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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
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COMMISSION FILE NUMBER 000-22043
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NEW ERA OF NETWORKS, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 84-1234845
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE GREENWOOD PLAZA
6550 GREENWOOD PLAZA BOULEVARD
ENGLEWOOD, COLORADO 80111
(Address of principal executive offices)
Registrant's Telephone Number, including area code: (303) 694-3933
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past (90) days. Yes [X] No [ ]
The number of shares of the issuer's Common Stock outstanding as of May 1,
2001 was 36,934,770.
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INDEX
PAGE
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements....................................................................... 3
Consolidated Balance Sheets................................................................ 3
Consolidated Statements of Operations...................................................... 4
Consolidated Statements of Cash Flows...................................................... 5
Notes to Consolidated Financial Statements................................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................. 22
PART II OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... 24
Item 2. Changes in Securities...................................................................... 24
Item 3. Defaults Upon Senior Securities............................................................ 24
Item 4. Submission of Matters to a Vote of Security Holders........................................ 24
Item 5. Other Information.......................................................................... 24
Item 6. Exhibits and Reports on Form 8-K........................................................... 24
Signatures........................................................................................... 25
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NEW ERA OF NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2001 2000
------------- -------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents ...................................... $ 28,384,281 $ 12,521,383
Short-term investments in marketable securities ................ 16,408,203 28,114,872
Accounts receivable, net of allowance for uncollectible
accounts of $9,324,000 and $8,741,000, respectively ......... 30,252,686 41,355,879
Unbilled revenue ............................................... 922,669 1,531,478
Prepaid expenses and other ..................................... 12,359,544 13,614,518
------------- -------------
Total current assets ................................... 88,327,383 97,138,130
------------- -------------
Property and equipment:
Computer equipment and software ................................ 29,409,708 27,579,357
Furniture, fixtures and equipment .............................. 6,882,789 6,632,175
Leasehold improvements ......................................... 7,771,527 6,921,185
------------- -------------
44,064,024 41,132,717
Less--accumulated depreciation ................................. (17,797,909) (15,213,956)
------------- -------------
Property and equipment, net .................................... 26,266,115 25,918,761
Long-term investments in marketable securities ................... 7,264,971 10,558,712
Restricted long-term investments in marketable securities ........ 7,000,000 7,000,000
Intangible assets, net ........................................... 178,412,208 195,884,328
Deferred income taxes, net ....................................... 2,199,005 2,226,422
Other assets, net ................................................ 6,666,788 10,757,976
------------- -------------
Total assets ........................................... $ 316,136,470 $ 349,484,329
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................... $ 6,901,793 $ 9,254,252
Accrued liabilities ............................................ 18,663,401 24,686,731
Current portion of deferred revenue ............................ 18,570,850 19,207,229
------------- -------------
Total current liabilities .............................. 44,136,044 53,148,212
Deferred revenue ................................................. 302,411 364,755
------------- -------------
Total liabilities ...................................... 44,438,455 53,512,967
------------- -------------
Stockholders' equity:
Common stock, $.0001 par value, 200,000,000 shares
authorized; 37,032,411 and 36,722,944 shares issued;
36,884,849 and 36,575,382 shares outstanding,
respectively ................................................ 3,700 3,671
Additional paid-in capital ..................................... 434,279,393 432,421,610
Accumulated deficit ............................................ (152,336,824) (128,687,936)
Accumulated other comprehensive loss ........................... (6,459,229) (3,973,564)
Treasury stock, 147,562 shares of common stock, at cost ........ (2,549,712) (2,549,712)
Deferred stock-based compensation .............................. (1,239,313) (1,242,707)
------------- -------------
Total stockholders' equity ............................. 271,698,015 295,971,362
------------- -------------
Total liabilities and stockholders' equity ............. $ 316,136,470 $ 349,484,329
============= =============
See notes to consolidated financial statements.
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NEW ERA OF NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2001 2000
------------ ------------
Revenues:
Software licenses ............................................. $ 22,817,785 $ 24,073,914
Software maintenance .......................................... 8,436,707 5,264,256
Professional services ......................................... 11,980,892 12,753,646
------------ ------------
Total revenues ........................................ 43,235,384 42,091,816
------------ ------------
Cost of revenues:
Cost of software licenses ..................................... 1,168,385 554,717
Cost of software maintenance and professional services ........ 11,674,246 10,069,275
------------ ------------
Total cost of revenues ................................ 12,842,631 10,623,992
------------ ------------
Gross profit ..................................................... 30,392,753 31,467,824
------------ ------------
Operating expenses:
Sales and marketing ........................................... 17,982,499 17,476,531
Research and development ...................................... 10,789,600 9,367,223
General and administrative .................................... 5,290,974 3,970,579
Asset impairment charge ....................................... 3,916,378 --
Stock-based compensation and related payroll taxes ............ 108,436 560,996
Amortization of intangibles and other
acquisition-related charges ................................ 16,495,501 7,439,905
------------ ------------
Total operating expenses .............................. 54,583,388 38,815,234
------------ ------------
Loss from operations ............................................. (24,190,635) (7,347,410)
Other income, net ................................................ 783,216 1,640,292
------------ ------------
Loss before income taxes ......................................... (23,407,419) (5,707,118)
Provision for income taxes ....................................... 241,469 200,749
------------ ------------
Net loss ......................................................... $(23,648,888) $ (5,907,867)
============ ============
Net loss per common share, basic and diluted ..................... $ (0.64) $ (0.17)
============ ============
Weighted average shares of common stock
outstanding, basic and diluted ................................ 36,769,116 34,691,960
============ ============
See notes to consolidated financial statements.
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NEW ERA OF NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2001 2000
------------ ------------
Cash flows from operating activities:
Net loss ............................................................. $(23,648,888) $ (5,907,867)
Adjustments to reconcile net loss to net cash
used in operating activities--
Depreciation and amortization ...................................... 17,780,073 9,027,575
Asset impairment charge ............................................ 3,916,378 --
Stock-based compensation, exclusive of payroll taxes ............... 103,394 98,333
Provision for deferred income taxes, net ........................... -- (1,630,924)
Charge in lieu of income taxes ..................................... -- 1,527,961
Loss on asset disposition .......................................... -- 40,910
Acquisition charges paid with common stock ......................... -- 148,703
Changes in assets and liabilities--
Accounts receivable, net ........................................... 10,645,534 (2,138,829)
Unbilled revenue ................................................... 602,508 (1,204,487)
Prepaid expenses and other ......................................... 1,162,013 (622,540)
Other assets, net .................................................. 165,528 86,975
Accounts payable ................................................... (2,009,451) (1,518,049)
Accrued liabilities ................................................ (3,034,590) (3,527,776)
Accrued restructuring charges ...................................... (2,449,095) (1,286,975)
Deferred revenue, current and long-term ............................ (609,371) 3,679,356
------------ ------------
Net cash provided by (used in) operating activities ....... 2,624,033 (3,227,634)
------------ ------------
Cash flows from investing activities:
Proceeds from sales and maturities of investments .................... 15,786,528 7,725,419
Purchases of developed software and other intangibles ................ (10,752) 7,518
Business combinations, net of cash acquired .......................... -- (17,683,223)
Purchases of property and equipment .................................. (3,224,558) (3,371,258)
Investment in note receivable--related party ......................... -- (4,187,338)
------------ ------------
Net cash provided by (used in) investing activities ....... 12,551,218 (17,523,918)
------------ ------------
Cash flows from financing activities:
Proceeds from issuances of common stock .............................. 1,757,813 7,897,671
------------ ------------
Net cash provided by financing activities ................. 1,757,813 7,897,671
------------ ------------
Effect of exchange rate changes on cash ................................ (1,070,166) (160,041)
------------ ------------
Net increase (decrease) in cash and cash equivalents ................... 15,862,898 (13,013,922)
Cash and cash equivalents, beginning of period ......................... 12,521,383 49,796,989
------------ ------------
Cash and cash equivalents, end of period ............................... $ 28,384,281 $ 36,783,067
============ ============
Supplemental cash flow information:
Cash paid during the period for--
Interest ........................................................... $ 864 $ 3,674
============ ============
Taxes .............................................................. $ 74,478 $ 303,963
============ ============
Supplemental disclosures of noncash transactions:
Common stock issued for business combinations ........................ $ -- $ 20,000,000
============ ============
Accrued business combination costs ................................... $ -- $ 118,000
============ ============
Additions to deferred stock-based compensation
charged to additional paid-in capital .............................. $ 100,000 $ 196,667
============ ============
Restructuring charge--option reimbursement ........................... $ -- $ 148,703
============ ============
See notes to consolidated financial statements.
