Back to GetFilings.com
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.
3
. "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.
4
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
5
. 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
6
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.
7
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
8
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:
10
. 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 t