1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
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 SOUTH 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 October
31, 1999 was 33,713,182.
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2
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................................. 12
Item 3. Quantitative and Qualitative Disclosures about Market
Risk...................................................... 28
PART II OTHER INFORMATION
Item 1. Legal Proceedings........................................... 30
Item 2. Changes in Securities....................................... 30
Item 3. Defaults Upon Senior Securities............................. 30
Item 4. Submission of Matters to a Vote of Security Holders......... 30
Item 5. Other Information........................................... 30
Item 6. Exhibits and Reports on Form 8-K............................ 30
Signatures.............................................................. 32
2
3
NEW ERA OF NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(UNAUDITED)
Current assets:
Cash and cash equivalents................................. $ 49,299,812 $174,173,008
Short-term investments in marketable securities........... 3,577,333 10,658,577
Accounts receivable, net of allowance for uncollectible
accounts of $1,600,000 and $800,000, respectively...... 41,601,278 28,310,275
Unbilled revenue.......................................... 4,488,974 3,124,536
Prepaid expenses and other................................ 6,107,593 2,356,324
Deferred income taxes, net................................ 147,300 147,300
Note receivable -- related party.......................... 16,504,094 --
------------ ------------
Total current assets.............................. 121,726,384 218,770,020
------------ ------------
Property and equipment:
Computer equipment and software........................... 16,428,428 9,327,048
Furniture, fixtures and equipment......................... 3,893,091 2,360,538
Leasehold improvements.................................... 1,536,825 1,569,125
------------ ------------
21,858,344 13,256,711
Less -- accumulated depreciation.......................... (5,651,419) (2,701,024)
------------ ------------
Property and equipment, net............................... 16,206,925 10,555,687
Long-term investments in marketable securities.............. 37,680,813 11,259,810
Intangible assets, net...................................... 177,739,691 51,876,649
Deferred income taxes, net.................................. 5,647,789 4,845,500
Other assets, net........................................... 1,314,612 1,370,283
------------ ------------
Total assets...................................... $360,316,214 $298,677,949
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 6,869,820 $ 5,650,308
Accrued liabilities....................................... 12,340,569 7,856,926
Accrued restructuring charges............................. 4,906,384 --
Current portion of deferred revenue....................... 12,382,180 9,406,637
------------ ------------
Total current liabilities......................... 36,498,953 22,913,871
Deferred revenue............................................ 78,437 149,137
------------ ------------
Total liabilities................................. 36,577,390 23,063,008
------------ ------------
Stockholders' equity:
Common stock, $.0001 par value, 200,000,000 shares
authorized; 33,583,753 and 30,333,778 shares issued and
outstanding, respectively.............................. 3,358 3,033
Additional paid-in capital................................ 385,522,924 295,570,769
Accumulated deficit....................................... (61,191,274) (20,016,790)
Accumulated other comprehensive income.................... (248,809) 57,929
Treasury stock............................................ (347,375) --
------------ ------------
Total stockholders' equity........................ 323,738,824 275,614,941
------------ ------------
Total liabilities and stockholders' equity........ $360,316,214 $298,677,949
============ ============
See notes to consolidated financial statements.
3
4
NEW ERA OF NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
Revenues:
Software licenses.................. $ 12,427,211 $ 10,713,736 $ 38,659,632 $ 24,553,964
Software maintenance............... 4,076,947 1,243,763 10,875,673 2,504,397
Professional services.............. 15,361,745 5,505,823 38,082,549 11,446,971
------------ ------------ ------------ ------------
Total revenues............. 31,865,903 17,463,322 87,617,854 38,505,332
------------ ------------ ------------ ------------
Cost of revenues:
Cost of software licenses.......... 508,506 451,944 915,620 1,115,947
Cost of software maintenance and
professional services........... 11,730,107 3,518,187 28,248,135 7,179,483
------------ ------------ ------------ ------------
Total cost of revenues..... 12,238,613 3,970,131 29,163,755 8,295,430
------------ ------------ ------------ ------------
Gross profit......................... 19,627,290 13,493,191 58,454,099 30,209,902
------------ ------------ ------------ ------------
Operating expenses:
Sales and marketing................ 16,077,806 5,732,578 39,323,721 13,165,903
Research and development........... 9,403,413 4,169,414 25,613,850 9,775,708
General and administrative......... 4,623,186 1,803,584 11,578,765 3,963,301
Charge for acquired in-process
research and development........ -- 13,857,000 -- 17,597,000
Restructuring costs................ 7,445,107 -- 7,445,107 --
Acquisition charges................ 25,152,863 -- 25,152,863 --
Amortization of intangibles........ 7,155,921 482,225 12,208,218 612,885
------------ ------------ ------------ ------------
Total operating expenses... 69,858,296 26,044,801 121,322,524 45,114,797
------------ ------------ ------------ ------------
Loss from operations................. (50,231,006) (12,551,610) (62,868,425) (14,904,895)
Other income, net.................... 1,736,447 896,182 5,679,659 1,682,979
------------ ------------ ------------ ------------
Loss before benefit from income
taxes.............................. (48,494,559) (11,655,428) (57,188,766) (13,221,916)
Income tax benefit................... 13,560,632 -- 16,014,282 --
------------ ------------ ------------ ------------
Net loss............................. $(34,933,927) $(11,655,428) $(41,174,484) $(13,221,916)
============ ============ ============ ============
Net loss per common share, basic and
diluted............................ $ (1.06) $ (0.49) $ (1.30) $ (0.63)
============ ============ ============ ============
Weighted average shares of common
stock outstanding, basic and
diluted............................ 33,008,293 23,958,146 31,709,627 20,981,480
============ ============ ============ ============
See notes to consolidated financial statements.
4
5
NEW ERA OF NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
1999 1998
------------- ------------
Cash flows from operating activities:
Net loss.................................................. $ (41,174,484) $(13,221,916)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities --
Depreciation and amortization........................... 15,683,723 1,551,133
Minority interest share of losses....................... (12,720) --
Benefit for deferred income taxes, net.................. (16,701,289) --
Imputed interest on business combination................ -- 90,000
Charges for acquired in-process research and
development............................................ -- 17,597,000
Acquisition charges paid with common stock.............. 8,268,759 --
Noncash restructuring charges........................... 831,477 --
Changes in assets and liabilities --
Accounts receivable, net................................ (5,405,839) (3,604,011)
Unbilled revenue........................................ (734,196) (1,198,396)
Prepaid expenses and other.............................. (3,123,470) (1,075,276)
Other assets, net....................................... 913,549 (167,063)
Accounts payable........................................ (2,129,335) 1,049,041
Accrued liabilities..................................... (5,341,150) 2,540
Accrued restructuring charges........................... 4,906,384 --
Deferred revenue, current and long-term................. 530,112 1,393,628
------------- ------------
Net cash provided by (used in) operating
activities....................................... (43,488,479) 2,416,680
------------- ------------
Cash flows from investing activities:
Purchases of short-term investments in marketable
securities.............................................. (11,937,580) (5,529,436)
Proceeds from sale of short-term investments in marketable
securities.............................................. 19,066,968 12,071,081
Purchases of long-term investments in marketable
securities.............................................. (33,474,451) (2,946,326)
Proceeds from sale of long-term investments in marketable
securities.............................................. 6,515,033 --
Purchases of developed software and other intangibles..... (4,170,321) --
Business combinations, net of cash acquired............... (38,822,641) (22,131,246)
Purchases of property and equipment....................... (7,969,471) (4,837,662)
Investment in note receivable -- related party............ (16,504,094) --
------------- ------------
Net cash used in investing activities.............. (87,296,557) (23,373,589)
------------- ------------
Cash flows from financing activities:
Proceeds from issuance of common stock.................... 5,869,837 56,038,889
Purchase of treasury stock................................ (347,375) --
Common stock issuance costs............................... -- (3,545,538)
Principal payments on notes payable to banks.............. -- (3,018,853)
------------- ------------
Net cash provided by financing activities.......... 5,522,462 49,474,498
Effect of exchange rate changes on cash..................... 389,378 50,291
------------- ------------
Net increase (decrease) in cash and cash equivalents........ (124,873,196) 28,567,880
Cash and cash equivalents, beginning of period.............. 174,173,008 7,150,362
------------- ------------
Cash and cash equivalents, end of period.................... $ 49,299,812 $ 35,718,242
============= ============
Supplemental cash flow information:
Cash paid during the period for --
Interest................................................ $ 29,678 $ 32,620
============= ============
Taxes................................................... $ 882,073 $ --
============= ============
Supplemental disclosures of noncash transactions:
Common stock issued for business combinations............. $ 75,721,687 $ 22,600,000
============= ============
Accrued business combination costs........................ $ 255,099 $ 1,463,000
============= ============
Common stock issued for acquisition charges............... $ 8,268,759 $ --
============= ============
Restructuring charge -- option remeasurement.............. $ 480,979 $ --
============= ============
Restructuring charge -- loss on asset disposition......... $ 350,498 $ --
============= ============
See notes to consolidated financial statements.
