading symbol, or in any other manner that is likely to result in
confusion in the marketplace, or to dilute the meaning or value of NEON's name.
NEON's claims are based upon its prior and continuous use of "NEON" as its
corporate name. NEON believes that it has superior rights to use "NEON" and that
New Era of Networks' use of "NEON" is causing confusion in the marketplace. This
and any other litigation to enforce NEON's right to use the NEON name in NEON's
business or to prevent others from using the NEON name may be expensive and
time-consuming, may divert management resources and may not be adequate to
protect NEON's business. If NEON should lose any such litigation, it may have to
change its name, which also would be expensive and time-consuming and could
adversely affect NEON's business.
On October 29, 1999, NEON entered into an agreed settlement with BMC
Software of its lawsuit with BMC Software. BMC Software originally filed the
lawsuit in August 1995 in the District Court of Travis County, Texas, 200th
Judicial District, against Peregrine/Bridge Transfer Corporation, John J. Moores
and a group of employees of Peregrine/Bridge Transfer Corporation who were also
former employees of BMC Software. In the lawsuit, BMC Software had alleged
misappropriation and infringement of certain trade secrets, confidential
information and corporate opportunity, as well as breach of contract and
fiduciary relations by the named individuals. NEON, which is the exclusive
distributor of software products developed by Peregrine/Bridge Transfer
Corporation, had been named as a co-defendant in this lawsuit in December 1996.
The October 1999 settlement resolved claims by BMC Software relating to NEON's
and Peregrine/ Bridge Transfer Corporation's title in and right to market the
products of Peregrine/Bridge Transfer Corporation that were the subject of the
lawsuit. Under the terms of the settlement, BMC Software paid $30 million to
parties other than NEON. BMC Software and NEON also entered into a software
distribution agreement under which, if fully performed by the parties, NEON
would receive an aggregate of $8.6 million, payable quarterly over two years,
for its products. In addition, the settlement does not obligate NEON or any
other co-defendant to make any present or future cash payment or disgorgement or
impose any restriction on the marketing and sale by NEON of its or
Peregrine/Bridge Transfer Corporation's products. NEON has been indemnified for
its costs and expenses in this lawsuit by Peregrine/Bridge Transfer Corporation
under the terms of its distributor agreement with Peregrine/Bridge Transfer
Corporation.
NEON is involved in various other claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of any of these matters will not have a material adverse effect on
NEON's consolidated financial position, results of operations or liquidity.
21
<PAGE> 24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No stockholder votes took place during the fourth quarter of the fiscal
year ended March 31, 2000.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
NEON's Common Stock trades on the Nasdaq Stock Market under the symbol
"NESY." NEON completed its initial public offering in March 1999 and sold
3,041,000 shares of its common stock at a price of $15.00 per share. The
following table sets forth, for the fiscal periods indicated, the ranges of high
and low last reported sale prices for the Common Stock since the initial public
offering.
<TABLE>
<CAPTION>
HIGH LOW
------ -------
<S> <C> <C>
FISCAL YEAR ENDED MARCH 31, 2000:
Fourth Quarter............................................ $40.00 $27.875
Third Quarter............................................. 39.25 16.50
Second Quarter............................................ 38.50 26.625
First Quarter............................................. 50.00 32.50
FISCAL YEAR ENDED MARCH 31, 1999:
Fourth Quarter (March 5, 1999 -- March 31, 1999).......... $55.00 $15.00
</TABLE>
During the three year period ended March 31, 2000, NEON issued unregistered
shares of its Common Stock to a limited number of persons as described below.
(1) In June 1998, NEON issued and sold 47,780 shares of common stock
to Wayne E. Webb, Jr. for an aggregate purchase price of $86,004 pursuant
to a restricted stock purchase effected under the 1993 Stock Plan.
(2) Effective immediately prior to the consummation of the sale of
shares of common stock pursuant to NEON's public offering, NEON issued
3,125,000 shares of its common stock to JMI Equity Fund, L.P. pursuant to
the conversion of 625,000 shares of its Series A Redeemable, Convertible
Preferred Stock held by such entity.
None of the foregoing transactions involved any underwriters, underwriting
discounts or commissions, or any public offering, and NEON believes that each
transaction was exempt from the registration requirements of the Act by virtue
of Section 4(2) thereof or Rule 701 pursuant to compensatory benefit plans and
contracts relating to compensation as provided under such Rule 701. The
recipients in such transactions represented their intention to acquire the
securities for investment only and not with a view to or for sale in connection
with any distribution thereof, and appropriate legends were affixed to the share
certificates and instruments issued in such transactions. All recipients had
adequate access, through their relationships with NEON, to information about
NEON.
HOLDERS
On June 12, 2000, the last reported sale price of the common stock on the
Nasdaq Stock Market was $22.00 per share. At June 12, 2000, there were 126
holders of record of NEON's common stock, although NEON believes that the number
of beneficial owners of its common stock is substantially greater, and 9,427,486
shares outstanding.
In March 1999, NEON completed the initial public offering of its common
stock. The Securities and Exchange Commission declared the Form S-1 Registration
Statement (File No. 333-69651) relating to NEON's initial public offering
effective on March 4, 1999. In the initial public offering, NEON issued and sold
3,041,000 shares for an aggregate price to the public of $45,615,000 and a
single selling stockholder sold
22
<PAGE> 25
64,000 shares of common stock for an aggregate offering price of $960,000. The
initial public offering was a firm commitment underwriting, and the managing
underwriters of the initial public offering were Donaldson, Lufkin & Jenrette
Securities Corporation, Hambrecht & Quist LLC and CIBC Oppenheimer Corp. The
underwriting discount incurred by NEON relating to its initial public offering
was $3,193,050. Net offering proceeds received by NEON from the initial public
offering were approximately $41.2 million. Approximately $1.0 million of the
proceeds received by NEON from its initial public offering were used to repay
existing indebtedness. NEON invested the proceeds received by it from the
initial public offering (other than the proceeds used to repay the existing
indebtedness described above) in short term, interesting-bearing,
investment-grade securities.
DIVIDENDS
NEON has never declared any cash dividends on its common stock. NEON does
not anticipate paying any cash dividends on its common stock in the foreseeable
future and intends to retain its earnings, if any, to finance the expansion of
its business and for general corporate purposes. Any payment of future dividends
will be at the discretion of the Board of Directors and will depend upon, among
other things, NEON's earnings, financial condition, capital requirements, level
of indebtedness, contractual restrictions and other factors that NEON's Board of
Directors deems relevant.
23
<PAGE> 26
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The selected consolidated financial data below should be read in
conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and Item 8, "Consolidated Financial
Statements and Supplementary Data," included elsewhere herein.
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------ ------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
License...................................... $22,860 $15,420 $ 9,806 $6,183 $2,190
Maintenance.................................. 6,859 4,596 2,397 1,003 276
------- ------- ------- ------ ------
Total revenues....................... 29,719 20,016 12,203 7,186 2,466
Cost of revenues:
Cost of licenses............................. 1,484 1,032 552 212 18
Cost of maintenance.......................... 1,699 986 743 392 159
------- ------- ------- ------ ------
Total cost of revenues............... 3,183 2,018 1,295 604 177
------- ------- ------- ------ ------
Gross profit................................... 26,536 17,998 10,908 6,582 2,289
Operating expenses:
Sales and marketing.......................... 11,330 7,418 5,713 3,469 1,307
Research and development..................... 5,612 3,800 2,258 1,525 1,205
General and administrative................... 3,459 2,566 1,480 696 310
Non-cash compensation........................ 490 767 14 -- --
Amortization of acquisition related costs.... 238 -- -- -- --
------- ------- ------- ------ ------
Total operating expenses............. 21,129 14,551 9,465 5,691 2,822
------- ------- ------- ------ ------
Operating income (loss)........................ 5,407 3,447 1,443 891 (532)
Interest and other, net........................ 2,256 185 28 (67) (66)
------- ------- ------- ------ ------
Income (loss) before provision for income
taxes........................................ 7,663 3,632 1,471 823 (598)
Provision for income taxes..................... 2,759 1,380 310 7 --
------- ------- ------- ------ ------
Net income (loss).............................. 4,904 2,252 1,161 816 (598)
Dividends on series A redeemable convertible
preferred stock.............................. -- (75) (100) (80) (80)
------- ------- ------- ------ ------
Net income (loss) applicable to common
stockholders................................. $ 4,904 $ 2,177 $ 1,061 $ 736 $ (678)
======= ======= ======= ====== ======
Earnings (loss) per common share(a):
Basic........................................ $ 0.55 $ 0.71 $ 0.45 $ 0.35 $(1.62)
======= ======= ======= ====== ======
Diluted...................................... $ 0.47 $ 0.30 $ 0.19 $ 0.14 $(1.62)
======= ======= ======= ====== ======
Shares used in computing earnings (loss) per
common share(a):
Basic........................................ 8,914 3,065 2,371 2,094 417
Diluted...................................... 10,461 7,517 6,268 5,671 417
</TABLE>
24
<PAGE> 27
<TABLE>
<CAPTION>
AS OF MARCH 31,
----------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------ ------- -------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents..................... $37,120 $45,400 $2,804 $ 1,705 $ 131
Working capital............................... 41,430 45,295 973 876 47
Total assets.................................. 60,500 52,635 6,352 3,093 730
Secured notes payable......................... -- -- 1,049 1,049 1,130
Series A redeemable, convertible preferred
stock....................................... -- -- 1,663 1,563 1,233
Total stockholders' equity (deficit).......... 51,858 45,830 (234) (1,416) (2,228)
</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.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion contains forward-looking statements that involve
risks and uncertainties. NEON's actual results could differ materially from
those discussed in the forward-looking statements as a result of certain factors
including those set forth under "Risk Factors" and elsewhere in this Report. The
following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto appearing elsewhere in
this Report.
OVERVIEW
NEON develops, markets and supports eBusiness 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 group, Shadow Enterprise Direct, in February 1996. NEON's
Shadow products provide rapid and cost-effective access to and connectivity
between enterprise data, transactions and applications. Shadow Direct enables
client/server applications to access and integrate with mainframe data and
applications. Shadow Enterprise Direct provides access and integration between
client/server systems. NEON's iWave product group provides a cross-platform EAI
and B2B integration platform from one infrastructure. 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 thirteen products, improves the
availability and performance of mainframe subsystems to support the growing
demands placed on the mainframe. In May 1999 NEON introduced Halo SSO, its
Enterprise Security Management product, to provide cost-effective and automated
management of small numbers of key corporate security issues across common and
interoperable mainframe and desktop environments.
