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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE PERIOD
ENDED MARCH 31, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD
FROM TO
COMMISSION FILE NUMBER 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 Identification No.)
incorporation or organization)
7400 EAST ORCHARD ROAD, SUITE 230
ENGLEWOOD, COLORADO 80111
(Address of principal executive offices)
Registrant's telephone number, including area code: (303) 694-3933
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last
report)
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 March
31, 1998 was 9,213,666.
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INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets................................................................. 2
Consolidated Statements of Operations....................................................... 3
Consolidated Statements of Cash Flows....................................................... 4
Notes to Consolidated Financial Statements.................................................. 5
ITEM 2. MANAGEMENT'S DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................... 7
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.................................. 17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS........................................................................... 18
ITEM 2. CHANGES IN SECURITIES....................................................................... 18
ITEM 3. DEFAULTS UPON SENIOR SECURITIES............................................................. 18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......................................... 18
ITEM 5. OTHER INFORMATION........................................................................... 18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................................................ 18
SIGNATURES............................................................................................. 19
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NEW ERA OF NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
THREE MONTHS
ENDED YEAR ENDED
MARCH 31, 1998 DECEMBER 31, 1997
-------------- -----------------
(UNAUDITED)
Current assets:
Cash and cash equivalents................................. $ 6,486,784 $ 7,150,362
Short-term investments.................................... 14,544,993 15,573,617
Accounts receivable, net of an allowance for uncollectible
accounts of $300,000................................... 12,088,479 11,072,850
Unbilled revenue.......................................... 1,870,397 1,667,456
Prepaid expenses and other................................ 1,328,325 1,020,394
------------ ------------
Total current assets.............................. 36,318,978 36,484,679
------------ ------------
Property and equipment:
Computer equipment and software........................... 3,329,054 2,725,144
Furniture, fixtures and equipment......................... 850,929 640,218
Leasehold improvements.................................... 264,240 86,563
------------ ------------
4,444,223 3,451,925
Less -- accumulated depreciation.......................... (1,251,160) (1,036,088)
------------ ------------
Property and equipment, net............................... 3,193,063 2,415,837
------------ ------------
Other assets, net........................................... 1,333,787 1,328,659
------------ ------------
Total assets...................................... $ 40,845,827 $ 40,229,175
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,672,905 $ 2,171,722
Accrued liabilities....................................... 1,647,795 2,081,959
Current portion of bank borrowings........................ 49,766 66,963
Deferred revenue.......................................... 1,121,460 1,177,262
------------ ------------
Total liabilities................................. 4,491,926 5,497,906
------------ ------------
Stockholders' equity:
Common stock, $.0001 par value, 45,000,000 shares
authorized; 9,213,666 and 9,106,157 shares issued and
outstanding, respectively.............................. 921 911
Additional paid-in capital................................ 47,032,666 46,191,190
Accumulated deficit....................................... (10,725,600) (11,517,978)
Cumulative translation adjustment......................... 45,914 57,146
------------ ------------
Total stockholders' equity........................ 36,353,901 34,731,269
------------ ------------
Total liabilities and stockholders' equity........ $ 40,845,827 $ 40,229,175
============ ============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
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NEW ERA OF NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-------------------------
1998 1997
----------- ----------
Revenues:
Software licenses......................................... $ 6,572,634 $2,447,410
Services and maintenance.................................. 3,009,489 1,226,438
----------- ----------
Total revenues.................................... 9,582,123 3,673,848
Cost of revenues:
Cost of software licenses................................. 222,000 249,806
Cost of services and maintenance.......................... 1,526,458 800,157
----------- ----------
Total cost of revenues............................ 1,748,458 1,049,963
----------- ----------
Gross profit................................................ 7,833,665 2,623,885
Operating expenses:
Sales and marketing....................................... 3,605,521 1,690,082
Research and development.................................. 2,691,047 1,222,464
General and administrative................................ 991,464 494,636
Amortization of intangibles............................... 49,377 --
----------- ----------
Total operating expenses.......................... 7,337,409 3,407,182
----------- ----------
Income (loss) from operations............................... 496,256 (783,297)
Other income (expense), net................................. 296,122 (1,103)
----------- ----------
Income (loss) before provision for income taxes............. 792,378 (784,400)
Provision for income taxes.................................. -- --
----------- ----------
Net income (loss)........................................... $ 792,378 $ (784,400)
=========== ==========
Net income (loss) per common share, basic................... $ 0.09 $ (0.57)
=========== ==========
Net income (loss) per common share, diluted................. $ 0.08 $ (0.57)
=========== ==========
Weighted average shares of common stock outstanding,
basic..................................................... 9,154,642 1,375,606
=========== ==========
Weighted average shares of common stock outstanding,
diluted................................................... 10,166,297 1,375,606
=========== ==========
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
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NEW ERA OF NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
--------------------------
1998 1997
----------- -----------
Cash flows from operating activities:
Net income (loss)......................................... $ 792,378 $ (784,400)
Adjustments to reconcile net income (loss) to net cash
used in operating activities --
Depreciation and amortization.......................... 263,837 121,893
Changes in assets and liabilities --
Accounts receivable, net............................. (1,025,237) (1,173,369)
Unbilled revenue..................................... (203,949) (253,750)
Prepaid expenses and other........................... (311,612) (68,297)
Other assets, net.................................... (59,785) 37,886
Accounts payable..................................... (502,226) 365,272
Accrued liabilities.................................. 62,030 127,760
Deferred revenue..................................... (55,821) 90,000
----------- -----------
Net cash used in operating activities............. (1,040,385) (1,537,005)
----------- -----------
Cash flows from investing activities:
Proceeds from sale of short-term investments.............. 1,028,624 --
Purchase of property and equipment........................ (992,296) (202,629)
----------- -----------
Net cash provided by (used in) investing
activities..................................... 36,328 (202,629)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock.................... 345,323 101,798
Common stock issuance costs............................... -- --
Proceeds from issuance of preferred stock................. -- --
Preferred stock from issuance costs....................... -- --
Principal payments on notes payable to banks.............. (16,886) (1,935)
Payment of deferred offering costs........................ -- (106,929)
----------- -----------
Net cash provided by (used in) financing
activities..................................... 328,437 (7,066)
----------- -----------
Effect of exchange rate on cash............................. 12,042 --
Net increase in cash and cash equivalents................... (663,578) (1,746,700)
Cash and cash equivalents, beginning of period.............. 7,150,362 3,387,466
----------- -----------
Cash and cash equivalents, end of period.................... $ 6,486,784 $ 1,640,766
=========== ===========
Supplemental disclosures of noncash transactions:
Accrued deferred offering costs........................... $ 1,300 $ 402,000
=========== ===========
Common stock issued under employee stock purchase plan.... $ 496,164 $ 0
=========== ===========
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
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NEW ERA OF NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(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 as included in the Company's Registration
Statement on Form S-1 and related Prospectus dated June 18, 1997, and the
Company Annual Report on Form 10-K for the fiscal year ended December 31, 1997.
