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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, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-25457
NEON Systems, Inc.
(Exact name of Registrant as specified in its charter)
Delaware 76-0345839
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
14100 Southwest Freeway, Suite 500, 77478
Sugar Land, Texas (zip code)
(Address of principal executive offices)
(281) 491-4200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of Each Class on which registered
------------------- -------------------
None None
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 25, 2002 was $23,099,138, based on the last sale price of
$5.45 for Registrant's Common Stock on the Nasdaq National Market on June 25,
2002.
As of June 25, 2002, 8,682,691 shares of the Registrant's Common Stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Selected portions of the Proxy Statement for the Annual Meeting of
Stockholders to be held in the third calendar quarter of 2002 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, 2002 are incorporated by reference into
Part III of this Form 10-K.
NEON SYSTEMS, INC.
FORM 10-K
FOR FISCAL YEAR ENDED MARCH 31, 2002
TABLE OF CONTENTS
Page
----
PART I
1. Business ............................................................................... 3
2. Properties ............................................................................. 14
3. Legal Proceedings ...................................................................... 14
4. Submission of Matters to a Vote of Security Holders .................................... 14
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters .................. 16
6. Selected Consolidated Financial Data ................................................... 17
7. Management's Discussion and Analysis of Financial Condition and Results of Operations .. 18
7A. Quantitative and Qualitative Disclosures about Market Risk ............................. 28
8. Consolidated Financial Statements and Supplementary Data ............................... 29
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ... 48
PART III
10. Directors and Executive Officers of Registrant ......................................... 48
11. Executive Compensation ................................................................. 48
12. Security Ownership of Certain Beneficial Owners and Management ......................... 48
13. Certain Relationships and Related Transactions ......................................... 48
PART IV
14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K ...................... 49
2
PART I
This Report contains certain forward-looking statements of the intentions,
hopes, beliefs, expectations, strategies and predictions of NEON Systems, Inc.
("NEON") or its management with respect to future activities or other future
events or conditions within the meaning of Section 27A of the Securities Act of
1933, as amended (the "Act"), and Section 21E of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), which are intended to be covered by the
safe harbors created thereby and the Safe Harbor Provisions of the Private
Securities Litigation Reform Act of 1995. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential," "continue," or the negative of these terms or other comparable
terms. Investors are cautioned that all forward-looking statements involve risks
and uncertainties and other factors, many of which are outside NEON's control,
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 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 Systems, Inc. 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 for the IBM
mainframe platform. The IBM mainframe is a critical processing platform for
major corporations due to the high performance, availability, scalability, and
security inherent in the platform. For more than thirty years there has been
ongoing investment in mission critical data and applications that reside on the
IBM mainframe platform and it remains today a primary repository for corporate
data and applications for large organizations. The NEON products allow our
customers to more effectively utilize their investment in IBM mainframe-based
database and application systems when used in the following activities:
. Implementing new applications that leverage legacy data and application
assets
. Improving the availability, recoverability, and control of IBM's IMS
database management system
. Re-deployment of applications in an IBM CICSPlex environment
. Implementing consolidated problem management across disparate help-desk
systems
Over the past year, NEON has re-organized internally into three separate
divisions that focus product development, sales and support in three key
solution areas. NEON believes this new organizational structure will allow each
product set to maximize its ability to serve its respective markets and
maximize the value these solutions bring to our customers and stockholders. The
divisions were created by segmenting the products and associated assets and
personnel. The following product branding and capabilities are the basis of the
new divisional structure:
. "Shadow" branded products - These products provide access and
integration of IBM mainframe data and applications from standard
application client environments. The Shadow products provide direct
access to mainframe data stored in Adabas, DB2, IMS/DB, and VSAM. In
addition, Shadow products provide direct access to applications found in
IMS/TM, CICS/TS, and Natural.
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. "NEON" branded products - These products provide enhanced availability,
recoverability, and control for the IBM IMS database management system
by providing high-speed utilities and monitoring capabilities. In
addition, the NEON branded products allow customers to more rapidly
deploy CICS applications in the IBM CICSPlex environment. These products
are marketed and sold by NEON under a development and distribution
agreement with Peregrine/Bridge Transfer Corporation (PBTC).
. "iWave" branded products - Helpdesk integration software - NEON's iWave
Helpdesk Integrator integrates disparate helpdesk, network management,
database management, and systems management applications across
mainframe and distributed systems environments.
Shadow Branded Products - Access and Integration for Legacy Systems on the IBM
Mainframe
Shadow branded products are packaged to meet the needs of two distinct buyers of
access and integration software for the IBM mainframe:
. Shadow Direct - Shadow Direct is a mainframe centric product that is
targeting the organization that has a mainframe centric view of
information technology. Shadow Direct is positioned as the best of
breed "IT infrastructure" for all access and integration of mainframe
data and transactions and is well suited for direct sales into the
traditional mainframe software buyer community.
. Shadow Connect - Shadow Connect is a connector packaging of Shadow and
targets organizations who view mainframes as one of the many platforms
that must be integrated with non-mainframe platforms. These buyers do
not have a mainframe-centric view of information technology. Shadow
Connect is NEON's primary offering through its OEM/Reseller indirect
channel.
NEON Branded Products - High availability solutions for CICS and IMS
CICS and IMS are the most mature transaction and database systems in the
world. Both are designed to handle large volumes of activity, and both are
deeply embedded in critical business applications for many of the world's
largest organizations. NEON's products for CICS and IMS keep these critical
systems working at the highest levels of availability, recoverability and
control and help customers take advantage of significant advances in mainframe
processing. NEON markets these products pursuant to a distribution agreement
with PBTC. NEON's products for CICS and IMS include:
. The NEON Affinity Server for CICS allows customers to take advantage of
new system and performance improvements available from IBM on the
mainframe CICSPlex facility without incurring the cost of re-writing
existing applications.
. NEON high speed database utilities are used for IMS database
reorganization to arrange data within a database for the fastest
possible access, and eliminate performance degradation that naturally
occurs as information is added, changed, or deleted.
. NEON also provides IMS products that are used to (1) increase the
maximum amount of data that can be stored in a single database, and (2)
address complex technical issues related to the randomizer which is used
to spread out data for easy access and the indexes which are used to
find data in a database.
. NEON backup and recovery utilities for IMS decrease "downtime" after a
database problem by providing high-speed backup and recovery functions,
plus tools to verify the integrity of the database before and after a
recovery.
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iWave Branded Products - Helpdesk Integration
The helpdesk applications that IT support personnel use to track and
resolve problems are critical to ensuring customer satisfaction and the
performance of business-critical systems. However, the information required to
track and resolve problems across enterprise systems is normally found in
discrete systems. It is difficult and costly to create custom interfaces between
the mainframe helpdesk, distributed systems helpdesk, network management,
database management, and systems management applications that are required to do
the job correctly. NEON's iWave branded products eliminate this problem by
providing interfaces and information mapping between the industry's largest
helpdesk, network management, and systems management applications. NEON's iWave
products can help customers migrate between systems due to changing needs,
connect "islands" of information, and streamline support processes. The end
result is increased value of existing systems, reduced migration and integration
costs, and improved performance of IT support systems and the personnel who use
them.
NEON's Markets
NEON's products address market opportunities found in large organizations around
the world. The products support business-critical applications of large
companies that use mainframes independently or in conjunction with new systems
deployments. NEON's products help customers continue to leverage and increase
the value of their mainframe and enterprise computing systems, allowing them to
create, manage, and maintain high-value applications dependent on the IBM
mainframe platform.
Industry Background
A critical aspect of all large business operations is the ability to effectively
utilize information technology. Organizations are dependent on a variety of
applications, information systems, and technology infrastructures, which are
used to run the day-to-day operations of the business. Over time, organizations
have made significant investments in these various applications, information
systems, and technology infrastructures that have become known as legacy
systems. Ever changing business demands along with the constant introduction of
new technology create new challenges for these organizations, as they must
implement new solutions in harmony with these legacy systems.
Many 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. The demand for
flexible integration of legacy systems comes at the same time as there are
increasing demands to improve availability of critical legacy database
management systems and manage an increasingly complex information technology
infrastructure.
The following critical elements of information technology infrastructure are key
considerations for organizations meeting the ongoing challenges of successful
business operations in an age of ever increasing technology choices:
. 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.
. Application Servers/Application Platforms. Organizations must have the
capability to develop and deploy new applications as well as to
integrate existing applications to take advantage of the data and
business processing in legacy systems. There is an increasing
convergence of specific technologies associated with
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. these functions (application development, application run-time
execution, and application integration) that is manifesting itself in
the form of an all-purpose technology platform. This technology
platform is generically referred to as an "Application Server" or,
more recently, an "Application Platform." The primary vendors of these
platforms are IBM, BEA, Oracle, and Sun with many other vendors
participating in various aspects of this platform trend. The ability
to provide the critical capabilities of application development,
deployment and integration in a single solution suite from these major
vendors is of significant importance to organizations as they look for
complete capabilities from a fewer number of stable solutions
providers. The Application Server/Application Platform appears to be
the current basis for the majority of in-house application development
by larger organizations and is an emerging standard for development by
external packaged application vendors.
. IBM 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 reside
on mainframe systems, representing a wealth of important corporate
information that must be leveraged in the ongoing deployment of new
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 provide
specific support for a variety of functions, including Enterprise
Resource Planning (ERP), Customer Relationship Management (CRM), Human
Resource Management Systems (HRMS), 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.
NEON Product Advantages
NEON's products provide organizations with the following benefits in deploying
new applications and extending existing applications:
. Easy To Use And Cost-Effective. The NEON software products were
designed to be easy to use, 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 Helpdesk Integrator product provides numerous help
desk interfaces that can be used to consolidate trouble ticket
information. NEON believes that its IMS products lead the market place
in performance and low cost of deployment.
. Preservation of Information Technology Investment. The NEON, 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 product family, organizations
can continue to use these reliable, mission-critical applications as
new technologies and market opportunities evolve. NEON believes that
its software products are unique in the industry in the depth of
support provided for the IBM OS/390 environment.
. Flexibility. The NEON software products use industry-standard
technologies that allow users to integrate with a variety of data and
application sources. The NEON software products' flexible architecture
allows
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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 and Scalability. The NEON 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 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. The NEON
software products provide a number of utilities that support all
phases of the application lifecycle. The NEON software products'
end-to-end diagnostics provide rapid resolution of development
problems, resulting in faster delivery of applications. The NEON
product family maintains the required performance and availability of
mainframe-based applications operating in a distributed environment at
significantly reduced system maintenance costs.
The NEON Strategy
NEON's goal is to continue to grow as a leading provider of software solutions
in markets for or related to the IBM mainframe platform. The following are key
elements of the NEON strategy:
. Maintain and Enhance Technological Leadership. NEON believes that it
is a technology leader in providing software solutions for the IBM
mainframe platform. The foundation of its technological leadership is
the product architecture and core code base that underlies the Shadow,
NEON and iWave products. This architecture not only provides
significant advantages over competing products, but also 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.
The NEON products provide more cost effective and higher performing
ways to manage IMS and CICS systems and provide key infrastructure for
integration of packaged applications and enterprise data.
. Leverage Installed Base of Customers. Approximately 400 organizations
worldwide have purchased NEON's products. NEON's customers span major
industries, including energy, manufacturing, financial services,
government 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 the iWave branded and NEON branded products. 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 licensed and
embedded NEON technology into their products pursuant to OEM/Reseller
agreements. NEON believes that there are significant revenue growth
opportunities in working with partners to establish alternate sales
channels for its products.
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Sales Strategy
NEON sells its products through a direct sales force and through indirect
channels.
Direct Sales Channel. NEON utilizes a direct sales 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
sales. The direct sales force for North America is based in Sugar Land, Texas
and generates a majority of NEON's revenues. In January 1997, NEON established
its first international direct sales office in Windsor, England. In August 1997,
NEON established another international direct sales office in Frankfurt,
Germany, and in May 2000, NEON established a sales office in Sydney, Australia.
Indirect Sales Channel. NEON utilizes indirect sales channels, emphasizing
Marketing/Referral, International Distributorships and OEM/Reseller
Relationships with key partners.
. International Distributorships. NEON has also established indirect
distribution channels through independent distributors in Europe,
Latin America and the Pacific Rim. At March 31, 2002, NEON had 14
distributors covering 22 countries. NEON's distributors typically
perform marketing, sales and technical support functions in their
assigned country or region. They may distribute directly to the
customer, via other resellers or through a combination of both
channels. NEON continuously trains its international distributors in
both product capabilities and sales methodologies. For financial
information attributable to each of NEON's geographic sales areas, see
"Note 9 - Operations by Geographic Location and Significant Customers"
of the Notes to the Financial Statements.
. Original Equipment Manufacturer OEM/Reseller Relationships. NEON has
OEM/Reseller relationships with a number of companies. 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. Large-scale Systems Integrators also resell
the products in value-added solutions to the end-user.
. Marketing/Referral Relationships. NEON has developed marketing and
referral relationships with a number of companies. These companies
generate qualified leads to NEON in return for a referral fee. These
Marketing/Referral Partners also engage in joint marketing
opportunities with NEON.
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.
Customers
NEON's customer base spans major industries, including energy,
manufacturing, financial services, government and retail. NEON provides its
products to customers under non-exclusive, non-transferable licenses. Under
NEON's
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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. NEON had one customer that represented 10% and two
customers who aggregated 14% of consolidated revenue in fiscal 2002, one
customer that represented 16% of consolidated revenue in fiscal 2001, and no
customers that accounted for 10% or more of consolidated revenue in fiscal 2000.
Customer Support
Customer support personnel provide pre-sale, installation and post-sale
technical support by toll-free telephone, e-mail and facsimile, and through
NEON's Internet site and bulletin boards. Customer support is available on a
24x7 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. At March 31, 2002,
NEON had 13 customer support employees.
Product Development
NEON's research and development efforts are focused on continuing to deliver
new capabilities that allow our customers to extend their usage of our products,
developing support for new releases of software on which our products are
dependent, and providing maintenance for resolution of problems which may be
encountered when using our software. NEON incorporates the recommendations of
existing and potential customers when developing its products and believes that
continued dialogue with customers is an important element in developing
enhancements to existing products and in the development of new products.
NEON has dedicated, and expects to continue to dedicate a significant
amount of resources to developing new and enhanced products. NEON continues to
follow a plan of continuous product improvement and enhancement. At any point in
time a number of product development initiatives will be underway. Currently,
NEON is adding support for new integration capabilities to provide
bi-directional support, new integration encoding schemes, and support for
emerging application interfaces. NEON is expanding the number of applications
and data sources supported by iWave Integrator and developing more efficient and
cost effective utilities for IMS subsystems management in the area of
monitoring, and recovery. NEON believes that these development efforts will
increase Shadow's technical leadership in the integration market, broaden
operational issues solved by the NEON branded IMS products, and expand the
potential market for the iWave Integrator product.
NEON has made an investment in Scalable Software, Inc., a developer of
Software Solutions for IT portfolio management. Scalable Software is a company
founded by Louis R. Woodhill, NEON's President and Chief Executive Officer.
Several members of NEON's Board of Directors have a financial interest in and
serve as members of the Board of Directors and Officers of Scalable Software.
NEON has entered into agreements to advance up to $9.0 million to Scalable
Software, of which $3.5 million is secured by personal guarantees from John J.
Moores, Louis R. Woodhill and Jim Woodhill. In addition, NEON has obtained a
two-year option to acquire Scalable Software. Scalable Software is a
Houston-based provider of client effectiveness management tools for Windows
networks. NEON believes that the Scalable products are gaining increasing levels
of acceptance in the marketplace and a reputation for ease of installation and
use. See Management's Discussion and Analysis of Financial Condition and Results
of Operations - Related Party Transactions and Note 4 to NEON's financial
statements.