5
6
NEW ERA OF NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying 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 (the
"SEC"). 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 the Company's audited
consolidated financial statements included in the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1998. The consolidated results
of operations for the three and nine months ended September 30, 1999 are not
necessarily indicative of the results to be expected for any subsequent period
or for the entire fiscal year ending December 31, 1999.
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. Certain reclassifications have been made to prior period
financial statements to conform to the September 30, 1999 presentation.
2. BUSINESS COMBINATIONS
Microscript, Inc.
On June 28, 1999, the Company acquired all of the outstanding capital stock
of Microscript, Inc. ("Microscript"), a Massachusetts corporation. Microscript
is a supplier of application integration software on the Windows NT platform.
The aggregate consideration paid by the Company was approximately
$33,085,000, of which $8,741,000 was paid or payable in cash and approximately
$19,000,000 was paid through the issuance of 423,700 unregistered shares of
common stock of the Company. The Company also issued stock options exercisable
for 110,428 shares of the Company's common stock to assume all of the
outstanding Microscript stock options valued at approximately $5,000,000. The
fees and expenses related to the acquisition were approximately $345,000. An
additional 22,255 shares of the Company's common stock may be awarded as
additional purchase consideration upon the completion of the Microscript audited
financial statements for the year ended December 31, 1998. The acquisition was
accounted for under the purchase method of accounting and, accordingly, the
assets, liabilities and operating results of Microscript have been included in
the accompanying consolidated financial statements from June 28, 1999.
An independent valuation of Microscript's net assets was performed to
assist in the allocation of the purchase price. A portion of the purchase price
was assigned to marketable software products ($5,800,000), other intangibles
($16,373,000) and goodwill ($9,444,000), which are being amortized on a
straight-line basis over three- and seven-year periods, respectively.
Microscript's other assets were valued at $3,462,000 and its liabilities assumed
totaled $1,994,000. Upon the finalization of the purchase price allocation in
the third quarter of 1999, we recorded a deferred tax liability and
corresponding increase to goodwill of $8,538,000 as the value assigned to the
software products and other intangibles is not amortizable for tax purposes.
In July 1999, the Company agreed with the former equityholders of
Microscript to provide additional consideration to more closely reflect the
value agreed upon in the original purchase negotiations. The
6
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NEW ERA OF NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
aggregate adjustment to the purchase consideration of approximately $16,600,000
in cash was reflected in the Company's financial statements for the third
quarter of 1999 as a one-time charge to net income.
Convoy Corporation
On June 9, 1999, the Company acquired all of the outstanding capital stock
of Convoy Corporation, a Delaware corporation ("Convoy"). Convoy is a worldwide
provider of application integration software for PeopleSoft applications.
The aggregate consideration paid by the Company was $42,809,000. At closing
the Company issued 807,115 unregistered shares of its common stock valued at
$36,267,000. The Company also issued 105,333 stock options exercisable for
shares of the Company's common stock to assume all outstanding Convoy stock
options and warrants valued at approximately $4,733,000. Fees and expenses
related to the acquisition were approximately $1,809,000. The acquisition was
accounted for under the purchase method of accounting and, accordingly, the
assets, liabilities and operating results of Convoy have been included in the
accompanying consolidated financial statements from June 1, 1999.
An independent valuation of Convoy's net assets was performed to assist in
the allocation of the purchase price. A portion of the purchase price was
assigned to marketable software products ($8,500,000), other intangibles
($5,344,000) and goodwill ($30,559,000), which are being amortized on a
straight-line basis over three- and seven-year periods, respectively. Convoy's
other assets were valued at approximately $2,129,000 and its liabilities assumed
totaled approximately $3,723,000. Upon the finalization of the purchase price
allocation in the third quarter of 1999, we recorded a deferred tax liability
and corresponding increase to goodwill of $5,330,000 as the value assigned to
the software products and other intangibles is not amortizable for tax purposes.
In August 1999, the Company agreed with the former equityholders of Convoy
to provide additional consideration to more closely reflect the value agreed
upon in the original purchase negotiations. Accordingly, 618,225 shares of the
Company's common stock was issued to the prior Convoy equityholders. This
adjustment to the purchase consideration was reflected in the Company's
financial statements for the third quarter of 1999 as a one-time charge to net
income of approximately $8,269,000.
SLI International AG Acquisition
On May 4, 1999, the Company acquired all of the outstanding capital stock
of SLI International AG, a Swiss corporation ("SLI"), a worldwide provider of
SAP R/3 software implementation, training support and other related
change-management services. The aggregate consideration paid by the Company was
$22,700,000, of which $16,500,000 was paid in cash and $5,500,000 was paid with
138,452 shares of the Company's common stock. Fees and expenses related to this
transaction were approximately $700,000. In addition, up to 75,519 additional
shares of the Company's common stock may be issued to the shareholders of SLI
upon the achievement of certain performance targets. If earned, these shares
will be recorded as additional purchase price based on their fair value at the
time they are earned. The acquisition was accounted for under the purchase
method of accounting and, accordingly, the assets, liabilities and operating
results have been included in the Company's consolidated financial statements
from May 1, 1999.
An independent valuation of SLI's net assets was performed to assist in the
allocation of the purchase price. A portion of the purchase price was allocated
to other intangibles ($9,360,000) and goodwill ($12,296,000) and is being
amortized on a straight-line basis over a seven-year period. Upon finalization
of the purchase price allocation in the third quarter of 1999, we recorded a
deferred tax liability and corresponding increase to goodwill of $2,031,000 as
the value assigned to other intangibles is not amortizable for tax purposes.
SLI's other assets were valued at approximately $4,813,000 and its liabilities
assumed totaled approximately $3,769,000.
7
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NEW ERA OF NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
VIE Systems, Inc. Acquisition
On April 5, 1999, the Company acquired all of the outstanding capital stock
of VIE Systems, Inc., a Delaware corporation ("VIE"), a provider of EAI software
with a strong presence in travel, transportation, financial services, and retail
markets. Assets acquired by the Company included VIE's products, including its
Copernicus EAI product and formatter patent. The acquisition was accounted for
under the purchase method of accounting and, accordingly, the assets,
liabilities and operating results have been included in the Company's
consolidated financial statements from April 1, 1999.
The aggregate consideration paid by the Company was $12,000,000 in cash. In
addition, up to $3,000,000 of cash may be paid to the shareholders of VIE upon
the achievement of certain performance targets. In accordance to the purchase
agreement, payments will be made to the respective VIE shareholders to the
extent these performance targets are met, beginning in the fourth quarter of
1999 and continuing every six months until the second quarter of 2002.
D&M (Asia) Ltd. and Database & Management (S) Pte. Ltd.
On February 19, 1999, the Company acquired all of the outstanding capital
stock of D&M (Asia) Ltd., a Hong Kong corporation and Database & Management (S)
Pte. Ltd., a Singapore corporation (collectively "D&M"). D&M provides
professional integration services to customers in the Pacific Rim.
The aggregate consideration paid by the Company was $6,050,000, payable as
follows: $3,000,000 in cash and approximately $2,900,000 through the issuance of
48,940 unregistered shares of the Company's common stock. Fees and expenses
related to this transaction were approximately $150,000. The acquisition was
accounted for under the purchase method of accounting and, accordingly, the
assets, liabilities and operating results of D&M have been included in the
accompanying consolidated financial statements from March 1, 1999.
An independent valuation of D&M's net assets was performed to assist in the
allocation of the purchase price. The portion of the purchase price in excess of
the fair value of the net tangible assets of D&M was allocated to goodwill
($5,336,000) and is being amortized on a straight-line basis over a seven-year
period. D&M's other assets were valued at approximately $1,098,000 and its
liabilities assumed totaled approximately $384,000.
