UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly 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: 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 April
30, 1998 was 36,588,240.
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LEGATO SYSTEMS, INC.
INDEX
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Page
PART I: Condensed Financial Information
<S> <C> <C>
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 1998 and December 31, 1997 .................... 3
Condensed Consolidated Statements of Operations for the three month periods ended March 31,
1998 and 1997 ..................................................................................... 4
Condensed Consolidated Statements of Cash Flows for the three month periods ended March 31,
1998 and 1997 ..................................................................................... 5
Notes to the Condensed Consolidated Financial Statements ............................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .......... 8
PART II: Other Information
Item 6. Exhibits and Reports on Form 8-K ................................................................ 18
Signature .................................................................................................. 18
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<PAGE>
PART I: Condensed Financial Information
Item 1: Financial Statements
LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
(unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 54,930 $ 34,891
Short-term investments 24,870 28,147
Accounts receivable, net 20,227 21,426
Other current assets 3,657 4,365
Deferred tax asset 2,835 2,702
Total current assets 106,519 91,531
Long-term investments 6,576 8,953
Property and equipment, net 11,359 10,514
Intangible assets, net 3,134 3,431
Deposits and other assets 411 362
Total assets $ 127,999 $ 114,791
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 8,811 $ 8,223
Deferred revenues 12,777 12,491
Total current liabilities 21,588 20,714
Deferred tax liability 689 768
Commitments
Stockholders' equity:
Common stock 73,543 66,327
Retained earnings 32,179 26,982
Total stockholders' equity 105,722 93,309
Total liabilities and stockholders' equity $ 127,999 $ 114,791
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The accompanying notes are an integral part of the Condensed
Consolidated Financial Statements.
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LEGATO SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
<S> <C> <C>
Revenues:
Product and other $ 18,076 $ 9,098
Royalty and license 4,743 4,403
Software subscription 5,595 3,623
Total revenues 28,414 17,124
Cost of revenues:
Product and other 1,631 765
Software subscription 1,650 1,120
Total cost of revenues 3,281 1,885
Gross profit 25,133 15,239
Operating expenses:
Research and development 4,469 3,196
Sales and marketing 10,585 5,809
General and administrative 2,405 1,481
Amortization of intangibles 279 279
Total operating expenses 17,738 10,765
Income from operations 7,395 4,474
Interest and other income, net 851 445
Income before provision for income taxes 8,246 4,919
Provision for income taxes 3,051 1,940
Net income $ 5,195 $ 2,979
Basic earnings per share $ 0.14 $ 0.09
Diluted earnings per share $ 0.13 $ 0.08
Shares used in basic earnings per share calculations 36,221 34,462
Shares used in diluted earnings per share calculations 39,155 37,825
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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>
<CAPTION>
Three Months Ended
March 31,
1998 1997
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,195 $ 2,979
Adjustments to reconcile net income to net cash provided by operating
activities:
Net deferred tax asset (212) (166)
Depreciation and amortization 1,255 722
Tax benefit from exercise of stock options 3,467 503
Changes in operating assets and liabilities:
Accounts receivable 1,199 (1,466)
Other current assets 709 961
Other current liabilities 872 1,778
Net cash provided by operating activities 12,485 5,311
Cash flows from investing activities:
Purchase of available-for-sale securities (8,135) (1,673)
Maturities and sales of available-for-sale securities 13,810 --
Acquisition of property and equipment (1,820) (2,103)
Other (31) (46)
Net cash provided by (used in) investing activities 3,824 (3,822)
Cash flows from financing activities:
Proceeds from issuance of common stock 3,725 1,050
Other 5 5
Net cash provided by financing activities 3,730 1,055
Net increase in cash and cash equivalents 20,039 2,544
Cash and cash equivalents at beginning of period 34,891 27,770
Cash and cash equivalents at end of period $ 54,930 $ 30,314
</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 1997 Report on
Form 10-K/A should be read in conjunction with these Condensed Consolidated
Financial Statements. The balance sheet at December 31, 1997 was derived from
audited financial statements; however, it does not include all disclosures
required by generally accepted accounting principles.
Note 2. Computation of Earnings Per Share
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" ("SFAS 128"), effective December 31,
1997. SFAS 128 requires the presentation of basic and diluted earnings per
share. Basic earnings per share is computed by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per share is computed giving effect to all
dilutive potential common shares that were outstanding during the period.
