SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

 

ý  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended June 30, 2004

 

OR

 

o  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)

 

 

 

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 ý  No o

 

The number of shares of the registrant’s common stock outstanding as of July 31, 2004, was 8,917,427.

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes  o  No  ý

 

 

NEON SYSTEMS, INC.

 

FORM 10-Q

 

FOR THE QUARTER ENDED JUNE 30, 2004

 

INDEX

 

		PAGE
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets at June 30, 2004 and March 31, 2004	3
	Consolidated Statements of Operations for the Three Months Ended June 30, 2004 and 2003	4
	Consolidated Statements of Cash Flows for the Three Months Ended June 30, 2004 and 2003	5
	Condensed Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	16
Item 4.	Controls and Procedures	17
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	17
Item 2.	Changes in Securities and Use of Proceeds	17
Item 3.	Defaults Upon Senior Securities	17
Item 4.	Submission of Matters to a Vote of Security Holders	17
Item 5.	Other Information	17
Item 6.	Exhibits and Reports on Form 8-K	19
SIGNATURES		20

 

2

 

PART I - FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

NEON SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

 

		JUNE 30, 2004			MARCH 31, 2004
		(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	26,474		$	20,899
Accounts receivable, net		2,489			6,150
Other current assets		1,161			1,232
Total current assets		30,124			28,281
Property and equipment, net		540			475
Note receivable, net (Note 7)		4,260			7,760
Purchased technology, net		399			—
Other assets		487			341
Total assets		$	35,810		$	36,857
LIABILITIES & STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	222		$	298
Accrued expenses		1,366			2,733
Deferred revenue		6,563			7,540
Total current liabilities		8,151			10,571
Deferred revenue – long term		1,298			931
Accrued restructuring expenses – long term (Note 6)		932			898
Total liabilities		10,381			12,400
STOCKHOLDERS’ EQUITY:
Preferred stock, $.01 par value. Authorized 10,000,000 shares; no shares issued and outstanding		—			—
Common stock, $.01 par value. Authorized 30,000,000 shares; 8,917,227 and 8,914,547 shares issued and outstanding at June 30, 2004 and March 31, 2004, respectively		98			98
Additional paid-in capital		51,703			51,696
Treasury Stock, 913,400 shares at cost		(2,649		)	(2,649		)
Accumulative other comprehensive loss		(423		)	(421		)
Accumulated deficit		(23,300		)	(24,267		)
Total stockholders’ equity		25,429			24,457
Commitments and contingencies (Note 5)
Total liabilities and stockholders’ equity		$	35,810		$	36,857

 

SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

3

 

NEON SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

 

		THREE MONTHS ENDED JUNE 30,
		2004			2003
Revenues:
License		$	1,103		$	1,560
Maintenance		2,468			2,580
Total revenues		3,571			4,140
Cost of revenues:
Cost of licenses		32			83
Cost of maintenance		364			374
Total cost of revenues		396			457
Gross profit		3,175			3,683
Operating expenses:
Sales and marketing		1,555			1,675
Research and development		983			1,172
General and administrative		930			780
Total operating expenses		3,468			3,627
Operating income (loss)		(293		)	56
Interest and other income, net		45			53
Gain on sale of notes receivable (Note 7)		1,215			—
Income from continuing operations before income taxes		967			109
Provision for income taxes		—			—
Income from continuing operations		967			109
Gain from discontinued operations, net (Note 8)		—			46
Net income		$	967		$	155
Earnings per common share —Basic:
Income from continuing operations		$	0.11		$	0.01
Gain from discontinued operations, net		—			0.01
Net income		$	0.11		$	0.02
Earnings per common share —Diluted:
Income from continuing operations		$	0.10		$	0.01
Gain from discontinued operations, net		—			0.01
Net income		$	0.10		$	0.02
Weighted average shares outstanding:
Basic		8,915			8,801
Diluted		9,379			9,058

 

SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

4

 

NEON SYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

 

		THREE MONTHS ENDED JUNE 30,
		2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	967		$	155
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		131			116
Gain on sale of notes receivable (Note 7)		(1,215		)	—
Gain from discontinued operations, net (Note 8)		—			(46		)
Increase (decrease) in cash resulting from changes in operating assets and liabilities:
Accounts receivable		3,641			195
Other current assets		70			290
Other assets		(136		)	10
Accrued expenses		(1,315		)	(390		)
Accounts payable		(76		)	(60		)
Deferred revenue and other		(593		)	(1,034		)
Net cash provided by (used in) operating activities		1,474			(764		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(169		)	(31		)
Purchase of technology		(264		)	—
Acquisition-related costs (Note 9)		(172		)	—
Proceeds from sale of notes receivable		4,715			—
Proceeds from sale of business		—			335
Net cash provided by investing activities		4,110			304
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercises of stock options		7			24
Net cash provided by financing activities		7			24
Net cash flows from discontinued operations		—			9
Net increase (decrease) in cash and cash equivalents		5,591			(427		)
Effect of exchange rate changes on cash		(16		)	1
Cash and cash equivalents at beginning of period		20,899			19,791
Cash and cash equivalents at end of period		$	26,474		$	19,365
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes		$	—		$	—
Cash paid during the period for interest		$	—		$	—