3. LOSS PER COMMON SHARE
Under Statement of Financial Accounting Standards No. 128 "Earnings Per
Share", basic loss per common share is determined by dividing net income 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 Statement of
Financial Accounting Standards 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 income reported by the Company are the cumulative
translation adjustment and unrealized
8
9
NEW ERA OF NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
loss on marketable securities available for sale. The Company's comprehensive
income for the three and nine months ended September 30, 1999 and 1998 was as
follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
Net loss for the period...... $(34,933,927) $(11,655,428) $(41,174,484) $(13,221,916)
Change in cumulative
translation adjustment..... 562,846 69,071 183,533 144,603
Unrealized loss on marketable
securities................. (23,531) -- (490,271) --
------------ ------------ ------------ ------------
Comprehensive loss........... $(34,394,612) $(11,586,357) $(41,481,222) $(13,077,313)
============ ============ ============ ============
5. RELATED PARTY NOTE RECEIVABLE
During the third and second quarters of 1999, the Company funded
approximately $8,600,000 and $7,900,000, respectively, toward a short-term
construction loan to Greenwood Plaza Partners, LLP ("GPP") for construction of
two buildings and a parking structure. GPP is principally owned by the Company's
Chief Executive Officer and Chairman of the Board. The Company is currently
leasing the completed portions of the buildings from GPP for use as its
principal corporate headquarters.
In connection with this loan, the Company has committed to fund up to an
additional $14,940,000. The loan matures in April 2000 and bears interest at a
floating interest rate of 90-day LIBOR plus 2.05%. During construction, GPP
intends to obtain permanent financing from a third-party lender. The terms of
the construction financing are consistent with those that were in place with
GPP's previous lender and have been approved by the Company's board of
directors. The loan is secured with the project's assets, the project's rental
income and the personal guarantee of the Company's Chief Executive Officer and
Chairman of the Board.
6. STOCKHOLDERS' EQUITY
On June 15, 1999, the Company's stockholders approved an amendment to the
Company's Certificate of Incorporation to increase the authorized shares of
common stock from 45,000,000 to 200,000,000. The Certificate of Amendment was
filed with the State of Delaware on August 11, 1999. In August 1999, the NEON
Board of Directors authorized the repurchase of up to 10% of NEON's outstanding
shares of common stock over a 12-month period. During August 1999, a total of
20,000 shares were repurchased by the Company.
7. RESTRUCTURING CHARGES
In July 1999, the Company's management and board of directors approved
restructuring plans, which included initiatives to integrate the operations of
the recently acquired companies, consolidate duplicative facilities, and reduce
overhead. Total accrued restructuring costs of $7,445,000 were recorded in the
third quarter related to these initiatives. Management expects the restructuring
efforts to be finalized by March 2000.
Accrued restructuring charges include $3,296,000 representing the cost of
involuntary employee separation benefits related to approximately 150 employees
worldwide. Employee separation benefits include severance, medical and other
benefits. Employee separations will affect the majority of business functions,
job classes and geographies, with a majority of the reductions in North America
and Europe. The restructuring plans also include costs totaling $4,149,000
associated with the closure and consolidation of office space, principally in
North America and Europe.
9
10
NEW ERA OF NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The accrued restructuring costs and amounts charged against the provision
as of September 30, 1999 were as follows:
REMAINING
CURRENT ACCRUAL AT
TOTAL QUARTER SEPTEMBER 30,
ACCRUED SPENDING 1999
---------- ----------- -------------
Employee separations........................... $3,296,000 $(1,943,000) $1,353,000
Facility closure costs......................... 4,149,000 (596,000) 3,553,000
---------- ----------- ----------
Total accrued restructuring costs.... $7,445,000 $(2,539,000) $4,906,000
========== =========== ==========
8. SEGMENT INFORMATION
In the fourth quarter of 1998, the Company adopted Statement of Financial
Accounting Standards No. 131 "Disclosure 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.
The Company classifies its business activities into three operating
segments: The Americas; Europe and Asia Pacific; and Corporate and Other.
Information regarding the Company's operations in these three operating
segments, which are managed separately, are 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 the Company's 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 SEPTEMBER 30, 1999 THREE MONTHS ENDED SEPTEMBER 30, 1998
------------------------------------------ ------------------------------------------
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...................... $17,334 $11,568 $ 2,964 $ 31,866 $12,467 $4,627 $ 369 $ 17,463
Total cost of revenues.............. 4,387 4,287 3,565 12,239 1,807 1,116 1,047 3,970
------- ------- -------- -------- ------- ------ -------- --------
Gross profit........................ 12,947 7,281 (601) 19,627 10,660 3,511 (678) 13,493
Selling and marketing............... 6,982 5,144 3,952 16,078 2,963 1,495 1,276 5,733
Research and development............ -- -- 9,404 9,404 -- -- 4,169 4,169
General and administrative.......... -- -- 4,623 4,623 -- -- 1,804 1,804
------- ------- -------- -------- ------- ------ -------- --------
Operating profit (loss) before
acquisition-related and
restructuring charges............. 5,965 2,137 (18,580) (10,478) 7,697 2,016 (7,927) 1,787
Acquisition-related and
restructuring charges............. -- -- 39,753 39,753 -- -- 14,338 14,338
------- ------- -------- -------- ------- ------ -------- --------
Operating profit (loss)............. 5,965 2,137 (58,333) (50,231) 7,697 2,016 (22,265) (12,551)
Other income and expense, net....... -- -- 1,737 1,737 -- -- 896 896
------- ------- -------- -------- ------- ------ -------- --------
Net income (loss) before tax........ 5,965 2,137 (56,596) (48,494) 7,697 2,016 (21,369) (11,655)
Tax benefit......................... -- -- 13,560 13,560 -- -- -- --
------- ------- -------- -------- ------- ------ -------- --------
Net income (loss) after tax......... $ 5,965 $ 2,137 $(43,036) $(34,934) $ 7,697 $2,016 $(21,369) $(11,655)
======= ======= ======== ======== ======= ====== ======== ========
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NEW ERA OF NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NINE MONTHS ENDED SEPTEMBER 30, 1999 NINE MONTHS ENDED SEPTEMBER 30, 1998
------------------------------------------ ------------------------------------------
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...................... $51,458 $29,166 $ 6,994 $ 87,618 $23,646 $11,165 $ 3,694 $ 38,505
Total cost of revenues.............. 12,599 11,855 4,710 29,164 3,438 2,190 2,667 8,295
------- ------- -------- -------- ------- ------- -------- --------
Gross profit........................ 38,859 17,311 2,284 58,454 20,208 8,975 1,027 30,210
Selling and marketing............... 20,046 10,838 8,440 39,324 6,203 3,971 2,993 13,167
Research and development............ -- -- 25,614 25,614 -- -- 9,775 9,775
General and administrative.......... -- -- 11,579 11,579 -- -- 3,964 3,964
------- ------- -------- -------- ------- ------- -------- --------
Operating profit (loss) before
acquisition-related and
restructuring charges............. 18,813 6,473 (43,349) (18,063) 14,005 5,004 (15,705) 3,304
Acquisition-related and
restructuring charges............. -- -- 44,806 44,806 -- -- 18,209 18,209
------- ------- -------- -------- ------- ------- -------- --------
Operating profit (loss)............. 18,813 6,473 (88,155) (62,869) 14,005 5,004 (33,914) (14,905)
Other income and expense, net....... -- -- 5,680 5,680 -- -- 1,683 1,683
------- ------- -------- -------- ------- ------- -------- --------
Net income (loss) before tax........ 18,813 6,473 (82,475) (57,189) 14,005 5,004 (32,231) (13,222)
Tax benefit......................... -- -- 16,014 16,014 -- -- -- --
------- ------- -------- -------- ------- ------- -------- --------
Net income (loss) after tax......... $18,813 $ 6,473 $(66,461) $(41,175) $14,005 $ 5,004 $(32,231) $(13,222)
======= ======= ======== ======== ======= ======= ======== ========
9. LITIGATION
The Company and some of its officers have been named as defendants in a
consolidated class action lawsuit alleging violation of the federal securities
laws. These lawsuits were filed in federal court in Colorado in July and August
1999. The lawsuit asserts claims on behalf of purchasers of the Company's
securities between October 29, 1998 and July 7, 1999. The complaint alleges 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 these lawsuits
are without merit. The Company intends to deny all material allegations and to
defend itself vigorously. An adverse judgment or settlement in these lawsuits
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
consolidated financial statements.