Competition
NEON competes in markets that are intensely competitive and characterized
by rapidly changing technology and evolving standards. NEON expects 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.
NEON's Shadow products compete principally with products from established
vendors such as IBM, Oracle, Merant, Sybase (including New Era of Networks),
WebMethods, Vitria, Information Builders, BEA Systems, IONA Technologies, TIBCO,
and SeeBeyond. The NEON branded products for IMS face significant competition
from products offered by BMC Software, IBM, and Computer Associates. NEON's
iWave products face competition from low function integration solutions inherent
in the help desk products themselves and in broad based integration solutions
found in competitors' products that compete with Shadow. Other competitive
factors include:
. Business applications vendors who may internally develop, or attain
through acquisitions and partnerships, integration solutions or IMS and
CICS management solutions;
. Internal development efforts by corporate information technology
departments; and
. New entrants to the integration or IMS and CICS management markets.
9
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. Increased competition
could result in price reductions, fewer customer orders, reduced gross margins,
longer sales cycles and loss of market share, any of which could 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. 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.
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, 2002, NEON and its subsidiaries employed 120 persons,
including 63 in sales, marketing and field operations, 35 in research and
development and 22 in finance and administration. 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.
RISK FACTORS
This report on Form 10-K, including Management's Discussion and Analysis of
Financial Condition and Results of Operations, contains forward-looking
statements and other prospective information relating to future events. These
forward-looking statements and other information are subject to certain risks
and uncertainties that could cause results to differ materially from historical
results or anticipated results, including the following:
Some Members Of Our Board Of Directors And Management May Have Conflicts Of
Interests And/Or Are Interested Parties To Certain Transactions Of NEON
Members of our Board of Directors and our Executive Officers are
shareholders, directors and/or officers in other companies, some of which are
identified and discussed in the section on "Related Party Transactions" herein,
including the following:
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. Peregrine/Bridge Transfer Corporation
. Scalable Software, Inc.
. Sheer Genius Software, Inc
See "Related Party Transactions" in Management's Discussions and Analysis of
Financial Condition and Results of Operations and Note 4 to NEON's consolidated
financial statements.
Such relationships may give rise to conflicts of interest resulting from the
balancing of such officer/director's duties to NEON's stockholders and their
corresponding duties to the stockholders of any company in which they also hold
positions as directors (or officers), especially in the context of business
negotiations between NEON and such other company. In any event where an officer
or director has a conflict of interest, the Board of Directors has reviewed such
conflict and fully discussed the interests of the directors and/or officers
involved. On any votes related thereto, the interested party has abstained.
Notwithstanding such procedures, NEON may face the threat of shareholder claims
based solely on the mere appearance of conflicts of interest in any related
party business transaction.
Uncertainty Regarding Management May Adversely Affect Our Business
In June 2001, Steve Odom, our then-President, Chief Operating Officer and
Chief Financial Officer, resigned. Immediately after Mr. Odom's resignation,
John Moores, Chairman of our Board of Directors, became our interim Chief
Executive Officer and Wayne Webb, our Vice President and General Counsel, became
our interim President. On June 28, 2001, James Bradford Poynter was hired by
NEON as its Chief Financial Officer. On October 17, 2001, NEON announced that
the Board of Directors had hired Louis R. Woodhill as NEON's Chief Executive
Officer and President. Such continuous change in management may cause
uncertainties concerning NEON's future direction and results. In addition, since
Mr. Woodhill is still the Chief Executive Officer and President of Scalable
Software, the failure of NEON to exercise its option to acquire Scalable
Software may result in additional uncertainty with respect to his continued
management of NEON, which uncertainty could materially adversely affect our
business, operating results and financial condition.
Our Stock Price May Fluctuate And Be Impacted By A Number Of Internal And
External Factors
. As of June 3, 2002, our common stock began trading on the Nasdaq Stock
Market under the ticker symbol "NEON". Previously, we had traded under
the ticker symbol "NESY". In previous years our stock price has
fluctuated and continues to be subject to wide swings in price based
on a number of factors including the following:
Our future operating results may vary significantly from quarter to quarter
due to a variety of factors, many of which are outside our control. In
addition, the amount of revenues associated with sales of our software can
vary significantly. Therefore, it is likely that in one or more future
quarters our results may fall below the expectations of securities analysts
and investors. 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 will likely decline.
. Seasonal Trends In Sales Of Our Products May Affect Investors'
Expectations Regarding Our Financial Performance
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
11
results in a given year may be adversely impacted if this seasonal trend
continues. We believe that our seasonality is due in part to the calendar
year budgeting cycles of many of our customers, our employee recognition
policies which tend to reward our sales personnel for achieving fiscal
year-end rather than quarterly revenue quotas, and the timing of our hiring
of sales force personnel. In future periods, we expect that this seasonal
trend will continue to cause first fiscal quarter license revenues to
decrease from the level achieved in the preceding quarter.
. Because A Significant Percentage Of Our Revenues Are Derived From Our
Shadow Product Line, Decreased Demand For These Products Could
Adversely Affect Our Business
The Shadow product line represented 88%, 75%, and 86% of our revenues in
fiscal 2000, 2001 and 2002, respectively. 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 the Shadow product line 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.
. 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 NEON's expense, resales of their shares of common
stock. Mr. Schaeffer and the individuals and entities to which JMI Equity
Fund, L.P. has distributed its shares of our common stock beneficially own,
in the aggregate, approximately 4.3 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.
Reduced Customer Reliance Upon Mainframe Computers Could Adversely Affect Our
Business
We are dependent upon the continued use and acceptance of mainframe
computers in a computing environment increasingly based on distributed
platforms, including client/server and Internet-based computing networks.
Decreased use of the mainframe or reduced demand for Web-based and client/server
applications accessing mainframe data and transactions could have a material
adverse effect on our business, operating results and financial condition. We
derive our revenues primarily from our Shadow products, and, to a lesser extent,
from our Enterprise Subsystem Management products that backup, recover,
reorganize and manage IMS databases, and our helpdesk integration software
products that allow customers to integrate helpdesk systems either with other
helpdesk systems, network system management products or asset management
products. 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; and
. Growth in business demands to integrate helpdesk systems, and/or to
integrate helpdesk systems with network system management or asset
management software products.
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.
12
Rapid Technological Change Could Render Our Products Obsolete
Our markets are characterized by rapid technological change, frequent new
product introductions and enhancements, uncertain product life cycles, changes
in customer requirements and evolving industry standards. The introduction of
new products embodying new technologies and the emergence of new industry
standards could render our existing products obsolete which would have a
material adverse effect on our business, operating results and financial
condition. Our future success will depend upon our ability to continue to
develop and introduce a variety of new products and product enhancements to
address the increasingly sophisticated needs of our customers. We may experience
delays in releasing new products and product enhancements in the future.
Material delays in introducing new products or product enhancements may cause
customers to forego purchases of our products and purchase those of our
competitors.
We May Be Unable To Enforce Or Defend Our Ownership And Use Of Proprietary
Technology
Our success depends to a significant degree upon our proprietary
technology. We rely on a combination of trademark, trade secret and copyright
law, and contractual restrictions and passwords to protect our proprietary
technology. However, these measures provide only limited protection, and we may
not be able to detect unauthorized use or take appropriate steps to enforce our
intellectual property rights, particularly in foreign countries where the laws
may not protect our proprietary rights as fully as in the United States.
Companies in the software industry have experienced substantial litigation
regarding intellectual property. Any litigation to enforce our intellectual
property rights would be expensive and time-consuming, would divert management
resources and may not be adequate to protect our business.
We could be subject to claims that we have infringed the intellectual
property rights of others. In addition, we may be required to indemnify our
distribution partners and end-users for similar claims made against them. Any
claims against us could require us to spend significant time and money in
litigation, pay damages, develop new intellectual property or acquire licenses
to intellectual property that is the subject of the infringement claims. These
licenses, if required, may not be available on acceptable terms. As a result,
intellectual property claims against us could have a material adverse effect on
our business, operating results and financial condition.
Loss Of Code-Sharing Or Distributor Rights Could Divert Our Resources From New
Product Development
We have code-sharing arrangements with third parties under which we have
obtained and used some source code in the development of some of our software
products. If any of these agreements are terminated, we could be required to
discontinue our use of the acquired code, and we would have to spend time and
software development resources to replace that code. Any diversion of these
resources could 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 distribution agreement
with an initial term through March 31, 2004. The license may be terminated by
either party in the event of default. Termination of the agreement could have a
material adverse effect on our business, operating results and financial
condition.
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 have a material adverse effect on
our business, operating results and financial condition. Despite testing, we
cannot be certain that errors will not be found in our products. 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 Officers And Directors Control NEON, And These Officers And Directors Could
Control Matters Submitted To Our Stockholders
13
At present, our executive officers and directors and entities affiliated
with them beneficially own approximately 51.2% of our outstanding common stock.
As a result, these stockholders, if they act together, could control most
matters submitted to our stockholders for a vote, including the election of
directors.
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 comprises 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 Windsor, England; Frankfurt, Germany; and
Sydney, Australia. Management believes that its current facilities are adequate
to meet its needs through the next 12 months and that, if required, suitable
additional space will be available on commercially reasonable terms to
accommodate expansion of NEON's operations.
ITEM 3. LEGAL PROCEEDINGS
NEON is not currently involved in any claims or legal actions, except for
those that arise in the ordinary course of business. In the opinion of
management, the ultimate disposition of any of those matters would not have a
material adverse effect on NEON's consolidated financial position, results of
operations or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On March 26, 2002, NEON convened its Annual Meeting of Stockholders for the
fiscal year ended March 31, 2001. The Annual Meeting was held at later date that
usual due to a number of factors, including changes in management, a
restructuring of the Company along product division lines and the initial review
of the Special Committee of the Board of Directors of the proposed acquisition
of Scalable Software, Inc. As of the record date of February 26, 2002, there
were 8,672,103 shares issued and outstanding. At the Annual Meeting, which was
held at NEON's headquarters in Sugar Land, Texas on March 26, 2002 and adjourned
until April 5, 2002 for certification of the voting results, the following
matters were submitted to the stockholders for a vote and were approved by the
vote reflected below each such proposal:
. Election of three Class II directors to serve on the Board of Directors
We currently have eight directors holding office. The directors are divided
into three classes with staggered terms:
Class I Directors, Louis R. Woodhill, James R. Woodhill and Charles E.
Noell, III, whose terms will expire at the annual meeting to be held in
2003.
Class II Directors, Richard Holcomb, George H. Ellis and Norris van den
Berg, whose terms expired at the Annual Meeting dated March 26, 2002.
Class III Directors, John J. Moores and Peter Schaeffer, whose terms will
expire at the next annual meeting to be held in the third calendar quarter
of 2002.
At the annual meeting of stockholders held on March 26, 2002, the following
three directors were elected as Class II Directors for terms expiring at
the annual meeting to be held in 2004: Richard Holcomb, George H. Ellis and
Norris van den Berg.
The voting results were as follows:
14
Nominee Votes For (%) Votes Withheld (%)
---------------------------------------------------------------------------
Norris van den Berg 8,101,128 93.42% 56,782 0.65%
George Ellis 8,101,827 93.42% 56,083 0.65%
Richard Holcomb 8,101,427 93.42% 56,483 0.65%
. Ratification of KPMG LLP as independent auditors for the fiscal year
ending March 31, 2002
The Board of Directors selected KPMG LLP as the Company's independent
public accountants for the fiscal year ending March 31, 2002. The selection
was based upon the recommendation of our audit committee. KPMG LLP has
audited the Company's financial statements since its initial public
offering in fiscal 1999.
At the Annual Meeting of Stockholders on March 26, 2002, the stockholders
ratified the Board's selection of KPMG as NEON's independent auditors,
casting 8,152,765 votes in favor of the ratification (94.01%) and 4,515
votes against ratification (0.06%), with 630 abstentions (0.01%).
. Amendment of our Amended and Restated Certificate of Incorporation
On January 28, 2002, our Board of Directors unanimously adopted resolutions
recommending that our stockholders authorize the amendment and restatement
of our Amended and Restated Certificate of Incorporation to remove Article
11 of our Certificate of Incorporation. Article 11 of our Certificate of
Incorporation provided that there must be an affirmative vote of the
holders of at least two-thirds of our shares to adopt an agreement of
merger or to approve the sale, lease or exchange of all or substantially
all of our property and assets. This supermajority-voting requirement
exceeded the vote that would otherwise have been required for mergers and
similar transactions under Delaware law. In addition, the language as
drafted in Article 11 may have required stockholder approval for certain
transactions that would not otherwise require stockholder approval.
At the Annual Meeting of Stockholders on March 26, 2002, the stockholders
approved the Amendment to our Amended and Restated Certificate of
Incorporation, casting 6,103,822 votes in favor of the Amendment (70.38%)
and 153,004 votes against the Amendment (1.76%), with 3,130 Abstentions
(0.04%) and 1,897,954 broker non-votes.
. Adoption of NEON's 2002 Stock Plan
On January 28, 2002, our Board of Directors adopted the 2002 Stock Plan,
subject to the approval of stockholders, and reserved 2,000,000 shares of
our common stock for issuance under the 2002 Stock Plan plus (a) any shares
of our common stock which have been reserved but not issued under our 1999
Long-Term Incentive Plan as of the date of stockholder approval of the 2002
Stock Plan, (b) any shares of our common stock returned to the 1999
Long-Term Incentive Plan as a result of termination of options or
repurchase of shares of our common stock issued under the 1999 Long-Term
Incentive Plan and (c) annual increases on the first day of each fiscal
year, beginning April 1, 2003, equal to the lesser of (i) 750,000 shares,
(ii) 5% of the outstanding shares on such date or (iii) a lesser amount
determined by our Board of Directors. The 2002 Stock Plan was intended to
replace the 1999 Long-Term Incentive Plan.
At the Annual Meeting of Stockholders on March 26, 2002, the stockholders
approved the adoption of the NEON 2002 Stock Plan, casting 5,908,765 votes
in favor of the Plan (68.14%) and 342,696 votes against the adoption of the
Plan (3.95%), with 8,495 abstentions and 1,897,954 broker non-votes.
. Adoption of NEON's 2002 Director Option Plan
On January 28, 2002, our Board of Directors adopted the 2002 Director
Option Plan, subject to the approval of our stockholders. The 2002 Director
Option Plan was intended to replace our Stock Option Plan for Non-Employee
Directors, which the Board of Directors terminated after approval of the
2002 Director Option Plan. Our Board of Directors has reserved a maximum of
250,000 shares of our common stock for issuance under the
15
2002 Director Option Plan plus (a) any shares of our common stock which had
been reserved but not issued under our Stock Option Plan for Non-Employee
Directors as of the date of stockholder approval of the 2002 Director
Option Plan, (b) any shares of our common stock returned to the Stock
Option Plan for Non-Employee Directors as a result of termination of
options or repurchase of shares issued under the Stock Option Plan for
Non-Employee Directors, and (c) annual increases on the first day of each
fiscal year, beginning on April 1, 2003, equal to the lesser of (i) 2% of
the outstanding shares of our common stock on such date or (ii) an amount
determined by our Board of Directors.