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NEW ERA OF NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated interim financial statements have
been prepared by New Era of Networks, Inc. (the "Company"), without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted pursuant to such rules and regulations. These financial
statements should be read in conjunction with our audited consolidated financial
statements included in our Annual Report on Form 10-K for the fiscal year ended
December 31, 2000. The consolidated results of operations for the three months
ended March 31, 2001 are not necessarily indicative of the results to be
expected for any subsequent period or for the entire fiscal year ending December
31, 2001.
The accompanying unaudited consolidated interim financial statements
reflect, in the opinion of management, all adjustments that are of a normal and
recurring nature and that are necessary for a fair presentation of the financial
position and results of operations for the periods presented. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
2. INVESTMENTS IN NONMARKETABLE SECURITIES
During 2000, we invested $8.9 million in equity securities of five
companies with technologies or products that are complementary to our own. No
public market existed for any securities of these investees at the time of our
investment, nor is there any assurance that a public market will ever exist.
These investments are accounted for under the cost method because our ownership
interests are less than 20% and we do not have the ability to exercise
significant influence over their operations. Our initial cost was equal to the
estimated fair value of the securities at the time of purchase, as evidenced by
concurrent independent third-party investments in such companies. If and when
any of these investments become publicly traded and meet the criteria for
"available-for-sale" securities pursuant to Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," they will be accounted for accordingly. Otherwise, future
appreciation will be recognized only upon sale or other disposition of the
securities.
An impairment charge of approximately $3.9 million was recognized in the
quarter ended March 31, 2001, with respect to two of these investments. The
provision includes $2.5 million due to a bankruptcy filing by one investee that
we were not aware of when we announced results for the quarter on April 19,
2001. Consequently, the results in the accompanying consolidated statements of
operations differ from the previously announced results for the quarter.
3. NET LOSS PER COMMON SHARE
Under SFAS No. 128 "Earnings Per Share", basic earnings or loss per common
share is determined by dividing net income or loss from continuing operations
available to common shareholders by the weighted average number of common shares
outstanding during each period. Diluted earnings per common share includes the
effects of potentially issuable common stock, but only if dilutive. The treasury
stock method, using the average price of the Company's common stock for the
period, is applied to determine dilution from options and warrants.
4. COMPREHENSIVE LOSS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130
"Reporting Comprehensive Income" ("SFAS 130"). The purpose of SFAS 130 is to
report a measure of all changes in equity that result from recognized
transactions and other economic events of the period other than transactions
with owners in their capacity as owners. The only items of other comprehensive
loss reported by the Company are the cumulative translation adjustment and
unrealized loss on marketable securities available for sale. The Company's
comprehensive loss for the three months ended March 31, 2001 and 2000 was as
follows.
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THREE MONTHS ENDED
MARCH 31,
----------------------------
2001 2000
------------ -----------
Net loss ......................................................... $(23,648,888) $(5,907,867)
Change in cumulative translation adjustment ...................... (3,271,783) 312,698
Change in unrealized loss on marketable securities ............... 786,118 (1,134,172)
------------ -----------
Comprehensive loss ............................................... $(26,134,553) $(6,729,341)
============ ===========
5. RELATED PARTY TRANSACTIONS
The Company has leased two buildings and a parking structure in Englewood,
Colorado from Greenwood Plaza Partners, LLP ("GPP") for use as its principal
corporate headquarters. GPP is principally owned by the Company's Chief
Executive Officer and Chairman of the Board.
Through April 2000, the Company had funded approximately $25.4 million
toward a short-term loan to GPP for construction of the leased facilities. In
May 2000, GPP obtained interim (five-year) financing from a third-party lender
and repaid the loan from us in full. Terms of the interim financing require that
the Company maintain a balance of cash or investments with the lender. At March
31, 2001, the restricted cash balance was $7.0 million. The restricted cash
represents one source of collateral to the lender in recognition that the
Company has a long-term master lease for the entire facility.
6. RESTRUCTURING CHARGES
During the fourth quarter of 2000, the Company's management approved
restructuring plans that included additional initiatives to consolidate
duplicate facilities, change to geographically focused business units and place
nonproducing product lines into a maintenance-only mode. Management expects the
restructuring effort to be finalized during the second quarter of 2001.
Accrued restructuring charges for the 2000 restructuring effort included
$3,523,000 representing the cost of involuntary employee separation benefits
related to approximately 130 employees worldwide. Employee separation benefits
include severance, medical and other benefits. Employee terminations were made
in the majority of business functions, job classes and geographies, with the
majority of reductions in North America and the United Kingdom. The 2000
restructuring plans also included estimated costs of $1,543,000 associated with
the closure and consolidation of office space, principally in North America and
the United Kingdom.
In July 1999, the Company's management and board of directors approved
restructuring plans that included initiatives to integrate the operations of the
recently acquired companies, consolidate duplicate facilities, and reduce
overhead. Total restructuring costs of $7,450,000 were recorded in the third
quarter of 1999 related to these initiatives. Restructuring efforts related to
staff terminations have been completed. The remaining employee separations
accrual relates to future benefits payable to terminated employees. Facilities
related restructuring efforts, which are dependent on our ability to sublet a
corporate office, remain outstanding as of March 31, 2001. This facility has
been vacated by the Company and monthly rental payments are being charged to the
1999 restructuring reserve.
The 1999 restructuring charges included $3,301,000 of involuntary employee
termination benefits related to approximately 150 employees worldwide. Employee
separation benefits included severance, medical, other benefits and related
employment taxes. Employee separations affected the majority of business
functions, job classes and geographies, with a majority of the reductions in
North America and Europe. The restructuring plan also included costs totaling
$4,149,000 associated with the closure and consolidation of office space,
principally in North America and Europe.
TOTAL ACCRUED AT APPROXIMATE TOTAL ACCRUED AT
DECEMBER 31, YEAR-TO-DATE MARCH 31,
2000 SPENDING 2001
---------------- ------------ ----------------
(AMOUNTS IN THOUSANDS)
2000 Restructuring:
Employee separations .................... $2,880 $(1,865) $1,015
Facility closure costs .................. 1,543 (516) 1,027
1999 Restructuring:
Employee separations .................... 139 (17) 122
Facility closure costs .................. 871 (105) 766
------ ------- ------
Total accrued restructuring costs ... $5,433 $(2,503) $2,930
====== ======= ======
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7. SEGMENT INFORMATION
In the fourth quarter of 1998, we adopted SFAS No. 131 "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131
establishes standards for reporting information about operating segments in
annual financial statements and requires selected information about operating
segments in interim financial reports issued to stockholders. It also
establishes standards for related disclosures about products and services and
geographic areas. Operating segments are components of an enterprise for which
separate financial information is available and is evaluated regularly by the
chief operating decision maker, or decision making group, in deciding how to
allocate resources and assess performance of the segments of an enterprise. The
operating segments are managed separately because each operating segment
represents a strategic business unit that offers products and services in
different markets.
We classify our business activities into three operating segments: The
Americas; Europe and Asia Pacific; and Corporate and Other. Information
regarding our operations in these three operating segments, which are managed
separately, is set forth below. The accounting policies of the operating
segments are the same as those described in the summary of significant
accounting policies included in our Annual Report on Form 10-K for consolidated
results. There are no significant intersegment sales or transfers between the
segments for the periods presented.