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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 which 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 SEC. In addition, the discussion of our results of operations
should be read in conjunction with matters described in detail in our 1998 Form
10-K Report.
OVERVIEW
Our net loss for the third quarter of 1999 was $34.9 million, or $1.06 per
share compared to a net loss of $11.7 million, or $0.49 per share, for the same
period last year. Our net loss for the first nine months of 1999 was $41.2
million, or $1.30 per share compared to a net loss of $13.2 million, or $0.63
per share, for the same period last year. Excluding restructuring and
acquisition-related charges and amortization, and assuming a 35% tax rate, the
net loss per diluted share for the third quarter of 1999 and nine months ended
September 30, 1999 was $0.17 and $0.25, respectively. This compares to a net
earnings per diluted share of $0.06 and $0.14 for the same periods of 1998.
During the third quarter of 1999, our results of operations reflected an
operating loss of $50.2 million compared to an operating loss of $12.6 million
for the third quarter last year. Quarterly operating expenses, excluding
restructuring and acquisition-related charges and amortization, increased 157%
to $30.1 million in the third quarter of 1999 from $11.7 million in the same
period last year which exceeded revenue growth of 82%. Our operating loss for
the first nine months of 1999 was $62.9 million compared to an operating loss of
$14.9 million for the same period last year. For the nine-month period ending
September 30, 1999, operating expenses, excluding restructuring and
acquisition-related charges and amortization, increased 184% to $76.5 million
from $26.9 million in the same period of 1998. Revenues grew 128% in the same
nine-month periods.
A shortfall in license revenues in the second quarter of 1999, combined
with increases in expenses in sales and administration in anticipation of higher
revenues, impacted our results for the nine months ended September 30, 1999.
There were two primary reasons for our second quarter of 1999 revenue shortfall.
First, a significant number of software license sales our partners, as well as
our internal sales force, had projected for the quarter did not close or closed
for smaller amounts than anticipated. For example, we noted delays in sales
where customer's approval processes were elevated to higher levels, as well as
clients who chose to purchase on a project-by-project basis rather than a volume
buy. In addition, sales through some of our channel partners were delayed due to
a variety of factors, including our software being bundled into large enterprise
agreements which generally involve a longer sales cycle, and customers electing
to defer their purchase decision. Second, our software license revenue growth is
increasingly dependent on our sales and marketing partnership with IBM. The
sales forces of both IBM and NEON can sell the MQSeries Integrator ("MQSI")
product, but the economics are different depending on which partner actually
takes the order. In the second quarter of 1999, the percentage of total MQSI
sales recorded by IBM was much higher than anticipated, which resulted in lower
than expected royalty income.
During the third quarter of 1999, we implemented or created plans to
implement significant personnel reductions and facility consolidations. These
actions largely addressed expense-saving opportunities resulting from
consolidations of facilities and eliminations of redundant positions resulting
from recent acquisitions. Consequently, we incurred a one-time charge to
operating expenses of approximately $7 million.
We have also increased our focus on controlling expenses by closely
monitoring hiring. Controls over discretionary expenses have also been tightened
throughout the organization.
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In addition, in early July 1999, IBM informed us that, effective with the
third quarter of 1999, they would no longer provide timely royalty information
necessary to reasonably estimate our share of MQSI revenues from IBM sales of
that product during each quarter. Because our quarterly financial reports must
be filed before we receive this royalty information, beginning with the third
quarter of 1999, we began recording royalty income from IBM on a one-quarter
lag. Accordingly, third quarter IBM royalty income will be recognized in our
fourth quarter.
The following table sets forth the percentages that selected items in the
Consolidated Statements of Operations bear to total revenues:
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- --------------
1999 1998 1999 1998
----- ----- ----- -----
Revenues:
Software licenses..................................... 39% 61% 44% 64%
Software maintenance.................................. 13 7 12 6
Professional services................................. 48 32 44 30
---- --- --- ---
Total revenues................................ 100 100 100 100
Cost of revenues:
Cost of software licenses(1).......................... 4 4 2 5
Cost of software maintenance and professional
services(2)........................................ 60 52 58 51
---- --- --- ---
Total cost of revenues........................ 38 23 33 22
Gross profit.................................. 62 77 67 78
Operating expenses:
Sales and marketing................................... 50 33 45 34
Research and development.............................. 30 24 29 25
General and administrative............................ 15 10 13 10
Acquisition charges and amortization of intangibles... 124 82 51 48
---- --- --- ---
Total operating expenses...................... 219 149 138 117
---- --- --- ---
Loss from operations.................................... (157) (72) (71) (39)
Other income, net....................................... 5 5 6 5
---- --- --- ---
Loss before provision for income taxes.................. (152) (67) (65) (34)
Benefit from income taxes............................... 42 -- 18 --
---- --- --- ---
Net loss...................................... (110)% (67)% (47)% (34)%
==== === === ===
Net income (loss) excluding restructuring and
acquisition-related charges and
amortization, net of tax effect if taxed at
a 35% rate.................................. (18)% 10% (9)% 8%
==== === === ===
- ---------------
(1) As a percentage of software licenses revenue.
(2) As a percentage of software maintenance and professional services revenue.
REVENUES
Our revenues grew by 82% to $31.9 million for the quarter ended September
30, 1999 from $17.5 million for the quarter ended September 30, 1998. For the
first nine months of 1999, total revenues grew by 128% to $87.6 million from
$38.5 million for the same period in 1998. The increase in total revenues for
the third quarter and nine-month period ended September 30, 1999 compared to the
corresponding periods last year resulted primarily from the expansion of our
product and services offerings through both internal development and
acquisition.
Software license revenues increased 16% to $12.4 million for the quarter
ended September 30, 1999 from $10.7 million for the quarter ended September 30,
1998. As previously discussed, IBM informed us that
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14
effective with the third quarter of 1999, they would no longer provide timely
royalty information necessary for us to reasonably estimate our share of MQSI
revenues from IBM sales of that product during each quarter. Accordingly, we now
recognize this license revenue on a one-quarter lag. Consequently, no third
quarter IBM royalty revenue was recorded. Third quarter royalty revenue from IBM
will be recognized in our fourth quarter. Software license revenues increased
57% to $38.7 million for the nine-month period ended September 30, 1999 from
$24.6 million for the nine-month period ended September 30, 1998. Although the
change from the prior year reflected a net increase in license revenue resulting
primarily from license sales of acquired companies, it was net of the impact of
recording no third quarter IBM sales of the MQSI product.
Software maintenance revenues increased 228% to $4.1 million for the
quarter ended September 30, 1999 from $1.2 million for the quarter ended
September 30, 1998. Software maintenance revenues increased 334% to $10.9
million for the nine-month period ended September 30, 1999 from $2.5 million for
the nine-month period ended September 30, 1998. The increase during both the
quarter and nine-month period compared to the corresponding period last year was
primarily a result of our growing installed base of customers and the consistent
renewal rates for existing customers.
Professional services revenue grew 180% to $15.4 million for the quarter
ended September 30, 1999 from $5.5 million for the quarter ended September 30,
1998. Professional services revenue grew 234% to $38.1 million for the
nine-month period ended September 30, 1999 from $11.4 million for the nine-month
period ended September 30, 1998. We continued to experience increased demand for
services in both the quarter and the first nine months of 1999 compared to the
same periods last year. The increase was primarily due to higher revenue from
consulting, which is the largest component of services, although training
revenue also increased during the quarter and six-month period. The increase in
consulting revenue was primarily due to the acquisition of companies with
service-oriented operations including D&M and SLI, and prior periods' license
fee revenue growth, which resulted in more demand for implementation services.
COST OF REVENUES
Cost of software licenses include royalty payments to third parties for
jointly developed products, software purchased from third parties for resale,
documentation and software delivery expenses. The cost of license fees increased
13% to $509,000 for the quarter ended September 30, 1999 from $452,000 for the
quarter ended September 30, 1998. For the nine-month period, the cost of
software licenses decreased 17% to $916,000 from $1.1 million for the same
period last year due primarily to a decrease in royalty expenses payable to IBM.
This decrease was a result of a shift in the taking of customer orders. For the
nine months ended September 30, 1998, the majority of all MQIntegrator orders
were taken by our sales representatives and we paid IBM a royalty percentage.
However, in the nine months ended September 30, 1999, a substantial amount of
the customer orders for MQSI were taken by IBM or an IBM distributor and we
recorded a net royalty income.