At the Annual Meeting of Stockholders on March 26, 2002, the stockholders
approved the adoption of NEON's 2002 Director Option Plan, casting
5,647,900 votes in favor of the adoption (65.13%) and 335,511 votes against
the adoption (3.87%), with 276,545 votes abstaining (3.19%) and 1,897,954
broker non-votes.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
NEON's Common Stock has traded on the Nasdaq Stock Market under the symbol
"NESY" from its initial public offering until June 2, 2002. On June 3, 2002,
NEON changed the ticker symbol for its shares of common stock trading on the
Nasdaq Stock Market from "NESY" to "NEON". 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.
High Low
------- -------
Fiscal Year Ended March 31, 2002:
Fourth Quarter $ 8.70 $ 4.55
Third Quarter $ 4.20 $ 3.07
Second Quarter $ 8.74 $ 3.90
First Quarter $ 8.52 $ 4.06
Fiscal Year Ended March 31, 2001:
Fourth Quarter $ 8.31 $ 4.06
Third Quarter $ 11.44 $ 4.75
Second Quarter $ 22.00 $ 10.00
First Quarter $ 33.00 $ 16.00
During the fiscal year ended March 31, 2002, NEON issued no unregistered
shares of its Common Stock.
Holders
On June 25, 2002, the last reported sale price of the common stock on the
Nasdaq Stock Market was $5.45 per share. At June 25, 2002, there were 191
registered holders of record of NEON's common stock (although NEON believes that
the number of beneficial owners of its common stock is substantially greater)
and 8,682,691 shares outstanding.
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.
16
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.
Years Ended March 31,
-------------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- -------- -------- --------
Statement of Operations Data:
Revenues:
License $ 12,021 $ 17,826 $ 22,860 $ 15,420 $ 9,806
Maintenance 9,414 8,798 6,859 4,596 2,397
--------- --------- -------- -------- --------
Total revenues 21,435 26,624 29,719 20,016 12,203
Cost of revenues:
Cost of license 3,022 2,471 1,484 1,032 552
Cost of maintenance 2,115 2,365 1,719 1,002 743
--------- --------- -------- -------- --------
Total cost of revenues 5,137 4,836 3,203 2,034 1,295
--------- --------- -------- -------- --------
Gross profit 16,298 21,788 26,516 17,982 10,908
Operating expenses:
Sales and marketing 13,368 15,639 11,474 7,536 5,713
Research and development 6,046 8,329 5,847 4,052 2,272
General and administrative 5,097 8,957 3,549 2,947 1,480
Restructuring costs 908 -- -- -- --
Asset write-down charges 887 -- -- -- --
Amortization of goodwill 478 478 239 -- --
--------- --------- -------- -------- --------
Total operating expenses 26,784 33,403 21,109 14,535 9,465
--------- --------- -------- -------- --------
Operating income (loss) (10,486) (11,615) 5,407 3,447 1,443
Interest, net 1,174 2,486 2,256 185 28
Equity loss in affiliate (2,097) -- -- -- --
Gain from settlement of litigation 9,260 -- -- -- --
Valuation allowance of note receivable (2,000) -- -- -- --
Other, net 16 -- -- -- --
--------- --------- -------- -------- --------
Income (loss) before provision for income taxes (4,133) (9,129) 7,663 3,632 1,471
Benefit (provision) for income taxes -- 1,884 (2,759) (1,380) (310)
--------- --------- -------- -------- --------
Net income (loss) (4,133) (7,245) 4,904 2,252 1,161
Dividends on series A redeemable convertible preferred
stock -- -- -- (75) (100)
--------- --------- -------- -------- --------
Net income (loss) applicable to common stockholders $ (4,133) $ (7,245) $ 4,904 $ 2,177 $ 1,061
========= ========= ======== ======== ========
Earnings (loss) per common share (a):
Basic $ (0.44) $ (0.77) $ 0.55 $ 0.71 $ 0.45
========= ========= ======== ======== ========
Diluted $ (0.44) $ (0.77) $ 0.47 $ 0.30 $ 0.19
========= ========= ======== ======== ========
Shares used in computing earnings (loss) per common share (a):
Basic 9,325 9,432 8,914 3,065 2,371
Diluted 9,325 9,432 10,461 7,517 6,268
17
As of March 31,
------------------------------------------------------------
2002 2001 2000 1999 1998
--------- ----------- ---------- --------- -------
Balance Sheet Data:
Cash and cash equivalents $ 34,506 $ 42,774 $ 37,120 $ 45,400 $ 2,804
Working capital 33,276 40,347 41,430 45,295 973
Total assets 53,600 63,378 60,500 52,635 6,352
Secured notes payable -- -- -- -- 1,049
Series A redeemable convertible preferred stock -- -- -- -- 1,663
Total stockholders' equity (deficit) 42,924 49,314 51,858 45,830 (234)
(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 and analysis should be read in conjunction with
our consolidated financial statements and the related notes thereto included in
this report on Form 10-K. The discussion and analysis contains forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. These statements are based
on our current expectations and entail various risks and uncertainties such as
our plans, objectives, expectations and intentions. Our actual results could
differ materially from those projected in the forward-looking statements as a
result of various factors. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "expects," "plans,"
"anticipates," "believes," "estimates," "predicts," "potential," "continue," or
the negative of these terms or other comparable terms. 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 software products that allow our
customers to more efficiently use and manage the data housed on their mainframe
computer systems. 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 derives revenue from software licenses and maintenance services.
Historically, NEON's Shadow product line has generated substantially all of
NEON's revenue. 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 sales process typically
takes approximately nine months. After the initial year of license, NEON
provides ongoing maintenance services, which include technical support and
product enhancements, for an annual fee. In fiscal 2002, 2001, and 2000,
maintenance revenues represented 44%, 33% and 23% of total revenues,
respectively. Maintenance revenues are expected to continue to increase as a
percentage of total revenues as NEON's customer base continues to grow. Any
factors adversely affecting the pricing of, demand for, or market acceptance of,
our products, such as competition or technological change, could materially
adversely affect our business, operating results and financial condition.
Since NEON's inception, we have incurred substantial costs to develop our
technology and products, to recruit and train personnel for our engineering,
sales and marketing and technical support departments, and to establish an
administrative organization. We anticipate that our operating expenses will
increase in the future as we increase our sales and marketing operations,
develop new distribution channels, fund greater levels of research and
development, broaden our technical support and improve our operational and
financial systems. Accordingly, we will need to increase our annual revenue to
generate operating profits. There can be no assurance in future quarters that we
will achieve or sustain revenue growth and/or return to profitability. As a
result, management believes that its cash resources may decline as a result of
continuing losses from operations, the advance royalty payments made to PBTC
18
and incremental costs associated with the acquisition and operation of Scalable
Software. See "Related Party Transactions" below and in Note 4 to NEON's
financial statements.
NEON conducts its business in the United Kingdom and Germany through two
wholly owned consolidated subsidiaries. Revenues from these subsidiaries are
denominated in local currencies. In connection with these foreign operations,
NEON is exposed to foreign currency fluctuations for its net working capital
positions. At March 31, 2002, NEON had unhedged net current liabilities of
1,597,830 British pounds and unhedged net current assets of 807,431 Euros. 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 14%, 16% and 20% in fiscal 2002,
2001, and 2000, respectively. 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.
In view of the rapidly changing nature of our business and the current
weakness in the mainframe software market, we believe that period-to-period
comparisons of our revenue and operating results are not necessarily meaningful
and should not be relied upon as indications of our future performance. Further,
we do not believe that historical growth rates are necessarily representative of
our future growth potential.
Related Party Transactions
Members of NEON's Board of Directors and certain executive officers of
NEON are shareholders and/or directors in other companies with which NEON has
business relationships. See "Risk Factors - Some Members of Our Board of
Directors and Management May have Conflicts of Interest and/or Are Interested
Parties to Certain Transactions of NEON." Transactions between NEON and these
other companies are described below.
Peregrine/Bridge Transfer Corporation
Distribution Agreement. NEON entered into a distribution agreement with
Peregrine/Bridge Transfer Corporation ("PBTC"), a database software company, in
January 1996. In December 1998, NEON amended its distribution agreement with
Peregrine/Bridge Transfer Corporation under which PBTC granted NEON an
exclusive, worldwide license to market and sublicense PBTC's only products, its
Enterprise Subsystem Management products. The amended distribution agreement has
an initial term through March 31, 2004. The agreement also provides that NEON
pay royalties for the license of products and for maintenance and support and
upgrade services equal to 50% of the revenues received by NEON. The terms of
this agreement provide that NEON will pay PBTC a minimum advance royalty of
$250,000 per quarter during fiscal year 2000, $500,000 per quarter during fiscal
year 2001, $750,000 per quarter during fiscal year 2002, $1,000,000 per quarter
during fiscal year 2003 and $1,250,000 per quarter during fiscal year 2004, for
an aggregate payment of $15 million. This royalty payment is recorded as a
prepaid expense and offset by 50% of NEON's sales of PBTC products. NEON
incurred royalty expense of $1,454,458 and $1,588,000 for the twelve months
ended March 31, 2002 and 2001, respectively to PBTC.
The amended Distribution Agreement also provides that PBTC will reimburse NEON
for the amount of unearned royalty advances when the Agreement terminates in
2004. The balance of the unearned advance payments was $2.1 million at March 31,
2002, and increased to approximately $3.1 million subsequent to year end.
Management believes that while the current and reasonably foreseeable business
prospects for revenue received by NEON from licenses and maintenance for PBTC
products are expected to be sufficient to offset the unearned advance payments
as of March 31, 2002, these revenues may not be sufficient to meet the aggregate
future minimum royalties to be paid by NEON to PBTC. As a result, the balance of
unearned advance payments may increase substantially by the time the Agreement
terminates. PBTC's sole source of income is the royalty payments made by NEON
and PBTC
19
has a substantial negative net worth. As a result, PBTC may be unable to repay
any unearned advances at the termination of the agreement in 2004.
Services Agreement. NEON also has a services agreement with PBTC pursuant to
which PBTC reimburses NEON for PBTC's share of the general and administrative
expenses supplied to it by NEON. Such amounts are presented as a reduction of
general and administrative expenses in the accompanying consolidated financial
statements. The Company revised the services agreement with PBTC in October
2001, as a result of which PBTC's monthly payment to NEON declined from $30,000
per month to $5,000 per month and NEON's services were substantially reduced.
NEON interlocks with Peregrine/Bridge Transfer Corporation. John J. Moores,
Charles E. Noell, III and Norris van den Berg, directors of NEON, also serve as
directors of PBTC. Wayne E. Webb, Jr., Senior Vice President and General Counsel
of NEON, served as the Vice President and General Counsel of PBTC until February
of 2002, when he was appointed its President and CEO. On June 1, 2001, Mr. Webb
was appointed President and Chief Executive Officer of NEON Systems, Inc., an
office he held until Mr. Louis Woodhill assumed those positions. Through his
interest in Skunkware, Inc., John J. Moores, Chairman of the NEON Board of
Directors, beneficially owns approximately 90% of PBTC. Through their interests
in Skunkware, Inc., each of Messrs. Noell, van den Berg and Webb beneficially
own approximately 1%, and each of Don Pate, Senior Vice President and General
Manager, Enterprise Subsystems Management Division of NEON and Jonathan J. Reed,
Vice President, Business Development and Product Marketing of NEON, beneficially
own less than 1%, of PBTC. Additionally, Messrs. Noell, Moores and van den Berg
serve as directors of Skunkware, Inc.
Scalable Software, Inc.
Scalable Software, Inc. is a company founded by Louis R. Woodhill,
NEON's President and Chief Executive Officer. Several members of NEON's Board of
Directors and Mr. Woodhill have a financial interest in Scalable Software. The
percentage beneficial ownership of the NEON directors and executive officers who
have a financial interest in Scalable Software is set forth below:
Name Ownership Percentage,
---- ---------------------
Jim Woodhill 24.3%
John J. Moores (and affiliates) 23.8%
Louis R. Woodhill 16.7%
Charles E. Noell (and affiliates) 15.1%
Peter Schaeffer 1.5%
--------
Total 81.4%
========
On July 17, 2001, NEON announced that it had entered into a letter of
intent to acquire Scalable Software, Inc., a Houston-based provider of software
solutions for IT portfolio management. Louis R. Woodhill, NEON's President and
CEO, is also a shareholder, director, President and CEO of Scalable Software. In
connection with the letter of intent, NEON and Scalable Software entered into a
Promissory Note dated July 17, 2001, which provided bridge financing to Scalable
in a maximum amount of $3.0 million with a maturity date of December 31, 2001,
secured by the personal guarantees of John J. Moores, Louis R. Woodhill and Jim
Woodhill. On November 13, 2001, the promissory note was amended to increase the
maximum lending limit to $3.5 million with an original maturity date of March
31, 2002, with such increased amount also being guaranteed by Messrs. Moores,
Woodhill and Woodhill.
Due to the interests in Scalable Software by several members of NEON's
Board of Directors, the Board of Directors concluded that it would be
appropriate to create a Special Committee comprised solely of directors who had
no interest in Scalable Software to review the terms of the proposed
acquisition. After thorough consideration and discussion by the Special
Committee and its advisors, the Special Committee proposed that the payment of
the consideration for the proposed acquisition be structured as an earn out, in
which the NEON stock to be used as consideration would be placed in escrow
subject to release to the Scalable Software shareholders upon Scalable
Software's attainment of specified revenue and profitability goals. This
proposal was unacceptable to Scalable
20
Software's management and Board of Directors and was rejected. The status of the
proposed acquisition was then discussed at a special meeting of NEON's Board of
Directors in December 2001. After thorough consideration and discussion and upon
endorsement by the Special Committee, NEON's Board of Directors approved
modifications to the proposed terms and conditions for the acquisition such that
the transaction would be structured as an option to acquire Scalable Software as
discussed below. In addition, NEON also announced on December 21, 2001, that
Louis R. Woodhill, its President and Chief Executive Officer, and Jim Woodhill
had been appointed to the Board of Directors of NEON. Louis R. Woodhill and Jim
Woodhill were both directors and shareholders of Scalable Software and Louis R.
Woodhill was also the President and Chief Executive Officer of Scalable
Software. As of June 2002, their status as shareholders, directors and as
officers of Scalable Software remains unchanged.
NEON has obtained a two-year option to acquire Scalable Software as
outlined in the Agreement and Plan of Merger dated June 26, 2002. In connection
with this Option, NEON agreed to provide bridge financing of up to $5.5 million,
in addition to the $3.5 million previously loaned to Scalable Software that is
secured by personal guarantees from John J. Moores, Louis R. Woodhill and Jim
Woodhill. The aggregate financing has a 36-month term and will not bear interest
during the term of the two-year option to acquire Scalable Software. After the
expiration of the Option, the loan will bear interest at the prime rate plus two
percentage points. In addition to the personal guarantees of John J. Moores,
Louis R. Woodhill and Jim Woodhill for the initial $3.5 million loaned to
Scalable Software, the $5.5 million loan will be secured by all of the
intellectual property rights of Scalable Software. NEON may exercise the Option
to acquire Scalable Software at any time during the two-year term, subject to
provisions that require NEON to exercise its Option within a 30-day window under
certain circumstances or forfeit the Option. If NEON exercises the Option and
acquires Scalable Software, each of the approximately 19,400,000 outstanding
shares of common stock of Scalable Software will be converted into approximately
0.135 of a share of NEON common stock and outstanding options and warrants to
purchase approximately 3,000,000 shares of common stock of Scalable Software
will become options and warrants to purchase common stock of NEON on the same
conversion basis. If Scalable Software incurs more indebtedness for borrowed
money or issues more equity, the exchange ratio will be reduced. Prior to NEON
exercising the Option to acquire Scalable Software, a Special Committee would be
appointed to review the negotiated terms of the proposed acquisition and NEON
would seek to obtain a fairness opinion regarding the transaction from a
financial advisory firm. The acquisition of Scalable Software will also require
approval of the stockholders of NEON and the NEON Board of Directors.