 

SEE ACCOMPANYING CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

5

 

NEON SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1—BASIS OF PRESENTATION

 

The accompanying unaudited consolidated financial statements for NEON Systems, Inc. and its subsidiaries (collectively, “NEON”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and in accordance with Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, the unaudited consolidated financial statements contained in this report reflect all adjustments, consisting of only normal recurring adjustments, considered necessary for a fair presentation of the financial position and the results of operations for the interim periods presented. Operating results for interim periods are not necessarily indicative of results for the full year. These unaudited consolidated financial statements, footnote disclosures and other information should be read in conjunction with the financial statements and the notes thereto included in NEON’s audited consolidated financial statements for the fiscal year ended March 31, 2004, which are included in NEON’s Form 10-K for the fiscal year ended March 31, 2004.  Certain prior period amounts have been reclassified to conform to current period presentation.

 

NOTE 2—PER SHARE INFORMATION

 

In calculating earnings per share information, NEON follows the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 128, Earnings Per Share. Basic earnings per share is computed by dividing net income applicable to common stockholders by the weighted average number of shares of common stock outstanding during the period.  Diluted earnings per share is computed by dividing net income applicable to common stockholders by the weighted average number of shares of common stock outstanding, adjusted to reflect common stock equivalents, such as convertible preferred stock, stock options and warrants to purchase common stock, to the extent they are dilutive, less the number of shares that could have been repurchased with the exercise proceeds using the treasury stock method.

 

Earnings per share:

(In thousands, except per share date)

 

		THREE MONTHS ENDED JUNE 30,
		2004			2003
Net income available for common shareholders		$	967		$	155
Weighted average outstanding shares of common stock		8,915			8,801
Dilutive effect of employee stock options		464			257
Common stock and common stock equivalents		9,379			9,058
Earnings per share:
Basic		$	0.11		$	0.02
Diluted		$	0.10		$	0.02

 

At June 30, 2004 and 2003, there were options outstanding to purchase 2.8 million shares of common stock with a weighted-average exercise price of $6.00 and $8.96, respectively. For the three months ended June 30, 2004 and 2003, 1.4 million and 1.8 million, respectively, were excluded from the calculation of diluted earnings per share because the effect was anti-dilutive.

 

6

 

Employee 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.  The following table illustrates the effect on net income if the fair-value-based method had been applied to all outstanding and unvested awards in each period (in thousands, except per share data):

 

		THREE MONTHS ENDED JUNE 30,
		2004			2003
Net income as reported		$	967		$	155
Deduct total stock-based employee compensation expense determined under fair-value-based method for all awards		(385		)	(410		)
Pro forma net income (loss)		$	582		$	(255	)
Basic earnings (loss) per share:
As reported		$	0.11		$	0.02
Pro forma		$	0.07		$	(0.03	)
Diluted earnings (loss) per share:
As reported		$	0.10		$	0.02
Pro forma		$	0.06		$	(0.03	)

 

NOTE 3—INCOME TAXES

 

NEON has recorded no income tax provision as the current year taxable income is offset by net operating loss carry-forwards that NEON had previously reserved.  At March 31, 2004, NEON has a net operating loss carry-forward for income tax purposes of approximately $19.3 million that is available to offset future taxable income. 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 the tax year 2020.  There can be no assurance that the operations will generate taxable income in the future to utilize these losses.  As of June 30, 2004 and March 31, 2004, the valuation allowance fully offsets the Company’s net deferred tax assets.

 

NOTE 4—SEGMENT REPORTING

 

NEON considers its business activities to be in a single segment.  NEON did not have any customers, individually or in aggregate that accounted for 10% or more of consolidated revenue during the three-month periods ending June 30, 2004 and June 30, 2003.

 

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The table below summarizes revenues by geographic region.

 

		THREE MONTHS ENDED JUNE 30,
		2004			2003
Revenues:
North America		$	2,551		$	2,670
United Kingdom		928			1,296
Other		92			174
		$	3,571		$	4,140
Operating income (loss):
United States		$	(574	)	$	(624	)
United Kingdom		313			629
Other		(32		)	51
		$	(293	)	$	56

 

		JUNE 30, 2004			MARCH 31, 2004
Identifiable Assets:
United States		$	32,499		$	33,258
United Kingdom		3,185			3,302
Other		126			297
		$	35,810		$	36,857

 

NOTE 5—COMMITMENTS AND CONTINGENCIES

 

On January 29, 2003, NEON received notification that it had been sued in Fort Bend County, Texas for alleged tortious interference with contract, tortious interference with prospective business relations and unfair competition in a lawsuit styled Phoenix Network Technologies (Europe) Limited vs. NEON Systems, Inc. and Computer Associates International Inc., 400^th District Court, Ft. Bend County, Richmond, Texas, Cause Number 03-CV-127800. On October 27, 2003, the court granted NEON’s motion to dismiss the case.  Phoenix Network Technologies has appealed this decision, and NEON is continuing to defend this action.  Aside from this action, NEON is not involved in any current claim or legal action other than those arising in the ordinary course of business.