NEON has devoted significant resources to building its sales and marketing
functions, resulting in revenues increasing from $2.5 million in fiscal 1996 to
$29.7 million in fiscal 2000. NEON's revenues increased $9.7 million, or 48%,
from $20.0 million in fiscal 1999 to $29.7 million in fiscal 2000. 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, approximately 90% of customers have elected to
continue maintenance service after the first year. In fiscal 2000, 1999 and
1998, maintenance revenues represented 23%, 23% and 20% of total revenues,
25
<PAGE> 28
respectively. Maintenance revenues are expected to continue to increase as a
percentage of total revenues as NEON's customer base continues to grow.
NEON recognizes revenues in accordance with the American Institute of
Certified Public Accountants Statement of Position 97-2. NEON sells its products
under perpetual license and recognizes license revenues when all of the
following conditions are met: a non-cancellable license agreement has been
signed; the product has been delivered; there are no material uncertainties
regarding customer acceptance; collection of the receivable is probable; and no
other significant vendor obligation exists. Maintenance revenues are recognized
ratably over the maintenance service period, which is typically one year. The
portion of maintenance revenues that has not yet been recognized as revenue is
reported as deferred revenue on NEON's balance sheet.
NEON conducts its business in the United Kingdom and Germany through two
wholly-owned consolidated subsidiaries. Revenues from these subsidiaries are
denominated in local currencies. Pursuant to these foreign operations, NEON is
exposed to foreign currency fluctuations for its net working capital positions.
At March 31, 2000, NEON had unhedged net current assets denominated in British
pounds aggregating 1,588,012 British pounds and unhedged net current liabilities
denominated in Deutsche marks aggregating 590,803 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 28%, 28% and 41% in fiscal 2000, 1999 and 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 and from the level experienced in fiscal 2000.
26
<PAGE> 29
RESULTS OF OPERATIONS
The following table sets forth, for the periods illustrated, certain
statement of operations data expressed as a percentage of total revenues:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------
2000 1999 1998
----- ----- -----
<S> <C> <C> <C>
Revenues:
License................................................... 76.9% 77.0% 80.4%
Maintenance............................................... 23.1 23.0 19.6
----- ----- -----
Total revenues.................................... 100.0 100.0 100.0
Cost of revenues:
Cost of licenses.......................................... 5.0 5.2 4.5
Cost of maintenance....................................... 5.7 4.9 6.1
----- ----- -----
Total cost of revenues............................ 10.7 10.1 10.6
----- ----- -----
Gross profit................................................ 89.3 89.9 89.4
Operating expenses:
Sales and marketing....................................... 38.1 37.1 46.8
Research and development.................................. 18.9 19.0 18.5
General and administrative................................ 11.6 12.8 12.2
Non-cash compensation..................................... 1.6 3.8 0.1
Amortization of acquisition related costs................. 0.8 -- --
----- ----- -----
Total operating expenses.......................... 71.1 72.7 77.6
----- ----- -----
Operating income............................................ 18.2 17.2 11.8
Interest and other, net..................................... 7.6 0.9 0.2
----- ----- -----
Income before provision for income taxes.................... 25.8 18.1 12.1
Provision for income taxes.................................. 9.3 6.9 2.5
----- ----- -----
Net income........................................ 16.5% 11.3% 9.5%
===== ===== =====
</TABLE>
FISCAL YEARS ENDED MARCH 31, 2000, 1999 AND 1998
REVENUES
Total Revenues. Total revenues were $29.7 million, $20.0 million and $12.2
million in fiscal 2000, 1999 and 1998, respectively, representing
period-to-period increases of 48% and 64% for the fiscal 2000 and 1999 periods.
No customer accounted for 10% or more of NEON's total revenues in fiscal 2000.
License. License revenues were $22.9 million, $15.4 million and $9.8
million in fiscal 2000, 1999 and 1998, respectively, representing
period-to-period increases of 48% and 57% for the fiscal 2000 and 1999 periods.
Of the $7.5 million increase in license revenue in fiscal 2000 as compared to
fiscal 1999, $5.9 million or 79%, was attributable to increases in license sales
of NEON's existing Shadow products, including $2.0 million of revenues under a
software distribution agreement with BMC Software entered in connection with
NEON's settlement of a lawsuit originally filed by BMC Software (See Item 3.
Legal Proceedings). Primarily all of the remaining increase in license revenues
in fiscal 2000 as compared to fiscal 1999 was attributable to license sales of
Enterprise Subsystem Management products. The license revenue increase in fiscal
1999 compared to fiscal 1998 was attributable to increases in the number of
license sales of NEON's existing Shadow products, and to a lesser extent, to
license sales of new Enterprise Subsystem Management products.
Maintenance. Maintenance revenues were $6.9 million, $4.6 million and $2.4
million in fiscal 2000, 1999 and 1998, respectively, representing
period-to-period increases of 49% and 92% for the fiscal 2000 and 1999 periods.
These increases resulted from renewals of maintenance agreements from NEON's
installed base of customers and the recognition of deferred first-year
maintenance service fees on an increased level of license sales.
27
<PAGE> 30
COST OF REVENUES
Cost of Licenses. Cost of license revenues includes costs of product
licenses, such as product manuals, distribution and media costs for NEON's
software products, as well as royalty payments to third parties related to
license revenues primarily resulting from NEON's sales of Enterprise Subsystem
Management products. Cost of license revenues was $1.5 million, $1.0 million and
$552,000 in fiscal 2000, 1999 and 1998, respectively, representing 6%, 7% and 6%
of total license revenues in the respective periods. The dollar increases were
due primarily to increased sales of Enterprise Subsystem Management products and
the corresponding increased royalties paid to Peregrine/Bridge Transfer
Corporation under NEON's distributorship agreement with Peregrine/Bridge
Transfer Corporation.
Cost of Maintenance. Cost of maintenance revenues includes personnel and
other costs related to NEON's customer support departments. Cost of maintenance
revenues was $1.7 million, $986,000 and $743,000 in fiscal 2000, 1999 and 1998,
respectively, representing 25%, 21% 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. NEON expects that annual cost of maintenance will
increase in absolute dollars but should not vary substantially as a percentage
of total maintenance revenues from the level experienced in the fiscal year
ended March 31, 2000.
OPERATING EXPENSES
Sales and Marketing. Sales and marketing expenses include salaries,
commissions, bonuses, benefits and travel expenses of sales, presales support
and marketing personnel, together with trade show participation and other
promotional expenses. Sales and marketing expenses were $11.3 million, $7.4
million and $5.7 million in fiscal 2000, 1999 and 1998, respectively,
representing 38%, 37% and 47% of total revenues in the respective periods. The
dollar increase from fiscal 1999 to fiscal 2000 resulted primarily from
increases in compensation costs due to the hiring of additional North American
sales personnel and increased commissions paid as a result of NEON's revenue
growth, as well as an increase in costs associated with the sales offices in the
United Kingdom and Germany. In addition, the dollar increase reflects increased
commissions to NEON's independent international agents and increased marketing
and selling expenses, principally due to increases in marketing efforts and a
larger number of sales and marketing staff. The dollar increase from fiscal 1998
to fiscal 1999 reflects an increase in additional compensation expenses incurred
in the hiring of additional North American sales personnel and the payment of
increased sales commissions as a result of NEON's revenue growth. As NEON
continues to devote resources to the expansion of its sales and marketing
organization, NEON expects that annual sales and marketing expenses will
increase in absolute dollars but should not vary substantially as a percentage
of total revenues from the level experienced in the fiscal year ended March 31,
2000.
Research and Development. Research and development expenses include
salaries, bonuses and benefits to product authors, product developers and
product documentation personnel and the computer hardware, software and
telecommunication expenses associated with these personnel. NEON compensates
product authors based on a percentage of product license revenues generated by
products for which they are responsible. Research and development expenses were
$5.6 million, $3.8 million and $2.3 million in fiscal 2000, 1999 and 1998,
respectively, representing 19% of total revenues in each of these respective
periods. The dollar increases in these periods were primarily attributable to
increased compensation costs due to additional staffing and, to a lesser extent,
increased product commissions paid to product authors. Research and development
expenses are expected to increase in absolute dollar amounts but not vary
substantially as a percentage of total revenues from the level experienced in
the fiscal year ended March 31, 2000. NEON has adopted Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed." Research and development expenditures
generally have been charged to operations as incurred and any capitalizable
amounts have been immaterial.
General and Administrative. General and administrative expenses include
salaries, personnel and related costs for NEON's executive, financial, legal and
administrative staff. General and administrative expenses were $3.5 million,
$2.6 million and $1.5 million in fiscal 2000, 1999 and 1998, respectively,
representing 12%,
28
<PAGE> 31
13% and 12% of total revenues in the respective periods. The dollar increases
resulted primarily from increases in office and administrative costs associated
with NEON's subsidiaries in the United Kingdom and Germany, increases in
occupancy costs and increases in compensation expenses due principally to
administrative personnel additions necessary to support NEON's growth. NEON
anticipates general and administrative expenses will continue to increase in
absolute dollars but should not vary substantially as a percentage of total
revenues from the level experienced in the fiscal year ended March 31, 2000.
Non-Cash Compensation. During the twelve months prior to NEON's initial
public offering on March 5, 1999, NEON granted stock options at prices
subsequently considered 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, which is amortizable to
expense over the vesting period of the granted options. This deferred
compensation balance was reduced during the fiscal year ended March 31, 2000 by
$321,000 due to the cancellation of options associated with terminated
employees. During the fiscal year ended March 31, 2000, $490,000 was recognized
as non-cash compensation expense. The deferred balance of $899,000 will be
recognized over the remaining vesting period, approximately three years, of the
granted options. Additionally, in the third quarter of fiscal year 2000,
$349,000 was recognized as non-cash compensation expense related to
performance-based options granted to a NEON executive. The expense related to
the performance-based options was reversed in the fourth quarter, since the
applicable performance targets were not met and the options were cancelled.