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
increased 234% to $11.7 million for the quarter ended September 30, 1999 from
$3.5 million for the quarter ended September 30, 1998. For the nine-month period
ended September 30, 1999, cost of software maintenance and professional services
increased 292% to $28.2 million from $7.2 million for the same period last year.
The increase was primarily due to increased personnel expenses and subcontracted
service costs to support the growth in demand for implementation and consulting
services and our acquisition of SLI, a professional services company, in May
1999. During the first nine months of 1999, a larger percentage of professional
services revenue was delivered by subcontractors, which increased the related
costs compared to the same period last year. As a result, the gross margin on
services revenue decreased to 40% and 42% for the third quarter and first nine
months of 1999, respectively, compared to 48% and 49% for the third quarter and
the first nine months of 1998, respectively.
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OPERATING EXPENSES
Sales and Marketing
Sales and marketing expense consists of personnel, commissions and related
overhead costs for the sales and marketing activities. Sales and marketing
expense increased to $16.1 million for the quarter ended September 30, 1999 from
$5.7 million for the quarter ended September 30, 1998, representing 50% and 33%
of total revenues, respectively. Sales and marketing expense increased to $39.3
million for the nine-month period ended September 30, 1999 from $13.2 million
for the corresponding period last year, representing 45% and 34% of total
revenues, respectively. On an absolute basis, the increase in expense for both
the quarter and nine-month period was due to adding the operations of acquired
companies and the result of additional personnel and expanded marketing
activities. The total number of sales and marketing personnel more than doubled
as of September 30, 1999 compared to a year ago.
Research and Development
Research and development expense includes personnel and related overhead
costs for product development, enhancements, upgrades, quality assurance and
testing. Research and development expense increased to $9.4 million for the
quarter ended September 30, 1999 from $4.2 million for the quarter ended
September 30, 1998. Research and development expense increased to $25.6 million
for the nine-month period ended September 30, 1999 from $9.8 million for the
nine-month period ended September 30, 1998. The increase was primarily due to an
increase in the number of research and development personnel compared to the end
of the third quarter last year. Of this increase in personnel, approximately
one-third was related to growth from acquisitions. We anticipate that future
research and development expenses will increase in the fourth quarter of 1999,
as compared with the same period of 1998, due in part to the addition of the
research and development teams of our newly acquired subsidiaries in the second
quarter of 1999. Additionally, we are continuing our development and
enhancements of our e-Business Integration products and integration adapters
tools.
General and Administrative
General and administrative expense includes personnel and related overhead
costs for the support and administrative functions. General and administrative
expense increased to $4.6 million for the quarter ended September 30, 1999 from
$1.8 million for the quarter ended September 30, 1998. General and
administrative expense increased to $11.6 million for the nine-month period
ended September 30, 1999 from $4.0 million for the nine-month period ended
September 30, 1998. The total dollar amount of expense increased primarily due
to an increase in personnel to facilitate expansion of our operations.
Restructuring Charges
Management and the board of directors approved a restructuring plan in July
1999 to address expense-sharing opportunities created largely due to the
consolidation of duplicate facilities and redundant positions from recent
acquisitions.
The restructuring charge of $7,445,000 includes $3,296,000 of employee
separation benefits related to approximately 150 employees worldwide. The
separations have affected all business functions, job classifications and
geographic areas with most of the reductions in North America and Europe. The
charge also includes $4,149,000 of costs for closure and consolidation of office
space primarily in North America and Europe. The restructuring efforts are
expected to be complete by March 2000.
Acquisition Charges/Charge for Acquired In-process Research and Development
In July and August 1999, we agreed with the former equityholders of
Microscript and Convoy, respectively, to provide additional consideration to
more closely reflect the value agreed upon in the original purchase
negotiations. Accordingly, approximately $16,600,000 in cash was paid to the
former equityholders of Microscript and 618,225 shares of our common stock
valued at $8,269,000 was issued to the former Convoy
15
16
equityholders. These acquisition charges were reflected in our financial
statements for the third quarter of 1999 as a one-time charge to net income. For
the three months ended September 30, 1998, $13.9 million of the CAI purchase
price was allocated to in-process research and development and charged to
expense. The nine months ended September 30, 1998 also includes $3.7 million of
the MSB purchase price, which was allocated to in-process research and
development projects and charged to expense.
OTHER INCOME, NET
Other income, net includes interest income earned on cash, cash
equivalents, short-term and long-term marketable securities, notes
receivable -- related party, interest expense, foreign currency gains and
losses, and other nonoperating income and expenses. Interest income increased to
$1.6 million for the quarter ended September 30, 1999 and $5.9 million for the
nine-month period ended September 30, 1999 from $909,000 for the quarter ended
September 30, 1998 and $1.8 million for the nine-month period ended September
30, 1998. The increase was primarily due to interest earned on the remaining
proceeds from the follow-on offerings completed in May and December of 1998.
PROVISION FOR INCOME TAXES
We reported no income tax expense or benefit for the quarter and the nine
months ended September 30, 1998. Our deferred tax assets were fully offset by a
valuation allowance until the fourth quarter of 1998. During 1998, our deferred
tax assets increased to approximately $9.0 million, principally for the
intangible assets acquired from CAI that were expensed, but which must be
amortized for tax purposes over 15 years, and additions to our tax credit
carryovers. We also realized reduced U.S. taxes of approximately $3.2 million
for deductions related to the exercise of stock options. As required, the tax
benefit from these deductions was added to additional paid-in capital and
excluded from net income. Without the stock option deductions, we would have
fully used our carryovers and paid U.S. federal taxes in 1998. Consequently, we
concluded that it was likely that we would realize at least $5.0 million of our
deferred tax assets and we adjusted the valuation allowance during the fourth
quarter to $4.0 million. At December 31, 1998, our balance sheet reflected net
deferred tax assets of approximately $5.0 million.
We reported an income tax benefit for the quarter ended September 30, 1999
of $13.6 million. The benefit results primarily from increasing our deferred tax
assets to reflect additional tax losses and tax credits that we currently
project we will generate during 1999. The projected 1999 benefit also includes
$700,000 relating to increased tax credits and other adjustments to estimated
deferred tax assets as of December 31, 1998 based on actual tax returns filed
for 1998. During the second quarter we purchased all the stock of four
companies. In each case we allocated the purchase price to the tangible assets,
intangible assets, and liabilities acquired according to their fair values. We
allocated the excess of the purchase price over the fair value of the
identifiable net tangible and intangible assets to goodwill. For tax purposes,
we assumed the historic tax basis of the assets and liabilities of the acquired
companies. Consequently, during the third quarter when the purchase price
allocations were finalized, we recorded net deferred tax liabilities for the tax
effect of these basis differences, other than goodwill, of $15.9 million. We
also recorded a corresponding amount of additional goodwill during the third
quarter. The deferred tax asset at September 30, 1999, of $5.7 million is net of
the unamortized portion of these deferred tax liabilities at that date of $14.9
million.
The deferred tax provision for the nine months ended September 30, 1999,
reflects our current estimated effective tax rate for calendar 1999 of
approximately 28%. The provision includes $500,000 of state taxes projected to
be payable for 1999, net of deferred tax benefits we believe are more likely
than not to be realized. The effective tax rate for the third quarter is lower
than the projected effective tax rate for 1999 of 28%, as we had computed taxes
using a 35% effective tax rate in the first and second quarters. We have reduced
the estimated calendar 1999 effective tax rate as it is uncertain whether we
will receive a tax benefit for certain nonrecurring expenses incurred during the
third quarter. The timing and tax consequences of additional transactions, as
well as operating results during the remainder of 1999, could cause our actual
effective tax rate to vary significantly from our current estimate.
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LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1999, our principal sources of liquidity consisted of
$90.6 million of cash, cash equivalents, short-term and long-term investments in
marketable securities compared with $196.1 million at December 31, 1998. No
amounts were outstanding under the line of credit during the nine-month periods
ended September 30, 1999 or 1998. The Company had working capital of $85.2
million at September 30, 1999. Included in determining such amounts are
short-term deferred revenue and customer deposits of $12.4 million. 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. Without the short-term deferred revenue and customer deposits, working
capital would have been $97.6 million.
We used $43.5 million in cash for operating activities during the
nine-month period ended September 30, 1999 compared to generating $2.4 million
in cash during the nine-month period ended September 30, 1998. The decrease in
operating cash flow was due primarily to the net loss from operations for the
nine months ended September 30, 1999. As adjusted to eliminate the effect of
noncash charges and benefits, this net loss was $33.1 million. Cash payments for
acquisition charges of approximately $16.6 million and cash paid for
restructuring charges of approximately $1.7 million had a significant impact on
cash used for operations.