The consolidated results of operations for the three months ended March 31,
1998, are not necessarily indicative of the results to be expected for any
subsequent period or for the entire fiscal year ending December 31, 1998.
The accompanying unaudited consolidated interim financial statements
reflect, in the opinion of management, all adjustments which are of a normal and
recurring nature, necessary for a fair presentation of the financial position
and results of operations for the periods presented. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
2. NET INCOME (LOSS) PER COMMON SHARE.
The Company has adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share," ("SFAS 128") as required, by retroactively restating
loss per share amounts for all periods presented. Under SFAS 128, basic earnings
(loss) per common share is determined by dividing net income (loss) from
continuing operations available to common shareholders by the weighted average
number of common shares outstanding during each period. Diluted earnings per
common share includes the effects of potentially issuable common stock, but only
if dilutive. The treasury stock method, using the average price of the Company's
Common Stock for the period, is applied to determine dilution from options and
warrants. The if-converted method is used for convertible securities.
Loss per share amounts presented in the Prospectus dated June18, 1997 and
subsequent filings with the SEC were determined on a pro forma basis as required
by SEC Staff Accounting Bulletin No. 83 ("SAB No. 83"). Pro forma weighted
average shares outstanding included effects of certain securities issued by the
Company prior to its IPO, regardless of being antidilutive. In February 1998,
SAB No. 83 was superceded by SEC Staff Accounting Bulletin No. 98 ("SAB No. 98")
which effectively required the Company to retroactively restate its loss per
common share.
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NEW ERA OF NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. COMPREHENSIVE INCOME.
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 item
of other comprehensive income reported by the Company is the cumulative
translation adjustment. The Company's comprehensive income for the three months
ended March 31, 1998 and 1997 was as follows:
THREE MONTHS ENDED
----------------------
MARCH 31, MARCH 31,
1998 1997
--------- ---------
Net income (loss) for the period............................ $792,378 $(784,400)
Change in cumulative translation adjustment................. (11,232) --
-------- ---------
Comprehensive income (loss)................................. $781,146 $(784,400)
======== =========
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ITEM 2. MANAGEMENT'S DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table sets forth the percentages that selected items in the
Consolidated Statements of Operations bear to total revenues.
THREE MONTHS
ENDED
MARCH 31,
------------
1997 1998
---- ----
Revenues:
Software licenses......................................... 67% 69%
Services and maintenance.................................. 33 31
--- ---
Total revenues.............................................. 100 100
Cost of revenues:
Cost of software licenses(1).............................. 10 3
Cost of services and maintenance(1)....................... 65 51
--- ---
Total cost of revenues...................................... 29 18
Gross profit........................................... 71 82
Operating expenses:
Sales and marketing....................................... 46 38
Research and development.................................. 33 28
General and administrative................................ 13 10
Charge for acquired in-process research and development... -- --
Amortization of intangibles............................... -- 1
--- ---
Total operating expenses.................................... 92 77
--- ---
Income (loss) from operations............................... (21) 5
Other income (expense), net................................. -- 3
--- ---
Income (loss) before provision for income taxes............. (21) 8
Provision for income taxes.................................. -- --
=== ===
Net income (loss)........................................... (21)% 8%
=== ===
- ---------------
(1) As a percentage of software licenses and services and maintenance revenues,
respectively.
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REVENUES
The Company's revenues increased from $3.7 million in the quarter ended
March 31, 1997 to $9.6 million in the quarter ended March 31, 1998. This
increase resulted from significantly increased indirect channel revenues,
increased international presence, additions to the Company's product portfolio,
and an increase in the Company's sales force. The acquisition of Menhir in
September 1997 added the Rapport product to NEON's portfolio, which contributed
both to increased software licenses and services and maintenance revenues. In
the first quarter of 1998, indirect channel revenues increased to 32% of total
revenues, as compared with no indirect channel revenues for the first quarter of
1997, and international revenues increased to 34% of total revenues, as compared
with 25% of total revenues for the first quarter of 1997.