 

NOTE 6—RESTRUCTURING CHARGES

 

During prior periods, NEON recorded various restructuring charges related to future losses due to the abandonment of leased facilities and employee severance associated with corporate reorganizations.  If, in the future, NEON is able to sublease or renegotiate the leases related to these abandoned facilities, reversal of all or a portion of such accrued losses may occur.

 

8

 

The following table provides a roll-forward of the restructuring accrual account for the three months ended June 30, 2004 (in thousands):

 

				Balance at March 31, 2004			Amounts Charged to Expense			Net Amounts Paid			Other			Balance at June 30, 2004
2002 Restructuring Accrual		Facility closure		$	54		$	—		$	(5	)	$	—		$	49
2003 Restructuring Accrual		Facility closure		1,462			(114		)	(122		)	(12		)	1,214
2004 Restructuring Accrual		Employee severance		35			—			(35		)	—			—
		Facility closure		3			—			(3		)	—			—
		Totals		$	1,554		$	(114	)	$	(165	)	$	(12	)	$	1,263

 

The $1.3 million balance at June 30, 2004 consists of future cash payments for abandoned facilities that will be paid through 2006. The current portion of this liability, $331,000, is included in accrued expenses.

 

During the three months ended June 30, 2004, NEON renegotiated an abandoned lease that had been previously accrued, resulting in a decrease of the liability by $114,000, which is reported in general and administrative expenses in the consolidated statement of operations.

 

Other adjustments relate primarily to the effect of currency translation on foreign balances.

 

NOTE 7—RELATED PARTY TRANSACTIONS

 

Certain former members of NEON’s Board of Directors and certain former executive officers of NEON were shareholders and/or directors in other companies with which NEON has investments.  Transactions between NEON and these other companies are described below. The directors and officers involved in such transactions are no longer officers and directors of NEON.

 

NEON Enterprise Software, Inc. (formerly Peregrine/Bridge Transfer Corporation)

 

NEON entered into a Termination and Customer Support Agreement on August 14, 2002, which terminated a distribution agreement with Peregrine/Bridge Transfer Corporation (PBTC), a database software company whose sole stockholder is an affiliate of John J. Moores, NEON’s former Chairman of the Board of Directors. PBTC subsequently changed its name to NEON Enterprise Software, Inc. (“NESI”).

 

NEON currently holds a consolidated promissory note receivable  from NESI in the aggregate principal amount of $3.6 million, bearing no interest to its due date of March 31, 2005. This consolidated promissory note is secured by all of the intellectual property of NESI (“NESI IP”). NEON also currently holds a $3.0 million convertible promissory note receivable from NESI bearing no interest to its due date of March 31, 2005, which is also secured by the NESI IP. The $3.0 million convertible note is convertible by NEON, in its discretion, into equity in NESI at an agreed pre-cash valuation of $30.0 million dollars. Such conversion right will expire on the due date of the $3.0 million convertible note. On the closing of the transaction in August 2002, NEON recorded the notes receivable from NESI at their estimated net present value, which was calculated at $4.3 million in aggregate value. NEON will adjust the carrying value of the note if the net realizable value is determined to be below the carrying value. NEON had an external valuation of the NESI IP performed as of March 31, 2004 and determined that no further impairment of the notes were required.  NEON also evaluates the NESI IP on a quarterly basis to determine the notes’ net realizable value. NEON is not aware of any changes that have occurred which  would result in an adjustment to the carrying value.

 

9

 

Scalable Software, Inc.

 

Scalable Software, Inc. (Scalable), a Houston-based provider of software solutions for IT portfolio management, is a company founded by Louis R. Woodhill, who served as NEON’s Chief Executive Officer until March 2003. Several former members of NEON’s Board of Directors, including Louis R. Woodhill, John J. Moores, Peter Schaeffer, Charles E. Noell III and Jim Woodhill, had or have a financial interest in Scalable.

 

In June 2002, NEON obtained a two-year option to acquire Scalable 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 (subsequently increased to $6.0 million in October 2002), in addition to $3.5 million previously loaned to Scalable that was secured by personal guarantees from John J. Moores, Louis R. Woodhill and Jim Woodhill. The aggregate financing had a 36-month term and did not bear interest during the term of the two-year option to acquire Scalable, which expires June 26, 2004. After the expiration of the option, the loan was scheduled to bear interest at the prime rate plus two percentage points to its due date of June 26, 2005 and thereafter on any unpaid principal and interest amounts outstanding. 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, the $6.0 million loan was secured by all of the intellectual property rights of Scalable. In January 2003, Scalable exhausted its credit facility with NEON. Scalable has asked for and received waivers of NEON’s right of first refusal with respect to additional venture capital bridge financing.