Our accounts receivable, net increased to $41.6 million at September 30,
1999 compared to $28.3 million at December 31, 1998. Of the $13.3 million
increase in accounts receivable, net, $7.9 million of the increase was due to
acquisitions which occurred in the first two quarters of 1999. As required by
purchase accounting, our accounts receivable balance includes each of the
acquired entity's respective accounts receivable balances while sales are
included only from the effective date of the acquisition.
We used $87.3 million in cash for investing activities for the nine-month
period ended September 30, 1999 compared to $23.4 million for the nine-month
period ended September 30, 1998. In both periods, one of the primary investing
activities was the net purchases of short-term and long-term marketable
securities. The increase from the prior year was primarily due to the investment
of the remaining proceeds from follow-on offerings during the first two quarters
of 1999. In the nine months ended September 30, 1999, we continue to invest cash
in business combinations. The most significant cash outlays for acquisitions
resulted from the VIE, SLI and Microscript acquisitions with net cash
investments of $11.9 million, $16.2 million and $6.7 million, respectively.
During the first nine months of both years, we purchased furniture, fixtures and
equipment necessary to support our expanding operations. During the second and
third quarters of 1999, we funded approximately $16.5 million toward a
short-term construction loan to Greenwood Plaza Partners, LLP ("GPP") for
construction of two buildings and a parking structure. GPP is principally owned
by the Company's Chief Executive Officer and Chairman of the Board. During the
third quarter of 1999, the Company began leasing the completed portion of the
buildings from GPP for use as its principal corporate headquarters. We replaced
an existing lender for the first phase of construction, and have committed to
fund up to $31.4 million for one year at a floating interest rate of 90-day
LIBOR plus 2.05%. During construction, GPP intends to obtain permanent financing
from a third-party lender. The terms of the construction financing are
consistent with those that were in place with GPP's previous lender and have
been approved by our board of directors.
Financing activities provided $5.5 million in cash during the first nine
months of 1999 compared to $49.5 million for the same period last year. For the
1999 period, this cash was from exercises of common stock options and the
Employee Stock Purchase Plan. In the 1998 period, we received $51.5 million in
net proceeds from our May 1998 secondary offering and $1.0 million in proceeds
from the exercise of stock options, warrants and the Employee Stock Purchase
Plan.
In July 1999, we agreed with the former equityholders of Microscript to pay
additional purchase consideration to more closely reflect the purchase value
agreed upon in the purchase negotiations. This required additional cash
expenditures of $16.6 million in third quarter 1999.
We believe that our existing balances of cash, cash equivalents and
short-term 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
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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.
IN-PROCESS RESEARCH AND DEVELOPMENT
During fiscal year 1998, we acquired Century Analysis, Inc. (CAI), and MSB
Consultants (MSB). We continued to incur research and development expenses in
the third quarter of 1999 on the in-process research and development (IPR&D)
projects acquired from these two companies. Detailed descriptions of these
projects were included in our 10-K for the year ended 1998; specific activities
for the third quarter of 1999 follows.
As of the date of the CAI acquisition, CAI had invested $4.9 million in the
IPR&D identified in our 10-K. We estimated that an additional $4.2 million would
be required over the next 12 to 18 months following the acquisition to develop
the products to commercial viability.
We have continued to invest additional R&D dollars in the acquired IPR&D
projects. In the third quarter of 1999, we expended approximately forty-five man
months on the acquired CAI projects in total. We are contemplating various
strategies with respect to the continued development of the IPR&D projects.
Significant achievements had been accomplished as of the valuation date on the
IPR&D projects such as the development of frameworks for design and coding, and
construction of the various codes and surrounding architectures. We continue to
make progress in these areas, among others.
As of September 30, 1999, we project the remaining costs required to
complete the next generation Impact/TDM project to be approximately $1.3 million
should this project be completed as anticipated on the acquisition date. In the
third quarter of 1999 we spent roughly $200,000 towards the further development
of Impact/TDM. The next generation Impact/TDM project has been incorporated into
our NEON Common Architecture R&D strategy, and the continued development and
remaining costs for completion are being incorporated into this global
architecture strategy. We estimate the total costs for the Impact/TDM project
within our global architecture to be approximately the same as initially
projected.
CAI had expended a total of approximately $3.1 million on Component-related
projects prior to the closing of the acquisition. For these projects to reach
technological feasibility, additional efforts were projected to cost
approximately $850,000. In the third quarter of 1999 NEON spent roughly $100,000
towards these Component-related projects. We have continued development work in
this area and initial product release dates are set for the fourth quarter of
1999.
CAI had expended approximately $1.1 million on Other Enterprise Technology
Solutions as of September 1998. For these projects to reach technological
feasibility, we projected that additional efforts would need to be accomplished
in a timely manner and would cost approximately $1.6 million. We continue to
spend heavily on these projects and at this time, significant additional
achievements have been made. Specifically, we spent roughly $100,000 on the XML
technology, which was released in the third quarter. NEON spent approximately
another $100,000 on CORBA technology which is being brought into a stand alone
adapter product. This product was originally scheduled to be released by year
end 1999, but the release date is now moved to the end of the first quarter in
2000.
MSB was working on the Price Server (with new capabilities), aRTe (designed
for a Windows NT environment), and Quantum Leap on the date of acquisition.
These projects are particularly complex due to the modular nature of MSB's
products and technology.
As of the date of acquisition, MSB had invested $3.1 million in the IPR&D
identified above. We estimated that an additional $850,000 would be required to
over the 18 to 24 months following the acquisition to develop the aforementioned
products to commercial viability.
We have continued to invest additional R&D dollars in the acquired IPR&D
projects during the third quarter. We expect to continue development on all of
these projects through their completion. Currently, the timeline and
expectations for completion of these projects do not differ materially from what
was anticipated
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at the time of the purchase. We also have a higher level of certainty that the
projects will be released as planned. Our current revenue and cost estimates do
not materially differ from the initial valuation.
We believe that the work performed as of the valuation date had encompassed
many of the critical elements needed to complete the Price Server project. We
estimate that approximately $1,500,000 in development costs was incurred as of
the acquisition date and approximately $220,000 would be required to complete
the remaining development tasks. We spent approximately $90,000 in the third
quarter. The Pricing module for banking applications became available during the
first half of 1999. The Price Server project is essentially complete and has
been incorporated into the NEON product infrastructure.
In order to achieve milestones for the aRTe project, we estimate that MSB
had spent approximately $1,500,000 on this project as of June 1998. Remaining
R&D expenditures were estimated to be approximately $230,000 in order to
complete this project. We spent approximately $65,000 in the third quarter.
aRTe's functionality was incorporated into a NEON product introduction in
mid-1999, and further enhancements are being made during the remainder of 1999.
It was estimated that $75,000 had been incurred as of the acquisition date
for the Quantum Leap project and that approximately $400,000 would be required
to complete the product. We spent approximately $130,000 in the third quarter.
The first version of this product was released in the fourth quarter of 1998,
and further development efforts are underway to incorporate Quantum Leap
technology into another of our products scheduled to be released in the fourth
quarter of 1999.
We do not break down revenues attributable specifically to CAI- and
MSB-derived products, but we anticipate doing so later in 1999 or the beginning
of 2000. As products are offered both as a suite and as individual applications,
NEON license fees are not necessarily application specific. However, we believe
that overall revenues generated to date concur with the assumptions used in the
valuation analysis. Within the MSB product line, the product revenue we expect
during 1999 from the products sold on a stand-alone version, as well as the
product suite incorporating the technology, is substantially the same as
initially forecasted in the valuation study. The product that incorporates the
CAI Component related projects has a release date now estimated for the fourth
quarter. We believe that the total forecast for this product, as well as the
other CAI projects, remains substantially the same as in the valuation study
over the remaining life of the products.
We currently believe that expenses associated with completing the purchased
in-process research and development are consistent with the estimates used in
the valuation. In addition, completion dates for the development projects
discussed above remain consistent with projections used at the time of the
acquisition as well as are consistent with the numbers presented in this
analysis. The only change was that the COBRA is scheduled to be released one
quarter after our initial estimate. Research and development spending with
respect to these offerings is expected to continue at a rate that is consistent
with our overall research and development spending. We do not believe that the
acquisitions resulted in any material changes in our profit margins or in
selling, general and administrative expenses. We do not believe that we achieved
any material expense reductions or synergies as a result of the acquisitions.