THREE MONTHS ENDED MARCH 31, 2001 THREE MONTHS ENDED MARCH 31, 2000
---------------------------------------------- -------------------------------------------
EUROPE EUROPE
THE AND ASIA CORPORATE THE AND ASIA CORPORATE
AMERICAS PACIFIC AND OTHER TOTAL AMERICAS PACIFIC AND OTHER TOTAL
-------- -------- --------- -------- -------- -------- --------- --------
(AMOUNTS IN THOUSANDS)
Total revenues .................... $ 10,801 $12,670 $ 19,764 $ 43,235 $20,551 $9,456 $ 12,085 $ 42,092
Total cost of revenues ............ 2,590 6,860 3,393 12,843 4,224 2,816 3,584 10,624
-------- ------- -------- -------- ------- ------ -------- --------
Gross profit ...................... 8,211 5,810 16,371 30,392 16,327 6,640 8,501 31,468
Selling and marketing ............. 9,251 5,466 3,265 17,982 8,075 4,746 4,656 17,477
Research and development .......... -- -- 10,790 10,790 -- -- 9,367 9,367
General and administrative ........ -- -- 5,291 5,291 -- -- 3,971 3,971
-------- ------- -------- -------- ------- ------ -------- --------
Operating profit (loss) before
charges ......................... (1,040) 344 (2,975) (3,671) 8,252 1,894 (9,493) 653
Asset impairment charge ........... -- -- 3,916 3,916 -- -- -- --
Amortization of intangibles and
acquisition-related charges ..... -- -- 16,495 16,495 -- -- 7,440 7,440
Stock-based compensation and
related taxes ................... -- -- 108 108 -- -- 561 561
-------- ------- -------- -------- ------- ------ -------- --------
Operating profit (loss) ........... (1,040) 344 (23,494) (24,190) 8,252 1,894 (17,494) (7,348)
Other income, net ................. -- -- 783 783 -- -- 1,640 1,640
-------- ------- -------- -------- ------- ------ -------- --------
Net income (loss) before taxes .... (1,040) 344 (22,711) (23,407) 8,252 1,894 (15,854) (5,708)
Provision for income taxes ........ -- -- 241 241 -- -- 201 201
-------- ------- -------- -------- ------- ------ -------- --------
Net income (loss) after taxes ..... $ (1,040) $ 344 $(22,952) $(23,648) $ 8,252 $1,894 $(16,055) $ (5,909)
======== ======= ======== ======== ======= ====== ======== ========
8. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation--an Interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 and, among other issues
clarifies the following: the definition of an employee for purposes of applying
APB Opinion No. 25; the criteria for determining whether a plan qualifies as a
noncompensatory plan; the accounting consequence of various modifications to the
terms of previously fixed stock options or awards; and the accounting for an
exchange of stock compensation awards in a business combination. FIN 44 is
effective July 1, 2000, but certain conclusions in FIN 44 cover specific events
that occurred after either December 15, 1998 or January 12, 2000. To the extent
our stock-based compensation awards are or become subject to "variable
accounting" because of FIN 44, we expect that significant periodic fluctuations
in the price of our common stock may cause the application of FIN 44 to have a
material impact on stock-based compensation reported in our future results of
operations.
9. LITIGATION
In March 2001, the Company was named as a defendant in a legal proceeding
filed by a former Company employee in Labor Court in Nanterre, France. The
complaint alleges nonpayment of salaries due, nonpayment of commissions due and
abusive dismissal. The Company intends to deny all material allegations and to
defend itself vigorously. An adverse judgment or settlement in the proceeding
could have a material adverse effect on the Company's financial condition or
results of operations. The ultimate outcome of the action cannot be presently
determined. Accordingly, no provision for any liability or loss that may result
from adjudication or settlement thereof has been made in the accompanying
unaudited consolidated financial statements.
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In January 2001 the Company was named as a defendant in a number of class
action lawsuits filed in Federal District Court for the State of Colorado
alleging violation of the federal securities laws. Certain executive officers of
the Company also are named as defendants. Most of the complaints in these
lawsuits assert claims on behalf of purchasers of the Company's securities
between October and December 2000. The complaints allege that the Company and
the other defendants made material misrepresentations and omissions regarding
the Company's business and prospects, causing harm to purchasers of the
Company's securities. The complaints do not specify the amount of damages
sought. These cases are in the early stages and the Company has not yet formally
responded to the complaints. The Company believes this class action lawsuit is
without merit. The Company intends to deny all material allegations and to
defend itself vigorously. An adverse judgment or settlement in this lawsuit
could have a material adverse effect on the Company's financial condition or
results of operations. The ultimate outcome of these actions cannot be presently
determined. Accordingly, no provision for any liability or loss that may result
from adjudication or settlement thereof has been made in the accompanying
unaudited consolidated financial statements.
The Company and certain of its executive officers are defendants in a
consolidated class action lawsuit alleging violation of the federal securities
laws. This action was filed in federal court in Colorado in July 1999. The
complaint asserts claims on behalf of purchasers of the Company's securities
from April 21, 1999 through July 6, 1999. In May 2001, the parties reached a
tentative settlement agreement subject to final documentation and court
approval. The settlement will have no material adverse affect on the Company.
Accordingly, no provision for any liability or loss that may result from
adjudication or settlement thereof has been made in the accompanying unaudited
consolidated financial statements.
In January 2000, the Company and VIE Systems, Inc. were named as defendants
in a lawsuit filed by New Paradigm Software Corp. ("New Paradigm") in U.S.
District Court for the Southern District of New York. The complaint alleges
breach of contract, interference with contract and unjust enrichment, and seeks
compensatory and punitive damages as well as rescission. In July 2000, the Court
granted the Company's motion to dismiss the Plaintiff's claims of unjust
enrichment and for rescission. The Company believes the lawsuit is without
merit. The Company intends to deny all material allegations and to defend itself
vigorously. An adverse judgment or settlement in the lawsuit could have a
material adverse effect on the Company's financial condition or results of
operations. The ultimate outcome of the action cannot be presently determined.
Accordingly, no provision for any liability or loss that may result from
adjudication or settlement thereof has been made in the accompanying unaudited
consolidated financial statements.
The Company is involved in a declaratory judgment action in Federal
District Court for the State of Colorado and a trademark dilution case in Texas
District Court for Bend County against NEON Systems, Inc. over the use of the
trademark NEON. An adverse judgment or settlement, particularly in the Texas
action, may result in increased costs and expenses and may have an adverse
effect on our business. The Texas damage action was filed in June 1999. The
ultimate outcome of the action cannot be presently determined. Accordingly, no
provision for any liability or loss that may result from adjudication or
settlement thereof has been made in the accompanying unaudited consolidated
financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion in this Report on Form 10-Q contains certain trend analysis
and other forward-looking statements. Words such as "anticipate," "believe,"
"plan," "estimate," "expect," "seek," and "intend," and words of similar import
are intended to identify such forward-looking statements. These statements are
not guarantees of future performance and are subject to business and economic
risks and uncertainties that are difficult to predict. Therefore, our actual
results of operations may differ materially from those expressed or forecasted
in the forward-looking statements as a result of a number of factors, including,
but not limited to, those set forth in this discussion under "Factors That May
Affect Future Results" and other risks detailed from time to time in reports
filed with the Securities and Exchange Commission. In addition, the discussion
of our results of operations should be read in conjunction with matters
described in detail in our 2000 Form 10-K Report.
On February 20, 2001, we entered into an Agreement and Plan of
Reorganization with Sybase, Inc. providing for Sybase to acquire all of the
outstanding shares of our common stock. Sybase has offered through its wholly
owned subsidiary, to exchange .3878 shares of Sybase common stock for each
outstanding share of our common stock that is validly tendered. The Sybase
shares offered to our shareholders were registered with the Securities and
Exchange Commission on Form S-4. A prospectus and exchange offer was delivered
to holders of our common stock. Details of the merger transaction were included
in the prospectus and exchange offer documents.
Consummation of the offer and subsequent merger is subject to a number of
conditions, most of which have been satisfied, and is expected to occur during
the second quarter of 2001. Approximately 80% of our outstanding common shares
were tendered to Sybase prior to April 26, 2001. As required by Delaware law, an
information statement (Schedule 14C) was subsequently prepared and mailed to all
shareholders who did not tender their shares. It is anticipated that on or about
June 18, 2001, all shares of our common stock will automatically
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convert to the right to receive .3878 shares of Sybase common stock, we will
become a wholly owned subsidiary of Sybase, and our common stock will no longer
be separately traded. The common stock of Sybase, par value $.001, is currently
traded on the Nasdaq National Market under the symbol "SYBS."
The following discussion reflects the present intentions of our management.
Operating decisions made by Sybase subsequent to the merger may differ from our
present intentions.
OVERVIEW
We began operations in January 1994 to develop, market and support
enterprise software for application integration. In 1994 and 1995 our Company
was in the development stage and was principally focused on product development
and assembling its management team and infrastructure. Software license revenues
were not significant until the commercial release of our NEONet software in
January 1996. Since that time, a substantial portion of our revenues has been
attributable to licenses of NEONet and follow-on products such as MQIntegrator
and e-Biz Integrator and related services. In December 1997, we entered into a
license agreement with IBM for the joint development of a product designed to
integrate IBM's MQSeries product with certain of our products. Under the terms
of the amended agreement, both NEON and IBM began selling the resulting
MQIntegrator or MQSeries Integrator products and other NEON adapter products.
In June 1997, we completed our initial public offering and issued 6,348,000
shares of common stock, and received net proceeds of approximately $34.3
million. In May and December 1998, we completed follow-on offerings and issued
4,757,000 and 4,780,000 shares of our common stock, respectively, and received
net proceeds of approximately $50.6 million and $153.7 million, respectively.
