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, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the transition period from to .
Commission File Number: 0-26130
LEGATO SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3077394
(State of incorporation) (I.R.S. Employer
Identification No.)
3210 Porter Drive
Palo Alto, California 94304
(Address of principal executive offices)
(650) 812-6000
(Registrant's telephone number, including area code)
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 period 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 outstanding of the registrant's common stock as of October
31, 1997 was 17,681,247.
<PAGE>
LEGATO SYSTEMS, INC.
INDEX
Page
PART I: Condensed Financial Information
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 1997
and December 31, 1996 3
Condensed Consolidated Statements of Income for the three
and nine month periods ended September 30, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows for the
nine month periods ended September 30, 1997 and 1996 5
Notes to the Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
PART II: Other Information
Item 6. Exhibits and Reports on Form 8-K 16
Signature 17
<PAGE>
PART I: Condensed Financial Information
Item 1: Financial Statements
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
September 30, December 31,
1997 1996
(unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 36,796 $ 27,673
Short-term investments 23,863 22,391
Accounts receivable, net 16,101 9,839
Other current assets 2,454 2,870
Deferred tax asset 2,876 2,652
----------- ----------
Total current assets 82,090 65,425
Long-term investments 6,635 7,017
Property and equipment, net 9,433 6,029
Other assets 548 201
Intangible assets, net 3,723 4,470
----------- ----------
Total assets $ 102,429 $ 83,142
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 7,676 $ 5,919
Deferred revenues 10,354 7,581
----------- ----------
Total current liabilities 18,030 13,500
Deferred tax liability 1,019 1,254
Stockholders' equity:
Capital stock 60,924 56,580
Retained earnings 22,456 11,808
----------- ----------
Total stockholders' equity 83,380 68,388
----------- ----------
Total liabilities and stockholders' equity $ 102,429 $ 83,142
=========== ==========
</TABLE>
The accompanying notes are an integral part of the Condensed
Consolidated Financial Statements.
<PAGE>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share data)
<TABLE>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Product and other $ 12,685 $ 8,272 $ 32,413 $ 22,322
Royalty and license 4,703 3,732 12,737 9,295
Software subscription 4,048 2,545 11,057 6,430
----------- ----------- ----------- -----------
Total revenues 21,436 14,549 56,207 38,047
Cost of revenues:
Product and other 1,352 695 3,104 1,667
Software subscription 1,144 722 3,111 2,106
----------- ----------- ----------- -----------
Total cost of revenues 2,496 1,417 6,215 3,773
----------- ----------- ----------- -----------
Gross profit 18,940 13,132 49,992 34,274
Operating expenses:
Research and development 3,625 2,318 10,223 6,267
Sales and marketing 7,178 4,289 19,233 12,355
General and administrative 1,665 1,915 4,294 4,725
Amortization of intangibles 279 276 839 818
In-process research and development -- -- -- 1,849
----------- ----------- ----------- -----------
Total operating expenses 12,747 8,798 34,589 26,014
----------- ----------- ----------- -----------
Income from operations 6,193 4,334 15,403 8,260
Interest and other income, net 554 442 1,499 1,307
----------- ----------- ----------- -----------
Income before provision for income taxes 6,747 4,776 16,902 9,567
Provision for income taxes 2,395 1,815 6,254 4,390
----------- ----------- ----------- -----------
Net income $ 4,352 $ 2,961 $ 10,648 $ 5,177
=========== =========== =========== ===========
Net income per share $ .23 $ .16 $ .57 $ .28
=========== =========== =========== ===========
Shares used in per share calculation 18,855 18,923 18,730 18,676
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the Condensed
Consolidated Financial Statements.
<PAGE>
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
<TABLE>
Nine Months Ended
September 30,
1997 1996
<S> <C> <C>
Cash flows from operating activities:
Net income $ 10,648 $ 5,177
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,572 1,408
Deferred tax asset (224) 463
Write-off of in-process research and development -- 1,849
Other -- 163
Changes in operating assets and liabilities:
Accounts receivable (6,262) (1,236)
Other current assets (734) 1,318
Current liabilities 7,176 6,091
--------- ---------
Net cash provided by operating activities 13,176 15,233
Cash flows from investing activities:
Acquisition of property and equipment (5,372) (4,508)
Purchase of available-for-sale securities (24,964) (47,040)
Proceeds from maturity and sale of available-
for-sale securities 23,876 38,212
Payment for purchase of subsidiaries, net of
cash acquired -- (5,924)
Other (439) (197)
--------- ---------
Net cash used in investing activities (6,899) (19,457)
Cash flows from financing activities:
Proceeds from issuance of common stock 2,832 1,583
Other 14 14
--------- ---------
Net cash provided by financing activities 2,846 1,597
--------- ---------
Net increase (decrease) in cash and cash equivalents 9,123 (2,627)
Cash and cash equivalents at beginning of period 27,673 29,870
--------- ---------
Cash and cash equivalents at end of period $ 36,796 $ 27,243
========= =========
Supplemental information:
Income taxes paid $ 2,912 $ 2,554
========= =========
Non-cash transactions:
Deferred tax liability $ -- $ 1,568
========= =========
Tax benefit from stock plans $ 1,496 $ 4,000
========= =========
</TABLE>
The accompanying notes are an integral part of the Condensed
Consolidated Financial Statements.