Management believes that the Scalable Software products are gaining
increasing levels of acceptance in the marketplace and a reputation for ease of
installation and use. Management further believes that the long term prospects
for the products are excellent. However, management also believes that Scalable
Software will exhaust its line of credit from NEON before it is able to generate
cash from operations sufficient to sustain its operations. In that event, and if
Scalable Software is unable to secure additional financing, it could become the
subject of bankruptcy proceedings. If Scalable Software is subject to bankruptcy
proceedings, it is possible that the security interests held by NEON in the
intellectual property of Scalable Software could be set aside, and in such event
NEON would be an unsecured creditor with respect to its $5.5 million loan to
Scalable Software.
As noted above, certain members of NEON's board of directors and
executive officers also serve as directors and executive officers of Scalable
Software and claim beneficial ownership of approximately 81% of Scalable's
common stock. In addition, NEON has an option to acquire all of the outstanding
shares of Scalable Software and is currently providing Scalable's primary
financing for its operations. Therefore, NEON recognizes 100% of Scalable
Software's losses to the extent of advances made in excess of the guaranteed
amount. At March 31, 2002, NEON had made total advances of $5.8 million to
Scalable Software (including $2.3 million of unguaranteed advances) and
recognized an associated loss of $2.1 million.
Sheer Genius Software, Inc.
On January 3, 2002, NEON entered into a development services agreement
with Sheer Genius Software, Inc. of Austin, Texas, a company owned by Jim
Woodhill. Also, JMI Services, Inc., a private company owned by John J. Moores,
NEON's Chairman, is a creditor of Sheer Genius, holding a promissory note dated
August 31, 2001 in the amount of $200,000. Under the first project description
negotiated for such development services agreement, Sheer Genius will provide
development services to NEON on a budgeted time and materials basis and will
deliver fixed deliverables, consisting primarily of developed source code. The
term of the initial project description was six months and the maximum aggregate
fees were $480,000. This agreement was recently amended to extend the contract
period for an additional three months with additional maximum aggregate fees of
$300,000. While NEON is currently Sheer Genius Software's sole source of income,
it is free to solicit other customers. Under the
21
services agreement, all intellectual property created by Sheer Genius in the
course of performing the services shall be owned by NEON. Additionally, Sheer
Genius will receive a license back of such intellectual property for limited use
in the development by Sheer Genius of software that does not compete with
software distributed by NEON. The Board of Directors reviewed the terms of the
services agreement and project description and approved such agreements
following disclosure of the interest of its officers and directors associated
with Sheer Genius.
Critical Accounting Policies
The following is a discussion of the accounting policies that we
believe (1) are most important to the portrayal of our financial condition and
results of operations and (2) require our most difficult, subjective or complex
judgments, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain.
Revenue Recognition Policies
Statement of Position 97-2, "Software Revenue Recognition" (SOP 97-2), was
issued in October 1997 by the American Institute of Certified Public Accountants
(AICPA) and was amended by Statement of Position 98-4 (SOP 98-4) and Statement
of Position 98-9 (SOP 98-9). NEON adopted SOP 97-2 effective July 1, 1997, SOP
98-4 effective March 31, 1998 and SOP 98-9 effective April 1, 1999. NEON
believes its current revenue recognition policies and practices are consistent
with SOP 97-2, SOP 98-4 and SOP 98-9. 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; no other significant vendor obligations exist; and
vendor-specific objective evidence exists to allocate the total fee to elements
of the arrangement. Vendor-specific objective evidence is based on the price
generally charged when an element is sold separately, or if not yet sold
separately, is established by authorized management. All elements of each order
are valued at the time of revenue recognition. License revenues generally
include software maintenance agreements for the first year following the date of
sale. In such cases, revenues are allocated between licenses fees and
maintenance revenues based on vendor-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 distributors
and resellers. License and maintenance revenues from these transactions are
recognized when sold to the ultimate end user and all of the above conditions
are met.
Capitalized Software Costs
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. No such costs have been
capitalized to date.
Allowance for Doubtful Accounts Receivable
As a part of its normal accounting procedures, NEON evaluates outstanding
accounts receivable to estimate whether they will be collected. This is a
subjective process that involves making judgments about our customers' ability
and willingness to pay these accounts. An allowance for doubtful accounts is
recorded as an offset to accounts receivable in order to present a net balance
that we believe will be collected. In estimating the appropriate balance for
this allowance, we consider (1) specific reserves for accounts we believe may
prove to be uncollectible and (2) additional reserves, based on historical
collections, for the remainder of our accounts. Additions to the allowance for
doubtful accounts are charged to operating expenses, and deductions from the
allowance are recorded when specific accounts receivable are written off as
uncollectible. If our estimate of uncollectible accounts should prove to be
inaccurate at some future date, the results of operations for the period could
be materially affected by any necessary correction to the allowance for doubtful
accounts.
22
Deferred Income Taxes
NEON records deferred income tax assets and liabilities on our balance sheet
related to events that impact our financial statements and tax returns in
different periods. In order to compute these deferred tax balances, we first
analyze the differences between the book basis and tax basis of our assets and
liabilities (referred to as "temporary differences"). These temporary
differences are then multiplied by current tax rates to arrive at the balances
for the deferred income tax assets and liabilities. If deferred tax assets
exceed deferred tax liabilities, we must estimate whether those net deferred
asset amounts will be realized in the future. A valuation allowance is then
provided for the net deferred asset amounts that are not likely to be realized.
The change in our net deferred income tax balances during a period results
in a deferred income tax provision or benefit in our statement of operations. If
our expectations about the future tax consequences of past events should prove
to be inaccurate, the balances of our deferred income tax assets and liabilities
could require significant adjustments in future periods. Such adjustments could
cause a material effect on our results of operations for the period of the
adjustment.
Accounting for Advances to Scalable Software
As discussed more fully in "Related Party Transactions" above, certain
members of NEON's board of directors and executive officers also serve as
directors and executive officers of Scalable Software and claim beneficial
ownership of approximately 81% of Scalable's common stock. In addition, NEON has
an option to acquire all of the outstanding shares of Scalable Software and is
currently providing Scalable's primary financing for its operations. Therefore,
NEON determined that it has effective control of Scalable Software and began
accounting for its investment in Scalable Software using the modified equity
method of accounting. Under this method of accounting, NEON recognizes 100% of
Scalable Software's losses to the extent of its advances made to Scalable
Software in excess of the amounts guaranteed by Messrs. Moores, Woodhill and
Woodhill.
Advance Payments to PBTC
As discussed more fully in "Related Party Transactions" above, as part of a
distribution agreement with PBTC, NEON makes advance royalty payments to PBTC.
PBTC earns such advance payments as NEON recognizes license and maintenance
revenues related to its distribution of the PBTC products. At the termination of
the agreement, PBTC is to reimburse NEON for any unearned royalty advances. In
determining whether the unearned advance payments to PBTC may be realized and
recovered, management considers the future revenue anticipated to be generated
from the license and maintenance of PBTC products, as well as PBTC's ability and
intent to reimburse any unearned royalty advances.
Results of Operations
The following table sets forth, for the periods illustrated, certain
statement of operations data expressed as a percentage of total revenues:
Years Ended March 31,
------------------------------------------
2002 2001 2000
---------- ---------- -------
Revenues:
License 56.1% 67.0% 76.9%
Maintenance 43.9 33.0 23.1
------- ---------- ----------
Total revenue 100.0 100.0 100.0
Cost of revenues:
Cost of license 14.1 9.3 5.0
Cost of maintenance 9.9 8.9 5.8
------- ---------- ----------
Total cost of revenues 24.0 18.2 10.8
------- ---------- ----------
Gross profit 76.0 81.8 89.2
Operating expenses:
Sales and marketing 62.4 58.7 38.6
Research and development 28.2 31.3 19.7
23
General and administrative 23.8 33.6 11.9
Restructuring Costs 4.2 -- --
Asset Write-down Charges 4.1 -- --
Amortization of goodwill 2.2 1.8 0.8
---------- ---------- ----------
Total operating expenses 124.9 125.4 71.0
---------- ---------- ----------
Operating income (loss) (48.9) (43.6) 18.2
Interest , net 5.5 9.3 7.6
Equity loss in affiliate (9.8) -- --
Gain from Settlement of Litigation 43.1 -- --
Valuation Allowance of Note Receivable (9.3) -- --
Other, net 0.1 -- --
---------- ---------- --------
Income (loss) before provision for income taxes (19.3) (34.3) 25.8
Benefit (provision) for income taxes -- 7.1 (9.3)
---------- ---------- ----------
Net income (loss) (19.3)% (27.2)% 16.5%
========== ========== ==========
Fiscal Years Ended March 31, 2002, 2001, and 2000
Revenues
Total Revenues. Total revenues were $21.4 million, $26.6 million and $29.7
million in fiscal 2002, 2001 and 2000, respectively, representing
period-to-period changes of (20)% and (10)% for the fiscal 2002 and 2001
periods. NEON had one customer that represented 10% and two customers who
aggregated 14% of consolidated revenue in fiscal 2002, one customer that
represented 16% of consolidated revenue in fiscal 2001, and no customers that
accounted for 10% or more of consolidated revenue in fiscal 2000.
License. License revenues were $12.0 million, $17.8 million and $22.9
million in fiscal 2002, 2001 and 2000, respectively, representing
period-to-period changes of (33)% and (22)% for the fiscal 2002 and 2001
periods. The decrease in fiscal 2002 of $5.8 million as compared to fiscal 2001,
and the decrease of $5.0 million in fiscal 2001 as compared to fiscal 2000 is
primarily due to an overall weakness in the mainframe software market since
December 31, 1999. License revenues includes $2.2 million, $4.4 million and $2.1
million for fiscal 2002, 2001 and 2000, respectively, of revenue under a
software distribution agreement with BMC Software entered in connection with
NEON's settlement of a lawsuit originally filed by BMC Software. Product price
increases during the periods were not significant.
Maintenance. Maintenance revenues were $9.4 million, $8.8 million, and $6.9
million in fiscal 2002, 2001 and 2000, respectively, representing
period-to-period increases of 7% and 28% for the fiscal 2002 and 2001 periods.
These increases resulted from renewals of maintenance agreements from NEON's
growing installed base of customers.
Cost of Revenues
Cost of Licenses. Cost of license revenues includes costs of product
licenses, such as product manuals, distribution and media costs for NEON's
software products, as well as royalty payments to third parties related to
license revenues primarily resulting from NEON's sales of Enterprise Subsystem
Management products. Cost of license revenues was $3.0 million, $2.5 million and
$1.5 million, in fiscal 2002, 2001 and 2000, respectively, representing 25%, 14%
and 6% of total license revenues in the respective periods. The dollar increases
were due primarily to increased sales of Enterprise Subsystem Management
products, resulting in 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 $2.1 million, $2.4 million and $1.7 million in fiscal 2002, 2001
and 2000, respectively, representing 22%, 27% and 25% of total maintenance
revenues in the respective periods. The dollar changes during the periods were
due principally to changes in the number of technical support staff providing
support to NEON's 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 fiscal
2000.
Operating Expenses
24
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 $13.4 million, $15.6
million and $11.5 million in fiscal 2002, 2001 and 2000, respectively,
representing 62%, 59% and 39% of total revenue in the respective periods. The
increase in sales and marketing expense as a percentage of total revenue in
fiscal 2002 is due primarily to the reduction in total revenue for the period
then ended. The dollar decrease from fiscal 2001 to fiscal 2002 resulted
primarily from decreases in travel costs and marketing activity such as trade
shows and advertisements as well as decreased commissions related to lower
sales. The dollar increase from fiscal 2000 to fiscal 2001 resulted primarily
from increases in compensation costs due to the hiring of additional North
American sales personnel and increased commissions, 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. As NEON continues to devote resources to the enhancement
and expansion of its sales and marketing organization, NEON expects that annual
sales and marketing expenses will increase in absolute dollars.
Research and Development. Research and development expenses include
salaries, bonuses and benefits to product development and product documentation
personnel and the computer hardware, software and telecommunication expenses
associated with these personnel. Research and development expenses were $6.0
million, $8.3 million and $5.8 million in fiscal 2002, 2001 and 2000,
respectively, representing 28%, 31% and 20% of total revenues in each of these
respective periods. The decrease in the percentage of total revenue and dollars
in fiscal 2002 is primarily due to the reduction of development personnel
associated with NEON's change in product strategy. The dollar and percentage
increase from fiscal 2000 to fiscal 2001 was primarily attributable to increased
compensation costs due to additional staffing. Research and development expenses
are expected to increase in absolute dollar amounts.
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 $5.1 million,
$4.5 million (excluding $4.5 million from nonrecurring charges during fiscal
2001) and $3.5 million in fiscal 2002, 2001 and 2000, respectively, representing
24%, 17% and 12% of total revenues in the respective periods. The nonrecurring
charges consisted of $3.8 million for charges related to the departure of
certain personnel, a $400,000 charge for the cost of strategic consulting
projects and a $250,000 realized foreign currency loss. The dollar increase from
fiscal 2001 to fiscal 2002, excluding nonrecurring charges, is primarily from
increases in office occupancy costs and the related computer hardware, software
and telecommunication expenses related to expansion of office facilities, and
increases in personnel costs. The percentage increase is due to a reduction in
total revenue in fiscal 2002. The dollar increase from fiscal 2000 to fiscal
2001, excluding non recurring charges, is due to increases in occupancy costs
and increases in compensation expenses due principally to administrative
personnel additions necessary to support NEON's expected growth. NEON
anticipates general and administrative expenses will continue to increase in
absolute dollars.
Restructuring Costs and Asset Write-Down Charges. During the year ended
March 31, 2002, the Company recorded a restructuring charge of $908,000. These
charges related to reductions in the Company's cost structure and corporate
reorganization, including reductions in force, and abandonment of leased
facilities. These restructuring costs included severance costs of $570,000 and
losses from lease commitments of $338,000. In addition, NEON has recorded a
non-cash charge of $887,000 during the year ended March 31, 2002 related to the
write-down of pre-paid royalties and other assets.
Non-Cash Compensation. The deferred compensation balance was reduced by
$420,000, $137,000 and $321,000 during fiscal 2002, 2001 and 2000, respectively,
due to the cancellation of restricted stock awards and options associated with
terminated employees. NEON has recognized $331,000, $409,000 and $490,000 in
fiscal 2002, 2001 and 2000, respectively, in amortization of non-cash deferred
compensation expense associated with the initial public offering. The deferred
balance related to the initial public offering of $26,000 will be recognized
over the remaining vesting period during fiscal 2003. During fiscal 2002 and
2001, NEON amortized $10,000 and $75,000, respectively, in deferred compensation
related to the restricted stock granted to an executive officer.
Amortization of Acquisition Related Costs. On September 29, 1999, NEON
acquired various software products and miscellaneous assets from Beyond
Software, Inc. a privately held company based in Santa Clara, California, for
25
$1.9 million, plus the assumption of certain liabilities. The transaction
resulted in goodwill of approximately $2.4 million, which is being amortized on
a straight-line basis over five years. Amortization expense related to this
transaction of $478,000 was recognized in both fiscal 2002 and 2001.