 

On June 9, 2004, NEON entered into a Note Purchase Agreement with JMI Services, Inc., the largest shareholder of Scalable, to sell the $3.5 million guaranteed note and the $6.0 million secured note issued by Scalable to NEON for an aggregate cash purchase price of $4.8 million.  JMI Services is an affiliate of John J. Moores, NEON’s largest shareholder.  The proposed purchase of the Scalable notes was reviewed by NEON’s fully independent Board of Directors.  The board requested and received a fairness opinion from Avail Consulting, Inc., a Houston, Texas based independent valuation and financial consultant, stating that the transaction was fair to the stockholders of NEON from a financial standpoint and their recommendation that the Board accept the cash purchase offer made by JMI Services, Inc.  Closing of the transaction occurred on June 17, 2004.

 

NEON recorded the carrying value of its net advance to Scalable at the guaranteed amount of $3.5 million.  As a result of the sale of the notes during the three months ended June 30, 2004, NEON recorded a net gain of $1.2 million, consisting of proceeds in excess of the recorded net book value and direct selling costs.

 

NOTE 8 –  DISCONTINUED OPERATIONS

 

On June 20, 2003, NEON divested of its iWave product line assets.  As a result of the transaction, NEON recorded a gain on the sale of $290,000, net of closing expenses, during the three months ended June 30, 2003.  Total revenues attributed to the iWave product line for the three months ended June 30, 2003 were $194,000.  Operating losses associated with the iWave product line of $244,000 for the three months ended June 30, 2003 were offset against the gain on disposal of the  discontinued operations in the consolidated statements of operations.

 

NOTE 9 –  SUBSEQUENT EVENTS

 

On July 15, 2004, NEON closed its acquisition of InnerAccess Technologies, Inc., a company incorporated under the laws of the province of Quebec, Canada.  InnerAccess is a company which develops, markets and licenses web services technology and provides services related to the integration of mainframe data sources with modern distributed computing systems.  In connection with the acquisition, NEON and InnerAccess entered into a Combination Agreement, which provided for the amalgamation of InnerAccess, three single purpose entities holding the majority of the shares of InnerAccess (the “Principal Shareholders”), and NEON’s wholly-owned subsidiary, NEON Systems Canada Inc. (the “Amalgamated Entity”).  In connection with the amalgamation, the shareholders of InnerAccess (“InnerAccess Shareholders”) exchanged their shares of the capital stock of InnerAccess for (i) class A redeemable shares of the Amalgamated Entity which entitled such InnerAccess Shareholders to receive $0.174 per share redeemed by the Amalgamated Entity and (ii) class B redeemable shares of the Amalgamated Entity which entitled such InnerAccess Shareholder to receive 0.02952 of a share of

 

10

 

NEON common stock per share redeemed by the Amalgamated Entity.  Upon the full redemption of the redeemable preferred shares, NEON will have paid the InnerAccess Shareholders a total of $2.4 million dollars in cash purchase price and issued 407,123 shares of NEON common stock in consideration for the acquisition of InnerAccess by NEON.

 

In addition, NEON has assumed certain special warrants of InnerAccess, which (on a converted basis) represent the right to acquire an additional 19,894 shares of NEON common stock at a cash exercise price equal to $9.50 per share.  In connection with the issuance of the shares of NEON common stock, NEON entered into a registration rights agreement with each former InnerAccess Shareholder.  Such Registration Rights Agreement grants to each such former InnerAccess Shareholder a right to piggyback on any public offering of NEON shares of common stock during the one year period following the closing of the acquisition of InnerAccess  by NEON.

 

The Amalgamated Entity now has offices in Quebec City, Quebec, Canada and in Toronto, Ontario, Canada.   In connection with the acquisition, the President and CEO of InnerAccess, Jean-Daniel Bégin, became NEON’s Vice President of Product Management and became an executive officer of NEON.

 

ITEM 2.          MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis should be read in conjunction with NEON’s consolidated financial statements and the related notes thereto included in this report on Form 10-Q. 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, including those set forth below in Part II, Item 5 under “Factors that May Affect Future Results.”  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.

 

OVERVIEW

 

NEON Systems, Inc. (“NEON”) is a leading provider of enterprise-class mainframe integration software.  NEON develops, markets and supports a unified mainframe integration platform that supports a broad range of requirements for modern Service-Oriented Architectures and emerging Event-Driven Architectures. NEON’s Shadow technology provides flexible, industry standard interfaces to enable highly secure and scalable mainframe integration, allowing organizations to reduce total cost of ownership and risk associated with mainframe integration, while streamlining the number of incumbent technologies needed for such integration.

 

In July 2004, NEON closed its acquisition of InnerAccess Technologies, a Quebec corporation which develops mainframe integration software products with particular specialization in web services for mainframe integration and integration of IDMS databases.

 

Business Environment

 

NEON derives revenue from software licenses and maintenance services. License fees, which are graduated and based upon various industry standard measures of product usage such as mainframe potential capacity, CPUs, and users, are generally due upon license grant and include a one-year maintenance period. The sales process typically takes between six and nine months. After the initial year of license, NEON provides ongoing maintenance services, which include technical support and product enhancements, for an annual fee. 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.