Dilutive potential common equivalent shares consist of the incremental common
shares issuable upon conversion of stock options. Prior period earnings per
share amounts have been restated to comply with SFAS 128.
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted earnings
per share is provided as follows (in thousands, except per share amounts):
Three Months Ended
March 31,
1998 1997
Numerator - basic and diluted earnings per share
Net income $ 5,195 $ 2,979
Denominator - basic earning per share
Weighted average common shares outstanding 36,221 34,462
Basic earnings per share $ 0.14 $ 0.09
Denominator - diluted earnings per share
Weighted average common shares outstanding 36,221 34,462
Effect of dilutive securities:
Common stock options 2,934 3,363
Weighted average common and common
equivalent shares 39,155 37,825
Diluted earnings per share $ 0.13 $ 0.08
Options to purchase 11,000 and 119,000 shares of common stock were outstanding
at March 31, 1998 and 1997, respectively, but were not included in the
calculation of diluted earnings per share because the options' exercise prices
were greater than the average market price of the common shares.
<PAGE>
Note 3. Stock Split
The Company effected a two-for-one stock split (in the form of a stock
dividend) on April 17, 1998. This stock split has been retroactively reflected
in the accompanying Condensed Consolidated Financial Statements.
Note 4. Software Moguls Acquisition
In August 1998, the Company issued 249,999 shares of common stock in
exchange for all the outstanding shares of Software Moguls, Inc., a developer of
advanced backup-retrieval products for the Windows NT and UNIX environments. The
Company accounted for the combination as a pooling of interests. Accordingly,
the Company restated the accompanying financial statements and financial data to
represent the combined financial results of the previously separate entities for
all periods presented.
The table below presents the separate results of operations for Software
Moguls, Inc. for the periods prior to the combination. The Company's results of
operations include Software Moguls since the transaction (in thousands):
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
Revenues:
<S> <C> <C>
Legato Systems, Inc. $ 27,854 $ 16,620
Software Moguls, Inc. 560 504
--------- ---------
Total $ 28,414 $ 17,124
========= =========
Net Income (Loss):
Legato Systems, Inc. $ 5,195 $ 3,164
Software Moguls, Inc. -- (185)
--------- --------
Total $ 5,195 $ 2,979
========= =========
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Note 5. Other Matters
Comprehensive Income
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income," effective January 1, 1998.
This statement requires the disclosure of comprehensive income and its
components in a full set of general-purpose financial statements. Comprehensive
income is defined as net income plus revenues, expenses, gains and losses that,
under generally accepted accounting principles, are excluded from net income.
The components of comprehensive income, which are excluded from net income, are
not significant, individually or in aggregate, and therefore, no separate
statement of comprehensive income has been presented.
Revenue Recognition
The Company has adopted the provisions of Statement of Position 97-2,
Software Revenue Recognition ("SOP 97-2"), as amended by SOP 98-4, Deferral of
the Effective Date of Certain Provisions of SOP 97-2, effective January 1, 1998.
SOP 97-2 supercedes Statement of Position 91-1 and delineates the accounting for
software product and maintenance revenues. Under SOP 97-2, the Company
recognizes product revenues and license fees upon shipment if a signed contract
exists, the fee is fixed and determinable, collection of resulting receivables
is probable and product returns are reasonably estimable, except for sales to
distributors, which are recognized upon sale by the distributors to their
customers. In addition, for contracts with multiple obligations (e.g.
deliverable and undeliverable products, services and maintenance), revenue must
be allocated to each component of the contract based on evidence of its fair
value which is specific to the Company, or for products not being sold
separately, the price established by management.
Revenue allocated to undelivered products is recognized when the criteria
for product and license revenue set forth above are met. Revenue allocated to
maintenance fees for ongoing customer support and product updates is recognized
ratably over the period of the maintenance contract. Payments for maintenance
fees are generally made in advance and are non-refundable. Revenue allocated to
other services is recognized as the related services are performed.
Segment Reporting
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information." ("SFAS 131"), which supercedes Statement of
Financial Accounting Standards, "Financial Reporting for Segments of a Business
Enterprise" ("SFAS 14"). 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. This statement is effective
for fiscal years beginning after December 15, 1997. The statement's interim
reporting disclosures are not required until the first quarter immediately
subsequent to the fiscal year in which SFAS 131 is effective.