<PAGE>
LEGATO SYSTEMS, INC.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Basis of Presentation
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (all of which are
normal and recurring in nature) necessary to present fairly the financial
position, results of operations and cash flows of Legato Systems, Inc. and its
subsidiaries ("Legato" or the "Company"). The results of operations for the
interim periods presented are not necessarily indicative of the results that may
be expected for any future interim periods or for the full fiscal year. The
Notes to the Consolidated Financial Statements contained in the 1996 Report on
Form 10-K should be read in conjunction with these Condensed Consolidated
Financial Statements. The balance sheet at December 31, 1996 was derived from
audited financial statements; however, it does not include all disclosures
required by generally accepted accounting principles.
Note 2. Computation of Net Income Per Share
Net income per share is based upon the weighted average number of common
and common equivalent shares outstanding. Common equivalent shares are included
in the per share calculations where the effect of their inclusion would be
dilutive. Dilutive common equivalent shares consist of the incremental common
shares issuable upon conversion of stock options (using the treasury stock
method).
In February, 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS
128"). This statement replaces the presentation of primary earnings per share
with a presentation of basic earnings per share. It also requires dual
presentation of basic and diluted earnings per share on the face of the income
statement for all entities with complex capital structures and requires a
reconciliation of the numerator and denominator of the basic earnings per share
computation to the numerator and denominator of the diluted earnings per share
computation. This statement is effective for periods ending after December 15,
1997, including interim periods, and requires restatement of all prior period
earnings per share data presented after the effective date. SFAS 128 will not
have a material impact on the Company's financial position, results of
operations or cash flows.
Note 3. Other Matters
In June, 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income." This statement establishes standards
for reporting and display of comprehensive income and its components (including
revenues, expenses, gains and losses) in a full set of general purpose financial
statements. This statement is effective for fiscal years beginning after
December 15, 1997, with earlier application permitted.
In June, 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures About Segments of an Enterprise and Related Information"
("SFAS 131"), which supersedes SFAS 14, "Financial Reporting for Segments of a
Business Enterprise." SFAS 131 changes current practice under SFAS 14 by
establishing a new framework on which to base segment reporting and also
requires interim reporting of segment information. SFAS 131 is effective for
fiscal years beginning after December 31, 1997 with earlier application
encouraged. The statement's interim reporting disclosures would not be required
until the first quarter immediately subsequent to the fiscal year in which SFAS
131 is effective.
In October, 1997, the Accounting Standards Executive Committee issued
Statement of Position 97-2 ("SOP 97-2"), Software Revenue Recognition, which
delineates the accounting for software product and maintenance revenues. SOP
97-2 supersedes the Accounting Standards Executive Committee Statement of
Position 91-1, Software Revenue Recognition, and is effective for transactions
entered into in fiscal years beginning after December 15, 1997. The Company is
evaluating the requirements of SOP 97-2 and the effects, if any, on the
Company's current revenue recognition policies.
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The discussion in this report on Form 10-Q contains forward looking
statements that involve risks and uncertainties. The Company's actual results
may differ materially from the results discussed in the forward-looking
statements. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed under the heading "Risk Factors"
contained herein and in the Company's other filings with the Securities and
Exchange Commission, including but not limited to those discussed under the
heading "Risk Factors" in the Company's 1996 Report on Form 10-K.
RESULTS OF OPERATIONS
OVERVIEW
The Company develops, markets and supports network storage management
software products for heterogeneous client/server computing environments and
large scale enterprises. The Company's NetWorker family of software products,
from which the Company derives a substantial majority of its revenues, supports
many storage management server platforms and can accommodate a variety of
clients, servers and storage devices. The Company licenses its products through
resellers and directly to end users in North America, Latin America, Europe,
Asia Pacific, and Japan. The Company also licenses its source code in exchange
for initial licensing fees to original equipment manufacturers ("OEMs") and
receives ongoing royalties from the OEMs' product sales. Substantially all of
the OEMs are large computer system and software suppliers located in the United
States, Europe, Asia Pacific, and Japan.
Selected elements of the Company's consolidated financial statements are
shown below as a percentage of total revenues.
