<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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)
DELAWARE 76-0345839
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
14100 SOUTHWEST FREEWAY, SUITE 500, SUGAR LAND, TEXAS 77478
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (281) 491-4200
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
The number of shares of the registrant's common stock outstanding as of August
8, 2000 was 9,438,918.
<PAGE> 2
NEON SYSTEMS, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2000
INDEX
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at June 30, 2000 and March 31,
2000........................................................ 3
Consolidated Statements of Operations for the Three Months
Ended June 30, 2000 and 1999 ............................... 4
Consolidated Statements of Cash Flows for the Three Months
Ended June 30, 2000 and 1999................................ 5
Condensed Notes to Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk.. 12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 13
Item 2. Changes in Securities and Use of Proceeds................... 13
Item 3. Defaults Upon Senior Securities............................. 13
Item 4. Submission of Matters to a Vote of Security Holders......... 13
Item 5. Other Information........................................... 13
Item 6. Exhibits and Reports on Form 8-K............................ 13
SIGNATURES........................................................... 14
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, 2000 MARCH 31, 2000
------------- --------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $25,463,224 $37,120,342
Short-term investments 13,795,613 1,977,500
Accounts receivable-trade 9,516,360 9,602,979
Accounts receivable-related party 73,962 --
Deferred tax assets 834,227 712,948
Other current assets 915,334 658,326
----------- -----------
Total current assets 50,598,720 50,072,095
----------- -----------
Furniture and equipment 1,918,945 1,612,080
Purchased software 1,386,126 1,114,788
Less: accumulated depreciation and amortization (996,232) (832,073)
----------- -----------
Property and equipment, net 2,308,839 1,894,795
Marketable securities 2,158,033 2,660,267
Goodwill, net 2,027,500 2,146,764
Other assets, net 3,678,844 3,726,236
----------- -----------
Total assets $60,771,936 $60,500,157
=========== ===========
LIABILITIES & STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accrued expenses $ 1,271,219 $ 818,637
Accounts payable 1,400,028 2,032,442
Accounts payable - related party -- 6,942
Taxes payable 456,737 318,534
Deferred maintenance revenue 5,575,740 5,466,000
----------- -----------
Total current liabilities 8,703,724 8,642,555
----------- -----------
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; 9,434,969 and 9,005,584 shares issued and
outstanding at June 30, 2000 and March 31,
2000, respectively 94,350 90,056
Additional paid-in capital 46,879,210 46,697,813
Accumulated other comprehensive income (loss) (389,946) (155,221)
Unearned portion of deferred compensation (795,143) (899,377)
Retained earnings 6,279,741 6,124,331
----------- -----------
Total stockholders' equity 52,068,212 51,857,602
Commitments and contingencies (Note 7)
----------- -----------
Total liabilities and stockholders' equity $60,771,936 $60,500,157
=========== ===========
</TABLE>
SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE> 4
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
----------------------------------------
2000 1999
----------- ----------
<S> <C> <C>
Revenues:
License $ 5,283,559 $4,449,670
Maintenance 2,341,485 1,635,992
----------- ----------
Total revenues 7,625,044 6,085,662
Cost of revenues:
Cost of licenses 845,740 94,343
Cost of maintenance 535,673 272,252
----------- ----------
Total cost of revenues 1,381,413 366,595
----------- ----------
Gross profit 6,243,631 5,719,067
Operating expenses:
Sales and marketing 3,604,031 2,454,181
Research and development 1,870,927 1,196,863
General and administrative 972,640 714,334
Non-cash compensation 104,234 136,338
Amortization of acquisition related costs 119,265 --
----------- ----------
Total operating expenses 6,671,097 4,501,716
----------- ----------
Operating income (loss) (427,466) 1,217,351
Interest income 664,508 543,497
Interest expense (3,443) (572)
Other, net 8,811 (51,978)
----------- -----------
Income before provision for income taxes 242,410 1,708,298
Provision for income taxes 87,000 649,153
----------- ----------
Net income $ 155,410 $ 1,059,145
=========== ===========
Earnings per share:
Basic $ 0.02 $ 0.12
=========== ===========
Diluted $ 0.02 $ 0.10
=========== ===========
Shares used in computing earnings per share:
Basic 9,281,681 8,849,896
Diluted 10,278,577 10,236,134
</TABLE>
SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE> 5
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
----------------------------------
2000 1999
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 155,410 $ 1,059,145