Software license revenues increased from $2.4 million, or 67% of revenues,
in the quarter ended March 31, 1997 to $6.6 million, or 69% of revenues, in the
quarter ended March 31, 1998. The growth in software license revenues reflected
the growing market awareness and acceptance of the Company's products and the
establishment of distributor and reseller relationships with IBM, PeopleSoft,
Candle Corporation, and NIWS (Japan), all of which contributed to software
license revenues in the quarter ended March 31, 1998.
Services and maintenance revenues increased from $1.2 million, or 33% of
revenues, in the quarter ended March 31, 1997 to $3.0 million, or 31% of
revenues, in the quarter ended March 31, 1998. The growth of services and
maintenance revenues resulted from professional service engagements associated
with the growing sales of the Company's products, increased maintenance revenue
from the larger installed base of software license customers, and increased
training revenue.
In the quarter ended March 31, 1998, the Company's largest customer and top
ten customers accounted for 10% and 57%, respectively, of total revenues. This
compares with 25% and 75%, respectively, for the same period in 1997. To date,
the Company's revenues have been derived primarily from sales to large banks and
financial institutions, which accounted for 72% of total revenues for the year
ended December 31, 1997. In the first quarter of 1998, sales to banks and
financial institutions accounted for approximately 44% of total revenues.
COST OF REVENUES
Cost of revenues consist of costs of software licenses and costs of
services and maintenance. As a percentage of total revenue, cost of revenues
declined from 29% in the quarter ended March 31, 1997 to 18% in the quarter
ended March 31, 1998. Although cost of revenue decreased as a percentage of
total revenue, the costs increased on an absolute dollar basis by approximately
$700,000. This increase was due primarily to the growth in professional service
engagements.
Cost of software licenses consisted primarily of royalty payments for the
three months ended March 31, 1997. With the fulfillment of the royalty
obligation to Merrill Lynch in the fourth quarter of 1997, the cost of software
licenses for the three months ended March 31, 1998 consisted primarily of the
internal costs associated with the fulfillment of license development
arrangements and software packaging and distribution.
Costs of service and maintenance consist primarily of personnel, facility
and system costs incurred in providing professional service consulting,
training, and customer support services. Costs of services and maintenance
decreased as a percentage of services and maintenance revenue from 65% in the
quarter ended March 31, 1997 to 51% in the quarter ended March 31, 1998,
although costs of services and maintenance increased $726,000 in absolute
dollars. This improved margin resulted primarily from improved utilization of
field service personnel and an increase in professional service rates.
OPERATING EXPENSES
Sales and Marketing
Sales and marketing expenses increased from $1.7 million, or 46% of total
revenues, in the quarter ended March 31, 1997 to $3.6 million, or 38% of total
revenues, in the quarter ended March 31, 1998. The increase in absolute dollars
reflected the hiring of additional sales representatives and marketing
personnel, increased
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promotional programs, and increased sales commissions associated with higher
revenues. Sales and marketing expenses declined as a percent of total revenues
due to higher percentage growth in revenues, and efficiencies associated with
the achievement of economies of scale.
Research and Development
Research and development expenses increased from $1.2 million, or 33% of
revenues, in the quarter ended March 31, 1997 to $2.7 million, or 28% of
revenues, in the quarter ended March 31, 1998. The increase in absolute dollars
principally reflected the hiring of additional personnel. The decline as a
percentage of revenues was due to higher percentage growth in revenues. No
software development costs have been capitalized to date in accordance with SFAS
No. 86.
General and Administrative
General and administrative expenses grew from $495,000, or 13% of total
revenues, in the quarter ended March 31, 1997 to $992,000, or 10% of total
revenues, in the quarter ended March 31, 1998. Expenses grew in dollars as the
Company added personnel to its finance, legal, MIS, and human resource
departments, but declined as a percent of total revenues primarily due to higher
percentage growth in revenues.
OTHER INCOME (EXPENSE), NET
The Company reported other expense of $1,000 in the quarter ended March 31,
1997 and other income of $296,000 in the quarter ended March 31, 1998. The
increase in other income was due to interest earned on cash invested from the
proceeds of the Company's initial public offering in June of 1997. The Company
anticipates that interest income may decline in future periods as cash balances
may be used to fund future acquisitions, as well as fund the ongoing operations
of the Company.
PROVISION FOR INCOME TAXES
The Company has reported no income tax expense for any period. As of March
31, 1998, the net deferred tax asset of approximately $3.1 million was offset by
a valuation allowance of a like amount. The comparable figure for December 31,
1997 was $3.4 million.
NET INCOME (LOSS)
Net income for the three months ended March 31, 1998 was approximately
$792,000, or $0.08 per Common Share on 10.2 million weighted average shares
outstanding on a diluted basis. This compares to a net loss of $784,000, or
$0.57 per Common Share on 1.4 million weighted average shares outstanding on a
diluted basis in the first quarter of 1997. The improved net income position
resulted from the increased growth of the Company's revenues, particularly the
growth of software license revenues, as compared with the growth of costs and
expenses.
LIQUIDITY AND CAPITAL RESOURCES
The Company reported $21.0 million in cash, cash equivalents and short-term
investments at March 31, 1998, compared to $22.7 million at December 31, 1997.
There was no significant bank debt in either period. The Company maintains a
line of credit that can be used for working capital requirements on an as-needed
basis. Accounts receivable, net, grew from $11.1 million at December 31, 1997 to
$12.1 million at March 31, 1998. Unbilled revenue, which represents progress on
funded development projects which is not billed until specified by a contract
date or milestone, grew from $1.7 million to $1.9 million over the same period.