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The discussion in this report on Form 10-Q/A contains forward-looking
statements that involve risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements regarding the Company's expectations, beliefs, intentions or
strategies regarding the future. All forward-looking statements included in this
document are based on information available to the Company on the date hereof,
and the Company assumes no obligation to update any such forward-looking
statements. The Company's actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed elsewhere in this item under
the heading "Risk Factors" in the Company's 1997 Report on Form 10-K/A, and the
risks discussed in the Company's Securities and Exchange Commission filings.
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, and
Global Enterprise Management Systems (G.E.M.S.) support many storage management
server platforms and can accommodate a variety of servers, clients,
applications, databases and storage devices. The Company licenses its products
through resellers and directly to end users in North America, Europe and Asia
Pacific. 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 and
Asia Pacific.
Selected elements of the Company's consolidated financial statements are
shown below as a percentage of total revenues.
Three Months Ended
March 31,
1998 1997
Revenues:
Product and other 63.6% 53.1%
Royalty and license 16.7 25.7
Software subscription 19.7 21.2
Total revenues 100.0 100.0
Cost of revenues:
Product and other 5.7 4.5
Software subscription 5.8 6.5
Total cost of revenues 11.5 11.0
Gross profit 88.5 89.0
Operating expenses:
Research and development 15.7 18.7
Sales and marketing 37.3 33.9
General and administrative 8.5 8.6
Amortization of intangibles 1.0 1.6
Total operating expenses 62.5 62.8
Income from operations 26.0 26.2
Interest and other, net 3.0 2.6
Income before provision for income taxes 29.0 28.8
Provision for income taxes 10.7 11.3
Net income 18.3% 17.5%
REVENUES
Total revenues for the first quarter of 1998 increased 66 percent over
revenues for the comparable period of 1997. The increase was 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 $18.1 million
and $9.1 million for the first quarters of 1998 and 1997, respectively,
representing an increase of 99 percent. Product revenue increased 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. The
Company recognizes product revenues and license fees upon shipment if a signed
contract exists, the fee is fixed and determinable, collection of resulting
receivables is probable and product returns are reasonably estimable, except for
sales to distributors, which are recognized upon sale by the distributors to
their customers. Prior growth rates of the Company's product and other revenues
are not indicative of future product and other revenue growth rates and may not
be sustainable in the future.
Royalty and License Revenues. Royalty and license revenues were $4.7
million and $4.4 million for the first quarters of 1998 and 1997, respectively,
representing an increase of 8 percent. The increases in royalty and license
revenues primarily relate to increased royalties from product sales by OEMs.
Royalty revenues are recognized upon receipt of quarterly royalty reports from
OEMs related to their product sales for the previous quarter. Since its OEMs
generally have stronger product sales for the December quarter, the Company
would expect the first quarter to reflect stronger OEM performance. Prior growth
rates of the Company's royalty and license revenues are not indicative of future
royalty and license revenues growth rates and may not be sustainable in the
future.
Software Subscription Revenues. Software subscription revenues were $5.6
million and $3.6 million for the first quarters of 1998 and 1997, respectively,
representing an increase of 54 percent. This growth was primarily due to the
increase in the number of registered customers for the Company's products
electing to subscribe to maintenance and support contracts, an increase in the
renewal of software subscriptions after the initial one-year term and an
increase in internal staffing for software subscription sales. Software
subscription fees for ongoing customer support and product updates are collected
in advance and are recognized ratably over the period of the contract. Prior
growth rates of the Company's software subscription revenues are not indicative
of future software subscription revenue growth rates and may not be sustainable
in the future.
International product sales were $7.7 million and $3.9 million for the
first quarters of 1998 and 1997, respectively. International product sales
accounted for 43 percent of total product and other revenues in the first
quarters of 1998 and 1997. The increase in international sales in absolute
dollars was primarily attributable to an increase in the market acceptance of
the Company's products overseas, an increase in the number of international
sales offices, and an increase in the number of international distributors and
resellers marketing the Company's products. The majority of international sales
during these periods were made in Europe and Canada. The Company continues 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.
GROSS PROFIT
Gross profit was $25.1 million or 88.5 percent of total revenues and $15.2
million or 89.0 percent of total revenues for the first quarters of 1998 and
1997, respectively. The increase in total gross profit in absolute dollars was
primarily attributable to the higher levels of revenues from all sources.