Interest Income, Net. Interest income net was $1.2 million, $2.5 million
and $2.3 million for the fiscal years ended March 31, 2002, 2001, and 2000,
respectively. The changes are primarily the result of changes in cash and
investment balances during the respective periods as well as changes in the
investment yields realized. NEON's cash and cash equivalents and investment
balances were primarily derived from the $41.2 million of net proceeds received
from NEON's March 1999 initial public offering and $9.3 million from the
settlement of the New Era of Networks litigation. See Note 5 to NEON's financial
statements.
Equity in Loss of Affiliate. Certain members of NEON's board of directors
and executive officers also serve as Scalable Software directors and executive
officers and claim beneficial ownership of approximately 81% of Scalable's
common stock. In addition, NEON has an option to acquire all of the outstanding
shares of Scalable Software and has advanced Scalable Software $5.8 million as
of March 31, 2002. Scalable Software is therefore deemed to be effectively
controlled by NEON and NEON accounts for its investment in Scalable Software
using the modified equity method of accounting. Under this method, NEON
recognizes 100% of Scalable Software's income or loss to the extent of advances
made in excess of the guaranteed amount. During the year ended March 31, 2002,
NEON recognized an equity loss in affiliate of $2.1 million representing its
share of the losses of Scalable Software. See "Related Party Transactions" and
Note 4 to NEON's financial statements.
Gain from Settlement of Litigation and Valuation of Note Receivable. During
2002, NEON received approximately $9.3 million in connection with the settlement
of its lawsuit against New Era of Networks. See Note 5 to NEON's financial
statements. In May 2001, NEON made an advance on a note receivable to
Enterworks Software, Inc. in the amount of $2 million. During the year ended
March 31, 2002, NEON recorded a reserve of $2 million as a valuation allowance
against this note receivable.
Benefit (Provision) for Income Taxes. There was no benefit (provision) for
income taxes in fiscal 2002, due to the recording of a valuation allowance
against all tax benefits arising from NEON's operating losses. NEON recorded a
tax benefit (provision) for fiscal 2001 and 2000 using the effective income tax
rate of 21% and (36)%, respectively.
Liquidity and Capital Resources
NEON's cash and cash equivalent balance was $34.5 million and $42.8 million
at March 31, 2002 and 2001, respectively. The decrease is due primarily to
operational losses, loan advances to Scalable Software, advanced royalty
payments to PBTC and the repurchase of 913,400 shares of the Company's common
stock. See "Related Party Transactions" and Notes 4 and 8 to NEON's financial
statements.
Net cash provided by (used in) operating activities was $2.0 million, $3.3
million, and ($121,000) in fiscal 2002, 2001 and 2000, respectively. The funds
provided in fiscal 2002 resulted primarily from the proceeds of the settlement
of its lawsuit against New Era of Networks, decreases in accounts receivable and
other assets offset by decreases in operating liabilities. The funds provided in
fiscal 2001 resulted primarily from decreases in accounts receivable and an
increase in operating liabilities. Net cash used in operating activities during
fiscal 2000 was primarily from increases in accounts receivable and an advance
royalty payment to Sterling Software of $3.5 million, partially offset by the
increased profitability from NEON's business growth.
Net cash provided by (used in) investing activities was $(7.7) million,
$1.9 million and ($8.1) million in fiscal 2002, 2001 and 2000, respectively. The
funds used in fiscal 2002 resulted primarily from the loan advances made to
Scalable Software. See "Related Party Transactions" and Note 4 to NEON's
financial statements. The funds provided in fiscal 2001 resulted primarily from
maturities of short-term and long-term marketable securities partially offset by
purchases of property and equipment and the $1 million payment to complete the
acquisition of intellectual property from Sterling Software. The funds used in
fiscal 2000 were a result of purchases of both short-term and long-term
marketable securities and the acquisition of assets of Beyond Software Inc. As
of
26
March 31, 2002, NEON had no material commitment for capital expenditures.
NEON's net cash provided by (used in) financing activities was $(2.5)
million, $241,000 and $109,000 in fiscal 2002, 2001 and 2000, respectively. Net
cash used in fiscal 2002 resulted primarily from the repurchase of common stock.
Net cash provided by financing activities in fiscal 2001 and 2000 was from
amounts received from the exercise of employee stock options.
NEON's cash and cash equivalents balance was approximately $34.5 million at
March 31, 2002 and was invested in various types of commercial paper and money
market securities. NEON believes that a near-term change in interest rates will
have an immaterial affect on its financial position, results of operations or
net cash flows for fiscal year 2003.
NEON believes that its current balances of cash and cash equivalents 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.
The following table summarizes our contractual cash obligations as of March
31, 2002:
Fiscal Year Ending March 31,
2003 2004 2005 2006 2007 Thereafter Totals
Operating Leases $1,277,774 $1,148,694 $1,140,330 $ 84,519 $14,142 $ -- $3,665,459
Scalable Software $3,200,000 -- -- -- -- -- $3,200,000
PBTC Royalty Advance $4,000,000 $5,000,000 -- -- -- -- $9,000,000
Employment Agreements (a) $ 187,011 $ 131,798 $ 138,513 $142,678 -- -- $ 600,000
(a) On March 29, 2002, NEON entered into an agreement with Mark Cresswell
and Peter Cook, as Principals of Lakeview Advisors Corporations (BV1) Limited,
to pay Messrs. Cresswell and Cook up to $600,000 to be paid on a quarterly basis
over the course of 48 months. The payments to Messrs. Cresswell and Cook are
contingent upon and related to their continued employment with NEON. Should
either Mr. Cresswell or Mr. Cook leave the employment of NEON, other than being
terminated without cause, NEON would be required to only make an additional
payment of $50,000, with no additional amounts due under the Agreement.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133").
This statement establishes accounting and reporting standards for derivative
instruments and hedging activities and, as amended, is effective for all fiscal
years beginning after June 15, 2000. The statement requires balance sheet
recognition of derivatives as assets or liabilities measured at fair value.
Accounting for gains and losses resulting from changes in the values of
derivatives is dependent on the use of the derivative and whether it qualifies
for hedge accounting. The adoption of SFAS 133 could increase the volatility of
reported earnings and other comprehensive income in the future. In general, the
amount of volatility will vary with the level of derivative activities during
any period. Effective April 1, 2001, NEON adopted SFAS 133 and has not
identified any derivative instruments subject to the provisions of SFAS 133.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that
the purchase method of accounting be used for all business combinations
initiated or completed after June 30, 2001, and specifies criteria for the
recognition and reporting of intangible assets apart from goodwill. Under SFAS
No. 142, the Company no longer amortizes goodwill and intangible assets with
indefinite useful lives, but instead tests those assets for impairment at least
annually. SFAS No. 142 also requires that intangible assets with definite useful
lives be amortized over such lives to their estimated residual values.
27
The Company adopted SFAS No. 141 on July 1, 2001 and adopted SFAS No. 142
on April 1, 2002. Any goodwill or any intangible asset determined to have an
indefinite useful life that is acquired in a purchase business combination
completed after June 30, 2001 will not be amortized, but will continue to be
evaluated for impairment in accordance with the appropriate pre-SFAS No. 142
accounting literature. Goodwill and intangible assets acquired in business
combinations completed before July 1, 2001 will continue to be amortized through
March 31, 2002. SFAS No. 142 requires the Company to perform a transitional
goodwill impairment evaluation as of the date of adoption. To accomplish this
the Company must identify its reporting units and determine the carrying value
of each reporting unit by assigning the assets and liabilities, including the
existing goodwill and intangible assets, to those reporting units as of the date
of adoption. The Company then has up to six months from the date of adoption to
determine the fair value of each reporting unit and compare it to the reporting
unit's carrying amount. To the extent a reporting unit's carrying amount exceeds
its fair value, an indication exists that the reporting unit's goodwill may be
impaired and the Company must perform the second step of the transitional
impairment test. In the second step, the Company must compare the implied fair
value of the reporting unit's goodwill, determined by allocating the reporting
unit's fair value to all of its assets (recognized and unrecognized) and
liabilities in a manner similar to a purchase price allocation in accordance
with SFAS No. 141, to its carrying amount, both of which would be measured as of
the date of adoption. This second step is required to be completed as soon as
possible, but no later than the end of the year of adoption. Any transitional
impairment loss will be recognized as the cumulative effect of a change in
accounting principle in the Company's statement of earnings.
As of the date of adoption of SFAS Nos. 141 and 142, the Company's
unamortized goodwill in the amount of $1,193,000 is subject to transition
provisions of SFAS Nos. 141 and 142. Amortization expense related to goodwill
was $478,000, $478,000 and $239,000 for the years ended March 31, 2002, 2001 and
2000, respectively. Management has completed a preliminary evaluation of the
effects of SFAS Nos. 141 and 142 and does not currently believe that they will
have a material impact on the Company's consolidated financial statements.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," but retains many of its fundamental provisions. SFAS No. 144
also clarifies certain measurement and classification issued from SFAS No. 121.
In addition, SFAS No. 144 supersedes the accounting and reporting provisions for
the disposal of a business segment as found in Accounting Principles Board
Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects of
Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." SFAS No. 144 retains the basic requirements
in APB Opinion No. 30 to separately report discontinued operations, and broadens
the scope of such requirement to include more types of disposal transactions.
The scope of SFAS No. 144 excludes goodwill. The provisions of SFAS No. 144 are
effective for fiscal years beginning after December 15, 2002, and are to be
applied prospectively. NEON adopted the requirements of SFAS No. 144 as of April
1, 2002.
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
its exposure to changes in interest rates and foreign currency exchange rates.
The majority of NEON's foreign currency transactions are denominated in
British pounds sterling, which is the functional currency of NEON Systems (UK)
Ltd., a subsidiary of NEON. 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 cash management policy, whereby its
principal concern is the preservation of liquid funds while maximizing its yield
on such assets. NEON's cash and cash equivalents balance was approximately $34.5
million at March 31, 2002 and was invested in various types of commercial paper
and money market securities.
28
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NEON SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report ............................................................................... 32
Consolidated Balance Sheets ................................................................................ 33
Consolidated Statements of Operations ...................................................................... 34
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) ............................ 35
Consolidated Statements of Cash Flows ...................................................................... 36
Notes to Consolidated Financial Statements ................................................................. 37
29
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,
2002 and 2001, and the related consolidated statements of operations,
stockholders' equity and comprehensive income (loss), and cash flows for each of
the years in the three-year period ended March 31, 2002. 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 auditing standards generally
accepted in the United States of America. 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, 2002 and 2001, and the
results of their operations and their cash flows for each of the years in the
three-year period ended March 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.
KPMG LLP
Houston, Texas
June 27, 2002
30
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of March 31,
--------------------------------
2002 2001
-------------- -------------
ASSETS
Current Assets:
Cash and cash equivalents $ 34,506,349 $ 42,773,856
Short-term investments -- 514,828
Accounts receivable- trade, net of allowance for returns of $267,000 and $187,000 4,650,348 6,072,332
Deferred tax assets 607,566 607,566
Tax receivable 1,054,075 2,392,311
Other current assets 3,132,620 2,050,586
-------------- -------------
Total current assets 43,950,958 54,411,479
-------------- -------------
Property and equipment:
Furniture and equipment 2,931,861 2,190,497
Purchased software 1,578,727 1,472,218
Less accumulated depreciation and amortization (2,339,972) (1,558,951)
-------------- -------------
Property and equipment, net 2,170,616 2,103,764
Note receivable 3,702,199 --
Long-term investments -- 319,613
Intangible assets, net of accumulated amortization of $3,061,323 and $1,121,338 3,712,872 5,652,857
Other assets, net 62,875 890,630
-------------- -------------
Total assets $ 53,599,520 $ 63,378,343
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 297,556 $ 1,385,541
Accrued expenses 2,203,628 5,197,674
Deferred maintenance revenue 8,173,929 7,481,593
-------------- -------------
Total current liabilities 10,675,113 14,064,808
-------------- -------------
Stockholders' Equity:
Preferred stock, $.01 par value. Authorized 10,000,000 shares; no shares issued
and outstanding at March 31, 2002 and 2001, respectively -- --
Common stock, $.01 par value. Authorized 30,000,000 shares; 8,674,953 and
9,516,804 shares issued and outstanding at March 31, 2002 and 2001,
respectively 95,883 95,167
Additional paid-in-capital 51,232,825 51,550,518
Treasury stock, 913,400 shares at cost (2,648,860) --
Accumulated other comprehensive income (loss) (475,065) (423,574)
Unearned portion of deferred compensation (26,156) (787,705)
Retained earnings (deficit) (5,254,220) (1,120,871)
-------------- -------------
Total stockholders' equity 42,924,407 49,313,535
-------------- -------------
Commitments and contingencies (Note 5)
Total liabilities and stockholders' equity $ 53,599,520 $ 63,378,343
============== =============
See Accompanying Notes to Consolidated Financial Statements.
31
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended March 31,
----------------------------------------------------
2002 2001 2000
------------- ------------- -------------
Revenues:
License $ 12,020,769 $ 17,826,050 $ 22,859,955
Maintenance 9,414,417 8,797,623 6,858,758
------------- ------------- -------------
Total revenues 21,435,186 26,623,673 29,718,713
Cost of revenues:
Cost of licenses 3,022,338 2,471,083 1,483,597
Cost of maintenance 2,114,616 2,365,315 1,719,826
------------- ------------- -------------
Total cost of revenues 5,136,954 4,836,398 3,203,423
------------- -- ---------- -------------
Gross profit 16,298,232 21,787,275 26,515,290
Operating expenses:
Sales and marketing 13,368,120 15,638,339 11,473,837
Research and development 6,046,214 8,329,039 5,846,789
General and administrative 5,096,476 8,957,622 3,549,468
Restructuring costs 908,000 -- --
Asset write-down charges 887,000 -- --
Amortization of goodwill 477,996 477,527 238,529
------------- ------------- -------------
Total operating expenses 26,783,806 33,402,527 21,108,623
------------- ------------- -------------
Operating income (loss) (10,485,574) (11,615,252) 5,406,667
Interest income 1,174,974 2,486,230 2,314,595
Interest expense (768) (6,140) (3,412)
Equity loss in affiliate (2,097,801) -- --
Gain from settlement of litigation 9,259,815 -- --
Valuation allowance of note receivable (2,000,000) -- --
Other, net 16,005 6,152 (54,850)
------------- ------------- -------------
Income (loss) before provision for income taxes (4,133,349) (9,129,010) 7,663,000
Benefit (provision) for income taxes -- 1,883,808 (2,758,680)
------------- ------------- -------------
Net income (loss) $ (4,133,349) $ (7,245,202) $ 4,904,320
============= ============= =============
Earnings (losses) per common share:
Basic $ (0.44) $ (0.77) $ 0.55
============= ============= =============
Diluted $ (0.44) $ (0.77) $ 0.47
============= ============= =============
Shares used in computing earnings (losses) per common share:
Basic 9,324,936 9,431,500 8,914,474
Diluted 9,324,936 9,431,500 10,461,032
See Accompanying Notes to Consolidated Financial Statements.