<TABLE>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
----------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
Revenues:
Product and other 59.2% 56.9% 57.7% 58.7%
Royalty and license 21.9 25.6 22.6 24.4
Software subscription 18.9 17.5 19.7 16.9
---------- ----------- ---------- ---------
Total revenues 100.0 100.0 100.0 100.0
Cost of revenues:
Product and other 6.3 4.7 5.5 4.4
Software subscription 5.3 5.0 5.6 5.5
---------- ----------- ---------- ---------
Total cost of revenues 11.6 9.7 11.1 9.9
---------- ----------- ---------- ---------
Gross profit 88.4 90.3 88.9 90.1
Operating expenses:
Research and development 16.9 15.9 18.2 16.5
Sales and marketing 33.5 29.5 34.2 32.5
General and administrative 7.8 13.2 7.6 12.4
Amortization of intangibles 1.3 1.9 1.5 2.1
In-process research and development -- -- -- 4.9
----------- ----------- ----------- ---------
Total operating expenses 59.5 60.5 61.5 68.4
---------- ----------- ---------- ---------
Income from operations 28.9 29.8 27.4 21.7
Interest income (net) 2.6 3.0 2.6 3.4
---------- --------- ---------- ---------
Income before provision for income taxes 31.5 32.8 30.0 25.1
Provision for income taxes 11.2 12.4 11.1 11.5
---------- ----------- ---------- ---------
Net income 20.3% 20.4% 18.9% 13.6%
========== =========== ========== =========
</TABLE>
<PAGE>
REVENUES
Revenues for the third quarter of 1997 increased 47 percent over revenues
for the third quarter of 1996, and revenues for the first nine months of 1997
grew 48 percent from the comparable period of 1996. These increases were
attributable to increased licensing of the Company's products, increased sales
of software subscriptions, as well as increased royalty revenue.
Product and Other Revenues. Product and other revenues were $12.7 million
and $8.3 million for the third quarters of 1997 and 1996, respectively,
representing an increase of 53 percent. For the first nine months of 1997 and
1996, product and other revenues were $32.4 million and $22.3 million,
respectively, representing an increase of 45 percent. Product revenue increased
over these periods primarily as a result of the continued acceptance of the
Company's products. Other revenues were less than 5 percent of total revenues
for the periods presented. Prior growth rates of the Company's product and other
revenues may not be indicative of future product and other revenues growth rates
and may not be sustainable in the future.
Royalty and License Revenues. Royalty and license revenues were $4.7
million and $3.7 million for the third quarters of 1997 and 1996, respectively,
representing an increase of 26 percent. The increase was primarily attributable
to a 37 percent increase in royalty revenues from product sales by OEMs to $4.6
million in the third quarter of 1997, as compared with $3.3 million in the
year-ago quarter. License fee revenue was $150,000 in the third quarter of 1997,
compared to $400,000 in the same period of 1996. Royalty and license revenues
were $12.7 million and $9.3 million for the first nine months of 1997 and 1996,
respectively, representing an increase of 37 percent, due primarily to a 43
percent increase in royalty revenues on a comparable period basis. License fee
revenue for the first nine months of 1997 and 1996 of $700,000 and $880,000,
respectively, reflect licenses sold for the Company's products. Royalty revenues
are recognized upon receipt of quarterly royalty reports from OEMs related to
their product sales for the previous quarter. Prior growth rates of the
Company's royalty and license revenues may not be indicative of future royalty
and license revenues growth rates and may not be sustainable in the future.
Software Subscription Revenues. Software subscription revenues were $4.0
million and $2.5 million for the third quarters of 1997 and 1996, respectively,
representing an increase of 59 percent. For the first three quarters of 1997 and
1996, software subscription revenues were $11.1 million and $6.4 million,
respectively, an increase of 72 percent. This growth was primarily due to the
increase in the number of registered servers for the Company's products that are
covered under maintenance and support contracts, as well as the renewal of
software subscriptions after the initial one-year term, and increased internal
staffing for software subscription sales. Prior growth rates of the Company's
software subscription revenues may not be indicative of future software
subscription revenue growth rates and may not be sustainable in the future.
International product sales were $4.8 million and $2.5 million for the
third quarters of 1997 and 1996, respectively, representing a 91 percent
increase. International product sales accounted for 38 percent and 31 percent of
total product and other revenues in the third quarters of 1997 and 1996,
respectively. For the first nine months of 1997 and 1996, international product
sales were $13.1 million and $7.1 million, respectively. International product
sales accounted for 40 percent and 32 percent of total product and other
revenues in the first nine months of 1997 and 1996, respectively. The majority
of international sales during these periods were made in Europe. The Company
intends to continue to expand its international operations, which requires
significant management attention and financial resources and could materially
adversely affect the Company's operating results. To the extent that the Company
is unable to effect these additions in a timely manner, the Company's growth, if
any, in international sales will be limited, and the Company's business,
operating results and financial condition could be materially adversely
affected.
<PAGE>
GROSS PROFIT
Gross profit was $18.9 million and $13.1 million for the third quarters of
1997 and 1996, respectively, representing 88 percent and 90 percent of total
revenues, respectively. Gross profit was $50.0 million, or 89 percent of total
revenues, for the first three quarters of 1997, compared to $34.3 million, or 90
percent of total revenues, in the same period of 1996. The increases in total
gross profit are attributable to the higher levels of revenues from all sources,
including royalties and license revenues which do not generate any material cost
of revenues.