Amortization of Acquisition Related Costs. On September 29, 1999, NEON
completed its acquisition of the assets of Beyond Software Inc. The acquisition
resulted in goodwill of approximately $2.4 million, which is being amortized on
a straight-line basis over five years. Goodwill amortization of $239,000 was
recognized in the fiscal year ended March 31, 2000.
Interest and Other Income, Net. Interest income was $2.3 million, $212,000
and $64,000 for the fiscal years ended March 31, 2000, 1999 and 1998,
respectively. The increases primarily result from investment of the increase in
NEON's cash and cash equivalents and investments balances derived primarily from
the $41.2 million of net proceeds received from NEON's March 1999 initial public
offering.
Provision for Income Taxes. NEON fully utilized its net operating loss
carry-forward for U.S. income tax purposes in fiscal 1998. NEON's U.S. income
taxes prior to fiscal 1998 were offset by net operating loss carry-forwards. The
effective income tax rate was 36%, 38% and 21% for fiscal 2000, 1999 and 1998,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
NEON's cash and cash equivalent balance was $37.1 million and $45.4 million
at March 31, 2000 and 1999, respectively. The decrease was due primarily to the
investment of $4.6 million in marketable securities. Additional cash
requirements included the acquisition of assets from Beyond Software Inc. in
September 1999 and the $3.5 million royalty advance to Sterling Software, Inc.
(Sterling) in December 1999 in connection with its acquisition of certain assets
from Sterling and the right to use, reproduce, copy and sell certain of
Sterling's products. These uses of cash were offset partially by profitable
operating results. The increase from March 31, 1998 to March 31, 1999 primarily
resulted from the $41.2 million net proceeds received from NEON's March 1999
initial public offering as well as positive cash flows from operating
activities.
Net cash provided by (used in) operating activities was ($121,000), $2.5
million and $1.3 million in fiscal 2000, 1999 and 1998, respectively. The use of
funds in fiscal 2000 resulted primarily from increases in accounts receivable
and an advance royalty payment to Sterling of $3.5 million, partially offset by
the increased profitability from NEON's business growth. Net cash provided by
operating activities during fiscal 1999 and 1998 was primarily the result of
increased profitability from the growth of NEON's business offset by increases
in accounts receivable.
A majority of NEON's revenues are recorded in the latter half of each
quarter. Accordingly, as NEON's quarterly revenues have increased, the aggregate
balance of accounts receivable-trade has also increased. Certain transactions in
fiscal 2000 included extended payment terms, totaling approximately $2.8
million,
29
<PAGE> 32
which further contributed to NEON's increasing accounts receivable-trade
balance. These amounts are due to be fully paid in fiscal 2001. Increases in
NEON's accounts receivable-trade balance will reduce interim cash flows
otherwise available from NEON's operating results.
Net cash used by NEON in investing activities was $8.1 million, $234,000
and $276,000 in fiscal 2000, 1999 and 1998, respectively. Purchases of both
short-term and long-term marketable securities and the acquisition of assets of
Beyond Software Inc. were the principal uses of investing funds in fiscal 2000.
Net cash used for investing activities in fiscal 1999 and 1998 was principally
for purchases of property and equipment, including computer hardware and
software to support NEON's growing employee base. As of March 31, 2000, NEON had
no material commitment for capital expenditures.
NEON's net cash provided by financing activities was $109,000, $40.2
million and $28,000 in fiscal 2000, 1999 and 1998, respectively. Net cash
provided by financing activities in fiscal 2000 was from amounts received from
the exercise of employee stock options, while net cash provided by financing
activities in fiscal 1999 consisted primarily of the $41.2 million net proceeds
received from NEON's March 1999 initial public offering offset by the subsequent
repayment of $1.0 million of secured notes payable. The cash provided by
financing activities in fiscal 1998 was from amounts received from the exercise
of employee stock options.
NEON adheres to a conservative investment policy, whereby its principal
concern is the preservation of liquid funds while maximizing its yield on such
assets. Cash and cash equivalents approximated $37.1 million at March 31, 2000
and were invested in varying types of money market securities. An additional
$2.0 million was invested in short-term available-for-sale marketable securities
with maturity dates from three months to one year in term, and $2.7 million was
invested in available-for-sale marketable securities with maturity dates beyond
one year. NEON believes that a near-term change in interest rates would not
materially affect its financial position, results of operations or net cash
flows for fiscal year 2001.
NEON believes that its current balances of cash and short-term investments
in marketable investment securities as well as cash provided by future
operations will be sufficient to meet its working capital and anticipated
capital expenditure requirements for at least the next 12 months. Thereafter,
NEON may require additional funds to support its working capital requirements or
for other purposes and may seek to raise such additional funds through public or
private equity financing or from other sources. There can be no assurance that
additional financing will be available at all, or if available, that such
financing will be obtainable on terms acceptable to NEON or that any additional
financing will not be dilutive.
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, there was widespread concern prior
to January 1, 2000 that some of these systems could fail to operate or fail to
produce correct results if "00" was interpreted to mean 1900, rather than 2000.
These problems have been commonly referred to as the Year 2000 Problem.
Present Year 2000 Status. NEON made the necessary conversions to become
Year 2000 compatible, spending less than $100,000 in this effort. No material
problems were encountered throughout the organization associated with the date
rollover. The minor problems that were encountered did not affect mission
critical systems, did not affect customers, did not disrupt business operations,
did not impact revenue and were corrected in a timely manner.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. It requires that companies recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. The Company expects to adopt SFAS No. 133 on
April 1, 2001, but has not determined the impact on its financial position,
results of operations or liquidity.
30
<PAGE> 33
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
NEON is exposed to a variety of risks, including foreign currency exchange
rate fluctuations and changes in the market value of its investments. In seeking
to minimize the risks and/or costs associated with such activities, NEON manages
exposure to change in interest rates and foreign currency exchange rates.
The majority of NEON's foreign currency transactions are denominated in
British pound sterling, which is the functional currency of NEON Systems (UK)
Ltd. As sales contracts are denominated and settled in the functional currency,
risks associated with currency fluctuations are minimized to foreign currency
translation adjustments. NEON does not currently hedge against foreign currency
translation risks and believes that foreign currency exchange risk is not
significant to its operations.
NEON adheres to a conservative investment policy, whereby its principal
concern is the preservation of liquid funds while maximizing its yield on such
assets. Cash and cash equivalents approximated $37.1 million at March 31, 2000
and were invested in varying types of money market securities. An additional
$2.0 million was invested in short-term available-for-sale marketable securities
with maturity dates from three months to one year in term, and $2.7 million was
invested in available-for-sale marketable securities with maturity dates beyond
one year. NEON believes that a near-term change in interest rates would not
materially affect its financial position, results of operations or net cash
flows for fiscal year 2001.
31
<PAGE> 34
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NEON SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ 33
Consolidated Balance Sheets................................. 34
Consolidated Statements of Operations....................... 35
Consolidated Statements of Stockholders' Equity (Deficit)
and Comprehensive Income.................................. 36
Consolidated Statements of Cash Flows....................... 37
Notes to Consolidated Financial Statements.................. 38
</TABLE>
32
<PAGE> 35
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,
2000 and 1999, and the related consolidated statements of operations,
stockholders' equity (deficit) and comprehensive income and cash flows for each
of the years in the three-year period ended March 31, 2000. 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, 2000 and 1999, and the
results of their operations and their cash flows for each of the years in the
three-year period ended March 31, 2000, in conformity with generally accepted
accounting principles.
KPMG LLP
Houston, Texas
April 24, 2000
33
<PAGE> 36
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF MARCH 31,
-------------------------
2000 1999
----------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $37,120,342 $45,400,015
Short-term investments.................................... 1,977,500 --
Accounts receivable-trade................................. 9,602,979 5,438,319
Accounts receivable-related party......................... -- 278,817
Deferred tax assets....................................... 712,948 571,990
Other current assets...................................... 658,326 410,620
----------- -----------
Total current assets.............................. 50,072,095 52,099,761
----------- -----------
Property and equipment:
Furniture and equipment................................... 1,612,080 895,970
Purchased software........................................ 1,114,788 78,774
Less accumulated depreciation and amortization............ (832,073) (487,670)
----------- -----------
Property and equipment, net....................... 1,894,795 487,074
Marketable securities....................................... 2,660,267 --
Goodwill, net............................................... 2,146,764 --
Other assets, net........................................... 3,726,236 47,916
----------- -----------
Total assets...................................... $60,500,157 $52,634,751
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accrued expenses.......................................... $ 818,637 $ 1,250,051
Accounts payable.......................................... 2,032,442 1,474,763
Accounts payable-related party............................ 6,942 --
Taxes payable............................................. 318,534 371,844
Deferred maintenance revenue.............................. 5,466,000 3,707,997
----------- -----------
Total current liabilities......................... 8,642,555 6,804,655
----------- -----------
Stockholders' Equity:
Preferred stock, $.01 par value. Authorized 10,000,000
shares; no shares issued and outstanding............... -- --
Common stock, $.01 par value. Authorized 30,000,000
shares; 9,005,584 and 8,848,251 shares issued and
outstanding at March 31, 2000 and 1999, respectively... 90,106 88,483
Additional paid-in capital................................ 46,697,763 46,174,124
Accumulated other comprehensive income (loss)............. (155,221) 57,849
Unearned portion of deferred compensation................. (899,377) (1,710,371)
Retained earnings......................................... 6,124,331 1,220,011
----------- -----------
Total stockholders' equity........................ 51,857,602 45,830,096
Commitments and contingencies (Note 7)
----------- -----------
Total liabilities and stockholders' equity........ $60,500,157 $52,634,751
=========== ===========
</TABLE>
See Accompanying Notes to Consolidated Financial Statements.