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Depreciation and amortization 164,159 49,479
Deferred tax expense (121,279) --
Non-cash compensation expense 104,234 136,338
Amortization of acquisition related costs 119,265 --
Increase (decrease) in cash resulting
from changes in operating assets and
liabilities:
Accounts receivable 12,657 467,299
Other current assets (257,008) (421,737)
Other assets 47,392 2,215
Accrued expenses 445,640 (85,099)
Accounts payable (632,415) (19,122)
Taxes payable 138,203 415,515
Deferred maintenance revenue 109,740 95,449
----------- -----------
Net cash provided by operating activities 285,998 1,699,482
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities (11,306,744) --
Purchases of furniture and equipment (306,865) (43,560)
Purchases of computer software (271,338) (7,472)
----------- -----------
Net cash used in investing activities (11,884,947) (51,032)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercises of stock options 185,691 801
----------- -----------
Net cash provided by financing activities 185,691 801
----------- -----------
Net increase (decrease) in cash and cash
equivalents (11,413,258) 1,649,251
Effect of exchange rates on cash (243,860) (10,633)
Cash and cash equivalents at beginning of
period 37,120,342 45,400,015
----------- -----------
Cash and cash equivalents at end of period $25,463,224 $47,038,633
=========== ===========
Supplemental disclosure of cash flow
information:
Cash paid during the period for income taxes $ 62,655 $ 233,638
=========== ===========
Cash paid during the period for interest $ 3,443 $ --
=========== ===========
</TABLE>
SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
<PAGE> 6
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION
NEON Systems, Inc. and subsidiaries (collectively, "NEON") are comprised of
the parent company, NEON Systems, Inc., and its wholly-owned 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.
The condensed consolidated financial statements included herein have been
prepared by NEON without audit pursuant to the rules and regulations of the
Securities and Exchange Commission. The financial statements reflect all normal
and recurring adjustments which in the opinion of management are necessary for a
fair presentation of the financial position, results of operations and cash
flows for the interim periods presented. The results of operations for the
periods presented are not necessarily indicative of the results to be expected
for the full year. The accompanying unaudited condensed financial statements
should be read in conjunction with the financial statements and notes included
in NEON's Annual Report on Form 10-K for the fiscal year ended March 31, 2000.
NOTE 2--PER SHARE INFORMATION
Per share information is based on the weighted average number of common
shares outstanding during each period for the basic computation and, if
dilutive, the weighted-average number of potential common shares resulting from
the assumed conversion of outstanding stock options and convertible preferred
stock for the diluted computation.
A reconciliation of the numerators and denominators of the basic and diluted
per share computation is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
2000 1999
---- ----
<S> <C> <C>
Net income $ 155,410 $1,059,145
========== ==========
Weighted average number of common
shares outstanding during the period:
Basic 9,281,681 8,849,896
Dilutive stock options 996,896 1,386,238
---------- ----------
Diluted 10,278,577 10,236,134
========== ==========
Income per common share:
Basic $ 0.02 $ 0.12
========== ==========
Diluted $ 0.02 $ 0.10
========== ==========
</TABLE>
During the the twelve months prior to NEON's initial public offering on
March 5, 1999, NEON granted stock options at prices considered to be below the
then fair value of the underlying stock. The cumulative differential between the
fair value of the underlying stock and the exercise price of the granted options
was $2.5 million, which is amortizable to expense over the vesting period of the
granted options. This deferred compensation balance is reduced periodically as a
result of the cancellation of options associated with terminated employees.
During the three months ended June 30, 2000, $104,000 was recognized as non-cash
compensation expense. The deferred balance of $795,000 will be recognized over
the remaining vesting period, approximately two years, of the granted options.
For the three month periods ended June 30, 2000 and 1999, 365,039 and -0-
stock options, respectively, were not included in the computation of diluted net
income per share because the effect would be antidilutive. For the three-month
periods ended June 30, 2000 and 1999, 1,773,580 and 1,756,132 stock options were
included in the computation of diluted net income per share.
6
<PAGE> 7
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--MARKETABLE SECURITIES
NEON considers all highly liquid investments with a maturity of three months
or less to be cash equivalents.