RESULTS OF OPERATIONS FOR THREE MONTHS ENDED MARCH 31, 2001 AND 2000
The following table sets forth the percentages that selected items in the
Consolidated Statements of Operations bear to total revenues:
THREE MONTHS
ENDED
MARCH 31,
--------------
2001 2000
---- ----
Revenues:
Software licenses .............................................. 53% 57%
Software maintenance ........................................... 20 13
Professional services .......................................... 27 30
---- ----
Total revenues ................................. 100 100
Cost of revenues:
Cost of software licenses(1) ................................... 5 2
Cost of software maintenance and professional services(2) ...... 57 56
---- ----
Total cost of revenues ........................ 30 25
---- ----
Gross profit .................................. 70 75
Operating expenses:
Sales and marketing ............................................ 42 42
Research and development ....................................... 25 22
General and administrative ..................................... 12 9
Asset impairment charge ........................................ 9 --
Stock-based compensation and related payroll taxes ............. -- 1
Amortization of intangibles and other
acquisition-related charges .................................. 38 18
---- ----
Total operating expenses ...................... 126 92
---- ----
Loss from operations ............................................. (56) (17)
Other income, net ................................................ 2 4
---- ----
Loss before income taxes ......................................... (54) (13)
Provision for income taxes ....................................... 1 --
---- ----
Net loss ......................................................... (55)% (13)%
==== ====
Net income (loss), excluding stock-based compensation,
acquisition, asset impairment and restructuring charges
as adjusted for their respective tax effects ................... (4)% 4%
==== ====
(1) As a percentage of software licenses revenue.
(2) As a percentage of combined software maintenance and professional services
revenue.
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REVENUES
Our total revenues grew by 3% to $43.2 million for the quarter ended March
31, 2001 from $42.1 million for the quarter ended March 31, 2000. The revenue
mix between software licenses, software maintenance, and professional services
was 53%, 20% and 27%, respectively, for the first quarter of 2001 compared to
57%, 13% and 30%, respectively, for the same quarter last year. The increase in
total revenues for the three-month period ended March 31, 2001, compared to the
corresponding period last year, was primarily from growth in indirect channel
revenues.
Software license revenues decreased 5% to $22.8 million for the quarter
ended March 31, 2001 from $24.1 million for the quarter ended March 31, 2000.
Software license revenues from sales by our direct sales force decreased in the
first quarter of 2001 compared with the first quarter of 2000 as a result of
delays in customer's capital spending decisions and a decrease in the
transaction average selling price in reaction to a weakening economy. Indirect
channel revenues increased as a percentage of total license revenues to 72% for
the quarter ended March 31, 2001 from 43% for the same period of 2000 due to
increased sales channel volume by IBM. During 2000 and the first quarter of
2001, the royalty arrangement with IBM provided for a fixed minimum royalty
payable to us for each quarter, followed by a royalty "true-up" payment
determined approximately 60 days after each quarter-end and recognized as
revenue by us on a one-quarter lag basis. Effective with the second quarter of
2001, the fixed minimum royalty arrangement was discontinued and all royalty
income will be recorded on a one-quarter lag. Consequently, second quarter 2001
royalties from IBM are likely to be lower than for the comparable quarter of
2000. During the second quarter of 2001, IBM will pay only the excess, if any,
of royalties due us from their first quarter sales over the final minimum
payment received and recognized by us as revenue during the quarter ended March
31, 2001. We expect that future software license revenue will reflect continued
strength in the indirect channels, as well as include an increasing amount of
software license revenue from the sale of the NEON e-Biz platforms and adapters.
Software maintenance revenues increased 60% to $8.4 million for the quarter
ended March 31, 2001 from $5.3 million for the quarter ended March 31, 2000. The
increase during the three-month period ended March 31, 2001, compared to the
corresponding period last year, was primarily a result of our growing installed
base of customers and the growing installed base of indirect IBM MQSeries
Integrator customers.
Professional services revenue consists of revenue for consulting and
training services, which are generally contracted for on a time and materials
basis. These revenues decreased 6% to $12.0 million for the quarter ended March
31, 2001 from $12.8 million for the quarter ended March 31, 2000. The decrease
was primarily due to a decrease in revenue from consulting, which is the largest
component of professional services revenue. The decrease in consulting revenue
was primarily due to a decline in direct license fee revenue, which resulted in
less demand for our implementation services.
COST OF REVENUES
Cost of revenues consists of costs of software licenses and costs of
software maintenance and professional services. As a percentage of total
revenues, total cost of revenues increased to 30% for the three months ended
March 31, 2001 compared to 25% for the three months ended March 31, 2000.
Cost of software licenses includes royalty payments to third parties for
jointly developed products, software purchased from third parties for resale,
documentation and software replication and delivery expenses. The cost of
license fees increased as a percentage of software license fee revenues to 5%
for the quarter ended March 31, 2001 from 2% for the quarter ended March 31,
2000. This increase was due to an increase in sales of royalty bearing products.
We expect that royalty payments to third parties will continue to increase in
the future as sales of these royalty-bearing products increase.
Cost of software maintenance and professional services includes the
personnel and related overhead costs for services, including consulting,
training and customer support, as well as fees paid to third parties for
subcontracted services. Cost of software maintenance and professional services
remained approximately the same percentage of associated software maintenance
and professional services revenues, 57% and 56%, respectively, for the quarters
ended March 31, 2001 and 2000.
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OPERATING EXPENSES
Sales and Marketing
Sales and marketing expense consists of personnel, commissions and related
overhead, and advertising and costs for sales and marketing activities. Sales
and marketing expense increased to $17.9 million for the quarter ended March 31,
2001 from $17.5 million for the quarter ended March 31, 2000, representing 41%
and 42% of total revenues, respectively. The decrease as a percentage of total
revenues for the quarter was primarily the result of a discontinuation of
advertising and branding activities in the fourth quarter of 2000. We expect to
continue to expand the direct sales force and professional marketing staff,
further increase our international presence, and continue to develop our
indirect sales channels and increase promotional activity. Accordingly, we
expect sales and marketing expense to continue to grow in absolute dollars.
Research and Development
Research and development expense includes personnel and related overhead
costs for product development, enhancements, upgrades, quality assurance and
testing. We have not capitalized internally generated software development costs
and have expensed all of these costs as incurred in accordance with SFAS No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed." Research and development expense increased to $10.8 million for the
quarter ended March 31, 2001 from $9.4 million for the quarter ended March 31,
2000, representing 25% and 22% of total revenues, respectively. The increase was
primarily due to the use of contract services in a number of research and
development projects. Due to the completion of the projects which required the
use of third-party consultants and the conclusion of development work on
application products targeted at the financial service market, we anticipate
research and development expenditures in absolute dollars to remain flat or
decline through the remainder of 2001.
General and Administrative
General and administrative expense consists primarily of personnel and
related overhead costs, outside professional fees and software and equipment
costs for finance, legal, human resources and administrative functions. General
and administrative expense increased to $5.3 million for the quarter ended March
31, 2001 from $4.0 million for the quarter ended March 31, 2000, representing
12% and 9% of total revenues, respectively. The total dollar amount of expense
increased primarily due to an increase in personnel to facilitate expansion of
our operations, as well as an increase to depreciation expense for time
reporting and sales order automation tools placed in service during the fourth
quarter of 2000.
Restructuring Charges
During the fourth quarter of 2000, the Company's management approved
restructuring plans that included additional initiatives to consolidate
duplicate facilities, organize the Company into geographically focused business
units and place nonproducing product lines into a maintenance-only mode.
Management expects the restructuring effort to be finalized during the second
quarter of 2001.
Accrued charges for the 2000 restructuring effort include $3.5 million
representing the cost of involuntary employee separation benefits related to
approximately 130 employees worldwide. Employee separation benefits include
severance, medical and other benefits. Employee terminations were made in the
majority of business functions, job classes and geographies, with the majority
of reductions in North America and the United Kingdom. The 2000 restructuring
plans also include estimated costs of $1.5 million associated with the closure
and consolidation of office space, principally in North America and the United
Kingdom.
In July 1999, the Company's management and board of directors approved
restructuring plans that included initiatives to integrate the operations of
recently acquired companies, consolidate duplicate facilities, and reduce
overhead. Total restructuring costs of $7.5 million were recorded in the third
quarter of 1999 related to these initiatives. Restructuring efforts related to
staff terminations have been completed. The remaining accrual relates to future
benefits payable to terminated employees. Facilities related restructuring
efforts, which are dependent on our ability to sublet a corporate office, remain
outstanding as of December 31, 2000. The Company has vacated this facility and
monthly rental payments are being charged to the 1999 restructuring reserve.
The 1999 restructuring charges included $3.3 million of involuntary employee
termination benefits related to approximately 150 employees worldwide. Employee
separations affected the majority of business functions, job classes and
geographies, with a majority of the reductions occurring in North America and
Europe. The restructuring plan also included costs totaling $4.1 million
associated with the closure and consolidation of office space, principally in
North America and Europe.
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Asset Impairment Charge
During 2000, we invested $8.9 million in equity securities of five companies
with technologies or products that are complementary to our own. No public
market existed for any securities of these investees at the time of our
investment, nor is there any assurance that a public market will ever exist.