Cash used for operating activities was $1.0 million and $1.5 million for
the first three months of 1998 and 1997, respectively. A $1.6 million
improvement in net profit was offset, in part, by decreases in accounts payable
due to the satisfaction of certain liabilities.
Cash provided by investing activities was $36,000 in the first three months
of 1998 compared to usage of $203,000 for the same period of 1997. The net cash
provided by investing activities in the 1998 period is the
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net proceeds from the maturities of short-term investments net of $992,000 of
capital expenditures. The usage of cash for the comparable period of 1997 was
due solely to capital expenditures.
Cash provided by financing activities was $328,000 in the first three
months of 1998 compared to usage of $7,000 for the same period of 1997. Through
March 31, 1998, the Company had received $345,000 for issuance of Common Stock
associated with the exercise of options and warrants.
The Company believes that the proceeds from this offering, along with its
existing balance of cash, cash equivalents and short-term investments will be
sufficient to meet the Company's working capital and capital expenditure needs
at least for the next twelve months. Thereafter, the Company may require
additional sources of funds to continue to support its business. There can be no
assurance that such capital, if needed, will be available or will be available
on terms acceptable to the Company.
FACTORS THAT MAY AFFECT FUTURE RESULTS
Uncertainty of Future Operating Results; Lengthy Sales Cycle; Fluctuations
in Quarterly Results. Although the Company has experienced significant revenue
growth in recent periods, such growth rates will not be sustainable and are not
necessarily indicative of future operating results and operating margins. The
Company's quarterly operating results have fluctuated significantly in the past
and may vary significantly in the future. Future operating results will depend
on many factors, including, among others, the growth of the EAI software market,
the size and timing of software licenses, the delay or deferral of customer
implementations, the ability of the Company to maintain or increase market
demand for the Company's products, the timing of new product announcements and
releases by the Company, competition by existing and emerging competitors in the
application integration software market, the ability of the Company to expand
its direct sales force and develop indirect distribution channels, the Company's
success in developing and marketing new products and controlling costs,
budgeting cycles of customers, product life cycles, software defects and other
product quality problems, the mix of products and services sold, decreased
margins associated with higher expenses of subcontract labor, international
operations, uncertainties in revenue recognition associated with adoption of
Statement of Position ("SOP") 97-2, and general domestic and international
economic and political conditions. A significant portion of the Company's
revenues has been, and the Company believes will continue to be, derived from a
small number of relatively large customer contracts or arrangements, and the
timing of revenue recognition from such contracts and arrangements has caused
and may continue to cause material fluctuations in the Company's operating
results, particularly on a quarterly basis. For example, in the fourth quarter
of 1997 the Company's largest customer accounted for approximately 14% of the
Company's total revenues, and in the first quarter of 1998 its largest customer
accounted for approximately 10% of the Company's total revenues. See
"-- Customer Concentration; Dependence Upon Financial Institutions Industry;
Risks of New Targeted Market Segments." Quarterly revenues and operating results
typically depend upon the volume and timing of customer contracts received
during a given quarter, and the percentage of each contract which the Company is
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 the Company's 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. To the extent this trend
continues, any failure or delay in the closing of orders during the last part of
any given quarter will have a material adverse effect on the Company's business,
financial condition and results of operations.
In addition, the timing of license revenue is difficult to predict because
of the length and variability of the Company's sales cycle. The purchase of the
Company's products by its customers typically involves a significant technical
evaluation and commitment of capital and other resources, with the attendant
delays frequently associated with customers' internal procedures to approve
large capital expenditures and to test, implement and accept new technologies
that affect key operations. This evaluation process frequently results in a
lengthy sales process of several months and subjects the sales cycle associated
with the purchase of the Company's products to a number of significant risks,
including customers' budgetary constraints and internal acceptance reviews. The
length of the Company's sales cycle may vary substantially from customer to
customer, particularly for customers within different vertical market segments.
See "Business -- Sales and Marketing." The Company's operating expense levels
are relatively fixed and are based in part on expectations
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of future revenues. Consequently, any delay in the recognition of revenue from
quarter to quarter could result in operating losses. To the extent that such
operating expenses precede, or are not subsequently followed by, increased
revenues, the Company's operating results would be materially adversely
affected.