Gross profit from product and other revenues increased 50 percent to $11.3
million (or 89 percent of product and other revenues) in the third quarter of
1997 from $7.6 million (or 92 percent of product and other revenues) in the same
quarter of 1996. For the first nine months of 1997 and 1996, gross profit from
product and other revenues increased 42 percent to $29.3 million (or 90 percent
of product and other revenues) from $20.7 million (or 93 percent of product and
other revenues), respectively. Costs of product and other revenues consist
primarily of product media, documentation and packaging, as well as the cost of
providing certain training and consulting. The decrease in gross profit as a
percentage of product and other revenues for the third quarter and first nine
months of 1997 compared to the same periods of 1996 was primarily due to
increases in training and consulting costs. In the first quarter of 1996,
product costs included clinical research expenses, reflecting the principal
activity of Innovus, Inc., which was acquired along with Innovus Technologies,
Inc. in January 1996. Substantially all of the net assets of Innovus, Inc., the
Company's clinical research business, were sold in September 1996 and the
Company has discontinued all clinical research activities. The discontinuance
did not have a significant effect on the operating results of the Company.
Gross profit from software subscription revenue increased 59 percent to
$2.9 million (or 72 percent of software subscription revenue) in the third
quarter of 1997 from $1.8 million (or 72 percent of software subscription
revenue) in the third quarter of 1996. On a year-to-date basis, gross profit
from software subscription revenue increased 84 percent to $7.9 million (or 72
percent of software subscription revenue) in 1997 from $4.3 million (or 67
percent of software subscription revenue) in 1996. The increases in gross profit
from software subscriptions as a percentage of the related revenues were
primarily attributable to the Company's leveraging of its installed base through
subscription renewals, as well as more efficient utilization of resources
devoted to this activity.
OPERATING EXPENSES
Research and Development. Research and development expenses were $3.6
million and $2.3 million in the third quarters of 1997 and 1996, respectively,
an increase of 56 percent. As a percentage of total revenues, research and
development increased to 17 percent in the third quarter of 1997 from 16 percent
in the same quarter of 1996. Research and development expenses were $10.2
million and $6.3 million in the first nine months of 1997 and 1996, or 18
percent and 17 percent of total revenues, respectively. The increases in
absolute dollars are principally a result of increased staffing to support new
research and development activities. The Company believes that research and
development expenses will increase in absolute dollar amounts as it continues to
invest in developing new products, applications, and product enhancements.
Sales and Marketing. Sales and marketing expenses were $7.2 million and
$4.3 million in the third quarters of 1997 and 1996, respectively. As a
percentage of total revenues, sales and marketing expenses increased to 34
percent in the third quarter of 1997 from 30 percent in the comparable 1996
period. Sales and marketing expenses were $19.2 million and $12.4 million in the
first nine months of 1997 and 1996, or 34 percent and 33 percent of total
revenues, respectively. The increases in absolute dollars are principally a
result of increased headcount. The Company believes that sales and marketing
expenses will increase in dollar amounts as the Company continues to expand its
sales and marketing staff.
<PAGE>
General and Administrative. General and administrative expenses were $1.7
million and $1.9 million in the third quarters of 1997 and 1996, respectively.
As a percentage of total revenues, general and administrative expenses decreased
to 8 percent in the third quarter of 1997 from 13 percent in the comparable 1996
period. General and administrative expenses were $4.3 million and $4.7 million
in the first nine months of 1997 and 1996, respectively. As a percentage of
total revenues, general and administrative expenses decreased to 8 percent in
the first nine months of 1997 from 12 percent in the same period of 1996. These
decreases, as a percentage of total revenues, were attributable to leveraging
general and administrative expenses over a larger revenue base. Additional
decreases, as a percentage of total revenues and actual spending, were due to
allocating a greater amount of central operating expenses to benefiting
organizations. The Company expects that general and administrative expenses will
increase in dollar amounts as the Company expands its staffing and other support
operations.
Amortization of Intangibles. Amortization of purchased technology and
goodwill were $839,000 and $818,000 in the first nine months of 1997 and 1996,
respectively. These intangibles were recorded following an acquisition in the
first quarter of 1996. The Company plans to amortize these intangibles on a
straight-line basis over five years.
In-process Research and Development. In the quarter ended March 31, 1996,
the Company expensed $1.8 million of non-tax deductible in-process research and
development in connection with an acquisition.
Interest and Other Income, Net. Net interest income was $554,000 and
$442,000 in the third quarters of 1997 and 1996, respectively, and $1.5 million
and $1.3 million in the first nine months of 1997 and 1996, respectively.
Interest and other income primarily represents interest income on funds
available for investment.
Provision for Income Taxes. The provision for income taxes for the first
nine months of 1997 was $6.3 million, compared to $4.4 million for the first
nine months of 1996. The effective tax rate for the first nine months of 1997
was 37 percent as compared with 38 percent for the comparable period in 1996.