These investments are accounted for under the cost method. Our initial cost was
equal to the estimated fair value of the securities at the time of purchase, as
evidenced by concurrent independent third-party investments in such companies.
An impairment charge of approximately $3.9 million was recognized in the
quarter ended March 31, 2001, with respect to two of these investments. The
provision includes $2.5 million due to a bankruptcy filing by one investee that
we were not aware of when we announced results for the quarter on April 19,
2001. Consequently, the results in the accompanying condensed statement of
operations differ from the previously announced results for the quarter.
Stock-based Compensation and Related Payroll Taxes
Stock-based compensation and related payroll taxes reflect the noncash
compensation expense associated with restricted stock grants, our stock option
bonus program, our 401k program which provides for a match in our common stock,
and payroll taxes associated with the exercise of taxable employee option
grants.
Amortization of Intangibles and Other Acquisition-related Charges
For the three-month period ended March 31, 2001 and 2000, amortization of
intangibles and other acquisition related charges included primarily
amortization of goodwill and other intangible assets related to our acquisition
activities. The allocation of purchase price has been determined by independent
appraisals of net assets acquired. Through the fourth quarter of 2000, these
assets were amortized over estimated useful lives which range from three to ten
years. Beginning in the first quarter of 2001, management revised the estimate
of useful lives for certain intangibles. These assets are now being amortized
over three to five years. In addition, during the first quarter of 2001 we
incurred approximately $2 million of outside professional fees associated with
our merger with Sybase Corporation.
OTHER INCOME, NET
Other income, net includes interest income earned on cash, cash equivalents,
short-term and long-term marketable securities, interest expense, foreign
currency gains and losses, and other nonoperating income and expenses. Other
income, net decreased to approximately $783,000 for the quarter ended March 31,
2001 from $1.6 million for the quarter ended March 31, 2000. The decrease was
primarily due to the reduction in invested cash balances resulting from cash
used for acquisitions, purchases of other noncurrent assets and cash used in
operations. We anticipate other income, net to decline in 2001 as we expect
average cash balances to be lower in 2001 than in 2000.
PROVISION FOR INCOME TAXES
The provision for income taxes for the three months ended March 31, 2001
consists of state and foreign taxes projected to be payable with respect to
income for the period attributable to those jurisdictions. We presently expect
to pay no federal income taxes for year 2001 based on projected taxable income,
including deductions related to stock options exercised during the year. We
estimate our effective tax rate for the year, exclusive of state and foreign
taxes currently payable, will be zero. We currently expect to increase the
valuation allowance during 2001 to offset any projected increases in our net
deferred tax assets.
The valuation allowance against our deferred tax assets increased to
approximately $38.9 million at December 31, 2000. A portion of the valuation
allowance, $4.5 million, relates to tax loss carryforwards of purchased
businesses. If these deferred tax assets are realized, the benefit will reduce
goodwill arising from prior acquisitions. An additional portion of the
allowance, $18.0 million, relates to stock option compensation deductions
included in our net operating loss carryforwards. If and when we determine to
reverse that portion of the valuation allowance, the benefit will be added to
paid-in capital, rather than being shown as a reduction of future income tax
expense. The same treatment will apply to any portion of our net operating loss
attributable to our stock option deductions generated during the year 2001. The
remaining $16.4 million valuation allowance relates to operating loss
carryforwards and credit carryforwards that, based on a judgmental assessment of
present circumstances using a more likely than not standard, management believes
will not result in a reduction of future taxes payable.
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NET LOSS
We reported a net loss of $23.6 million, or $0.64 per share for the three
months ended March 31, 2001. The loss includes asset impairment, stock-based
compensation and related payroll taxes, and acquisition-related amortization and
charges of approximately $20.5 million. Excluding these charges and assuming a
35% tax rate, we generated a net loss of approximately $1.9 million, or $0.05
per diluted share. We reported a net loss of $5.9 million, or $0.17 per share
for the three months ended March 31, 2000. The loss includes stock-based
compensation and related payroll taxes and acquisition-related amortization and
charges of approximately $8.0 million. Excluding these charges and assuming a
35% tax rate, we generated net income of approximately $1.5 million, or $0.04
per diluted share.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2001, our principal sources of liquidity consisted of $59.1
million of cash, cash equivalents, and investments in marketable securities
compared with $58.2 million at December 31, 2000. No amounts were outstanding
under our line of credit during the three-month periods ended March 31, 2001 and
2000. We had working capital of $44.2 million at March 31, 2001 compared with
$44.0 million at December 31, 2000. Included in determining such amounts are
short-term deferred revenue and customer deposits of $18.6 million at March 31,
2001 and $19.2 million at December 31, 2000. The majority of short-term deferred
revenue represents annual support payments billed to customers, which is
recognized ratably as revenue over the support service period.
Cash provided by operating activities was approximately $2.6 million during
the three-month period ended March 31, 2001 compared to a cash usage of
approximately $3.2 million during the three-month period ended March 31, 2000.
The improvement in operating cash flow was due mainly to improved operating
results, exclusive of noncash charges such as depreciation, amortization and
asset impairment. Our accounts receivable, net decreased to $30.3 million at
March 31, 2001 compared to $41.4 million at December 31, 2000. Collection during
the quarter of the variable portion of the IBM royalty recognized on a
one-quarter lag basis favorably impacted the relationship of our quarter-end
receivables to revenues for the quarter.
We received $12.6 million in cash from investing activities for the
three-month period ended March 31, 2001 compared to $17.5 million for the
three-month period ended March 31, 2000. In the three months ended March 31,
2001, we continued to invest cash in marketable securities and property and
equipment. Cash outlays for acquisitions in the first three months of 2000
resulted from the PaperFree acquisition with net cash investments of
approximately $17.7 million. During the first three months of 2001 and 2000, we
purchased furniture, fixtures and equipment necessary to support our expanding
operations.
Financing activities provided $1.8 million in cash during the first three
months of 2001 compared to $7.9 million for the same period last year. For both
periods, this cash was primarily from exercises of common stock options under
our stock option plans and the Employee Stock Purchase Plan.
We believe that our existing balances of cash, cash equivalents and
long-term investments in marketable securities will be sufficient to meet our
anticipated working capital and capital expenditure needs at least for the next
12 months. Thereafter, we may require additional sources of funds to continue to
support our business. There can be no assurance that such capital, if needed,
will be available or will be available on terms acceptable to us.
FOREIGN CURRENCY RISK
We operate wholly owned subsidiaries located in England, France,
Switzerland, Germany, Australia, Japan, Malaysia, Hong Kong and Singapore.
Transactions of these operations are typically denominated in local currency,
thereby creating exposure to changes in exchange rates. The changes in foreign
exchange rates may positively or negatively affect our sales, gross margins and
stockholders' equity. We do not believe that reasonably possible near-term
changes in exchange rates will result in a material effect on our future
earnings, fair values or cash flows and, therefore, have chosen not to enter
into foreign currency hedging instruments. There can be no assurance that this
approach will be successful, especially in the event of significant, sudden and
adverse changes in foreign exchange rates relative to the United States dollar.
See Item 3, "Quantitative and Qualitative Disclosures about Market Risk."
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation--an Interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application
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of APB Opinion No. 25 and, among other issues clarifies the following: the
definition of an employee for purposes of applying APB Opinion No. 25; the
criteria for determining whether a plan qualifies as a noncompensatory plan; the
accounting consequence of various modifications to the terms of previously fixed
stock options or awards; and the accounting for an exchange of stock
compensation awards in a business combination. FIN 44 is effective July 1, 2000,
but certain conclusions in FIN 44 cover specific events that occurred after
either December 15, 1998 or January 12, 2000. To the extent our stock-based
compensation awards are or become subject to "variable accounting" because of
FIN 44, we expect that significant periodic fluctuations in the price of our
common stock may cause the application of FIN 44 to have a material impact on
stock-based compensation reported in our future results of operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS
As described by the following factors, past financial performance should not
be considered a reliable indicator of future performance and investors should
not use historical trends to anticipate results or trends in future periods.
RISKS RELATED TO THE PROPOSED OFFER AND MERGER WITH SYBASE
We urge you to read Sybase's Registration Statement on Form S-4 and
Schedule 14C containing or incorporating by reference such documents and other
information, when they become available, because they will contain important
information about Sybase, NEON, the proposed acquisition and related matters,
including a discussion of the risks related to the proposed offer and merger
with Sybase including the following:
- the susceptibility to fluctuations in the market price of Sybase
common stock to be received by NEON stockholders in the offer and
merger in exchange for NEON common stock;
- the risk that Sybase may not successfully integrate Sybase and NEON
and realize the expected benefits of the merger;
- the risk that receipt of Sybase shares in the offer and the merger
may be taxable to you under certain circumstances; and
- the risk that our partners and customers will respond negatively to
the proposed combination.