As a result of these and other factors, the Company believes that
period-to-period comparisons of its historical results of operations are not
necessarily meaningful and should not be relied upon as indications of future
performance. It is possible that the Company's future quarterly operating
results from time to time may not meet the expectations of stock market analysts
or investors, which would likely have an adverse effect on the market price of
the Company's Common Stock. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Limited Operating History; History of Operating Losses; Accumulated
Deficit. The Company was formed in 1993, and installed NEONet at its first
customer site in January 1996. The Company commenced shipment of its principal
product, NEONet, in July 1996. Accordingly, the Company has only a limited
operating history upon which an evaluation of the Company and its prospects can
be based. Prior to 1996, the Company recorded only nominal product revenue, and
the Company has not been profitable on an annual basis. At March 31, 1998, the
Company had an accumulated deficit of approximately $10.7 million. The Company's
prospects must be evaluated in light of the risks, uncertainties, expenses and
difficulties frequently encountered by companies in the early stage of their
development. The new and rapidly evolving markets in which the Company operates
makes these risks, uncertainties, expenses and difficulties particularly
pronounced. In order to address these risks and uncertainties the Company must,
among other things, successfully implement its sales and marketing strategy,
expand its direct sales channels, develop its indirect distribution channels,
respond to competitive and other developments in the application integration
software market, attract and retain qualified personnel, continue to develop and
upgrade its products and technology more rapidly than competitors, and
commercialize its products and services that incorporate existing and future
technologies. There can be no assurance that the Company will be able to
successfully implement any of its strategies or successfully address these risks
and uncertainties, or that the Company will be profitable in the future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Customer Concentration; Dependence Upon Financial Institutions Industry;
Risks of New Targeted Market Segments. In fiscal 1997, the Company's top ten
customers accounted for 56% of total revenues. For the quarter ended December
31, 1997 and the first quarter of 1998, the Company's largest customer accounted
for approximately 14% and 10%, respectively, of the Company's total revenues. In
addition, to date the Company's revenues have been derived primarily from sales
to large banks and financial institutions, which accounted for 72% of total
revenues for the year ended December 31, 1997. In the first quarter of 1998,
sales to banks and financial institutions accounted for approximately 44% of
total revenues. This decline in the concentration of sales to banks and
financial institutions was primarily the result of an increase in indirect
channel license revenues, which accounted for 32% of total revenues in the first
quarter of 1998. There can be no assurance that these customers or other
customers of the Company will continue to purchase the Company's products in the
future. The Company's failure to add new customers that make significant
purchases of the Company's products and services would have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The Company has limited experience in marketing its products to customers
outside of the financial institutions industry. The additional market segments
currently targeted by the Company are likely to have significantly different
market characteristics than the financial institutions segment, and licensing
NEONet products in such other segments may require pricing structures, sales
methods, sales personnel, consulting services and customer support that differ
from those previously used by the Company. There can be no assurance that the
Company will be successful in achieving significant market acceptance or
penetration in the additional segments targeted by the Company. If the Company
is unsuccessful in penetrating additional vertical market segments, its future
growth, financial condition and results of operations will be materially
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business -- Customers."
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Product Concentration. A substantial portion of the Company's revenues have
been attributable to licenses of NEONet and related services. The Company
currently expects that revenues attributable to NEONet and related services will
continue to account for a substantial majority of the Company's revenues at
least through 1998. Accordingly, the Company's future operating results will be
dependent upon the level of market acceptance of, and demand for, NEONet. The
Company's future performance will, to a large extent, depend upon the successful
development, introduction and customer acceptance of new and enhanced releases
of NEONet and other products. There can be no assurance that the Company's
products will achieve continued market acceptance or that the Company will be
successful in marketing any new or enhanced products. In the event that the
Company's current or future competitors release new products that have more
advanced features, offer better performance or are more price competitive than
NEONet, demand for the Company's products may decline. A decline in demand for
NEONet as a result of competition, technological change or other factors would
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Business -- Products and Services" and
"Business -- Product Development."
Integration of Acquisitions and Joint Ventures. In September 1997, the
Company acquired Menhir through its wholly-owned subsidiary, New Era of Networks
Limited, and may from time to time acquire companies with complementary products
and services in the application integration or other related software markets.
The Company's acquisition of Menhir will, and any future acquisitions may expose
the Company to increased risks, including those associated with the assimilation
of new operations and personnel, the diversion of financial and management
resources from existing operations, and the inability of management to
successfully integrate acquired businesses, personnel and technologies.
Furthermore, there can be no assurance that the Company will be able to generate
sufficient revenues from any such acquisition to offset associated acquisition
costs, or that the Company will be able to maintain uniform standards of quality
and service, controls, procedures and policies, which may result in the
impairment of relationships with customers, employees, and new management
personnel. Certain acquisitions may also result in additional stock issuances
which could be dilutive to the Company's stockholders. The Company may also
evaluate, on a case-by-case basis, joint venture relationships with
complementary businesses. Any such joint venture investment 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 the Company's
business, financial condition and results of operations.
Risks Associated with Expanding Distribution; Indirect Distribution Channel
Risks. To date, the Company has sold its products primarily through the
Company's direct sales force and has supported its customers with its technical
and customer support staff. The Company's commissioned sales force has increased
from one person in January 1996 to 25 people as of March 31, 1998. The Company's
ability to achieve significant revenue growth in the future will depend in large
part on its ability to recruit and train sufficient direct sales, technical and
customer personnel, particularly additional sales personnel focusing on the new
vertical market segments targeted by the Company's marketing strategy. The
Company has at times experienced and continues to experience difficulty in
recruiting qualified sales, technical and support personnel. The inability of
the Company to rapidly and effectively expand its direct sales force and its
technical and support staff could materially adversely affect the Company's
business, financial condition and operating results.
The Company believes that future growth also will depend upon its success
in developing and maintaining strategic relationships with distributors,
resellers, and systems integrators. The Company's strategy is to continue to
increase the proportion of customers served through these indirect channels.
Although sales through indirect channels accounted for less than 10% of total
revenues in 1997, indirect sales increased to approximately 15% of total
revenues in the fourth quarter of 1997 and to approximately 32% in the first
quarter of 1998. The Company is currently investing, and plans to continue to
invest, significant resources to develop the indirect channel, which could
adversely affect the Company's operating results if the Company's efforts do not
generate license and service revenues necessary to offset such investment. The
Company's inability to recruit and retain qualified distributors, resellers and
systems integrators could adversely affect the Company's results of operations.
The Company's success in selling into indirect distribution channels could also
adversely
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affect the Company's average selling prices and result in lower gross margins,
since lower unit prices are typically charged on sales through indirect
channels. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations;" and "Business -- Sales and Marketing."