NEON has evaluated its investment policies consistent with Statement of
Financial Accounting Standards No. 115 (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>
JUNE 30, 2000 MARCH 31, 2000
------------- --------------
<S> <C> <C>
Debt Securities:
Cost $15,990,847 $4,684,103
Gross unrealized losses (37,201) (46,336)
----------- ----------
Estimated fair value $15,953,646 $4,637,767
=========== ==========
</TABLE>
The amortized cost and estimated fair value based on published closing
prices of securities at June 30, 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 JUNE 30, 2000
-------------------------------
ESTIMATED FAIR
COST VALUE
----------- --------------
<S> <C> <C>
Available-for-sale:
Due in one year or less $13,821,394 $13,795,613
Due after one year through
five years 2,169,453 2,158,033
</TABLE>
NOTE 4--OTHER ASSETS
In December 1999, NEON Beyond Acquisition Corporation 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. In December 1999, NEON 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 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.
NOTE 5--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 $119,000 was
recognized in the three months ended June 30, 2000.
7
<PAGE> 8
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--OPERATIONS BY GEOGRAPHIC LOCATION
The table below summarizes selected financial information with respect to
NEON's operations by geographic locations.
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
-----------------------------------
2000 1999
----------- -----------
<S> <C> <C>
Revenues:
North America $ 6,874,841 $ 4,480,660
Europe and other 750,203 1,605,002
----------- -----------
$ 7,625,044 $ 6,085,662
=========== ===========
Operating income (loss):
North America $ 386,389 $ 1,879,956
Europe and other (813,855) (662,605)
----------- -----------
$ (427,466) $ 1,217,351
=========== ===========
Identifiable assets:
North America $57,423,855 $50,954,898
Europe and other 3,348,081 3,244,350
---------- -----------
$60,771,936 $54,199,248
=========== ===========
</TABLE>
NOTE 7--CONTINGENCIES
A number of organizations, including New Era of Networks, are utilizing the
name "Neon," alone and in combination with other words, as a trademark, a
tradename or both. New Era of Networks is also a developer and distributor of
middleware and other software products. New Era of Networks has used the acronym
"NEON" in its business, is listed on the Nasdaq National Market under the symbol
"NEON" and has sought to obtain federal trademarks for products and services
whose names include the word "NEON." NEON is currently opposing in the U.S.
Patent and Trademark Office New Era of Networks' application to trademark
"NEONET." On December 24, 1998, New Era of Networks filed a complaint against
NEON in the United States District Court for the District of Colorado seeking
(1) a declaratory judgment that New Era of Networks' use of certain trademarks,
including "NEONET," does not infringe NEON's rights or constitute unfair
competition and (2) cancellation of NEON's federal trademark registration for
NEON. NEON has filed an Answer denying the material allegations of that
complaint, and the parties are currently engaged in discovery.
On June 23, 1999, NEON sued New Era of Networks in Fort Bend County, Texas,
alleging that New Era of Networks' use of "NEON" was in violation of Texas law
concerning tradenames and trademarks. 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 July 3, 2000 New Era of Networks filed an additional complaint against
NEON seeking a declaration that New Era's recently announced branding initiative
was not unfair competition or violative of any of NEON's proprietary rights.
This new complaint was filed in the United States District Court for Colorado,
and has been assigned to the same court as the prior complaint. NEON expects
this case to be consolidated with the prior complaint, and will defend and seek
redress against this action as is appropriate. At the date of this Report, the
United States District Court for Colorado has declined to assign a trial date
for either of these actions.
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.
8
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion contains certain forward-looking statements that
involve risks and uncertainties. NEON's actual results and the timing of certain
events could differ materially from those discussed in the forward-looking
statements as a result of certain factors, including those set forth under the
heading "Risk Factors" in NEON's filings with the Securities and Exchange
Commission, including its Form 10-K for the fiscal year ended March 31, 2000.
Additional information concerning factors that could cause results to differ
materially from those forward-looking statements is contained under Item 5.
"Other Information." All forward-looking statements in this discussion are
expressly qualified in their entirety as described below under Item 5 and in
NEON's Form 10-K.
OVERVIEW
NEON develops, markets and supports Enterprise Access and Integration,
Security, and Subsystem Management software for all industries. NEON was
incorporated in May 1993 and is a successor by merger to NEON Systems, Inc., an
Illinois corporation which was incorporated in June 1991. NEON introduced its
first generally available products, Shadow Direct and Shadow Web Server, in
November 1994 and January 1995, respectively. NEON introduced the third member
of the Shadow product line, Shadow Enterprise Direct, in February 1996. NEON's
Shadow products provide rapid and cost-effective access to and connectivity
between enterprise data, transactions and applications. Shadow Direct enables
client/server applications to access and integrate with mainframe data and
applications. Shadow Enterprise Direct provides access and integration between
client/server systems. In addition, through its distributor agreement with
Peregrine/Bridge Transfer Corporation, NEON launched the first of its Enterprise
Subsystem Management products in January 1997. This product line, which
currently consists of ten products, improves the availability and performance
of mainframe subsystems to support the growing demands placed on the mainframe.