34
<PAGE> 37
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------------------------
2000 1999 1998
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
License.............................................. $22,859,955 $15,420,415 $ 9,806,287
Maintenance.......................................... 6,858,758 4,595,781 2,396,520
----------- ----------- -----------
Total revenues............................... 29,718,713 20,016,196 12,202,807
Cost of revenues:
Cost of licenses..................................... 1,483,597 1,031,708 551,736
Cost of maintenance.................................. 1,699,290 986,392 742,953
----------- ----------- -----------
Total cost of revenues....................... 3,182,887 2,018,100 1,294,689
----------- ----------- -----------
Gross profit........................................... 26,535,826 17,998,096 10,908,118
Operating expenses:
Sales and marketing.................................. 11,330,245 7,417,664 5,712,689
Research and development............................. 5,611,653 3,800,091 2,257,915
General and administrative........................... 3,458,986 2,566,500 1,480,616
Non-cash compensation................................ 489,746 767,284 13,662
Amortization of acquisition related costs............ 238,529 -- --
----------- ----------- -----------
Total operating expenses..................... 21,129,159 14,551,539 9,464,882
----------- ----------- -----------
Operating income....................................... 5,406,667 3,446,557 1,443,236
Interest income........................................ 2,314,595 212,474 64,029
Interest expense....................................... (3,412) (81,667) (85,521)
Other, net............................................. (54,850) 54,660 49,151
----------- ----------- -----------
Income before provision for income taxes..... 7,663,000 3,632,024 1,470,895
Provision for income taxes............................. 2,758,680 1,380,170 309,802
----------- ----------- -----------
Net income................................... 4,904,320 2,251,854 1,161,093
Dividends on series A redeemable, convertible preferred
stock................................................ -- (75,000) (100,000)
----------- ----------- -----------
Net income applicable to common
stockholders............................... $ 4,904,320 $ 2,176,854 $ 1,061,093
=========== =========== ===========
Earnings per common share:
Basic................................................ $ 0.55 $ 0.71 $ 0.45
=========== =========== ===========
Diluted.............................................. $ 0.47 $ 0.30 $ 0.19
=========== =========== ===========
Shares used in computing earnings per common share:
Basic................................................ 8,914,474 3,065,219 2,370,525
Diluted.............................................. 10,461,032 7,517,217 6,267,775
</TABLE>
See Accompanying Notes to Consolidated Financial Statements.
35
<PAGE> 38
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
AND COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
ACCUMULATED
OTHER UNEARNED RETAINED TOTAL
ADDITIONAL COMPREHENSIVE PORTION OF EARNINGS STOCKHOLDERS'
COMMON PAID-IN INCOME DEFERRED ACCUMULATED EQUITY
STOCK CAPITAL (LOSS) COMPENSATION DEFICIT) (DEFICIT)
------- ----------- ------------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT MARCH 31, 1997....... $22,604 $ 577,712 $ 1,133 $ -- $(2,017,936) $(1,416,467)
Comprehensive income:
Net income.................... -- -- -- -- 1,161,093 1,161,093
Foreign currency translation
loss........................ -- -- (2,095) -- -- (2,095)
-----------
Total 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)
Comprehensive income:
Net income.................... -- -- -- -- 2,251,854 2,251,854
Foreign currency translation
gain........................ -- -- 58,811 -- -- 58,811
-----------
Total comprehensive
income................ 2,310,665
Exercise of stock options....... 1,465 142,814 -- -- -- 144,279
Tax benefit related to exercise
of stock options.............. -- 23,709 -- -- -- 23,709
Deferred compensation related to
options granted............... -- 2,477,655 -- (2,477,655) -- --
Amortization of deferred stock
compensation.................. -- -- -- 767,284 -- 767,284
Preferred stock dividends....... -- -- -- -- (75,000) (75,000)
Preferred stock conversion to
common stock.................. 31,250 1,707,083 -- -- -- 1,738,333
Initial public offering......... 30,410 41,124,112 -- -- -- 41,154,522
------- ----------- --------- ----------- ----------- -----------
BALANCE AT MARCH 31, 1999....... 88,483 46,174,124 57,849 (1,710,371) 1,220,011 45,830,096
Comprehensive income:
Net income.................... -- -- -- -- 4,904,320 4,904,320
Foreign currency translation
loss........................ -- -- (166,734) -- -- (166,734)
Unrealized securities
losses...................... -- -- (46,336) -- -- (46,336)
-----------
Total comprehensive
income................ 4,691,250
Exercise of stock options....... 1,623 107,663 -- -- -- 109,286
Tax benefit related to exercise
of stock options.............. -- 737,224 -- -- -- 737,224
Deferred compensation related to
options granted............... -- (321,248) -- 321,248 -- --
Amortization of deferred stock
compensation.................. -- -- -- 489,746 -- 489,746
------- ----------- --------- ----------- ----------- -----------
BALANCE AT MARCH 31, 2000....... $90,106 $46,697,763 $(155,221) $ (899,377) $6,124,331 $51,857,602
======= =========== ========= =========== =========== ===========
</TABLE>
See Accompanying Notes to Consolidated Financial Statements
36
<PAGE> 39
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------------------------
2000 1999 1998
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.......................................... $ 4,904,320 $ 2,251,854 $ 1,161,093
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization.................... 344,403 198,539 144,344
Deferred tax expense............................. (140,958) (163,561) (380,532)
Noncash compensation expense..................... 489,746 767,284 13,662
Amortization of acquisition related costs........ 238,529 -- --
Increase (decrease) in cash, net of acquisition,
resulting from changes in:
Accounts receivable.............................. (3,823,421) (3,252,830) (1,424,468)
Other current assets............................. (247,706) (164,427) (218,291)
Other assets..................................... (3,678,320) (42,648) (5,268)
Accrued expenses................................. (1,013,006) 657,937 199,211
Accounts payable................................. 480,329 1,114,944 204,686
Customer deposits................................ -- -- (146,400)
Taxes payable.................................... 683,914 30,497 364,263
Deferred maintenance revenue..................... 1,641,013 1,123,657 1,437,081
----------- ----------- -----------
Net cash provided by (used in) operating
activities................................ (121,157) 2,521,246 1,349,381
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of furniture and equipment................ (510,951) (233,815) (263,219)
Purchases of computer software...................... (1,036,014) -- (12,964)
Acquisition......................................... (1,870,000) -- --
Purchases of marketable securities.................. (4,684,103) -- --
----------- ----------- -----------
Net cash used in investing activities....... (8,101,068) (233,815) (276,183)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable.......................... -- (1,049,101) --
Issuance of common stock............................ 109,286 41,298,801 27,782
----------- ----------- -----------
Net cash provided by financing activities... 109,286 40,249,700 27,782
----------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents......................................... (8,112,939) 42,537,131 1,100,980
Effect of exchange rates on cash...................... (166,734) 58,811 (2,095)
Cash and cash equivalents at beginning of period...... 45,400,015 2,804,073 1,705,188
----------- ----------- -----------
Cash and cash equivalents at end of period............ $37,120,342 $45,400,015 $ 2,804,073
=========== =========== ===========
Supplemental disclosure of non-cash financing
activities:
Conversion of Series A Redeemable, Convertible
Preferred Stock into common stock................ $ -- $ 1,738,333 $ --
=========== =========== ===========
Cash paid during the year for income taxes............ $ 2,237,286 $ 1,542,690 $ 242,930
=========== =========== ===========
Cash paid during the year for interest................ $ 3,412 $ 97,916 $ 83,928
=========== =========== ===========
</TABLE>
See Accompanying Notes to Consolidated Financial Statements.
37
<PAGE> 40
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
NEON Systems, Inc. and subsidiaries (collectively, "NEON") is comprised of
the parent company, NEON Systems, Inc., and its wholly-owned subsidiaries, NEON
Beyond Acquisition Corporation, NEON Systems (UK) Ltd., NEON Systems (GmbH), and
NEON Systems Australia Pty. Ltd. NEON develops, markets and supports eBusiness
Integration software. NEON's primary product group, Shadow, helps organizations
access and integrate data, transactions and applications from the Internet and
mainframe and client/server systems. In addition, NEON develops, markets and
supports Enterprise Subsystem Management and Enterprise Security Management
software.
Basis of Consolidation of Financial Statements
All significant intercompany balances and transactions have been eliminated
in consolidation.
Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
Revenue Recognition
Revenues from software license sales are recognized when all of the
following conditions are met: a non-cancelable license agreement has been
signed; the product has been delivered; there are no material uncertainties
regarding customer acceptance; collection of the receivable is probable; and no
other significant vendor obligations exist. License revenues generally include
software maintenance agreements for the first year following the date of sale.
In such cases, revenues are allocated between license fees and maintenance
revenues based on NEON specific evidence. Revenues from first-year maintenance
agreements and separately priced software maintenance agreements for subsequent
years are deferred and recognized ratably on a straight-line basis over the
maintenance period.
NEON also markets and sells its products through independent foreign
distributors. License and maintenance revenues from these transactions are
recognized when all of the above conditions are met.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
accelerated methods for computer hardware and straight-line methods for other
property based on the estimated useful lives, generally three to seven years, of
the various classes of property.
Cash and Cash Equivalents
Cash and cash equivalents (interest-bearing deposits) with original
maturities of less than three months are included in cash and cash equivalents.
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
38
<PAGE> 41
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
determined based on the temporary differences between the financial statement
and tax bases of assets and liabilities using enacted tax rates.
Per Share Information
Per share information is based on the weighted average number of common
shares outstanding during each period for the basic computation and, if
dilutive, the weighted average number of potential common shares resulting from
the assumed conversion of outstanding stock options and convertible preferred
stock for the diluted computation.
A reconciliation of the numerators and denominators of the basic and
diluted per share computation is as follows:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-------------------------------------
2000 1999 1998
----------- ---------- ----------
<S> <C> <C> <C>
Net income.............................................. $ 4,904,320 $2,251,854 $1,161,093
Dividends on series A redeemable, convertible preferred
stock................................................. -- (75,000) (100,000)
----------- ---------- ----------
Net income applicable to common
stockholders................................ $ 4,904,320 $2,176,854 $1,061,093
=========== ========== ==========
Weighted average number of common shares outstanding
during the period:
Basic................................................. 8,914,474 3,065,219 2,370,524
Dilutive stock options................................ 1,546,558 1,549,601 772,251
Series A redeemable, convertible preferred stock...... -- 2,902,397 3,125,000
----------- ---------- ----------
Diluted....................................... 10,461,032 7,517,217 6,267,775
=========== ========== ==========
Income per common share:
Basic................................................. $ 0.55 $ 0.71 $ 0.45
=========== ========== ==========
Diluted............................................... $ 0.47 $ 0.30 $ 0.19
=========== ========== ==========
</TABLE>
During the twelve months prior to NEON's initial public offering on March
5, 1999, NEON granted stock options at prices subsequently considered 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, which is amortizable to expense over the vesting period of the
granted options. This deferred compensation balance was reduced during the
fiscal year ended March 31, 2000 by $321,000 due to the cancellation of options
associated with terminated employees. During the fiscal year ended March 31,
2000, $490,000 was recognized as non-cash compensation expense. The deferred
balance of $899,000 will be recognized over the remaining vesting period,
approximately three years, of the granted options. Additionally, in the third
quarter of fiscal year 2000, $349,000 was recognized as non-cash compensation
expense related to performance-based options granted to a NEON executive. The
expense related to the performance-based options was reversed in the fourth
quarter, since the applicable performance targets were not met and the options
were cancelled.