Risks Associated with International Operations. Sales of the Company's
products outside of North America in the fourth quarter of 1997 and the first
quarter of 1998 represented approximately 29% and 34%, respectively, of total
revenues, increasing from approximately 28% in fiscal year 1997. The Company
continues to expand its international operations, and these efforts require
significant management attention and financial resources, as well as the
development of international versions of the Company's products. The Company has
committed resources to the opening of international sales offices and the
expansion of international sales and support channels. There can be no assurance
that the Company's efforts to develop and expand international sales and support
channels will be successful. International sales are subject to a number of
risks, including longer payment cycles, unexpected changes in regulatory
requirements, import and export restrictions and tariffs, difficulties in
staffing and managing foreign operations, the burden of complying with a variety
of foreign laws, greater difficulty in accounts receivable collection,
potentially adverse tax consequences, currency fluctuations, the imposition of
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. If the Company increases its international sales,
its total revenues may also be affected to a greater extent by seasonal
fluctuations resulting from lower sales that typically occur during the summer
months in Europe and other parts of the world. In addition, the market for
application integration software outside of North America is not as developed
and there can be no assurance that it will grow at the same rate as in North
America or that, if it does develop rapidly, the Company will be successful in
such international markets.
Competition. The market for the Company's products is intensely competitive
and is expected to become increasingly competitive as current competitors expand
their product offerings and new competitors enter the market. The Company's
current competitors include a number of companies offering one or more solutions
to the application integration problem, some of which are directly competitive
with the Company's products.
To date, the Company has faced competition and sales resistance from the
internal information technology departments of potential customers that have
developed or may develop in-house systems that may substitute for those offered
by the Company. The Company expects that internally developed application
integration systems will continue to be a principal source of competition for
the foreseeable future. In particular, the Company has had difficulties making
sales to organizations whose internal development groups have already progressed
significantly toward completion of systems that the Company's products might
replace, or where the underlying technologies used by such groups differ
fundamentally from the Company's products.
The Company's competitors also include software vendors targeting the
enterprise-wide application integration market through various technological
solutions. For example, Microsoft, BEA Systems and others provide messaging and
queuing solutions that compete with the NEONet Messaging and Queuing module. In
the future these vendors could elect to provide a more complete integration
solution that would also compete with NEONet's dynamic formatting and
rules-based engine modules. In addition, a large number of other companies
provide alternative solutions to application integration utilizing other
technologies such as data synchronization, transaction monitoring, and
subject-based publish/subscribe messaging systems. The Company also faces
competition from relational database vendors such as Oracle, Informix, Sybase
and Microsoft. In addition, NEON faces competition from vendors offering EAI
capabilities, including TSI International Software Ltd., Active Software and
Vitria Technology, Inc.
The Company also may face competition from system integrators and
professional service organizations which design and develop custom systems and
perform custom integration. Certain of these firms may possess industry specific
expertise or reputations among potential customers for offering enterprise
solutions to application integration needs. These systems integrators and
consulting firms can be resellers of the Company's products and may engage in
joint marketing and sales efforts with the Company. The Company relies upon such
firms for recommendations of NEONet products during the evaluation stage of the
purchase
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process, as well as for implementation and customer support services. These
systems integrators and consulting firms may have similar, and often more
established, relationships with the Company's competitors, and there can be no
assurance that these firms will not market or recommend software products
competitive with the Company's products.
Most of the Company's competitors have longer operating histories,
significantly greater financial, technical, marketing and other resources,
significantly greater name recognition, and a larger installed base of customers
than the Company. In addition, many of the Company's competitors have
well-established relationships with current and potential customers of the
Company, have extensive knowledge of the application integration industry, and
are capable of offering a single-vendor solution. As a result, the Company's
competitors may be in a better position than the Company to devote significant
resources toward the development, promotion and sale of their products and to
respond more quickly to new or emerging technologies and changes in customer
requirements. In addition, current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties
to increase the ability of their products to address customer needs.
Accordingly, it is possible that new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. The Company also
expects that the competition will increase as a result of software industry
consolidations. Increased competition is likely to result in price reductions,
reduced gross margins and loss of market share, any of which could materially
adversely affect the Company's business, financial condition and results of
operations. There can be no assurance that the Company will be able to compete
successfully against current and future competitors, or that competitive
pressure faced by the Company will not materially adversely affect its business,
financial condition and results of operations. See "Business -- Competition."
Fixed-Price Development and Service Contracts. The Company offers
development and consulting services to its customers. Typically, the Company
enters into service agreements with its customers on a "time and materials"
basis. Certain customers have asked for, and the Company has from time to time
entered into, fixed-price service contracts. These contracts may specify certain
milestones to be met by the Company regardless of actual costs incurred by the
Company in fulfilling these obligations. Certain of these fixed price contracts
provide for significant potential revenue, which if not completed in a timely
manner would delay the timing of or reduce the total amount of revenue
recognized by the Company. Such delay or reduction could have a material adverse
effect on the Company's financial results. There can be no assurance that the
Company can successfully complete these contracts on budget, and the Company's
inability to do so could have a material adverse effect on its business,
financial condition and results of operations.