These documents and amendments to these documents will be filed with the
U.S. Securities and Exchange Commission and delivered to our stockholders.
Failure to complete the merger could negatively impact NEON stock price and
future business and operations.
If the merger is not completed for any reason, we may be subject to a number
of material risks, including the following:
- we may be required under limited circumstances to pay Sybase a
termination fee of up to $15 million;
- the price of our common stock may decline to the extent that the
current market price of our common stock reflects a market assumption
that the merger will be completed; and
- costs incurred by us related to the merger such as legal and
accounting fees, as well as a portion of the financial advisor fees
that would be payable upon completion of the merger, must be paid by
us even if the merger is not completed.
RISKS RELATED TO OUR BUSINESS
Our operating results fluctuate significantly and we may not be able to
maintain our historical growth rates.
Although we have had significant revenue growth in the past, such
growth rates may not be sustainable, and you should not use these past results
to predict future operating margins and results. Our quarterly operating results
have fluctuated significantly in the past and may vary significantly in the
future. Our future operating results will depend on many factors, including the
following.
- the continued growth of the e-Business Integration and EAI software
markets;
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- the size of the orders for our products, and the timing of such
orders;
- potential delays in our implementations at customer sites;
- continued development of indirect distribution channels;
- increased demand for our products;
- the timing of our product releases;
- competition; and
- the effects of global economic uncertainty on capital expenditures
for software.
Quarterly revenues and operating results depend upon the volume and timing
of customer contracts received during a given quarter, and the percentage of
each contract which we are able to recognize as revenue during each quarter,
each of which is difficult to forecast. In addition, as is common in the
software industry, a substantial portion of our revenues in a given quarter
historically has been recorded in the third month of that quarter, with a
concentration of such revenues in the last two weeks of the third month. If this
trend continues, any failure or delay in the closing of orders during the last
part of a quarter will have a material adverse effect on our business.
As a result of these and other factors, we believe that period-to-period
comparisons of our historical results of operations are not a good predictor of
our future performance. If our future operating results are below the
expectations of stock market analysts, our stock price may decline.
Our industry is highly competitive.
The software industry is highly competitive. We may encounter competition
from new competitors, including established software companies with substantial
resources. Some of our competitors may have financial, technical, marketing or
other capabilities more extensive than ours and may be able to respond more
quickly to new or emerging technologies and other competitive pressures. We may
not be able to compete successfully against our present or future competitors,
and competition may adversely affect our businesses, financial condition or
operating results.
Software license revenue growth is dependent on our relationship with IBM and
other partners.
Our revenue growth since 1998 has reflected strong sales of MQIntegrator and
MQSeries Integrator through IBM's distribution and reseller channel. Revenue
from indirect channel partners, including IBM, accounted for 72% and 43% of our
total software license revenues in the first quarter of 2001 and 2000,
respectively. We expect that IBM and our other partners will account for a
material percentage of our software license revenue during the remainder of
2001. Any delay or shortfall in such revenues from our partners could have a
material adverse effect on our business and operating results.
If our sales cycle is longer than we anticipate, our operating results may
suffer.
Historically our customers typically have taken a long time to evaluate our
products. Therefore the timing of license revenue is difficult to predict. A
sale of our products to a customer typically involves a significant technical
evaluation and a commitment of capital and other resources by the customer. This
evaluation process frequently results in a sales cycle that lasts several
months. Additional delays are caused by customers' internal procedures to
approve large capital expenditures and to test, implement and accept new
technologies that affect key operations within their organization. Our operating
expense levels are relatively fixed in the short-term and are based in part on
expectations of future revenues. Consequently, any delay in the recognition of
revenue due to a longer sales cycle caused by these factors could result in
operating losses.
We have a short operating history and a history of operating losses.
An investor in our common stock must evaluate the risks, uncertainties,
expenses and difficulties frequently encountered by early stage companies in
rapidly evolving markets. We have had only a limited operating history upon
which an evaluation of our Company and its prospects can be based. Prior to
1996, we recorded only nominal product revenue and, including
acquisition-related charges, we
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have not been profitable on an annual basis. At March 31, 2001, our Company had
an accumulated deficit of approximately $152.3 million (which includes
acquisition-related, restructuring, asset impairment and stock-based
compensation charges). To address these risks and uncertainties, we must do the
following.
- successfully implement our sales and marketing strategy;
- further develop our indirect distribution channels;
- respond to competition;
- continue to attract and retain qualified personnel;
- continue to develop and upgrade our products and technology more
rapidly than competitors; and
- commercialize our products and services with future technologies.
We may not successfully implement any of our strategies or successfully
address these risks and uncertainties. Even if we accomplish these objectives we
may not be profitable in the future.
Inability to integrate acquired companies may increase the costs of recent
acquisitions.
We may from time to time acquire companies with complementary products and
services in the application integration or other related software markets.
Between September 1997 and April 2000, we acquired ten companies. These
acquisitions will expose us to increased risks and costs, including the
following:
- assimilating new operations, systems, technology and personnel; and
- diverting financial and management resources from existing
operations.
We may not be able to generate sufficient revenues from any of these
acquisitions to offset the associated acquisition costs. We will also be
required to maintain uniform standards of quality and service, controls,
procedures and policies. Our failure to achieve any of these standards may hurt
relationships with customers, employees, and new management personnel. In
addition, our future acquisitions may result in additional stock issuances,
which could be dilutive to our stockholders.
We may also evaluate joint venture relationships with complementary
businesses. Any joint venture we enter into would involve many of the same risks
posed by acquisitions, particularly those risks associated with the diversion of
resources, the inability to generate sufficient revenues, the management of
relationships with third parties, and potential additional expenses, any of
which could have a harmful effect on our business, financial condition and
results of operations.
Our investment strategy could cause financial or operational problems.
During 2000 we had invested approximately $8.9 million in early-stage,
e-Business companies with technologies or products complementary to our own, and
we may continue making such investments in the future. No public market existed
for these securities at the time of our investment and there is no assurance
that such a public market will ever exist. These investments may not result in
any meaningful commercial benefit to us, and our investments could lose all or a
significant part of their value. As of March 31, 2001, two of our investments
had become impaired and, accordingly, we recorded an asset impairment charge of
approximately $3.9 million.
Our failure to manage growth of operations may adversely affect us.
We must plan and manage effectively in order to successfully offer products
and services and implement our business plan in a rapidly evolving market. We
continue to increase the scope of our operations domestically and
internationally and have grown our headcount substantially. For example, at
January 1, 1996, we had a total of 35 employees and at March 31, 2001 we had a
total of 962 employees. We may further expand domestically or internationally
through internal growth or through acquisitions of related companies and
technologies. This growth will continue to place a significant strain on our
management systems and resources.
For us to effectively manage our growth, we must continue to enact the
following measures:
- improve our operational, financial and management controls;
- improve our reporting systems and procedures;
- install new management and information control systems; and
- expand, train and motivate our workforce.
We have completed the migration of our legacy accounting system in the U.S.
to an ERP suite that allows greater flexibility in reporting and tracking
results. We are in the process of integrating an additional ERP package in
Europe and Asia with our U.S. system. If we fail to integrate this ERP package
in an efficient and timely manner, or if the new systems fail to adequately
support our level of operations, we could incur substantial additional expenses
to remedy such failure.
Our operating results are substantially dependent on our suite of e-Business
and EAI products.
A substantial majority of our revenues come from the NEON e-Business and EAI
suite of products and related services, and we expect this pattern to continue.
Accordingly, our future operating results will depend on the demand for our
suite of e-Business and EAI products and related services by future customers,
including new and enhanced releases that are subsequently introduced. There can
be no assurance that the market will continue to demand our current products or
that we will be successful in marketing any new or enhanced products. If our
competitors release new products that are superior to our products in
performance or price, demand for our products may decline. A decline in demand
for our products and services as a result of competition, technological change
or other factors would have a harmful effect on our business, financial
condition and results of operations.
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Failure to add customers or expand into new markets may be harmful to our
business.
A significant portion of our revenue has come from a small number of large
purchasers. For example, in the first quarter of 2001 and 2000, excluding
royalties from IBM and other indirect channel partners, our top ten customers
accounted for 27% and 30% of total revenues, respectively. Historically, our
revenues have been derived primarily from sales to large banks and financial
institutions. Recently a growing portion of our total revenues has been derived
from sales of our products and services to commercial customers seeking further
e-Business enabling of their information systems and operations. These customers
or other customers may not continue to purchase our products. Our failure to add
new customers that make significant purchases of our products and services would
have a harmful effect on our business, financial condition and results of
operations.