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, 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.
39
<PAGE> 42
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (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
NEON applies the intrinsic value-based method of accounting prescribed by
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. SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, established accounting and disclosure requirements using a fair
value-based method of accounting for stock-based employee compensation plans.
Alternatively, SFAS No. 123 allows entities to continue to apply the provisions
of APB Opinion No. 25 and provide pro forma net income and pro forma earnings
per share disclosures for employee stock option grants made in 1996 and future
years as if the fair-value-based method defined in SFAS No. 123 had been
applied. NEON has elected to continue to apply the provisions of APB Opinion No.
25 and provide the pro forma disclosure provisions of SFAS No. 123.
Foreign Currency Translation
For NEON's international subsidiaries, the functional currencies are the
British pound and the German mark. Accordingly, assets and liabilities of the
subsidiaries are translated into U.S. dollars at year-end exchange rates. Income
and expense items are translated at average rates prevailing during the period.
The adjustments resulting from translating the financial statements of the
international subsidiaries are reflected as a cumulative translation adjustment
included in stockholders' equity (deficit) as a component of accumulated other
comprehensive income.
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 net income, foreign
currency translation gains (losses), and unrealized gains (losses) on debt
securities.
NOTE 2 -- SECURED NOTE PAYABLE
During the year ended March 31, 1997 NEON amended and consolidated three
original notes dated September 29, 1994, March 30, 1995 and November 22, 1995
for $300,000, $350,000 and $480,000, respectively. These notes and accrued
interest of $169,101 at March 31, 1997 were converted to a new senior note in
the principal amount of $1,049,101 and $250,000 of principal was converted into
125,000 shares of NEON's Series A Redeemable, Convertible Preferred Stock.
The new note was secured by accounts receivable and property and equipment
and accrued interest at the rate of eight percent per annum. Proceeds from the
initial public offering were used to retire the note in March 1999.
NOTE 3 -- SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK
The Series A Redeemable, Convertible Preferred Stock was convertible into
shares of NEON common stock. Each share of Series A Redeemable, Convertible
Preferred Stock was convertible into five shares of
40
<PAGE> 43
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
common stock (subject to adjustment upon the occurrence of certain events). The
Series A Redeemable, Convertible Preferred Stock also had voting rights based on
the common stock conversion ratio.
The Series A Redeemable, Convertible Preferred Stock accrued annual
dividends at $0.16 per share. The Series A Redeemable, Convertible Preferred
Stock had mandatory conversion and mandatory redemption provisions, which
required among other things that the Series A Redeemable, Convertible Preferred
Stock be redeemed in April 2000, at the original issuance price of $2.00 per
share plus cumulative unpaid dividends. Series A Redeemable, Convertible
Preferred Stock dividends accrued, but not yet declared, at March 31, 1998 were
$413,333.
Immediately prior to the completion of the initial public offering, the
holder of the Series A Redeemable, Convertible Preferred Stock converted the
625,000 shares then outstanding into 3,125,000 shares of common stock.
NOTE 4 -- STOCK OPTION PLANS
Under the 1993 Stock Plan for the officers and employees of NEON, the Board
of Directors authorized the grant of non-qualified incentive stock options to
purchase up to 2,600,000 shares of NEON's Common Stock. Such options become
exercisable either on the date of grant or in such installments as the grant may
specify up to 10 years from the date of grant.
In January 1999, NEON adopted the 1999 Long-Term Incentive Plan which
provides for the grant of incentive stock options and non-qualified stock
options to purchase NEON common stock, stock appreciation rights, restricted
stock and performance units, to key employees of NEON. NEON has reserved
2,000,000 shares of its common stock for issuance under the 1999 Plan. In
connection with NEON's adoption of the 1999 Plan, NEON will not make any new
grants under the 1993 Plan and options previously issued under the 1993 Plan
will be exercisable in accordance with their terms.
NEON has adopted the Stock Option Plan for Non-Employee Directors for
compensation of its outside directors and has reserved 100,000 shares of its
common stock for issuance thereunder. Outside directors joining the Board of
Directors will receive options to purchase 7,500 shares of NEON common stock
exercisable at the fair market value of the common stock at the close of
business on the date immediately preceding the date of grant (the initial
outside directors will be eligible for such grants upon their re-election to the
Board of Directors). These annual options will vest equally in 33 1/3%
increments over the three-year period from the date of grant. All stock options
granted pursuant to the Stock Option Plan for Non-Employee Directors will be
nonqualified stock options and will remain exercisable for a period of ten years
from the date of grant or, if earlier, six months after the option holder ceases
to be a director of NEON. In the event of a change in control of NEON or certain
other significant events, all options outstanding under the Stock Option Plan
for Non-Employee Directors shall terminate, provided that immediately before the
effective date of such transaction each holder of an outstanding option under
the Stock Option Plan for Non-Employee Directors shall be entitled to purchase
the total number of shares of common stock that such option holder would have
been entitled to purchase during the entire remaining term of the option.
At March 31, 2000, stock options to acquire 2,213,704 shares were granted
and outstanding, with exercise prices ranging from $0.01 to $34.375 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 $489,700, $767,300 and $13,700, for the years ended March 31,
2000, 1999 and 1998, respectively. As of March 31, 2000 there was approximately
$899,000 of deferred compensation related to granted but non-vested stock
options. This deferred compensation is being recognized over the remaining
vesting period of the options.
NEON applies APB Opinion No. 25 in accounting for its plans and,
accordingly, compensation cost has been recognized to the extent that the
estimated value of the underlying stock exceeds the exercise price on
41
<PAGE> 44
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the date of the grant. Had NEON determined compensation cost based on SFAS No.
123, NEON's net income and per share amounts would have been the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
------------------------------------
2000 1999 1998
---------- ---------- ----------
<S> <C> <C> <C>
Net income as reported........................... $4,904,320 $2,251,854 $1,161,093
========== ========== ==========
Net income, pro forma............................ $3,625,663 $2,164,250 $1,097,780
========== ========== ==========
Net income per share as reported................. $ 0.55 $ 0.71 $ 0.45
========== ========== ==========
Net income per share, pro forma.................. $ 0.41 $ 0.69 $ 0.42
========== ========== ==========
</TABLE>
Prior to NEON's initial public offering, the fair value of each option
grant was determined on the date of grant using the minimum value method.
Subsequent to the offering, the fair value was determined using the
Black-Scholes model. The weighted average fair market value of an option granted
during 2000, 1999 and 1998 was $16.10, $1.48 and $0.87, respectively. Except for
the volatility assumption, which was only used under the Black-Scholes model,
the following range of assumptions was used to perform the calculations:
expected life of five years in 2000, 1999 and 1998; risk-free interest rates of
6.0% during 2000, 5.8% during 1999 and 5.9% during 1998; expected volatility of
159% in 2000, 141% in 1999, and no expected volatility in 1998; and no expected
dividend yield for the three years ended March 31, 2000. Because additional
stock options are expected to be granted each year, the above pro forma
disclosures are not representative of pro forma effects on reported financial
results for future years.
Stock option activity during periods indicated is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
<S> <C> <C>
BALANCE AT MARCH 31, 1997................................... 1,204,695 $ 0.18
Granted................................................... 303,920 0.86
Exercised................................................. (275,421) 0.09
Forfeited................................................. (24,054) 0.44
---------
BALANCE AT MARCH 31, 1998................................... 1,209,140 0.36
Granted................................................... 624,590 5.54
Exercised................................................. (146,450) 0.97
Forfeited................................................. (58,203) 1.26
---------
BALANCE AT MARCH 31, 1999................................... 1,629,077 2.26
Granted................................................... 1,062,057 22.68
Exercised................................................. (162,407) 1.55
Forfeited................................................. (315,023) 20.35
---------
BALANCE AT MARCH 31, 2000................................... 2,213,704 $ 9.64
=========
</TABLE>
42
<PAGE> 45
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information concerning currently outstanding
and exercisable options:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------ OPTIONS EXERCISABLE
WEIGHTED ----------------------
AVERAGE WEIGHTED WEIGHTED
RANGE OF OUTSTANDING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
-------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$0.01-$5 1,172,582 6.97 $ 0.60 848,044 $ 0.33
$5-$10 5,700 8.82 $ 8.00 1,425 $ 8.00
$10-$15 348,240 8.77 $12.56 78,205 $12.54
$15-$20 326,703 9.56 $16.85 50,000 $16.75
$20-$25 11,370 9.69 $22.31 -- --
$25-$30 250,125 9.60 $28.86 -- --
$30-$35 98,984 9.59 $32.79 -- --
--------- -------
2,213,704 977,674
========= =======
</TABLE>
At March 31, 2000, the weighted average remaining contractual life of
outstanding options was 8.1 years. At March 31, 2000, 1999 and 1998, the number
of options exercisable was 977,674, 746,708 and 566,936, respectively, and the
weighted average exercise prices of those options were $2.16, $0.25 and $0.20,
respectively.