This decrease reflects the impact of recent tax law changes primarily related to
the research and development credit extension.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and marketable securities totaled
$67.3 million at September 30, 1997, representing 66 percent of total assets.
Cash and cash equivalents are highly liquid with original maturities of ninety
days or less. Marketable securities consist mainly of municipal securities. At
September 30, 1997, the Company had no long-term debt and stockholders' equity
was $83.4 million.
Cash generated from operations and sales of common stock have been
sufficient to finance the Company's operations. Cash, cash equivalents and
marketable securities increased $10.2 million during the first nine months of
1997, primarily reflecting net cash provided by operating activities of $13.2
million and proceeds from the issuance of common stock under the Company's stock
plans of $2.8 million. These amounts were partially offset by purchases of
property and equipment of $5.4 million.
The Company believes its current cash balances and cash flow from
operations, if any, will be sufficient to meet its working capital and capital
expenditure requirements for at least the next twelve months.
<PAGE>
RISK FACTORS
In addition to other information in this Report on Form 10-Q, the following
risk factors should be considered carefully in evaluating the Company and its
business.
Fluctuations in Quarterly Operating Results; Future Operating Results Uncertain
The Company's quarterly operating results have in the past varied and may
in the future vary significantly depending on a number of factors, including the
size and timing of significant orders; increased competition; market acceptance
of new products, applications and product enhancements; changes in pricing
policies by the Company and its competitors; the ability of the Company to
timely develop, introduce and market new products, applications and product
enhancements and to control costs; the Company's success in expanding its sales
and marketing programs; technological changes in the network storage management
market; the mix of sales among the Company's channels; deferrals of customer
orders in anticipation of new products, applications or product enhancements;
changes in Company strategy; personnel changes; and general economic factors.
The Company's future revenues are difficult to predict. The Company
operates with virtually no order backlog because its software products typically
are shipped shortly after orders are received. In addition, the Company does not
recognize revenues on sales to domestic distributors until the products are sold
through to end users. As a result, product revenues in any quarter are
substantially dependent on orders booked and shipped and on sell-through to end
users in that quarter. Revenues for any future quarter are not predictable with
any significant degree of certainty. Product and software subscription revenues
are also difficult to forecast because the network storage management market is
rapidly evolving and the Company's sales cycle varies substantially from
customer to customer. Royalty and license revenues are substantially dependent
upon sales by OEMs of their products that incorporate the Company's software.
Accordingly, royalty and license revenues are subject to OEMs' product cycles,
which are also difficult to predict. Royalty and license revenues are further
impacted by fluctuations in licensing activity from quarter-to-quarter because
initial license fees generally are non-recurring and recognized upon the signing
of the license agreement. The Company's expense levels are based, in part, on
its expectations as to future revenues. If revenue levels are below
expectations, operating results are likely to be adversely affected. Net income
may be disproportionately affected by a reduction in revenues because a
proportionately smaller amount of the Company's expenses varies with its
revenues. As a result, the Company believes that period-to-period comparisons of
its results of operations are not necessarily meaningful and should not be
relied upon as indications of future performance. Due to all of the foregoing
factors, it is possible that in some future quarter the Company's operating
results may be below the expectations of public market analysts and investors.
In such event, the price of the Company's Common Stock would likely be
materially adversely affected.
Product Concentration
The Company currently derives a substantial majority of its revenues from
its NetWorker software products and related services, and the Company expects
that revenues from NetWorker will continue to account for a majority of the
Company's revenues for the foreseeable future. Broad market acceptance of
NetWorker is, therefore, critical to the Company's future success. As a result,
a decline in unit prices of or demand for NetWorker, or failure to achieve broad
market acceptance of NetWorker, as a result of competition, technological change
or otherwise, would have a material adverse effect on the business, operating
results and financial condition of the Company. The life cycle of NetWorker is
difficult to estimate due in large measure to the recent emergence of the
Company's market, the effect of new products, applications or product
enhancements, technological changes in the network storage management
environment in which NetWorker operates and future competition. The Company's
future financial performance will depend in part on the successful development,
introduction and market acceptance of new products, applications and product
enhancements. There can be no assurance that the Company will continue to be
successful in marketing NetWorker or any new products, applications or product
enhancements.
<PAGE>
Competition
The network storage management market is intensely competitive, highly
fragmented and characterized by rapidly changing technology and evolving
standards. Competitors vary in size and in the scope and breadth of the products
and services offered. 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, operating results and
financial condition. Many of the Company's current and potential competitors
have significantly greater financial, technical, marketing and other resources
than the Company. As a result, they may be able to respond more quickly to new
or emerging technologies and changes in customer requirements, or to devote
greater resources to the development, promotion, sale and support of their
products than the Company. The Company also expects that competition will
increase as a result of future software industry consolidations, which have
occurred in the network storage management market in the past. In addition,
current and potential competitors have established or may establish cooperative
relationships among themselves or with third parties. Accordingly, it is
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share. In addition, network operating system
vendors could introduce new or upgrade existing operating systems or
environments that include storage management functionality offered by the
Company's products, which could render the Company's products obsolete and
unmarketable. There can be no assurance that the Company will be able to compete
successfully against current or future competitors or that competitive pressures
faced by the Company will not materially adversely affect its business,
operating results and financial condition.