 

In mid-2000, the mainframe software market began to weaken as the global economies entered a recessionary period.  Prior to 2000, many of NEON’s customers were experiencing consistent growth of their mainframe systems and, as a result,

 

11

 

they purchased additional software capacity in anticipation of continued growth at rates consistent with history. Additionally, during this time frame, the competitive landscape for NEON’s product also began to intensify.

 

During fiscal 2003, NEON began restructuring the company to concentrate on its core mainframe integration business, which has historically accounted for the majority of its revenues. NEON divested  its non-core products and reduced the size of its sales, marketing and administrative organizations. During this period NEON also began to develop new mainframe integration products as well as identify other adjacent market products, technologies and companies which were complementary to NEON’s existing product portfolio.

 

Many of NEON’s customers remain cautious about their capital spending. Although general economic conditions have improved, NEON is still uncertain as to future spending patterns of its customers. NEON believes that period-to-period comparisons of our revenue and operating results should not be relied upon as indications of our future performance. Further, NEON does not believe that its historical growth rates in prior years are necessarily representative of its future growth potential.

 

Related Party Transactions

 

Certain former members of NEON’s Board of Directors and certain former executive officers of NEON were shareholders and/or directors in other companies with which NEON has investments.  Transactions between NEON and these other companies are described below. The directors and officers involved in such transactions are no longer officers and directors of NEON.

 

NEON Enterprise Software, Inc. (formerly Peregrine/Bridge Transfer Corporation)

 

NEON entered into a Termination and Customer Support Agreement on August 14, 2002, which terminated a distribution agreement with Peregrine/Bridge Transfer Corporation (PBTC), a database software company whose sole stockholder is an affiliate of John J. Moores, NEON’s former Chairman of the Board of Directors. PBTC subsequently changed its name to NEON Enterprise Software, Inc. (“NESI”).

 

NEON currently holds a consolidated promissory note receivable from NESI in the aggregate principal amount of $3.6 million, bearing no interest to its due date of March 31, 2005. This consolidated promissory note is secured by all of the intellectual property of NESI (“NESI IP”). NEON also currently holds a $3.0 million convertible promissory note receivable from NESI bearing no interest to its due date of March 31, 2005, which is also secured by the NESI IP. The $3.0 million convertible note is convertible by NEON, in its discretion, into equity in NESI at an agreed pre-cash valuation of $30.0 million dollars. Such conversion right will expire on the due date of the $3.0 million convertible note. On the closing of the transaction in August 2002, NEON recorded the notes receivable from NESI at their estimated net present value, which was calculated at $4.3 million in aggregate value. NEON will adjust the carrying value of the note if the net realizable value is determined to be below the carrying value. NEON had an external valuation of its notes receivable due from NESI as of March 31, 2004 and determined that no further impairment of the notes were required.   NEON also evaluates the NESI IP on a quarterly basis to determine the notes’ net realizable value. NEON is not aware of any changes that have occurred which would result in an adjustment of the carrying value.

 

Scalable Software, Inc.

 

Scalable Software, Inc. (Scalable), a Houston-based provider of software solutions for IT portfolio management, is a company founded by Louis R. Woodhill, who served as NEON’s Chief Executive Officer until March 2003. Several former members of NEON’s Board of Directors, including Louis R. Woodhill, John J. Moores, Peter Schaeffer, Charles E. Noell III and Jim Woodhill, had or have a financial interest in Scalable.

 

In June 2002, NEON obtained a two-year option to acquire Scalable 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 (subsequently increased to $6.0 million in October 2002), in addition to $3.5 million previously loaned to Scalable that was secured by personal guarantees from John J. Moores, Louis R. Woodhill and Jim Woodhill. The aggregate financing had a 36-month term and did not bear interest during the term of the two-year option to acquire Scalable, which expires June 26, 2004. After the expiration of the option, the loan was scheduled to bear interest at the prime rate plus two percentage points to its due date of June 26, 2005 and thereafter on any unpaid principal and interest amounts outstanding. In addition to the personal guarantees

 

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of John J. Moores, Louis R. Woodhill and Jim Woodhill for the initial $3.5 million loaned to Scalable, the $6.0 million loan was secured by all of the intellectual property rights of Scalable. As of January 2003, Scalable had exhausted its credit facility with NEON. Scalable has asked for and received waivers of NEON’s right of first refusal with respect to additional venture capital bridge financing.

 

On June 9, 2004, NEON entered into a Note Purchase Agreement with JMI Services, Inc., the largest shareholder of Scalable, to sell the $3.5 million guaranteed note and the $6.0 million secured note issued by Scalable to NEON in connection with NEON’s financing obligations for an aggregate cash purchase price of $4.8 million.  JMI Services is an affiliate of John J. Moores, NEON’s largest shareholder. The proposed purchase of the Scalable notes was reviewed by NEON’s fully independent Board of Directors.  The board requested and received a fairness opinion from Avail Consulting, Inc., a Houston, Texas based independent valuation and financial consultant, stating that the transaction was fair to the stockholders of NEON from a financial standpoint. NEON also engaged Avail Consulting to perform a valuation on both notes receivable from Scalable. The value received by JMI Services exceeded the estimated fair value of both notes, as determined by Avail Consulting.  Closing of the transaction occurred on June 17, 2004.