NEON announced the release on May 3, 1999 of its new enterprise security
management product, Halo SSO(TM). On September 29, 1999 NEON closed its
acquisition of the principal assets of Beyond Software Inc., a privately-held
company based in Santa Clara, California, that provided Enterprise Access and
Integration software for IBM OS/390(R) -MVS(R) and VM/ESA(R) mainframe
platforms. The assets, including rights to Beyond Software's VM/ESA(R) software
products, were acquired for $1.87 million, plus the assumption of certain
liabilities.
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 nine 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. 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, Germany, and Australia
through three wholly-owned consolidated subsidiaries. Revenues from these
subsidiaries are denominated in local currencies. Pursuant to these foreign
operations, NEON is exposed to foreign currency fluctuations for its net working
capital positions. At June 30, 2000, NEON had unhedged net current assets
denominated in British pounds aggregating 1,032,677 British pounds, unhedged net
current liabilities denominated in deutschemarks aggregating 1,136,686
deutschemarks and unhedged net current liabilities denominated in Australian
dollars aggregating 25,176 Australian dollars. 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 12% and 34% of total revenues in the three months ended June 30,
2000 and 1999, respectively. The British pound, German mark and Australian
dollar 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
9
<PAGE> 10
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 fiscal 2001 revenues from international operations
should not vary substantially as a percentage of total revenue and from the
level experienced in fiscal 2000.
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>
THREE MONTHS ENDED JUNE 30,
----------------------------
2000 1999
---- ----
<S> <C> <C>
Revenues:
License 69% 73%
Maintenance 31 27
--- ---
Total revenues 100 100
Cost of revenues:
Cost of licenses 11 2
Cost of maintenance 7 4
--- ---
Total cost of revenues 18 6
--- ---
Gross profit 82 94
Operating expenses:
Sales and marketing 47 40
Research and development 25 20
General and administrative 13 12
Non-cash compensation 1 2
Amortization of acquisition related costs 2 --
--- ---
Total operating expenses 88 74
--- ---
Operating income (6) 20
Interest and other, net 9 8
--- ---
Income before provision for income taxes 3 28
Provision for income taxes 1 11
--- ---
Net income 2% 17%
=== ===
</TABLE>
THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE MONTHS ENDED JUNE 30, 1999
REVENUES
Total revenues. NEON's revenues increased $1.5 million or 25% from $6.1
million for the three months ended June 30, 1999 to $7.6 million for the three
months ended June 30, 2000. Two customers individually accounted for 27% and for
14% of total revenues in the three months ended June 30, 2000; two customers
accounted for 29% and for 18% of total revenues in the three months ended June
30, 1999.
License. License revenues increased $834,000 or 19% from $4.4 million for
the three months ended June 30, 1999 to $5.3 million for the three months ended
June 30, 2000. This was primarily attributable to an increase of $1.2 million in
license sales of Enterprise Subsystem Management products and sales totalling
$350,000 of NEON's new iWave products. These sales increases were partially
offset by a decrease of $715,000 in sales of our Shadow product group for the
three month period ended June 30, 2000. License revenues for the three months
ended June 30, 2000 include $986,000 attributable to a software distribution
agreement with BMC Software entered in connection with NEON's settlement of a
lawsuit originally filed by BMC Software. As the lawsuit settlement and
distribution agreement were entered into in October 1999, there were no
corresponding revenues under the BMC Software distribution agreement in the
three months ended June 30, 1999.
Maintenance. Maintenance revenues increased $700,000 or 43% from $1.6
million for the three months ended June 30, 1999 to $2.3 million for the three
months ended June 30, 2000. This increase resulted primarily from the increase
in NEON's cumulative installed base of customers.
10
<PAGE> 11
COST OF REVENUES
Cost of licenses. Cost of license revenues includes costs of product
licenses, such as product manuals, distribution and media costs for NEON's
software products, as well as royalty payments to third parties related to
license revenues primarily resulting from NEON's sales of Enterprise Subsystem
Management products. Cost of license revenues increased $751,000 or 797% from
$94,000, or 2% of license revenues, for the three months ended June 30, 1999 to
$846,000, or 16% of license revenues, for the three months ended June 30, 2000.