32
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME (LOSS)
Accumulated
Other Unearned
Additional Comprehensive Portion Of Retained
Common Paid-In Treasury Income Deferred Earnings
Stock Capital Stock (Loss) Compensation (Deficit)
-------- ------------ ----- ------ ------------ ------------
Balance at March 31, 1999 $ 88,483 $ 46,174,124 $ -- $ 57,849 $ (1,710,371) $ 1,220,011
Comprehensive income:
Net income -- -- -- -- -- 4,904,320
Foreign currency translation loss -- -- -- (166,734) -- --
Unrealized securities losses -- -- -- (46,336) -- --
Total comprehensive income -- -- -- -- -- --
Exercise of stock options 1,623 107,663 -- -- -- --
Tax benefit related to exercise of
stock options -- 737,224 -- -- -- --
Deferred compensation related to --
options granted -- (321,248) -- -- 321,248 --
Amortization of deferred stock
compensation -- -- -- -- 489,746 --
-------- ------------ ----------- ---------- ------------ ------------
Balance at March 31, 2000 $ 90,106 $ 46,697,763 $ -- $ (155,221) $ (899,377) $ 6,124,331
Comprehensive income (loss):
Net loss -- -- -- -- -- (7,245,202)
Unrealized security gains -- -- -- 61,066 -- --
Foreign currency translation loss -- -- -- (329,419) -- --
Total comprehensive loss -- -- -- -- -- --
Exercise of stock options 5,061 235,820 -- -- -- --
Compensation related to changes to
previously granted options -- 3,149,000 -- -- -- --
Tax benefit related to exercise of
stock options -- 1,096,196 -- -- -- --
Amortization of deferred stock
compensation -- -- -- -- 483,411 --
Deferred compensation related to
restricted stock grants -- 509,380 -- -- (509,380) --
Deferred compensation related to
options granted -- (137,641) -- -- 137,641 --
-------- ------------ ----------- ---------- ------------ ------------
Balance at March 31, 2001 $ 95,167 $ 51,550,518 $ -- $ (423,574) $ (787,705) $ (1,120,871)
Comprehensive income (loss):
Net loss -- -- -- -- -- (4,133,349)
Unrealized security gains -- -- -- (14,730) -- --
Foreign currency translation loss -- -- -- (36,761) -- --
Total comprehensive loss -- -- -- -- -- --
Exercise of stock options 716 102,575 -- -- -- --
Stock repurchase -- -- (2,648,860) -- -- --
Amortization of deferred stock
compensation -- -- -- -- 341,281 --
Deferred compensation related to
restricted stock grants -- (420,268) -- -- 420,268 --
-------- ------------ ----------- ---------- ------------ ------------
Balance at March 31, 2002 $ 95,883 $ 51,232,825 $(2,648,860) $ (475,065) $ (26,156) $ (5,254,220)
======== ============ =========== ========== ============ ============
Total
Stockholders'
Equity
------
Balance at March 31, 1999 $ 45,830,096
Comprehensive income:
Net income 4,904,320
Foreign currency translation loss (166,734)
Unrealized securities losses (46,336)
-------------
Total comprehensive income 4,691,250
Exercise of stock options 109,286
Tax benefit related to exercise of
stock options 737,224
Deferred compensation related to
options granted --
Amortization of deferred stock
compensation 489,746
-------------
Balance at March 31, 2000 $ 51,857,602
Comprehensive income (loss):
Net loss (7,245,202)
Unrealized security gains 61,066
Foreign currency translation loss (329,419)
-------------
Total comprehensive loss (7,513,555)
Exercise of stock options 240,881
Compensation related to changes to
previously granted options 3,149,000
Tax benefit related to exercise of
stock options 1,096,196
Amortization of deferred stock
compensation 483,411
Deferred compensation related to
restricted stock grants --
Deferred compensation related to
options granted --
-------------
Balance at March 31, 2001 $ 49,313,535
Comprehensive income (loss):
Net loss (4,133,349)
Unrealized security gains (14,730)
Foreign currency translation loss (36,761)
-------------
Total comprehensive loss (4,184,840)
Exercise of stock options 103,291
Stock repurchase (2,648,860)
Amortization of deferred stock
compensation 341,281
Deferred compensation related to
restricted stock grants --
-------------
$ 42,924,407
=============
See Accompanying Notes to Consolidated Financial Statements.
33
NEON SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended March 31,
-----------------------------------------------
2002 2001 2000
------------ ------------ ------------
Cash Flows from Operating Activities:
Net income (loss) $ (4,133,349) $ (7,245,202) $ 4,904,320
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 2,143,948 1,146,992 344,403
Deferred tax expense (benefit) -- 105,382 (140,958)
Non-cash compensation expense 341,281 3,632,411 489,746
Amortization of goodwill 477,996 477,527 238,529
Asset write-down 2,887,000 -- --
Equity loss in affiliate 2,097,801 -- --
Increase (decrease) in cash, net of acquisitions, resulting from changes in:
Accounts receivable 1,419,422 3,207,293 (3,823,421)
Other current assets (1,169,278) (1,412,874) (247,706)
Other assets 27,755 (552,008) (3,678,320)
Accrued expenses (2,996,381) 4,231,199 (1,013,006)
Accounts payable (1,090,023) (678,038) 480,329
Taxes payable (receivable) 1,338,236 (1,614,649) 683,914
Deferred maintenance revenue 692,336 1,965,569 1,641,013
------------ ------------ ---------------
Net cash provided by (used in) operating activities 2,036,744 3,263,602 (121,157)
------------ ------------ ---------------
Cash Flows From Investing Activities:
Purchase of property and equipment (747,875) (951,577) (1,546,965)
Acquisition of intangibles (1,000,000) (1,870,000)
Maturities and sales of marketable securities 819,711 3,864,392 --
Notes receivable (7,800,000) -- --
Purchase of marketable securities -- -- (4,684,103)
------------ ------------ ---------------
Net cash provided by (used in) investing activities (7,728,164) 1,912,815 (8,101,068)
------------ ------------ ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 103,291 240,881 109,286
Stock repurchase (2,648,860) -- --
------------ ------------ ---------------
Net cash provided by (used in) financing activities (2,545,569) 240,881 109,286
------------ ------------ ---------------
Net increase (decrease) in cash and cash equivalents (8,236,989) 5,417,298 (8,112,939)
Effect of exchange rates on cash (30,518) 236,216 (166,734)
Cash and cash equivalents at beginning of year 42,773,856 37,120,342 45,400,015
------------ ------------ ---------------
Cash and cash equivalents at end of year $ 34,506,349 $ 42,773,856 $ 37,120,342
============ ============ ===============
Cash (refunded) paid during the year for income taxes $ (1,488,684) $ -- $ 2,237,286
============ ============ ===============
Cash paid during the year for interest $ 768 $ 6,140 $ 3,412
============ ============ ===============
See Accompanying Notes to Consolidated Financial Statements.
34
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 its subsidiaries (collectively, "NEON") develops,
markets and supports software products for the IBM mainframe platform. NEON's
primary product group, the Shadow branded products, provide access and
integration of IBM mainframe data and applications from standard application
client environments, including the Internet and client/server systems. In
addition, NEON develops, markets and supports NEON branded products that provide
enhanced availability, recoverability and control for the IBM IMS database
management system and allows more rapid deployment of CICS applications in the
IBM CICSPlex environment. NEON's iWave branded products integrate helpdesk,
network management, database management and systems management applications
across mainframe and distributed systems environments.
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
Statement of Position 97-2, SOFTWARE REVENUE RECOGNITION (SOP 97-2), was
issued in October 1997 by the American Institute of Certified Public Accountants
(AICPA) and was amended by Statement of Position 98-4 (SOP 98-4) and Statement
of Position 98-9 (SOP 98-9). NEON adopted SOP 97-2 effective July 1, 1997, SOP
98-4 effective March 31, 1998 and SOP 98-9 effective April 1, 1999. NEON
believes its current revenue recognition policies and practices are consistent
with SOP 97-2, SOP 98-4 and SOP 98-9. 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; no other significant vendor obligations exist; and
vendor-specific objective evidence exists to allocate the total fee to elements
of the arrangement. Vendor-specific objective evidence is based on the price
generally charged when an element is sold separately, or if not yet sold
separately, is established by authorized management. All elements of each order
are valued at the time of revenue recognition. License revenues generally
include software maintenance agreements for the first year following the date of
sale. In such cases, revenues are allocated between licenses fees and
maintenance revenues based on vendor-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 distributors
and resellers. License and maintenance revenues from these transactions are
recognized when sold to the ultimate end-user and all of the above conditions
are met.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
straight-line methods for property and equipment based on the estimated useful
lives, generally three to seven years, of the various classes of property.
35
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 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:
Years Ended March 31,
-------------------------------------------
2002 2001 2000
------------ ----------- ------------
Net income (loss) $(4,133,349) $(7,245,202) $ 4,904,320
Net income (loss) applicable to common stockholders $(4,133,349) $(7,245,202) $ 4,904,320
============ =========== ============
Weighted average of common shares outstanding during the period:
Basic 9,324,936 9,431,500 8,914,474
Dilutive stock options -- -- 1,546,558
------------ ----------- ------------
Diluted 9,324,936 9,431,500 10,461,032
============ =========== ============
Income (loss) per common share:
Basic $ (0.44) $ (0.77) $ 0.55
=========== =========== ============
Diluted $ (0.44) $ (0.77) $ 0.47
=========== =========== ============
Outstanding options to purchase 2,770,344, 2,556,550 and 667,146 shares of
common stock were excluded from the respective computation of diluted earnings
per share for the years ended March 31, 2002, 2001 and 2000, respectively, as
the effect was anti-dilutive.
Deferred 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. In addition, during the year ended March 31, 2001 NEON granted
restricted stock awards to an executive officer. These deferred compensation
balances were reduced during the fiscal year ended March 31, 2002, 2001 and 2000
by $420,000, $137,000 and $321,000, respectively, due to the cancellation of
restricted stock awards and options associated with terminated employees. During
the fiscal years ended March 31, 2002, 2001 and 2000, $331,000, $409,000 and
$490,000 respectively, were recognized as non-cash deferred compensation expense
The deferred balance of $26,000 will be recognized over the remaining vesting
period during fiscal 2003. Additionally, during the fiscal years ended March 31,
2002 and 2001, NEON recorded a deferred compensation charge of $10,000 and
$75,000, respectively, related to the restricted stock granted to an executive
officer.
36
During the fiscal year ended March 31, 2001, NEON took charges of $3.2
million related to changes made to options previously granted to the former
chief executive officer and chief financial officer upon their resignations in
December and October 2000, respectively. These charges were based on the fair
value of those options at the date of the modification and are non-cash in
nature. Additionally, in the third quarter of fiscal 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.
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 insignificant because the time
between a product meeting the definition of technological feasibility and being
ready to market is very short.
Stock Based Compensation
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, the Euro and the Australian dollar. 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 as a
component of accumulated other comprehensive income (loss).
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. As of March 31, 2002, all of the accumulated other comprehensive
income (loss) relates to foreign currency translation gains (losses).
37
NOTE 2 -- STOCK OPTION PLANS
Under the 1993 Stock Plan (1993 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 (1999 Plan)
that 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 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 has not made any new grants under the
1993 Plan and options previously issued under the 1993 Plan are exercisable in
accordance with their terms.
On January 28, 2002, the Board of Directors adopted the 2002 Stock Plan, and
reserved 2,000,000 shares of NEON common stock for issuance under the 2002 Stock
Plan plus (a) any shares of NEON common stock that had been reserved but not
issued under our 1999 Long-Term Incentive Plan as of the date of stockholder
approval of the 2002 Stock Plan, (b) any shares of NEON common stock returned to
the 1999 Long-Term Incentive Plan as a result of termination of options or
repurchase of shares of NEON common stock issued under the 1999 Long-Term
Incentive Plan and (c) annual increases on the first day of each fiscal year,
beginning April 1, 2003, equal to the lesser of (i) 750,000 shares of NEON
common stock, (ii) 5% of the outstanding shares of NEON common stock on such
date or (iii) a lesser amount determined by our Board of Directors. The 2002
Stock Plan replaces the 1999 Long-Term Incentive Plan. On March 26, 2002, the
stockholders of NEON approved the 2002 Stock Plan at NEON's Annual Meeting of
Stockholders. As of March 31, 2002, no options had been granted pursuant to the
2002 Stock Plan.
In January 1999, NEON adopted the Stock Option Plan for Non-Employee
Directors for compensation of its outside directors and reserved 100,000 shares
of its common stock for issuance thereunder. Outside directors joining the Board
of Directors were to 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 would 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 were to be
nonqualified stock options and 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 would 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 would 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.
On January 28, 2002, the Board of Directors adopted the 2002 Director
Option Plan. The 2002 Director Option Plan is intended to replace the Stock
Option Plan for Non-Employee Directors. The Board of Directors has reserved a
maximum of 250,000 shares of NEON common stock for issuance under the 2002
Director Option Plan plus (a) any shares of NEON common stock which had been
reserved but not issued under the Stock Option Plan for Non-Employee Directors
as of the date of stockholder approval of the 2002 Director Option Plan, (b) any
shares of NEON common stock returned to the Stock Option Plan for Non-Employee
Directors as a result of termination of options or repurchase of shares issued
under the Stock Option Plan for Non-Employee Directors, and (c) annual increases
on the first day of each fiscal year, beginning on April 1, 2003, equal to the
lesser of (i) 2% of the outstanding shares of NEON common stock on such date or
(ii) an amount determined by our Board of Directors. On March 26, 2002, the
stockholders of NEON approved the 2002 Director Option Plan at the NEON Annual
Meeting of Stockholders. At the conclusion of the Annual Meeting on March 26,
2002, options to purchase 187,500 of the available 305,000 share option pool
were issued as initial options to Non-Employee Directors who had served in any
of the previous three fiscal years.
38
NEON applies APB Opinion No. 25 in accounting for its Plans and,
accordingly, compensation cost has been recognized to the extent that the
estimated value of the underlying stock exceeds the exercise price on the date
of the grant. Had NEON determined compensation cost based on the fair value
methodology of SFAS No. 123, NEON's net income (loss) and per share amounts
would have been the pro forma amounts indicated below:
Years Ended March 31,
-------------------------------------------------
2002 2001 2000
-------------- ------------- -------------
Net income (loss) as reported $ (4,133,349) $ (7,245,202) $ 4,904,320
============== ============= =============
Net income (loss), pro forma $ (6,746,715) $ (15,148,922) $ 807,697
============== ============= =============
Net income (loss) per share as reported $ (0.44) $ (0.77) $ 0.55
============== ============= =============
Net income (loss) per share, pro forma $ (0.72) $ (1.61) $ 0.09
============== ============= =============
Prior to NEON's initial public offering in March 1999, 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 2002, 2001 and 2000 was $3.49, $9.87 and $16.10, respectively. The
following range of assumptions was used to perform the calculations: expected
life of five years in 2002, 2001 and 2000; risk-free interest rates of 4.0%
during 2002, 5.79% during 2001, and 6.0% during 2000; expected volatility of
0.688 in 2002, 1.684 in 2001, and 1.39 in 2000, and no expected dividend yield
for the three years ended March 31, 2002. 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 the years ended March 31, 2002, 2001 and 2000 is as
follows.
Weighted
Number of Average
Shares Exercise
------
Price
-----
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
Granted 1,221,415 9.45
Exercised (506,100) 0.47
Forfeited (372,469) 18.30
-----------
Balance at March 31, 2001 2,556,550 $ 10.17
Granted 1,591,980 5.80
Exercised (71,549) 1.44
Forfeited (1,306,637) 8.93
-----------
Balance at March 31, 2002 2,770,344 $ 8.46
===========
39
Options Outstanding Options Exercisable
------------------------------------------------- ---------------------------
Weighted
Weighted Average Weighted
Range of Average Outstanding Average
Exercise Number Exercise Contractual Number Exercise
Prices Outstanding Price Life Exercisable Price
----------- ------------- ---------- --------- ------------- --------
$0.01 - $ 5 835,410 $ 1.77 6.68 488,654 0.61
$ 5 - $10 1,091,102 6.82 9.42 117,016 6.64
$ 10 - $15 295,215 12.19 7.00 201,935 12.36
$ 15 - $20 398,943 16.69 7.80 335,572 16.37
$ 20 - $25 20,130 21.66 7.94 6,361 21.68
$ 25 - $30 97,980 28.67 7.65 50,130 28.64
$ 30 - $35 31,564 32.53 7.46 15,785 32.53
----------- -----------
2,770,344 1,215,453
=========== ===========
At March 31, 2002, the weighted average remaining contractual life of
outstanding options was 8 years. At March 31, 2002, 2001 and 2000, the number of
options exercisable was 1,215,453, 1,109,816 and 977,674, respectively, and the
weighted average exercise prices of those options were $9.18, $9.02 and $2.16,
respectively.