Management of Growth. The Company is currently experiencing a period of
rapid growth that has placed and is expected to continue to place a strain on
the Company's administrative, financial and operational resources. From January
1, 1996 through March 31, 1998, the size of the Company's staff increased from
35 to 255 full time equivalent employees. Except for George F. (Rick) Adam, Jr.,
the Company's Chief Executive Officer, and Harold A. Piskiel, the Company's
Chief Technology Officer, all of the Company's senior management joined the
Company in 1996 or 1997. In addition, the Company has expanded geographically by
adding sales personnel in New York City, Chicago, San Francisco, Philadelphia,
Boston, Atlanta, London, England and Sydney, Australia. The Company may further
expand into these regions or into others through internal growth or through
acquisitions of related companies and technologies. Such expansion may strain
management's ability to successfully integrate its operations throughout these
regions. Any additional growth within a short time period may divert management
attention from day-to-day operations, which could have a material adverse effect
on the Company's business, financial condition, and results of operations.
The Company's ability to manage its staff and facilities growth effectively
will require it to continue to improve its operational, financial and management
controls, reporting systems and procedures, to install new management
information and control systems and to expand, train, motivate and manage its
work force. In particular, the Company is currently migrating its existing
accounting software to a packaged application, which will allow greater
flexibility in reporting and tracking results. There can be no assurance that
the Company will install such software package in an efficient and timely manner
or that the new systems will be adequate to support the Company's level of
operations. If the Company's management is unable to manage growth effectively
and new employees are unable to achieve targeted performance levels, the
Company's
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business, financial condition and results of operations would be materially
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Dependence Upon Emerging Market for Application Integration Software.
Substantially all of the Company's revenues to date have been attributable to
sales of application integration software products and services, and the Company
expects that substantially all revenues in the foreseeable future will be
derived from such products. The market for application integration software is
relatively new and emerging. The Company's future financial performance will
depend, to a large extent, on continued growth in the number of organizations
demanding software and services for application integration and seeking outside
vendors to develop, manage and maintain the integration software used for their
mission-critical applications. Many potential customers for third-party
application integration software have made significant investments in internally
developed integration systems, and are highly dependent upon the continued use
of such internally developed systems. The dependence of organizations on such
internally developed systems coupled with the significant costs required to
shift to third-party products may substantially inhibit future demand for third-
party application integration software products, such as those offered by the
Company. There can be no assurance that the market for application integration
software products and services will continue to grow. If the application
integration market fails to grow or grows more slowly than the Company currently
anticipates, the Company's business, financial condition and results of
operations would be materially adversely affected.
The Company intends to continue to devote considerable resources educating
potential customers about application integration software. Even if a sizable
market for third-party application integration continues to develop, there can
be no assurance that such expenditures or any other marketing efforts will
enable the Company's products to achieve or sustain significant market
acceptance. If the Company is unsuccessful in establishing broad market
acceptance for its current and future products, the Company's future growth,
financial condition and results of operations will be materially adversely
affected. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business -- Research and Development."
Rapid Technological Change; Platform Coverage; Dependence on New Products.
The market in which the Company competes is characterized by rapid technological
change, frequent new product introductions and enhancements, changes in customer
demands and evolving industry standards. The introduction of products
incorporating new technologies and the emergence of shifting customer
requirements, or changing industry standards, could render certain of the
Company's existing products obsolete. The technological life cycles of the
Company's products are difficult to estimate, and may vary across vertical
market segments. The Company's future success will depend upon its ability to
continue to enhance its current product line and to continue to develop and
introduce new products that keep pace with competitive and technological
developments. Such developments will require the Company to continue to make
substantial product development investments.
The Company currently serves, and intends to continue to serve, a customer
base with a wide variety of hardware, software, database, and networking
platforms. To gain broad market acceptance, the Company believes that in the
future it must support the NEONet product suite on a variety of platforms.
The success of the Company's products will depend on various factors,
including the ability to integrate the Company's products with multiple
platforms as compared to competitive offerings, the portability of the Company's
products, particularly the number of hardware platforms, operating systems and
databases that the Company's products can source or target, the integration of
additional software modules under development with existing products, and the
Company's management of software development being performed by third party
developers. There can be no assurance that the Company will be successful in
developing and marketing product enhancements or new products that respond to
these technological changes, shifting customer tastes, or evolving industry
standards, or that the Company will not experience difficulties that could delay
or prevent the successful development, introduction and marketing of these
products. If the Company is unable to develop and introduce new products or
enhancements of existing products in a timely manner or if the Company
experiences delays in the commencement of commercial shipments of new products
and enhance-
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ments, the Company's business, operating results and financial condition would
be materially adversely affected. See "Business -- Product Development."
Risk of Software Defects. Software products as complex as those offered by
the Company frequently contain undetected errors or defects, especially when
first introduced or when new versions or enhancements are released. Testing of
the Company's products is particularly challenging because it is difficult to
simulate the wide variety of computer environments into which the Company's
application integration software is deployed. Despite product testing by the
Company and its customers, the Company has in the past shipped product releases
of NEONet with some defects and has discovered other software errors in its
products after their commercial shipment. There can be no assurance that,
despite testing by the Company and by current and potential customers, defects
and errors will not be found in new products or in new versions or enhancements
of existing products after commencement of commercial shipments. Although
defects have not materially and adversely affected the Company's operating
results to date, any defects discovered in the future could result in adverse
customer reaction, negative publicity regarding the Company, its products or
delay in or failure to achieve market acceptance, any of which could have a
material adverse effect upon the Company's business, operating results and
financial condition. See "Business -- Research and Development."
Dependence on Relationships with Complementary Vendors. The Company
believes that, in order to provide competitive solutions for heterogeneous, open
computing environments, it will be necessary to develop, maintain and enhance
close relationships with a wide range of vendors, including database, ERP,
supply chain and Electronic Data Interchange (EDI) software vendors, as well as
hardware and operating system vendors. There can be no assurance that the
Company will be able to maintain its existing relationships or develop
additional relationships with such vendors. The Company's failure to do so could
adversely affect the portability of the Company's products to existing and new
platforms and databases and the timing of the release of new and enhanced
products for the marketplace by the Company.