The increase in the cost of license revenues was attributable to additional
royalties on increased shipments of Enterprise Subsystem Management products
sold by NEON under the terms of its distributor agreement with Peregrine/Bridge
Transfer Corporation.
Cost of maintenance. Cost of maintenance revenues includes personnel and
other costs related to NEON's customer support department. Cost of maintenance
revenues increased $263,000, or 97% from $272,000, or 17% of maintenance
revenues, for the three months ended June 30, 1999 to $536,000, or 23% of
maintenance revenues, for the three months ended June 30, 2000. The increase
was due principally to increased compensation and other staffing costs
associated with an increase in the number of support personnel required to
provide maintenance services to NEON's growing installed customer base.
OPERATING EXPENSES
Sales and marketing. Sales and marketing expenses include salaries,
commissions, bonuses, benefits and travel expenses of sales, presales support
and marketing personnel, together with trade show participation and other
promotional expenses. These expenses increased $1.1 million, or 47% from $2.5
million, or 40% of total revenues, for the three months ended June 30, 1999 to
$3.6 million, or 47% of total revenues, for the three months ended June 30,
2000. This dollar increase includes a $764,000 increase in compensation and
facilities expenses associated with additional North American sales and
marketing personnel and the payment of increased sales commissions as a result
of NEON's revenue growth. In addition, the dollar increase includes
approximately $241,000 of increased international agent commissions. Sales and
marketing expenses are expected to increase in absolute dollar amounts in
future periods. However, if total revenues increase in future periods from the
level experienced for the quarter ended June 30, 2000, these expenses are
expected to decrease as a percentage of total revenues from the level
experienced for the three months ended June 30, 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
increased $674,000, or 56% from $1.2 million, or 20% of total revenues, for the
three months ended June 30, 1999 to $1.9 million, or 25% of total revenues, for
the three months ended June 30, 2000. The increase results primarily from a
$569,000 increase in compensation costs and the computer hardware, software and
telecommunication expenses related to increased staffing. Research and
development expenses are expected to increase in absolute dollar amounts in
future periods. However, if total revenues increase in future periods from the
level experienced for the quarter ended June 30, 2000, these expenses are
expected to decrease as a percentage of total revenues from the level
experienced for the three months ended June 30, 2000. NEON follows SFAS No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed". Research and development expenditures in general have been charged to
operations as incurred and any amounts which were capitalizable have been
immaterial.
General and administrative. General and administrative expenses include
salaries, personnel and related costs for NEON's executive, financial, legal and
administrative staff. General and administrative expenses increased $258,000, or
36% from $714,000, or 12% of total revenues, for the three months ended June 30,
1999 to $973,000, or 13% of total revenues, for the three months ended June 30,
2000. This increase resulted primarily from a $96,000 increase in legal
expenses, primarily associated with the litigation with New Era of Networks (See
Note 7 to the Financial Statements) and increases of $133,000 in compensation
and facilities costs related to increased staffing. NEON anticipates that
general and administrative expenses will continue to increase in absolute
dollars in future periods, but should not vary substantially as a percentage
of total revenues from the level experienced for the three months ended
June 30, 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 is reduced periodically as a result of the cancellation of
options associated with terminated employees. During the three months ended
June 30, 1999, $136,000 was recognized as non-cash compensation expense, while
$104,000 was recognized as non-cash compensation expense during the three months
ended June 30, 2000. The deferred balance of $795,000 will be recognized over
the remaining vesting period, approximately two years, of the granted options.
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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. Amortization of acquisition related costs
of $119,000 was recognized in the three months ended June 30, 2000.
Interest and other income, net. Interest income increased $121,000 from
$544,000 for the three months ended June 30, 1999 to $665,000 for the three
months ended June 30, 2000. The increase includes $89,000 related to license
sales with deferred customer payments. Additionally, more favorable interest
rates have been obtained by investing in marketable securities with longer
maturities.
Provision for income taxes. Income tax expense is lower for the current
quarter by $562,000 compared to the quarter ended June 30, 1999 because of the
decline in net income and a reduction in NEON's effective income tax rate from
38% to 36%.
LIQUIDITY AND CAPITAL RESOURCES
NEON's cash and cash equivalents balance decreased to $25.5 million at June
30, 2000 from $37.1 million at March 31, 2000. This decrease was due primarily
to the investment of $11.3 million in highly liquid marketable securities. At
March 31, 2000, NEON had invested $4.6 million in highly liquid marketable
securities compared to $16 million as of June 30, 2000.