The rates utilized to discount the net cash flows to their present value
were consistent with the nature of the forecast and the risks associated with
the projected growth, profitability and developmental projects. Discount rates
of 35% and 35% for CAI and 32% and 25% for MSB were deemed appropriate for the
business enterprises and for the acquired completed in-process research and
development, respectively. These discount rates were consistent with the
acquired companies' various stages of development; the uncertainties in the
economic estimates described above; the inherent uncertainty at the time of the
acquisition surrounding the successful development of the purchased in-process
technology; the useful life of such technology; the profitability levels of such
technology; and the inherent uncertainties of the technological advances that
were indeterminable at the time of the acquisition.
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FOREIGN CURRENCY RISK
We have wholly owned subsidiaries located in England, France, Switzerland,
Australia, Germany, Japan, Hong Kong and Singapore. Sales and expenses from
these operations are typically denominated in local currency, thereby creating
exposures to changes in exchange rates. The changes in foreign exchange rates
may positively or negatively affect our sales, gross margins and retained
earnings. 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 such an approach
will be successful, especially in the event of a significant and sudden decline
in the value of foreign exchange rates relative to the United States dollar.
The impact of changes in foreign currency exchange rates on our financial
statements is principally included as a component of "other comprehensive
income" and reflected in equity as "cumulative translation adjustments."
However, actual transaction gains and losses reflected in net income relate
principally to intercompany balances with our foreign subsidiaries. These
transaction gains and losses were approximately $204,000 and $12,000 for the
three and nine months ended September 30, 1999, respectively.
YEAR 2000 COMPLIANCE
The Year 2000 computer problem, commonly referred to as the Y2K bug,
continues to create a risk for our Company and, therefore, we make the following
Year 2000 readiness disclosure. An adverse impact on our operations could occur
if computer systems do not correctly recognize date information when the year
changes to 2000. Our Company's risks continue to exist in the following areas:
1) systems used by our Company to run its business; 2) systems used by our
suppliers; 3) potential warranty and other claims from our customers; and 4) the
potential reduced spending by other companies on our software products due to
significant information systems spending to remediate Year 2000 problems.
Our Company is a relatively new corporation and, therefore, does not expect
to encounter many Year 2000 computer problems associated with our internal
systems, equipment, or facilities. As internal systems and equipment have been
implemented, and as we have expanded into new facilities, in the normal course
of our Company's growth or through acquisition (e.g., SLI, Convoy, Microscript),
we have attempted to obtain, and received, assurances of Year 2000 readiness
from appropriate sources. We will continue to obtain such assurances for future
internal systems, equipment, and facilities. In addition, we continue to
monitor, including performing additional testing, as appropriate, the Year 2000
readiness status of previously obtained equipment, internal systems, and
facilities. Noncompliant systems, equipment, or facilities are expected to be
replaced or upgraded in a timely manner prior to December 31, 1999. We have not
currently identified alternative remediation strategies or contingency plans if
replacement or upgrade is not feasible, since we perceive this possibility to be
low, but will continue to reevaluate the need for alternative remediation
strategies and contingency plans as warranted by further risk analysis. For
internal Year 2000 noncompliance issues identified to date and expected
throughout 1999, the cost of upgrade or replacement is not expected to be
material to our operating results. However, if significant new noncompliance
issues are subsequently identified, and replacement or upgrade is delayed beyond
December 31, 1999, operating results could be materially adversely affected.
We have limited material relationships with suppliers, domestically or
internationally, whose inability to provide products or services would have a
material adverse impact on operating results. Suppliers where such material
relationships do exist appear to be limited to utility companies whose inability
to provide service could materially affect all business entities. We have and
will continue to monitor their Year 2000 efforts and will develop contingency
plans as appropriate.
Our Company, based on certain products not including date fields, date
field testing of other products, Y2K certification of CAI acquired products, and
Y2K related compliance information evaluated during recent acquisition due
diligence, believes the majority of our current products are Year 2000 compliant
and has provided Year 2000 warranties to many of our customers. In fact, we
believe that some customers may be purchasing certain of our products as in
interim solution to their Year 2000 needs until their current suppliers reach
compliance. However, since all customer situations cannot be anticipated,
particularly those involving
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third-party products, increased warranty and other claims may be seen as a
result of the transition to Year 2000. Litigation in general may also increase
regarding Year 2000 compliance issues, although recently enacted Federal
legislation, which we are currently evaluating in order to implement processes
for effective adherence, may impact this anticipated increase. Therefore, the
impact of customer claims could have a material adverse impact on our operating
results.
Finally, Year 2000 compliance issues continue to be issues of focus for
almost all businesses. Companies whose computer systems and applications may
require significant hardware and software upgrades or modifications may
reallocate capital expenditures to fix Year 2000 problems of existing systems,
or reevaluate their current system needs. In addition, those Companies who have
completed Year 2000 upgrades or modifications, or are near completion, may still
continue to defer purchases of additional software until after the transition to
the Year 2000 to avoid the possibility of introducing additional contingencies
that they may believe may affect their Year 2000 compliance. If customers defer
purchases of our software because of reallocation or to avoid perceived
additional contingencies, or move to other systems or suppliers due to
reevaluation, this too could have a material adverse impact on our operating
results.
Our Company realizes the possibility that, in total, all of the potential
material adverse impacts discussed above may occur. To date, due to the
uncertainty in predicting actual outcomes, including impact based on action or
inaction by third-parties, this is considered the most reasonably likely worst
case scenario. However, contingency plans are currently not in place due to the
current state of information that is available to us and the anticipated flux of
reliable information prior to December 31, 1999, which could change the Year
2000 landscape relative to our Company several times over in the coming months.
Appropriate contingency plans will be put in place as available, reliable
information takes on a more static quality.
In order to evaluate the above risks, implement any necessary remediations
in the future, provide risk reevaluations and continued appropriate monitoring
activities, and develop appropriate contingency plans as warranted, we have
designated appropriate individuals within the organization responsible for Year
2000 issues. We will continue to assess the need for additional Year 2000
readiness personnel as appropriate.
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.
OUR OPERATING RESULTS FLUCTUATE SIGNIFICANTLY AND DEPEND ON MANY FACTORS.
Except for the second quarter of 1999 results, we have had significant
historic revenue growth. As in the second quarter of 1999, such growth rates may
not be sustainable, and you should not use these past results to predict future
operating margins or 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 Enterprise
Application Integration ("EAI") software market;
- 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;
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- the effects of global economic uncertainty on capital expenditures for
software; and
- the effects of Year 2000 issues on software purchases.
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 have 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, such as occurred in the second quarter of 1999, 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.
SOFTWARE LICENSE REVENUE IS DEPENDENT ON OUR RELATIONSHIP WITH IBM.
Our revenue growth for the first half of 1999 reflected strong sales of
MQSI and its predecessor product, MQIntegrator, through IBM's distribution and
reseller channel. MQSI is an IBM-branded product for which IBM has assumed
production and fulfillment obligations. IBM sells this product directly through
its distributors and resellers and we resell it both directly and through our
indirect channels. In the first half of 1999, royalty income from IBM sales of
MQSI accounted for a significant portion of our total software license revenue
and we expect it to continue to be a significant percentage of our software
license revenue in the future. Through the second quarter of 1999, we recorded
royalty income for the MQSI product in the same quarter in which IBM recorded
the sale to its customer. In July 1999, IBM informed us that effective with the
third quarter of 1999, they would no longer provide timely royalty information
necessary for us to reasonably estimate our share of MQSI revenue from IBM sales
of the product during each quarter. Because our quarterly financial results must
be filed before we receive this royalty information, beginning with the third
quarter of 1999, we began recording royalty income from IBM on a one-quarter
lag. Accordingly, third quarter IBM royalty income will be recognized in our
fourth quarter. We continue to be dependent on IBM's management of the MQSI
product, and any delay or shortfall in revenues from IBM, or in our ability to
report revenue, 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.
Our customers typically take 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 companies in rapidly
evolving markets. We have had 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 we have not been profitable on an
annual basis. At September 30, 1999, our Company had an accumulated deficit of
approximately $61 million (which includes acquisition-related
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charges and a one-time restructuring charge). To address these risks and
uncertainties, we must do the following:
- successfully implement our sales and marketing strategy;
- expand our direct sales channels;
- further develop our indirect distribution channels;
- respond to competition;
- continue to attract and retain qualified personnel;
- continue to develop and upgrade our e-Business Integration and EAI
products and technology more rapidly than competitors; and
- commercialize our e-Business Integration and EAI 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.