 

NEON recorded the carrying value of its net advance to Scalable at the guaranteed amount of $3.5 million.  As a result of the sale of the notes during the three months ended June 30, 2004, NEON recorded a net gain of $1.2 million, consisting of proceeds in excess of the recorded net book value and direct selling costs.

 

Critical Accounting Policies

 

The following is a discussion of the accounting policies that NEON believes (1) are most important to the portrayal of its 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 obtained, 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 each element of the arrangement. Vendor-specific objective evidence is based on the price generally charged when an element is sold separately. All elements of each order are valued at the time of revenue recognition. NEON will defer license revenue for all delivered elements associated with a sales arrangement, if vendor-specific objective evidence cannot be established for each undelivered element. License revenues generally include software maintenance agreements for the first year following the date of sale. In such cases, revenues are allocated between license and maintenance revenues based on the residual method provided by SOP 98-9. Deferred revenue is generally based on vendor-specific objective evidence of the fair value of maintenance with the remaining portion of the total arrangement value allocated to license revenues.  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 as above, when sold to the ultimate end user and all of the above conditions are met.

 

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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 have been charged to operating expenses as incurred. 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 readiness for market is very short.

 

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 NEON believe will be collected. In estimating the appropriate balance for this allowance, NEON considers (1) specific reserves for accounts NEON believes 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 or when actual experience differs from management’s original estimate. If NEON’s 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.

 

Deferred Income Taxes

 

NEON records deferred income tax assets and liabilities on its balance sheet related to events that impact its financial statements and tax returns in different periods. In order to compute these deferred tax balances, NEON first analyzes the differences between the book basis and tax basis of its 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, NEON 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 NEON’s net deferred income tax balances during a period results in a deferred income tax provision or benefit in its statement of operations. If NEON’s expectations about the future tax consequences of past events should prove to be inaccurate, the balances of its deferred income tax assets and liabilities could require significant adjustments in future periods. Such adjustments could cause a material effect on NEON’s results of operations for the period of the adjustment.

 

RESULTS OF OPERATIONS

 

The following table sets forth, for the periods illustrated, certain statement of operations data expressed as a percentage of total revenues:

 

		THREE MONTHS ENDED JUNE 30,
		2004		2003
Revenues:
License		30.9	%	37.7	%
Maintenance		69.1		62.3
Total revenues		100.0		100.0
Cost of revenues:
Cost of licenses		0.9		2.0
Cost of maintenance		10.2		9.0
Total cost of revenues		11.1		11.0
Gross profit		88.9		89.0
Operating expenses:
Sales and marketing		43.5		40.5
Research and development		27.5		28.3
General and administrative		26.0		18.8
Total operating expenses		97.0		87.6
Operating income (loss)		(8.1	)	1.4
Interest and other income, net		1.3		1.3
Gain on sale of notes receivable		34.0		—
Income from continuing operations before income taxes		27.2		2.7
Provision for income taxes		—		—
Income from continuing operations		27.2		2.7
Gain on disposal of discontinued operations, net		—		1.1
Net income		27.2	%	3.8	%

 

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THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THREE MONTHS ENDED JUNE 30, 2003

 

REVENUES

 

License revenues for the three months ended June 30, 2004 were $1.1 million, a decrease of $457,000 from $1.6 million for the three months ended June 30, 2003. The decline in license revenue was primarily due to a reduction in the quantity of license transactions in both the United States and United Kingdom.

 

Maintenance revenues for the three months ended June 30, 2004 were $2.5 million, a decrease of $112,000 from $2.6 million for the three months ended June 30, 2003. The decrease primarily resulted from the receipt of certain maintenance payments during the three months ended June 30, 2003 that related to prior periods.

 

COST OF REVENUES

 

Cost of license revenues for the three months ended June 30, 2004 were $32,000, or 2.9% of license revenues, and primarily represented amortization of product technology that was acquired in April 2004. Cost of license revenues for the three months ended June 30, 2003 were $83,000, or 5.3% of license revenues, and primarily attributed to royalty payments.

 

Cost of maintenance revenues includes personnel and other customer support costs. Cost of maintenance revenues for the three months ended June 30, 2004 were $364,000, or 14.7% of maintenance revenues, as compared to $374,000, or 14.5% of maintenance revenues, for the three months ended June 30, 2003.

 

OPERATING EXPENSES

 

Sales and marketing expenses include personnel costs, sales commissions and travel expenses of sales, presales support and marketing personnel, along with trade show participation and other promotional expenses. Sales and marketing expenses for the three months ended June 30, 2004 were $1.6 million, a decrease of $120,000 from $1.7 million for the three months ended June 30, 2003. The reduction was primarily due to lower personnel costs.

 

Research and development expenses primarily include personnel costs associated with NEON’s product development staff. Research and development expenses for the three months ended June 30, 2004 were $1.0 million, a decrease of $189,000 from $1.2 million for the three months ended June 30, 2003.  The decrease in research and development is primarily due to a reduction in costs associated with contract development.