Dependence on New Software Products; Rapid Technological Change
The network storage management market is characterized by rapid
technological change, changing customer needs, frequent new software product
introductions and evolving industry standards. The introduction of products
embodying new technologies and the emergence of new industry standards could
render the Company's existing products obsolete and unmarketable. The Company's
future success will depend upon its ability to develop and introduce new
software products (including new releases, applications and enhancements) on a
timely basis that keep pace with technological developments and emerging
industry standards and address the increasingly sophisticated needs of its
customers. There can be no assurance that the Company will be successful in
developing and marketing new products that respond to technological changes or
evolving industry standards, that the Company will not experience difficulties
that could delay or prevent the successful development, introduction and
marketing of these new products, or that its new products will adequately meet
the requirements of the marketplace and achieve market acceptance. If the
Company is unable, for technological or other reasons, to develop and introduce
new products in a timely manner in response to changing market conditions or
customer requirements, the Company's business, operating results and financial
condition will be materially adversely affected. The Company currently has plans
to introduce and market several potential new products in the next twelve
months. Some of the Company's competitors currently offer certain of the
functionality expected to be offered by these potential new products. Due to the
complexity of client/server software and the difficulty in gauging the
engineering effort required to produce these potential new products, such
potential new products are subject to significant technical risks. There can be
no assurance that such potential new products will be introduced on a timely
basis or at all. In the past, the Company has experienced delays in the
commencement of commercial shipments of its new products, resulting in customer
frustrations and delay or loss of product revenues. If potential new products
are delayed or do not achieve market acceptance, the Company's business,
operating results and financial condition will be materially adversely affected.
The Company has also, in the past, experienced delays in purchases of its
products by customers anticipating the launch of new products by the Company.
There can be no assurance that material order deferrals in anticipation of new
product introductions will not occur.
Software products as complex as those offered by the Company may contain
undetected errors or failures when first introduced or as new versions are
released. The Company has, in the past, discovered software errors in certain of
its new products after their introduction and has experienced delays or lost
revenues during the period required to correct these errors. Although the
Company has not experienced material adverse effects resulting from any such
errors to date, there can be no assurance that, despite testing by the Company
and by current and potential customers, errors will not be found in new products
after commencement of commercial shipments, resulting in loss of or delay in
market acceptance, which could have a material adverse effect upon the Company's
business, operating results and financial condition.
Risks Associated with Strategy of Expanding OEM Channel; Reliance on Resellers
An integral part of the Company's strategy is to increase the proportion of
the Company's customers licensed through OEMs. There can be no assurance that
such customers will continue to account for a significant percentage of the
Company's revenues in the future. The Company is currently investing, and
intends to continue to invest, significant resources to develop this channel,
which could materially adversely affect the Company's operating margins. There
can be no assurance that the Company will be successful in its efforts to
increase the revenues represented by this channel. The Company is dependent upon
its OEMs' ability to develop new products, applications and product enhancements
on a timely and cost-effective basis that will meet changing customer needs and
respond to emerging industry standards and other technological changes. There is
no assurance that the Company's OEMs will effectively meet these technological
challenges. These OEMs are not within the control of the Company, may
incorporate into their products the technologies of other companies in addition
to those of the Company and are not obligated to purchase products from the
Company. In addition, the Company's OEMs generally have exclusive rights to the
Company's technology on their respective platforms, subject to certain minimum
royalty obligations. There can be no assurance that any OEM will continue to
carry the Company's products, and the inability to recruit, or the loss of,
important OEMs could materially adversely affect the Company's business,
operating results and financial condition.
The Company also relies significantly on its distributors, systems
integrators and value added resellers (collectively, "resellers") for the
marketing and distribution of its products. The Company's agreements with
resellers are generally not exclusive and in many cases may be terminated by
either party without cause. Many of the Company's resellers carry product lines
that are competitive with those of the Company. There can be no assurance that
these resellers will give a high priority to the marketing of the Company's
products (they may, in fact, give a higher priority to other products, including
the products of competitors) or that they will continue to carry the Company's
products. Events or occurrences of this nature could materially adversely affect
the Company's business, operating results and financial condition. The Company's
results of operations could also be materially adversely affected by changes in
reseller inventory strategies, which could occur rapidly, and in many cases, may
not be related to end user demand. There can be no assurance that the Company
will retain any of its current resellers, nor can there be any assurance that,
in such event, the Company will be successful in recruiting replacement or new
organizations to represent it. Any such changes in the Company's distribution
channels could materially adversely affect the Company's business, operating
results and financial condition.