Dependence on Key Personnel; Ability to Attract and Retain Personnel. The
Company's future success will depend in large part upon the continued service of
its key technical, sales and senior management personnel, none of whom is bound
by an employment agreement. The loss of any of the Company's senior management
or other key research, development, sales and marketing personnel, particularly
if lost to competitors, could have a material adverse effect on the Company's
business, financial condition and results of operations. In particular, the
Company's Chief Executive Officer, George F. (Rick) Adam and Harold A. Piskiel,
Chief Technology Officer of the Company, would be difficult to replace. The
Company's future success will depend in large part upon its ability to attract,
retain and motivate highly skilled employees. There is significant competition
for employees with the skills required to perform the services offered by the
Company and there can be no assurance that the Company will be able to continue
to attract and retain sufficient numbers of highly skilled employees. Because of
the complexity of the application integration software market, the Company has
in the past experienced, and expects in the future to experience, a significant
time lag between the date on which technical and sales personnel are hired and
the time at which persons become fully productive. If the Company is unable to
manage the post-sales process effectively, its ability to attract repeat sales
or establish strong account references could be adversely affected, which may
materially affect the Company's business, financial condition and results of
operations. See "Management."
Protection of Intellectual Property; Risks of Infringement. The Company's
success and ability to compete is dependent in part upon its proprietary
technology. The Company relies on a combination of copyright, trademark and
trade secret laws, as well as confidentiality agreements and licensing
arrangements, to establish and protect its proprietary rights. The Company
presently has no patents, but has three patent applications pending. Despite the
Company's efforts to protect its proprietary rights, existing copyright,
trademark and trade secret laws afford only limited protection. Moreover, the
laws of certain countries do not protect the Company's proprietary rights to the
same extent as do the laws of the United States. In addition, attempts may be
made to copy or reverse engineer aspects of the Company's products or to obtain
and use information that the Company regards as proprietary. Accordingly, there
can be no assurance that the Company will be able to protect its proprietary
rights against unauthorized third-party copying or use, which could materially
adversely affect the Company's business, operating results or financial
condition. Moreover, there can be no assurance that others will not develop
products that infringe the Company's proprietary rights,
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or that are similar or superior to those developed by the Company. Policing the
unauthorized use of the Company's products is difficult and litigation may be
necessary in the future to enforce the Company's intellectual property rights,
to protect the Company's 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 the
Company's business, financial condition or results of operations.
There can be no assurance that third parties will not claim infringement by
the Company with respect to current or future products. The Company expects that
application integration software developers will increasingly be subject to
infringement claims as the number of products in different industry segments
overlap. In this regard, the Company is aware that one of its competitors has a
U.S. patent covering certain aspects of publish/subscribe messaging systems.
This competitor has invited the Company to consider discussing a license under
its patent. The Company believes its NEONet product does not infringe any valid
claim of the patent. However, any claims, with or without merit, could be
time-consuming, result in costly litigation, cause product shipment delays, or
require the Company to enter into royalty or licensing agreements, any of which
could have a material adverse effect upon the Company's business, financial
condition and operating results. There can be no assurance that such royalty or
licensing agreements, if required, would be available on terms acceptable to the
Company, or at all. Moreover, the cost of defending patent litigation could be
substantial, regardless of the outcome. There can be no assurance that legal
action claiming patent infringement will not be commenced against the Company,
or that the Company would necessarily prevail in such litigation given the
complex technical issues and inherent uncertainties in patent litigation. In the
event a patent claim against the Company was successful and the Company could
not obtain a license on acceptable terms or license a substitute technology or
redesign to avoid infringement, the Company's business, financial condition and
results of operations would be materially adversely affected.
Product Liability. The Company's license agreements with its customers
typically contain provisions designed to limit the Company's exposure to
potential product liability claims. It is possible, however, that the limitation
of liability provisions contained in the Company's license agreements may not be
effective as a result of federal, state or local laws or unfavorable judicial
decisions. Although the Company has not experienced any product liability claims
to date, the license and support of the Company's software by the Company
entails the risk of such claims. A successful product liability claim brought
against the Company would have a material adverse effect on the Company's
business, operating results and financial condition.
Impact of the Year 2000 Issue. Many 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,
in less than two years, computer systems and/or software products used by many
companies may need to be upgraded to comply with such year 2000 requirements.
The Company believes it is currently expending sufficient resources to review
its product and services, as well as its internal management information system
in order to identify and modify those products, services and systems that are
not year 2000 compliant. The Company expects such modifications will be made on
a timely basis and does not believe that the cost of such modifications will
have a material effect on the Company's operating results. There can be no
assurance, however, that the Company will be able to modify timely and
successfully such products, services and systems to comply with the year 2000
requirements, which could have a material adverse effect on the Company's
operating results. Moreover, the Company believes that some customers may be
purchasing the Company's 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 current
customers of the Company, 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 the Company's business, operating
results and financial condition. Furthermore, there can be no assurance that
these or other factors relating to the year 2000 compliance issues, including
litigation, will not have a material adverse effect on the Company's business,
financial condition or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON 8-K
(a) Exhibit 27.1: Financial Data Schedule.
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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: May 8, 1998
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EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
----------- -----------
27.1 -- Financial Data Schedule