While we have developed experience marketing our products to financial
institutions, we have less experience with other vertical market segments. New
market segments that we are currently targeting are likely to have significantly
different characteristics than the financial institutions segment. As a result,
we may change our pricing structures, sales methods, sales personnel, consulting
services and customer support. We may not be successful in selling our products
and services to the additional segments targeted. Our inability to expand sales
of our products and services into these additional markets would have a harmful
effect on our business, financial condition and results of operations.
Our growth is dependent upon the successful development of our direct and
indirect sales channels.
We sell our products primarily through our direct sales force and we support
our customers with our internal technical and customer support staff. We will
continue to rely on our ability to recruit and train additional sales people and
qualified technical support personnel. Our ability to achieve significant
revenue growth in the future will greatly depend on our ability to recruit and
train sufficient technical, customer and direct sales personnel, particularly
additional sales personnel focusing on the new vertical market segments that we
target. We have in the past and may in the future experience difficulty in
recruiting qualified sales, technical and support personnel. Our inability to
rapidly and effectively expand our direct sales force and our technical and
support staff could harm our business, financial condition and results of
operations.
We believe that future growth also will depend on developing and maintaining
successful strategic relationships with distributors, resellers, and systems
integrators. Our strategy is to continue to increase the proportion of customers
served through these indirect channels. We are currently investing, and plan to
continue to invest, significant resources to develop these indirect channels.
This could harm our operating results if these efforts do not generate license
and service revenues necessary to offset such investment. Also, our inability to
recruit and retain qualified distributors, resellers and systems integrators
could harm our results of operations. Another risk is that because lower unit
prices are typically charged on sales made through indirect channels, increased
indirect sales could harm our average selling prices and result in lower gross
margins.
There are many risks associated with international operations.
We continue to expand our international operations, and these efforts
require significant management attention and financial resources. Each version
of our product also has to be localized within each country. We have committed
resources to the opening and integration of additional international sales
offices and the expansion of international sales and support channels. Our
efforts to develop and expand international sales and support channels may not
be successful. International sales are subject to a number of risks, including
the following:
- longer payment cycles;
- unexpected changes in regulatory requirements;
- difficulties and expenses associated with complying with a variety of
foreign laws;
- import and export restrictions and tariffs;
- difficulties in staffing and managing foreign operations;
- difficulty in accounts receivable collection and potentially adverse
tax consequences;
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- currency fluctuations;
- currency exchange or price controls; and
- political and economic instability abroad.
Additionally, intellectual property may be more difficult to protect outside
of the United States. International sales can also be affected to a greater
extent by seasonal fluctuations resulting from the lower sales that typically
occur during the summer months in Europe and other parts of the world. In
addition, the market for our products are not as developed outside of North
America. We may not be able to successfully penetrate international markets or
if we do, there can be no assurance that we will grow these markets at the same
rate as in North America.
We must keep pace with technological change to remain competitive.
The market for our products is characterized by rapid technological change,
frequent new product introductions and enhancements, changes in customer demands
and evolving industry standards. Our existing products could be rendered
obsolete if we fail to keep up in any of these ways. We have also found that the
technological life cycles of our products are difficult to estimate, partially
because they may vary according to the particular application or vertical market
segment. We believe that our future success will depend upon our ability to
continue to enhance our current product line while we concurrently develop and
introduce new products that keep pace with competitive and technological
developments. These developments require us to continue to make substantial
product development investments.
Existing Products. We currently serve a customer base with a wide variety of
hardware, software, database, and networking platforms. To gain broad market
acceptance, we believe that we will have to support our products on a variety of
platforms. Our success will depend, among others, on the following factors:
- our ability to integrate our products with multiple platforms,
especially relative to our competition;
- the portability of our products, particularly the number of hardware
platforms, operating systems and databases that our products can
source or target;
- the integration of additional software modules under development with
existing products; and
- our management of software development being performed by third-party
developers.
Future Products. There can be no assurance that we will be successful in
developing and marketing future product enhancements or new products that
respond to technological changes, shifting customer preferences, or evolving
industry standards. We may experience difficulties that could delay these
products. If we are unable to develop and introduce new products or enhancements
of existing products in a timely manner or if we experience delays in the
commencement of commercial shipments of new products and enhancements, then
customers may forego purchases of our products and purchase those of our
competitors.
Our introduction of new or enhanced products could reduce revenues from
existing products.
We periodically announce the release of a variety of new products. These
announcements are generally intended to enhance the ability of our partners and
direct sales force to market and sell more complete solutions to customers and
to improve productivity, revenues and profitability. These new products,
however, may compete against our existing products and could, therefore, have an
adverse effect on our other license fees and professional service revenue.
Our growth is in part dependent upon a robust Internet industry.
Because global commerce and online exchange of information on the Internet
and other similar open wide area networks are new and evolving, it is difficult
to predict with any assurance whether the Internet will prove to be and remain a
viable commercial marketplace for our products. Our ability to derive revenues
from Internet products and services will depend in part upon a robust Internet
industry and our ability to respond to the software development challenges it
presents. Moreover, critical issues concerning the commercial use of the
Internet, including security, reliability, cost, ease of use and access, and
quality of service, remain
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unresolved and may impact the growth of Internet use and our products. If the
Internet does not continue to grow as a commercial marketplace, our business
could be materially and adversely affected.
Our failure to maintain close relationships with key software vendors will
adversely affect our product offering.
We believe that in order to provide competitive solutions for heterogeneous,
open computing environments, it is necessary to develop, maintain and enhance
close relationships with a wide range of vendors, including database, enterprise
resource planning, supply chain and electronic data interchange software
vendors, as well as hardware and operating system vendors. There can be no
assurance that we will be able to maintain our existing relationships or develop
additional relationships with such vendors. Our failure to do so could adversely
affect the portability of our products to existing and new platforms and
databases and the timing of the release of new and enhanced products.
Our failure to adequately protect our proprietary rights may adversely affect
us.
Our success and ability to compete is dependent in part upon our proprietary
technology. We rely on a combination of copyright, trademark and trade secret
laws, as well as confidentiality agreements and licensing arrangements, to
establish and protect our proprietary rights. We presently have four patents.
Despite our efforts to protect our proprietary rights, existing copyright,
trademark and trade secret laws afford only limited protection. In addition, the
laws of certain foreign countries do not protect our rights to the same extent
as do the laws of the United States. Attempts may be made to copy or reverse
engineer aspects of our products or to obtain and use information that we regard
as proprietary. Accordingly, there can be no assurance that we will be able to
protect our proprietary rights against unauthorized third-party copying or use.
Any infringement of our proprietary rights could materially adversely affect our
future operating results. Furthermore, policing the unauthorized use of our
products is difficult and litigation may be necessary in the future to enforce
our intellectual property rights, to protect our trade secrets or to determine
the validity and scope of the proprietary rights of others. Such litigation
could result in substantial costs and diversion of resources and could have a
material adverse effect on our future operating results.
Our stock price has been highly volatile.
The trading price of our common stock has fluctuated significantly since our
initial public offering in June 1997. In addition, the trading price of our
common stock could be subject to wide fluctuations in response to quarterly
variations in operating results, announcements of technological innovations or
new products by us or our competitors, developments with respect to patents or
proprietary rights, changes in financial estimates by securities analysts and
other events or factors. In addition, the stock market has experienced
volatility that has particularly affected the market prices of equity securities
of many high technology companies and that often has been unrelated or
disproportionate to the operating performance of such companies. These broad
market fluctuations may adversely affect the market price of our common stock.
We could be harmed by costly litigation.
We are a defendant in multiple class action lawsuits that allege violations
of federal and state securities laws by us and our officers and directors in
1999 and 2000. An adverse judgment or settlement in any of these lawsuits could
have a material adverse effect on the Company's financial condition or results
of operations. No provision for any liability or loss that may result from
adjudication or settlement thereof has been made in the accompanying unaudited
consolidated financial statements because the ultimate outcome of these actions
was unknown as of the date of the financial statements. These actions may be
settled or decided in a manner adverse to us. The cost of such settlements or
adverse decisions could exceed our maximum aggregate director and officers
liability insurance coverage. If this occurs, we may incur additional expense in
order to satisfy our outstanding obligations to indemnify our officers and
directors against such claims.
We are also a party to various legal disputes and proceedings arising from
the ordinary course of business. In the opinion of management, resolution of
these matters is not expected to have a material adverse effect on our
consolidated financial position. However, depending on the amount and timing, an
unfavorable resolution of some or all of these matters could materially affect
our future results of operations or cash flows in a particular period. See Note
9 of Notes to Consolidated Financial Statements for additional information
regarding these claims.
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Our inability to attract and retain personnel may adversely affect us.