Gross profit from product and other revenues increased 97.3 percent to
$16.4 million in the first quarter of 1998 from $8.3 million in the comparable
period in 1997. Gross profit as a percentage of product and other revenues was
91.0 percent and 91.6 percent in the first quarters of 1998 and 1997,
respectively. Gross profit from product and other revenues consists of product
and other revenues less the related cost, which consists primarily of product
media, documentation and packaging costs and the costs of providing certain
training and consulting. The decrease in gross profit from product and other
revenues as a percentage of product and other revenues was primarily due to
increases in training and consulting costs.
Gross profit from software subscription revenues increased 57.6 percent to
$3.9 million in the first quarter of 1998 from $2.5 million in the first quarter
of 1997. Gross profit as a percentage of software subscription revenues was 70.5
percent and 69.1 percent in the first quarters of 1998 and 1997, respectively.
Costs of software subscription revenues consist primarily of personnel-related
costs incurred in providing telephone support and the costs of providing
software updates.
OPERATING EXPENSES
Research and Development. Research and development expenses increased 39.8
percent to $4.5 million in the first quarter of 1998 from $3.2 million in the
first quarter of 1997. The increase in research and development expenses
primarily reflects increased staffing and associated support for engineers
necessary to expand and enhance the Company's product line. As a percentage of
total revenues, research and development decreased to 15.7 percent in the first
quarter of 1998 from 18.7 percent in the first quarter of 1997, primarily as a
result of research and development expenses increasing less than the rate of
increase in total revenues. The Company believes that research and development
expenses will increase in absolute dollars as it continues to invest in
developing new products, applications, and product enhancements.
Sales and Marketing. Sales and marketing expenses were $10.6 million and
$5.8 million in the first quarter of 1998 and 1997, respectively. As a
percentage of total revenues, sales and marketing expenses increased to 37.3
percent in the first quarter of 1998 from 33.9 percent in the comparable 1997
period, primarily attributable to the growth of the Company's sales force and
associated support personnel, increased marketing and promotional activities and
increased commission expenses. The Company believes that sales and marketing
expenses will increase in absolute dollars as the Company continues to expand
its sales and marketing staff.
General and Administrative. General and administrative expenses were $2.4
million and $1.5 million in the first quarter of 1998 and 1997, respectively. As
a percentage of total revenues, general and administrative expenses decreased to
8.5 percent in the first quarter of 1998 from 8.6 percent in the comparable 1997
period. The increase in dollar amounts were primarily attributed to increased
staffing and related costs required to manage and support the Company's
expansion. The Company expects that general and administrative expenses will
increase in absolute dollars from the first quarter of 1998 level as the Company
expands its staffing and other support operations.
Amortization of Intangibles. Amortization of intangibles was $279,000 in
the first quarter of both 1998 and 1997. The related intangibles were recorded
following an acquisition in the first quarter of 1996. The Company is amortizing
these intangibles on a straight-line basis over five years.
Interest and Other Income, Net. Interest and other income, net, were
$851,000 and $445,000 in the first quarter of 1998 and 1997, respectively.
Interest and other income primarily represent interest income from funds
available for investment. The increase in interest income relates primarily to
interest earned from the increased cash provided by the Company's operations.
Provision for Income Taxes. The provision for income taxes for the first
quarter of 1998 was $3.1 million, compared to $1.9 million for the first quarter
of 1997. The effective tax rates for the first quarter of 1998 and 1997 were 37
percent and 39 percent, respectively.
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and investments totaled $86.4 million
at March 31, 1998 and represented 67 percent of total assets. Cash and cash
equivalents are highly liquid investments with original maturities of ninety
days or less. Investments consist mainly of short-term and long-term municipal
securities. At March 31, 1998, the Company had no long-term debt and
stockholders' equity was $105.7 million.
Cash generated from operations and sales of common stock has been
sufficient to finance the Company's operations to date. Cash and cash
equivalents increased $20.0 million during the first three months of 1998. Net
cash provided by operating activities of $12.5 million was derived primarily
from net income of $5.2 million, changes in operating assets and liabilities of
$2.8 million and $3.5 million related to the tax benefit from the exercise of
stock options. Cash provided by investing activities of $3.8 million primarily
reflected the maturities and sales of available-for-sale securities, net of
purchases of available-for-sale securities, of $5.7 million, offset by the
acquisition of property and equipment of $1.8 million. Cash from financing
activities of $3.7 million reflects proceeds received from the issuance of
common stock under the Company's stock plans.