NOTE 3 -- INCOME TAXES
The benefit (provision) for income taxes consists of the following:
Years Ended March 31,
------------------------------------------------
2002 2001 2000
------------- ------------- -------------
United States Federal $ -- $ 1,989,190 $ (2,665,430)
Current -- (105,382) 140,958
Deferred -- (210,460)
State current -- -- (23,748)
------------- ------------- -------------
Foreign current $ -- $ 1,883,808 $ (2,758,680)
============= ============= =============
For the years ended March 31, 2002, 2001, and 2000, NEON's effective income
tax rate differed from the statutory tax rate as follows:
Years Ended March 31,
----------------------------------------------------------------------------
2002 2001 2000
------------------------- ------------------------ --------------------
Statutory tax rate $ (1,405,339) (34.0)% $ (3,103,863) (34.0)% $ 2,605,420 34.0%
Increase (decrease) in valuation allowance 117,223 2.8 2,038,031 22.2 278,913 3.6
R & E and AMT Credits -- -- (378,547) (4.1) (302,832) (3.9)
State tax expense, net of federal benefit -- -- -- -- 138,904 1.8
Equity in Scalable Software 713,252 17.3 -- -- -- --
Foreign sales corporation -- -- -- -- (101,383) (1.3)
Non-deductible expenses and other 574,864 13.9 (439,429) (4.8) 139,658 1.8
------------- ------- ------------- ------ ----------- ------
Effective tax rate $ -- --% $ (1,883,808) (20.7)% $ 2,758,680 36.0%
============= ======= ============= ====== =========== ======
40
As of March 31, 2002 and 2001, deferred tax assets were as follows:
As of March 31,
---------------
2002 2001
------------ ------------
Deferred compensation expense $ 1,669,527 $ 1,652,826
Net operating loss carryforwards:
United States 563,693 1,726,964
Australia 134,249 101,560
United Kingdom 481,170 44,279
Germany 655,893 864,067
Bad debt 739,200 --
Restructuring 112,732 --
R&E and AMT Credits 378,547 378,547
Other 269,065 118,610
------------ ------------
Total deferred tax assets 5,004,076 4,886,853
Valuation allowance (4,396,510) (4,279,287)
------------ ------------
Net deferred tax assets $ 607,566 $ 607,566
============ ============
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, 2002, NEON has a net operating loss carry-forward for income
tax purposes of $5,431,056 that is available to offset future taxable income, if
any. The net operating loss carry-forward consists of $1,525,142 in the United
States, $1,603,901 in the United Kingdom, $1,929,098 in Germany, and $372,915 in
Australia. The net operating loss carry-forwards in the United Kingdom, Germany
and Australia carry forward indefinitely. The net operating loss carry-forward
for the United States begins expiring in 2020.
NOTE 4 -- RELATED PARTY TRANSACTIONS
Members of NEON's Board of Directors and certain executive officers of NEON
are shareholders and/or directors in other companies with which NEON has
business relationships. Transactions between NEON and these other companies are
described below.
Peregrine/Bridge Transfer Corporation
Distribution Agreement. NEON entered into a distribution agreement with
Peregrine/Bridge Transfer Corporation ("PBTC"), a database software company, in
January 1996. In December 1998, NEON amended its distribution agreement with
Peregrine/Bridge Transfer Corporation under which PBTC granted NEON an
exclusive, worldwide license to market and sublicense PBTC's only products, its
Enterprise Subsystem Management products. The amended distribution agreement has
an initial term through March 31, 2004. The agreement also provides that NEON
pay royalties for the license of products and for maintenance and support and
upgrade services equal to 50% of the revenues received by NEON. The terms of
this agreement provide that NEON will pay PBTC a minimum advance royalty of
$250,000 per quarter during fiscal year 2000, $500,000 per quarter during fiscal
year 2001, $750,000 per quarter during fiscal year 2002, $1,000,000 per quarter
during fiscal year 2003 and $1,250,000 per quarter during fiscal year 2004, for
an aggregate payment of $15 million. This royalty payment is recorded as a
prepaid expense and offset by 50% of NEON's sales of PBTC products. NEON
incurred royalty expense of $1,454,458 and $1,588,000 for the twelve months
ended March 31, 2002 and 2001, respectively to PBTC.
The amended Distribution Agreement also provides that PBTC will reimburse NEON
for the amount of unearned royalty advances when the Agreement terminates in
2004. The balance of the unearned advance payments was $2.1 million at March 31,
2002, and increased to approximately $3.1 million in April 2002. Management
believes that while the current and reasonably foreseeable business prospects
for revenue received by NEON from licenses and maintenance for PBTC products are
expected to be sufficient to offset the unearned advance payments as of March
31, 2002, these revenues may not be sufficient to meet the aggregate future
minimum royalties to be paid by NEON
41
to PBTC. As a result, the balance of unearned advance payments may increase
substantially by the time the Agreement terminates. PBTC's sole source of income
is the royalty payments made by NEON and PBTC has a substantial negative net
worth. As a result, PBTC may be unable to repay any unearned advances at the
termination of the agreement in 2004.
Services Agreement. NEON also has a services agreement with PBTC pursuant to
which PBTC reimburses NEON for PBTC's share of the general and administrative
expenses supplied to it by NEON. Such amounts are presented as a reduction of
general and administrative expenses in the accompanying consolidated financial
statements. The Company revised the services agreement with PBTC in October
2001, as a result of which PBTC's monthly payment to NEON declined from $30,000
per month to $5,000 per month and NEON's services were substantially reduced.
NEON interlocks with Peregrine/Bridge Transfer Corporation. John J. Moores,
Charles E. Noell, III and Norris van den Berg, directors of NEON, also serve as
directors of PBTC. Wayne E. Webb, Jr., Senior Vice President and General Counsel
of NEON, served as the Vice President and General Counsel of PBTC until February
of 2002, when he was appointed its President and CEO. On June 1, 2001, Mr. Webb
was appointed President and Chief Executive Officer of NEON Systems, Inc., an
office he held until Mr. Louis Woodhill assumed those positions. Through his
interest in Skunkware, Inc., John J. Moores, Chairman of the NEON Board of
Directors, beneficially owns approximately 90% of PBTC. Through their interests
in Skunkware, Inc., each of Messrs. Noell, van den Berg and Webb beneficially
own approximately 1%, and each of Don Pate, Senior Vice President and General
Manager, Enterprise Subsystems Management Division of NEON and Jonathan J. Reed,
Vice President, Business Development and Product Marketing of NEON, beneficially
own less than 1%, of PBTC. Additionally, Messrs. Noell, Moores and van den Berg
serve as directors of Skunkware, Inc.
Scalable Software, Inc.
Scalable Software, Inc. is a company founded by Louis R. Woodhill.
Several members of NEON's Board of Directors and NEON's Chief Executive Officer
have a financial interest in Scalable Software. The percentage beneficial
ownership of the NEON directors and executive officers who have a financial
interest in Scalable Software is set forth below:
Name Ownership Percentage
---- --------------------
Jim Woodhill 24.3%
John J. Moores (and affiliates) 23.8%
Louis R. Woodhill 16.7%
Charles E. Noell (and affiliates) 15.1%
Peter Schaeffer 1.5%
------
Total 81.4%
======
On July 17, 2001, NEON announced that it had entered into a letter of
intent to acquire Scalable Software, Inc., a Houston-based provider of software
solutions for IT portfolio management. Louis R. Woodhill, NEON's President and
CEO, is also a shareholder, director, and the President and Chief Executive
Officer of Scalable Software. In connection with the letter of intent, NEON and
Scalable Software entered into a Promissory Note dated July 17, 2001, which
provided bridge financing to Scalable in a maximum amount of $3.0 million with a
maturity date of December 31, 2001, secured by the personal guarantees of John
J. Moores, Louis R. Woodhill and Jim Woodhill. On November 13, 2001, the
promissory note was amended to increase the maximum lending limit to $3.5
million with an original maturity date of March 31, 2002, with such increased
amount also being guaranteed by Messrs. Moores, Woodhill and Woodhill.
Due to the interests in Scalable Software of several members of NEON's
Board of Directors, the Board of Directors concluded that it would be
appropriate to create a Special Committee comprised solely of directors who had
no interest in Scalable Software to review the terms of the proposed
acquisition. After thorough consideration and discussion by the Special
Committee and its advisors, the Special Committee proposed that the payment of
the
42
consideration for the proposed acquisition be structured as an earn out, in
which the NEON stock to be used as consideration would be placed in escrow
subject to release to the Scalable Software shareholders upon Scalable
Software's attainment of specified revenue and profitability goals. This
proposal was unacceptable to Scalable Software's management and its Board of
Directors and was rejected. The status of the proposed acquisition was then
discussed at a special meeting of NEON's Board of Directors in December 2001.
After thorough consideration and discussion and upon endorsement by the Special
Committee, NEON's Board of Directors approved modifications to the proposed
terms and conditions for the acquisition such that the transaction would be
structured as an option to acquire Scalable Software as discussed below. In
addition, NEON also announced on December 21, 2001, that Louis R. Woodhill, its
President and Chief Executive Officer, and Jim Woodhill had been appointed to
the Board of Directors of NEON. Louis R. Woodhill and Jim Woodhill were both
directors and stockholders of Scalable Software and Louis R. Woodhill was also
the President and Chief Executive Officer of Scalable Software. As of June 2002,
their status as shareholders, directors and as officers of Scalable Software
remains unchanged.
NEON has obtained a two-year option to acquire Scalable Software as
outlined in the Agreement and Plan of Merger dated June 26, 2002. In connection
with this Option, NEON agreed to provide bridge financing of up to $5.5 million,
in addition to the $3.5 million previously loaned to Scalable Software that is
secured by personal guarantees from John J. Moores, Louis R. Woodhill and Jim
Woodhill. The aggregate financing has a 36-month term and will not bear interest
during the term of the two-year option to acquire Scalable Software. After the
expiration of the option, the loan will bear interest at the prime rate plus two
percentage points. In addition to the personal guarantees of John J. Moores,
Louis R. Woodhill and Jim Woodhill for the initial $3.5 million loaned to
Scalable Software, the $5.5 million loan will be secured by all of the
intellectual property rights of Scalable Software. NEON may exercise the option
to acquire Scalable Software at any time during the two-year term, subject to
provisions that require NEON to exercise its option within a 30-day window under
certain circumstances or forfeit the option. If NEON exercises the option and
acquires Scalable Software, each of the approximately 19,400,000 outstanding
shares of common stock of Scalable Software will be converted into approximately
0.135 of a share of NEON common stock and outstanding options and warrants to
purchase approximately 3,000,000 shares of common stock of Scalable Software
will become options and warrants to purchase common stock of NEON on the same
conversion basis. If Scalable Software incurs more indebtedness for borrowed
money or issues more equity, the exchange ratio will be reduced. Prior to NEON
exercising the option to acquire Scalable Software, a Special Committee would be
appointed to review the negotiated terms of the proposed acquisition and NEON
would seek to obtain a fairness opinion regarding the transaction from a
financial advisory firm. The acquisition of Scalable Software will also require
approval of the stockholders of NEON and the NEON Board of Directors.
Scalable Software may exhaust its line of credit from NEON before it is
able to generate cash from operations sufficient to sustain its operations. In
that event, and if Scalable Software is unable to secure additional financing,
it could become the subject of bankruptcy proceedings. If Scalable Software is
subject to bankruptcy proceedings, it is possible that the security interests
held by NEON in the intellectual property of Scalable Software could be set
aside, and NEON could be an unsecured creditor with respect to the $5.5 million
loan.
As noted above, certain member's of NEON's board of directors and
executive officers also serve as directors and executive officers of Scalable
Software and claim beneficial ownership of approximately 81% of Scalable's
common stock. In addition, NEON has an option to acquire all of the outstanding
shares of Scalable Software and is currently providing Scalable's primary
financing for its operations. Therefore, NEON recognizes 100% of Scalable
Software's losses to the extent of advances made in excess of the guaranteed
amount. At March 31, 2002, NEON had made total advances of $5.8 million to
Scalable Software (including $2.3 million of unguaranteed advances) and
recognized an associated loss of $2.1 million.
Sheer Genius Software, Inc.
On January 3, 2002, NEON entered into a services agreement with Sheer
Genius Software, Inc. of Austin, Texas, a company owned by Jim Woodhill. Also,
JMI Services, Inc., a private company owned by John J. Moores, NEON's Chairman,
is a creditor of Sheer Genius, holding a promissory note dated August 31, 2001
in the amount of $200,000. Under the first project description negotiated for
such services agreement, Sheer Genius will provide development services to NEON
on a budgeted time and materials basis and will deliver fixed deliverables,
consisting primarily of developed source code. The term of the initial project
description was six months and the maximum aggregate fees were $480,000. This
agreement was recently amended to extend the contract period for an additional
three months with additional maximum aggregate fees of $300,000. While NEON is
currently Sheer Genius' sole source of income, it is free to solicit other
customers. Under the
43
services agreement, all intellectual property created by Sheer Genius in the
course of performing the services shall be owned by NEON. Additionally, Sheer
Genius will receive a license back of such intellectual property for limited use
in the development by Sheer Genius of software that does not compete with
software distributed by NEON. The Board of Directors reviewed the terms of the
services agreement and project description and approved such agreements
following disclosure of the interest of its officers and directors associated
with Sheer Genius.
NOTE 5 -- COMMITMENTS AND CONTINGENCIES
NEON leases office space and computer software under operating lease
agreements expiring through fiscal 2015. In addition, NEON is obligated to make
advances to Scalable Software, Inc. and PBTC. See Note 4 above. The following
table summarizes our contractual cash obligations as of March 31, 2002:
Fiscal Year Ending March 31
2003 2004 2005 2006 2007 Thereafter Totals
Operating Leases $1,277,774 $1,148,694 $1,140,330 $ 84,519 $14,142 $ -- $3,665,459
Scalable Software $3,200,000 -- -- -- -- -- $3,200,000
PBTC Royalty Advance $4,000,000 $5,000,000 -- -- -- -- $9,000,000
Employment Agreements (a) $ 187,011 $ 131,798 $ 138,513 $142,678 -- -- $ 600,000
(a) On March 29, 2002, NEON entered into an agreement with Mark Cresswell and
Peter Cook, as Principals of Lakeview Advisors Corporations (BV1) Limited, to
pay Messrs. Cresswell and Cook up to $600,000 to be paid on a quarterly basis
over the course of 48 months. The payments to Messrs. Cresswell and Cook are
contingent upon their continued employment with NEON. Should either Mr.
Cresswell or Mr. Cook leave the employment of NEON, other than being terminated
without cause, NEON would be required to only make an additional payment of
$50,000, with no additional amounts due under the Agreement.
Total rent expense under all operating leases was $1,438,597, $2,027,647 and
$1,109,047 in the years ended March 31, 2002, 2001 and 2000, respectively.