Our success depends on the continued service of our key technical, sales and
senior management personnel. None of these persons are bound by an employment
agreement. The loss of any of our senior management or other key research,
development, sales and marketing personnel, particularly if lost to competitors,
could have a harmful effect on our future operating results. In particular
George F. (Rick) Adam, our Chief Executive Officer, would be difficult to
replace. Our future success will depend in large part upon our ability to
attract, retain and motivate highly skilled employees. We face significant
competition for individuals with the skills required to perform the services we
offer. We cannot assure that we will be able to retain sufficient numbers of
these highly skilled employees. Because of the complexity of the e-Business and
EAI software and Internet integration markets, we have in the past experienced a
significant time lag between the date on which technical and sales personnel are
hired and the time at which such persons become fully productive, and we expect
this pattern to continue.
There is substantial risk that future regulations could be enacted that either
directly restrict our business or indirectly Impact our business by limiting
the growth of Internet commerce.
As Internet commerce evolves, we expect that federal, state or foreign
agencies will adopt regulations covering issues such as user privacy, pricing,
content and quality of products and services. If enacted, these laws, rules or
regulations could limit the market for our products and services, which could
materially adversely affect our business, financial condition and operating
results. Although many of these regulations may not apply to our business
directly, we expect that laws regulating the solicitation, collection or
processing of personal/consumer information could indirectly affect our
business. The Telecommunications Act of 1996 prohibits certain types of
information and content from being transmitted over the Internet. The
prohibition's scope and the liability associated with a Telecommunications Act
violation are currently unsettled. In addition, although substantial portions of
the Communications Decency Act were held to be unconstitutional, we cannot be
certain that similar legislation will not be enacted and upheld in the future.
It is possible that this type of legislation could expose companies involved in
Internet commerce to liability, which could limit the growth of Internet
commerce generally. Legislation like the Telecommunications Act and the
Communications Decency Act could dampen the growth in Web usage and decrease its
acceptance as a communications and commercial medium.
The United States government also regulates the export of encryption
technology, which some of our products may incorporate. If our export authority
is revoked or modified, if our software is unlawfully exported or if the United
States government adopts new legislation or regulation restricting export of
software and encryption technology, our business, operating results and
financial condition could be materially adversely affected. Current or future
export regulations may limit our ability to distribute our software outside the
United States. Although we take precautions against unlawful export of our
software, we cannot effectively control the unauthorized distribution of
software across the Internet.
Intellectual property claims can be costly and result in the loss of
significant rights.
Third parties have, and may again in the future claim that we have infringed
their current or future products. We currently have pending against us a
trademark infringement suit seeking to enjoin us from further use of the
trademark "NEON." We expect that e-Business and EAI software developers will
increasingly be subject to infringement claims as the number of products in
different industry segments overlap. Any claims, with or without merit, could be
time-consuming, result in costly litigation, cause product shipment delays, or
require us to enter into royalty or licensing agreements, any of which could
have a harmful effect upon our operating results. There can also be no assurance
that such royalty or licensing agreements, if required, would be available on
terms acceptable to us, if at all. There can be no assurance that legal action
claiming patent infringement will not be commenced against us, or that we would
prevail in such litigation given the complex technical issues and inherent
uncertainties in patent litigation. In the event a patent claim against us was
successful and we could not obtain a license on acceptable terms or license a
substitute technology or redesign to avoid infringement, our business, financial
condition and results of operations would be harmed.
Global economic uncertainty may affect the capital expenditures of our
customers.
The e-Business and EAI software and Internet integration markets have been
negatively impacted by certain generic factors, including global economic
difficulties and uncertainty, declines in the stock market on which our common
stock trades, reductions in capital expenditures by large customers, and
increasing competition. These factors could in turn give rise to longer sales
cycles, deferral or delay of customer purchasing decisions, and increased price
competition. The presence of such factors in the e-Business and EAI software
market could harm our operating results.
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Foreign currency exchange rates can affect our profitability.
Although the pricing strategy for our international operations takes into
account changes in exchange rates over time, we face exposure to adverse
movements in foreign currency exchange rates. These exposures may change
overtime as business practices evolve and could have a material adverse impact
on our financial position and results of operations. Historically, our primary
exposures have related to non-U.S.-dollar denominated sales and expenses in
Europe and Asia Pacific.
Adoption of the Euro presents uncertainties for our company.
In the first part of 1999, the new "Euro" currency was introduced in certain
European countries that are part of the European Monetary Union, or EMU. By
2002, all EMU countries are expected to be operating with the Euro as their
single currency. A significant amount of uncertainty exists as to the effect the
Euro will have on the marketplace generally and, additionally, all of the final
rules and regulations have not yet been defined and finalized by the European
Commission with regard to the Euro currency. We are currently assessing the
effect the introduction of the Euro will have on our internal accounting systems
and the sales of our products. We are not aware of any material operational
issues or costs associated with preparing our internal systems for the Euro.
However, we do utilize third-party vendor equipment and software products that
may or may not be EMU compliant. Although we are currently taking steps to
address the impact, if any, of EMU compliance for such third party products, the
failure of any critical components to operate properly post-Euro could have a
harmful effect on the business, financial condition and results of operations of
our Company or require us to incur expenses to remedy such problems.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of operations, our financial position and cash flows
are subject to a variety of risks, which include market risks associated with
changes in foreign currency exchange rates, movements in interest rates and
equity price risk. We do not, in the normal course of business, use derivative
financial instruments for trading or speculative purposes. Uncertainties that
are either nonfinancial or nonquantifiable, such as political, economic, tax,
other regulatory or credit risks are not included in the following assessment of
our market risks.
FOREIGN CURRENCY EXCHANGE RATES
Operations outside of the U.S. expose us to foreign currency exchange rate
changes and could impact translations of foreign denominated assets and
liabilities into U.S. dollars and future earnings and cash flows from
transactions denominated in different currencies. During the first three months
of 2001, 29% of our total revenue was generated from our international
operations, and the net assets of our foreign subsidiaries totaled 13% of
consolidated net assets as of March 31, 2001. Our exposure to currency exchange
rate changes is diversified due to the number of different countries in which we
conduct business. We operate outside the U.S. primarily through wholly owned
subsidiaries in England, France, Switzerland, Australia, Germany, Japan,
Malaysia, Hong Kong and Singapore. These foreign subsidiaries use local
currencies as their functional currency, as sales are generated and expenses are
incurred in such currencies. Foreign currency gains and losses will continue to
result from fluctuations in the value of the currencies in which we conduct our
operations as compared to the U.S. dollar, and future operating results will be
affected to some extent by gains and losses from foreign currency exposure. We
do not believe that possible near-term changes in exchange rates will result in
a material effect on our future earnings or cash flows and, therefore, have
chosen not to enter into foreign currency hedging instruments. There can be no
assurance that such approach will be successful, especially in the event of a
sudden and significant decline in the value of foreign currencies relative to
the U.S. dollar.
INTEREST RATES
Our exposure to market risk associated with changes in interest rates
relates primarily to our investments in marketable securities. Our investments,
including cash equivalents, consist of U.S., state and municipal bonds, as well
as domestic corporate bonds, with maturities of greater than 12 months. All
short-term investments are classified as available-for-sale as defined in SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and
accordingly are carried at market value. Our short-term investment objectives
are safety, liquidity and yield. Changes in interest rates could impact our
anticipated interest income or could impact the fair market value of our
investments. However, we believe these changes in interest rates will not cause
a material impact on our financial position, results of operations or cash
flows.
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EQUITY PRICE RISK
Our exposure to equity price risk relates to changes in the valuation of
our investments in privately held companies. During 2000, we invested $8.9
million among five investments. An impairment charge of approximately $3.9
million was recognized in the quarter ended March 31, 2001, with respect to two
of these investments. The provision includes $2.5 million due to a bankruptcy
filing by one investee that we were not aware of when we announced results for
the quarter on April 19, 2001. Consequently, the results in the accompanying
consolidated statements of operations differ from the previously announced
results for the quarter.
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PART II.
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is currently involved in various civil litigation relating to
the conduct of its business, some of which are addressed elsewhere in this
report or in the Company's Annual Report on Form 10-K for the year ended
December 31, 2000, as filed with the Securities and Exchange Commission. While
the outcome of any particular lawsuit cannot be predicted with certainty, the
Company believes that these matters will not have a material adverse effect on
its consolidated financial statements except as noted in the footnotes to the
consolidated financial statements.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit
(1) None.
(b) Reports on Form 8-K
(1) None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NEW ERA OF NETWORKS, INC.
(Registrant)
By: /s/ LONNIE S. CLARK
--------------------------------------
Lonnie S. Clark,
Vice President of Accounting
(Principal Financial Officer)
Date: May 15, 2001
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