Net cash provided by operating activities was $286,000 in the three months
ended June 30, 2000, while the net cash provided by operating activities was
$1.7 million in the three months ended June 30, 1999. The reduction in net cash
provided by operating activities during the three months ended June 30, 2000 was
primarily the result of reduced net income and decreased balances in NEON's
accounts payable.
Net cash used by NEON in investing activities was $11.9 million and $51,000
in the three months ended June 30, 2000 and 1999, respectively. Purchases of
marketable securities totalling $11.3 million as well as purchases of property
and equipment, including computer software, were the principal uses of investing
funds in the three months ended June 30, 2000. The principal investing use in
the three months ended June 30, 1999 was the purchase of property and equipment,
including computer hardware and software to support NEON's growing employee
base. As of June 30, 2000, NEON had no material commitment for capital
expenditures.
NEON's net cash provided by financing activities was $186,000 and $1,000 in
the three months ended June 30, 2000 and 1999, respectively. Net cash provided
by financing activities in both periods was cash received from the exercise of
employee stock options.
NEON believes that its current balances of cash and investments in
highly-liquid 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.
ITEM 3. 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 the
British pound sterling, which is the functional currency of NEON Systems (UK)
Ltd. As sales contracts are denominated and settled in the functional currency,
risks associated with currency fluctuations are minimized to foreign currency
translation adjustments. 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 $25.5 million at June 30, 2000,
and were invested in different types of money market securities. An additional
$13.8 million was invested in short-term available-for-sale marketable
securities with maturity dates from three months to one year in term, and $2.2
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 2000.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS - Please see the discussion in Part I, Note 7 of
the "Condensed Notes to Consolidated Financial Statements," which is
incorporated by reference in this Part II, Item 1.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS - In March 1999, NEON
completed the initial public offering of its common stock (the "IPO").
In the IPO, NEON issued and sold 3,041,000 shares for an aggregate
price to the public of $45,615,000, and a sole selling stockholder
sold 64,000 shares of common stock for an aggregate offering price of
$960,000. The IPO was a firm commitment underwriting, and the managing
underwriters of the IPO were Donaldson, Lufkin & Jenrette Securities
Corporation, Hambrecht & Quist LLC and CIBC Oppenheimer Corp. The
underwriting discount incurred by NEON relating to the IPO was
$3,193,050. Net offering proceeds received by NEON from the IPO were
approximately $41.2 million. Approximately $1.0 million of the
proceeds received by NEON from the IPO was used to repay existing
indebtedness and $1.9 million was used in connection with the
September 1999 acquisition of the assets of Beyond Software Inc. An
additional $3.5 million was paid to Sterling Software in December 1999
as a nonrefundable advance on future royalties to be earned by
Sterling from NEON's sale of certain Sterling products. The remainder
of the proceeds from the IPO (other than the proceeds used to repay
the existing indebtedness and other uses described in Part I, Item 2.
"Management's Discussion and Analysis of Financial Condition and
Results of Operations" under the caption "Liquidity and Capital
Resources") has been invested in interest-bearing, investment-grade
securities.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS- Not Applicable.
ITEM 5. OTHER INFORMATION - RISKS ASSOCIATED WITH FORWARD-LOOKING
STATEMENTS - This filing contains certain forward-looking statements
such as NEON's or management's intentions, hopes, beliefs,
expectations, strategies, predictions or any other variations thereof
or comparable phraseologies of NEON's future activities or other
future events or conditions within the meaning of Section 27A of the
Securities Act and Section 21E of the Securities Exchange Act of 1934,
as amended, which are intended to be covered by the safe harbors
created thereby. Investors are cautioned that all forward-looking
statements involve risks and uncertainty. Although NEON presently
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 filing 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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit 27 - Financial Data Schedule
(b) REPORTS ON FORM 8-K - NEON did not file any reports on Form 8-K
during the first quarter of its fiscal year 2001, which was the
quarter for which this report is filed.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NEON SYSTEMS, INC.
August 11, 2000 /s/ JOE BACKER
-----------------------------------------
Joe Backer, President and Chief Executive
Officer
(Principal executive officer)
August 11, 2000 /s/ JOHN REILAND
------------------------------------------
John S. Reiland, Chief Financial Officer
(Chief accounting officer)
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
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27.1 Financial Data Schedule