NOTE 5 -- INCOME TAXES
The provision (benefit) for income taxes consists of the following:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------
2000 1999 1998
---------- ---------- ---------
<S> <C> <C> <C>
United States Federal:
Current........................................ $2,665,430 $1,414,724 $ 647,905
Deferred....................................... (140,958) (189,260) (354,340)
State -- current................................. 210,460 100,000 23,210
Foreign -- current............................... 23,748 54,706 (6,973)
---------- ---------- ---------
$2,758,680 $1,380,170 $ 309,802
========== ========== =========
</TABLE>
For the years ended March 31, 2000, 1999 and 1998, NEON's effective income
tax rate differed from the statutory tax rate as follows:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
-----------------------------------------------------------
2000 1999 1998
----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Statutory tax rate................. $2,605,420 34.0% $1,234,888 34.0% $ 500,105 34.0%
Increase (decrease) in valuation
allowance........................ 278,913 3.6 205,729 5.7 (217,427) (14.8)
R & E and AMT Credits.............. (302,832) (3.9) (105,858) (2.9) -- --
State tax expense, net of federal
benefit.......................... 138,904 1.8 66,000 1.8 23,210 1.6
Foreign sales corporation.......... (101,383) (1.3) (48,550) (1.3) -- --
Non-deductible expenses and
other............................ 139,658 1.8 27,961 0.7 3,914 0.3
---------- ---- ---------- ---- --------- -----
Effective tax rate................. $2,758,680 36.0% $1,380,170 38.0% $ 309,802 21.1%
========== ==== ========== ==== ========= =====
</TABLE>
43
<PAGE> 46
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of March 31, 2000, 1999 and 1998, deferred tax assets were as follows:
<TABLE>
<CAPTION>
AS OF MARCH 31,
-----------------------------------
2000 1999 1998
---------- ---------- ---------
<S> <C> <C> <C>
Deferred maintenance revenues.................... $ 130,759 $ 212,284 $ 318,291
Deferred compensation expense.................... 464,598 283,588 --
Net operating loss carryforwards:
United Kingdom................................. 105,030 -- 54,484
Germany........................................ 709,822 430,909 225,180
Other............................................ 12,561 76,118 7,757
---------- ---------- ---------
Total deferred tax assets.............. 1,422,770 1,002,899 605,712
Valuation allowance.................... (709,822) (430,909) (225,180)
---------- ---------- ---------
Net deferred tax assets................ $ 712,948 $ 571,990 $ 380,532
========== ========== =========
</TABLE>
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized and a valuation allowance is recorded.
At March 31, 2000, NEON has a net operating loss carryforward for income
tax purposes of $2,087,712 related to Germany, which is available to offset
future taxable income in Germany, if any. The net operating loss is carried
forward indefinitely. At March 31, 2000, NEON has a net operating loss
carryforward for income tax purposes of $350,151 related to the United Kingdom,
which is available to offset future taxable income in the United Kingdom, if
any. The net operating loss is carried forward indefinitely.
NOTE 6 -- RELATED PARTY TRANSACTIONS
NEON entered into a distributor agreement with Peregrine/Bridge Transfer
Corporation, a database software company, in January 1996. In December 1998,
NEON amended its distributor agreement with Peregrine/Bridge Transfer
Corporation whereby Peregrine/Bridge Transfer Corporation has granted the
Company an exclusive, worldwide license to market and sublicense Enterprise
Subsystem Management products, with the exception of limited co-marketing rights
held by IBM relating to one of Peregrine/Bridge Transfer Corporation's
Enterprise Subsystem Management products. The amended distributor 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 $979,246, $703,337 and $448,917 for the years ended March 31,
2000, 1999 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 $23,995 per month
under the services agreement. Such amounts totaled $287,940 for the year ended
March 31, 2000 and $287,076 for each of the years ended March 31, 1999 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(payable)-related party
of ($6,942) and $278,817 as of March 31, 2000 and 1999, respectively.
NEON and Peregrine/Bridge Transfer Corporation have certain common
directors. In addition, the controlling stockholder of Peregrine/Bridge Transfer
Corporation's sole shareholder, Skunkware, Inc., is
44
<PAGE> 47
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NEON's chairman of the Board of Directors. NEON's president and chief executive
officer, chief financial officer and general counsel have the same
responsibilities at Peregrine/Bridge Transfer Corporation.
NOTE 7 -- COMMITMENTS AND CONTINGENCIES
NEON leases office space and computer software under operating lease
agreements expiring through fiscal 2015. Future minimum rental payments under
operating leases having initial or remaining noncancellable lease terms in
excess of one year are as follows:
<TABLE>
<S> <C>
Years Ending March 31,
2001........................................................ $ 1,803,757
2002........................................................ 1,796,800
2003........................................................ 1,628,881
2004........................................................ 1,503,198
2005........................................................ 1,384,096
Thereafter.................................................. 3,273,650
-----------
$11,390,382
===========
</TABLE>
Total rent expense under all operating leases was $1,109,047, $715,636 and
$433,035, in the years ended March 31, 2000, 1999 and 1998, respectively.
A number of organizations, including New Era of Networks, Inc., are
utilizing the name "NEON," alone and in combination with other words, as a
trademark, a tradename or both. New Era of Networks is also a developer and
distributor of middleware and other software products. New Era of Networks has
used the acronym "NEON" in its business, is listed on the Nasdaq National Market
under the symbol "NEON" and has sought to obtain federal trademarks for products
and services whose names include the word "NEON." NEON is currently opposing in
the U.S. Patent and Trademark Office New Era of Networks' application to
trademark "NEONET." On December 24, 1998, New Era of Networks filed a complaint
against NEON in the United States District Court for the District of Colorado
seeking (1) a declaratory judgment that New Era of Networks' use of certain
trademarks, including "NEONET," does not infringe NEON's rights or constitute
unfair competition and (2) cancellation of NEON's federal trademark registration
for NEON. NEON has filed an answer denying the material allegations of that
complaint. On February 11, 2000, the judge in the Colorado proceeding advised
the parties that the court intends to grant summary judgment for cancellation of
the federal trademark registration for the "NEON" mark. If such judgment is
entered, it will not affect NEON's right to use the "NEON" mark, which NEON
believes to be superior to those of New Era of Networks. Discovery has been
completed in the action, but no trial date has been set.
On June 23, 1999, NEON sued New Era of Networks in Fort Bend County, Texas,
alleging that New Era of Networks' use of "NEON" was in violation of Texas law
concerning tradenames and trademarks, and at the time of filing of this Report
the parties were in the discovery phase of this litigation. In this litigation,
NEON seeks to enjoin New Era of Networks from using "NEON" as its "nickname,"
its Nasdaq trading symbol, or in any other manner that is likely to result in
confusion in the marketplace, or to dilute the meaning or value of NEON's name.
NEON's claims are based upon its prior and continuous use of "NEON" as its
corporate name. NEON believes that it has superior rights to use "NEON" and that
New Era of Networks' use of NEON is causing confusion in the marketplace. This
and any other litigation to enforce NEON's right to use the NEON name in NEON's
business or to prevent others from using the NEON name may be expensive and
time-consuming, may divert management resources and may not be adequate to
protect NEON's business. If NEON should lose any such litigation, it may have to
change its name, which also would be expensive and time-consuming and could
adversely affect NEON's business.
45
<PAGE> 48
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On October 29, 1999, NEON entered into an agreed settlement with BMC
Software of its lawsuit with BMC Software. BMC Software originally filed the
lawsuit in August 1995 in the District Court of Travis County, Texas, 200th
Judicial District, against Peregrine/Bridge Transfer Corporation, John J. Moores
and a group of employees of Peregrine/Bridge Transfer Corporation who were also
former employees of BMC Software. In the lawsuit, BMC Software had alleged
misappropriation and infringement of certain trade secrets, confidential
information and corporate opportunity, as well as breach of contract and
fiduciary relations by the named individuals. NEON, which is the exclusive
distributor of software products developed by Peregrine/Bridge Transfer
Corporation, had been named as a co-defendant in this lawsuit in December 1996.
The October 1999 settlement resolved claims by BMC Software relating to NEON's
and Peregrine/ Bridge Transfer Corporation's title in and right to market the
products of Peregrine/Bridge Transfer Corporation that were the subject of the
lawsuit. Under the terms of the settlement, BMC Software paid $30 million to
parties other than NEON. BMC Software and NEON also entered into a software
distribution agreement under which, if fully performed by the parties, NEON
would receive an aggregate of $8.6 million, payable quarterly over two years,
for its products. In addition, the settlement does not obligate NEON or any
other co-defendant to make any present or future cash payment or disgorgement or
impose any restriction on the marketing and sale by NEON of its or
Peregrine/Bridge Transfer Corporation's products. NEON has been indemnified for
its costs and expenses in this lawsuit by Peregrine/Bridge Transfer Corporation
under the terms of its distributor agreement with Peregrine/Bridge Transfer
Corporation.
NEON is involved in various other claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of any of these matters will not have a material adverse effect on
NEON's consolidated financial position, results of operations or liquidity.
NOTE 8 -- OPERATIONS BY GEOGRAPHIC LOCATION 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 80% of total European revenues in fiscal 2000, 1999 and 1998.
Neon's U.S. operations accounted for 100% of total North American revenues in
fiscal 2000, 1999 and 1998.
During the fiscal years ended March 31, 2000 and 1998, NEON had no customer
which accounted for 10% or more of consolidated revenue. NEON had one customer
which accounted for 12% of consolidated revenue during the fiscal year ended
March 31, 1999.
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------------------------
2000 1999 1998
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
North America....................................... $23,726,805 $15,500,792 $ 9,923,198
Europe.............................................. 5,991,908 4,515,404 2,279,609
----------- ----------- -----------
$29,718,713 $20,016,196 $12,202,807
=========== =========== ===========
Operating income (loss):
North America....................................... $ 6,863,868 $ 3,780,724 $ 2,140,816
Europe.............................................. (1,457,201) (334,167) (697,580)
----------- ----------- -----------
$ 5,406,667 $ 3,446,557 $ 1,443,236
=========== =========== ===========
Identifiable assets:
North America....................................... $55,809,380 $49,896,957 $ 3,964,737
Europe.............................................. 4,690,777 2,737,794 2,387,433
----------- ----------- -----------
$60,500,157 $52,634,751 $ 6,352,170
=========== =========== ===========
</TABLE>
46
<PAGE> 49
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth certain unaudited quarterly information with
respect to the Company's results of operations for the years ended 2000, 1999
and 1998. Earnings per share are computed independently for each of the quarters
presented. Therefore, the sum of the quarterly earnings per share may not equal
the total earnings per share amounts for the fiscal year.