 

General and administrative expenses include personnel and other costs associated with NEON’s executive, financial, legal and administrative functions. General and administrative expenses for the three months ended June 30, 2004 were $930,000, an increase of $150,000 from $780,000 for the three months ended June 30, 2003. The increase was primarily related to greater personnel costs.

 

Interest and other income for the three months ended June 30, 2004 and 2003 was $45,000 and $53,000, respectively.

 

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During the three months ended June 30, 2004, NEON recognized a gain on sale of the notes receivable from Scalable Software (see Related Party Transactions).  The gain of $1.2 million resulted from net cash proceeds of $4.7 million in excess of the recorded net book value of $3.5 million for the notes.

 

On June 20, 2003, NEON divest of its iWave product line assets.  As a result of the transaction, NEON recorded a gain on the sale of $290,000, after closing expenses, during the three months ended June 30, 2003.  Total revenues attributed to the iWave product line for the three months ended June 30, 2003 were $194,000.  Operating losses associated with the iWave product line of $244,000 for the three months ended June 30, 2003 were offset against the gain on disposal of the discontinued operations in the consolidated financial statements.

 

No provision for income taxes was recorded for the three months ended June 30, 2004 and 2003, as the taxable income is offset by net operating loss carry-forwards that NEON had previously reserved.  As of March 31, 2004, NEON had a net operating loss carry-forward for income tax purposes of approximately $19.3 million that is available to offset future taxable income, if any. 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 the tax year 2020.  There can be no assurance that the operations will generate taxable income in the future to utilize these losses.  Therefore, as of June 30, 2004 and March 31, 2004, NEON has recorded a full valuation allowance for the deferred tax assets related to the future benefits, if any, for these loss carryforwards.

 

LIQUIDITY AND CAPITAL RESOURCES

 

NEON’s cash and cash equivalents at June 30, 2004 were $26.5 million, an increase of $5.6 million from $20.9 million at March 31, 2004. This increase was due primarily to the sale of the notes receivable from Scalable Software (See Related Party Transactions) and collection of account receivables.

 

Net cash provided by operating activities was $1.5 million, versus $764,000 used in operations for the three months ended June 30, 2004 and 2003, respectively.  Net cash provided by operating activities for the three months ended June 30, 2004 resulted primarily from collection of receivables, less reduction of certain accrued liabilities.  The net cash used in operating activities during the three months ended June 30, 2003, resulted primarily from a reduction in deferred revenue.

 

During the three months ended June 30, 2004, net cash provided by investing activities was $4.1 million, primarily resulting from the proceeds from the sale of the notes receivable from Scalable Software.  Net cash provided by investing activities during the three months ended June 30, 2003 was $304,000, primarily due to the sale of the iWave product line.

 

NEON’s net cash provided by financing activities was $7,000 and $24,000 for the three months ended June 30, 2004 and 2003, respectively. The net cash provided by financing activities in both periods represents proceeds from the exercise of employee stock options.

 

NEON’s future liquidity and capital requirements will depend upon numerous factors, including the costs associated with potential future business and product acquisitions, the costs and timing of expansion of product development efforts and the success of these development efforts, the costs and timing of expansion of sales and marketing activities, the extent to which our existing and new products gain market acceptance, market developments, the costs involved in maintaining and enforcing intellectual property rights, the level and timing of license revenue, and other factors. NEON believes that its current balance of cash and cash equivalents will be sufficient to meet its working capital, funding commitments and anticipated capital expenditure requirements for at least the next 12 months. NEON may require additional funds to support its working capital requirements or for other purposes and may seek to raise additional funds through public or private equity financing or from other sources. There can be no assurance that additional financing will be available at all, or if available, that such financing will be obtainable on terms acceptable to NEON, or that any additional financing will not be dilutive.

 

ITEM 3.                             QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

NEON is exposed to a variety of risks, including foreign currency exchange rate fluctuations and changes in the market value of its investments.

 

The majority of NEON’s foreign currency transactions are denominated in the British pounds sterling, which is the

 

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functional currency of NEON Systems (UK) Ltd. As these 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.  As a result of NEON’s acquisition of InnerAccess Technologies, Inc. in July 2004, additional risks associated with currency fluctuations between Canadian dollar and US dollars may occur.

 

NEON adheres to a conservative investment policy, whereby its principal concern is the preservation of liquid funds while maximizing its yield on such assets. Cash and cash equivalents approximated $26 million at June 30, 2004, and were invested in different types of commercial paper and money securities.  NEON believes that a near-term change in interest rates would not materially affect its financial position, results of operations or net cash flows for fiscal year 2005.

 

ITEM 4.          CONTROLS AND PROCEDURES

 

As of the end of the period covered by this Quarterly Report on Form 10-Q, NEON carried out an evaluation, under the supervision and with the participation of NEON’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of NEON’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934).  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that NEON’s disclosure controls and procedures are effective in ensuring that material information is accumulated and communicated to management, and made known to the Chief Executive Officer and Chief Financial Officer, on a timely basis to allow disclosure as required in this Quarterly Report on Form 10-Q.  There have been no significant changes in NEON’s internal controls or in other factors which could significantly affect internal controls subsequent to the date NEON carried out its evaluation.