NEON has resolved its litigation with New Era of Networks in a confidential
settlement that resolved all pending litigation between the parties. NEON
received a cash payment of approximately $9.3 million, net of attorney fees, in
the fiscal quarter ending September 30, 2001, as a result of this settlement,
and is reporting such payment as a non-recurring item. The litigation arose from
the fact that a number of organizations, including New Era of Networks, Inc.,
were utilizing the name "Neon," alone and in combination with other words, as a
trademark, a trade name or both. New Era of Networks, which was recently
acquired by Sybase, Inc., is also a developer and distributor of middleware and
other software products. New Era of Networks had used the acronym "NEON" in its
business, was listed on the Nasdaq National Market under the symbol "NEON" and
had sought to obtain federal trademarks for products and services whose names
include the word "NEON." 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 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 intended to grant summary judgment for
cancellation of the federal trademark registration for the "NEON" mark. 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" was in violation of
Texas law concerning misappropriation of trade names. In this litigation, NEON
sought 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 were based upon its prior and continuous use of "NEON" as its
corporate name. On June 1, 2001, the jury in the Fort Bend County, Texas suit
returned a verdict in NEON's favor awarding NEON $14 million in actual damages
and $25 million in punitive damages. On June 26, 2001, the judge issued a final
judgment confirming the award of actual and punitive damages, and granted a
permanent injunction prohibiting New Era from referring to itself as "NEON" in
advertising, marketing or other public disclosures; from distributing software
that includes one or more
44
occurrences of the "NEON" mark, and within specified time periods to replace
documentation, installed code, and advertising materials that include any use of
the mark "NEON."
NEON is involved in no current claims and legal actions other than those
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 6 - RESTRUCTURING CHARGES AND ASSET WRITE-DOWN CHARGES
During the year ended March 31, 2002, the Company recorded a restructuring
charge of $908,000. These charges related to reductions in the Company's cost
structure and corporate reorganization, including reductions in force, and
abandonment of leased facilities. These restructuring costs included severance
costs of $570,000 and losses from lease commitments of $338,000. Cash paid, for
severance costs and leasing expenses during the year ended March 31, 2002,
totaled $570,000 and $94,000, respectively. As of March 31, 2002, the Company
has included in accrued liabilities $244,000 related to lease commitments
included in the restructuring charge.
NEON has recorded a non-cash charge or $887,000 during the year ended March
31, 2002, related to the write-down of pre-paid royalties and other assets.
NOTE 7 - NOTE RECEIVABLE
NEON made an advance on a note receivable to Enterworks Software, Inc. in the
amount of $2 million. The Enterworks Software loan is a Demand 10% Convertible
Promissory Note and was issued under a Convertible Promissory Note and Warrant
Agreement dated May 23, 2001 in a second round of financing for Enterworks. The
loan accrues interest at 10% per annum and matures on demand made by the holders
representing at least 50% of the outstanding principal amount of the Demand
Notes. During the year ended March 31, 2002, NEON recorded a reserve of $2
million as a valuation allowance against this note receivable.
NOTE 8 - TREASURY STOCK PURCHASE
NEON purchased 913,400 shares of its outstanding common stock in a
transaction arising from an unsolicited offer. The shares were purchased at a
purchase price of $2.90 per share for a total aggregate purchase price of
$2,648,860. The shares purchased amounted to approximately 9.5% of NEON's then
outstanding shares of common stock.
NOTE 9 -- 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 2002, 2001 and 2000.
Neon's U.S. operations accounted for 100% of total North American revenues in
fiscal 2002, 2001 and 2000.
NEON had one customer that represented 10% and two customers who aggregated
14% of consolidated revenue in fiscal 2002, one customer that represented 16% of
consolidated revenue in fiscal 2001, and no customers that accounted for 10% or
more of consolidated revenue in fiscal 2000.
Years Ended March 31,
2002 2001 2000
-------------- -------------- --------------
Revenues:
United States $ 18,411,471 $ 22,327,954 $ 23,726,805
United Kingdom 2,295,000 3,742,093 4,845,891
Other 728,715 553,626 1,146,017
-------------- -------------- --------------
$ 21,435,186 $ 26,623,673 $ 29,718,713
============== ============== ==============
Operating income (loss):
United States $ (9,457,644) $ (9,703,253) $ 6,863,868
United Kingdom (774,940) (597,686) (864,062)
45
Other (252,990) (1,314,313) (593,139)
-------------- -------------- --------------
$ (10,485,574) $ (11,615,252) $ 5,406,667
============== ============== ==============
Identifiable assets:
United States $ 49,697,942 $ 58,191,743 $ 55,809,380
United Kingdom 3,364,754 4,308,145 3,943,498
Other 536,824 878,455 747,279
-------------- -------------- --------------
$ 53,599,520 $ 63,378,343 $ 60,500,157
============== ============== ==============
46
NOTE 10 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth certain unaudited quarterly information with
respect to the Company's results of operations for the fiscal years 2002, 2001
and 2000. 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.
(In Thousands, Except Per Share Data) 2002 Quarter
------------------------------------------------
1/st/ 2/nd/ 3/rd/ 4/th/
-------- ------- ------- -------
Revenues $ 6,197 $ 4,852 $ 5,073 $ 5,313
Gross Profit 5,122 3,767 4,214 3,195
Net income (loss) (2,410) 5,958 (2,559) (5,122)
Earnings (loss) per common share:
Basic $ (0.25) $ 0.62 $ (0.27) $ (0.59)
Diluted $ (0.25) $ 0.59 $ (0.27) $ (0.59)
2001 Quarter
------------------------------------------------
1/st/ 2/nd/ 3/rd/ 4/th/
-------- ------- ------- -------
Revenues $ 7,625 $ 5,678 $ 6,387 $ 6,933
Gross Profit 6,244 4,664 4,964 5,915
Net income (loss) 155 (1,270) (5,173) (957)
Earnings (loss) per common share:
Basic $ 0.02 $ (0.13) $ (0.55) $ (0.10)
Diluted $ 0.02 $ (0.13) $ (0.55) $ (0.10)
2000 Quarter
------------------------------------------------
1/st/ 2/nd/ 3/rd/ 4/th/
-------- ------- ------- -------
Revenues $ 6,086 $ 6,059 $ 8,919 $ 8,655
Gross Profit 5,719 5,392 7,668 7,736
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
NOTE 11 -- MARKETABLE SECURITIES
NEON considers all highly liquid investments with maturity of three months
or less to be cash equivalents.
NEON has evaluated its investment policies consistent with Financial
Accounting Standards Board Statement No. 115 ("SFAS 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 115 as of March 31, 2001:
March 31, 2001
--------------
Debt Securities:
Cost $ 819,711
Gross unrealized gains (losses) 14,730
----------
Estimated fair value $ 834,441
==========
All marketable securities were sold or matured during the year ended March 31,
2002.
47
NOTE 12 -- 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 $478,000 was
recognized in both the fiscal years ended March 31, 2002 and 2001.
NOTE 13 -- OTHER ASSETS
In December 1999, NEON entered into an agreement with Sterling Software,
which was subsequently acquired by Computer Associates, Inc., which granted NEON
the right to use, reproduce, copy and sell certain products. As consideration
for this agreement, NEON made a nonrefundable advance of $3.5 million for the
future royalties to be earned by Computer Associates from sales made by NEON of
$14 million of such products. NEON also acquired an option to purchase the
intellectual property underlying such products at any time through December 30,
2000 for $1 million. In October 2000, NEON exercised its option to purchase the
intellectual property. The purchase was completed on December 21, 2000 and the
total unamortized consideration was recorded as an intangible asset and is being
amortized over 3 years on the straight-line method.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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 in October 2002, which will be filed not
later than 120 days after the end of NEON's fiscal year ended March 31, 2002 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 in the third calendar quarter of 2002, which
will be filed not later than 120 days after the end of NEON's fiscal year ended
March 31, 2002 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 in the
third calendar quarter of 2002, which will be filed not later that 120 days
after the end of NEON's fiscal year ended March 31, 2002 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 in the third calendar
quarter of, 2002, which will be filed not later than 120 days after the end of
NEON's fiscal year ended March 31, 2002 and which is incorporated herein by this
reference.
48
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, 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) The following consolidated financial statement schedule of NEON
Systems, Inc. is included in Item 14(d):
Schedule II - Valuation and Qualifying Accounts
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.
Exhibit
Number Description
------- -----------
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).
3.3+ Amendment to the Amended and Restated Certificate of
Incorporation of NEON Systems, Inc. dated May 15, 2002.
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).
49
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).
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).
50
10.19 Stockholders Agreement dated May 19, 1993 by and among NEON
Systems, Inc. and JMI Equity Fund, L.P. and Peter Schaeffer
(incorporated by reference to Exhibit 10.19 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.20 Stock Restriction Agreement dated May 19, 1993 by and among
NEON Systems, Inc., Peter Schaeffer and JMI Equity Fund,
L.P. (incorporated by reference to Exhibit 10.20 to NEON's
Registration Statement on Form S-1 (Registration Number
333-69651) effective March 5, 1999).
10.21 Service Agreement dated as of December 18, 1998 by and
among NEON Systems, Inc. and Peregrine/Bridge Transfer
Corporation (incorporated by reference to Exhibit 10.21 to
NEON's Registration Statement on Form S-1 (Registration
Number 333-69651) effective March 5, 1999).
10.22 Stock Purchase Agreement dated June 1, 1998 by and between
NEON Systems, Inc. and Wayne E. Webb, Jr. (incorporated by
reference to Exhibit 10.22 to NEON's Registration Statement
on Form S-1 (Registration Number 333-69651) effective March
5, 1999).
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).
10.25*+ Employment Agreement dated January 4, 2002 between NEON
Systems, Inc. and Louis R. Woodhill.
10.26 Amendment to 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 10.25 to NEON's
Annual Report on Form 10-K for the fiscal year ended
March 31, 2002 filed on June 29, 2001).
10.27+* NEON Systems, Inc. 2002 Stock Plan effective as of
March 26, 2002.
10.28+* NEON Systems, Inc. 2002 Director Option Plan, effective as
of March 26, 2002.
10.29+* Resolutions of the Board of Directors of NEON Systems,
Inc. dated January 28, 2002 related to a change in
compensation for Louis R. Woodhill.
10.30+* Offer Letter dated October 11, 2001 between NEON Systems,
Inc. and Mark Cresswell.
10.31+* Asset Purchase Agreement between NEON Systems, Inc. and
Lakeview Advisors Corporation (BVI) Limited dated March
29, 2002.
10.32+ Option Agreement between NEON Systems, Inc. and Scalable
Software, Inc., dated June 26, 2002.
10.33+ Promissory Note between NEON Systems, Inc. and Scalable
Software, Inc. dated, June 26, 2002.
10.34+ Security Agreement between NEON Systems, Inc. and Scalable
Software, Inc. dated, June 26, 2002.
10.35+ Guaranty Agreement between NEON Systems, Inc., John
J. Moores, Louis R. Woodhill and James R. Woodhill,
dated June 26, 2002.
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).
+ 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.
Wayne Webb, 14100 Southwest Freeway, Suite 500, Sugar Land,
Texas 77478.
51
(b) Reports on Form 8-K.
The following reports on Form 8-K were filed during the last quarter of
fiscal 2002:
. A Current Report on Form 8-K was filed on January 3, 2002, which
included a copy of a press release announcing that NEON had repurchased
913,400 shares of its outstanding common stock for $2.90 per share.
. A Current Report on Form 8-K was filed on March 26, 2002, which
included a copy of a press release announcing the results of our Annual
Meeting.
(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.
52
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders NEON Systems, Inc.:
Under date of June 27, 2002, we reported on the consolidated balance sheets of
NEON Systems, Inc. and subsidiaries as of March 31, 2002, and 2001, and the
related consolidated statements of operations, stockholders' equity and
comprehensive income (loss), and cash flows for each of the years in the
three-year period ended March 31, 2002, which are included in the 2002 Annual
Report on Form 10-K of NEON Systems, Inc. In connection with our audits of the
aforementioned consolidated financial statements, we also audited the related
consolidated financial statement schedule of valuation and qualifying accounts.
This consolidated financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, present fairly,
in all material respects, the information set forth therein.
KPMG LLP
Houston, Texas
June 27, 2002
53
NEON SYSTEMS, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
YEAR ENDED MARCH 31, 2002
Additions Deductions
--------- ----------
Effect
Amounts Amounts of
Balance at Charged to Written Exchange Balance
Beginning Operating Off Against Rate at End
Description of Year Expenses Receivables Changes of Year
----------- ---------- ---------- ----------- -------- --------
Allowance for Doubtful
Accounts Receivable $187,000 $80,000 $ -- $ -- $267,000
======== ======= ====== ===== ========
54
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/ LOUIS R. WOODHILL
--------------------------------------
Louis R. Woodhill
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Date: June 27, 2002
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes and constitutes
John J. Moores and Louis R. Woodhill, 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.
Signatures Title Date
---------- ----- ----
/s/ JOHN J. MOORES Chairman of the Board
- ---------------------------------------------------
John J. Moores
/s/ LOUIS R. WOODHILL Director, President and Chief Executive
- --------------------------------------------------- Officer
Louis Woodhill
/s/ JAMES BRADFORD POYNTER Chief Financial Officer
- ---------------------------------------------------
James Bradford Poynter
/s/ PETER SCHAEFFER Director
- ---------------------------------------------------
Peter Schaeffer
/s/ CHARLES E. NOELL III Director
- ---------------------------------------------------
Charlie E. Noell III
/s/ NORRIS VAN DEN BERG Director
- ---------------------------------------------------
Norris van den Berg
/s/ RICHARD HOLCOMB Director
- ---------------------------------------------------
Richard Holcomb
/s/ GEORGE ELLIS Director
- ---------------------------------------------------
George Ellis
/s/ JIM WOODHILL Director
- ---------------------------------------------------
Jim Woodhill
55
Exhibit
Number Description
------- -----------
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).
3.3+ Amendment to the Amended and Restated Certificate of
Incorporation of NEON Systems, Inc. dated May 15, 2002.
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).
56
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).
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).
57
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).
10.25*+ Employment Agreement dated January 4, 2001 between NEON
Systems, Inc. and Louis R. Woodhill.
10.26 Amendment to 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 10.25 to NEON's
Annual Report on Form 10-K fir the fiscal year ended
March 31, 2002, filed on June 29, 2001).
10.27+* NEON Systems, Inc. 2002 Stock Plan effective as of March
26, 2002.
10.28+* NEON Systems, Inc. 2002 Director Option Plan, effective as
of March 26, 2002.
10.29+* Resolutions of the Board of Directors of NEON Systems, Inc.
dated January 28, 2002 related to a change in compensation
for Louis R. Woodhill.
10.30+* Offer Letter dated October 11, 2001 between NEON Systems,
Inc. and Mark Cresswell.
10.31+* Asset Purchase Agreement between NEON Systems, Inc. and
Lakeview Advisors Corporation (BVI) Limited dated March
29, 2002.
10.32+ Option Agreement between NEON Systems, Inc. and Scalable
Software, Inc., dated June 26, 2002.
10.33+ Promissory Notes between NEON Systems, Inc. and Scalable
Software, Inc. dated, June 26, 2002.
10.34+ Security Agreement between NEON Systems, Inc. and Scalable
Software, Inc. dated, June 26, 2002.
10.35+ Guaranty Agreement between NEON Systems, Inc., John J.
Moores, Louis R. Woodhill and James R. Woodhill,
dated June 26, 2002.
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).
+ 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.
Wayne Webb, 14100 Southwest Freeway, Suite 500, Sugar Land,
Texas 77478.
58