<TABLE>
<CAPTION>
2000 QUARTER
---------------------------------
1ST 2ND 3RD 4TH
(IN THOUSANDS, EXCEPT PER SHARE DATA) ------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues........................................... $6,086 $6,059 $8,919 $8,655
Gross profit....................................... 5,719 5,392 7,686 7,738
Net income......................................... 1,059 851 1,451 1,543
Earnings per common share:
Basic............................................ $ 0.12 $ 0.10 $ 0.16 $ 0.17
Diluted.......................................... $ 0.10 $ 0.08 $ 0.14 $ 0.15
</TABLE>
<TABLE>
<CAPTION>
1999 QUARTER
---------------------------------
1ST 2ND 3RD 4TH
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues........................................... $3,849 $4,136 $5,850 $6,181
Gross profit....................................... 3,372 3,678 5,451 5,497
Net income......................................... 145 251 968 888
Earnings per common share:
Basic............................................ $ 0.05 $ 0.09 $ 0.35 $ 0.20
Diluted.......................................... $ 0.02 $ 0.04 $ 0.14 $ 0.11
</TABLE>
<TABLE>
<CAPTION>
1998 QUARTER
---------------------------------
1ST 2ND 3RD 4TH
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues........................................... $2,372 $2,523 $3,264 $4,044
Gross profit....................................... 2,072 2,350 3,062 3,425
Net income......................................... 166 129 579 286
Earnings per common share:
Basic............................................ $ 0.06 $ 0.04 $ 0.23 $ 0.11
Diluted.......................................... $ 0.03 $ 0.02 $ 0.09 $ 0.04
</TABLE>
NOTE 10 -- MARKETABLE SECURITIES
NEON has evaluated its investment policies consistent with SFAS No. 115,
ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES, and determined
that its investment securities are to be classified as available-for-sale.
Available-for-sale securities are carried at fair value, with the unrealized
gains and losses reported in stockholders' equity under the caption "Accumulated
other comprehensive income (loss)." The cost of securities sold is based on the
specific identification method. Interest and dividends on securities classified
as available-for-sale are included in interest income.
The following is a summary of marketable securities classified as
"available-for-sale" securities as required by SFAS No. 115:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
2000 1999
---------- ---------
<S> <C> <C>
Debt Securities:
Cost...................................................... $4,684,103 $ --
Gross unrealized losses................................... (46,336) --
---------- ----
Estimated fair value.............................. $4,637,767 $ --
========== ====
</TABLE>
47
<PAGE> 50
NEON SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and estimated fair value based on published closing
prices of securities at March 31, 2000, by contractual maturity, are shown
below. Expected maturities may differ from contractual maturities because the
issuers of the securities may have the right to repay obligations without
prepayment penalties.
<TABLE>
<CAPTION>
AS OF MARCH 31, 2000
-----------------------
ESTIMATED
COST FAIR VALUE
---------- ----------
<S> <C> <C>
Available-for-sale:
Due in one year or less................................... $2,007,228 $1,977,500
Due after one year through five years..................... 2,676,875 2,660,267
</TABLE>
NOTE 11 -- ACQUISITIONS
On September 29, 1999, NEON completed its acquisition of assets from Beyond
Software Inc. The business, headquartered in Santa Clara, California, was
acquired for $1,870,000 in cash, plus the assumption of certain liabilities. The
acquisition resulted in goodwill of $2.4 million, which is being amortized on a
straight-line basis over five years. Goodwill amortization of $239,000 was
recognized in the fiscal year ended March 31, 2000.
NOTE 12 -- OTHER ASSETS
In December 1999, NEON entered into an agreement with Sterling Software and
certain of its affiliates ("Sterling") that grants NEON certain rights to use,
reproduce, copy and sell certain Sterling products. NEON has made a
nonrefundable advance to Sterling of $3.5 million as consideration for future
royalties to be earned by Sterling from sales of $14 million of such products by
NEON. This amount has been included in "Other Assets" on the accompanying
consolidated balance sheet. Under the agreement with Sterling, NEON also
acquired an option to purchase the intellectual property underlying such
products at any time through December 30, 2000 for $1,000,000.
48
<PAGE> 51
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Information called for by Item 10 will be set forth under the caption
"Election of Directors" in NEON's Proxy Statement with respect to its Annual
Meeting of Stockholders to be held August 22, 2000, which will be filed not
later than 120 days after the end of NEON's fiscal year ended March 31, 2000 and
which is incorporated herein by this reference.
ITEM 11. EXECUTIVE COMPENSATION
Information called for by Item 11 will be set forth under the caption
"Executive Compensation" in NEON's Proxy Statement with respect to its Annual
Meeting of Stockholders to be held August 22, 2000, which will be filed not
later than 120 days after the end of NEON's fiscal year ended March 31, 2000 and
which is incorporated herein by this reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information called for by Item 12 will be set forth under the caption
"Security Ownership of Certain Beneficial Owners and Management" in NEON's Proxy
Statement with respect to its Annual Meeting of Stockholders to be held August
22, 2000, which will be filed not later than 120 days after the end of NEON's
fiscal year ended March 31, 2000 and which is incorporated herein by this
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information called for by Item 13 will be set forth under the caption
"Certain Relationships and Related Transactions" in NEON's Proxy Statement with
respect to its Annual Meeting of Stockholders to be held August 22, 2000, which
will be filed not later than 120 days after the end of NEON's fiscal year ended
March 31, 2000 and which is incorporated herein by this reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are being filed as part of this Report:
(a)(1) Consolidated Financial Statements
See Index to Consolidated Financial Statements on page 32.
(a)(2) All other schedules are omitted because they are not
applicable, not required or the required information is in the Financial
Statements or the Notes thereto.
(a)(3) The following exhibits are filed or incorporated by reference
as part of this Report as required by Item 601 of Regulation S-K. The
exhibits designated by an asterisk are management contracts and
compensatory plans and arrangements required to be filed as exhibits to
this Report.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
3.1 -- Amended and Restated Certificate of Incorporation of NEON
Systems, Inc. (incorporated by reference to Exhibit 3.1
to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
</TABLE>
49
<PAGE> 52
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
3.2 -- Bylaws of NEON Systems, Inc. (incorporated by reference
to Exhibit 3.2 to NEON's Registration Statement on Form
S-1 (Registration Number 333-69651) effective March 5,
1999).
4.1 -- Specimen Stock Certificate (incorporated by reference to
Exhibit 4.1 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
4.2 -- Certificate of Incorporation, as amended, and Bylaws of
NEON Systems, Inc. (see Exhibits 3.1 and 3.2).
10.1* -- NEON Systems, Inc. 1993 Stock Plan (incorporated by
reference to Exhibit 10.1 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
10.2* -- NEON Systems 401(k) Plan (incorporated by reference to
Exhibit 10.2 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.3* -- NEON Systems, Inc. 1999 Long-Term Incentive Plan
(incorporated by reference to Exhibit 10.3 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.4* -- NEON Systems, Inc. Stock Option Plan for Non-Employee
Directors (incorporated by reference to Exhibit 10.4 to
NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999).
10.5 -- Distributor Agreement dated as of January 1, 1996 by and
between Peregrine/ Bridge Transfer Corporation and NEON
Systems, Inc., as amended (incorporated by reference to
Exhibit 10.5 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.6 -- Texaco Inc. Information Technology Department
Miscellaneous Work Agreement dated as of July 1, 1991
between NEON Systems, Inc. and Texaco, Inc. (incorporated
by reference to Exhibit 10.6 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
10.7 -- Series A Stock Purchase Agreement dated as of May 19,
1993 by and between NEON Systems, Inc., JMI Equity Fund,
L.P. and Peter Schaeffer (incorporated by reference to
Exhibit 10.7 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.8 -- Secured Convertible Promissory Note Purchase Agreement
dated as of September 29, 1994 by and between NEON
Systems, Inc. and JMI Equity Fund, L.P., as amended
(incorporated by reference to Exhibit 10.8 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.9 -- Secured Convertible Promissory Note Purchase Agreement
dated as of March 30, 1995 by and between NEON Systems,
Inc. and JMI Equity Fund, L.P., as amended (incorporated
by reference to Exhibit 10.9 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
10.10 -- Secured Convertible Promissory Note Purchase Agreement
dated as of November 22, 1995 by and between NEON
Systems, Inc. and JMI Equity Fund, L.P. (incorporated by
reference to Exhibit 10.10 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
</TABLE>
50
<PAGE> 53
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.11 -- Secured Promissory Note dated March 31, 1997 to the order
of JMI Equity Fund, L.P. in the original principal amount
of $1,049,100.78, as amended (incorporated by reference
to Exhibit 10.11 to NEON's Registration Statement on Form
S-1 (Registration Number 333-69651) effective March 5,
1999).
10.12 -- Amendment to Convertible Debt Documentation and Exercise
of Conversion Right dated March 31, 1997 by and between
NEON Systems, Inc. and JMI Equity Fund, L.P.
(incorporated by reference to Exhibit 10.12 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.13 -- Registration Rights Agreement dated as of May 19, 1993 by
and between NEON Systems, Inc., JMI Equity Fund, L.P. and
Peter Schaeffer (incorporated by reference to Exhibit
10.13 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.14* -- Form of Indemnification Agreement between NEON Systems,
Inc. and each of its directors (incorporated by reference
to Exhibit 10.14 to NEON's Registration Statement on Form
S-1 (Registration Number 333-69651) effective March 5,
1999).
10.15 -- Lease Agreement between Turner Andreac, LLC and NEON
Systems, Inc. for office space located at 14100 Southwest
Freeway, Suite 500 in Sugar Land, Texas (incorporated by
reference to Exhibit 10.15 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
10.16 -- Lease Agreement, dated December 9, 1996, between Nu-Swift
Sovereign Limited and NEON Systems (U.K.) Limited for
office space located at Sovereign House 26/30 London Road
in Twickenham, Middlesex (incorporated by reference to
Exhibit 10.16 to NEON's Registration Statement on Form
S-1 (Registration Number 333-69651) effective March 5,
1999).
10.17 -- Lease Agreement dated September 1, 1997 between NEON
Systems GmbH and Triple P. Deutschland GmbH (incorporated
by reference to Exhibit 10.17 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
10.18 -- Agreement by and between Goal Systems International,
Inc., NEON Systems, Inc. and Peter Schaeffer dated
January 8, 1992 (incorporated by reference to Exhibit
10.18 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.19 -- Stockholders Agreement dated May 19, 1993 by and among
NEON Systems, Inc. and JMI Equity Fund, L.P. and Peter
Schaeffer (incorporated by reference to Exhibit 10.19 to
NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999).