International Operations; Risks Associated with International Sales
The Company believes that its continued growth and profitability will
require further expansion of its international operations. In order to
successfully expand international sales, the Company must establish additional
foreign operations, hire additional personnel and recruit additional
international resellers. This will require significant management attention and
financial resources and could materially adversely affect the Company's
operating margins. To the extent that the Company is unable to effect these
additions in a timely manner, the Company's growth, if any, in international
sales will be limited, and the Company's business, operating results and
financial condition could be materially adversely affected. In addition, there
can be no assurance that the Company will be able to maintain or increase
international market demand for the Company's products. The Company's
international sales are currently denominated in U.S. dollars. An increase in
the value of the U.S. dollar relative to foreign currencies could make the
Company's products more expensive and, therefore, potentially less competitive
in those markets. In some markets, localization of the Company's products is
essential to achieve market penetration. The Company may incur substantial costs
and experience delays in localizing its products, and there can be no assurance
that any localized product will ever generate significant revenues. In addition,
the Company relies significantly on its distributors and other resellers in
international sales efforts. Since these distributors and other resellers are
not employees of the Company and typically do not offer the Company's products
exclusively, there can be no assurance that they will continue to market the
Company's products. Additional risks inherent in the Company's international
business activities generally include unexpected changes in regulatory
requirements, tariffs and other trade barriers, lack of acceptance of localized
products, if any, in foreign countries, longer accounts receivable payment
cycles, difficulties in managing international operations, potentially adverse
tax consequences including restrictions on the repatriation of earnings, and the
burdens of complying with a wide variety of foreign laws. There can be no
assurance that such factors will not have a material adverse effect on the
Company's future international sales and, consequently, the Company's business,
operating results and financial condition.
Management of Expanding Operations
The Company has recently experienced a period of significant expansion of
its operations that has placed a significant strain upon its management systems
and resources. In addition, the Company has recently hired a significant number
of employees, and plans to further increase its total headcount. The Company
also plans to expand the geographic scope of its customer base and operations.
This expansion has resulted and will continue to result in substantial demands
on the Company's management resources. From time to time, the Company receives
customer complaints about the timeliness and accuracy of customer support.
Although the Company plans to add customer support personnel in order to address
current customer support needs and intends to closely monitor progress in this
area, there can be no assurance that these efforts will be successful. If the
Company's efforts are not successful, the Company's business, operating results
and financial condition could be materially adversely affected. The Company's
ability to compete effectively and to manage future expansion of its operations,
if any, will require the Company to continue to improve its financial and
management controls, reporting systems and procedures on a timely basis and
expand, train and manage its employee work force. There can be no assurance that
the Company will be able to do so successfully. The Company's failure to do so
could have a material adverse effect upon the Company's business, operating
results and financial condition.
Dependence Upon Key Personnel
The Company's future performance also depends in significant part upon the
continued service of its key technical and senior management personnel, none of
whom is bound by an employment agreement. The loss of the services of one or
more of the Company's officers or other key employees could have a material
adverse effect on the Company's business, operating results and financial
condition. The Company's future success also depends on its continuing ability
to attract and retain highly qualified technical and managerial personnel.
Competition for such personnel is intense, and there can be no assurance that
the Company can retain its key technical and managerial employees or that it can
attract, assimilate or retain other highly qualified technical and managerial
personnel in the future.
Dependence on Growth in the Network Storage Management Market; General Economic
and Market Conditions
All of the Company's business is in the network storage management market,
which is still an emerging market. The Company's future financial performance
will depend in large part on continued growth in the number of organizations
adopting network storage management solutions for their client/server computing
environments. There can be no assurance that the market for network storage
management will continue to grow. If the network storage management market fails
to grow or grows more slowly than the Company currently anticipates, the
Company's business, operating results and financial condition would be
materially adversely affected. During recent years, segments of the computer
industry have experienced significant economic downturns characterized by
decreased product demand, production overcapacity, price erosion, work slowdowns
and layoffs. The Company's operations may, in the future, experience substantial
fluctuations from period-to-period as a consequence of such industry patterns,
general economic conditions affecting the timing of orders from major customers,
and other factors affecting capital spending. There can be no assurance that
such factors will not have a material adverse effect on the Company's business,
operating results or financial condition.
Dependence on Proprietary Technology; Risks of Infringement
The Company depends significantly upon proprietary technology. The Company
relies on a combination of copyright and trademark laws, trade secrets,
confidentiality procedures and contractual provisions to protect its proprietary
rights. The Company seeks to protect its software, documentation and other
written materials under trade secret and copyright laws, which afford only
limited protection. The Company presently holds two patents. There can be no
assurance that the Company will develop additional proprietary products or
technologies that are patentable, that any issued patent will provide the
Company with any competitive advantages or will not be challenged by third
parties, or that the patents of others will not have a material adverse effect
on the Company's ability to do business. Furthermore, there can be no assurance
that others will not independently develop similar products, duplicate the
Company's products or, if patents are issued to the Company, design around the
patents issued to the Company. Despite the Company's efforts to protect its
proprietary rights, unauthorized parties may attempt to copy aspects of the
Company's products or to obtain and use information that the Company regards as
proprietary. Policing unauthorized use of the Company's products is difficult,
and although the Company is unable to determine the extent to which piracy of
its software products exists, software piracy can be expected to be a persistent
problem. In selling its products, the Company relies primarily on "shrink wrap"
licenses that are not signed by licensees, and, therefore, such licenses may be
unenforceable under the laws of certain jurisdictions. In addition, the laws of
some foreign countries do not protect the Company's proprietary rights to as
great an extent as do the laws of the United States. There can be no assurance
that the Company's means of protecting its proprietary rights will be adequate
or that the Company's competitors will not independently develop similar
technology, duplicate the Company's products or design around patents issued to
the Company or other intellectual property rights of the Company.