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.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products include
coding to accept only two digit entries in the date code field. These date 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 used by many companies will need to be upgraded to comply with
such "Year 2000" requirements. Systems that do not properly recognize such
information could generate erroneous data or cause a system to fail. Significant
uncertainty exists in the software industry concerning the potential effects
associated with such compliance.
The Company has conducted Year 2000 compliance reviews for current versions
of the Company's products. The review includes assessment, implementation,
validation testing and contingency planning. The Company continues to respond to
customer concerns about prior versions of the Company's products on a
case-by-case basis. Although the Company believes its software products are Year
2000 compliant, the Company provides no assurance that its software products
contain all the necessary software routines and programs for the accurate
calculation, display, storage and manipulation of data involving dates. Failure
of the Company's software products to contain all the necessary software
routines and programs for the accurate calculation, display, storage and
manipulation of data involving dates would have a material adverse effect on the
Company's business, operating results and financial condition.
The Company has tested software obtained from third parties that is
incorporated into the Company's products, and seeks assurances from vendors that
licensed software is Year 2000 compliant. Despite testing by the Company,
current customers and potential customers, and assurances from developers of
products incorporated into the Company's products, such products may contain
undetected errors or defects associated with Year 2000 date functions. Known or
unknown errors or defects in the Company's products may result in delay or loss
of revenue, diversion of development resources, damage to the Company's
reputation, or increased service and warranty costs. The occurrence of any of
the foregoing could materially adversely affect the Company's business,
operating results, or financial condition.
The Company does not currently have any information concerning the Year
2000 compliance status of its customers. As is the case with other similarly
situated software companies, if its current or future customers fail to achieve
Year 2000 compliance or if they divert technology expenditures to address Year
2000 compliance problems, the Company's business, results of operations, or
financial condition could be materially adversely affected.
The Company has initiated an assessment of material internal systems. The
Company believes the software and hardware it uses internally comply with Year
2000 requirements and is not aware of any material operational issues or costs
associated with preparing its internally used software and hardware for the Year
2000. However, the Company provides no assurances that it will not experience
serious, unanticipated negative consequences, including material costs caused by
undetected errors or defects in the technology used in its internal systems. The
occurrence of any of the foregoing could have a material adverse effect on the
Company's business, operating results or financial condition.
The Company has funded its Year 2000 compliance review from operating cash
flows and has not separately accounted for these costs in the past. The Company
will incur additional amounts related to the Year 2000 compliance review
including administrative personnel to manage the review, outside contractors to
provide technical advice and technical support for its products, product
engineering and customer satisfaction. However, management does not anticipate
that the Company will incur significant operating expenses or be required to
invest heavily in computer systems improvements to be Year 2000 compliant.
The Company is currently developing contingency plans to be implemented as
part of its efforts to identify and correct Year 2000 problems affecting its
internal systems. The Company expects to complete its contingency plans by the
first quarter of 1999. Depending on the systems affected, these plans could
include accelerated replacement of affected equipment or software, short to
medium-term use of backup equipment and software, increased work hours for
Company personnel or use of contract personnel to correct (on an accelerated
schedule) any Year 2000 problems that arise or to provide manual workarounds for
information systems, and similar approaches. If the Company is required to
implement any of these contingency plans, it could have a material adverse
effect on the Company's financial condition and results of operations.
The discussion of the Company's efforts, and management's expectations,
relating to Year 2000 compliance are forward-looking statements. The Company's
ability to achieve Year 2000 compliance and the level of incremental costs
associated therewith, could be adversely impacted by, among other things, the
availability and cost of programming and testing resources, vendors' ability to
modify proprietary software, and unanticipated problems identified in the
ongoing compliance review.
RISK FACTORS
In addition to the other information in this Report, 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.
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. The Company's major competitors on the Novell NetWare and
Windows NT platforms include Computer Associates (Cheyenne Software) and Seagate
(Palindrome and Arcada); on the Sun Solaris/SunOS platform include Computer
Associates (Legent/Lachman), EMC2 (Epoch), Peripheral Devices (Delta
Microsystems), Software Moguls, Spectra Logic and Veritas; on the AIX platform
include IBM; and on the HP-UX platform include Hewlett Packard. In the future,
as the Company enters new markets, the Company expects that such markets will
have additional, market-specific competitors. In addition, many of the Company's
existing competitors are broadening their platform coverage. The Company also
expects increased competition from systems and network management companies,
especially those that have historically focused on the mainframe market and are
broadening their focus to include the client/server market. In addition, because
there are relatively low barriers to entry in the software market, the Company
expects additional competition from other established and emerging companies.