FAILURE TO ADD CUSTOMERS OR EXPAND INTO NEW MARKETS MAY HAVE A MATERIAL ADVERSE
EFFECT ON OUR BUSINESS.
A significant portion of our revenue has come from a small number of large
purchasers. For example, for the three and nine months ended September 30, 1999
our top ten customers accounted for 33% and 40% of total revenues, respectively.
For the three months ended September 30, 1999 and 1998, our largest customer
accounted for approximately 9% and 20% of our total revenues, respectively.
Historically, our revenues have been derived primarily from sales to large banks
and financial institutions. For example, sales to large banks and financial
institutions accounted for 27% and 34% of total revenues for the three months
ended September 30, 1999. 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 material adverse 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 will materially
adversely effect our business.
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 materially adversely affect our business.
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 adversely affect 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
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could adversely affect 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 adversely affect our average selling prices and
result in lower gross margins.
OUR OPERATING RESULTS ARE SUBSTANTIALLY DEPENDENT ON OUR SUITE OF EAI PRODUCTS.
A substantial majority of our revenues come from the NEON 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 NEON 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 NEON in performance or price, demand for our products may
decline. A decline in demand for NEON as a result of competition, technological
change or other factors would have a material adverse effect on our business,
financial condition and results of operations.
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 June 1999, we acquired eight companies, four of which
were acquired in the second quarter of 1999. These acquisitions will expose us
to increased risks and costs, including the following:
- assimilating new operations and personnel;
- diverting financial and management resources from existing operations;
and
- integrating acquired personnel and technologies.
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 material adverse effect on our financial condition and
results of operations.
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;
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- difficulty in accounts receivable collection and potentially adverse tax
consequences;
- 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 is 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.
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. At January 1, 1996,
we had a total of 35 employees and at September 30, 1999 we had a total of 1,005
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.
In particular, we are currently migrating our existing accounting software
to a packaged application that will allow greater flexibility in reporting and
tracking results. If we fail to install this software in an efficient and timely
manner or if the new systems fail to adequately support our level of operations,
then we could incur substantial additional expenses to remedy such failure.
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;
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- 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 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 INABILITY TO ATTRACT AND RETAIN PERSONNEL MAY ADVERSELY AFFECT US.
Our success greatly 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 material adverse effect on our future operating
results. In particular George F. (Rick) Adam, our Chief Executive Officer,
Patrick Fortune, our Chief Operating Officer, and Harold A. Piskiel, our Chief
Technology 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 EAI software and internet integration market, 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.
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
two patents, and we have two patent applications pending. 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.
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INTELLECTUAL PROPERTY CLAIMS CAN BE COSTLY AND RESULT IN THE LOSS OF SIGNIFICANT
RIGHTS.
It is also possible that third parties will claim that we have infringed
their current or future products. We expect that 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 material adverse 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 materially adversely
affected.
We are 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.
The Texas damage action was filed in June 1999. An adverse judgment or
settlement, particularly in the Texas action, may result in increased costs,
expenses and may have an adverse effect on our business.
GENERAL ECONOMIC CONDITIONS MAY ADVERSELY AFFECT OUR BUSINESS.
The EAI software and internet integration market could be negatively
impacted by certain factors that have impacted the ERP software market,
including global economic difficulties and uncertainty, 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 EAI software and internet integration market could adversely
affect our operating results.
YEAR 2000 RISKS MAY RESULT IN MATERIAL ADVERSE EFFECTS ON OUR BUSINESS.
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. Beginning in the year
2000, these code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, computer systems and/or
software products used by many companies may need to be upgraded to comply with
such year 2000 requirements. While we have assessed our products, services and
internal systems, certain internal financial packages have not yet been
implemented and may require further assessment by us. We believe we are
currently expending sufficient resources to review our products and services, as
well as our internal management information system in order to remedy those
products, services and systems that are not year 2000 compliant. We expect such
modifications will be made on a timely basis and we do not believe that the cost
of such modifications will have a material effect on our operating results.
There can be no assurance, however, that we will be able to modify such
products, services and systems in a timely and successful manner to comply with
the year 2000 requirements, which could have a material adverse effect on our
operating results. Moreover, we believe that some customers may be purchasing
our products as an interim solution to their year 2000 needs until their current
suppliers reach compliance. Conversely, year 2000 issues could cause a
significant number of companies, including our current customers, to reevaluate
their current system needs and as a result consider switching to other systems
and suppliers. Any of the foregoing could result in a material adverse effect on
our business, operating results and financial condition. Additionally, during
the remainder of 1999 there is likely to be an increased customer focus on
addressing year 2000 issues, creating the risk that customers may reallocate
capital expenditures to fix year 2000 problems of existing systems. If customers
defer purchases of our software because of such a reallocation, it could
adversely affect our operating results.
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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, and often such fluctuations have been
unrelated or disproportionate to our operating performance. 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.
ADOPTION OF THE EURO PRESENTS UNCERTAINTIES FOR OUR COMPANY.
In January 1999, the new "Euro" currency was introduced in certain European
countries that are part of the European Monetary Union, or EMU. During 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 may have an
adverse effect on the business or 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 and movements in interest rates. We
do not, in the normal course of business, use derivative financial instruments
for trading or speculative purposes. Uncertainties that are either non-financial
or non-quantifiable, 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 nine months
of 1999, 36% of our total revenue was generated from our international
operations, and the net assets of our foreign subsidiaries totaled 7% of
consolidated net assets as of September 30, 1999. 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,
Hong Kong and Singapore. These foreign subsidiaries use the 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 the U.S. dollar relative to
foreign currencies.
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INTEREST RATES
Our exposure to market risk associated with changes in interest rates
relates primarily to our investments in marketable securities and our related
party note receivable. 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. Additionally, interest income on our related party receivable is based on
a floating interest rate of 90-day LIBOR plus 2.05%. Changes in interest rates
could impact our anticipated interest income or could impact the fair market
value of our investments. However, we believe that 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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PART II.
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has been named as a defendant in a number of class action
lawsuits alleging violation of the federal securities laws. Certain executive
officers of the Company also are named as defendants. These lawsuits were filed
in federal court in Colorado in July and August 1999. Most of the complaints in
these lawsuits assert claims on behalf of purchasers of the Company's securities
between April 21, 1999 and July 6, 1999. A few of the complaints assert claims
on behalf of purchasers between October 29, 1998 and July 7, 1999. 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 these lawsuits are without merit. The Company intends to deny all
material allegations and to defend itself vigorously. An adverse judgment or
settlement in these lawsuits 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 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, expenses and may have an adverse effect
on our business. The Texas damage action was filed in June 1999.
ITEM 2. CHANGES IN SECURITIES
In July 1999, the Company issued 618,225 unregistered shares of common
stock to the former equityholders of Convoy to more closely reflect the value
agreed upon in the original purchase negotiations. The Company relied upon the
exemptions from registration provided by Rule 506 of Regulation D and Section
4(2) under the Securities Act of 1933, as amended, in issuing such shares.
In August 1999, the NEON Board of Directors authorized the repurchase of up
to 10% of NEON's outstanding shares of common stock over a 12-month period.
During August 1999, a total of 20,000 shares were repurchased by the Company.
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
EXHIBIT NO. DESCRIPTION
----------- -----------
27.1 -- Financial Data Schedule.
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(b) Reports on Form 8-K
(1) A Form 8-K was filed July 13, 1999 with respect to the acquisition
of Microscript, Inc., a Massachusetts corporation pursuant to an Agreement and
Plan of Reorganization effective June 28, 1999 between Microscript, Inc., the
Registrant and a wholly-owned subsidiary of the Registrant.
(2) A Form 8-K/A was filed on August 23, 1999, providing the following
Item 7 information:
- The financial statements for Convoy Corporation for the years
ended March 31, 1999 and 1998.
- Pro forma statements of operations for the Registrant and
Convoy Corporation for the six months ended June 30, 1999 and
the year ended December 31, 1998.
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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/ STEPHEN E. WEBB
----------------------------------
Stephen E. Webb,
Senior Vice President,
Chief Financial Officer
(Principal Financial Officer)
Date: November 12, 1999
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EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
----------- -----------
27.1 -- Financial Data Schedule.