There has also been substantial amounts of litigation in the software
industry regarding intellectual property rights. The Company has from time to
time received claims that it is infringing third parties' intellectual property
rights, and there can be no assurance that third parties will not in the future
claim infringement by the Company with respect to current or future products,
trademarks or other proprietary rights. The Company expects that software
product developers will increasingly be subject to infringement claims as the
number of products and competitors in the Company's industry segment grows and
the functionality of products in different industry segments overlaps. Any such
claims, with or without merit, could be time-consuming, result in costly
litigation, cause product shipment delays or require the Company to enter into
royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company or at all,
which could have a material adverse effect upon the Company's business,
operating results and financial condition.
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. In selling its products, the Company relies primarily on
"shrink wrap" licenses that are not signed by licensees, and, therefore, such
licenses may be unenforceable under the laws of certain jurisdictions. As a
result of these and other factors, the limitation of liability provisions
contained in the Company's license agreements may not be effective. The
Company's products can be used to manage data critical to organizations, and, as
a result, the sale and support of products by the Company may entail the risk of
product liability claims. A successful product liability claim brought against
the Company could have a material adverse effect upon the Company's business,
operating results and financial condition.
Possible Volatility of Stock Price
The trading price of the Company's Common Stock has been subject to wide
fluctuations. The trading price of the Company's Common Stock could be subject
to wide fluctuations in the future in response to quarterly variations in
operating results, announcements of technological innovations or new products,
applications or product enhancements by the Company or its competitors, 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 to the operating performance of such
companies. These broad market fluctuations may adversely affect the market price
of the Company's Common Stock.
<PAGE>
PART II: Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11.1 Statement of Computation of Net Income Per Share
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended September 30,
1997.
<PAGE>
SIGNATURE
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.
LEGATO SYSTEMS, INC.
Date: November 13, 1997 /s/ Stephen C. Wise
-------------------
Stephen C. Wise
V.P. of Finance and Chief Financial Officer
(Duly authorized officer and principal
financial and accounting officer)
<PAGE>
Exhibit 11.1
LEGATO SYSTEMS, INC.
STATEMENT OF COMPUTATION OF NET INCOME PER SHARE
(in thousands, except per share data)
<TABLE>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
-------- -------- -------- --------
Primary:
<S> <C> <C> <C> <C>
Weighted average common shares outstanding 17,498 16,675 17,312 16,408
Weighted average common equivalent shares 1,357 2,248 1,418 2,268
--------- --------- --------- --------
Total weighted average common and common
equivalent shares 18,855 18,923 18,730 18,676
--------- --------- --------- --------
Net income $ 4,352 $ 2,961 $ 10,648 $ 5,177
========= ========= ========= ========
Net income per share $ .23 $ .16 $ .57 $ .28
========= ========= ========= ========
Fully Diluted:
Weighted average common shares outstanding 17,498 16,675 17,312 16,408
Weighted average common equivalent shares 1,555 2,328 1,702 2,345
--------- --------- --------- --------
Total weighted average common and common
equivalent shares 19,053 19,003 19,014 18,753
--------- --------- --------- --------
Net income $ 4,352 $ 2,961 $ 10,648 $ 5,177
========= ========= ========= ========
Net income per share $ .23 $ .16 $ .56 $ .28
========= ========= ========= ========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONDENSED
CONSOLIDATED BALANCE SHEET - UNAUDITED AND CONDENSED CONSOLIDATED STATEMENT OF
INCOME AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
</LEGEND>
<CIK> 0000859360
<NAME> LEGATO SYSTEMS, INC.
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 36,796
<SECURITIES> 30,498
<RECEIVABLES> 16,101
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 82,090
<PP&E> 9,433
<DEPRECIATION> 0
<TOTAL-ASSETS> 102,429
<CURRENT-LIABILITIES> 18,030
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 83,380
<TOTAL-LIABILITY-AND-EQUITY> 102,429
<SALES> 0
<TOTAL-REVENUES> 56,207
<CGS> 6,215
<TOTAL-COSTS> 40,804
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 16,902
<INCOME-TAX> 6,254
<INCOME-CONTINUING> 10,648
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,648
<EPS-PRIMARY> 0.57
<EPS-DILUTED> 0.56
</TABLE>