 

PART II - OTHER INFORMATION

 

ITEM 1.          LEGAL PROCEEDINGS - - On January 29, 2003, NEON received notification that it had been sued in Fort Bend County, Texas for alleged tortious interference with contract, tortious interference with prospective business relations and unfair competition in a lawsuit styled Phoenix Network Technologies (Europe) Limited vs. NEON Systems, Inc. and Computer Associates International Inc., 400^th District Court, Ft. Bend County, Richmond, Texas, Cause Number 03-CV-127800. On October 27, 2003, the court granted NEON’s motion to dismiss the case.  Phoenix Network Technologies has appealed this decision, and NEON is continuing to defend this action.  Aside from this action, NEON is not involved in any current material claim or legal action other than those arising in the ordinary course of business.

 

ITEM 2.                             CHANGES IN SECURITIES AND USE OF PROCEEDS - None

 

ITEM 3.                             DEFAULTS UPON SENIOR SECURITIES - Not applicable.

 

ITEM 4.          SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS – Not applicable.

 

ITEM 5.          OTHER INFORMATION –

 

RISK FACTORS THAT MAY AFFECT FUTURE RESULTS

 

This report on Form 10-Q, 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:

 

Our Stock Price May Fluctuate And Be Impacted By A Number Of Internal And External Factors

 

•                  Our stock price has fluctuated and is subject to wide swings in price based on a number of factors, including our quarterly operating results, which may vary significantly from quarter to quarter.

 

Our future operating results may vary significantly from quarter to quarter due to a variety of factors, many of which are outside our control. Therefore, it is likely that in one or more future quarters our results may fall below the expectations of

 

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securities analysts and investors. We operate with virtually no order backlog because our products are shipped and revenues are recognized shortly after orders are received. In addition, the amount of revenues associated with sales of our software can vary significantly. In various quarters in the past, we have derived a significant portion of our software license revenues from a small number of relatively large sales. An inability to close one or more large sales that we had targeted to close in a particular period could materially adversely affect our operating results for that period. Moreover, we typically realize a majority of our software license revenues in the last month of a quarter. As a result, minor delays in the timing of customer orders can shift a sale from its contemplated quarter of completion to a subsequent quarter and cause significant variability in our operating results for any particular period. Accordingly, we believe that period-to-period comparisons of our operating results are not necessarily a meaningful indication of future performance. Although we generally do not give guidance as to future operating results, if our quarterly results do not meet investors’ expectations, the trading price of our common stock will likely decline.

 

•                  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.

 

Reduced Customer Reliance Upon Mainframe Computers Could Adversely Affect Our Business

 

We are dependent upon the continued use and acceptance of mainframe computers in a computing environment increasingly based on distributed platforms, including client/server and Internet-based computing networks. Decreased use of the mainframe or in the growth of demand for Web-based and client/server applications accessing mainframe data and transactions could have a material adverse effect on our business, operating results and financial condition. We now derive our revenues solely from our Shadow 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

 

•      Continued market acceptance of the Shadow products and enhancements to these products.

 

Loss of Key Software Developers Could Adversely Affect Our Business

 

Our success is dependent upon the continued service and skills of our key software developers. The loss of the services of any of these key software developers could have a negative impact on our business because of their unique skills, years of industry experience, and the difficulty of promptly finding qualified replacement personnel. We do not intend to maintain “key-man” life insurance policies covering any of our employees. Significant competition exists for employees with the skills required to develop the software products and perform the maintenance services that we offer, and we may not be able to continue to retain sufficient numbers of highly skilled employees.

 

We May Lose Market Share And Be Required To Reduce Prices As A Result Of Competition From Our Existing Competitors, Other Vendors And Information Systems Departments Of Customers

 

We compete in markets that are intensely competitive and feature rapidly changing technology and evolving standards. Our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements. Competitive pressures could reduce our market share or require us to reduce the price of our products, either of which could have a material adverse effect on our business, operating results and financial condition.

 

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

 

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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.

 

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.

 

ITEM 6.          EXHIBITS AND REPORTS ON FORM 8-K

 

(a)                            EXHIBITS

 

Exhibit Number		Description
31.1		Certification of Mark J. Cresswell, principal executive officer of NEON Systems, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Brian D. Helman, principal financial and accounting officer of NEON Systems, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Mark J. Cresswell, principal executive officer of NEON Systems, Inc. pursuant to 18 U.S.C. SECTION 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Brian D. Helman, principal financial and accounting officer of NEON Systems, Inc. pursuant to 18 U.S.C. SECTION 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b)                            REPORTS ON FORM 8-K

 

None

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

				NEON SYSTEMS, INC.
Date:	August 16, 2004			/s/ Brian D. Helman
				Chief Financial Officer
				(principal financial and accounting officer)
Date:	August 16, 2004			/s/ Mark J. Cresswell
				President and Chief Executive Officer
				(principal executive officer)

 

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