10.20 -- Stock Restriction Agreement dated May 19, 1993 by and
among NEON Systems, Inc., Peter Schaeffer and JMI Equity
Fund, L.P. (incorporated by reference to Exhibit 10.20 to
NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999).
10.21 -- Service Agreement dated as of December 18, 1998 by and
among NEON Systems, Inc. and Peregrine/Bridge Transfer
Corporation (incorporated by reference to Exhibit 10.21
to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
</TABLE>
51
<PAGE> 54
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.22 -- Stock Purchase Agreement dated June 1, 1998 by and
between NEON Systems, Inc. and Wayne E. Webb, Jr.
(incorporated by reference to Exhibit 10.22 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.23 -- Stockholders Agreement, dated June 1, 1998, by and
between NEON Systems, Inc. and Wayne E. Webb, Jr.
(incorporated by reference to Exhibit 10.23 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.24 -- Form of NEON Distributor Agreement (incorporated by
reference to Exhibit 10.24 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
21.1 -- Subsidiaries of NEON Systems, Inc. (incorporated by
reference to Exhibit 21.1 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
23.0+ -- Consent of KPMG LLP to Form S-8 Registration Statement of
NEON Systems, Inc.
24.1+ -- Power of Attorney (included on first signature page).
27.1+ -- Financial Data Schedule for year ended March 31, 2000.
</TABLE>
---------------
+ Filed herewith
* Management contract or compensatory plan or arrangement. NEON will furnish a
copy of any exhibit listed above to any stockholder without charge upon
written request to Mr. John Reiland, 14100 Southwest Freeway, Suite 500, Sugar
Land, Texas 77478.
(b) Reports on Form 8-K.
The Company did not file any Form 8-K Current Reports during the last
quarter of the fiscal year ended March 31, 2000.
(c) The Index to Exhibits filed or incorporated by reference pursuant to
Item 601 of Regulation S-K and the Exhibits being filed with this
Report are included following the signature page to this Form 10-K.
(d) Not applicable.
52
<PAGE> 55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NEON SYSTEMS, INC.
By: /s/ JOE BACKER
----------------------------------
Joe Backer,
President and Chief Executive
Officer
Date: June 22, 2000
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes and constitutes
Joe Backer and John S. Reiland, and each of them singly, his true and lawful
attorneys-in-fact with full power of substitution and resubstitution, for him
and in his name, place and stead, in any and all capacities to sign and file any
and all amendments to this report with all exhibits thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, and he
hereby ratifies and confirms all that said attorneys-in-fact or any of them, or
their substitutes, may lawfully do or cause to be done by virtue hereof.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
---------- ----- ----
<C> <S> <C>
/s/ JOHN J. MOORES Chairman of the Board June 22, 2000
-----------------------------------------------------
John J. Moores
/s/ JOE BACKER President and Chief Executive June 22, 2000
----------------------------------------------------- Officer (Principal Executive
Joe Backer Officer) and Director
/s/ PETER SCHAEFFER Chief Technology Officer and June 22, 2000
----------------------------------------------------- Director
Peter Schaeffer
/s/ JOHN S. REILAND Chief Financial Officer June 22, 2000
----------------------------------------------------- (Principal Financial and
John S. Reiland Accounting Officer) and
Director
/s/ CHARLES E. NOELL III Director June 22, 2000
-----------------------------------------------------
Charles E. Noell III
/s/ NORRIS VAN DEN BERG Director June 22, 2000
-----------------------------------------------------
Norris van den Berg
/s/ RICHARD HOLCOMB Director June 22, 2000
-----------------------------------------------------
Richard Holcomb
/s/ GEORGE ELLIS Director June 22, 2000
-----------------------------------------------------
George Ellis
</TABLE>
53
<PAGE> 56
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
3.1 -- Amended and Restated Certificate of Incorporation of NEON
Systems, Inc. (incorporated by reference to Exhibit 3.1
to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
3.2 -- Bylaws of NEON Systems, Inc. (incorporated by reference
to Exhibit 3.2 to NEON's Registration Statement on Form
S-1 (Registration Number 333-69651) effective March 5,
1999).
4.1 -- Specimen Stock Certificate (incorporated by reference to
Exhibit 4.1 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
4.2 -- Certificate of Incorporation, as amended, and Bylaws of
NEON Systems, Inc. (see Exhibits 3.1 and 3.2).
10.1* -- NEON Systems, Inc. 1993 Stock Plan (incorporated by
reference to Exhibit 10.1 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
10.2* -- NEON Systems 401(k) Plan (incorporated by reference to
Exhibit 10.2 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.3* -- NEON Systems, Inc. 1999 Long-Term Incentive Plan
(incorporated by reference to Exhibit 10.3 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.4* -- NEON Systems, Inc. Stock Option Plan for Non-Employee
Directors (incorporated by reference to Exhibit 10.4 to
NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999).
10.5 -- Distributor Agreement dated as of January 1, 1996 by and
between Peregrine/ Bridge Transfer Corporation and NEON
Systems, Inc., as amended (incorporated by reference to
Exhibit 10.5 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.6 -- Texaco Inc. Information Technology Department
Miscellaneous Work Agreement dated as of July 1, 1991
between NEON Systems, Inc. and Texaco, Inc. (incorporated
by reference to Exhibit 10.6 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
10.7 -- Series A Stock Purchase Agreement dated as of May 19,
1993 by and between NEON Systems, Inc., JMI Equity Fund,
L.P. and Peter Schaeffer (incorporated by reference to
Exhibit 10.7 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.8 -- Secured Convertible Promissory Note Purchase Agreement
dated as of September 29, 1994 by and between NEON
Systems, Inc. and JMI Equity Fund, L.P., as amended
(incorporated by reference to Exhibit 10.8 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.9 -- Secured Convertible Promissory Note Purchase Agreement
dated as of March 30, 1995 by and between NEON Systems,
Inc. and JMI Equity Fund, L.P., as amended (incorporated
by reference to Exhibit 10.9 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
</TABLE>
<PAGE> 57
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.10 -- Secured Convertible Promissory Note Purchase Agreement
dated as of November 22, 1995 by and between NEON
Systems, Inc. and JMI Equity Fund, L.P. (incorporated by
reference to Exhibit 10.10 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
10.11 -- Secured Promissory Note dated March 31, 1997 to the order
of JMI Equity Fund, L.P. in the original principal amount
of $1,049,100.78, as amended (incorporated by reference
to Exhibit 10.11 to NEON's Registration Statement on Form
S-1 (Registration Number 333-69651) effective March 5,
1999).
10.12 -- Amendment to Convertible Debt Documentation and Exercise
of Conversion Right dated March 31, 1997 by and between
NEON Systems, Inc. and JMI Equity Fund, L.P.
(incorporated by reference to Exhibit 10.12 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.13 -- Registration Rights Agreement dated as of May 19, 1993 by
and between NEON Systems, Inc., JMI Equity Fund, L.P. and
Peter Schaeffer (incorporated by reference to Exhibit
10.13 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.14* -- Form of Indemnification Agreement between NEON Systems,
Inc. and each of its directors (incorporated by reference
to Exhibit 10.14 to NEON's Registration Statement on Form
S-1 (Registration Number 333-69651) effective March 5,
1999).
10.15 -- Lease Agreement between Turner Andreac, LLC and NEON
Systems, Inc. for office space located at 14100 Southwest
Freeway, Suite 500 in Sugar Land, Texas (incorporated by
reference to Exhibit 10.15 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
10.16 -- Lease Agreement, dated December 9, 1996, between Nu-Swift
Sovereign Limited and NEON Systems (U.K.) Limited for
office space located at Sovereign House 26/30 London Road
in Twickenham, Middlesex (incorporated by reference to
Exhibit 10.16 to NEON's Registration Statement on Form
S-1 (Registration Number 333-69651) effective March 5,
1999).
10.17 -- Lease Agreement dated September 1, 1997 between NEON
Systems GmbH and Triple P. Deutschland GmbH (incorporated
by reference to Exhibit 10.17 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
10.18 -- Agreement by and between Goal Systems International,
Inc., NEON Systems, Inc. and Peter Schaeffer dated
January 8, 1992 (incorporated by reference to Exhibit
10.18 to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.19 -- Stockholders Agreement dated May 19, 1993 by and among
NEON Systems, Inc. and JMI Equity Fund, L.P. and Peter
Schaeffer (incorporated by reference to Exhibit 10.19 to
NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999).
10.20 -- Stock Restriction Agreement dated May 19, 1993 by and
among NEON Systems, Inc., Peter Schaeffer and JMI Equity
Fund, L.P. (incorporated by reference to Exhibit 10.20 to
NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999).
</TABLE>
<PAGE> 58
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
10.21 -- Service Agreement dated as of December 18, 1998 by and
among NEON Systems, Inc. and Peregrine/Bridge Transfer
Corporation (incorporated by reference to Exhibit 10.21
to NEON's Registration Statement on Form S-1
(Registration Number 333-69651) effective March 5, 1999).
10.22 -- Stock Purchase Agreement dated June 1, 1998 by and
between NEON Systems, Inc. and Wayne E. Webb, Jr.
(incorporated by reference to Exhibit 10.22 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.23 -- Stockholders Agreement, dated June 1, 1998, by and
between NEON Systems, Inc. and Wayne E. Webb, Jr.
(incorporated by reference to Exhibit 10.23 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.24 -- Form of NEON Distributor Agreement (incorporated by
reference to Exhibit 10.24 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
21.1 -- Subsidiaries of NEON Systems, Inc. (incorporated by
reference to Exhibit 21.1 to NEON's Registration
Statement on Form S-1 (Registration Number 333-69651)
effective March 5, 1999).
23.0+ -- Consent of KPMG LLP to Form S-8 Registration Statement of
NEON Systems, Inc.
24.1+ -- Power of Attorney (included on first signature page).
27.1+ -- Financial Data Schedule for year ended March 31, 2000.
</TABLE>
---------------
+ Filed herewith
* Management contract or compensatory plan or arrangement. NEON will furnish a
copy of any exhibit listed above to any stockholder without charge upon
written request to Mr. John Reiland, 14100 Southwest Freeway, Suite 500, Sugar
Land, Texas 77478.