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 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 patent, 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 patent, trade secret and copyright laws, which afford
only limited protection. There can be no assurance that the Company will develop
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. 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 have 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.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products include
coding to accept only two digit entries in the date code field. These date 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 used by many companies will need to be upgraded to comply with
such "Year 2000" requirements. Systems that do not properly recognize such
information could generate erroneous data or cause a system to fail. Significant
uncertainty exists in the software industry concerning the potential effects
associated with such compliance.
The Company has conducted Year 2000 compliance reviews for current versions
of the Company's products. The review includes assessment, implementation,
validation testing and contingency planning. The Company continues to respond to
customer concerns about prior versions of the Company's products on a
case-by-case basis. Although the Company believes its software products are Year
2000 compliant, the Company provides no assurance that its software products
contain all the necessary software routines and programs for the accurate
calculation, display, storage and manipulation of data involving dates. Failure
of the Company's software products to contain all the necessary software
routines and programs for the accurate calculation, display, storage and
manipulation of data involving dates would have a material adverse effect on the
Company's business, operating results and financial condition.
The Company has tested software obtained from third parties that is
incorporated into the Company's products, and seeks assurances from vendors that
licensed software is Year 2000 compliant. Despite testing by the Company,
current customers and potential customers, and assurances from developers of
products incorporated into the Company's products, such products may contain
undetected errors or defects associated with Year 2000 date functions. Known or
unknown errors or defects in the Company's products may result in delay or loss
of revenue, diversion of development resources, damage to the Company's
reputation, or increased service and warranty costs. The occurrence of any of
the foregoing could materially adversely affect the Company's business,
operating results, or financial condition.
The Company does not currently have any information concerning the Year
2000 compliance status of its customers. As is the case with other similarly
situated software companies, if its current or future customers fail to achieve
Year 2000 compliance or if they divert technology expenditures to address Year
2000 compliance problems, the Company's business, results of operations, or
financial condition could be materially adversely affected.
The Company has initiated an assessment of material internal systems. The
Company believes the software and hardware it uses internally comply with Year
2000 requirements and is not aware of any material operational issues or costs
associated with preparing its internally used software and hardware for the Year
2000. However, the Company provides no assurances that it will not experience
serious, unanticipated negative consequences, including material costs caused by
undetected errors or defects in the technology used in its internal systems. The
occurrence of any of the foregoing could have a material adverse effect on the
Company's business, operating results or financial condition.
The Company has funded its Year 2000 compliance review from operating cash
flows and has not separately accounted for these costs in the past. The Company
will incur additional amounts related to the Year 2000 compliance review
including administrative personnel to manage the review, outside contractors to
provide technical advice and technical support for its products, product
engineering and customer satisfaction. However, management does not anticipate
that the Company will incur significant operating expenses or be required to
invest heavily in computer systems improvements to be Year 2000 compliant.
The Company is currently developing contingency plans to be implemented as
part of its efforts to identify and correct Year 2000 problems affecting its
internal systems. The Company expects to complete its contingency plans by the
first quarter of 1999. Depending on the systems affected, these plans could
include accelerated replacement of affected equipment or software, short to
medium-term use of backup equipment and software, increased work hours for
Company personnel or use of contract personnel to correct (on an accelerated
schedule) any Year 2000 problems that arise or to provide manual workarounds for
information systems, and similar approaches. If the Company is required to
implement any of these contingency plans, it could have a material adverse
effect on the Company's financial condition and results of operations.
The discussion of the Company's efforts, and management's expectations,
relating to Year 2000 compliance are forward-looking statements. The Company's
ability to achieve Year 2000 compliance and the level of incremental costs
associated therewith, could be adversely impacted by, among other things, the
availability and cost of programming and testing resources, vendors' ability to
modify proprietary software, and unanticipated problems identified in the
ongoing compliance review.
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
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended March 31, 1998.
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 18, 1998 /S/ Stephen C. Wise
Stephen C. Wise
V.P. of Finance and Chief Financial Officer
(Duly authorized officer and principal financial
and accounting officer)
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